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UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period
ended: March 31, 2004 OR
 [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period fromto Commission file number: 333-86972 SPECIALTY TRUST, INC. (Formerly Specialty Mortgage Trust, Inc.)
  Maryland
    
    88-0382463(State or other jurisdiction of
    
    (I.R.S. EmployerIncorporation or organization)
    
    Identification No.)
 6160 Plumas St.Reno, Nevada
    
    89509(Address of principal executive offices)
    
    (Zip Code)
 (775) 826-0809
(Registrants telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all documents
and reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No
[   ] Indicate by check mark whether the Registrant is an accelerated filer (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 stock, as of the last practicable date. Common Stock ($.01 par value)
    
    7,971,557 as of May 3, 2004




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INDEX PagePART I.   FINANCIAL INFORMATIONItem 1
    
    Financial Statements - Specialty Trust, Inc. (Unaudited)Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003
    
    
    3Consolidated Statements of Earnings for the Three Months Ended March 31, 2004 and 2003
    
    
    4Consolidated
Statements of Stockholders Equity and Comprehensive Income for the Three Months Ended March 31, 2004 and the Year Ended December 31, 2003
    
    
    5Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2
    
    Managements Discussion and Analysis of Financial Condition And Results of Operations
    
    
    16Item 3
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    26Item 4
    
    Controls and Procedures
    
    
    27PART II.  OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    28Item 2
    
    Changes in
Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    28Item 3
    
    Defaults Upon Senior Securities
    
    
    28Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    28Item 5
    
    Other Information
    
    
    28Item 6
    
    Exhibits and Reports on Form 8-KSignatures
    
    
    
    
    29EXHIBIT 31.1EXHIBIT 31.2Exhibit 32.1EXHIBIT 32.2
  2




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PART I. FINANCIAL INFORMATION 
 ITEM I. FINANCIAL STATEMENTS (UNAUDITED) SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 March 31, 2004
    
    December 31, 2003ASSETSASSETSCash and Cash Equivalents
    
    $
    15,207,645
    
    
    $
    2,593,407Accrued Interest Receivable
    
    
    977,121
    
    
    
    875,474Accounts Receivable
    
    
    7,260
    
    
    
    70,313Land Held for Residential Development
    
    
    2,097,260
    
    
    
    2,377,457Real Estate Owned (held for sale)
    
    
    7,679,627
    
    
    
    7,913,160Mortgage Loans Held for Investment, net of
allowance for loan losses of $1,447,622 and $1,424,256 and
unearned discount of $80,226 and $103,966 at March 31, 2004 and December 31, 2003, respectively
    
    
    85,198,688
    
    
    
    94,081,942Other Assets
    
    
    552,898
    
    
    
    546,941Total Assets
    
    $
    111,720,499
    
    
    $
    108,458,694LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIESDividends Payable
    
    $
    
    
    
    $
    2,305,444Accounts Payable - Related Party
    
    
    32,579
    
    
    
    119,284Accounts Payable and Accrued Expenses
    
    
    314,590
    
    
    
    326,844Accrued Interest Payable
    
    
    56,029
    
    
    
    56,952Deferred Revenue and Other Liabilities
    
    
    113,400
    
    
    
    113,400Lines of Credit
    
    
    
    
    
    
    Collateralized Notes
    
    
    34,883,732
    
    
    
    31,881,866Collateralized Notes - Related Party
    
    
    735,622
    
    
    
    1,528,413Total Liabilities
    
    
    36,135,952
    
    
    
    36,332,203STOCKHOLDERS EQUITYCommon Stock; $0.01 par value; 50,000,000 shares authorized,
7,846,551 and 7,684,813 shares issued and outstanding as of
March 31, 2004 and December 31, 2003, respectively
    
    $
    78,465
    
    
    $
    76,848Additional Paid-in Capital
    
    
    73,511,584
    
    
    
    71,828,838Retained Earnings
    
    
    1,994,498
    
    
    
    220,805Total Stockholders Equity
    
    
    75,584,547
    
    
    
    72,126,491Total Liabilities and Stockholders Equity
    
    $
    111,720,499
    
    
    $
    108,458,694
 The accompanying notes are an integral part of these unaudited statements. 3




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
 Three Months EndedMarch 31, 2004
    
    March 31, 2003RevenueInterest and Dividend Income:Mortgage Loans
    
    $
    2,667,263
    
    
    $
    2,836,394Cash Accounts
    
    
    29,500
    
    
    
    442,696,763
    
    
    
    2,836,438Interest Expense:Lines of Credit
    
    
    3,513
    
    
    
    115,384Notes Payable
    
    
    
    
    
    
    1,465Collateralized Notes
    
    
    473,156
    
    
    
    278,507Total Interest Expense
    
    
    476,669
    
    
    
    395,356Net Interest and Dividend Income
    
    
    2,220,094
    
    
    
    2,441,082Provision for Loan Losses
    
    
    23,366
    
    
    
    61,678Net Interest and Dividend
Income After Provision for Loan
Losses
    
    
    2,196,728
    
    
    
    2,379,404(Loss) Gain
on Sale of REO
    
    
    (47
    )
    
    
    1,004Other Income
    
    
    34,601
    
    
    
    Net Revenues
    
    
    2,231,282
    
    
    
    2,380,408ExpensesGeneral and Administrative
    
    
    166,556
    
    
    
    87,349Management and Directors Fees
    
    
    187,346
    
    
    
    192,132Other
    
    
    103,687
    
    
    
    55,957Total Expenses
    
    
    457,589
    
    
    
    335,438NET EARNINGS
    
    $
    1,773,693
    
    
    $
    2,044,970Basic Earnings per Share
    
    $
    0.23
    
    
    $
    0.28Diluted Earnings per Share
    
    $
    0.23
    
    
    $
    0.28
 The accompanying notes are an integral part of these unaudited statements. 4




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE
INCOME (UNAUDITED)
 Common Stock
    
    AdditionalPaid-in
    
    RetainedShares
    
    Amount
    
    Capital
    
    Earnings
    
    TotalBalance, January 1, 2003
    
    
    7,183,004
    
    
    $
    71,830
    
    
    $
    67,447,861
    
    
    $
    
    
    
    $
    67,519,691Net Earnings and Comprehensive
Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,252,745
    
    
    
    8,252,745Stock Options Exercised
    
    
    19,503
    
    
    
    195
    
    
    
    47,318
    
    
    
    
    
    
    
    47,513Dividends Reinvested on
Common Stock
    
    
    476,306
    
    
    
    4,763
    
    
    
    5,234,600
    
    
    
    
    
    
    
    5,239,363Stock Granted
    
    
    6,000
    
    
    
    60
    
    
    
    65,940
    
    
    
    
    
    
    
    66,000Dividends Declared on
Common Stock
    
    
    
    
    
    
    
    
    
    
    (966,881
    )
    
    
    (8,031,940
    )
    
    
    (8,998,821
    )Balance, December 31, 2003
    
    $
    7,684,813
    
    
    $
    76,848
    
    
    $
    71,828,838
    
    
    $
    220,805
    
    
    $
    72,126,491Net Earnings and Comprehensive
Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,773,693
    
    
    
    1,773,693Stock Options Exercised
    
    
    20,430
    
    
    
    204
    
    
    
    129,771
    
    
    
    
    
    
    
    129,975Dividends
Reinvested on Common Stock
    
    
    138,308
    
    
    
    1,383
    
    
    
    1,520,005
    
    
    
    
    
    
    
    1,521,388Stock Granted
    
    
    3,000
    
    
    
    30
    
    
    
    32,970
    
    
    
    
    
    
    
    33,000Balance, March 31, 2004
    
    
    7,846,551
    
    
    $
    78,465
    
    
    $
    73,511,584
    
    
    $
    1,994,498
    
    
    $
    75,584,547
 The accompanying notes are an integral part of these unaudited statements. 5




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Three Months EndedMarch 31, 2004
    
    March 31, 2003Cash Flows from Operating Activities:Net Earnings
    
    $
    1,773,693
    
    
    $
    2,044,970Adjustment to Reconcile Net Earnings to Net Cash
Provided by Operating Activities:Amortization and Depreciation
    
    
    16,940
    
    
    
    44,120Provision for Loan Losses
    
    
    23,366
    
    
    
    61,678Amortization of Loan Fees on Mortgage Loans
    
    
    (23,740
    )
    
    
    (23,630
    )Loss on Sale of Real Estate Owned
    
    
    47
    
    
    
    (1,004
    )Non-cash Stock Compensation
    
    
    16,500
    
    
    
    16,500Changes in Assets and Liabilities:Accrued Interest Receivable
    
    
    (101,647
    )
    
    
    (108,540
    )Other Assets and Accounts Receivable
    
    
    56,656
    
    
    
    (53,022
    )Accounts Payable (including Related Party) and Accrued Interest Payable
    
    
    (99,882
    )
    
    
    (130,359
    )Net Cash Provided by Operating activities
    
    
    1,661,933
    
    
    
    1,850,713Cash flows from investing activities:Investment in Real Estate Owned
    
    
    (138,882
    )
    
    
    Proceeds from Sale of Real Estate Owned
    
    
    372,368
    
    
    
    Investment in Land Held for Residential Development
    
    
    
    
    
    
    (43,001
    )Proceeds from Sale of Land Held for Residential Development
    
    
    323,198
    
    
    
    56,540Purchase of Mortgage Loans Held for Investment
    
    
    (13,475,538
    )
    
    
    (14,138,698
    )Principal repayments of Mortgage Loans Held for Investment
    
    
    22,359,166
    
    
    
    9,512,992Net Cash Provided by (Used in) Investing Activities
    
    
    9,397,311
    
    
    
    (4,569,166
    )Cash flows from financing activities:Proceeds from Common Stock Options Exercised
    
    
    129,975
    
    
    
    45,090Cash Dividends Paid
    
    
    (784,056
    )
    
    
    (871,685
    )Net Proceeds on Lines of Credit
    
    
    
    
    
    
    2,273,000Proceeds on Collateralized Notes
    
    
    10,023,000
    
    
    
    2,115,945Interest Reinvested in Collateralized Notes
    
    
    363,960
    
    
    
    233,015Principal Payments on Collateralized Notes
    
    
    (8,177,885
    )
    
    
    (1,114,293
    )Net Cash Provided by Financing Activities
    
    
    1,554,994
    
    
    
    2,681,072NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    12,614,238
    
    
    
    (37,381
    )Cash and Cash Equivalents at Beginning of Period
    
    
    2,593,407
    
    
    
    92,684Cash and Cash Equivalents at End of Period
    
    
    15,207,645
    
    
    
    55,303Supplemental Cash Flow Information:Cash Paid for Interest
    
    $
    477,592
    
    
    $
    159,048Supplemental Disclosure of Non-Cash Investing and
Financing Activities:Collateralized Notes Refinanced at Maturity
    
    $
    1,845,115
    
    
    $
    2,694,055Dividends Reinvested for Common Stock
    
    $
    1,521,388
    
    
    $
    1,283,216Common Stock Grants
    
    $
    33,000
    
    
    $
    33,000
 The accompanying notes are an integral part of these unaudited statements. 6




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 NOTES TO FINANCIAL STATEMENTS  March 31, 2004  (Unaudited)
 NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION Specialty Trust, Inc., formerly Specialty Mortgage Trust, and Subsidiaries (the
Company) is a Maryland corporation, which acquires and holds interests in
mortgage loans secured by property located in Nevada, Arizona, Colorado,
California, and Utah. The Companys strategy is to acquire land loans,
construction loans, commercial building loans and nonconforming single-family
and small multifamily residential loans. The Company has elected to be treated
as a real estate investment trust (REIT) under the Internal Revenue Code of
1986, as amended. The mortgage loans are originated and serviced by Specialty
Financial (the Manager), a private mortgage finance company operating in
Nevada, wholly owned by Nello Gonfiantini III, the Companys President and
Chairman of its Board of Directors. The Company was incorporated on October
21, 1997 and began operations on January 31, 1998, following the closing of the
Companys initial private placement of its preferred stock. The unaudited consolidated financial statements of the Company are prepared in
accordance with accounting principles generally accepted in the United States
of America (US GAAP) for interim financial information and in accordance with
the instructions to Form 10-Q. In the opinion of the Company all adjustments
necessary for a fair presentation of the financial position, results of
operations and cash flows for the periods presented have been included and are
normal and recurring in nature. The results for the three months ended March
31, 2004 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2004 or for any other period. These unaudited
consolidated financial statements should be read in conjunction with the
audited financial statements included in the Companys annual report on Form
10-K for the year ended December 31, 2003. The unaudited consolidated financial statements for the three months ended
March 31, 2004; include the accounts of the Company and its wholly owned
subsidiaries, Specialty Acquisition Corporation (SAC), a taxable REIT
subsidiary and Specialty Acquisition Corp. II (SAC II), a qualified REIT asset.
SAC was formed on May 2, 2002 to enable the Company to perform development
activities to land it had foreclosed upon (Note 4), and to maintain the
Companys qualified REIT status. SAC II was formed on January 17, 2003 to
enable the Company to hold property (Note 6). All inter-company accounts and
transactions have been eliminated upon consolidation. The prior year financial statements contain certain reclassifications to
conform to the current year classifications. These reclassifications had no
effect on net earnings. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
Management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. On an on-going basis, the Company
evaluates its estimates, including those related to the adequacy of the
allowance for loan losses and contingencies. The Company bases its estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. The one accounting
estimate that materially affects the financial statements is the allowance for
loan losses. 7




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Land Held for Residential Development Land Held for Residential Development consists of real estate acquired through
foreclosure and is carried at the lower of cost or the propertys estimated
fair value, less estimated costs to sell. Real Estate Owned Real Estate Owned consists of real estate acquired through foreclosure and is
carried at the lower of cost or the propertys estimated fair value, less
estimated costs to sell. Stock Options The Company accounts for stock based compensation under SFAS No. 123,
Accounting for Stock-Based Compensation,which requires the measurement of
stock compensation expense using the fair value method of accounting. Mortgage Loans The Company has both the intent and the ability to hold mortgage loans until
maturity. Therefore, mortgage loans are classified and accounted for as held
for investment and are carried at cost. The mortgage loans are originated by the Manager, in the name of the Manager,
and simultaneously sold, in whole or in part, to the Company. Loan servicing
is retained by the Manager. The Company follows the Financial Accounting Standards Boards (FASB) Statement
of Financial Accounting Standard (SFAS) 114, Accounting by Creditors for
Impairment of a Loan, and SFAS 118, Accounting by Creditors for Impairment of
a Loan-Income Recognition and Disclosure. Under SFAS 114, a loan is impaired
when, based on current information and events, it is probable that a creditor
will be unable to collect the contractual interest and principal payments of a
loan according to the contractual terms of the loan agreement. SFAS 114
requires that impaired loans be measured on the present value of expected
future cash flows discounted at the loans effective interest rate or, as a
practical expedient, at the loans observable market price or the fair value of
the collateral, if the loan is collateral dependent. The Company generally
obtains a third party appraisal on the underlying collateral for impaired loans
to determine the amount of impairment, if any. SFAS 118 clarifies interest
income recognition and the disclosure requirements of SFAS 114. The Company does not recognize interest income on loans once they are
determined to be impaired until the interest is collected in cash. Cash
receipts are allocated to interest income, except when such payments are
specifically designated as principal reduction or when the Company does not
believe the Companys investment in the loan is fully recoverable. Revenue Recognition Revenue is recognized on performing loans when interest has been earned
according to the terms of the loan. However, revenue ceases to be recognized
when the loan becomes 90 days delinquent, when foreclosure proceedings have
been initiated, or when the Loan-to-Value ratio exceeds 100%, whichever event
occurs first. Mortgage loan origination fees in excess of 2.5% charged to a borrower for and
upon the origination, extension or refinancing of a mortgage loan are paid to
the Company, effectively discounting the purchase price of the loan and are
amortized by the effective interest method over the contractual life of the
loan. These amounts are classified as unearned discounts. Mortgage loan
origination fees up to 2.5% are earned by the Manager prior to the purchase of
the mortgage loans by the Company. 8




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Earnings per Share Basic Earnings Per Share (EPS) is computed by dividing net earnings by the
weighted average number of shares of common stock outstanding during the
period. Diluted EPS is computed by dividing net earnings by the
weighted-average common shares and potentially dilutive securities outstanding
during the period. For the diluted EPS calculation, the weighted average
common shares and potentially dilutive securities outstanding include the
average number of shares of common stock outstanding, adjusted for the dilutive
effect of unexercised stock options using the treasury method. Allowance for Loan Losses The Company maintains an allowance for loan losses on mortgage loans.
Additions to the allowance are based on an assessment of certain factors
including, but not limited to, a review of collateral values, borrower payment
ability and general economic conditions. Additions to the allowance are
provided through a charge to current earnings. Actual losses on loans are
recorded as a charge-off or a reduction to the loan loss allowance. Subsequent
recoveries of amounts previously charged off are added back to the allowance. Evaluation of the adequacy of the allowance for loan losses is based primarily
on the Companys periodic assessment and grading of the loan portfolio.
Additional factors considered by the Company include the consideration of past
loan loss experience, trends in past due and nonperforming loans, risk
characteristics of the various classifications of loans, current economic
conditions, the fair value of underlying collateral and other regulatory or
legal issues that could affect loan losses. While the Company uses available
information to recognize losses on loans, future adjustments to the allowance
for loan losses may be necessary based on changes in economic conditions and
the impact of such changes on the Companys borrowers. Income Taxes Our financial results generally do not reflect provisions for current or
deferred income taxes. Management
believes that we have and intend to continue to operate in a manner that will
continue to allow the Company to be
taxed as a REIT and as a result, does not anticipate the payment of
substantial corporate level taxes. Many of
these requirements, however, are highly technical and complex. If we were to
fail to meet any of these
requirements, we would be subject to federal income tax. On May 2, 2002, we formed Specialty Acquisition Corp. (SAC) a wholly owned
taxable REIT subsidiary
effective January 1, 2003. A taxable REIT subsidiary is generally subject to
corporate level income tax on its
income and will generally be able to distribute only its net after tax earnings
to the Company as dividends.
Management believes that the deferred tax assets related to net operating
losses will most likely not be recovered. As of January 17, 2003, we formed a Qualified REIT Subsidiary (SAC II). A
Qualified REIT subsidiary is a
corporation in which a REIT owns 100% of the stock and which is not a taxable
REIT subsidiary. As a Qualified
REIT Subsidiary, SAC II is not treated as a separate corporation from the REIT
for tax purposes. Therefore, it is
subject to the IRS REIT asset, income and distribution requirements. In
addition, all of its assets, liabilities and
items of income, deduction and credit are treated as assets, liabilities, and
income, deductions and credit of the
REIT. Also, its activities are treated as activities of the REIT for purposes
of the REIT qualification tests and
prohibitive transaction limits. Recent Accounting Pronouncements In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity.
SFAS 150 also includes required disclosures for financial instruments within
its scope. 9




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The Company currently does not
have any financial instruments that are within the scope of this statement. NOTE 2. MORTGAGE LOANS HELD FOR INVESTMENT Mortgage Loan Products The Company has four mortgage loan products consisting of land, construction,
commercial building and other. Substantially all mortgage loan products have
similar stated interest rates ranging from 10.5% to 13.25%. Due to the similar
nature of the effective interest rates among the four loan products, the
Company does not compile or report revenues by product type. Pursuant to existing loan agreements, the Company is committed to fund
additional loan advances totaling $6,660,867 as of March 31, 2004. Allowance for Loan Losses The Company sets aside an allowance for loan losses through periodic charges to
earnings. While there exists probable asset quality problems in the loan
portfolio, the Company believes sufficient reserves have been provided in the
allowance to absorb probable losses in the loan portfolio at March 31, 2004 and
December 31, 2003. During the quarters ended March 31, 2004 and 2003, the
Company recorded a provision for loan losses of $23,366 and $61,678,
respectively. The following table presents a roll forward of the allowance for loan loss: Balance at January 1, 2003
    
    $
    1,815,576Provision for Loan Losses
    
    
    25,137Charge Offs
    
    
    (416,457
    )Balance at December 31, 2003
    
    $
    1,424,256Provision for Loan Losses
    
    
    23,366Charge Offs
    
    
    Balance at March 31, 2004
    
    $
    1,447,622
 NOTE 3. DELINQUENT LOANS At March 31, 2004, the Company had three loans that were 244 to 455 days past
due, totaling approximately $6.6 million in principal and accrued interest. The
Company accrued interest on these three loans until the loans were 90 days past
due; however, in accordance with the Companys revenue recognition policy, the
Company ceased to accrue additional interest income when the loan became 90
days past due. Accrued interest recorded during the 90-day period remains
accrued if the Company determines that the underlying collateral supports
recovery of the full principal and accrued interest. The accrued interest
recorded on the delinquent loans at March 31, 2004 was approximately $91,000.
The Company has evaluated the collectability of these delinquent loans
including 10




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accrued interest in light of the types and dollar amounts of the loans in the
portfolio, adverse situations that may affect the borrowers ability to repay,
prevailing economic conditions and the underlying collateral securing the loan
and has determined that the amounts are collectible. At December 31, 2003, the Company had three loans that were 153 to 364 days
past due, totaling approximately $6.6 million in principal and accrued
interest. The Company accrued interest on these three loans until the loans
were 90 days past due; however, in accordance with the Companys revenue
recognition policy, the Company ceased to accrue additional interest income
when these loans became 90 days past due. Accrued interest recorded during the
90-day period remains accrued if management determines that the underlying
collateral supports recovery of the Notes, principal and accrued interest. The
accrued interest on one delinquent loan was reversed because management
determined that the underlying collateral did not support recovery of the
interest. The accrued interest recorded on the other delinquent loans at
December 31, 2003 was approximately $91,000. Management has evaluated the
collectability of these delinquent loans in light of the types and dollar
amounts of the loans, adverse situations that may affect the borrowers ability
to repay, prevailing economic conditions and the underlying collateral securing
the loans and have determined that the amounts are collectible. NOTE 4. LAND HELD FOR RESIDENTIAL DEVELOPMENT In February 2001, the Company foreclosed on a mortgage loan in default and
obtained ownership of the residential land development project (the Project)
securing the loan. The Companys recorded investment in the loan at the time
of foreclosure was approximately $2.7 million. The Company obtained a
third-party appraisal of the Project at the time of the foreclosure, which was
used by management to value the Project at approximately $2.5 million, net of
estimated costs to sell. A loss of $225,000 was recorded upon recording the
initial carrying value of the Project upon foreclosure. The three phases
comprising the Project, which totaled 117 lots, were in various stages of
completion. The appraisal provided an allocation of the fair value as follows:
(i) phase Is 15 lots at $30,000 each, (ii) phase IIs 61 lots at approximately
$15,000 each, and (iii) phase IIIs 41 lots at approximately $15,000 each. The
appraisal was based on the current condition of the lots and did not consider
costs, which the Company or its assignee would incur to prepare these lots for
the commencement of homebuilding. The Company subsequently contributed the
Project to Specialty Acquisition Corporation (SAC), its wholly owned taxable
REIT subsidiary. In June 2002, SAC entered into an agreement with a third-party homebuilder to
transfer title of the lots to the homebuilder in exchange for an upfront
payment, in cash, equal to a portion of the original appraised value of the
uncompleted lots. Additionally, the homebuilder is responsible to pay SAC the
difference between the agreed value per lot and the cash previously received,
upon sale of the homes to third parties. SAC is also entitled to 50% of the
profits, if any, realized by the homebuilder upon closing of the sale of each
home, as well as repayment of infrastructure costs borne by the Company prior
to the agreement. SAC receives a security interest in each lot transferred to the homebuilder,
subordinate to the senior interest held by the homebuilders construction
lender. SAC is not obligated for any future of the Project once a completed
lot is delivered to the homebuilder. This arrangement is accounted for as a
real estate investment by which cash received upfront upon delivery of the
completed lots reduces SACs investment in the land held for residential
development. Upon the sale of competed homes by the homebuilder to an
independent third-party, SAC reduces land held for residential development
based on all cash proceeds received under the cost recovery method. After the
investment has been fully recovered, SAC will recognize revenue equal to its
share of the profits realized and received from home sales and may record a
provision for income taxes if SAC is anticipated to generate taxable income for
the year. On June 30, 2003, the homebuilder neglected to exercise his option to purchase
Phase III of the Project. The Company has subsequently listed the property for
sale. 11




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##### Table of Contents



All 76 lots in phases I and II were transferred to the homebuilder in 2002 upon
payment to SAC of $565,943. In order to complete the lots, SAC incurred site
mapping and other engineering costs, real estate taxes and insurance fees all
of which were capitalized. Twenty-one (21) homes were sold during the quarter
ended March 31, 2004. The following table provides a roll-forward of this
account: Balance at December 31, 2003
    
    $
    2,377,457Capitalized Costs
    
    
    43,001Net proceeds from sale of homes
    
    
    (323,198
    )Balance at March 31, 2004
    
    $
    2,097,260
 NOTE 5. REAL ESTATE OWNED (HELD FOR SALE) As of March 31, 2004 and December 31, 2003, real estate owned totaled $7.7
million and $7.9 million respectively. The properties acquired were as
follows:  
    
    A personal residence in Telluride, Colorado acquired on September 25,
2003 with a loan balance of approximately $1.7 million.
    
    Two parcels of raw land in Mesquite, Nevada acquired in August of
2003 with loan balances of approximately $2.6 million and $2.5 million.
    
    A commercial property located in Las Vegas, Nevada acquired in August
2002 with a loan balance of $950,000. During the year ended December 31, 2003, the Company had write-downs of
$250,000 related to the Mesquite, Nevada properties in the net balance of Real
Estate Owned. NOTE 6. QUALIFIED REIT ASSET As of January 17, 2003, the Company created a second subsidiary, SAC II (a
qualified REIT subsidiary), incorporated in Delaware. A qualified REIT
subsidiary is any corporation in which a REIT owns 100% of the stock. As a
Qualified REIT Subsidiary, SAC II is not treated as a separate corporation from
the REIT for tax purposes. Therefore, it is subject to the IRS REIT asset,
income and distribution requirements. In addition, all of its assets,
liabilities and items of income, deduction and credit are treated as assets,
liabilities and income of the REIT. Also, its activities are treated as
activities of the REIT for purposes of the REIT qualification tests and
prohibitive transaction limits. As of and for the three months ended March 31, 2004 there was no activity
recorded in SAC II. NOTE 7. COLLATERALIZED NOTES On May 7, 2002, the Companys registration statement (the 2002 Registration)
was declared effective by the Securities and Exchange Commission (SEC)
increasing the amount of Collateralized Notes available for sale up to
$269,312,000 (including amounts remaining unsold under the prior registration)
from the original $250,000,000, which had been declared effective by the SEC on
January 18, 2001. This 2002 Registration permits the issuance of
Collateralized Notes with maturities of up to five years. The Collateralized
Notes are secured by mortgage loans at least one and one-half times the
aggregate principal amount outstanding on the Collateralized Notes. The
outstanding Collateralized Notes have maturities ranging from 3 months to five
years from the date of issue and bear a fixed rate of interest ranging from
2.25% to 7.5% at March 31, 2004 and December 31, 2003. The effective yield
of Collateralized Notes outstanding at March 31, 2004 and December 12




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##### Table of Contents



31, 2003 was 5.80% and 5.58%, respectively. At March 31, 2004 and December 31,
2003, the Collateralized Notes were secured by $62,847,623 and $52,036,733
respectively, of mortgage loans pledged as collateral. NOTE 8. RELATED PARTY On October 23, 1997, the Company entered into a Management Agreement with the
Manager. The Agreement was subsequently updated through the Second Amended and
Restated Management Agreement dated January 1, 2004. The Manager is
responsible for the day-to-day operations of the Company and performs such
services and activities relating to the assets and operations of the Company as
are provided for in the Agreement. The Manager originates the mortgage loans
in the name of the Manager, and sells the loans, in whole or in part, to the
Company. The Manager retains the servicing of the mortgage loans. The Manager receives mortgage placement fees or points, usually charged to the
borrower for and upon origination, extension or refinancing of loans, up to
2.5% of the loan balance, with any additional fees or points paid to the
Company. The Manager receives a fee for loan servicing equal to one-half of
one percent per annum of all loans serviced. These fees are earned directly by
the Manager and are deducted from the interest or late payments paid to the
Company to cover the Managers costs to manage the portfolio, effectively
reducing the yield to the Company. Under the Amended Agreement, the Manager
receives a monthly base management fee equal to one-half of one percent of the
Mortgage Asset Portfolio at the end of the preceding quarter which includes
Mortgage Loans net of allowances and unearned discounts, Real Estate Owned and
Land Held for Residential Development. In addition, the Manager receives, as
incentive compensation for each fiscal quarter, an amount equal to 50% of the
tax - based net income before the dividend deduction of the Company, in excess
of an annualized return to the Company equal to 12%. Fees earned by the Manager for the three months ended March 31, 2004 and 2003,
are as follows: Three Months EndedMarch 31,2004
    
    2003Loan Origination and Extension Fees
    
    $
    556,500
    
    
    $
    38,389Loan Servicing Fees
    
    
    110,557
    
    
    
    108,563Late Payment Charges
    
    
    7,324
    
    
    
    Subtotal
    
    $
    674,381
    
    
    $
    146,952Base Management Fee
    
    
    130,467
    
    
    
    Incentive Compensation Bonus
    
    
    
    
    
    
    154,662Total Compensation
    
    $
    804,848
    
    
    $
    301,614
 The loan origination fees are received by the Manager as part of the initial
funding of the loan. Loan servicing fees reduce the amount of interest income
recognized by the Company as the Manager withholds the servicing fee from
interest payments received from borrowers. Late payment charges are received
directly by the Manager from the borrower. The Base Management Fee is paid
monthly to the Manager by the Company. The Managers incentive compensation is
calculated in accordance with the Agreement and is paid for or accrued in the
line item, Manager and Directors Fees, in the Companys financial statements. 13




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##### Table of Contents



There are several related parties who held Collateralized Notes issued by the
Company. As of March 31, 2004 and December 31, 2003, they owned $735,622 and
$1,528,413 in Collateralized Notes, which represents approximately 2.1% and
4.6% of the total Collateralized Note balance, respectively. SAC and SAC II have agreements with a realtor for the sale of property acquired
through foreclosure. Further, SAC currently has an agreement with a realtor
related to the development of the land held for residential development
discussed in Note 4. SAC paid the realtor a finders fee of $300 per lot and
will pay a 3.5% sales commission for each home sold. The realtor is an
employee of a real estate company, in which an independent director and member
of the Companys Audit Committee has an ownership interest. As of March 31,
2004 and December 31, 2003, SAC had an outstanding payable to the realtor of $0
and $0, respectively, related to the finders fee on phase II. Total fees paid
to the real estate company for the three months ended March 31, 2004 and 2003
were approximately $67,481 and $38,588 respectively. NOTE 9. EARNINGS PER SHARE The following is a reconciliation of earnings per share (in thousands, except
share and per share amounts): Three Months EndedMarch 31,2004
    
    2003Basic:Net earnings applicable to common stock
    
    $
    1,774
    
    
    $
    2,045Weighted average number of shares - basic
    
    
    7,822
    
    
    
    7,312Earnings per share - basic
    
    $
    0.23
    
    
    $
    0.28Diluted:Net earnings applicable to diluted earnings per
share
    
    $
    1,774
    
    
    $
    2,045Weighted average number of shares - basic
    
    
    7,822
    
    
    
    7,312Weighted average shares of dilutive stock
options using average period stock price
under the treasury stock method
    
    
    14
    
    
    
    28Weighted average number of shares - diluted
    
    
    7,836
    
    
    
    7,340Earnings per share - diluted
    
    $
    0.23
    
    
    $
    0.28
 14




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##### Table of Contents



ITEM 2.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION The following discussion should be read in conjunction with the Financial
Statements and Notes. Safe Harbor Statement Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995: Statements in this discussion regarding Specialty Trust, Inc., and our
business, which are not historical facts are forward-looking statements that
involve risks and uncertainties. For a discussion of such risks and
uncertainties, which could cause actual results to differ from those contained
in the forward-looking statements, please refer to Risk Factors commencing on
Page 13 of our Prospectus included in the Registration Statement on Form S-11
(File No. 333-86972) relating to our Collateralized Notes Program. Company Overview The Company is a mortgage finance company specializing in acquiring
nonconforming residential and commercial real estate mortgage loans for the
purpose of holding the loans in its portfolio. We fund our loans chiefly
through equity and to a lesser degree with short-term debt. This short-term
debt consists of secured bank lines of credit and the Collateralized Note
Program. Our business objective and strategy is to build and hold a portfolio of
mortgage loans for investment that generates net income for distribution to
stockholders. Loans are made principally to borrowers in the States of Nevada,
Arizona, Colorado, California and Utah whose needs are generally not being
served by traditional financial institutions. Our strategy is to focus on land
loans, construction loans, commercial building loans and nonconforming
single-family and small multi-family residential loans. We generally limit the
amount of our investment in any single mortgage loan or in mortgage loans to
one borrower to 10% of our total assets (approximately $10 million), although
the Board of Directors may approve exceptions. Most loans will have terms of
one to three years. Our mortgage loans may be secured by unimproved as well as
improved real property and non-income producing property as well as
income-producing real property. Some mortgage loans may be secured by a
borrowers leasehold interest in real property. Our loans generally produce
higher yields than those obtained on traditional single-family residential
mortgage loans, but are subject to higher risks of default and loss. We are structured as a real estate investment trust (REIT), thereby generally
eliminating federal taxes at the corporate level on income we distribute to
stockholders. Because we are not structured as a traditional lender that
accepts deposits, we are subject to substantially less regulatory oversight and
incur lower compliance expenses as compared to banks, thrift institutions and
many other holders of mortgage loans. Specialty Financial serves as our manager and is responsible for loan
originations, loan servicing, and our day-to-day operations, subject to the
supervision of our Board of Directors. Significant Aspects of first Quarter 2004 and Year End 2003 At March 31, 2004, we owned approximately $86.7 million of mortgage loans,
approximately $2.1 million of land held for residential development and $7.7 in
real estate owned and held for resale. Our total assets were approximately
$111.7 million. These assets are financed with approximately $35.6 million of
recourse short-term debt, and approximately $75.6 million of equity. As of March 31, 2004, our equity-to-assets ratio was 67.7%, our debt-to-equity
ratio was 47.1% and our annualized return on equity for the quarter ended March
31, 2004 was 9.6%. 15




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##### Table of Contents



At December 31, 2003, the Company owned approximately $95.6 million of mortgage
loans, approximately
$2.4 million of land held for residential development and $7.9 million real
estate owned and held for resale. Our total assets were approximately $108.5
million. The assets were financed with approximately $33.4 million in
collateralized notes, and approximately $72.1 million of common equity. As of December 31, 2003, our equity-to-assets ratio was 66.5%, our
debt-to-equity ratio was 46.3%, and our average return on equity for the year
ended December 31, 2003 was 11.4%. Critical Accounting Policies The Companys management is responsible to insure that its policies and
methodologies are in accordance with generally accepted accounting principles.
During the first quarter of 2004, management reviewed and evaluated the
Companys critical accounting policies and believes them to be appropriate. The Companys consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries, SAC and SAC II. The preparation of
consolidated financial statements in accordance with generally accepted
accounting principals requires us to make estimates and assumptions in certain
circumstances that affect amounts reported in the accompanying consolidated
financial statements. These estimates are based, in part, on our judgment and
assumptions regarding various economic conditions that we believe are
reasonable based on facts and circumstances existing at the time of reporting.
In preparing these consolidated financial statements, we have used our best
estimates and judgments of certain amounts included in the consolidated
financial statements, giving due consideration to materiality. The Company
does not believe that there is a great likelihood that materially different
amounts would be reported related to accounting policies described below.
However, application of these accounting policies involves the exercise of
judgment and use of assumptions as to future uncertainties and, as a result,
actual results could differ from those estimates. The following summarizes the components of our consolidated financial
statements where understanding accounting policies is critical to understanding
and evaluating our reported financial results, especially given the significant
estimates used in applying the policies. The discussion is intended to
demonstrate the significance of estimates to our financial statements and the
related accounting policies. Detailed accounting policies are described in
Note 1 to the Companys consolidated financial statements. Management has
discussed the development and selection of these critical accounting estimates
with the Audit Committee of our Board of Directors. The Audit Committee has
reviewed these disclosures. Revenue
Recognition
Revenue is recognized on performing loans when interest has been earned
according to the terms of the loan. However, revenue is no longer recognized
when the loan has become delinquent for 90 days, when foreclosure proceedings
have been initiated, or when the loan-to-value ratio exceeds 100%, whichever
event occurs first. Management believes the Companys revenue recognition
policies are appropriate to reflect the substance of the underlying
transactions. 16




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##### Table of Contents



Allowance for Loan Loss
The Company maintains an allowance for loan losses on its mortgage loans.
Additions to the allowance are based on an assessment of certain factors
including, but not limited to, a review of collateral values, borrower payment
ability and general economic conditions. Management believes that the
Companys policies and methodology are appropriate to reflect the potential
loss on the current loan portfolio. Impairment of Long-Lived Assets
Real estate investments held represent long-lived assets for accounting
purposes. The Company periodically reviews long-lived assets for impairment in
value whenever an event or changes in circumstances indicate that the carrying
amount of the assets may not be recoverable. In managements opinion, and
based on our estimates, real estate owned and land held for development are
considered to be held for sale and are not carried at amounts in excess of
their estimated fair value. Land held for residential development is carried
at the lower of cost or fair market value less estimated costs to sell. Fair
market value is derived using estimates and assumptions relating to eventual
sales prices and estimates for costs to complete. Management believes the
assumptions used in determining fair value are based on the best information
available at the time of analysis. Income Taxes
Our financial results generally do not reflect provisions for current or
deferred income taxes. Management
believes that we have and intend to continue to operate in a manner that will
continue to allow the Company to be
taxed as a REIT and as a result, does not anticipate the payment of
substantial corporate level taxes. Many of
these requirements, however, are highly technical and complex. If we were to
fail to meet any of these
requirements, we would be subject to federal income tax. On May 2, 2002, we formed Specialty Acquisition Corp. (SAC) a wholly owned
taxable REIT subsidiary
effective January 1, 2003. A taxable REIT subsidiary is generally subject to
corporate level income tax on its
income and will generally be able to distribute only its net after tax earnings
to the Company as dividends.
Management believes that the deferred tax assets related to net operating
losses will most likely not be recovered. As of January 17, 2003, we formed a Qualified REIT Subsidiary (SAC II). A
Qualified REIT subsidiary is a
corporation in which a REIT owns 100% of the stock and which is not a taxable
REIT subsidiary. As a Qualified
REIT Subsidiary, SAC II is not treated as a separate corporation from the REIT
for tax purposes. Therefore, it is
subject to the IRS REIT asset, income and distribution requirements. In
addition, all of its assets, liabilities and
items of income, deduction and credit are treated as assets, liabilities, and
income, deductions and credit of the
REIT. Also, its activities are treated as activities of the REIT for purposes
of the REIT qualification tests and
prohibitive transaction limits. Changes in Financial Condition AssetsCash and Cash Equivalents
Cash and cash equivalents increased by approximately $12.6 million (486%) as of
March 31, 2004, compared to December 31, 2003. The timing of loan fundings and
the timing of debt or equity issues generally determine the amount of cash held
by the Company. Our goal is to keep cash invested in loans or other financial
instruments and therefore to keep cash balances low whenever possible. Accrued Interest Receivable
Accrued interest receivable increased by approximately $100,000 (12%) as of
March 31, 2004 compared to December 31, 2003 primarily as the result of the
timing of interest payments made during the year ended December 31, 2003 as
compared to the quarter ended March 31, 2004. 17




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##### Table of Contents



Land Held for Residential Development
Land held for residential development decreased by approximately $280,000 (12%)
as of March 31, 2004 compared to December 31, 2003 as a result of increased
home sales. Land held for residential development consists of three phases of
undeveloped lots (the Project), which were obtained by the Company through
foreclosure in February 2001. This Project originally included 117 lots, which
were in various stages of completion at the time of foreclosure. An appraisal
was obtained at the time of foreclosure which provided an allocation of the
fair value as follows: (i) phase Is 15 lots at $30,000 each, (ii) phase IIs
61 lots at approximately $15,000 each and (iii) phase IIIs 41 lots at
approximately $15,000 each. The appraisal was based on the current condition
of the lots and did not consider costs, which the Company or its assignee would
incur to prepare these lots for the commencement of homebuilding. The Company
subsequently contributed the Project to Specialty Acquisition Corp. (SAC), its
wholly owned taxable REIT subsidiary formed in May 2002. In June 2002, SAC entered into an agreement with a third-party homebuilder to
transfer title to the lots on a phased basis to the homebuilder in exchange for
an upfront cash payment equal to a portion of the original appraised value of
the uncompleted lots. Additionally the homebuilder is responsible to pay SAC
the difference between the original appraisal value per lot and the cash
previously received, upon sale of the homes to third parties. SAC is also
entitled to 50% of the profits, if any, realized by the homebuilder upon
closing of the sale of each home built, as well as repayment of infrastructure
costs borne by the Company prior to the agreement. SAC receives a security
interest in each lot transferred to the homebuilder, subordinate to the senior
interest held by the homebuilders construction lender. SAC is not obligated
for any future costs of the Project once a completed lot is delivered to the
homebuilder. This arrangement is accounted for as a real estate investment by
which cash received upfront upon delivery of the completed lots reduces SACs
investment in the land held for residential development. Upon the sale of lots
and completed homes by the homebuilder to a third-party, SAC will record
proceeds as a reduction to the land held for residential development under the
cost recovery method. All 76 lots in phases I and II were transferred to the homebuilder in 2002 upon
payment to SAC of $565,943. In order to complete delivery of the lots, SAC
incurred site mapping costs, other engineering costs, real estate taxes, and
insurance fees; in 2002, all of which were capitalized. Twenty-one (21)
completed homes were sold during the three months ended March 31, 2004. The
following table a roll-forward of this account: Balance at December 31, 2003
    
    $
    2,377,457Capitalized Costs
    
    
    43,001Net proceeds from sale of homes
    
    
    (323,198
    )Balance at March 31, 2004
    
    $
    2,097,260
 Real Estate Owned
Real Estate Owned decreased by approximately $234,000 (3%). This decrease was
primarily due to the sale of a parcel of land during the quarter. Mortgage Loans
Mortgage loans held for investment net of allowance for loan losses and
unearned discounts decreased by approximately $8.9 million (9%) as of March 31,
2004 compared to December 31, 2003. This decrease was due primarily to an
overall decrease in the mortgage loan portfolio due to loan payoffs. The
allowance for loan losses was increased approximately $23,000 during the period
to provide for potential future loan losses. There were no credit losses
recorded during the period. LiabilitiesDividends Payable
Dividends payable decreased by approximately $2.3 million (100%) as of March
31, 2004 compared to December 31, 2003 due primarily to the dividends declared
prior to December 31, 2003 being paid out or reinvested during the quarter. 18




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##### Table of Contents



Accounts Payable and Accrued Expenses and Accounts Payable  Related Party
Accounts payable and accrued expenses and accounts payable related party
decreased by approximately $99,000 (22%) as of March 31, 2004 compared to
December 31, 2003. This decrease was due primarily to the management fee
payable to the Manager being higher, as of December 31, 2003 than as of March
31, 2004. In addition, professional fees related to the preparation of Form
10K were accrued as of December 31, 2003; and paid during the first quarter of
2004. Collateralized Notes and Collateralized Notes  Related Party
Collateralized Notes increased by approximately $2.2 million (7%) as of March
31, 2004 compared to December 31, 2003 due to increased issuance of such notes
caused by increased demand. Demand increased primarily because the stated
interest rates of the notes are slightly higher than the average rates paid by
banks. Our Collateralized Notes were authorized for public sale on January 19,
2001. Results of Operations The rate volume analysis set forth in the following table analyzes changes in
net interest income for the periods indicated by their rate and volume
components. Three Months EndedMarch 31, 2004Over/UnderMarch 31, 2003NetChange
    
    Rate
    
    VolumeInterest IncomeMortgage Loans
    
    
    (169,131
    )
    
    
    85,351
    
    
    
    (254,482
    )Cash Accounts
    
    
    29,456
    
    
    
    29
    
    
    
    29,427Total
    
    
    (139,675
    )
    
    
    85,380
    
    
    
    (225,055
    )ExpenseLine of Credit
    
    
    (111,871
    )
    
    
    
    
    
    
    (111,871
    )Notes Payable
    
    
    (1,465
    )
    
    
    
    
    
    
    (1,465
    )Collateralized Notes
    
    
    194,649
    
    
    
    1,922
    
    
    
    192,727Total
    
    
    81,313
    
    
    
    1,922
    
    
    
    79,391Change in net
interest income
    
    
    (220,988
    )
    
    
    83,458
    
    
    
    (304,446
    )
 Our operating results include all of the reported income of our mortgage
finance operation. A comparison of the three months ended March 31, 2004 to the
three months ended March 31, 2003 follows: Interest Income, Mortgage Assets and Interest Income Cash Accounts
Interest income decreased approximately $140,000 (5%) for the three months
ended March 31, 2004, as compared to the same period in prior year, due
primarily to the overall decrease in the mortgage loan portfolio. 19




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##### Table of Contents



Interest Expense  Lines of Credit
Interest expense on lines of credit decreased by approximately $112,000 (97%)
for the three months ended March 31, 2004, as compared to the same period in
prior year, primarily due to the Company not utilizing its lines of credit
during the first quarter of 2004.Interest Expense  Collateralized Notes
Interest expense on Collateralized Notes increased by approximately $195,000
(70%) for the three months ended March 31, 2004, as compared to the same period
in prior year. The increase was primarily due to the additional issuance of
collateralized notes. Total Expenses
Total expenses for the three months ended March 31, 2004 increased by
approximately $122,000 (36%) compared to the same period in prior year
primarily as a result of an increase in foreclosure costs, advertising
expenditures and filing fees for SEC reporting. Interest Rate/Market/Credit Risk We seek to manage the interest rate risk, credit risk and market risk to our
portfolio. By originating short-term loans (generally less than three years),
we can significantly reduce the risk of changing interest rates. Additionally,
we continue to monitor the quality of our loans through the consistent
application of our underwriting guidelines and loss mitigation practices of our
servicing procedures. In this way we seek to control credit risk. The
majority of our loans are located in Nevada; however, the Company is also
acquiring loans in Arizona, Colorado, California and Utah to help diversify the
portfolio and reduce the risk of investing in one market. The following table sets forth the weighted average yield earned on our assets
and the weighted average expense of our liabilities for the periods shown. AnnualizedThree Months EndedMarch 312004
    
    2003Interest IncomeMortgage Loans
    
    
    12.00
    %
    
    
    11.64
    %Cash Accounts
    
    
    1.08
    %
    
    
    0.72
    %Interest ExpenseLines of Credit
    
    
    4.00
    %
    
    
    4.16
    %Notes Payable
    
    
    0.00
    %
    
    
    0.50
    %Collateralized Notes
    
    
    5.48
    %
    
    
    5.44
    %Net Interest Spread
    
    
    5.26
    %
    
    
    6.80
    %
 20




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##### Table of Contents



Liquidity and Capital Resources We manage our short-term liquidity (defined as our funding needs to cover
commitments and anticipated uses occurring over the next 12 months) in a number
of ways. First, the scheduled interest payments from our mortgage portfolio
produce monthly cash flow which can be used to originate new loans and to pay
dividends to stockholders. This source provided approximately $2.7 million
during the 3 months ended March 31, 2004 and $11.7 million during the 12 months
ended December 31, 2003, respectively. Secondly, the payoff and the prepayment of loans provides additional liquidity
to our portfolio. Historically, we have experienced annual loan payoffs and
prepayments of approximately 30% to 35% of our outstanding portfolio. Since our
loan terms are usually one to three years, the rate of principal payoffs is
significant. With a current portfolio of approximately $85.2 million, we
anticipate annual cash flows from principal pay downs of approximately $29
million. As we continue to issue Collateralized Notes, our loan portfolio will
be able to be increased as will the cash flow from principal pay downs.
Typically, these funds are used to originate new mortgage loans, but there are
no restrictions on the use of the funds. The following table illustrates the scheduled maturities of mortgage loan
investments subsequent to March 31, 2004: Maturity
    
    AmountApril 1, 2004 to December 31, 2004
    
    $
    33,279,7752005
    
    
    36,634,4052006
    
    
    16,812,357$
    86,726,536
 Under existing mortgage loans, the Company is obligated to fund additional loan
amounts totaling $6,660,867 as of March 31, 2004. Thirdly, we have the ability to issue Collateralized Notes to provide
additional liquidity. Starting May 7, 2002, as a result of the 2002
Registration, the Company was permitted to offer Collateralized Notes with
maturities of up to five years. Although not a committed source, we may
utilize Collateralized Notes to meet a portion of our short-term funding needs
under normal market conditions. The following table reflects the maturities of Collateralized Notes as of March
31, 2004: Maturity
    
    AmountApril 1, 2004 to December 31, 2004
    
    $
    26,928,9222005
    
    
    7,031,9192006
    
    
    400,2082007
    
    
    345,9122008
    
    
    836,393thereafter
    
    
    76,000$
    35,619,354
 Lastly, we had four committed lines of credit with commercial banks to provide
another level of liquidity as of March 31, 2004. We can borrow $6.5 million,
$3.5 million, $7.0 million, and $2.5 million on four separate lines of credit
to provide funding for new mortgage loans, for an aggregate of $19.5 million in
available credit. The $6.5 million is available through June 15, 2004. The
$3.5 million line was available through April 15, 2004, at which point the line
was not renewed. The $7.0 million line is available through October 15, 2004.
The $2.5 million dollar line matured January 23, 2004 and was extended to April
23, 2004, at which point the line was not renewed. All lines of credit are
collateralized by a secured interest in mortgage loans and require the Company
to maintain certain financial covenants. Such covenants include restrictions
on (i) any change in business activities from those we are presently engaged
in, and (ii) any change in executive and management personnel that would 21




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result in reduced qualifications and experience compared to present personnel.
Such covenants also contain requirements for (i) minimum tangible net worth,
(ii) maximum debt to equity ratio, (iii) fixed charge coverage ratio, and (v) a
maximum allowable for lines of credit of $20 million. The Company was in
compliance with these covenants as of March 31, 2004.. We believe the combination of these sources of capital allows us to manage our
short-term liquidity needs in virtually any business situation and thereby
efficiently use our capital resources. With respect to our long-term liquidity (funding needs during periods beyond
the next 12 months), our only commitments that require funding are those
arising from our construction loans. There are no commitments for material
capital expenditures or payments due on long-term debt obligations. We believe
the same sources we rely on for short-term liquidity needs will be sufficient
to fund our long-term needs as well. Risk Management and the Allowance for Loan Losses The loan portfolio is the Companys primary asset subject to credit risk. To
account for this credit risk, the Company sets aside an allowance or reserve
for credit losses through periodic charges to earnings. These charges are
shown in the Companys Statement of Earnings as provision for loan losses.
Credit risk is managed and monitored through the use of prudent lending
standards, a thorough review of potential borrowers, and an on-going review of
payment performance. Asset quality administration, including early
identification of problem loans and timely resolution of problems, further
enhances the management of credit risk and the minimization of loan losses.
All specifically identifiable and quantifiable losses are immediately charged
off against the allowance. Charged-off loans are subject to periodic review,
and specific efforts are taken to achieve maximum recovery of principal and
interest. Management reviews the adequacy of the allowance for loan losses on a quarterly
basis to determine whether the allowance is adequate to provide for probable
losses inherent in the loan portfolio as of the balance sheet date. Valuation
of the adequacy of the allowance for loan losses is based primarily on
managements periodic assessment and grading of the loan portfolio as described
below. Additional factors considered by management include the consideration
of past loan loss experience, trends in past due and nonperforming loans, risk
characteristics of the various classifications of loans, current economic
conditions, the fair value of underlying collateral, and other regulatory or
legal issues that could affect loan losses. Loans are initially risk graded prior to loan origination. They are re-graded
quarterly. Numerous factors are considered such as renewal, loans to the same
borrower, identified facts demonstrating heightened risk of nonpayment, or if
they have become delinquent. The loan review, or grading process attempts to
identify and measure problem and watch list loans. Problem loans are those
loans with higher than average risk with workout and/or legal action probable
within one year. These loans are reported quarterly to the Companys Board of
Directors for action. Watch list loans are those loans considered as having
weakness detected in character, capacity to repay or balance sheet concerns,
which prompt management to take corrective action at the earliest opportunity.
Problem and watch list loans generally exhibit one or more of the following
characteristics:  -
    
    Adverse financial trends and conditions-
    
    Decline in the entire industry-
    
    Managerial problems-
    
    Customers failure to provide financial information or other collateral documentation-
    
    Repeated delinquency, overdrafts or renewals The Loan Review Committee of the Board of Directors reviews every significant
problem loan and assessments are performed quarterly to confirm the risk rating
to that loan, proper accounting and the adequacy of loan loss reserve assigned. 22




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After reviewing the loan portfolio, management will allocate or assign a
portion of the allowance for loan loss to groups of loans and to individual
loans to cover managements estimate of probable loss. Allocation is related
to the grade of the loan and includes a component resulting from the
application of the measurement criteria of SFAS 114 Accounting by Creditors
for Impairment of a Loan and SFAS 118 Accounting by Creditors for Impairment
of a Loan-Income Recognition and Disclosures. Management then compares the
amounts allocated for probable losses to the current allowance. To the extent
that the current allowance is insufficient to cover estimated probable losses,
management records an additional provision for credit loss. If the allowance
is greater than required at that point in time, provision expense is adjusted
accordingly. While management uses available information to recognize losses on loans,
future adjustments to the allowance for loan loss may be necessary based on
changes in economic conditions and the impact of such changes on the Companys
borrowers. Consistent with US GAAP and with the methodologies used in estimating the
unidentified losses in the loan portfolio, the allowance for loan loss consists
of two components as discussed below. First, the allowance includes a component resulting from the application of the
measurement criteria of SFAS 114 and SFAS 118. The second or general component of the allowance for loan loss is intended to
absorb inherent losses that may not be provided for by the first component.
The primary reason that the first component might not be sufficient to absorb
the losses present in the portfolio, (and the unallocated portion of the
allowance for loan loss is used to provide for the losses that have occurred),
is due to the inherent limitations to any credit risk grading process. Even
for experienced loan reviewers, grading loans and estimating losses involves a
significant degree of judgment regarding the present situation with respect to
individual loans and the portfolio as a whole. In addition, it is possible
that grading and loan review may be performed without the assurance that all
relevant facts are available to the reviewer. For example, troubled borrowers
may inadvertently or deliberately omit important information from
correspondence with the reviewer regarding the borrowers financial condition
and the diminished strength of repayment sources. While there exists probable asset quality problems in the Companys loan
portfolio, management believes sufficient amounts have been provided in the
allowance for loan loss to absorb probable losses in the loan portfolio at
March 31, 2004. Non-Performing Loans, Potential Problem Loans, and Other Real Estate As a Company policy the accrual of interest income is discontinued when a loan
becomes 90 days past due as to principal or interest. If collectibility is in
doubt, cash receipts on non-accrual loans are used to reduce principal rather
than recorded as interest income. Accrued interest recorded during the 90-day
period remains accrued if management determines that the underlying collateral
supports recovery of principal and accrued interest. At March 31, 2004 the
Company had three loans which were 244 to 455 days past due totaling
approximately $6.6 million in principal and accrued interest. Land Held for Residential Development and Real Estate Owned (Held for Sale) Land held for residential development and real estate owned (held for sale)
consists of real estate acquired through foreclosure and is carried at the
lower of the recorded investment in the loan, inclusive of any senior
indebtedness, or the propertys estimated fair value, less estimated selling
costs. Costs related to the improvements to the property are capitalized. Any
other costs are expensed. 23




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Inflation Virtually all of the Companys assets and liabilities are financial in nature.
As a result, interest rates and other factors drive the Companys performance
far more than does inflation. Changes in interest rates do not necessarily
correlate with inflation rates and changes in inflation rates. The Companys
consolidated financial statements are prepared in accordance with US GAAP,
while dividends are based on net income calculated for tax purposes. In each
case, the Companys Statements of Operations and Balance Sheets are measured
with reference to historical cost or fair value without considering inflation. Forward Looking Statements When used in this Quarterly Report on Form 10-Q, in future SEC filings, or in
other written or oral communications, the words or phrases will likely
result, are expected to, will continue, is anticipated, estimate,
project, or similar expressions are intended to identify forward-looking
statements for purposes of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the 1934 Act, as amended, and as such may involve
known and unknown risks, uncertainties and assumptions. These forward-looking statements are subject to various risks and
uncertainties, including, but not limited to, risks relating to: increases in
prepayment rates on the mortgage loans; changes in short-term interest rates;
the Companys ability to use borrowings to finance its assets; risks associated
with investing in real estate, including changes in business conditions and the
general economy; changes in government regulations affecting the Companys
business; and the Companys ability to maintain its qualification as a REIT for
Federal income tax purposes. These risks, uncertainties, and factors could
cause the Companys actual results to differ materially from those projected in
any forward-looking statements it makes. All forward-looking statements speak only as of the date they are made. The
Company does not undertake, and specifically disclaims any obligation to update
any forward-looking statements to reflect events or circumstances after the
date of such statements. Readers are cautioned that the Companys actual
results could differ materially from those set forth in such forward-looking
statements. 24




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk includes risks that arise from changes in interest rates, foreign
currency exchange rates, commodity prices, equity prices and other market
changes that affect market sensitive instruments. We are a party to various
financial instruments that are subject to market risk. These instruments
include commercial mortgage loans, land loans, nonconforming single-family and
small multifamily residential mortgage loans, borrowings under lines of credit
and the issuance of Collateralized Notes. Our financial instruments involve
elements of interest rate risk. Our loan portfolio is also subject to real
estate market risk. We have not entered into, nor do we intend to enter into, any financial
instruments for trading or speculative purposes. As we have no investments
outside of the United States, we are not subject to foreign currency exchange
rate risk. We do not hedge our exposure to changes in the fair value of our
loans through the use of derivative instruments. Instead, we have managed these
exposures through careful underwriting and servicing of our loans. Further, we
target as potential customers borrowers with relatively significant equity
value in their property. For the most part, our loans provide for either monthly payments of interest
only and a payment of principal in full at the end of the loan term, or monthly
payments of interest only with principal payments upon lot releases and
principal in full at the end of the loan term. Because of the high yield of
our loans, we do not believe that a 100-200 basis point increase or decrease in
general interest rates (from those prevailing at March 31, 2004) would have a
significant impact on the fair value of our fixed rate loan portfolio. A
significant increase in interest rates could, however, make it more difficult
for our borrowers to sell or refinance their respective properties. This could
have a material adverse effect on us, either through loan defaults or the need
to grant extensions of the maturity dates, thereby delaying repayment.
Additionally, a real estate market decline in Nevada, Arizona, Colorado,
California, or Utah could have a material adverse impact on us. If real estate
values were to decline, borrowers might find it difficult, if not impossible,
to repay some or all of the principal and accrued interest in connection with a
sale or refinancing of the underlying properties. A number of factors could
lead to a real estate market decline including, but not limited to, a slowdown
in the growth of the economy, increasing commercial interest rates and supply
and demand factors. It is not possible for us to quantify the potential loss in
earnings or cash flows that might result from a real estate market decline. We have attempted to mitigate these risk exposures by carefully underwriting
and servicing our loans. The underwriting decision to provide a loan to an
applicant is based primarily upon the loan-to-value ratio for the underlying
collateral. Thereafter, the Manager uses early intervention, aggressive
collection and loss mitigation techniques in the servicing process. While we
have attempted to mitigate these risk exposures, there can be no assurance that
these efforts will be successful. 25




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ITEM 4. CONTROLS AND PROCEDURES  (a)
    
    Disclosure Controls and
Procedures
The undersigned principal executive officer and principal
financial officer of Specialty Trust, Inc. conclude that
Specialty Trust, Inc.s disclosure controls and procedures are
effective based on their evaluation of these controls and
procedures required by paragraph (b) of Rule 13a-15 or 15d-15
of the Securities Exchange Act of 1934, as of the end of the
period covered by this report.(b)
    
    Changes in internal control over Financial Reporting.There have been no significant changes in Specialty Trust,
Inc.s internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of
Rule 13a-15 or 15d-15 of the Securities Exchange Act of 1934
that occurred during Specialty Trust, Inc.s last fiscal
quarter that has materially affected, or is reasonably likely
to materially affect, Specialty Trust, Incs internal control
over financial reporting The rest of this page is intentionally left blank 26




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PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS. At March 31, 2004, other than litigation by the Company in the
ordinary course of business involving foreclosures or other exercise
of its rights as a creditor, there were no material pending
proceedings to which the Company was a party or of which any of its
property was subject. 
 ITEM 2. CHANGES IN
SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES. None. The Company did not repurchase any of its equity securities
during the first quarter of
2004 and has not adopted any plan for such repurchase. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None 
 ITEM 5. OTHER INFORMATION. None 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.  (a)
    
    Exhibits Exhibit No.
    
    Document3.1*
    
    Articles of Incorporation3.3*
    
    Bylaws3.3.1*
    
    Amendment to Bylaws31.1
    
    Certification of the principal executive officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of the principal financial officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification of the Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2
    
    Certification of the Chief Financial Officer pursuant to Section 906 of the
Sarbanes-oxley Act of 2002.
  *
    Incorporated by reference to the correspondingly numbered exhibit
to the Registration Statement on Form S-11 (Registration No.
333-44860) filed by Specialty Trust, Inc. with the Securities and
Exchange Commission on August 30, 2000.  (b)
    
    Reports on Form 8-K
None filed during the quarter ended March 31, 2004 27




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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. SPECIALTY TRUST, INC.Dated: May 17, 2004
    
    By:
    
    /s/ Nello Gonfiantini IIINello Gonfiantini IIIChairman, President, and Secretary(Signed in the capacity of (i) dulyauthorized officer of the
registrant)Dated: May 17, 2004
    
    By:
    
    /s/ Tanya ParentsTanya ParentsInterim Chief Financial Officer(Signed in the capacity of (i) dulyauthorized officer of the registrant and(ii) principal financial officer of theregistrant)
 28