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UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K/A-1 þ
    
    ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934For
the fiscal year ended: December 31, 2004
 OR o
    
    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: 333-44860 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) The securities registered pursuant to Section 12(b) and 12(g) of the Act.  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. þ o
 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§
229.405 of this chapter) is not contained herein and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). o þ
 APPLICABLE ONLY TO CORPORATE ISSUERS: The aggregate market value of voting and non-voting common equity held by nonaffiliates of the
registrant was $62,535,708 as of the last business day of the registrants most recently completed
second fiscal quarter (June 30, 2004). Common Stock ($.01 par value)
    
    8,416,767 shares as of March 22, 2005.




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Explanatory Note This Form 10-K/A-1 is
being filed in order to properly reflect the signatures of our
Registered Public Accounting Firm on their reports on our
consolidated financial statements and schedules thereof as of the
year ended December 31, 2004. All other disclosures in this
document remain unchanged from the Form 10-K filed on March 31,
2005.




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INDEX PagePART I.Item 1.
    
    Business
    
    
    2Item 2.
    
    Properties
    
    
    26Item 3.
    
    Legal Proceedings
    
    
    26Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    26PART II.Item 5.
    
    Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    26Item 6.
    
    Selected Financial Data
    
    
    29Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    30Item 7A.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    43Item 8.
    
    Financial Statements and Supplementary Data
    
    
    44Item 9.
    
    Changes in and Disagreements with Accountants on Accounting  and Financial Disclosure
    
    
    44Item 9A.
    
    Controls and Procedures
    
    
    44Item 9B
    
    Other Information
    
    
    44PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    45Item 11.
    
    Executive Compensation
    
    
    50Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    51Item 13.
    
    Certain Relationships and Related Transactions
    
    
    53Item 14.
    
    Principal Accountant Fees and Services
    
    
    57PART IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    58EXHIBIT 11.1
    
    
    93EXHIBIT 21
    
    
    96EXHIBIT 31.1
    
    
    97EXHIBIT 31.2
    
    
    99EXHIBIT 32.1
    
    
    101EXHIBIT 32.2
    
    
    102EXHIBIT 11.1EXHIBIT 21EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  1




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PART I. 
 Item 1. Business Specialty Trusts (the Companys) business objective is to build and hold a portfolio
of mortgage loans for investment that generates net income for distribution to
stockholders. The Company finances its acquisitions of mortgage loans with equity and
secured borrowings. The Company is structured as a real estate investment trust
(REIT), thereby generally eliminating Federal income taxes at the corporate level on
income that is distributed to stockholders. Because the Company is not structured as a
traditional lender that accepts deposits, it is subject to substantially less
regulatory oversight and incurs lower compliance expenses as compared to banks, thrift
institutions, and many other holders of mortgage loans. The Manager Specialty Financial serves as the Companys manager (the Manager) and is responsible
for loan originations, loan servicing and day-to-day operations, subject to the
supervision of the Companys Board of Directors. Mr. Nello Gonfiantini, III, a
director and the Companys chief executive officer, is also an executive officer,
director and the sole stockholder of Specialty Financial. The Company has no separate
employees from the Manager and no ownership interest in the Manager. Specialty
Financial has significant operating discretion as to the implementation of the
Companys business strategy and policies. Specialty Financial is regulated as a mortgage company by the State of Nevada
Financial Institutions Division, Department of Business and Industry, has filed annual
reports with that agency and has been profitable each year since commencing operations
in 1995. The Manager operates from office space located at 6160 Plumas Street, Reno,
Nevada 89509, telephone (775) 826-0809. The Companys business strategies and policies are described below. Investment Strategies and Policies Mortgage Loan Acquisition Strategy. The Companys business objective and
strategy involves acquiring and holding loans to borrowers primarily in the Western
United States whose borrowing needs are generally not being served by traditional
financial institutions. Loans are made principally to borrowers in the states of
Nevada, Arizona, Colorado, California and Utah. The Companys strategy is to focus on
land loans, construction loans, commercial building loans and nonconforming
single-family and small multi-family residential loans. Management generally limits
the amount of investment in any single mortgage loan or in mortgage loans to one
borrower to 10% of total assets, although the Board of Directors may approve
exceptions. As of December 31, 2004, there were no mortgage loans which exceeded the
10% threshold, and one borrower whose total loans exceeded the 10% threshold, which
the Board approved. Most loans have terms of one to three years. At December 31, 2004
less than 1% of the Companys loan portfolio consisted of loans with originally stated
maturities of more than three years from the year of issuance. Management strives to
ensure that at any given time 90% of the Companys mortgage loan balances are secured
by first deeds of trust on the underlying real property, with the remaining mortgage
loan balances secured primarily by second deeds of trust. At December 31, 2004,
approximately 76% of the Companys mortgage loan portfolio was secured by first deeds
of trust and an additional 14% was secured by first priority in a pledged partnership 2




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interest. The mortgage loans may be secured by unimproved as well as improved real
property and non-income producing as well as income-producing real property. Some
mortgage loans may be secured by the borrowers leasehold interest in real property.
The loans generally produce higher yields than those obtained on traditional
single-family residential mortgage loans, but are subject to higher risk of default
and loss. The Company acquires loans originated by the Manager. The loans target as potential
customers borrowers with relatively significant equity value in their property, but
either:  -
    require a small commercial loan;-
    own real property which is difficult to evaluate under typical
residential underwriting guidelines or unlikely to support a mortgage saleable in
the secondary market;-
    are self-employed, tend to experience some volatility in their
income or have difficult-to-document sources of income; or-
    are otherwise unable to qualify for traditional mortgage loans. Management
intends to acquire loans that provide for monthly payments of interest. Currently, the majority of the
loans are at fixed rates of interest. As part of the acquisition or refinance of a
particular mortgage loan, the Company may acquire a shared appreciation interest or
other participation in the property securing the loan. The Company also purchases
loans that have a deferred interest component. These loans allow for monthly payments
of interest at a reduced rate while interest accrues throughout the life of the loan
at a higher rate and is due upon maturity of the loan. The deferred interest does
have the effect of increasing the potential risk on these loans. Risks by Type of Loan Most of the loans the Company acquires and holds require the borrower to make a
balloon payment of the principal amount upon maturity of the loan. At December 31,
2004, none of the Companys loan portfolio consisted of fully amortizing mortgage
loans. To the extent that a borrower has an obligation to pay a mortgage loan in a
large lump sum payment, its ability to satisfy this obligation may be dependent upon
its ability to obtain suitable refinancing, sell the underlying property or otherwise
raise a substantial cash amount. An increase in interest rates over the mortgage rate
applicable at the time the loan was originated may have an adverse effect on the
borrowers ability to obtain refinancing or to pay the required monthly payments. As a
result, such loans may involve a higher risk of default than fully amortizing loans. The Company generally holds its mortgage loans to maturity. In addition, the REIT
provisions of the Internal Revenue Code (the Code) limit in some respects the
Companys ability to sell mortgage loans. From time to time, however, Management may
decide to sell mortgage loans. This could occur for any number of reasons, for
example, to dispose of a mortgage loan as to which credit risk concerns have arisen,
to reduce interest rate risk, or generally to rebalance the Companys portfolio when
Management deems such action advisable. Management will select mortgage loans to be
sold according to the particular purpose such sale will serve. The Board of Directors
has not adopted a policy that would restrict Managements authority to determine the
timing of sales or the selection of mortgage loans to be sold. Types of Mortgage Loans. The principal types of mortgage loans that the Company
acquires are 3




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described below:  -
    Land Loans. Land loans are made against (a) undeveloped or
raw land zoned for either commercial or residential use and (b) land prepared
for commercial or residential development, typically with entitlements obtained
and basic infrastructure such as streets and utilities in place. An example of a
residential land development loan would be a loan secured by a residential
subdivision with residential lots ready for building. While land loans are
generally made at low loan-to-value ratios there is generally no cash flow from
the property and the borrowers other sources of income must be relied upon to
support the periodic interest payments due under the loans.-
    Construction Mortgage Loans. Construction loans are loans
made for the renovation of developed property, and for the construction of new
structures on undeveloped property. Construction loans acquired and held by the
Company will generally be secured by first deeds of trust on commercial or
residential real property. Most of the Companys construction loans are to
developers building the property for sale. Such loans are typically for terms of
from six months to two years. Generally the Company does not disburse funds with
respect to a particular construction loan until work in the previous phase of the
project on which the loan is being made has been completed, and until an
independent inspector has verified the quality of construction and adherence to
the construction plans and has reviewed the estimated cost of completing the
project. In addition, the Company requires the submission of signed labor and
material lien releases by the borrower in connection with each completed phase of
the project prior to making any periodic disbursements of proceeds of the loan to
the borrower.-
    Commercial Building Loans. Commercial building loans have
distinct risk characteristics depending on the type of structure on the property.
Commercial building loans generally lack standardized terms, which may complicate
their structure. Commercial buildings themselves tend to be unique and are more
difficult to value than residential properties. In addition, commercial
buildings, particularly industrial and warehouse properties, are generally
subject to relatively greater environmental risks than non-commercial properties,
with corresponding burdens and costs of compliance with environmental laws and
regulations.Commercial building loans are also subject to the effects of:  -
    local and other economic conditions on real estate values;-
    the ability of tenants to make lease payments;-
    the ability of a building to attract and retain tenants,
which may in turn be affected by local conditions such as oversupply of space
or a reduction in demand for rental space in the area, the attractiveness of
properties to tenants, competition from other available space, the ability of
the owner to pay leasing commissions, provide adequate maintenance and
insurance, pay tenant improvement costs and to make other tenant concessions;
and-
    increased operating costs, including energy costs and real
estate taxes. While owners of commercial buildings generally will carry comprehensive liability
and casualty coverage, such coverage may not provide full protection for the value
of the underlying property and may not protect against all casualty losses. If
underlying commercial buildings do not generate sufficient income to meet operating
expenses, debt service, capital 4




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expenditures and tenant improvements, borrowers under commercial building loans may
be unable to make payments of principal and interest in a timely fashion. Income
from and values of commercial buildings are also affected by such factors as
applicable laws, including tax laws, interest rate levels, the availability of
financing for owners and tenants, and the impact of and costs of compliance with
environmental controls and regulations. In the event of foreclosure on a commercial
building loan, there may be costs and delays involved in enforcing rights of a
property owner against tenants in default under the terms of leases with respect to
commercial properties and such tenants may seek the protection of the bankruptcy
laws, which can result in termination of lease contracts.  -
    Nonconforming Single-Family and Small Multifamily Residential
Mortgage Loans. The nonconforming single-family residential mortgage loans
are conventional mortgage loans that vary in one or more respects from the
requirements for participation in Fannie Mae or Freddie Mac programs. Credit
risks associated with nonconforming mortgage loans may be greater than those
associated with mortgage loans that conform to typical Fannie Mae and Freddie Mac
guidelines. The principal differences between nonconforming mortgage loans and
conforming mortgage loans include the applicable loan-to-value ratios, the credit
and income histories of the mortgagors, the documentation required for approval
of the mortgagors, the types of properties securing the mortgage loans, loan
sizes and the mortgagors occupancy status with respect to the mortgaged
property. Nonconforming loans may include loans secured by timeshare vacation
property. As a result of these and other factors which may cause these
nonconforming mortgage loans to experience higher risk of credit default and
loss, the interest rates charged on these loans are often higher than those
charged for conforming mortgage loans.Small multifamily mortgage loans are generally secured by a first lien on a 5-unit
to 20-unit residential property. Multifamily mortgage loans share many of the
characteristics and risks associated with commercial mortgage loans and are often
categorized as commercial loans rather than residential loans. Loans on mobile home
parks are also included in this residential category.-
    Junior Mortgage Loans. Second, third and wraparound
mortgage loans are secured by deeds of trust on single-family residences which
are already subject to prior mortgage indebtedness. A wraparound loan is a junior
mortgage loan having a principal amount equal to the outstanding balance under
the existing mortgage loans plus the amount actually to be advanced under the
wraparound mortgage loan. Under a wraparound loan, principal and interest
payments are generally made on behalf of the borrower to the holders of the prior
mortgage loans. Junior mortgage loans generally have lower qualifying
loan-to-value ratios. 5




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Table 1: Mortgage Loan Portfolio
(as of December 31, 2004) LAND LOANS ST Net
    
    
    Original Loan
    
    
    Current Loan
    
    
    Specialty TrustFootnotes
    
    Description of Loan
    
    Interest Rate
    
    
    Amount*
    
    
    Principal Amount
    
    
    Balance +
    
    
    Maturity
    
    
    LTV
    
    
    Lien PositionResidential Land Development
    
    
    13.00
    %
    
    
    2,185,000
    
    
    
    539,430
    
    
    
    539,430
    
    
    
    4/1/2005
    
    
    
    11
    %
    
    1st3
    
    Residential Land Development
    
    
    13.00
    %
    
    
    18,250,000
    
    
    
    18,250,000
    
    
    
    424,000
    
    
    
    2/1/2006
    
    
    
    28
    %
    
    2nd3
    
    Residential Land Development
    
    
    13.00
    %
    
    
    3,380,000
    
    
    
    2,880,000
    
    
    
    2,880,000
    
    
    
    1/1/2006
    
    
    
    55
    %
    
    1st3
    
    Residential Land Development
    
    
    13.00
    %
    
    
    8,600,000
    
    
    
    8,600,000
    
    
    
    8,600,000
    
    
    
    11/1/2006
    
    
    
    66
    %
    
    2ndResidential Land Development
    
    
    13.00
    %
    
    
    6,500,000
    
    
    
    6,500,000
    
    
    
    6,500,000
    
    
    
    12/1/2006
    
    
    
    65
    %
    
    1st3
    
    Residential Land Development
    
    
    13.00
    %
    
    
    1,300,000
    
    
    
    1,250,000
    
    
    
    1,250,000
    
    
    
    12/1/2006
    
    
    
    38
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    10,000,000
    
    
    
    289,941
    
    
    
    289,941
    
    
    
    12/1/2006
    
    
    
    91
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    157,757
    
    
    
    143,475
    
    
    
    143,475
    
    
    
    12/1/2006
    
    
    
    91
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    177,534
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    56
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    157,757
    
    
    
    151,361
    
    
    
    151,361
    
    
    
    12/1/2006
    
    
    
    91
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    10,000,000
    
    
    
    6,100,000
    
    
    
    6,100,000
    
    
    
    12/1/2006
    
    
    
    91
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    177,534
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    54
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    177,534
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    56
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    177,534
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    54
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    180,560
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    65
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    170,501
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    54
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    180,560
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    58
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    164,251
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    51
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    180,560
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    57
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    180,560
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    55
    %
    
    1st2
    
    Residential Land Development
    
    
    12.50
    %
    
    
    177,534
    
    
    
    22,965
    
    
    
    22,965
    
    
    
    12/1/2006
    
    
    
    49
    %
    
    1stResidential Land Development
    
    
    
    
    
    $
    62,475,176
    
    
    $
    44,956,822
    
    
    $
    27,130,8221
    
    Commercial Raw Land
    
    
    12.50
    %
    
    
    1,209,500
    
    
    
    1,209,500
    
    
    
    1,209,500
    
    
    
    1/1/2005
    
    
    
    59
    %
    
    1stCommercial Raw Land
    
    
    13.00
    %
    
    
    5,000,000
    
    
    
    5,000,000
    
    
    
    5,000,000
    
    
    
    7/1/2005
    
    
    
    23
    %
    
    1st1
    
    Commercial Raw Land
    
    
    12.25
    %
    
    
    3,000,000
    
    
    
    3,000,000
    
    
    
    3,000,000
    
    
    
    2/1/2006
    
    
    
    46
    %
    
    1stCommercial Raw Land
    
    
    13.00
    %
    
    
    5,000,000
    
    
    
    5,000,000
    
    
    
    5,000,000
    
    
    
    4/1/2005
    
    
    
    52
    %
    
    1stCommercial Raw Land
    
    
    
    
    
    $
    14,209,500
    
    
    $
    14,209,500
    
    
    $
    14,209,500TOTAL LAND LOANS
    
    
    
    
    
    $
    76,684,676
    
    
    $
    59,166,322
    
    
    $
    41,340,322
 6




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(as of December 31, 2004) ST Net
    
    
    Original Loan
    
    
    Current Loan
    
    
    Specialty TrustFootnotes
    
    Description of Loan
    
    Interest Rate
    
    
    Amount*
    
    
    Principal Amount
    
    
    Balance +
    
    
    Maturity
    
    
    LTV
    
    
    Lien PositionCONSTRUCTION LOANSSpec SFR Construction
    
    
    13.00
    %
    
    
    1,330,000
    
    
    
    1,330,000
    
    
    
    1,330,000
    
    
    
    5/1/2005
    
    
    
    70
    %
    
    1st4
    
    Spec SFR Construction
    
    
    12.50
    %
    
    
    235,000
    
    
    
    235,000
    
    
    
    235,000
    
    
    
    4/1/2005
    
    
    
    18
    %
    
    2ndSpec SFR Construction
    
    
    
    
    
    $
    1,565,000
    
    
    $
    1,565,000
    
    
    $
    1,565,000Commercial Construction
    
    
    13.00
    %
    
    
    10,800,000
    
    
    
    10,800,000
    
    
    
    10,800,000
    
    
    
    1/1/2007
    
    
    
    73
    %
    
    1st3
    
    Commercial Construction
    
    
    13.00
    %
    
    
    12,500,000
    
    
    
    9,592,000
    
    
    
    6,990,450
    
    
    
    7/1/2005
    
    
    
    43
    %
    
    1st4
    
    Commercial Construction
    
    
    13.00
    %
    
    
    5,100,000
    
    
    
    5,100,000
    
    
    
    5,100,000
    
    
    
    11/2/2004
    
    
    
    73
    %
    
    1stCommercial Construction
    
    
    
    
    
    $
    28,400,000
    
    
    $
    25,492,000
    
    
    $
    22,890,450TOTAL CONSTRUCTION LOANS
    
    
    
    
    
    $
    29,965,000
    
    
    $
    27,057,000
    
    
    $
    24,455,450NONCONFORMING SINGLE FAMILY AND MULTIFAMILY LOANSNonconforming
    
    
    17.50
    %
    
    
    5,300,000
    
    
    
    5,300,000
    
    
    
    5,300,000
    
    
    
    1/1/2007
    
    
    
    91
    %
    
    1st^Nonconforming
    
    
    17.50
    %
    
    
    7,750,000
    
    
    
    7,750,000
    
    
    
    7,750,000
    
    
    
    9/1/2006
    
    
    
    12
    %
    
    1st^Nonconforming
    
    
    12.25
    %
    
    
    3,500,000
    
    
    
    3,500,000
    
    
    
    3,500,000
    
    
    
    8/1/2005
    
    
    
    32
    %
    
    1stNonconforming
    
    
    13.00
    %
    
    
    2,500,000
    
    
    
    2,500,000
    
    
    
    2,500,000
    
    
    
    12/1/2006
    
    
    
    17
    %
    
    1stNonconforming
    
    
    13.00
    %
    
    
    4,708,000
    
    
    
    4,708,000
    
    
    
    4,708,000
    
    
    
    10/1/2006
    
    
    
    55
    %
    
    1stNonconforming
    
    
    13.00
    %
    
    
    1,819,603
    
    
    
    1,819,603
    
    
    
    1,819,603
    
    
    
    9/1/2006
    
    
    
    50
    %
    
    1stNonconforming
    
    
    13.00
    %
    
    
    3,220,321
    
    
    
    3,220,321
    
    
    
    3,220,321
    
    
    
    9/1/2006
    
    
    
    50
    %
    
    1stTOTAL NONCONFORMING
    
    
    
    
    
    $
    28,797,924
    
    
    $
    28,797,924
    
    
    $
    28,797,924TOTALS
    
    
    
    
    
    $
    135,447,600
    
    
    $
    115,021,246
    
    
    $
    94,593,696
 Footnotes: Borrowers with more than one loan:   1  Loans to same borrower or related parties secured by different parcels of real estate
aggregating $4,209,500.2  Loans to same borrower or related parties secured by different parcels of real estate
aggregating $6,937,3923  Loans to same borrower or related parties secured by different parcels of real estate
aggregating $20,144,450.4  Loans delinquent either in principal or interest at least 30 days.* Original loan amount includes future commitments on behalf of all investors of $3,647,385 as of
December 31, 2004.+ Specialty Trusts participation in current loan balance as of December 31, 2004 was $94,593,696.
Specialty Trusts maximum commitment of additional funds under existing loans was $3,647,385 at
December 31, 2004.^ Collateral represents first priority in a pledged partnership interest. 7




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Table 2: Types and Maturities of Mortgage Investments
(as of December 31, 2004) CarryingNumber
    
    
    AmountType of Loan
    
    of Loans
    
    
    of Mortgages
    
    
    Percent1st Mortgages
    
    
    32
    
    
    $
    72,284,696
    
    
    
    76.4
    %1 stPriority Interest
    
    
    2
    
    
    
    13,050,000
    
    
    
    13.8
    %2nd Mortgages
    
    
    3
    
    
    
    9,259,000
    
    
    
    9.8
    %37
    
    
    $
    94,593,696
    
    
    
    100.0
    %Residential Land
    
    
    21
    
    
    $
    27,130,822
    
    
    
    28.7
    %Construction
    
    
    5
    
    
    
    24,455,450
    
    
    
    25.9
    %Commercial Land
    
    
    4
    
    
    
    14,209,500
    
    
    
    15.0
    %Other
    
    
    7
    
    
    
    28,797,924
    
    
    
    30.4
    %37
    
    
    $
    94,593,696
    
    
    
    100.0
    %Maturing on or before December 31, 2005
    
    
    12
    
    
    $
    28,904,380
    
    
    
    30.6
    %Maturing on or between January 1, 2006
and December 31, 2007
    
    
    25
    
    
    
    65,689,316
    
    
    
    69.4
    %37
    
    
    $
    94,593,696
    
    
    
    100.0
    %
  Loans aggregating $5,452,238 in principal and accrued interest were at least 30 days past due
at December 31, 2004 Other Investments. The Company may purchase its own stock or the debt or equity of
other mortgage REITs or other companies when Management believes that such purchases
will yield attractive returns on capital employed. Any such purchase would be for
investment purposes and not for short-term trading (turnover) gain. REIT or other debt
or equity securities may be undervalued at points in the economic cycle. When the
stock market valuation of companies are low in relation to the market value of other
assets, stock purchases can be a way for the Company to acquire indirectly a
beneficial interest in a pool of mortgage assets or other types of assets at an
attractive price. Also, REITs and other companies may have attractive mortgage finance
or other businesses in which Management may want to become a partial owner. Management
does not, however, presently intend to invest in the securities of other issuers for
the purpose of exercising control or to underwrite securities of other issuers.
Management does not limit the amount of securities of other issuers that may be
acquired (beyond the limits imposed by the REIT qualification requirements), although
it is not anticipated that such holdings will comprise a substantial portion of the
Companys assets. At December 31, 2004, the Company did not own any such securities. 8




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Leverage Strategies and Policies The Company employs a debt financing strategy to increase its investment in mortgage
loans. By using the mortgage loans as collateral to borrow funds, the Company is able
to invest in mortgage loans with greater value than its equity. The Company has a
targeted ratio of debt-to-equity of approximately 1 to 1. While there are no charter
or bylaw limitations on the Companys use of leverage, Management currently has a
policy and has agreed with the Companys primary bank lenders not to exceed that
target by permitting debt, whether under bank lines or the Collateralized Note
program, to exceed equity. This financing strategy is designed to maintain a cushion
of equity sufficient to respond to short-term liquidity needs. Management anticipates
that all of the borrowing arrangements will require the Company to pledge cash or
additional mortgage loans in the event the market or discounted value of existing
collateral declines. To the extent that cash reserves are insufficient to cover such
deficiencies in collateral, the Company may be required to sell mortgage loans to
reduce the borrowings. The Company intends to finance its mortgage loan acquisitions through the
collateralized note program and bank warehouse credit lines. At December 31, 2004, the
amount of such credit lines was $13.5 million, with $0 outstanding at December 31,
2004. On August 5, 2004, Post Effective Amendment No. 2 to the Companys registration
statement was declared effective by the Securities and Exchange Commission (SEC)
changing the amount of collateralized notes available for public sale to $189,521,000
(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. The
collateralized notes are secured by mortgage loans at least one and one-half times the
aggregate principal amount outstanding on the collateralized notes. If there are not
sufficient qualifying mortgage loans in the loan portfolio to attain the required
levels, the Company is required to pledge restricted cash to the trustee of the notes
in order to collateralize the notes at the required level. In November 2004, the Companys Board of Directors determined that continuing the
Companys publicly offered collateralized note program would subject the Company to
significant costs and expenses, including costs of complying with the Sarbanes-Oxley
Act of 2002, that would exceed the benefits derived from the public issuance of the
notes. As a result, the Board directed that the public collateralized note program be
terminated. On December 15, 2004, Post Effective Amendment No. 3 to the Companys
registration statement was declared effective by the Securities and Exchange
Commission (SEC) thereby deregistering $165,915,000 collateralized notes which
represented all of the remaining registered but unsold collateralized notes. The
Company expects to be able to begin offering collateralized notes on a private basis
in June 2005. The outstanding collateralized notes have maturities ranging from three months to five
years from the date of issue and bear fixed rates of interest ranging from 3.25% to
7.50% at December 31, 2004, however, all of the collateralized notes will be redeemed
by June 2005 as a result of the deregistration of the collateralized note program.
Therefore, all of the collateralized notes have been disclosed as maturing in 2005.
As of December 31, 2004, $41,242,610 of these notes were outstanding. Managements goal is to strike a balance between the under-utilization of leverage,
which reduces potential returns to stockholders, and the over-utilization of leverage,
which could reduce the Companys ability to meet its obligations during adverse market
conditions. 9




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Operating Strategies and Policies Origination and Underwriting. Specialty Financial continuously evaluates
prospective mortgage loans to be acquired by Specialty Trust. The Manager generates
mortgage loan originations from referrals from real estate and mortgage loan brokers,
referrals from existing customers, new loans made to or refinancing of loans to
existing customers and personal solicitations of new borrowers. All potential mortgage loans are evaluated to determine if the mortgage loan is of a
type eligible for acquisition by Specialty Trust. The Companys policy generally
limits the amount of loans to one borrower or affiliated borrowers to less than 10% of
total assets and the loan-to-value ratio for any loan to a maximum of 80%, although
the Board of Directors may approve exceptions. As the notes to Table 1: Mortgage Loan
Portfolio indicate, at December 31, 2004, there were three instances of loans to the
same borrower or related parties secured by different parcels of real property. One of
these instances represents more than 10% of the portfolio. The Company also had one
loan that exceeded 10% of the portfolio. Management seeks personal guarantees from
affiliates of the borrower when possible. The Company does not have specific
requirements with respect to credit scores or payment histories. For income producing
properties, the net annual estimated cash flow after vacancy, and operating expenses
must equal or exceed the annual payments required on the mortgage loan. The Manager
requires full documentation of all loan applications/requests, including complete
organizational documents of the borrowing entity, if applicable, credit reports on
guarantors and borrowers, current (within 60 days) financial statements, and a minimum
of two years tax returns. A flood zone determination must be provided. A preliminary
title report is obtained and reviewed by the underwriter. ALTA surveys, Phase I
environmental reports and geotechnical reports are required on most loans but can be
waived on a case-by-case basis upon physical inspection and determination by Mr. Nello
Gonfiantini, III. Liability insurance is required on all loans and hazard insurance
is required on any structures. If the loan is to finance a purchase, a copy of the
purchase contract must be submitted. If the loan is for refinance, a copy of the
closing statement when purchased is reviewed. If a loan is for construction, a copy of
plans, specifications and cost breakdown must be reviewed and a construction control
company retained. The Companys underwriting guidelines are intended to evaluate the
capacity and willingness of the borrower to repay the loan and the adequacy of the
collateral securing the loan. On a case-by-case basis, exceptions to the underwriting
guidelines may be made by Nello Gonfiantini III, President and the loan review
committee where there are compensating factors, for example, low loan-to-value ratios
or guarantees from parties with strong financial resources or pledges of additional
collateral. Collateral valuation receives special attention in the Managers underwriting of the
mortgage loans. The Manager places great emphasis on the ability of collateral to
protect against losses in the event of default by borrowers. In determining the
adequacy of the mortgaged property as collateral, the Manager obtains independent,
on-site appraisals for each mortgage property and the property is inspected by an
officer or agent of the Manager. All independent appraisers must be licensed or
qualified as independent fee appraisers and certified by the state in which the
property being appraised is located. The appraiser is required to inspect the property
and verify that it is in good condition and that construction, if new, has been
completed. The appraisal is based on the market value of comparable properties, the
estimated rental income, if applicable, and the cost of replacement. The appraised
value of the property being financed must be such that it currently supports, and is
anticipated to support in the event of default, the outstanding mortgage loan balance.
The Manager generally relies on its own independent analysis and not exclusively on
such appraisals in determining whether or not to arrange a particular
mortgage 10




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##### Table of Contents



loan. Servicing. The Manager has established its own servicing operation in order to
service the mortgage loans. Servicing includes collecting and remitting loan payments,
making required advances, accounting for principal and interest, holding escrow or
impound funds for payment of taxes and insurance, making required inspections of the
property, contacting delinquent borrowers and supervising foreclosures and property
dispositions in the event of un-remedied defaults in accordance with the Companys
guidelines. The focus of the Managers servicing operation is on managing credit risk
in order to protect the Companys investment in the mortgage loans. The Manager
intends to use early intervention, aggressive collection and loss mitigation
techniques in the servicing process. Credit and Market Risk Management. Management believes that proper
underwriting and efficient servicing of the mortgage loans are the most effective
methods of managing credit risk. The Managers focus as a servicer of mortgage loans
it has originated is more on effective credit risk management than on cost control.
The Manager does not intend to be a low cost servicer, but instead puts the proper
resources to work to mitigate losses on the mortgage loans it services. Set forth below is a table detailing the Companys recent delinquency, foreclosure and
loss experience: Table 3: Delinquency, Foreclosure and Loss Experience December 31, 2004
    
    
    December 31, 2003Principal
    
    
    % of
    
    
    Principal
    
    
    % of$ of Loans
    
    
    Portfolio
    
    
    $ of Loans
    
    
    PortfolioTotal Portfolio
    
    $
    94,593,696
    
    
    
    100.00
    %
    
    $
    95,610,164
    
    
    
    100.00
    %Period of Delinquency
(Interest and/or Principal):30-59 days
    
    $
    5,452,238
    
    
    
    5.76
    %
    
    
    
    
    
    
    0.00
    %60 to 89 days
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %90 days or more
    
    
    
    
    
    
    0.00
    %
    
    
    3,777,407
    
    
    
    3.90
    %Total Delinquencies
(excluding foreclosures)
    
    $
    5,452,238
    
    
    
    5.76
    %
    
    $
    3,777,407
    
    
    
    3.90
    %Foreclosures Pending
    
    
    
    
    
    
    0.00
    %
    
    
    2,841,094
    
    
    
    2.80
    %Foreclosures Completed
    
    $
    2,378,989
    
    
    
    
    
    
    $
    10,224,992Losses Sustained for Period Ending on
Such Date
    
    $
    260,000
    
    
    
    
    
    
    $
    171,324
 The Company generally institutes foreclosure proceedings on defaulted loans when that
action is determined by the Manager to be in the best interests of shareholders.
Foreclosure may be appropriate where the project planned for the property has
encountered slower than anticipated development or sales results or where the
developers/borrowers financial condition has deteriorated such that completion of
the project has been jeopardized. A loan that is nearing 11




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##### Table of Contents



maturity or has defaulted may be a candidate for refinancing rather than foreclosure
when Management determines that the project planned remains viable and the value of
the property and other sources of repayment such as personal guarantees are sufficient
to support a new loan. In such cases, Management often works with marketing and other
real estate professionals to assist the developer in modifying the original project to
enhance its likelihood of success. Geographic Concentration.There are no limits on the geographic concentration of the
loans Management may acquire. Properties underlying mortgage loans are located
primarily in the states of Nevada, Arizona, Colorado and California. The percentage of geographic concentration by loan amount as of December 31, 2004 is
as follows: Arizona
    
    
    58
    %Nevada
    
    
    33
    %
    
    (approx. 25% in the Reno area and 8% in the Las Vegas area)California
    
    
    6
    %Colorado
    
    
    3
    %
 Interest Rate Risk Management. Management seeks to limit the Companys exposure to
changes in interest rates in several ways. The Company generally acquires short-term
loans with fixed interest rates and maturities of less than three years. While the
loan terms exceed the terms for interest rate adjustments on the Companys borrowings,
the resulting interest rate exposure is mitigated by the Companys leverage policy
limits. Under the Companys targeted debt-to-equity ratio of approximately 1 to 1, at
least 50% of the Companys earning assets will at all times be funded with equity. The
income from these assets will be available to cover increases in interest expense on
borrowings, to the extent not covered by the assets funded with such borrowings. In
addition, the higher yielding-higher risk nature of the mortgage loans provides a
greater net interest cushion that can withstand more interest rate increases on
borrowings than lower yielding-lower risk loans. The Company does not hedge its interest rate risk by purchasing interest rate caps,
floors or other derivative instruments. Management believes that the cost of such
hedging instruments would outweigh the potential benefits to be gained. Prepayment Risk Management. The Manager seeks to minimize the effects of faster than
anticipated prepayment rates in the portfolio, in part by originating mortgage loans
with prepayment penalties. The Manager also utilizes the production of new mortgage
loans as a hedge against prepayment risk. Other Company Policies The Companys Board of Directors has authorized the Manager to pursue a pilot project
for the investment by the Company (or a taxable subsidiary of the Company) in one or
more real property development projects. The Company would invest with a developer
partner to develop commercial real estate projects such as apartment or office
buildings and would continue to hold the property following completion of construction
to obtain rental income. In addition, the Company may, from time to time, hold real
estate owned (REO) as a result of foreclosure of defaulted mortgage loans.
Management does not intend to invest in mortgage securities or to issue mortgage
securities. The Company does not anticipate the need to issue senior securities or to
offer securities in exchange for property or stock. 12




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##### Table of Contents



The Companys Board of Directors has established the investment policies and
strategies summarized in this annual report. The Board of Directors has the power to
modify or waive such policies and strategies without the consent of the stockholders
to the extent that the Board of Directors determines that such modification or waiver
is in the best interest of stockholders. Among other factors, developments in the
market, which affect the policies and strategies mentioned in this annual report or
which change the Companys assessment of the market, may cause the Board of Directors
to revise the Companys policies and strategies. Certain Federal Income Tax Considerations The following discussion summarizes certain Federal income tax considerations relevant
to the Company and its investors. This discussion is based on existing Federal income
tax law, which is subject to change, possibly retroactively. This discussion does not
address all aspects of Federal income taxation that may be relevant to a particular
investor in light of their personal investment circumstances or to certain types of
investors subject to special treatment under the Federal income tax laws (including
financial institutions, insurance companies, broker-dealers and, except to the extent
discussed below, tax-exempt entities and foreign taxpayers) and it does not discuss
any aspects of state, local or foreign tax law. This discussion assumes that
investors will hold their investment in common stock or the Companys notes as a
capital asset (generally, property held for investment) under the Internal Revenue
Code (the Code). Investors are advised to consult their tax advisors as to the
specific tax consequences to them of purchasing, holding and disposing of the
Companys common stock or notes, including the application and effect of Federal,
state, local and foreign income and other tax laws to their investment. General. The Company has elected for Federal income tax purposes to be taxed as a
REIT, commencing with the taxable year ended December 31, 1998. Management believes
that the Company has operated, and anticipates that it will continue to operate, in a
manner that permits it to maintain its qualifications as a REIT. As described in more
detail below, because the Code generally requires REITs to distribute at least 90% of
their taxable earnings each year, and further allows the REIT to deduct such
distributions, qualification as a REIT generally eliminates the double taxation that
otherwise results under current law when a regular corporation earns income and
distributes that income to its stockholders. While it is the intent of Management to continue to operate as a REIT, there can be no
assurance that the Company will continue to qualify as a REIT in any particular tax
year, given the highly complex nature of the rules governing REITs, the ongoing
importance of factual determinations and the possibility of future changes in the
circumstances of the Company. If the Company failed to qualify as a REIT in any
particular year, it would be subject to Federal income tax as a regular, domestic
corporation, and the stockholders would be subject to tax in the same manner as
stockholders of a regular corporation. In this event, the Company could be subject to
potentially substantial income tax liability in respect of each taxable year that it
fails to qualify as a REIT and the amount of earnings and cash available for
distribution to the stockholders could be significantly reduced or eliminated. The following is a brief summary of certain technical requirements that the Company
must meet on an ongoing basis in order to qualify, and remain qualified, as a REIT
under the Code. Stock Ownership Tests.The Companys capital stock must be held by at least 100
persons for at least 335 days of a twelve-month year, or a proportionate part of a
short tax year. In addition, no more than 50% of the value of the Companys capital
stock may be owned, directly or indirectly, 13




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##### Table of Contents



by five or fewer individuals at any time during the last half of the taxable year.
Under the Code, most tax-exempt entities including employee benefit trusts and
charitable trusts (but excluding trusts described in 401(a) and exempt under 501(a))
are generally treated as individuals for these purposes. The Company must satisfy
these stock ownership requirements each taxable year. The Company must solicit
information from certain stockholders to verify ownership levels and the Companys
Articles of Incorporation impose certain repurchase obligations and restrictions
regarding the transfer of shares in order to aid in meeting the stock ownership
requirements. If the Company were to fail either of the stock ownership tests, it
would generally be disqualified from REIT status, unless, in the case of the five or
fewer requirement, the good faith exemption is available. Asset Tests.For tax years beginning after December 31, 2000, the Company must
generally meet the following REIT Asset Tests at the close of each quarter of each
taxable year:  (a)
    the 75% Asset Test: at least 75% of the value of the
Companys total assets must consist of Qualified REIT Real Estate Assets,
government securities, cash, and cash items; and(b)
    not more than 25% of the value of the Companys total assets is
represented by securities (other than those includible under the 75% Asset Test);(c)
    not more than 20% of the value of the Companys total assets is
represented by securities of one or more taxable REIT subsidiaries; and(d)
    the value of securities held by the Company, other than those of a
taxable REIT subsidiary, or taken into account for purposes of the 75% Asset
Test, must not exceed either (i) 5% of the value of the Companys total assets in
the case of securities of any one non-government issuer, or (ii) 10% of the
outstanding vote or value of any such issuers securities. In applying the above REIT Asset Tests, Management is generally required to re-value
all of the Companys assets at the end of any quarter in which the Company acquires a
substantial amount of new securities or other property that is not a Qualified REIT
Real Estate Asset. Management intends to monitor closely the purchase, holding and
disposition of the Companys assets in order to comply with the REIT Asset Tests.
Management anticipates that substantially all of the Companys assets will be
Qualified REIT Real Estate Assets and intends to limit, diversify or hold through a
taxable REIT subsidiary the Companys ownership of any assets not qualifying as
Qualified REIT Real Estate Assets so as to comply with the above REIT Asset Tests. If
it is anticipated that these limits would be exceeded, Management intends to take
appropriate measures, including the disposition of non-qualifying assets within the
permitted time periods for cure, so as to avoid exceeding such limits. Gross Income Tests.The Company must generally meet the following gross income tests
(the REIT Gross Income Tests) for each taxable year:  (a)
    at least 75% of the Companys gross income must be derived from
certain specified real estate sources including interest income and gain from the
disposition of Qualified REIT Real Estate Assets, foreclosure property or
qualified temporary investment income (i.e., income derived from new capital
within one year of the receipt of such capital) (the 75% Gross Income Test);
and,(b)
    at least 95% of the Companys gross income for each taxable year
must be derived from sources of income qualifying for the 75% Gross Income Test,
or from dividends, interest, and 14




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##### Table of Contents



gains from the sale of stock or other securities (including certain interest rate
swap and cap agreements, options, futures and forward contracts entered into to
hedge variable rate debt incurred to acquire Qualified REIT Real Estate Assets) not
held for sale in the ordinary course of business (the 95% Gross Income Test). Management intends to maintain the Companys REIT status by carefully monitoring the
Companys income, including income from sales of mortgage assets, to comply with the
REIT Gross Income Tests. Under certain circumstances, for example, (i) the sale of a
substantial amount of mortgage assets to repay borrowings in the event that other
credit is unavailable or (ii) the unanticipated decrease in qualifying income which
results in non-qualifying income exceeding 5% of gross income, the Company may be
unable to comply with certain of the REIT Gross Income Tests. Inadvertent failures to
comply with the REIT Gross Income Tests will not result in the Companys
disqualification as a REIT so long as certain disclosure and reasonable cause criteria
are met and the Company pays a 100% tax on an amount generally equal to the qualified
income shortfall. See Taxation of the Company below for a discussion of the tax
consequences of failure to comply with the REIT Provisions of the Code. Distribution Requirement. The Company is generally required to distribute to its
stockholders an amount equal to at least 90% of its REIT taxable income before
deduction of dividends paid and by excluding net capital gain. Such distributions
must be made in the taxable year to which they relate or, if declared before the
timely filing of the Companys tax return for such year and paid not later than the
first regular dividend payment after such declaration, in the following taxable year. The Internal Revenue Service (IRS) has ruled generally that if a REIT maintains a
dividend reinvestment plan that allows stockholders of the REIT to elect to have cash
distributions reinvested in shares of the REIT at a purchase price equal to at least
95% of the fair market value of such shares on the distribution date, then such
distributions qualify under the above distribution requirement. The Company maintains
a Dividend Reinvestment Plan (DRIP) and intends that the terms of the DRIP will
comply with the IRS public ruling guidelines for such plans. If the Company fails to meet the distribution test as a result of an adjustment to its
taxable income by the IRS, the Company may be able to avoid disqualification as a REIT
by paying a deficiency dividend within a specified time period and in accordance with
other requirements set forth in the Code. The Company would be liable for interest
based on the amount of the deficiency dividend. A deficiency dividend is not
permitted if the deficiency is due to fraud with intent to evade tax or to a willful
failure to file a timely tax return. Taxation of the Company. In any year in which the Company qualifies as a REIT, it
will generally not be subject to Federal income tax on that portion of its REIT
taxable income or capital gain that is distributed to the stockholders. It will,
however, be subject to Federal income tax at normal corporate income tax rates upon
any undistributed taxable income or capital gain. In addition, notwithstanding qualification as a REIT, the Company may also be subject
to tax in certain other circumstances as follows:  (a)
    if it fails to satisfy either of the REIT Gross Income Tests, but
nonetheless maintains qualification as a REIT because certain other requirements
are met, the Company will generally be subject to a 100% tax on the greater of
the amount by which it fails either the 75% or the 95% Gross Income Test; 15




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##### Table of Contents



(b)
    the Company will also be subject to a tax of 100% on net income
derived from any prohibited transaction (which includes dispositions of
property classified as dealer property). In certain circumstances, an REO that
is constructed upon or developed by the Company, shared appreciation mortgages
and other equity-like interests coupled with a mortgage may be deemed to give
rise to income from dealer property. In such event, such interests might give
rise to non-qualifying income for purposes of the REIT Gross Income Tests and the
100% prohibited transaction tax. Management does not believe that the Company
has engaged or will engage in transactions at the REIT level that would result in
the Company being classified as a dealer. However, there cannot be any assurance
that the Internal Revenue Service will agree;(c)
    if the Company has (i) net income from the sale or other
disposition of REO that is not further developed by the Company but which is
deemed held primarily for sale to customers in the ordinary course of business or
(ii) other non-qualifying income from foreclosure property, the Company will be
subject to Federal income tax on such income at the highest corporate income tax
rate; and(d)
    in addition, a nondeductible excise tax, equal to 4% of the excess
of required distributions over the amounts actually distributed will be imposed
on the Company for each calendar year to the extent that the sum of dividends
paid during the year, or declared during the last quarter of the year and paid
during January of the succeeding year, are less than the sum of (1) 85% of the
Companys ordinary income, (2) 95% of the Companys capital gain net income,
and (3) any undistributed income remaining from earlier years. The Company may
also be subject to the corporate alternative minimum tax (AMT), as well as
other taxes in certain situations not presently contemplated. If the Company fails any of the above-described REIT qualification tests in any
taxable year and the relief provisions available under the Code do not apply, the
Company would be subject to Federal income tax (including any applicable AMT) on its
taxable income at the regular corporate income tax rates. Distributions to
stockholders in any year in which the Company fails to qualify as a REIT would not be
deductible by the Company, nor would distributions generally be required to be made
under the Code. Further, unless entitled to relief under certain other provisions of
the Code, the Company would also be disqualified from re-electing REIT status for the
four taxable years following the year in which it became disqualified. The Company may also voluntarily revoke its election to be taxed as a REIT, although
Management has no intention of doing so, in which event the Company would be
prohibited, without exception, from electing REIT status for the year to which the
revocation relates and the following four taxable years. Management intends to monitor on an ongoing basis the Companys compliance with the
REIT requirements described above. In order to maintain its REIT status, the Company
may be required to limit the types of assets that it might otherwise acquire, or hold
certain assets at times when the Company might otherwise have determined that the sale
or other disposition of such assets would have been more prudent. Taxable REIT Subsidiaries. A Taxable REIT Subsidiary is any corporation in which a
REIT owns stock (directly or indirectly) and for which the REIT and such corporation
make an election to classify the corporation as a Taxable REIT Subsidiary. On May 2,
2002, Specialty Acquisition Corp (SAC) (wholly owned subsidiary created on May 2,
2002) and the Company 16




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elected to treat SAC as a Taxable REIT Subsidiary of the Company. Effective January 1,
2003, SAC formally obtained Taxable REIT Subsidiary status. The aggregate value of SAC along with any other Taxable REIT Subsidiary that the
Company may form in the future must be limited to 20% of the total value of the
Companys assets. In addition, the Company will be subject to a 100% penalty tax on
any rent, interest or other charges that it imposes on any Taxable REIT Subsidiary in
excess of an arms length price for comparable services. The Company anticipates that
any rents, interest or other charges imposed on SAC (or any other Taxable REIT
Subsidiary that it may form in the future) will be at arms length prices. The Company generally anticipates that it will derive income from SAC by way of
dividends. Such dividends are not real estate source income for purposes of the 75%
Gross Income Test. Therefore, when aggregated with the Companys other non-real
estate source income, such dividends must be limited to 25% of the Companys gross
income each year. The Company intends to monitor the value of its investment in and
the distributions from its Taxable REIT Subsidiaries to ensure compliance with all
applicable income and asset tests. A Taxable REIT Subsidiary doing business in the United States is generally subject to
corporate level tax on its net income and will generally be able to distribute only
net after-tax earnings to the Company as dividend distributions. Such dividends may,
however, qualify for the reduced dividends rate made available due to recent
legislation (described below). Qualified REIT Subsidiary. A Qualified REIT Subsidiary is a corporation in which the
REIT owns 100 percent of the stock and that is not a Taxable REIT Subsidiary. For
federal income tax purposes, the REIT is deemed to directly own the assets of the
Qualified REIT Subsidiary, and not the stock. For this reason, the assets and income
of the Qualified REIT Subsidiary are included with the REITs assets and income for
REIT qualification purposes. During 2003, the Company formed SAC II as a Qualified
REIT Subsidiary. Other Affiliates.At present, the Company has no other affiliates other than SAC and
SAC II. The Manager is an S-Corporation whose earnings are passed through to the sole
shareholder, Mr. Gonfiantini, as an individual. The Manager is not consolidated with
the Company for tax or accounting purposes. Fees paid to the Manager are generally
required to be reasonable and arms length; otherwise they may be re-characterized by
the IRS in ways that could have adverse tax consequences for the Company. Management
believes that the fees payable to the Manager, including any incentive or termination
fees, are reasonable compensation for the services provided. Taxation of Stockholders. For any taxable year in which the Company is treated as a
REIT for Federal income tax purposes, distributions (including constructive
distributions) made to holders of common stock other than tax-exempt entities (and not
designated as capital gain dividends) will generally be subject to tax as ordinary
income to the extent of the Companys current and accumulated earnings and profits as
determined for Federal income tax purposes. If the amount distributed exceeds a
stockholders allocable share of such earnings and profits, the excess will be treated
as a return of capital to the extent of the stockholders adjusted basis in the common
stock, which will not be subject to tax, and thereafter as a taxable gain from the
sale or exchange of a capital asset. Distributions designated by Management as capital gain dividends can generally be
treated by shareholders as gain from the sale or exchange of a capital asset held for
more than one year, but 17




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only to the extent that the designated distribution does not exceed the Companys
actual net capital gain for the taxable year. Distributions by the Company, whether characterized as ordinary income or as capital
gain, are not eligible for the reduced dividend rate available as a result of the
enactment of the Jobs and Growth Tax Relief Reconciliation Act of 2003. However,
distributions will qualify for the reduced rate to the extent they represent qualified
corporate dividends. A qualified corporate dividend is a dividend attributable to
income that was subject to corporate tax at the REIT level or attributable to
qualified dividend income received by the REIT (such as dividends from a Taxable REIT
Subsidiary). In the event that the Company realizes a loss for the taxable year, stockholders will
not be permitted to deduct any share of that loss. Further, if the Company (or a
portion of its assets) were to be treated as a taxable mortgage pool, or if it were to
hold residual interests in REMICs (Residential Mortgage Insurance Corporation) or
FASITs (Financial Asset Security Trust), any excess inclusion income derived there
from and allocated to a stockholder would not be allowed to be offset by a net
operating loss of such stockholder. Dividends declared during the last quarter of a taxable year and actually paid during
January of the following taxable year are generally treated as if received by the
stockholder on December 31 of the taxable year in which they are declared and not on
the date actually received. In addition, the Company may elect to treat certain other
dividends distributed after the close of the taxable year as having been paid during
such taxable year, but stockholders will be treated as having received such dividend
in the taxable year in which the distribution is made. Generally, a dividend distribution of earnings from a REIT is considered for estimated
tax purposes only when the dividend is made. However, effective December 15, 1999,
any person owning at least 10% of the vote or value of a closely held REIT must
accelerate recognition of year-end dividends received from the REIT in computing
estimated tax payments. The Company is not currently, and does not intend to be, a
closely held REIT. Upon a sale or other disposition of the common stock, a stockholder will generally
recognize a capital gain or loss in an amount equal to the difference between the
amount realized and the stockholders adjusted basis in such stock, which gain or loss
generally will be long-term if the stock was held for more than twelve months.
However, where a shareholder holding common stock for six months or less receives or
is deemed to receive a capital gains dividend, any subsequent loss on the sale of such
shares will generally be treated as a long-term capital loss to the extent of such
designated capital gains dividend. If common stock is sold after a record date but
before a payment date for declared dividends on such stock, a stockholder will
nonetheless be required to include such dividend in income in accordance with the
rules above for distributions, whether or not such dividend is required to be paid
over to the purchaser. Dividend Reinvestment Plan (DRIP) participants will generally be treated as having
received a dividend distribution, subject to tax as ordinary income, in an amount
equal to the fair market value of the common stock purchased with the reinvested
dividend proceeds generally on the date the Company credits such common stock to the
DRIP participants account, plus brokerage commissions, if any, allocable to the
purchase of such common stock. DRIP participants will have a tax basis in the shares
equal to such value. DRIP participants may not, however, receive any cash with which
to pay the resulting tax liability. Shares received pursuant to the DRIP will have a
holding period beginning on the day after their purchase by the plan administrator. 18




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The Company is required under Treasury Department regulations to demand annual written
statements from the record holders of designated percentages of its capital stock
disclosing the actual and constructive ownership of such stock and to maintain
permanent records showing the information received as to the actual and constructive
ownership of such stock and a list of those persons failing or refusing to comply with
such demand. In any year in which the Company does not qualify as a REIT, distributions made to the
stockholders would be taxable in the same manner discussed above, except that no
distributions could be designated as capital gain dividends, distributions would be
eligible for the corporate dividends received deduction, the excess inclusion income
rules would not apply, and stockholders would not receive any share of the Companys
tax preference items. In such event, however, the Company would be subject to
potentially substantial Federal income tax liability, and the amount of earnings and
cash available for distribution to its stockholders could be significantly reduced or
eliminated. Taxation of Tax-Exempt Stockholders. Subject to the discussion below regarding a
pension-held REIT, a tax-exempt stockholder is generally not subject to tax on
distributions from the Company or gain realized on the sale of the shares, provided
that such stockholder has not incurred indebtedness to purchase or hold its shares,
that its shares are not otherwise used in an unrelated trade or business of such
stockholder, and that the Company, consistent with its stated intent, does not form
taxable mortgage pools or hold residual interests in REMICs or FASITs that give rise
to excess inclusion income as defined under the Code. However, if the Company were
to hold residual interests in a REMIC or FASIT, or if a pool of its assets were to be
treated as a taxable mortgage pool, a portion of the dividends paid to a tax-exempt
stockholder may be subject to tax as unrelated business taxable income (UBTI).
Although Management does not intend to acquire such residual interests or believe that
the Company, or any portion of its assets, will be treated as a taxable mortgage pool,
no assurance can be given that the IRS might not successfully maintain that such a
taxable mortgage pool exists. If a qualified pension trust (i.e. any pension or other retirement trust that
qualifies under Section 401(a) of the Code) holds more than 10% by value of the
interests in a pension-held REIT at any time during a taxable year, a substantial
portion of the dividends paid to the qualified pension trust by such REIT may
constitute UBTI. For these purposes, a pension-held REIT is a REIT (i) that would
not have qualified as a REIT but for the provisions of the Code which look through
qualified pension trust stockholders in determining ownership of stock of the REIT and
(ii) in which at least one qualified pension trust holds more than 25% by value of the
interest of such REIT or one or more qualified pension trusts (each owning more than a
10% interest by value in the REIT) hold in the aggregate more than 50% by value of the
interests in such REIT. Assuming compliance with the ownership limit provisions in the
Companys Articles of Incorporation, it is unlikely that pension plans will accumulate
sufficient stock to cause the Company to be treated as a pension-held REIT. Distributions to certain types of tax-exempt stockholders exempt from federal income
taxation under Sections 501 (c)(7), (c)(9), (c)(17), and (c)(20) of the Code may also
constitute UBTI, and such prospective investors should consult their tax advisors
concerning the applicable set aside and reserve requirements. Taxation of Note Holders Characterization of Notes. Based on the advice of counsel, the Company treats the
Notes as debt for all tax purposes. 19




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(a) Status as Real Property Loans.Assuming the Notes are respected as debt issued by
the Company, for Federal income tax purposes: (i) Notes held by a thrift institution
taxed as a domestic building and loan association will not constitute
loans...secured by an interest in real property within the meaning of Code Section
7701 (a)(19)(C)(v) and (ii) interests on the Notes held by a real estate investment
trust will not be treated as interest on obligations secured by mortgages on
real property or on interest in real property within the meaning of Code Section
856(c)(4)(B) and the Notes will not constitute real estate assets or
government securities within the meaning of Code Section 856(c)(5)(A). (b) Taxation of Interest Income on the Notes.Because all Notes are anticipated to be
issued at par, interest paid or accrued on the Notes generally will be treated as
ordinary income to the note holders, and will be includible in income in accordance
with the note holders regular method of accounting. (c) Sale of Notes. Generally, if a note holder sells or otherwise disposes of their
Note, they will recognize gain or loss in an amount equal to the difference between
the amount realized on the sale and their adjusted tax basis in the Note. Any such
gain or loss recognized will be capital gain or loss if the Note is held as a capital
asset (generally, property held for investment) within the meaning of Code Section
1221, and will be short term capital gain or loss if the investment has been held for
not more than one year. However, certain types of investors (such as banks, thrifts
and other financial institutions), and certain investors engaged in risk reduction
strategies with respect to the Notes, may not qualify to treat the Notes as capital
assets, or the gain or loss there from as capital gain or loss. In addition, someone that purchases a Note from a note holder at a discount may become
subject to the market discount rules of sections 1276-1278 of the Code. As a result,
some, or all, of the principal paid or the gain recognized upon the disposition of the
Note by such holder could be taxed as ordinary interest income. (d) Foreign Investors. Assuming the Notes are respected as debt, interest paid on the
Notes to a holder that is a nonresident alien individual, foreign corporation or other
non-United States person, referred to as a Foreign Person, will be exempt from
United States Federal income and withholding taxes under the portfolio interest
provisions so long as (i) the interest is not effectively connected with a trade or
business of the recipient in the United States and (ii) the Foreign Person is not (a)
a direct or indirect ten percent or greater shareholder of the Company, (b) a
controlled foreign corporation, as that term is defined in the Code, related to the
Company, or (c) a bank receiving interest on an extension of credit made pursuant to a
loan agreement entered into in the ordinary course of its trade or business. Interest
paid to a Foreign Person that is not engaged in a United States trade or business and
that does not qualify under the portfolio interest exemption will generally be subject
to a 30% United States withholding tax unless the Foreign Person qualifies to claim a
lower rate under an applicable United States income tax treaty. In all events, a holder that is a Foreign Person must provide required information
certifications in order to claim any exemptions or reductions from withholding tax.
Foreign investors are urged to consult their tax advisors concerning regulations on
withholding and related certification requirements generally applicable to payments
made after December 31, 2000. If a Note were re-characterized as ownership of an equity interest in the Company, or
if exemptions from withholding tax are not available, certain payments related to the
Notes made to Foreign Persons would become subject to withholding tax at the rate of
30% and, in the hands 20




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of a corporate investor, could become subject to the branch profits tax. The Company
is not required to indemnify a note holder, or gross-up payments on the Notes, for any
withholding taxes. Information Reporting and Backup Withholding. The Company will report to its U.S.
stockholders, noteholders and the IRS the amount of distributions paid during each
calendar year, and the amount of tax withheld, if any. Under the backup withholding
rules, an investor may be subject to backup withholding generally equal to the fourth
lowest rate of Federal income tax then in effect with respect to distributions paid
unless such investor (a) is a corporation or comes within certain other exempt
categories and, when required, demonstrates that fact; or (b) provides a taxpayer
identification number, certifies as to no loss of exemption from backup withholding,
and otherwise complies with applicable requirements of the backup withholding rules.
An investor that does not provide the Company with its correct taxpayer identification
number may also be subject to penalties imposed by the IRS. Any amount paid as backup
withholding will be allowed as a credit against the investors income tax liability.
In addition, the Company may be required to withhold a portion of dividends and
capital gain distributions to any investors that do not certify under penalties of
perjury their non-foreign status. State and Local Taxes. The Company and its investors may be subject to state or local
taxation in various jurisdictions, including those in which it or they transact
business or reside. The state and local tax treatment of the Company and its
investors may not conform to the Federal income tax consequences discussed above.
Consequently, prospective investors should consult their own tax advisors regarding
the effect of state and local tax laws on an investment in the Companys stock or
Notes. Management Agreements Management Fees 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 original Management Agreement, the Company also paid to Specialty Financial
an incentive compensation for each fiscal quarter. For periods through the end of
fiscal year 2003, the incentive compensation was an amount equal to 50% of the net
tax-based income of Specialty Trust, before deduction of such incentive compensation,
in excess of an annualized return to Specialty Trust equal to 12%. The incentive
compensation calculation and payment were made quarterly in arrears. The term return
to Specialty Trust was calculated for the 21




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quarter by dividing taxable income for the quarter by the net worth for the quarter.
For such calculations, taxable income means the Companys taxable income before the
Managers incentive compensation, the deduction for dividends paid and net operating
loss deductions arising from losses in prior periods. A deduction for the Companys
interest expenses for borrowed money is taken when calculating taxable income. Net
worth for any period means the sum of the gross proceeds from all prior offerings of
equity securities by the Company, after deducting expenses and costs relating to the
offering (or for any period in which new equity securities are issued, the arithmetic
weighted average on the prior offering proceeds and the new proceeds for the period),
plus beginning retained earnings (without taking into account any losses incurred in
prior periods and excluding amounts reflecting taxable income to be distributed as
dividends and amounts reflecting valuation allowance adjustments). The definition
return to Specialty Trust was used only for purposes of calculating the incentive
compensation payable, and is not related to the actual distributions received by
stockholders. The incentive compensation payments to Specialty Financial were made
before any income distributions were made to the Companys stockholders. Under the Amended Agreement dated January 1, 2004, 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 could receive, 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 a Threshold Return which is a per annum target
percentage rate of return set by a mutual agreement between the Manager and the Board
of Directors of the Company for each calendar year beginning with the year 2004. For
the year 2004, the Threshold Return was set at 12%. Fees earned by the Manager for the years ended December 31, 2004, 2003 and 2002 are as
follows. Table 4: Components of Manager Compensation
For the years ended December 31, 2004
    
    
    2003
    
    
    2002Loan Origination and Extension Fees
    
    $
    2,894,828
    
    
    $
    2,259,153
    
    
    $
    1,610,059Loan Servicing Fees
    
    
    457,424
    
    
    
    455,923
    
    
    
    361,224Late Payment Charges
    
    
    49,842
    
    
    
    11,685
    
    
    
    9,295Subtotal
    
    $
    3,402,094
    
    
    $
    2,726,761
    
    
    $
    1,980,578Base Management Fee
    
    
    491,140
    
    
    
    
    
    
    
    Incentive Compensation Bonus
    
    
    
    
    
    
    391,579
    
    
    
    314,249Total Compensation
    
    $
    3,893,234
    
    
    $
    3,118,340
    
    
    $
    2,294,827
 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 the borrower. Late payment charges are received directly by
the Manager from the borrower. The incentive compensation was calculated in
accordance with the agreement and paid for or accrued in
Management and Directors fees in the Companys financial statements. 22




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Administrative Services Provided by the Manager Specialty Financial, as Manager, is responsible for the Companys day-to-day
operations and performs such services and activities relating to the assets and
operations of Specialty Trust as may be appropriate, including:  (i)
    representing Specialty Trust in connection with the origination or
purchase of mortgage loans;(ii)
    in accordance with the directions of the Board of Directors,
investing or reinvesting any money of Specialty Trust;(iii)
    furnishing reports and statistical and economic research to
Specialty Trust regarding Specialty Trusts real estate lending activities and
the performance of its portfolio of mortgage loans;(iv)
    administering the day-to-day operations of Specialty Trust and
performing administrative functions necessary in the management of Specialty
Trust, including the collection of revenues, the payment of Specialty Trusts
expenses, debts and obligations and the maintenance of appropriate computer
services to perform such administrative functions;(v)
    counseling Specialty Trust in connection with policy decisions to
be made by the Board of Directors;(vi)
    assisting Specialty Trust in its use of leverage to finance
mortgage loan acquisitions;(vii)
    overseeing the servicing of Specialty Trusts mortgage loans;(viii)
    establishing underwriting, appraisal and quality control procedures for the
mortgage loans of Specialty Trust;(ix)
    conducting a legal document review of each mortgage loan acquired
to verify the accuracy and completeness of the information contained in the
mortgage loans, security instruments and other pertinent documents in the
mortgage file;(x)
    providing Specialty Trust with data processing, legal and
administrative services to the extent required to implement the business strategy
of Specialty Trust;(xi)
    providing all actions necessary for compliance by Specialty Trust
with all federal, state and local regulatory requirements applicable to Specialty
Trust in respect of its business activities, including preparing or causing to be
prepared all financial statements required under applicable regulations and
contractual undertakings;(xii)
    providing all actions necessary to enable Specialty Trust to make
required federal, state and local tax filings and reports and generally enable
Specialty Trust to maintain its status as a REIT, including soliciting
stockholders for required information to the extent required by the REIT
provisions of the Code;(xiii)
    communicating on behalf of Specialty Trust with the stockholders of Specialty
Trust as required to satisfy any reporting requirements and to maintain effective
relations with such 23




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stockholders; and(xiv)
    performing such other services as may be required from time to
time for management and other activities relating to the assets of Specialty
Trust as the Board of Directors shall reasonably request or the Manager shall
deem appropriate under the particular circumstances. The Manager may enter into subcontracts with other parties to provide any such
services for the Company. Expenses The operating expenses required to be borne by the Manager include compensation and
other employment costs, the cost of office space and equipment and all other
administrative costs incurred in the Companys day-to-day operations. Those expenses
do not include debt service or taxes. While most costs are paid through the Manager
from fees earned by the Manager, the Company pays certain REIT-related expenses such
as directors fees, legal and accounting fees, and foreclosure and real estate owned
expenses directly. There are no caps or ceilings on any category of fees, compensation
or other expenses payable by the Company except for compensation payable to the
Manager and expenses to be borne by the Manager as described above. Term and Termination The management agreement had an initial term of three years beginning January 30, 1998
and is renewed automatically for successive one-year periods unless the Company timely
delivers a notice of nonrenewal. Upon nonrenewal of the management agreement without
cause, a termination fee will be payable to the Manager in an amount equal to the
greater of (i) the fair value of the management agreement as established by an
independent appraiser, or (ii) 4% of the mortgage loan portfolio of Specialty Trust.
At December 31, 2004, 4% of the Companys mortgage loan portfolio would be
approximately $3.8 million. In addition, the Company has the right to terminate the
management agreement at any time for cause. A majority of the Companys unaffiliated
directors (currently 6 of 7 directors are unaffiliated) may determine that the Manager
has violated the management agreement in a material respect and, after notice and an
opportunity to cure, terminate the agreement. Upon such a termination for cause, no
termination fee will be payable to the Manager. Potential Conflicts of Interest and Limits of Responsibility Certain provisions of the management agreement and the loan participation and
servicing agreement raise potential conflicts of interest or limit the Managers
responsibilities. Origination Fee.The first 2.5% (2 1/2 points) of any origination fees (points)
collected from the borrower is paid to the Manager as part of the initial funding of
the loan. The size of the mortgage origination fees are market driven but may vary and
may have a direct impact upon the interest rate the borrower is willing to pay and,
therefore, on the interest income the Company would receive from the loan. Loan Servicing Fee. As part of the servicing fee, one-half of one percent of the total
mortgage loan portfolio is paid to the Manager as a loan-servicing fee. Payment of
this fee, in effect,
lowers the yield on the mortgage loans. An undue emphasis on increasing the size of
the 24




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mortgage loan portfolio, thereby increasing the Managers compensation, could
result in the acquisition of riskier or more speculative loans. Base Management Fee.The Company pays the Manager a monthly base management fee equal
to 0.5% of the Mortgage Asset Portfolio. An undue emphasis on increasing the size of
the mortgage loan portfolio could result in the acquisition of riskier more
speculative loans or the reluctance by the Manager to sell REO properties and Land
Held for Residential Development, all of which are included in the Mortgage Asset
Portfolio for calculation of this fee. Incentive Fee.The Company also pays the Manager an incentive fee equal to 50% of the
Companys quarterly taxable income in excess of an annualized target return on its net
worth for that quarter. If the marketplace works as expected, i.e., higher risk,
higher reward, the incentive fee structure to the extent it encourages an undue
short-term emphasis on the acquisition of higher yielding loans could result in the
acquisition of riskier or more speculative loans. Services to Others. The management agreement does not limit or restrict the right of
the Manager to engage in any business or render services of any kind to any other
person, including the purchase of, or rendering advice to others purchasing mortgages
that meet the Companys policies and criteria. The management agreement does say that
the Manager and its officers may not provide services to another mortgage REIT unless
a majority of its unaffiliated directors (currently 6 of 7 directors are unaffiliated)
confirm that the other mortgage REIT has operating policies and strategies different
from the Companys. Neither Specialty Financial nor its sole owner provide or intend
to provide services to any mortgage REIT that is competitive to it or invests in
mortgages, which Specialty Trust might invest in, but there is nothing in the
management agreement that strictly precludes it. No Minimum Time Commitment. The management agreement does not impose a minimum time
commitment that the Manager and its personnel must devote to providing services to the
Company. The ability of the Manager to engage in other business activities could
reduce the time and effort spent by the Manager on the Companys Management. Limits of Manager Responsibility. The Manager assumes no responsibility other than to
render the services called for under the management agreement in good faith and shall
not be responsible for any action of the Board of Directors in following or declining
to follow any advice or recommendations of the Manager. The Manager, its directors,
officers, stockholders and employees will not be liable to the Company, any of its
subsidiaries, its subsidiaries stockholders or the unaffiliated directors for any
acts or omissions by the Manager, its directors, officers, stockholders or employees
under or in connection with the management agreement, except by reason of acts or
omissions constituting bad faith, willful misconduct, gross negligence or reckless
disregard of their duties under the management agreement. Indemnification.The Company has agreed to indemnify the Manager, its directors,
officers, stockholders and employees with respect to all expenses, losses, damages,
liabilities, demands, charges and claims arising from any acts or omissions of the
Manager made in good faith in the performance of its duties under the management
agreement and not constituting bad faith, willful misconduct, gross negligence or
reckless disregard of its duties. Available Information The Company expects to file annual, quarterly and special reports, and other
information with the SEC for so long as any of its publicly-issued collateralized notes remain
outstanding. Its SEC 25




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filings will be available to the public over the Internet at the
SECs web site at http://www.sec.gov. You may also read and copy any document the
Company files at the SECs public reference rooms in Washington, D.C., New York, New
York, and Chicago, Illinois. Please call the SEC at 1-800-SEC-0300 for further
information on the public reference rooms. The Manager maintains a website on the World Wide Web at www.specialtyfi.com. You may
also request a free copy of any of the above filings by writing or calling: Specialty Trust, Inc.
6160 Plumas Street
Reno, Nevada 89509
(775) 826-0809 26




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Item 2. Properties The Companys Manager, Specialty Financial, operates its executive
offices at 6160 Plumas Street, Reno, NV 89509. Specialty Trust
does not have any separate offices. 
 Item 3. Legal Proceedings At December 31, 2004, other than litigation in the ordinary course of business
involving foreclosures or other exercise of the Companys 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 4. Submission of Matters to a Vote of Security Holders None. 
 PART II. 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities (a)Market Information The Companys Common Stock has not been registered under the Securities act or any
state securities laws, and is privately held. The fair market value of the stock, as
determined by the Board of Directors, effective December 28, 2002 is $11.00 per share. (b)Investors The number of record holders of the Companys Common Stock as of December 31, 2004 and
2003, was 344 and 319, respectively. (c)Dividends The Company currently pays cash dividends on a quarterly basis. Total cash dividends
declared by the Company to shareholders as of December 31, 2004 and 2003 were
$9,259,950 ($1.15 per share) and $8,998,821 ($1.20 per share), respectively. In
general, consistent with the Companys underlying operational strategy, the Companys
dividends for the most part will be characterized as ordinary income to its
stockholders for federal tax purposes. However, a portion of the Companys dividends
may be characterized as capital gains or return of capital. The Company has a dividend reinvestment plan for shareholders who choose to reinvest
all or part of their distributions in additional shares of common stock instead of
receiving cash payments. The reinvestment price is the fair market value as determined
by the Board of Directors. Any future discount to the then current market price, if
there is a public market for the stock, cannot exceed 5% of the fair market value of
the stock to comply with REIT qualification requirements. The Company uses the
proceeds for mortgage loans, working capital and general corporate purposes. 27




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##### Table of Contents



The Company has elected to be treated as a REIT for federal tax purposes beginning
with its 1998 taxable year and, as such, has distributed and anticipates distributing
annually at least 90% (95% prior to January 1, 2001) of its taxable income, subject to
certain adjustments. Although the Company may borrow funds to make distributions;
cash for such distributions has generally been and is anticipated to continue to be
largely generated from the Companys results of operations. The Company declared the following dividends during the year ended December 31, 2004
and 2003: Dividend
    
    
    Dividendsper Share
    
    
    Reinvested Common
    
    
    CommonDeclaration Date
    
    Record Date
    
    
    Payment Date
    
    
    Stock
    
    
    Stock2004April 27, 2004
    
    March 31, 2004
    
    April 30, 2004
    
    $
    0.275
    
    
    $
    1,374,252June 21, 2004
    
    June 30, 2004
    
    July 15, 2004
    
    $
    0.30
    
    
    $
    1,548,206September 27, 2004
    
    September 30, 2004
    
    October 8, 2004
    
    $
    0.30
    
    
    $
    1,590,249December 13, 2004
    
    December 31, 2004
    
    January 14, 2005
    
    $
    0.275
    
    
    $
    1,472,4912003April 28, 2003
    
    March 31, 2003
    
    April 30, 2003
    
    $
    0.30
    
    
    $
    1,263,231June 30, 2003
    
    June 30, 2003
    
    July 28, 2003
    
    $
    0.30
    
    
    $
    1,324,128October 27, 2003
    
    September 30, 2003
    
    October 29, 2003
    
    $
    0.30
    
    
    $
    1,368,792December 8, 2003
    
    December 31, 2003
    
    January 12, 2004
    
    $
    0.30
    
    
    $
    1,521,383
 Dividends are declared by the Companys Board of Directors after considering the
Companys available cash for distribution, financial condition, ability to maintain
its REIT status, and such other factors that may be deemed relevant. See Item 7,
Managements Discussion and Analysis of Financial Conditions and Results of
Operations, for information regarding the sources of funds used for dividends and for
a discussion of factors, if any, which may adversely affect the Companys ability to
pay dividends at the same levels in 2005 and thereafter. 28




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##### Table of Contents



(d)
    Equity Compensation Plans The following table represents the number of securities to be issued and available for future
issuance at December 31, 2004. Number of securities remainingNumber of securities to be
    
    
    Weighted average exercise
    
    
    available for future issuanceissued upon exercise of
    
    
    price of outstanding
    
    
    Under equity compensation plansoutstanding options, warrants
    
    
    options, warrants and
    
    
    (excluding securities reflected inand rights (a)
    
    
    rights (b)
    
    
    column (a))Equity compensation
plans approved by
security holders
    
    
    531,732
    
    
    $
    10.82
    
    
    
    155,553Equity
compensation plans
not approved by
security holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    531,732
    
    
    $
    10.82
    
    
    
    155,553
 The total number of securities remaining for future issuance at December 31, 2004: 10% of outstanding stock
    
    
    827,253Less:Number of shares to be issued upon
exercise of outstanding stock options
    
    
    531,732Number of shares previously granted
and exercised
    
    
    139,968Number of securities remaining available
    
    
    155,553
 29




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##### Table of Contents



Item 6. Selected Financial Data The information in this table should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations and with the
financial statements and the notes thereto included elsewhere in this annual report. For the years ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Statement of Earnings Data:Interest and Dividend Income
    
    $
    12,037,650
    
    
    $
    11,676,727
    
    
    $
    9,726,660
    
    
    $
    7,797,169
    
    
    $
    5,715,590Interest Expense
    
    
    2,149,347
    
    
    
    1,741,831
    
    
    
    828,566
    
    
    
    744,020
    
    
    
    626,332Net Revenues
    
    
    10,724,708
    
    
    
    9,857,574
    
    
    
    8,167,593
    
    
    
    6,582,893
    
    
    
    4,689,258Net Earnings
    
    
    9,112,960
    
    
    
    8,252,745
    
    
    
    7,144,707
    
    
    
    6,085,129
    
    
    
    4,543,772Preferred Stock Dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,540,231
    
    
    
    5,070,963Net Earnings (Loss) attributable to Common Stock
    
    $
    9,112,960
    
    
    $
    8,252,745
    
    
    $
    7,144,707
    
    
    $
    1,544,898
    
    
    $
    (527,191
    )Basic Earnings (Loss) Per Share
    
    $
    1.14
    
    
    $
    1.11
    
    
    $
    1.02
    
    
    $
    0.79
    
    
    $
    (1.62
    )Diluted Earnings (Loss) Per Share
    
    $
    1.13
    
    
    $
    1.10
    
    
    $
    1.01
    
    
    $
    0.77
    
    
    $
    (1.62
    )Dividends  Preferred Stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    4,540,231
    
    
    $
    5,070,963Dividends  Common Stock
    
    $
    9,259,950
    
    
    $
    8,998,821
    
    
    $
    8,440,451
    
    
    $
    2,046,810
    
    
    
    Balance Sheet Data (Shown as of period end)Mortgage Loans
    
    $
    94,593,696
    
    
    $
    95,610,164
    
    
    $
    96,245,394
    
    
    $
    73,331,659
    
    
    $
    55,863,036Allowance for Loan Losses
    
    
    (1,130,138
    )
    
    
    (1,424,256
    )
    
    
    (1,815,576
    )
    
    
    (1,020,321
    )
    
    
    (750,000
    )Unearned Discount
    
    
    (112,625
    )
    
    
    (103,966
    )
    
    
    (120,489
    )
    
    
    (78,144
    )
    
    
    (8,187
    )Total Mortgage Loans, net
    
    $
    93,350,933
    
    
    $
    94,081,942
    
    
    $
    94,309,329
    
    
    $
    72,233,194
    
    
    $
    55,104,849Real Estate Owned
    
    $
    9,621,495
    
    
    $
    7,913,160
    
    
    $
    950,000
    
    
    $
    445,424
    
    
    
    Land Held for Residential Development
    
    $
    1,879,432
    
    
    $
    2,377,457
    
    
    $
    2,448,579
    
    
    $
    2,782,715
    
    
    
    Total Assets
    
    $
    122,136,068
    
    
    $
    108,458,694
    
    
    $
    99,323,596
    
    
    $
    77,667,422
    
    
    $
    58,659,056Short-Term Borrowings
    
    $
    41,242,610
    
    
    $
    33,410,279
    
    
    $
    29,107,031
    
    
    $
    9,475,441
    
    
    $
    11,005,960Number of Preferred Shares Outstanding
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,624,276Number of Common Shares Outstanding
    
    
    8,272,529
    
    
    
    7,684,813
    
    
    
    7,183,004
    
    
    
    6,822,703
    
    
    
    334,400
 30




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated 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 the Companys
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, see Risk Factors commencing on Page 13 of the Companys prospectus
included in the Registration Statement on Form S-11 (File No. 333-86962) filed on
April 25, 2002, relating to the Companys collateralized investment notes. 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. The company funds its loans chiefly through equity and to a
lesser degree with short-term debt. This short-term debt is in the form of secured
bank lines of credit or collateralized notes. The Companys 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, California, Utah, and Colorado whose needs are generally not being served by
traditional financial institutions. The Companys strategy is to focus on land loans,
construction loans, commercial building loans and nonconforming single-family and
small multifamily residential loans. The Company generally limits the amount of
investment in any single mortgage loan or in mortgage loans to one borrower to 10% of
Specialty Trust, Inc.s total assets, although the Board of Directors may approve
exceptions. As of December 31, 2004, there were no mortgage loans which exceeded the
10% threshold, and one borrower whose total loans exceeded the 10% threshold, which
the board approved. Most loans will have terms of one to three years. The Companys
mortgage loans may be secured by mortgages on unimproved as well as improved real
property and non-income producing as well as income-producing real property. Some
mortgage loans may be secured by borrowers leasehold interest in real property. The
Companys loans generally produce higher yields than are obtained on traditional
single-family residential mortgage loans, but are subject to higher risks of default
and loss. The Company is structured as a real estate investment trust (REIT), thereby generally
eliminating Federal taxes at the corporate level on income it distributes to
stockholders. Because the Company is not structured as a traditional lender that
accepts deposits, it is subject to substantially less regulatory oversight and
therefore incurs lower compliance expenses compared to banks, thrifts and many other
holders of mortgage loans. Specialty Financial serves as the Companys Manager and is responsible for loan
originations, loan servicing and the Companys day-to-day operations, subject to the
supervision of the Companys Board of Directors. 31




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##### Table of Contents



Significant Aspects of Years Ended 2004 and 2003 At December 31, 2004, the Company owned approximately $94.6 million of mortgage loans
and approximately $11.5 million of land held for residential development and
foreclosure property. The Companys total assets were approximately $122.1 million.
These assets were financed with approximately $41.2 million of collateralized notes,
and approximately $78.3 million of equity. At December 31, 2004, the Companys equity-to-assets ratio was 64.1% and the Companys
debt-to-equity ratio was 52.7%, the Companys return on equity for the year ended
December 31, 2004 was 12.1%. At December 31, 2003, the Company owned approximately $95.6 million of mortgage loans
and approximately $10.3 million of land held for residential development and
foreclosure property. The Companys total assets were approximately $108.5 million.
These assets were financed with approximately $33.4 million of collateralized notes
and approximately $72.1 million of equity. At December 31, 2003, the Companys equity-to-assets ratio was 66.5% and its
debt-to-equity ratio was 46.3%, its return on equity for the year ended December 31,
2003 was 11.4%. The increase in assets was primarily the result of an increase in cash received from
investing activities and net cash received from the collateralized note program of
approximately $6.3 million. The increase in liabilities was a result of the increased
use in the collateralized note program. The increase in stockholders equity was
primarily the result of stockholders reinvesting dividends from earnings in the
dividend reinvestment program for the year ended December 31, 2004. Critical Accounting Policies Management has the obligation to insure that its policies and methodologies are in
accordance with generally accepted accounting principles. During 2004, Management
reviewed and evaluated its 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 principles
requires Management 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 the Companys judgment and assumptions regarding
various economic conditions that it believes are reasonable based on facts and
circumstances existing at the time of reporting. In preparing these consolidated
financial statements, Management has made its 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 the Companys consolidated financial
statements where understanding accounting policies is critical to understanding and
evaluating its reported 32




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##### Table of Contents



financial results, especially given the significant estimates used in applying the
policies. The discussion is intended to demonstrate the significance of estimates to
the Companys consolidated financial statements and the related accounting policies. Detailed
accounting policies are described in Note 1 to the Companys consolidated financial
statements, included in Item 8. Management has discussed the development and
selection of these critical accounting estimates with the audit committee of the
Companys Board of Directors and the audit committee has reviewed its disclosure. 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 after 90 days, when foreclosure proceedings have been initiated, or
when the Loan-to-Value exceeds 100% whichever event occurs first. Management believes
the Companys revenue recognition policies are appropriate to reflect the substance of
the underlying transactions. Allowance for Loan Loss The Company maintains an allowance for possible loan losses on mortgage loans.
Additions to the allowance are based on an assessment of certain factors including,
but not limited to 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
any events or changes in circumstances indicate that the carrying amount of the assets
may not be recoverable. In Managements opinion, and based on its estimates, real
estate owned and land held for development are considered to be held for investment
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 value less cost
to sell. Fair 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 the fair value are based on the best information
available at the time of analysis. Income Taxes The Companys financial results generally do not reflect provisions for current or
deferred taxes. Management believes that the Company has and intends to continue to
operate in a manner that will continue to allow it to be taxed as a REIT and as a
result, does not anticipate paying substantial corporate level taxes. Many of these
requirements, however, are highly technical and complex. If the Company were to fail
to meet these requirements, the Company would be subject to federal income tax. 33




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##### Table of Contents



Off-Balance Sheet Commitments The majority of the Companys assets are funded with long-term debt issued in
securitizations. The Company consolidates the assets and liabilities of these
securitizations and therefore these transactions do not create off-balance sheet
commitments. The companys only category of off-balance sheet commitments is the forward purchase
commitments it enters into to purchase real estate loan assets. At December 31, 2004,
pursuant to the ordinary course of business, the Company had future commitments to
fund approximately $3.6 million in additional real estate loans under existing loan
arrangements. Changes in Financial Condition 2004 Compared to 2003 AssetsCash and Cash Equivalents and Restricted Cash.Cash and cash equivalents and
restricted cash increased by approximately $13.3 million as of December 31, 2004,
compared to December 31, 2003. The timing of loan funding and the timing of debt and
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
$300,000 (34%) as of December 31, 2004 compared to December 31, 2003 primarily due to
the Companys investment in loans with a deferred interest component in 2004. Under
these loans, borrowers pay a reduced rate of interest during the loan term while
interest accrues at a substantially higher rate. The deferred interest is due upon
maturity of the loan. Land Held for Residential Development.Land held for residential development
decreased by approximately $498,000 (21%) as of December 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. An appraisal was obtained at the
time of foreclosure, which provided an allocation of the fair values 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 cost, which the
company or its 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 for the uncompleted lots.
Additionally, the homebuilder is responsible to pay SAC the difference between the
original appraisal value per lot and 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 reduced 34




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##### Table of Contents



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 records proceeds as a
reduction to the land held for residential development as Phases I and II of the
development are expected to result in minimal profit. 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, engineering costs, real estate taxes and insurance fees in 2002,
all of which were capitalized. Forty-four homes were sold during the fiscal year ended
December 31, 2004 leaving eighteen homes to sell in Phases I and
II as well as the Phase III land. The following
provides a roll-forward of this account: Balance at December 31, 2003
    
    $
    2,377,457Capitalized costs
    
    
    212,636Net proceeds from sale of homes
    
    
    (710,661
    )Balance at December 31, 2004
    
    $
    1,879,432
 On June 20, 2003, the homebuilder neglected to exercise his option to purchase Phase
III of the Project. The Company has subsequently engaged a contractor to complete the
project. Real Estate Owned.Real Estate Owned increased by approximately $1.7 million (22%) as
of December 31, 2004 compared to December 31, 2003. This increase was due primarily to
the acquisition of property in Castle Rock, Colorado through foreclosure and
additional capitalized costs related to the property in Telluride, Colorado offset by
the sale of a portion of the parcel of raw land in Mesquite, Nevada and the sale of
the property in Las Vegas, Nevada. Mortgage Loans.Mortgage loans held for investment net of allowance for loan losses
and unearned discounts decreased by approximately $731,000 (1%) as of December 31,
2004 compared to December 31, 2003. The allowance for loan losses was decreased by
approximately $300,000 during the year ended December 31, 2004 due to the charge off
of a specific reserve to real estate owned and a decrease in the average risk rating
for the remaining portfolio. The Companys gross mortgage loan portfolio has declined by approximately $1.0 million
from its level at year-end 2003 due to paydowns and increased competition for new loan
originations. The generally high level of liquidity in the banking system has resulted
in competition from commercial banks and other financial institutions that typically
do not focus on the types of mortgage loans acquired by the Company. The Company has
elected to maintain its underwriting standards and threshold return requirements
rather than making concessions solely to support the level of the loan portfolio. Other Assets.Other assets decreased by approximately $387,000 (71%) as of December
31, 2004 compared to December 31, 2003 primarily due to the write off of debt offering
costs as a result of the Companys deregistration of its collateralized note program. LiabilitiesDividends Payable.Dividends payable decreased by approximately $30,000 (1%) as of
December 31, 2004 compared to December 31, 2003 due primarily to a decrease in the
dividend declared from $.30 per share in December of 2003 to $.275 per share in
December of 2004 which is partially offset by an increase in the number of shares
outstanding. Accounts Payable, Accrued Expenses and Accounts Payable-Related Party.Accounts
payable and accrued expenses and accounts payable-related party decreased by
approximately $187,000 35




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##### Table of Contents



(42%) as of December 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 December 31, 2004 and due to the timing of expenses being accrued
for at December 31, 2003. As of December 31, 2004, most of these expenses were paid
and therefore not included in accounts payable and accrued expenses. Deferred Revenue and Other Liabilities.Deferred revenue and other liabilities
decreased by approximately $113,000 due primarily to the recognition of a deferred
gain upon payoff of the related mortgage loan. Collateralized Notes and Collateralized Notes-Related Party.Collateralized notes
increased by approximately $7.8 million (23%) as of December 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
significantly higher than the average rates paid by banks. Our collateralized notes
were authorized for public sale on January 19, 2001. On November 24, 2004, the
Company filed Post Effective Amendment No. 3 to the Companys registration statement
to effectively deregister the remaining unsold collateralized notes. 2003 Compared to 2002 AssetsCash and Cash Equivalents. Cash and cash equivalents increased by approximately $2.5
million as of December 31, 2003, compared to December 31, 2002. The timing of loan
funding and the timing of debt or equity issues generally determine the amount of cash
held by the Company. It is the Companys goal to keep cash invested in loans or other
financial instruments and therefore keep cash balances low whenever possible. Accrued Interest Receivable.Accrued interest receivable decreased by approximately
$248,000 (22%). This decrease is primarily due to a decrease in delinquent and past
due loans. Land Held for Residential Development.Land held for residential development
decreased by approximately $71,000 (3%) as a result of the sale of completed homes.
The decrease is partially offset by the capitalization of additional costs of
approximately $197,000. Fourteen homes were sold during the fiscal year ended December 31, 2003. The
following provides a roll-forward of this account: Balance at December 31, 2002
    
    $
    2,448,579Capitalized costs
    
    
    197,438Net proceeds from sale of homes
    
    
    (268,560
    )Balance at December 31, 2003
    
    $
    2,377,457
 Real Estate Owned (Held for Sale).Real Estate Owned increased by approximately $7
million (733%) as a result of the acquisition of property, net of related sales. 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 speculative home in Aspen, Colorado with a loan balance of approximately
$1.9 36




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##### Table of Contents



million. During the third quarter, the property was sold. As a result, the
Company recognized a profit of approximately $90,000 and has a note receivable
in the amount of $125,000. The Company had write-downs of $250,000 related to the Mesquite, Nevada properties in
the net balance of Real Estate Owned. On April 4, 2003, the Company acquired real estate owned property through a
foreclosure on a mortgage loan whose outstanding balance at the time of foreclosure
was approximately $1.6 million, including principal and accrued interest. The
properties consisted of a hotel and three parcels of land, which were transferred from
mortgage loans to real estate owned upon foreclosure. The Company sold the hotel and
two of the parcels of land resulting in a loss of approximately $144,000 and $27,000,
respectively. LiabilitiesDividends Payable.Dividends Payable increased by approximately $151,000 (7%). This
increase was primarily due to the increase in the number of common shares outstanding,
which have been issued through the Dividend Reinvestment Program. Lines of Credit. Borrowings under lines of credit decreased by approximately $9.3
million at December 31, 2003. The decrease was primarily due to loan pay-offs of
approximately $12 million in December 2003. The Company used the cash to pay-off the
borrowings under the lines of credit. Collateralized Notes and Collateralized Notes  Related Party.Collateralized Notes
increased by approximately $13.6 million (69%) because of increased issuance of such
notes due to increased demand. The Companys stated interest rates are higher than
the average rates paid by state and federal banks. Increased advertising and
marketing efforts have allowed more investors to become aware of the interest rate
differences and as a result have moved their deposits from state and federal banks to
the Companys collateralized note program. The collateralized notes were approved for
public sale on January 18, 2001 in the Companys initial registration statement. 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. 37




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##### Table of Contents



Year Ended
    
    
    Year EndedDecember 31, 2004
    
    
    December 31, 2003Over/Under
    
    
    Over/UnderDecember 31, 2003
    
    
    December 31, 2002Net
    
    
    
    
    
    
    
    
    
    
    NetChange
    
    
    Rate
    
    
    Volume
    
    
    Change
    
    
    Rate
    
    
    VolumeInterest IncomeMortgage Loans
    
    $
    201,516
    
    
    $
    1,351,389
    
    
    $
    (1,149,873
    )
    
    $
    2,005,441
    
    
    $
    (614,808
    )
    
    $
    2,620,249Cash Accounts
    
    
    159,407
    
    
    
    1,916
    
    
    
    157,491
    
    
    
    (55,374
    )
    
    
    (22,116
    )
    
    
    (33,258
    )Total
    
    $
    360,923
    
    
    $
    1,353,305
    
    
    $
    (992,382
    )
    
    $
    1,950,067
    
    
    $
    (636,924
    )
    
    $
    2,586,991Interest ExpenseLine of Credit
    
    $
    (339,436
    )
    
    
    
    
    
    $
    (339,436
    )
    
    $
    305,212
    
    
    $
    2,697
    
    
    $
    302,515Notes Payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,623
    )
    
    
    
    
    
    
    (4,623
    )Collateralized
Notes
    
    $
    746,952
    
    
    $
    4,982
    
    
    $
    741,970
    
    
    
    612,676
    
    
    
    32,359
    
    
    
    580,317Total
    
    $
    407,516
    
    
    $
    4,982
    
    
    $
    402,534
    
    
    $
    913,265
    
    
    $
    35,056
    
    
    $
    878,209Change in Net
Interest Income
    
    $
    (46,593
    )
    
    $
    1,348,323
    
    
    $
    (1,394,916
    )
    
    $
    1,036,802
    
    
    $
    (671,980
    )
    
    $
    1,708,782
 The Companys operating results include all of the reported income of its
mortgage finance operation. The comparison of the year ended December 31, 2004 and
2003 is as follows: 2004 Compared to 2003 Interest Income, Mortgage Loans.Interest Income, Mortgage Loans increased
approximately $202,000 (2%) for the year ended December 31, 2004 as compared to 2003.
This increase was due primarily to an increase in interest income due to the receipt
of substantial delinquent interest during the year and an overall increase in the
average rates charged offset by a decrease in the volume of loans outstanding for
portions of the year. Interest Income, Cash Accounts.Interest Income, Cash Accounts increased approximately
$159,000 (817%) for the year ended December 31, 2004 as compared to December 31, 2003.
This increase was due primarily to an overall increase in average cash balances as a
result of paydowns of mortgage loans. Total Interest Expense.Interest expense increased by approximately $408,000 (23%)
for the year ended December 31, 2004 as compared to 2003. The increase was primarily
due to an increase in collateralized notes from the prior year. Provision for Loan Losses.Provision for Loan Losses decreased by approximately
$59,000 (236%) primarily due to a decrease in high risk or problem loans, some of
which were transferred to real estate owned upon foreclosure. Real Estate Owned Gain/(Loss).Real Estate Owned Gain/(Loss) increased by
approximately $819,000 due primarily to the sale of a portion of the REO held in
Mesquite, Nevada and the sale of the property in Las Vegas, Nevada and to the
recognition of deferred revenue as a result of the payoff of the related loan. Rental and Other Income. Rental and Other Income increased by approximately $36,000
(109%) for the year ended December 31, 2004 as compared to 2003. This increase was
primarily due to the receipt of rental income from an REO property during the year
ended December 31, 2004. 38




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##### Table of Contents



General and Administrative Expenses. General and Administrative expenses increased by
approximately $230,000 (39%) for the year ended December 31, 2004 compared to 2003.
This increase was due primarily to the write off of debt offering expenses as a result
of the Companys decision to deregister its remaining unsold collateralized notes. Management and Directors Fees. Management and Directors Fees increased by
approximately $118,000 (22%) due primarily to the establishment of a base management
fee paid from the Company to its Manager under an amended management agreement
effective January 1, 2004. The management fees paid to the Manager in 2004 consisted
entirely of the base management fee and no incentive compensation bonus was paid
during the year. Other Expenses.Other Expenses decreased by approximately $341,000 (71%) for the year
ended December 31, 2004 compared to prior year due to significantly greater
foreclosures in 2003 than 2004. 2003 Compared to 2002 Interest Income, Mortgage Loans.Interest income increased approximately $2.0 million
(20%) for the year ended December 31, 2003 as compared to 2002. This increase was due
primarily to additional funds invested in mortgage loans as a result of increased cash
available from dividend reinvestments during the period and the use of short-term
borrowings to fund a corresponding increase in loan demand. Total Interest Expense.Interest expense increased by approximately $913,000 (110%)
for the year ended December 31, 2003 as compared to 2002. The increase is primarily
due to an increase in collateralized notes from the prior year, as well as
significantly more line of credit borrowings during 2003 versus 2002. Provision for Loan Losses:Provision for Loan Losses decreased by approximately
$770,000 (97%) primarily due to a decrease in high risk or problem loans, some of
which were transferred to real estate owned upon foreclosure. Other Income.Other income decreased by approximately $49,000 for the year ended
December 31, 2003 as compared to 2002. This decrease was primarily due to the gain on
sale of real estate owned in fiscal year ended December 31, 2002 in addition to
operating income generated from one of the foreclosure properties. Total Expenses.Total expenses increased by approximately $582,000 (57%) for the year
ended December 31, 2003 as compared to 2002. Other expenses increased by
approximately $332,000, which primarily represents foreclosure fees paid by the
Company. In addition, there was an increase in professional fees from the prior year
due to increased audit and tax fees. Management and Directors fees also increased as
the Company incurred a management incentive bonus of approximately $392,000 in 2003
compared to $314,000 in 2002 and directors stock compensation fees of approximately
$66,000 in 2003 compared to $0 in 2002. Interest Rate/Market/Credit Risk Management seeks to manage the interest rate, credit and market risk of the Companys
portfolio. By originating short-term loans (generally less than three years), the
Company can significantly reduce the risk of changing interest rates. Although the
majority of the Companys 39




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loans are in the states of Arizona and Nevada, it is also acquiring loans in
California, Utah, and Colorado. The following table sets forth the weighted average yield earned on the Companys
assets and the weighted average expense of the Companys liabilities for the periods
shown. Interest Rate/ Market/ Credit Risk
For the years ended December 31, 2004
    
    
    2003
    
    
    2002Interest IncomeMortgage Loans
    
    
    13.21
    %
    
    
    11.77
    %
    
    
    12.53
    %Cash Accounts
    
    
    1.03
    %
    
    
    0.64
    %
    
    
    1.63
    %Interest ExpenseLine of Credit
    
    
    
    
    
    
    4.19
    %
    
    
    4.67
    %Notes Payable
    
    
    
    
    
    
    
    
    
    
    0.50
    %Collateralized Notes
    
    
    5.56
    %
    
    
    5.54
    %
    
    
    5.33
    %Net Interest Spread
    
    
    5.83
    %
    
    
    6.52
    %
    
    
    7.09
    %
 Liquidity and Capital Resources Management handles the Companys short-term liquidity (that is, the Companys 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 the Companys mortgage
portfolio produce monthly cash flow, which can be used to originate new loans, service
debt and pay dividends to stockholders. This source provided approximately $11.6
million during 2004. Management generally has the ability to apply this cash flow as
needed. Secondly, the payoff and prepayment of loans provides additional liquidity to the
Companys portfolio. Historically, the Company has experienced annual loan payoffs and
prepayments of approximately 30% to 35% of its outstanding portfolio. More recently,
the Company has experienced more accelerated payoffs due to more loans having shorter
maturities. The payoff of mortgage loans provided approximately $112 million during
2004. When the Company is again able to issue collateralized notes, its portfolio
will increase as will the cash flow from principal pay downs. Again, normally these
funds are used to originate new mortgage loans, but can be used in other ways. The following table illustrates the scheduled maturities of mortgage loan investments
subsequent to December 31, 2004: Maturity
    
    Amount2005
    
    $
    28,904,3802006
    
    
    49,589,3162007
    
    
    16,100,000$
    94,593,696
 Under existing loans, the Company is required to fund additional loan amounts totaling
$3,647,385 as of December 31, 2004. 40




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Thirdly, the Company had the ability to issue collateralized notes to provide
additional liquidity to its portfolio. As of May 7, 2002, the Company was able to
offer collateralized notes with maturities of up to five years. Management has
utilized collateralized notes to meet a portion of the Companys short-term funding
needs in the past. However, on November 24, 2004 the Company filed an amendment to its
registration effectively deregistering the collateralized note program. As a result,
no additional collateralized notes can be publicly offered under the program. The
Company expects to be able to begin offering collateralized notes on a private basis
in June 2005. See page 9 for further discussion of the change in the collateralized
note program. The following table reflects the maturities of collateralized notes as
of December 31, 2004: Maturity Year
    
    Amount2005
    
    $41,242,610
 Lastly, the Company had two committed lines of credit with commercial banks to provide
another level of liquidity as of December 31, 2004. The Company can borrow $6.5
million and $7.0 million on two separate lines of credit to provide funding for new
mortgage loans, for an aggregate of $13.5 million in available credit. The $6.5
million line is available through June 15, 2005. The $7.0 million line is available
through October 15, 2005. Both of the lines 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 the Company is presently engaged in, and (ii) any change in executive and
management personnel that would 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, and (iii) a maximum
amount allowable for lines of credit of $20 million. As of December 31, 2004, the
Company is in compliance with these covenants and had a zero outstanding balance on
these lines of credit. Management believes that the combination of these four sources of capital allows the
Company to manage its short-term liquidity needs in virtually any business situation
and thereby efficiently use its capital resources. With respect to the Companys long-term liquidity (funding needs during periods beyond
the next 12 months), its only commitments that require funding are those arising from
its construction loans. The Company does not have any commitments for material
capital expenditures or payments due on long-term debt obligations. The Company
believes the same four sources it relies on for short-term liquidity needs will be
sufficient to fund its long-term needs as well. Contractual Obligations and Commitments as of December 31, 2004 Payments Due or Commitment Expiration By PeriodLess ThanTotal
    
    
    1 Year
    
    
    1-5 YearsShort-Term
DebtCollateralized Notes
    
    $
    41,242,610
    
    
    $
    41,242,610
    
    
    $
    -0-Interest on
Collateralized Notes
    
    $
    955,200
    
    
    $
    955,200
    
    
    $
    -0-Total
    
    $
    42,197,810
    
    
    $
    42,197,810
    
    
    $
    -0-CommitmentsMortgage Loans
    
    $
    3,647,385
    
    
    $
    3,647,385
    
    
    $
    -0-
 41




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##### Table of Contents



Risk Management and the Allowance for Loan Losses

The loan portfolio is the Companys primary asset subject to credit risk. To reflect
this credit risk, the Company records an allowance for loan 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
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 informs Management of credit
risk and helps minimize 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. Evaluation 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 when originated. They are re-graded on a quarterly
basis and numerous factors are considered such as renewal, loans to the same borrower,
identified facts demonstrating heightened risk of nonpayment, and delinquency. The
loan review 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 directors
along with actions to be taken. Watch list loans are those loans considered as having
weakness detected in character, capacity to repay or balance sheet concerns and 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 condition                                               
| | - | -------------------------------------------------------------------------------------
|
| | - | Decline in the entire industry                                                       
|
| | - | Managerial problems                                                                  
|
| | - | Customers failure to provide financial information or other collateral documentation
|
| | - | Repeated delinquency or renewals.                                                    

The loan review committee reviews every significant problem loan and assessments are
performed quarterly to confirm the risk rating to that loan and the adequacy of loan
loss reserve assigned.

After reviewing the loan portfolio, Management evaluates the loan portfolio and
identifies those loans which they believe require a specific allowance. After
considering loans which require a specific allowance, the Company then allocates or
assigns a portion of the allowance for loan loss to groups of loans and individual
loans to cover Managements estimate of probable loss.

42



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##### Table of Contents



The allocation is related to the grade of the loan and includes a component resulting
from the application of the measurement criteria of Statements of Financial Accounting
Standards No 114 (SFAS 114) Accounting by Creditors for Impairment of a Loan and No
118 (SFAS 118) Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosure. Management then compares the amounts allocated for probable losses
to the current allowance. To the extent that the current allowance is insufficient to
cover Managements best estimate of probable losses, Management records additional
provision for loan loss. If the allowance is greater than what is 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 loss portfolio, the allowance for loan loss consists of two
components. 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 a component that
is intended to absorb losses that may not be provided for by the other component.
There are several reasons that the other components discussed above might not be
sufficient to absorb the losses present in the loan portfolio, and the unallocated
portion of the allowance for loan loss is used to provide for the losses that have
occurred because there are 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 done without knowing whether all relevant facts are at hand. For
example, troubled borrowers may inadvertently or deliberately omit important
information from correspondence with lending officers regarding their financial
condition and the diminished strength of repayment sources. While there exists probable asset quality problems in the loan portfolio, Management
believes sufficient reserves have been provided in the allowance for loan loss to
absorb probable losses in the loan portfolio at December 31, 2004. Non-Performing Loans, Potential Problem Loans, and Other Real Estate The accrual of interest income is discontinued when a loan becomes 90 days past due as
to principal or interest. If collectablity 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 the Notes, principal and accrued
interest. At December 31, 2004, the Company had two loans which were at least 30 days
past due totaling approximately $5.5 million in principal and accrued interest. At
December 31, 2003 the Company had two loans which were 306 to 364 days past due
totaling approximately $3.8 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) includes
real estate acquired through foreclosure and is carried at the lower of the recorded
investment in the 43




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##### Table of Contents



loan, inclusive of any senior indebtedness, or the propertys estimated fair value,
less estimated costs to sell. Costs related to the improvements to the property are
capitalized to the extent that the additional basis does not exceed the fair value of
the asset. All other costs are expensed. The Company uses its taxable REIT
subsidiary to hold all land held for development, as the REIT rules generally impose
prohibited transaction taxes on income earned by a REIT from development activities. 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 generally accepted accounting principles while
dividends are based on net income as 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 market value without considering inflation. Forward Looking Statements When used in this Annual Report on Form 10-K, 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, those 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 and 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. 
 Item 7A. 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. The Company is 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, lines of credit and collateralized notes. The Companys financial instruments
involve elements of interest rate risk. The Companys loan portfolio is also subject
to real estate market risk. 44




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##### Table of Contents



None of the Companys financial instruments have been entered into for trading
purposes. The Company has not entered into, nor does it intend to enter into, any
financial instruments for trading or speculative purposes. As the Company has no
investments outside of the United States, it is not subject to foreign currency
exchange rate risk. The Company does not hedge its exposure to changes in the fair
value of its loans through the use of derivative instruments. Instead, Management has
managed these exposures through careful underwriting and servicing of the Companys
loans. Further, Management targets as potential customers borrowers with relatively
significant equity value in their property. For the most part, the Companys loans provide for either monthly payments of interest
only and a payment of principal in full at the end of the loan term, principal and
interest payments with a balloon payment at the end of the loan term, or 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 the Companys loans, Management does not believe
that a 5% increase or decrease in general interest rates (from those prevailing at
December 31, 2004) would have a significant impact on the fair value of its fixed rate
loan portfolio. A significant increase in interest rates could, however, make it more
difficult for the Companys borrowers to sell or refinance their respective
properties. This could have a material adverse effect on the Company, 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,
Utah, or California could have a material adverse impact on the Company. 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 Management to quantify the potential loss in earnings or cash flows that
might result from a real estate market decline. The Company attempts to mitigate these risk exposures through its Manager. The
Manager carefully underwrites and services the Companys 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 Companys manager uses early
intervention, aggressive collection and loss mitigation techniques in the servicing
process. While Management has attempted to mitigate these risk exposures, there can be
no assurance that these efforts will be successful. 
 Item 8. Consolidated Financial Statements and Supplementary Data The Consolidated Financial Statements of the Company and the
related Notes, together with the Reports of Independent
Accountants thereon, are set forth on pages F-1 through F-28 of
this from 10-K and are incorporated herein by reference. 
 Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure For information relating to a change of accountants during fiscal year 2002, see the
Companys Form 8-K filed October 17, 2002 and Form 8-K/A filed October 25, 2002. 
 Item 9A. Controls and Procedures  (a)
    Evaluation of Disclosure Controls and Procedures. The Chief
Executive Officer and the Chief Financial Officer conclude that the Companys
disclosure controls and procedures are effective based on their evaluation of
these controls and procedures as of the end of the 45




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##### Table of Contents



period covered by this report.(b)
    Changes in Internal Control over Financial Reporting. During the
period covered by this annual report, there have been no changes in the Companys
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect the Companys internal control over
financial reporting. 
 Item 9 B. Other Information None 46




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##### Table of Contents



PART III 
 Item 10. Directors and Executive Officers of the Registrant The directors, executive officers and senior officers of Specialty Trust and their positions are: Name
    
    PositionNello Gonfiantini III (1)
    
    Chairman of the Board of Directors, PresidentGrace Caudill
    
    SecretaryStephen V. Novacek I (2)(4)(6)
    
    DirectorErnest Martinelli II (2)(3)(5)
    
    DirectorHarvey C. Fennell III (2)(3)
    
    DirectorMark Combs (2)(4)(5)
    
    DirectorSteve S. Johnson III (2)(3)(4)
    
    DirectorNazir Ansari II (2)(6)
    
    DirectorTanya McCaffery
    
    Interim Chief Financial Officer and Principal Accountant
 (1) Founder and promoter
of Specialty Trust.
(2) Independent Director
(3) Member of the Audit Committee
(4) Member of the Strategic Planning Committee
(5) Member of the Loan Review Committee
(6) Member of the Corporate Governance Committee 47




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##### Table of Contents



Information regarding the business background and experience of Specialty Trusts
directors and executive officers follows: NELLO GONFIANTINI III, age 50, is the sole founder and promoter of Specialty Trust and
serves as its Chairman of the Board and President. Mr. Gonfiantini has owned and
managed Specialty Financial, a private mortgage finance and real estate development
business in Reno, Nevada, since 1994. From 1986 until 1994, Mr. Gonfiantini was the
Chairman, CEO and President of Home Federal Savings Bank of Nevada, where he oversaw
the commercial and residential real estate lending operations. Prior to taking that
position in 1986, Mr. Gonfiantini was the Executive Vice President of Home Mortgage
Company, a mortgage banking firm and predecessor to Home Federal Savings Bank of
Nevada. Mr. Gonfiantini has a BA and an MBA from the University of Denver. GRACE CAUDILL,age 55, is the Corporate Secretary of Specialty Trust and Vice
President and Secretary of Specialty Financial, Manager of the Trust, Ms. Caudill is a
native Nevadan with over 30 years experience in all phases of real estate financing.
Her experience in underwriting loans on all types of real property includes
development loans on master planned communities, golf courses, income properties and
residential subdivisions. As a necessary part of underwriting such properties, Ms
Caudill has extensive knowledge of environmental issues, geotechnical reports, and
city and county mapping procedures. STEPHEN V. NOVACEK,age 59, has been a shareholder in the law firm, Hale, Lane, Peek,
Dennison and Howard, located in Reno, Las Vegas and Carson City, Nevada, since 1978.
Mr. Novacek specializes in real estate law and finance representing various
institutional lenders in residential and commercial transactions. He is a member of
the State Bar of Nevada and the American Bar Association. ERNEST MARTINELLI, age 76, retired as Vice Chairman of Bank of America Nevada in 1993
after a career in the banking business in Nevada. He is Vice Chair of the Board of
Directors of St. Marys Healthcare Network and President of Martinelli Properties,
Inc., a commercial real estate development and investment company. HARVEY C. FENNELL, age 57, is the Chief Financial Officer of Dickson Realty, Inc.,
Reno, Nevada, and has been a realtor since 1987. Mr. Fennell specializes in land and
commercial real estate sales. He has been a member of the Reno/Sparks Association of
Realtors and has served on its Board of Directors. He is a member of the Nevada Real
Estate Commission, a state regulatory agency. Prior to 1987, Fennell was a partner in
the accounting firm of KPMG. He formerly served as a director of Home Federal Savings
Bank in Reno, Nevada. MARK COMBS,age 58, is a private lender and investor specializing in large commercial
loans for land development and commercial construction. Mr. Combs has completed
numerous development projects including Saddlehorn, a 532 lot subdivision, in Reno,
Nevada. In 1978, after obtaining his real estate brokers license, Mr. Combs joined
his wife Fianna in Dickson Realty, a real estate company located in Reno, Nevada. Over
the next twelve years, Dickson Realty had grown to over 70 agents. In 1990, Mr. Combs
sold his interest in Dickson Realty to pursue the private lending business. Mr. Combs
is a native Nevadan and graduated from the University of Nevada with a finance degree
in 1969. 48




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##### Table of Contents



STEVE S. JOHNSON, age 49, joined Berry-Hinckley Industries in 1995 as its General
Manager and has been its President since 1997. Berry-Hinckley is a petroleum company
selling and distributing a variety of petroleum products and convenience goods in the
State of Nevada since 1928. Prior to 1995, Mr. Johnson was a CPA and partner in Grant
Thornton, an international accounting, auditing, and consulting firm. Mr. Johnson is
a native Nevadan and holds a BS in Business Administration from the University of
Nevada. NAZIR ANSARI,age 65, is emeritus professor of management at the University of Nevada,
Reno, and has been a Reno resident since 1967. Dr. Ansaris professional
specialization includes government-business relations, corporate governance, strategic
management and planning and international business. Dr. Ansari currently is a member
of the board of directors of Washoe Health System, board chairman of Hometown Health
Plan, and a director of Clark & Sullivan Contractors. In addition, Dr. Ansari is a
trustee of the Desert Research Institute and Sierra Nevada College, as well as a
director of Thunderbird Lodge preservation society. Dr. Ansari has received numerous
community and professional awards and received his Ph.D. in Business Administration
from the University of Illinois. TANYA MCCAFFERY, age 32, is the President of The CFO Group, Inc. an outsourced chief
financial officer consulting firm in Reno, Nevada and is a certified public accountant
in the state of Nevada. Prior to 2002, Ms. McCaffery was a senior auditor with Grant
Thornton, an international accounting and auditing firm. Ms. McCaffery holds a BS in
Accounting from the University of Nevada. Terms of Directors and Officers Specialty Trusts Board of Directors consists of such number of persons as shall be
fixed by the Board of Directors from time to time by resolution to be divided into
three classes, designated Class I, Class II and Class III, with each class to be as
nearly equal in number of directors as possible. Currently there are seven directors.
At each annual meeting, the successors to the class of directors whose term expires at
that time are to be elected to hold office for a term of three years, and until their
respective successors are elected and qualified, so that the term of one class of
directors expires at each such annual meeting. Class I DirectorsNello Gonfiantini III
    
    Term Expires 2007Stephen Novacek
    
    Term Expires 2007
 Class II DirectorsNazir Ansari
    
    Term Expires 2005Ernest Martinelli
    
    Term Expires 2005Mark Combs
    
    Term Expires 2005
 49




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##### Table of Contents



Class III DirectorsSteve Johnson
    
    Term Expires 2006Harvey Fennell
    
    Term Expires 2006
 In the case of a vacancy on the Board of Directors, including a vacancy created by an
increase in the number of directors, the vacancy may be filled by election of the
Board of Directors or the stockholders, with the director so elected to serve until
the next annual meeting of stockholders if elected by the Board of Directors. If
elected by the stockholders, the elected director may serve the remainder of the term
of the director being replaced. Any newly created directorships or decreases in
directorships are to be assigned by the Board of Directors so as to make all classes
as nearly equal in number as possible. Directors may be removed only for cause and
then only by vote of a majority of the combined voting power of stockholders entitled
to vote in the election for directors. Subject to the voting rights of the holders of
the common stock, the Charter may be amended by the vote of a majority of the combined
voting power of stockholders, provided that amendments to the Article dealing with
directors may only be amended if it is advised by at least two-thirds of the Board of
Directors and approved by vote of at least two-thirds of the combined voting power of
stockholders. The effect of the foregoing as well as other provisions of Specialty
Trusts Charter and Bylaws may discourage takeover attempts and make more difficult
attempts by stockholders to change management. Prospective investors are encouraged to
review the Charter and Bylaws in their entirety. Officers are elected annually and serve at the discretion of the Board of Directors.
There are no family relationships between the executive officers or directors. Committees of the Board Audit Committee. The Audit Committee is composed of Messrs. Johnson, Martinelli and
Fennell. The Audit Committee makes recommendations concerning the engagement of
independent registered public accountants, reviews with the
independent registered public accountants the
plans and results of the audit engagement, approves professional services provided by
the independent registered public accountants, reviews the
independence of the independent registered public accountants, considers the range of audit and non-audit fees and reviews the adequacy
of the Companys internal accounting controls. Audit Committee Financial Expert.The Board of Directors of the Company has
determined that Harvey Fennell qualifies as an Audit Committee Financial Expert as
that term is defined by the SEC under Item 401(h) of Regulation SK. The Audit Committee Financial Expert is independent as that term is used for the
determination of audit committee member independence under the NYSE Listed Company
Manual. Loan Review Committee. The Loan Review Committee is composed of Messrs. Martinelli
and Combs. The Committee reviews all loans and the risk rating assignments. Corporate Governance Committee. The Corporate Governance Committee is composed of
Messrs. Ansari and Novacek. The Committee will help to review and establish the
corporate standards for ethics. 50




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##### Table of Contents



Strategic Planning Committee. The Strategic Planning Committee is composed of Messrs.
Novacek, Johnson and Combs. The Committee will help to establish long range goals for
the Company. The Strategic Planning Committee was appointed at the board meeting on
December 13, 2004. Other Committees. The Board of Directors may establish other committees as deemed
necessary or appropriate from time to time, including, but not limited to, an
Executive Committee of the Board of Directors. In 2004, the Board of Directors met six times, Messrs. Bull and Martinelli were both
absent from the March 29, meeting, Mr. Peltyn was absent from the April 26 and June 21
meetings, and Dr. Ansari was absent from the November 27 meeting. The Audit Committee
met four times, the Loan Review Committee met seven times, the Compensation Committee
met five times and the Corporate Governance committee did not meet. Compensation Committee Interlocks No interlocking relationship exists between the Companys Board of Directors or
officers responsible for compensation decisions and the Board of Directors or
Compensation Committee of any other company. Code of Ethics The Company has adopted a Code of Ethics that applies to its principal executive
officer, its principal financial officer and its principal accounting officer, or
persons performing similar functions. The Companys Code of Ethics is made available
on the Managers website at www.specialtyfi.com. The Company intends to post on the Managers website any future amendment or change to
its Code of Ethics as well as any waiver from a provision of such Code granted to any
of the officers subject to it, as required by applicable law. 51




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##### Table of Contents



Item 11. Executive Compensation Compensation of Directors None of the Companys employee directors has received any separate compensation for
service on the Board of Directors or on any committee thereof. The Company pays
directors (Independent Directors) who are not employed by Specialty Trust $1,500 for
each meeting attended in person and $250 for each teleconference meeting in addition
to a directors stock compensation fee of 500 shares for each six months of service.
Committee members receive $500 for each meeting attended in person and $250 for each
teleconference meeting. In addition, each Director referred to as an Independent
Director is granted options to purchase 10,000 shares of common stock at the fair
market value of the common stock upon becoming a director. All directors receive
reimbursement of reasonable out-of-pocket expenses incurred in connection with
meetings of the Board of Directors. No director who is an employee of Specialty Trust
or the Manager will receive separate compensation for services rendered as a director. Executive Compensation Employee salaries and bonuses are paid through the Manager, Specialty Financial, as
part of and not in addition to the management fee. For the years ended December 31,
2004, 2003 and 2002, Specialty Financial earned $3,402,094, $2,726,761 and $1,980,578,
respectively, in total fees. Specialty Financial also received base management fees
and incentive compensation bonus of $491,140, $391,579 and $314,249 for the years
ended 2004, 2003 and 2002 respectively. The base management fee and incentive
compensation bonus are recorded in Management and Directors Fees in the Consolidated
Statement of Earnings. SPACE INTENTIONALLY LEFT BLANK 52




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##### Table of Contents



Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth certain information known to Specialty Trust with respect to
beneficial ownership of the Companys Capital Stock as of December 31, 2004, by each person other
than members of Management known to Specialty Trust to beneficially own more than five percent (5%)
of the Companys Capital Stock. Unless otherwise indicated in the footnotes to the table, the
beneficial owners named have, to the knowledge of the Company, sole voting and investment power
with respect to the shares beneficially owned, subject to community property laws where applicable. Beneficial OwnershipName of Beneficial Owner
    
    ofCapital
    
    Stock(1)Number
    
    
    PercentRaymond J. Poncia (1)
    
    
    652,929
    
    
    
    7.89
    %Angelo Petrini (2)
    
    
    511,628
    
    
    
    6.18
    %Julius and Joanne Ballardini (3)
    
    
    443,999
    
    
    
    5.37
    %
  (1)
    Consists of 326,464 shares of Common Stock held by the Raymond J. Poncia, Jr.
Family Trust and 326,464 shares of Common Stock held by Hotel-Casino Management, Inc. of
which Mr. Poncia is President.(2)
    Consists of 461,270 shares of Common Stock held by the 1987 Petrini Family Trust
of which Mr. Petrini is co-trustee with his wife Joan and 50,358 shares of Common Stock
held by Delta Saloon Profit Sharing Plan of which Mr. Petrini is trustee.(3)
    Consists of 443,999 shares of Common Stock held by the Julius and Joanne
Ballardini Family Trust Dated 4/14/92 of which Mr. & Mrs. Ballardini are trustees. Beneficial Ownership of Capital Stock by Directors and Management The following table sets forth certain information known to Specialty Trust with respect to
beneficial ownership of the Companys Capital Stock as of December 31, 2004, by each director and
by all directors and executive officers as a group. Unless otherwise indicated in the footnotes to
the table, the beneficial owners named have, to the knowledge of the Company, sole voting and
investment power with respect to the shares beneficially owned, subject to community property laws
where applicable. Beneficial OwnershipName of Beneficial Owner
    
    of Capital
    
    Stock (1)Number
    
    
    PercentNello Gonfiantini III (2)
    
    
    643,932
    
    
    
    7.78
    %Grace Caudill
    
    
    17,784
    
    
    
    *Stephen V. Novacek (3)
    
    
    22,271
    
    
    
    *Ernest Martinelli (4)
    
    
    202,000
    
    
    
    2.44
    %Harvey Fennell (5)
    
    
    87,449
    
    
    
    1.06
    %Mark Combs (6)
    
    
    2,228
    
    
    
    *Steve Johnson (7)
    
    
    50,500
    
    
    
    .61
    %Nazir Ansari (8)
    
    
    514
    
    
    
    *Tanya McCaffery
    
    
    0
    
    
    
    *All Directors and Executive Officers as a Group (9 persons)
    
    
    1,026,678
    
    
    
    12.41
    %
 53




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##### Table of Contents



*
    
    Less than one percent.(1)
    
    Assuming no exercise of the non-employee director options (except by the Security
holder named, separately).(2)
    
    Consists of 600,750 shares of Common Stock held in the Nello Gonfiantini III 1981
Trust of which Nello Gonfiantini III is trustee, 43,182 shares of Common Stock held by
Gonzo Properties of which Nello Gonfiantini III is a partner, but does not include
shares of Common Stock beneficially owned by persons related by blood or marriage to Mr.
Gonfiantini with respect to which he has neither voting nor investment power.(3)
    
    Consists of 22,271 shares of Common Stock held in the Novecek/Gruenewald 2002
Trust, which Mr. Novacek is co-trustee.(4)
    
    Consists of 152,000 shares of Common Stock held in the Ernest Martinelli Family
Trust of which Mr. Martinelli is trustee, and 50,000 shares of Common Stock held in the
Martinelli Family Partnership of which Mr. Martinelli is a partner.(5)
    
    Consists of 40,644 shares of Common Stock held in the Harvey and Nancy Fennell
Family Trust of which Mr. Fennell is co-trustee and 46,805 shares of Common Stock held
in the Dickson Realty Profit Sharing Plan of which Mr. Fennell is co-trustee.(6)
    
    Consists of 2,228 shares of Common Stock held in the Mark and Fianna Combs Family
Trust, which Mr. Combs is co-trustee.(7)
    
    Consists of 13,090 shares of Common Stock held in the Steve S. Johnson Family
Trust, 18,705 shares of Common Stock held by Andrew S. Johnson and 18,705 shares of
Common Stock held by Riley S. Johnson, for all of which Mr. Johnson is co-trustee.(8)
    
    Consists of 514 shares of Common Stock held in the Ansari Family Trust, which Dr.
Ansari is co-trustee. The information required by Item 12 with respect to equity compensation plans is contained
herein in Item 5 of this report under the caption Equity Compensation Plans 54




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##### Table of Contents



Item 13. Certain Relationships and Related Transactions The Manager Specialty Financial serves as the Companys manager and is responsible for loan
originations, loan servicing and the Companys day-to-day operations. Mr. Gonfiantini,
a director and the Companys sole executive officer, is also an executive officer,
director and the sole stockholder of Specialty Financial. The Company has no separate
employees from the Manager and it shares its facilities. The Company has no ownership
interest in the Manager. Specialty Financial has significant operating discretion as
to the implementation of the Company business strategy and policies. Administrative Services Provided by the Manager Specialty Financial, as Manager, is responsible for the Companys day-to-day
operations and performs such services and activities relating to the assets and
operations of Specialty Trust (the Company) as may be appropriate, including:  (i)
    representing the Company in connection with the origination or
purchase of mortgage loans;(ii)
    in accordance with the directions of the Board of Directors,
investing or reinvesting any money of the Company;(iii)
    furnishing reports and statistical and economic research to the
Company regarding the Companys real estate lending activities and the
performance of its portfolio of mortgage loans;(iv)
    administering the day-to-day operations of the Company and
performing administrative functions necessary in the management of the Company,
including the collection of revenues, the payment of the Companys expenses,
debts and obligations and the maintenance of appropriate computer services to
perform such administrative functions;(v)
    counseling the Company in connection with policy decisions to be
made by the Board of Directors;(vi)
    assisting the Company in its use of leverage to finance mortgage
loan acquisitions;(vii)
    overseeing the servicing of the Companys mortgage loans;(viii)
    establishing underwriting, appraisal and quality control procedures for the
mortgage loans of the Company;(ix)
    conducting a legal document review of each mortgage loan acquired
to verify the accuracy and completeness of the information contained in the
mortgage loans, security instruments and other pertinent documents in the
mortgage file;(x)
    providing the Company with data processing, legal and
administrative services to the extent required to implement the business strategy
of the Company; 55




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##### Table of Contents



(xi)
    providing all actions necessary for compliance by the Company with
all federal, state and local regulatory requirements applicable to the Company in
respect of its business activities, including preparing or causing to be prepared
all financial statements required under applicable regulations and contractual
undertakings;(xii)
    providing all actions necessary to enable the Company to make
required federal, state and local tax filings and reports and generally enable
the Company to maintain its status as a REIT, including soliciting stockholders
for required information to the extent required by the REIT Provisions of the
Code;(xiii)
    communicating on behalf of the Company with the stockholders of the Company as
required to satisfy any reporting requirements and to maintain effective
relations with such stockholders; and(xiv)
    performing such other services as may be required from time to
time for management and other activities relating to the assets of the Company as
the Board of Directors shall reasonably request or the Manager shall deem
appropriate under the particular circumstances. The Manager may enter into subcontracts with other parties to provide any such
services. Management Agreement Compensation Under the management agreement, the Manager will receive, beginning January 1, 2004:  (a)
    A monthly base management fee at a per annum rate equal to one-half
of one percent applied to the mortgage asset portfolio at the end of the
preceding calendar quarter.(b)
    An incentive fee for each fiscal quarter equal to 50% of the
taxable income of Specialty Trust, before deduction of such incentive fee, in
excess of an annualized Threshold Return for the quarter. Threshold Return is a
target percentage rate of return to be set by mutual agreement between the
Manager and the Company for each calendar year beginning with 2004. The
Threshold Return for 2004 has been set at 12%. Taxable income and net worth are
calculated as described above under the discussion of incentive compensation for
prior periods. For the year ended December 31, 2004, the Company incurred base management fees of
$491,140. For the years ended December 31, 2004, 2003 and 2002 the Company incurred
management incentive fees of $0, $391,579 and $314,249, respectively. Servicing Fee Loan Servicing Fee. As part of the servicing fee, one-half of one percent of the total
mortgage loan portfolio is paid to the Manager as a loan-servicing fee. 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 the borrower.
Payment of this fee, in effect, lowers the yield on the Companys mortgage loans. An
undue emphasis on increasing the size of the mortgage loan portfolio, thereby
increasing the Managers compensation, could result in the acquisition of riskier or
more speculative loans. For the years ended December 31, 2004, 2003 and 2002 the Company incurred
loan-servicing 56




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##### Table of Contents



fees of $457,424, $455,923 and $361,224 respectively. Loan Origination and Extension Fees Origination and Extension Fee. The first 2.5% (2 1/2 points) of any origination and
extension fees (points) collected from the borrower is paid to the Manager as part of
the initial funding of the loan. The size of the mortgage origination and extension
fees are market driven but may vary and may have a direct impact upon the interest
rate the borrower is willing to pay and, therefore, on the interest income the Company
would receive from the loan. For the years ended December 31, 2004, 2003 and 2002, the Manager retained loan
origination fees of $2,894,828, $2,259,153 and $1,610,059 respectively. Late Payment Charges Late Payment Charges. Any loan payment which is past due 10 days may be charged a
late payment charge of 10% of the total payment. Late payment charges are received
directly by the Manager from the borrower. The late fee may be waived at the
discretion of the Companys Manager. For the years ended December 31, 2004, 2003 and 2002 the Manager retained late charges
of $49,842, $11,685, and $9,295 respectively. Other Expenses The operating expenses required to be borne by the Manager include compensation and
other employment costs, the cost of office space and equipment and all other
administrative expenses incurred in the Companys day-to-day operations. Those
expenses do not include debt service or taxes. While most costs are paid through the
Manager from fees earned by the Manager, Management does pay directly certain
REIT-related expenses such as directors fees and legal and accounting fees. There are
no caps or ceilings on any category of fees, compensation or other expenses payable by
the Company except for compensation payable to the Manager and expenses to be borne by
the Manager as described above. Transactions with Management and Others Specialty Financial serves as the Companys Manager and is responsible for loan
originations, loan servicing and its day-to-day operations. Mr. Gonfiantini, a
director and our sole executive officer, is also an executive officer, director and
the sole stockholder of Specialty Financial. The Company has no separate employees
from the Manager and the Company shares its facilities. The Company has no ownership
interest in the Manager. Specialty Financial has significant operating discretion as
to the implementation of the Companys business strategy and policies. Term and Termination The management agreement had an initial term of three years beginning January 30, 1998
and is renewed automatically for successive one-year periods unless the Company timely
delivers a notice of non-renewal. Upon non-renewal of the management agreement without
cause, a termination fee will be payable to the Manager in an amount equal to the
greater of (i) the fair value of the management agreement as established by an
independent appraiser, or (ii) 4% of the mortgage loan portfolio of Specialty Trust.
At December 31, 2004, 4% of our mortgage loan 57




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##### Table of Contents



portfolio would be approximately $3.8 million. In addition, the Company has the right
to terminate the management agreement at any time for cause. A majority of the
Companys unaffiliated directors (currently 6 of 7 directors are unaffiliated) may
determine that the Manager has violated the management agreement in a material respect
and, after notice and an opportunity to cure, terminate the agreement. Upon such a
termination for cause, no termination fee will be payable to the Manager. Collateralized Notes In previous years, there were several related parties who held collateralized notes
with Specialty Trust. As of December 31, 2004, there were no related parties who
owned collateralized notes. 58




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##### Table of Contents



Item 14. Principal Accountant Fees and Services The aggregate fees and expenses billed by KPMG LLP for professional services rendered
for the fiscal years ended December 31, 2004 and 2003 are set forth below. 2004
    
    
    2003Audit fees
    
    $
    126,000
    
    
    $
    115,422Audit related fees
    
    $
    -0-
    
    
    $
    -0-Tax fees
    
    $
    29,100
    
    
    $
    27,090All other fees
    
    $
    2,675
    
    
    $
    10,815
 Audit fees were for the audits of the Companys annual consolidated financial
statements, review of Form S-11 in 2004 and 2003, and 8-K termination
letters, review of the financial statements included in the Companys quarterly
reports on Form 10-Q, and other assistance required to complete the year-end audits. Tax fees were for services rendered related to tax compliance and reporting. All other fees were rendered for general consulting relating to foreclosure properties
and dividends distributions. Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of
Independent Auditors It is the Audit Committees policy to review and pre-approve the scope, terms, and
related fees of all auditing services and permitted non-audit services provided by the
auditors, subject to the de minimus exceptions for non-audit services which are
approved by the Audit Committee prior to the completion of the audit. 59




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##### Table of Contents



PART IV 
 Item 15. Exhibits and Financial Statement Schedules  (a)
    Exhibits Exhibit No.
    
    Document3.1*
    
    
    Articles of Incorporation3.3*
    
    
    Bylaws3.3.1*
    
    
    Amendment to Bylaws4.1**
    
    
    Indenture dated as of January 1, 2001 between Specialty Mortgage
Trust, Inc. and Bankers Trust Company of California, a national banking
association, as Trustee4.1at
    
    Supplement No. 1 to Indenture4.1btt
    
    Supplement No. 2 to Indenture10.1*
    
    
    Amended and Restated Management Agreement10.1.2+
    
    
    Second Amended and Restated Management Agreement10.2*
    
    
    Master Loan Participation Agreement10.2.1+
    
    
    Amendment No.1 to Master Loan Participation Agreement11.1
    
    
    Schedules IV for the years ended December 31, 2004, 2003 and 200221
    
    
    Subsidiaries of the Registrant31.1
    
    
    Certification of the principal executive officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    
    Certification of the principal financial officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    
    Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.2
    
    
    Certification of 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 Mortgage Trust, Inc. with the Securities and Exchange Commission on
August 30, 2000. 60




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##### Table of Contents



**
    
    Incorporated by reference to the correspondingly numbered exhibit
to the Form 8-K filed by Specialty Mortgage Trust, Inc. with the Securities and
Exchange Commission on February 2, 2001.t
    
    Incorporated by reference to the correspondingly numbered exhibit to the
Registration Statement on Form S-11 (Registration Statement No. 333-86972) filed
by Specialty Trust, Inc. with the Securities and Exchange Commission on April 25,
2002.tt
    
    Incorporated by reference to the correspondingly numbered exhibit to the
Registration Statement on Form S-11 (Registration Statement No. 333-86972) filed
by Specialty Trust, Inc. with the Securities and Exchange Commission on July 28,
2003.+
    
    Incorporated by reference to the correspondingly numbered exhibit
to the Form 10-K Annual Report for 2003 filed by Specialty Trust, Inc. with the
Securities and Exchange Commission on March 30, 2004. SPACE INTENTIONALLY LEFT BLANK 61




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##### Table of Contents



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 3, 2005
    
    By:
    
    /s/ Nello Gonfiantini IIINello Gonfiantini III
Chairman and President(Signed in the capacity of (i) duly
authorized officer of the registrantDated: May 3, 2005
    
    By:
    
    /s/ Tanya M. McCafferyTanya M. McCaffery
Interim Chief Financial Officer(Signed in the capacity of (i) duly
authorized officer of the registrant and
(ii) Principal Financial Officer of the
registrant)
 62




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##### Table of Contents



Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant and in the capacities and on the dates
indicated. Signature
    
    Title
    
    Date/s/ Nello Gonfiantini, III
    
    Nello Gonfiantini, III
    
    March 29, 2005Chairman of the BoardPresident/s/ Grace C. Caudill
    
    Grace C. Caudill
    
    March 29, 2005Secretary/s/ Tanya M. McCaffery
    
    Tanya M. McCaffery
    
    March 29, 2005Interim Chief Financial OfficerPrincipal Accountant/s/ Stephen V. Novacek
    
    Stephen V. Novacek
    
    March 29, 2005Director/s/ Ernest Martinelli
    
    Ernest Martinelli
    
    March 29, 2005Director/s/ Harvey Fennell
    
    Harvey Fennell
    
    March 29, 2005Director/s/ Mark Combs
    
    Mark Combs
    
    March 29, 2005Director/s/ Steve Johnson
    
    Steve Johnson
    
    March 29,2005Director/s/ Nazir Ansari
    
    Nazir Ansari
    
    March 29,2005Director
 63




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##### Table of Contents



SPECIALITY TRUST INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS
 For Inclusion in Form 10-K
 Annual Report Filed with
 Securities and Exchange Commission
 December 31, 2004
 F-1




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##### Table of Contents



SPECIALITY TRUST INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageConsolidated Financial Statements  Specialty Trust, Inc. and Subsidiaries:Consolidated Balance Sheets at December 31, 2004 and 2003
    
    
    F-3Consolidated Statements of Earnings for the years ended December 31, 2004, 2003 and 2002
    
    
    F-4Consolidated Statements of Stockholders Equity and Comprehensive Income for the years ended December 31, 2004, 2003 and 2002
    
    
    F-5Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-9
 F-2




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##### Table of Contents



SPECIALTY TRUST INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
December 31,
 2004
    
    
    2003ASSETSASSETSCash and Cash Equivalents
    
    $
    14,879,417
    
    
    $
    2,593,407Restricted Cash
    
    
    1,001,536
    
    
    
    Accrued Interest Receivable
    
    
    1,175,049
    
    
    
    875,474Accounts Receivable
    
    
    68,578
    
    
    
    70,313Land Held for Residential Development
    
    
    1,879,432
    
    
    
    2,377,457Real Estate Owned (Held for Sale)
    
    
    9,621,495
    
    
    
    7,913,160Mortgage Loans Held for Investment, net of
allowance for loan losses of $1,130,138 and $1,424,256 and
unearned discount of $112,625 and $103,966 at December 31,
2004 and 2003, respectively
    
    
    93,350,933
    
    
    
    94,081,942Other Assets
    
    
    159,628
    
    
    
    546,941Total Assets
    
    $
    122,136,068
    
    
    $
    108,458,694LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIESDividends Payable
    
    $
    2,274,946
    
    
    $
    2,305,444Accounts Payable  Related Party
    
    
    61,233
    
    
    
    119,284Accounts Payable and Accrued Expenses
    
    
    198,043
    
    
    
    326,844Accrued Interest Payable
    
    
    65,475
    
    
    
    56,952Deferred Revenue and Other Liabilities
    
    
    
    
    
    
    113,400Collateralized Notes
    
    
    41,242,610
    
    
    
    31,881,866Collateralized Notes  Related Party
    
    
    
    
    
    
    1,528,413Total Liabilities
    
    $
    43,842,307
    
    
    $
    36,332,203STOCKHOLDERS EQUITYCommon Stock; $0.01 par value; 50,000,000
Shares authorized; 8,272,529 and 7,684,813
Issued and outstanding as of December 31, 2004
and 2003, respectively
    
    $
    82,725
    
    
    $
    76,848Additional Paid-in Capital
    
    
    77,432,753
    
    
    
    71,828,838Retained Earnings
    
    
    778,283
    
    
    
    220,805Total Stockholders Equity
    
    
    78,293,761
    
    
    
    72,126,491Total Liabilities and Stockholders Equity
    
    $
    122,136,068
    
    
    $
    108,458,694
 See accompanying notes to
consolidated financial statements. F-3




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##### Table of Contents



SPECIALTY TRUST INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF EARNINGS
Years ended December 31,
 2004
    
    
    2003
    
    
    2002RevenuesInterest and Dividend IncomeMortgage Loans
    
    $
    11,876,292
    
    
    $
    11,674,776
    
    
    $
    9,669,335Cash Accounts
    
    
    161,358
    
    
    
    1,951
    
    
    
    57,325Total Interest and Dividend Income
    
    
    12,037,650
    
    
    
    11,676,727
    
    
    
    9,726,660Interest ExpenseLines of Credit
    
    
    3,513
    
    
    
    342,949
    
    
    
    37,737Notes Payable  Related Parties
    
    
    
    
    
    
    
    
    
    
    4,623Collateralized Notes
    
    
    2,145,834
    
    
    
    1,398,882
    
    
    
    786,206Total Interest Expense
    
    
    2,149,347
    
    
    
    1,741,831
    
    
    
    828,566Net Interest and Dividend Income
    
    
    9,888,303
    
    
    
    9,934,896
    
    
    
    8,898,094(Reversal of Provision)/Provision for Loan Losses
    
    
    (34,118
    )
    
    
    25,137
    
    
    
    795,255Net Interest and Dividend Income after
(Reversal of Provision)/Provision for Loan Losses
    
    
    9,922,421
    
    
    
    9,909,759
    
    
    
    8,102,839Real Estate Owned Gain/(Loss)
    
    
    733,728
    
    
    
    (84,998
    )
    
    
    Rental and Other Income
    
    
    68,559
    
    
    
    32,813
    
    
    
    64,754Net Revenues
    
    
    10,724,708
    
    
    
    9,857,574
    
    
    
    8,167,593ExpensesGeneral and Administrative
    
    
    824,204
    
    
    
    594,122
    
    
    
    480,995Management and Directors Fees (including
incentive compensation bonus)
    
    
    645,279
    
    
    
    527,613
    
    
    
    390,903Other Expenses
    
    
    142,265
    
    
    
    483,094
    
    
    
    150,988Total Expenses
    
    
    1,611,748
    
    
    
    1,604,829
    
    
    
    1,022,886NET EARNINGS

    $
    9,112,960
    
    
    $
    8,252,745
    
    
    $
    7,144,707Basic Earnings Per Share
    
    $
    1.14
    
    
    $
    1.11
    
    
    $
    1.02Diluted Earnings Per Share
    
    $
    1.13
    
    
    $
    1.10
    
    
    $
    1.01
 See accompanying notes to
consolidated financial statements. F-4




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##### Table of Contents



SPECIALTY TRUST INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
Years ended December 31,
 AdditionalCommon Stock
    
    
    Paid-in
    
    
    RetainedShares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    TotalBalance, January 1, 2002
    
    
    6,822,703
    
    
    $
    68,227
    
    
    $
    64,957,811
    
    
    $
    
    
    
    $
    65,026,038Comprehensive income:Net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,144,707
    
    
    
    7,144,707Stock options exercised
    
    
    32,684
    
    
    
    327
    
    
    
    104,267
    
    
    
    
    
    
    
    104,594Non-employee stock option
Expense
    
    
    
    
    
    
    
    
    
    
    81,013
    
    
    
    
    
    
    
    81,013Dividends Reinvested on
Common Stock
    
    
    327,617
    
    
    
    3,276
    
    
    
    3.600,514
    
    
    
    
    
    
    
    3,603,790Dividends declared on
Common Stock ($1.20)
    
    
    
    
    
    
    
    
    
    
    (1,295,744
    )
    
    
    (7,144,707
    )
    
    
    (8,440,451
    )Balance, December 31, 2002
    
    
    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 ($1.20)
    
    
    
    
    
    
    
    
    
    
    (966,881
    )
    
    
    (8,031,940
    )
    
    
    (8,998,821
    )Balance, December 31, 2003
    
    
    7,684,813
    
    
    $
    76,848
    
    
    $
    71,828,838
    
    
    $
    220,805
    
    
    $
    72,126,491
 F-5




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##### Table of Contents



SPECIALTY TRUST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME  Continued
Years ended December 31, AdditionalCommon Stock
    
    
    Paid-in
    
    
    RetainedShares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    TotalBalance, December 31, 2003
    
    
    7,684,813
    
    
    $
    76,848
    
    
    $
    71,828,838
    
    
    $
    220,805
    
    
    $
    72,126,491Net Earnings and
Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,112,960
    
    
    
    9,112,960Stock Options Exercised
    
    
    33,163
    
    
    
    332
    
    
    
    213,838
    
    
    
    
    
    
    
    214,170Dividends Reinvested on
Common Stock
    
    
    548,553
    
    
    
    5,485
    
    
    
    6,028,605
    
    
    
    
    
    
    
    6,034,090Stock Granted
    
    
    6,000
    
    
    
    60
    
    
    
    65,940
    
    
    
    
    
    
    
    66,000Dividends Declared on
Common Stock ($1.15)
    
    
    
    
    
    
    
    
    
    
    (704,468
    )
    
    
    (8,555,482
    )
    
    
    (9,259,950
    )Balance, December 31, 2004
    
    
    8,272,529
    
    
    $
    82,725
    
    
    $
    77,432,753
    
    
    $
    778,283
    
    
    $
    78,293,761
 See accompanying notes to
consolidated financial statements. F-6




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##### Table of Contents



SPECIALTY TRUST INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
 2004
    
    
    2003
    
    
    2002Cash Flows from Operating Activities:Net Earnings
    
    $
    9,112,960
    
    
    $
    8,252,745
    
    
    $
    7,144,707Adjustment to Reconcile Net Earnings to Net Cash
Provided by Operating Activities:Amortization
    
    
    355,885
    
    
    
    57,347
    
    
    
    91,135(Reversal of Provision)/Provision for Loan Losses
    
    
    (34,118
    )
    
    
    25,137
    
    
    
    795,255Amortization of Loan Points on Mortgage Loans
    
    
    (90,091
    )
    
    
    (91,521
    )
    
    
    (68,628
    )Non-cash Stock Compensation
    
    
    66,000
    
    
    
    66,000
    
    
    
    81,013(Gain)/Loss on Sale of Real Estate Owned, net
    
    
    (733,728
    )
    
    
    84,998
    
    
    
    (32,776
    )Changes in Assets and Liabilities:Unearned Discounts
    
    
    98,750
    
    
    
    75,000
    
    
    
    Accrued Interest Receivable
    
    
    (299,575
    )
    
    
    5,998
    
    
    
    (287,028
    )Other Assets and Accounts Receivable
    
    
    33,163
    
    
    
    (85,277
    )
    
    
    (93,604
    )Deferred Revenue and Other Liabilities
    
    
    (10,500
    )
    
    
    10,500
    
    
    
    Accounts Payable (including Related Party) and Accrued Interest
Payable
    
    
    (178,329
    )
    
    
    64,007
    
    
    
    323,141Net Cash Provided by Operating Activities
    
    
    8,320,417
    
    
    
    8,464,934
    
    
    
    7,953,215Cash Flows from Investing Activities:Investment in Real Estate Owned
    
    
    (1,472,035
    )
    
    
    (298,576
    )
    
    
    Proceeds from Sales of Real Estate Owned
    
    
    2,513,517
    
    
    
    3,176,346
    
    
    
    473,022Investment in Land Held for Residential Development
    
    
    (212,636
    )
    
    
    (197,438
    )
    
    
    (231,807
    )Proceeds on Land Held For Residential
Development
    
    
    710,661
    
    
    
    268,560
    
    
    
    565,943Purchase of Mortgage Loans Held for Investment
    
    
    (113,365,118
    )
    
    
    (86,070,063
    )
    
    
    (70,550,293
    )Principal Repayments of Mortgage Loans Held for
Investment
    
    
    112,002,597
    
    
    
    76,480,299
    
    
    
    46,900,431Net Cash Provided by/(Used in) Investing
Activities
    
    
    176,986
    
    
    
    (6,640,872
    )
    
    
    (22,842,704
    )Cash Flows from Financing Activities:Proceeds from Common Stock Options Exercised
    
    
    214,170
    
    
    
    47,513
    
    
    
    104,594Deposits paid out relating to Common Stock Transactions
    
    
    
    
    
    
    
    
    
    
    (1,003,200
    )Cash Dividends Paid
    
    
    (3,256,358
    )
    
    
    (3,608,915
    )
    
    
    (4,728,571
    )Net (payments)/ proceeds on Line of Credit
    
    
    
    
    
    
    (9,336,000
    )
    
    
    9,336,000Proceeds on Collateralized Notes
    
    
    44,650,000
    
    
    
    18,976,326
    
    
    
    15,458,602Interest Reinvested in Collateralized Notes
    
    
    1,562,612
    
    
    
    1,128,357
    
    
    
    683,056Principal Payments on Collateralized Notes
    
    
    (38,380,281
    )
    
    
    (6,465,435
    )
    
    
    (5,846,068
    )Debt Issuance Costs
    
    
    
    
    
    
    (65,185
    )
    
    
    (84,429
    )Increase in Restricted Cash
    
    
    (1,001,536
    )
    
    
    
    
    
    
    Net Cash Provided by Financing Activities
    
    
    3,788,607
    
    
    
    676,661
    
    
    
    13,919,984NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    12,286,010
    
    
    
    2,500,723
    
    
    
    (969,505
    )Cash and Cash Equivalents at Beginning of Year
    
    
    2,593,407
    
    
    
    92,684
    
    
    
    1,062,189Cash and Cash Equivalents at end of Year
    
    $
    14,879,417
    
    
    $
    2,593,407
    
    
    $
    92,684
 F-7




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##### Table of Contents



SPECIALTY TRUST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
Years ended December 31, 2004
    
    
    2003
    
    
    2002Supplemental Cash Flow Information:Cash paid for interest
    
    $
    578,212
    
    
    $
    1,722,402
    
    
    $
    807,742Supplemental Disclosure of Non-cash Investing
and Financing Activities:Mortgage Loan Foreclosure Transfer to Real Estate Owned
    
    $
    2,378,989
    
    
    $
    10,224,992
    
    
    $
    1,883,000Dividends Declared but Not Paid
    
    $
    2,274,946
    
    
    $
    2,305,444
    
    
    $
    2,154,901Dividends Reinvested for Common Stock
    
    $
    6,034,090
    
    
    $
    5,239,363
    
    
    $
    3,603,790Reclassification of Allowance For Loan Losses to Real Estate
Owned
    
    $
    260,000
    
    
    $
    250,000
    
    
    
    Charge-off of Accrued Interest
    
    
    
    
    
    $
    166,457
    
    
    
    Note Received For Sale of Foreclosed Property
    
    
    
    
    
    $
    125,000
    
    
    
    Accrued Interest Transferred to Real Estate Owned
    
    
    
    
    
    $
    75,936
    
    
    
    Mortgage Loans issued to facilitate sale of real estate owned:Investment in Real Estate Owned
    
    
    
    
    
    
    
    
    
    $
    933,000Deferred Revenue
    
    
    
    
    
    
    
    
    
    $
    102,900Mortgage Loans
    
    
    
    
    
    
    
    
    
    $
    1,035,900
 See accompanying notes to
consolidated financial statements. F-8




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##### Table of Contents



SPECIALTY TRUST INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
 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 focus on
land loans, construction loans, commercial building loans and nonconforming single-family and small
multifamily residential loans. The Company has elected to be 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 business operating in
Nevada and wholly owned by Nello Gonfiantini III, the Companys President and Chairman of the 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 consolidated financial statements for the year ended December 31, 2004, include the accounts of
the Company and its wholly owned subsidiaries, Specialty Acquisition Corporation (SAC), a taxable
REIT subsidiary and Specialty Acquisition Corporation II (SAC II), a Qualified REIT subsidiary.
SAC was formed on May 2, 2002 to enable the Company to perform development activities to land it
foreclosed upon (Note 2), and to maintain the Companys qualified REIT status. SAC II was formed
as a Qualified REIT subsidiary for a particular piece of REO property acquired through foreclosure
during 2003. 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. Cash and Cash Equivalents The Company considers money market accounts to be cash equivalents. Land Held for Residential Development Land Held for Residential Development includes real estate acquired through foreclosure and is
carried at the lower of the cost or the propertys estimated fair value, less estimated costs to
sell. F-9




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##### Table of Contents



NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION (CONTINUED) Real Estate Owned Real estate owned includes real estate acquired through foreclosure and is carried at the lower of
the 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 calls for companies to measure stock compensation expense based upon the fair
value method of accounting. Advertising The Company expenses the costs of advertising as incurred. Total advertising expense for the years
ended December 31, 2004, 2003 and 2002 was $126,220, $176,811 and $7,080, respectively. Mortgage Loans The Company has both the intent and ability to hold mortgage loans until maturity and, 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 while servicing is retained by the Manager. A majority
of the Companys loans include a participating interest in which the Company and third party
investors share in the ownership of the loans. The Company follows the Financial Accounting Standards Board (FASB) Statement of Financial
Accounting Standards (SFAS) 114 Accounting by Creditors for Impairment of a Loan, and SFAS No.
118 Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures. Under
SFAS No. 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 No. 114 requires that impaired
loans be measured at 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 No. 118 clarifies interest income recognition and disclosures of SFAS No.
114. F-10




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##### Table of Contents



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 Management 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 is no longer recognized when the loan has become 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 or points charged to a borrower for and upon the origination,
extension or refinancing of a mortgage loan, in excess of 2.5% 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 or points up to 2.5% are earned by the Manager, prior to the purchase of the
mortgage loans by the Company. Deferred Charges Deferred charges are costs associated with origination of collateralized notes, which are amortized
by the effective interest method over the contractual life of the related obligation. As a result
of the deregistration of the collateralized note program resulting in
no additional collateralized notes being available for public sale
as discussed in Footnote 7, the unamortized
debt offering costs of $355,885 were fully amortized in 2004. Earnings per Share (EPS) Basic EPS is computed by dividing net income by the weighted average number of shares of common
stock outstanding during the period. Diluted EPS is computed by dividing net income 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. No potentially dilutive securities are included in the computation of any diluted per share amount for a period in which a
net operating loss is reported. 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, review of collateral
values, borrower payment ability and general economic conditions. Additions or reductions to the
allowance are provided through a charge or recovery to F-11




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##### Table of Contents



earnings, respectively. Loans are charges against the allowance for loan losses when Management
believes that the collectablity of the principal is unlikely. 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 Managements
periodic assessment and grading of the loan portfolio. 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.
While Management 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. Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with U.S.
generally accepted accounting principles 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
valuation of real estate owned and land held for residential
development as well as 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. Income Taxes The Company believes it has qualified as a REIT and generally is not subject to Federal income
taxes on the portion of taxable income which is distributed to its stockholders. The Company is,
however, subject to Federal income taxes for taxable income not distributed. Taxable income that is distributed is taxable to the stockholders as ordinary income. Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of financial statements
included in the following categories:  (a)
    Cash and Cash Equivalents. The carrying amount approximates fair value
because of the relatively short maturity of these instruments. F-12




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(b)
    Mortgage Loans Held for Investment Including Accrued Interest Receivable and
Accounts Receivable. The carrying value of these instruments approximates the fair
value. The fair value is estimated based upon projected cash flows discounted at the
estimated current interest rates at which similar loans would be made.(c)
    Lines of Credit and Collateralized Notes. The fair value of the Companys
lines of credit and collateralized notes are estimated based on the quoted market
prices for the same or similar issues or on the current rates offered to the Company
for debt of the same remaining maturities. The fair value approximates the carrying
value of the Companys lines of credit given the variable interest rate of the lines
of credit. The fair value of the collateralized notes approximates carrying values
due to their short-term nature.(d)
    Accounts Payable and Accrued Expenses, Accounts Payable  Related Party, and
Accrued Interest Payable. Due to the short-term nature of the balance sheet items,
the fair market value approximates the carrying value of these liabilities. 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. For the Company, SFAS 150 was effective for instruments entered into or modified
after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatorily
redeemable financial instruments. The effective date has been deferred
indefinitely for certain other types of mandatorily redeemable financial instruments. The Company
currently does not have any financial instruments that are within the scope of this Statement. FASB Interpretation No. 46, revised December 2003 (FIN 46R), Consolidation of Variable Interest
Entities addresses how a business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting rights and accordingly should
consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable
Interest Entities, (VIEs), that was issued in January 2003. The Company is required to apply FIN
46R to variable interests in VIEs created after December 31, 2003. For variable interests in VIEs
created before January 1, 2004, FIN 46R will be applied beginning on January 1, 2005. For any
VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets,
liabilities and noncontrolling interests of the VIE initially would be measured at their carrying
amounts with any difference between the net amount added to the balance sheet and any previously
recognized interest being recognized as the cumulative effect of an In December 2003, the
American Institute of Certified Public Accountants (AICPA) issued
Statement of Position No. 03-3, Accounting for Certain Loans or
Debt Securities Acquired in a Transfer (SOP 03-3), which
addresses accounting for differences between the contractual cash
flows of certain loans and debt securities and the cash flows
expected to be collected when loans or debt securities are acquired
in a transfer and those cash flow differences are attributable, at
least in part, to credit quality. As such, SOP 03-3 applies to
loans and debt securities acquired individually, in pools or as part
of a business combination and does not apply to originated loans. The
application of SOP 03-3 limits the interest income, including
accretion of purchase price discounts, that may be recognized for
certain loans and debt securities. Additionally, SOP 03-3 does
not allow the excess of contractual cash flows over cash flows
expected to be collected to be recognized as an adjustment of yield,
loss accrual or valuation allowance, such as the allowance for
possible loan losses. SOP 03-3 requires that increases in expected cash flows
subsequent to the initial investment be recognized prospectively
through adjustment of the yield on the loan or debt security over its
remaining life. Decreases in expected cash flows should be recognized
as impairment. In the case of loans acquired in a business
combination where the loans show signs of credit deterioration,
SOP 03-3 represents a significant change from current purchase
accounting practice whereby the acquirees allowance for loan
losses is typically added to the acquirer allowance for loan
losses. SOP 03-3 is effective for loans and debt securities acquired by
the Company beginning January 1, 2005. The adoption of this new
standard is not expected to have a material impact on the
Companys consolidated financial statements. F-13




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##### Table of Contents



accounting change. If determining the carrying amounts is not practicable, fair value at the date
FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of
the VIE. The Company currently does not have any VIEs. NOTE 2. FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK Financial instruments with concentrations of credit and market risk include cash, letters of credit
and mortgage loans. The Company maintains cash deposit accounts in banks, which, at times, may exceed Federally insured
limits. The Company entered into an irrevocable standby letter of credit for $389,199 to the City of Sparks
as a requirement by the City to guarantee completion by the Company of offsite improvements on the
land held for residential development. Once the offsite improvements are completed, which is
anticipated to be before the end of 2005, the funds securing the letter of credit will be released
back to the Company. Substantially all of the loans purchased by the Company are fixed rate loans secured by the first
deed of trust on commercial, land, nonconforming, and multi-family properties. Maturities on the
mortgage loans range from one to three years. Concentration of mortgage loans exists in Arizona and northern Nevada of approximately 58% and 25%,
respectively, as of December 31, 2004. As such, the Company has a significant geographic
concentration of credit risk that may be adversely affected by periods of economic decline. Concentration of mortgage loan products exists primarily in land loans. As such, the Company has a
significant product concentration of credit risk that may be adversely affected by periods of
economic decline. The following table illustrates the concentration percentages by product type: As of December 31, 2004
    
    
    2003Residential Land
    
    
    27,130,822
    
    
    
    29
    %
    
    $
    72,555,016
    
    
    
    76
    %Construction
    
    
    24,455,450
    
    
    
    26
    %
    
    
    18,989,693
    
    
    
    20
    %Commercial Land
    
    
    14,209,500
    
    
    
    15
    %
    
    
    
    
    
    
    Other non conforming Single Family and Multi-Family Land
    
    
    28,797,924
    
    
    
    30
    %
    
    
    4,065,455
    
    
    
    4
    %94,593,696
    
    
    
    100
    %
    
    $
    95,610,164
    
    
    
    100
    %
 A significant portion of the Companys mortgage loans will require the borrower to make a balloon
payment of the principal at maturity. To the extent that a borrower has an obligation to pay a
mortgage loan in a large lump sum payment, its ability to satisfy this obligation may be dependent
upon its ability to refinance or raise a substantial amount of F-14




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##### Table of Contents



cash. An increase in interest rates over the mortgage rate applicable at origination of the loan
may have an adverse effect on the borrowers ability to refinance the loan. The following table illustrates the scheduled maturities of mortgage loan investments subsequent to
December 31, 2004: Maturity
    
    Amount2005
    
    
    28,904,3802006
    
    
    49,589,3162007
    
    
    16,100,000$
    94,593,696
 Group concentration of credit risk exists in borrowers of mortgage loans. At December 31, 2004 and
2003, 55% and 38%, respectively, of mortgage loans were concentrated in multiple loans to five
borrowers. The amount of loss is limited to the recorded amounts of the loans of $52,131,842 and
$36,743,049 at December 31, 2004 and 2003, respectively. Multiple loans to one borrower or to
related entities generally contain cross default provisions. At December 31, 2004, there were no
loans with cross default provisions in excess of 10% of the portfolio. At December 31, 2003, there
was one loan with a cross default provision in excess of 10% of the portfolio. As of December 31,
2004, the portfolio contained one loan totaling $10,800,000, which exceeded 10% of total mortgage
loans. Additionally, one borrower had loans totaling $20,144,450, which exceeded 10% of total
mortgage loans at December 31, 2004. As such, the Company has a significant borrower concentration
of credit risk that may be adversely affected by periods of economic decline. The significant
borrower concentration of credit risk related to the top 10 borrowers of the portfolio represent
approximately 82% and 92% of the portfolio, as of December 31, 2004 and 2003, respectively. The
amount of loss is limited to the recorded amounts of the loans of $77,239,842 and $88,096,854 at
December 31, 2004 and 2003, respectively. NOTE 3. 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 this 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 F-15




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##### Table of Contents



Company subsequently assigned the Project to SAC, its wholly owned taxable REIT subsidiary. In June 2002, SAC entered into an agreement with a third-party homebuilder to transfer title to 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
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 reduced SACs investment in the land held for residential development. Upon the
sale of completed homes by the homebuilder to an independent third-party, SAC records proceeds as a
reduction to land held for residential development as Phases I and II of the development are
expected to result in minimal profit. SAC will recognize profit equal to its share of the profits
realized and received from home sales to the extent profit projections change and may record a
provision for income taxes if SAC is anticipated to generate taxable income for the year. On June 20, 2003, the homebuilder neglected to exercise his option to purchase Phase III of the
Project. The Company has subsequently listed the property for sale. 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 and
real estate taxes, and insurance fees, all of which were capitalized.
Forty-four homes were sold during the fiscal year ended
December 31, 2004 leaving eighteen homes to sell in
Phases I and II as well as the Phase III land. During the year
ended December 31 2003, fourteen homes were sold. The following provides a roll-forward of this account: Balance at December 31, 2002
    
    
    2,448,579Capitalized Costs
    
    
    197,438Net proceeds from sale of homes
    
    
    (268,560
    )Balance at December 31, 2003
    
    $
    2,377,457Capitalized costs
    
    
    212,636Net proceeds from sale of homes
    
    
    (710,661
    )Balance at December 31, 2004
    
    $
    1,879,432
 NOTE 4. REAL ESTATE OWNED (HELD FOR SALE) F-16




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##### Table of Contents



As of December 31, 2004 and 2003, real estate owned totaled $9.6 and $7.9 million, respectively.
The properties acquired were as follows:  
    A personal residence in Telluride, Colorado acquired in September of
2003 with a loan balance of approximately $1.7 million. The Company has
incurred approximately $1.5 million in costs to prepare the personal
residence for sale all of which was capitalized to Real Estate Owned.
    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.
Significant portions of this land were sold on various dates in 2004
resulting in gains of approximately $414,000.
    A commercial property located in Las Vegas, Nevada acquired in August
of 2002 with a loan balance of $950,000. This property was sold in July of
2004 resulting in gain on sale of approximately $217,000.
    A personal residence in Castle Rock, Colorado acquired in July of 2004
with a loan balance of approximately $2.4 million. During the year ended December 31, 2004, the Company had write-downs of $260,000 related to the
Castle Rock, Colorado property foreclosure. NOTE 5. 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 loans have similar effective interest rates ranging from
12.25% to 17.50%. Revenue by product will fluctuate based upon relative balances during the
period. Due to the similar nature of the effective interest rates, the Company does not compile
and report revenues by product type. See Note 2 (Financial Instruments and Concentrations of
Credit Risk) for a table that sets forth balances by mortgage loan product type. Under existing loans, the Company is required to fund additional loan amounts totaling $3,647,385
as of December 31, 2004. Of the mortgage loans outstanding as of December 31, 2004, approximately
76% are collateralized by first deeds of trust, while the remaining loans are collateralized by
second deeds of trust and partnership interests. F-17




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##### Table of Contents



NOTE 5. MORTGAGE LOANS HELD FOR INVESTMENT (CONTINUED) 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, Management believes sufficient
reserves have been provided in the allowance to absorb probable losses in the loan portfolio at
December 31, 2004 and 2003. During the years ended December 31, 2004, 2003 and 2002, the Company
has recorded a (reversal of provision)/provision for loan losses of $(34,118), $25,137, $ and
$795,255, respectively. At December 31, 2004 and 2003, Collateralized Notes were secured by $41,520,795 and $52,036,733,
respectively, of mortgage loans pledged as collateral. The Company was under-collateralized as of
December 31, 2004 due to the timing of a loan sale. The under-collateralization was cured in
January 2005. The following table presents a roll forward of the allowance for loan loss: Balance at January 1, 2002
    
    $
    1,020,321Provision for Loan Losses
    
    
    795,255Charge Offs
    
    
    Balance at December 31, 2002
    
    $
    1,815,576Provision for Loan Losses
    
    
    25,137Charge Offs
    
    
    (416,457
    )Balance at December 31, 2003
    
    $
    1,424,256Reversal of Provision for Loan Losses
    
    
    (34,118
    )Charge Offs
    
    
    (260,000
    )Balance at December 31, 2004
    
    $
    1,130,138
 Delinquent Loans At December 31, 2004, the Company had two loans that were at least 30 days past due totaling
approximately $5.5 million in principal and accrued interest. In accordance with its revenue
recognition policy, Management has accrued the delinquent interest on these loans. 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 its revenue
recognition policy, the Company ceases to accrue additional interest income if these loans become
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 F-18




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##### Table of Contents



$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 loan and determined that amounts are
collectible. NOTE 6. BANK LINES OF CREDIT At December 31, 2004, the Company had two committed lines of credit. The first line of credit
allows the Company to borrow up to $6.5 million and matures June 15, 2005. The second line of
credit allows the Company to borrow up to $7.0 million and matures on October 15, 2005. Both lines
bear interest at the banks prime rate (5.25% at December 31, 2004). As of December 31, 2004, the
Company had not assigned collateral to these lines and therefore the available and outstanding
amounts on the lines were zero. Lines of credit all contain renewal options for a nominal fee and
Management anticipates they will renew these lines. 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 the
Company are presently engaged in, and (ii) any change in executive and management personnel that
would 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, (iv) interest coverage ratio, and (v) a maximum allowable
for lines of credit of $20 million. The Company was in compliance with these covenants as of
December 31, 2004. NOTE 7. COLLATERALIZED NOTES As of August 5, 2004, Post Effective Amendment No. 2 to the Companys registration statement was
declared effective by the Securities and Exchange Commission (SEC) changing the amount of
collateralized notes available for sale to $189,521,000 (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. The collateralized notes are secured by mortgage loans at least one and one
half times the aggregate principal amount outstanding on the collateralized notes. If there are not
sufficient, qualifying mortgage loans in the loan portfolio to attain the required collateral
levels, the Company is required to pledge restricted cash to the trustee of the notes in order to
collateralize the notes at the required level. As of December 31, 2004 total restricted cash of
approximately $1 million was pledged to the trustee. The outstanding collateralized notes have maturities ranging from three months to five years from
the date of issue and bear fixed rates of interest ranging from 3.25% to 7.50% at December 31,
2004, however, all of the collateralized notes will be redeemed by June 2005 as a result of the
deregistration of the collateralized note program. Therefore, all of the collateralized notes have
been disclosed as maturing in 2005. As of December 31, 2004, $41,242,610 of these notes were
outstanding. F-19




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##### Table of Contents



The effective yield of collateralized notes outstanding at December 31, 2004 and 2003 was 5.77% and
5.58%, respectively. At December 31, 2004 and 2003, the collateralized notes were secured by
approximately $42.5 million and $52 million, respectively, of mortgage loans and restricted cash
pledged as collateral. In November 2004, the Companys Board of Directors determined that continuing the Companys
publicly offered collateralized note program would subject the Company to significant costs and
expenses, including costs of complying with the Sarbanes-Oxley Act of 2002, that would exceed the
benefits derived from the public issuance of the notes. As a result, the Board directed that the
public collateralized note program be terminated. On December 15, 2004, Post Effective Amendment
No. 3 to the Companys registration statement was declared effective by the Securities and Exchange
Commission (SEC) thereby deregistering $165,915,000 collateralized notes which represented all of
the remaining registered but unsold collateralized notes. The Company expects to be able to begin
offering collateralized notes on a private basis in June 2005. The following table reflects the maturities of collateralized notes as of December 31,
2004: Maturity Year
    

Amount2005
    
    $41,242,610
 SPACE INTENTIONALLY LEFT BLANK F-20




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##### Table of Contents



NOTE 8. SUMMARY OF QUARTERLY RESULTS OF OPERATIONS(UNAUDITED) 2004 Quarters EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 31(In thousands, except per share amount)Interest and dividend income
    
    $
    2,697
    
    
    $
    2,765
    
    
    $
    3,269
    
    
    $
    3,307Interest expense
    
    
    477
    
    
    
    512
    
    
    
    549
    
    
    
    611Net interest/ dividend income
    
    
    2,220
    
    
    
    2,253
    
    
    
    2,720
    
    
    
    2,696Rental and Other Income and
Gain/(Loss) on REO
    
    
    35
    
    
    
    34
    
    
    
    320
    
    
    
    413Provision/(Reversal
of Provision) for Loan Loss
    
    
    23
    
    
    
    58
    
    
    
    (176
    )
    
    
    61General and Administrative
    
    
    167
    
    
    
    124
    
    
    
    216
    
    
    
    317Management and Directors Fees
    
    
    187
    
    
    
    149
    
    
    
    159
    
    
    
    150Other Expenses
    
    
    104
    
    
    
    106
    
    
    
    (79
    )
    
    
    12Net Earnings
    
    $
    1,774
    
    
    $
    1,850
    
    
    $
    2,920
    
    
    $
    2,569Net Earnings per share  Basic
    
    $
    .23
    
    
    $
    .23
    
    
    $
    .36
    
    
    $
    .32Net Earnings per share  Diluted
    
    $
    .23
    
    
    $
    .23
    
    
    $
    .36
    
    
    $
    .31
 2003 Quarters EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 31(In thousands, except per share amount)Interest and dividend income
    
    $
    2,836
    
    
    $
    2,910
    
    
    $
    2,905
    
    
    $
    3,026Interest expense
    
    
    395
    
    
    
    450
    
    
    
    451
    
    
    
    445Net interest/ dividend income
    
    
    2,441
    
    
    
    2,460
    
    
    
    2,454
    
    
    
    2,581Rental and Other Income and
Gain/(Loss) on REO
    
    
    1
    
    
    
    (157
    )
    
    
    53
    
    
    
    51Provision/(Reversal
of Provision) for Loan Loss
    
    
    62
    
    
    
    421
    
    
    
    (359
    )
    
    
    (98
    )General and Administrative
    
    
    87
    
    
    
    168
    
    
    
    138
    
    
    
    201Management and Directors Fees
    
    
    192
    
    
    
    72
    
    
    
    108
    
    
    
    155Other Expenses
    
    
    56
    
    
    
    228
    
    
    
    174
    
    
    
    26Net Earnings
    
    $
    2,045
    
    
    $
    1,414
    
    
    $
    2,446
    
    
    $
    2,348Net Earnings per share  Basic
    
    $
    0.28
    
    
    $
    0.19
    
    
    $
    0.32
    
    
    $
    0.32Net Earnings per share  Diluted
    
    $
    0.28
    
    
    $
    0.19
    
    
    $
    0.32
    
    
    $
    0.31
 NOTE 9. EARNINGS PER SHARE Following is a reconciliation of earnings per share (in thousands, except per share amounts): For the years ended December 31, 2004
    
    
    2003
    
    
    2002Basic:Net Earnings Applicable to Common Stock
    
    $
    9,113
    
    
    $
    8,253
    
    
    $
    7,145Weighted Average Number of Shares  Basic
    
    
    8,028
    
    
    
    7,463
    
    
    
    7,033Earnings Per Share  Basic
    
    $
    1.14
    
    
    $
    1.11
    
    
    $
    1.02
 F-21




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##### Table of Contents



2004
    
    
    2003
    
    
    2002Diluted:Net Earnings for Diluted Earnings Per Share
    
    $
    9,113
    
    
    $
    8,253
    
    
    $
    7,145Weighted Average Number of Shares  Basic
    
    
    8,028
    
    
    
    7,463
    
    
    
    7,033Additional Shares due to dilutive Stock
Options
    
    
    9
    
    
    
    23
    
    
    
    39Weighted Average Number of Shares  Diluted
    
    
    8,037
    
    
    
    7,486
    
    
    
    7,072Earnings Per Share  Diluted
    
    $
    1.13
    
    
    $
    1.10
    
    
    $
    1.01Stock Options not included because they
were antidilutive
    
    
    
    
    
    
    
    
    
    
    
 NOTE 10. STOCK OPTIONS In October 1997, the Company adopted the 1997 Executive and Non-Employee Director Stock Option Plan
(the Plan) pursuant to which 300,000 shares of the Common Stock were reserved for issuance upon the
exercise of options granted. If the outstanding shares of Stock as reflected on the Companys
balance sheet exceeds 3,000,000, the total number of shares of Stock reserved and available for
issuance (inclusive of shares already issued) under the Plan shall automatically be increased so as
to equal 10% of the number of outstanding shares of stock. Therefore, the total number of shares
of Common Stock, which are available for issuance upon the exercise of options granted, was
827,253. Options granted may be designated as either (a) incentive stock options (ISOs) under the
Internal Revenue Code of 1986, as amended, at an exercise price equal to the fair market value of
the underlying stock, or (b) nonqualified options at a Board of Directors determined option price.
ISOs and nonqualified options may be granted by the Board of Directors to participating directors,
officers, other employees of the Company or its Manager, agents and consultants. Fair market value
is determined periodically by the Board of Directors. On April 26, 2004, the Board of Directors adopted, subject to the approval of the stockholders,
amendments to the Specialty Trust, Inc. 1997 Executive and Non-Executive Director Stock Option
Plan. The stockholders approved the amendments on June 21, 2004. The principal effect of the Plan
amendments is to make an additional 515,000 shares available for grant under the Plan, limit the
number of dividend equivalent rights (DERS) that may be attached to future grants to 235,350 shares
and limit the number of shares of restricted stock that may be the subject of future grants to the
same 235,350 shares. 25% of the shares subject to such stock options shall become exercisable on the first anniversary
of the date of grant of the stock option, and an additional 25% shall become exercisable on each of
the next three anniversaries of the date of grant. In general, vested options must be exercised
within three months after an employee leaves the Company or F-22




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##### Table of Contents



NOTE 10. STOCK OPTIONS (CONTINUED) 10 years after the stock options become vested. When options are exercised, the shares are newly
issued shares and the Company is not buying back existing shares.
Presented below is a summary of the Companys stock options and the related transactions for the
years ended December 31, 2004, 2003, and 2002: WeightedAverageExerciseShares
    
    
    PriceBalance at January 1, 2002
    
    
    118,632
    
    
    $
    4.65Granted
    
    
    85,000
    
    
    
    11.00Exercised
    
    
    (32,684
    )
    
    
    3.20Forfeited/ expired
    
    
    (11,250
    )
    
    
    5.00Balance at December 31, 2002
    
    
    159,698
    
    
    $
    8.30Granted
    
    
    
    
    
    
    Exercised
    
    
    (19,503
    )
    
    
    2.44Forfeited/expired
    
    
    (2,500
    )
    
    
    5.00Balance at December 31, 2003
    
    
    137,695
    
    
    $
    9.19Granted
    
    
    476,000
    
    
    $
    11.00Exercised
    
    
    (33,163
    )
    
    $
    6.46Forfeited/expired
    
    
    (48,800
    )
    
    $
    11.00Balance at December 31, 2004
    
    
    531,732
    
    
    $
    10.82
 F-23




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##### Table of Contents



NOTE 10. STOCK OPTIONS (CONTINUED) Stock Options Outstanding
    
    
    Stock Options ExercisableWeightedAverageExercise
    
    
    
    
    
    
    Contractual
    
    
    Exercise
    
    
    
    
    
    
    ExercisePrices
    
    
    Shares
    
    
    Life
    
    
    Price
    
    
    Shares
    
    
    PriceDecember 31, 2004$
    0.01
    
    
    
    6,750
    
    
    
    2.75
    
    
    $
    0.01
    
    
    
    6,750
    
    
    $
    0.015.00
    
    
    
    3,982
    
    
    
    5.58
    
    
    
    5.00
    
    
    
    3,982
    
    
    
    5.0011.00
    
    
    
    521,000
    
    
    
    9.66
    
    
    
    11.00
    
    
    
    15,000
    
    
    
    11.00531,732
    
    
    
    
    
    
    
    
    
    
    
    25,732December 31, 2003$
    0.01
    
    
    
    14,648
    
    
    
    3.75
    
    
    $
    0.01
    
    
    
    14,648
    
    
    $
    0.013.15
    
    
    
    1,200
    
    
    
    4.58
    
    
    
    3.15
    
    
    
    1,200
    
    
    
    3.155.00
    
    
    
    13,047
    
    
    
    6.00
    
    
    
    5.00
    
    
    
    8,422
    
    
    
    5.0011.00
    
    
    
    108,800
    
    
    
    8.64
    
    
    
    11.00
    
    
    
    32,550
    
    
    
    11.00Totals
    
    
    137,695
    
    
    
    
    
    
    
    
    
    
    
    56,820December 31, 2002$
    0.01
    
    
    
    23,148
    
    
    
    4.81
    
    
    $
    0.01
    
    
    
    23,148
    
    
    $
    0.010.05
    
    
    
    2,500
    
    
    
    5.09
    
    
    
    0.05
    
    
    
    2,500
    
    
    
    0.053.15
    
    
    
    2,500
    
    
    
    5.59
    
    
    
    3.15
    
    
    
    2,500
    
    
    
    3.155.00
    
    
    
    21,550
    
    
    
    7.02
    
    
    
    5.00
    
    
    
    7,300
    
    
    
    5.0011.00
    
    
    
    110,000
    
    
    
    9.70
    
    
    
    11.00
    
    
    
    6,250
    
    
    
    11.00Totals
    
    
    159,698
    
    
    
    
    
    
    
    
    
    
    
    41,698
 The fair value of the Companys stock options was estimated as of the grant date using the
Black-Scholes Option Pricing Model with the following weighted average assumptions for the years
ended December 31, 2004, 2003 and 2002: Dividend yield of 12.0% for all years, expected volatility
of 0.0% for all years, and an expected holding period of five years. The weighted average risk
free interest rate of 1.5%, 1.8% and 2.2% was used as of December 31, 2004, 2003 and 2002,
respectively. Based on these assumptions, compensation expense was $0, $0 and $81,013 for the
years ended December 31, 2004, 2003, and 2002, respectively. The weighted average fair value of options granted during each of the years ended December 31,
2004, 2003 and 2002 was $0, $0 and $81,013 respectively. F-24




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NOTE 11. 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 management agreement had an initial term of three years beginning January 30, 1998 and is
renewed automatically for successive one-year periods unless the Company timely delivers a notice
of non-renewal. Upon non-renewal of the management agreement without cause, a termination fee will
be payable to the Manager in an amount equal to the greater of (i) the fair value of the management
agreement as established by an independent appraiser, or (ii) 4% of the mortgage loan portfolio of
Specialty Trust. At December 31, 2004, 4% of the Companys mortgage loan portfolio would be
approximately $3.8 million. 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 original Management Agreement dated October 23, 1997, the Company also paid to Specialty
Financial an incentive compensation fee for each fiscal quarter. For periods through the end of
fiscal year 2003, the incentive compensation was an amount equal to 50% of the net tax-based income
of Specialty Trust, before deduction of such incentive compensation, in excess of an annualized
return to Specialty Trust equal to 12%. The incentive compensation calculation and payment were
made quarterly in arrears. The term return to Specialty Trust was calculated for the quarter by
dividing taxable income for the quarter by the net worth for the quarter. For such calculations,
taxable income means the Companys taxable income before the Managers incentive compensation,
the deduction for dividends paid and net operating loss deductions arising from losses in prior
periods. A deduction for the Companys interest expenses for borrowed money is taken when
calculating taxable income. Net worth for any period means the sum of the gross proceeds from all
prior offerings of equity securities by the Company, after deducting expenses and costs relating to
the offering (or for any period in which new equity securities are issued, the arithmetic weighted
average on the prior offering proceeds and the new proceeds for the period), plus beginning
retained earnings F-25




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##### Table of Contents



(without taking into account any losses incurred in prior periods and excluding amounts reflecting
taxable income to be distributed as dividends and amounts reflecting valuation allowance
adjustments). The definition return to Specialty Trust was used only for purposes of calculating
the incentive compensation payable, and was not related to the actual distributions received by
stockholders. The incentive compensation payments to Specialty Financial were made before any
income distributions were made to the Companys stockholders. Under the Amended Agreement dated January 1, 2004, 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 could receive, 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 a Threshold Return which is a per annum target
percentage rate of return set by a mutual agreement between the Manager and the Board of Directors
of the Company for each calendar year beginning with the year 2004. For the year 2004, the
Threshold Return was set at 12%. For the years ended December 31, 2004, 2003, and 2002 the Manager earned the following: 2004
    
    
    2003
    
    
    2002Loan Origination and
Extension Fees
    
    $
    2,894,828
    
    
    $
    2,259,153
    
    
    $
    1,610,059Loan Servicing Fees
    
    
    457,424
    
    
    
    455,923
    
    
    
    361,224Late Payment Charges
    
    
    49,842
    
    
    
    11,685
    
    
    
    9,295Subtotal
    
    
    3,402,094
    
    
    
    2,726,761
    
    
    
    1,980,578Base Management Fee
    
    
    491,140
    
    
    
    
    
    
    
    Incentive Compensation
    
    
    
    
    
    
    391,579
    
    
    
    314,249Total Compensation
    
    $
    3,893,234
    
    
    $
    3,118,340
    
    
    $
    2,294,827
 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 the borrower. Late payment
charges are received directly by the Manager from the borrower. The incentive compensation is
calculated in accordance with the agreement and paid for or accrued in Management and Directors
fees in the Companys financial statements. As of December 31, 2003, related parties owned approximately $1,528,000 in collateralized notes,
which represents approximately 4.6% of the total balance. As of December 31, 2004, no
collateralized notes were owned by related parties. F-26




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##### Table of Contents



In addition, SAC currently has an agreement with a realtor related to the development of the land
held for residential development. SAC will pay the realtor a finders fee of $300 per lot and a
3.5% brokers commission for each home sold. The realtor is a real estate company in which an
independent director and member of the audit committee is a substantial owner and executive
officer. As of December 31, 2004, SAC had no outstanding payable to the realtor related to the
finders fee on Phase II. Total fees paid to the real estate company for the fiscal year ended
December 31, 2004 and 2003 were $317,754 and $114,508 respectively. F-27




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##### Table of Contents



Report
of Independent
Registered Public Accounting Firm The
Board of Directors and Stockholders
Specialty Trust, Inc.: Under
date of March 23, 2005, we reported on the consolidated balance
sheets of Specialty Trust, Inc. and subsidiaries (the Company) as of
December 31, 2004 and 2003, and the related consolidated
statements of earnings, stockholders equity and comprehensive
income, and cash flows for each of the years in the three-year period
ended December 31, 2004, which are included in the
Companys 2004 Annual Report on Form 10-K. In connection with
our audits of the aforementioned consolidated financial statements, we
also audited the related consolidated financial statement schedule
included in such Form 10-K. This financial statement schedule is the
responsibility of the Companys management. Our responsibility
is to express and opinion on this financial statement schedule based
on our audits. In
our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set
forth therein. /s/ 

KPMG, LLP Sacramento, California
March 23, 2005 91




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##### Table of Contents



Report of Independent
Registered Public Accounting Firm Board
of Directors and Stockholders
Specialty Trust, Inc.: We
have audited the accompanying consolidated balance sheets of
Specialty Trust, Inc. and subsidiaries as of December 31, 2004
and 2003, and the related consolidated statements of earnings,
stockholders equity and comprehensive income, and cash flows for
each of the years in the three-year period ended December 31,
2004. These consolidated financial statements are the responsibility
of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits. We
conducted our audits in accordance with auditing standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In
our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Specialty Trust, Inc. and subsidiaries as of December 31, 2004
and 2003, and the results of their operations and their cash flows
for each of the years in the three-year period ended
December 31, 2004 in conformity with U.S. generally accepted
accounting principles. /s/ KPMG,
LLP Sacramento,
CaliforniaMarch 23, 2005 92