<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 14, 1997
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN GOVERNING INSTRUMENTS)
445 MARINE VIEW AVENUE, SUITE 230, DEL MAR, CALIFORNIA 92014
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
------------------------
JOHN M. ROBBINS
CHIEF EXECUTIVE OFFICER
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
445 MARINE VIEW AVENUE, SUITE 230
DEL MAR, CALIFORNIA 92014
(619) 350-5000
(NAME AND ADDRESS OF AGENT FOR SERVICE)
------------------------
COPIES TO:
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CAMERON JAY RAINS, ESQ. PETER T. HEALY, ESQ.
GRAY CARY WARE & FREIDENRICH O'MELVENY & MYERS LLP
4365 EXECUTIVE DRIVE, SUITE 1600 EMBARCADERO CENTER WEST
SAN DIEGO, CA 92121 275 BATTERY STREET, SUITE 2600
TELEPHONE: (619) 677-1400 SAN FRANCISCO, CA 94111
FACSIMILE: (619) 677-1477 TELEPHONE: (415) 984-8833
FACSIMILE: (415) 984-8701
</TABLE>
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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TITLE OF EACH CLASS OF PROPOSED MAXIMUM AGGREGATE AMOUNT OF
SECURITIES OFFERING PRICE(1)(2) REGISTRATION FEE
TO BE REGISTERED
- --------------------------------------------------------------------------------------------
Common Stock, $.01 par value.. $86,250,000 $26,137
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(1) Assumes exercise of an over-allotment option granted to the Underwriters.
(2) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(o).
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, as amended, or until the Registration Statement
shall become effective on such date as the Commission, acting pursuant to said
Section 8(a), may determine.
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<PAGE> 2
SUBJECT TO COMPLETION,
PRELIMINARY PROSPECTUS DATED AUGUST 14, 1997
5,000,000 SHARES
[LOGO]
COMMON STOCK
------------------------
All of the shares of Common Stock offered hereby are being sold by American
Residential Investment Trust, Inc. ("AMREIT" or the "Company"). Prior to this
Offering, there has been no public market for the Common Stock of the Company.
It is currently estimated that the initial public offering price per share will
be between $14.00 and $16.00. See "Underwriting" for information relating to the
determination of the initial public offering price.
Application has been made to list the Common Stock on the New York Stock
Exchange under the symbol " ."
SEE "RISK FACTORS" STARTING ON PAGE 11 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS. THESE RISKS INCLUDE:
- - Interest Rate Fluctuations May Adversely Affect Net Interest Income
- - Increased Levels of Mortgage Loan Prepayments May Adversely Affect Net
Interest Income
- - Limited Operating History Does Not Predict Future Performance
- - Inability to Acquire Mortgage Assets with Favorable Interest Rates and Terms
May Adversely Affect Net Interest Income
- - Failure to Implement Company's Leverage Strategy May Adversely Affect Results
of Operations
- - Failure to Successfully Manage Interest Rate Risks May Adversely Affect
Results of Operations
- - Value of Mortgage Loans May Be Adversely Affected by Characteristics of
Underlying Property and Borrower Credit
- - Conflicts of Interest; Management also Employed by and Owns Securities of
Manager
- - Dependence on Key Personnel for Successful Operations
- - Failure to Manage Expansion May Adversely Affect Results of Operations
- - Real Estate Market Conditions May Adversely Affect Results of Operations
- - Investments in Mortgage Assets May Be Illiquid
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
------------------------
- --------------------------------------------------------------------------------
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- ------------------------------------------------------------------------------------------------
Underwriting
Price to Discount and Proceeds to
Public Commissions(1) Company(2)
- ------------------------------------------------------------------------------------------------
Per Share.................................... $ $ $
- ------------------------------------------------------------------------------------------------
Total........................................ $ $ $
- ------------------------------------------------------------------------------------------------
Total Assuming Full Exercise of
Over-allotment Option(3)................... $ $ $
================================================================================================
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(1) See "Underwriting" for information regarding indemnification of the
Underwriters and other matters.
(2) Before deducting expenses estimated at $1,200,000, all of which are payable
by the Company. See "Underwriting."
(3) Assuming exercise in full of the 30-day option granted by the Company to the
Underwriters to purchase up to 750,000 additional shares, on the same terms,
solely to cover over-allotments. See "Underwriting."
-----------------------------
The shares of Common Stock are offered by the Underwriters, subject to
prior sale, when, as and if delivered to and accepted by the Underwriters, and
subject to their right to reject orders in whole or in part. It is expected that
delivery of the Common Stock will be made in New York City on or about
, 1997.
PAINEWEBBER INCORPORATED
OPPENHEIMER & CO., INC.
EVEREN SECURITIES, INC.
SUTRO & CO. INCORPORATED
THE DATE OF THIS PROSPECTUS IS , 1997.
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
<PAGE> 3
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING AND
MAY BID FOR AND PURCHASE SHARES OF THE COMMON STOCK IN THE OPEN MARKET. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
The Company intends to furnish its stockholders with annual reports
containing financial statements audited by its independent auditors and
quarterly reports for the first three quarters of each fiscal year containing
unaudited financial information.
TABLE OF CONTENTS
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PAGE
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PROSPECTUS SUMMARY............................. 3
The Company.................................. 3
The Manager.................................. 7
Summary Risk Factors......................... 8
The Offering................................. 9
Summary Financial Information................ 10
RISK FACTORS................................... 11
Interest Rate Fluctuations May Adversely
Affect Net Interest Income................. 11
Increased Levels of Mortgage Loan Prepayments
May Adversely Affect Net Interest Income... 11
Limited Operating History Does Not Predict
Future Performance......................... 12
Inability to Acquire Mortgage Assets with
Favorable Interest Rates and Terms May
Adversely Affect Net Interest Income....... 12
Failure to Implement Company's Leverage
Strategy May Adversely Affect Results of
Operations................................. 12
Failure to Successfully Manage Interest Rate
Risks May Adversely Affect Results of
Operations................................. 13
Value of Mortgage Loans May Be Adversely
Affected by Characteristics of Underlying
Property and Borrower Credit............... 13
Conflicts of Interests; Management Also
Employed by and Owns Securities of
Manager.................................... 14
Dependence on Key Personnel for Successful
Operations................................. 14
Failure to Manage Expansion May Adversely
Affect Results of Operations............... 15
Real Estate Market Conditions May Adversely
Affect Results of Operations............... 15
Investments in Mortgage Assets May Be
Illiquid................................... 15
Additional Risk Factors...................... 15
THE COMPANY.................................... 20
USE OF PROCEEDS................................ 20
DIVIDEND POLICY AND DISTRIBUTIONS.............. 21
DIVIDEND REINVESTMENT PLAN..................... 21
CAPITALIZATION................................. 22
DILUTION....................................... 23
SELECTED FINANCIAL DATA........................ 24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS................................... 25
Overview..................................... 25
Results Of Operations........................ 27
Liquidity And Capital Resources.............. 28
Recent Developments.......................... 28
BUSINESS....................................... 29
General...................................... 29
Residential Mortgage Industry................ 29
Investments.................................. 29
Funding...................................... 33
Capital Guidelines........................... 35
Risk Management.............................. 36
Certain Accounting Policies and Procedures... 40
Competition.................................. 40
Employees.................................... 41
Facilities................................... 41
Legal Proceedings............................ 41
MANAGEMENT OF THE COMPANY...................... 42
THE MANAGER.................................... 50
CERTAIN TRANSACTIONS........................... 55
PRINCIPAL STOCKHOLDERS......................... 59
DESCRIPTION OF CAPITAL STOCK................... 60
SHARES ELIGIBLE FOR FUTURE SALE................ 64
FEDERAL INCOME TAX CONSIDERATIONS.............. 64
ERISA CONSIDERATIONS........................... 74
UNDERWRITING................................... 75
CERTAIN PROVISIONS OF MARYLAND LAW AND THE
COMPANY'S CHARTER AND BYLAWS................. 77
LEGAL MATTERS.................................. 79
EXPERTS........................................ 80
ADDITIONAL INFORMATION......................... 80
GLOSSARY....................................... 81
INDEX TO FINANCIAL STATEMENTS.................. F-1
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information appearing in this Prospectus. Capitalized and other terms relating
to the mortgage industry used herein shall have the definitive meanings assigned
to them in the Glossary. Unless otherwise indicated, the information in this
Prospectus (i) assumes that the Underwriters' over-allotment option will not be
exercised and (ii) has been adjusted to reflect the 0.8-for-1 reverse stock
split to be effected prior to the closing of this Offering. See Note 8 of Notes
to Financial Statements.
This Prospectus contains forward looking statements that inherently involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward looking statements as a result of
certain factors. Investors should carefully consider the information set forth
under the heading "Risk Factors."
THE COMPANY
OVERVIEW
American Residential Investment Trust, Inc. ("AMREIT" or the "Company") is
a real estate investment trust which invests in adjustable-rate residential
Mortgage Securities. AMREIT's current investment portfolio is comprised solely
of Agency Securities; however, following this Offering, the Company will begin
investing in other types of Mortgage Securities and in Mortgage Loans acquired
directly from certain originators, such as mortgage banks and savings and loans
("Correspondents"). AMREIT has developed tailored Mortgage Loan products that it
will use to generate nonconforming Mortgage Loans through its Direct Purchase
Program. The Company will use its mortgage banking experience to acquire
nonconforming Mortgage Loans with higher overall returns than similar Mortgage
Loans originated by its competitors.
AMREIT will finance the acquisition of its Mortgage Securities and Mortgage
Loans (collectively "Mortgage Assets") with its equity base and with third party
borrowing facilities. The Company generally expects to maintain an
equity-to-assets ratio of 8% to 12% and to earn interest on the Mortgage Assets
financed with equity and a net interest spread on the Mortgage Assets financed
with borrowings. AMREIT is similar to a bank or savings and loan in its business
purpose but does not collect deposits and is not subject to certain regulations
governing banks and savings and loans. The Company has elected to be subject to
tax as a real estate investment trust ("REIT") and, therefore will generally not
be subject to federal taxes on its income to the extent that it distributes its
net income to stockholders and maintains its qualification as a REIT. The
Company believes that its REIT structure is the most efficient form in which to
invest in adjustable-rate Mortgage Assets.
The Company and its manager, Home Asset Management Corp. (the "Manager"),
were formed on February 11, 1997 through a private placement financing by McCown
De Leeuw & Co., TCW/Crescent Mezzanine, L.L.C. and members of the management
team. The Manager was formed for the purpose of managing the day-to-day
operations of AMREIT. The Manager is subject to direction by the Company's Board
of Directors which is composed of a majority of independent directors as well as
certain members of the management team. Following this Offering, affiliates of
the Manager will own 24% of AMREIT, and the Manager will receive the majority of
its income through dividends and incentive fees from the Company. Accordingly,
the Manager's financial interest will be significantly aligned with the
financial interest of AMREIT.
The Company's and the Manager's management team ("Management") is comprised
of former executive officers and founders of American Residential Mortgage
Corporation ("AMRES Mortgage"). Management is led by John Robbins, former
Chairman and CEO of AMRES Mortgage, and Jay Fuller, former Executive Vice
President and Chief Administrative Officer of AMRES Mortgage. Management has
over 75 years of experience in the mortgage origination business and extensive
experience in originating
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nonconforming Mortgage Loans. Management led AMRES Mortgage from a start-up
company to one of the nation's largest independent mortgage banks before its
sale to The Chase Manhattan Corporation in 1994.
CURRENT OPERATIONS
In the quarter ended June 30, 1997, AMREIT generated net income of
approximately $438,000 and net income per share of $0.26. From the commencement
of operations on February 11, 1997 through June 30, 1997, the Company generated
net income of approximately $584,000 and net income per share of $0.35. At June
30, 1997, the Company held Mortgage Assets that had a carrying value of
approximately $229 million. All Mortgage Assets held at June 30, 1997 were
Agency Securities backed by adjustable-rate single family residential Mortgage
Loans.
INVESTMENTS
AMREIT currently acquires adjustable-rate residential Mortgage Securities
in the capital markets. While the Company expects that a majority of its
Mortgage Assets will continue to be Mortgage Securities, it anticipates that it
will increasingly invest directly in adjustable-rate Mortgage Loans, including
tailored Mortgage Loan products generated through the Company's Direct Purchase
Program. Under the Direct Purchase Program, the Company believes that its
experienced management team can enhance the overall yield of the Company's
Mortgage Asset portfolio by acquiring relatively higher yielding Mortgage Loans
and avoiding the cost of using intermediaries. See "Risk Factors -- Inability to
Acquire Mortgage Assets with Favorable Interest Rates and Terms May Adversely
Affect Net Interest Income" and "Business -- Investments -- Direct Purchase
Program."
Capital Markets Program
The Company has purchased and intends to continue to purchase Mortgage
Securities in the capital markets. These Mortgage Assets generally have a higher
level of liquidity than the Mortgage Loans to be acquired under the Direct
Purchase Program and are expected to provide a stable flow of interest income
with relatively low levels of credit risk. The Mortgage Securities to be
acquired by the Company will be backed by a pool of adjustable-rate residential
Mortgage Loans. These Mortgage Securities entitle the holder to receive a pass
through of principal and interest payments on the underlying pool of Mortgage
Loans and are issued or guaranteed by federal government sponsored agencies
("Agency Securities") or issued by certain private institutions ("Privately
Issued Securities").
Direct Purchase Program
Under the Direct Purchase Program, the Manager will identify segments of
the residential Mortgage Loan market that it determines have the potential for
generating Mortgage Loans with relatively higher yields than other Mortgage
Loans with generally comparable risks. These segments typically will include
Mortgage Loans that are not readily available from large, nationally-based
Mortgage Loan originators due to factors related to the loan underwriting
process itself (such as the need to value a complex, mixed use property) or a
limited secondary market for resale of such types of Mortgage Loans. For
example, Management has identified the following segments of the residential
Mortgage Loan market for its initial tailored Mortgage Loan products: small
multifamily home loans, manufactured housing loans (not including mobile homes),
mixed use loans, rural home loans, mini-ranch home loans, and condominium/resort
loans. In addition, Management expects that new opportunities in other market
segments will become available as the Mortgage Loan market continues to change.
The Manager has created tailored Mortgage Loan products for the Company's
initial targeted market segments and has developed loan underwriting guidelines
for Correspondents. The tailored Mortgage Loan products generally will be
nonconforming, primarily as a result of the property type and, to a lesser
extent, the borrower's credit characteristics. Management intends to leverage
its experience in the residential mortgage industry to build a network of
Correspondents with expertise in market segments targeted by the Company. The
Manager will make arrangements for the Company to acquire Mortgage Loans through
the Manager's
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relationships with these Correspondents. Management has already identified and
is working with a number of Correspondents to generate Mortgage Loan products
for the Direct Purchase Program. In addition, the Company may also acquire
conforming Mortgage Loans and nonconforming jumbo Mortgage Loans from
Correspondents and purchase Mortgage Loans on a bulk basis. See "Risk
Factors -- Value of Mortgage Loans May be Adversely Affected by Characteristics
of Underlying Property and Borrower Credit" and "Business -- Investments."
The Company has not yet begun acquiring Mortgage Loans under the Direct
Purchase Program and there can be no assurance that the program will be
successfully implemented or that the Mortgage Assets acquired through the
program will be higher yielding.
FUNDING
AMREIT finances its portfolio of Mortgage Assets primarily through a form
of borrowing known as reverse repurchase agreements. In a reverse repurchase
agreement transaction, the Company agrees to sell a Mortgage Asset and
simultaneously agrees to repurchase the same Mortgage Asset one to six months
later at a higher price with the price differential representing the interest
expense. These transactions constitute collateralized borrowings for the
Company, based on the market value of the Company's Mortgage Assets. By using
the Company's Mortgage Assets as collateral to borrow funds, the Company is able
to purchase Mortgage Assets with significantly greater value than its equity.
The Company will have a targeted ratio of equity-to-assets of between 8% and
12%, which is generally greater than the levels of many other companies that
invest in Mortgage Assets, including many commercial banks, savings and loans,
FNMA and FHLMC. The Company has borrowing arrangements with ten financial
institutions consisting primarily of large investment banking firms. At June 30,
1997, the Company had borrowed funds under reverse repurchase agreements with
five of these firms and had incurred total reverse repurchase borrowings of
$209.5 million, with an average term to maturity of 62 days and a weighted
average borrowing rate of 5.69% per annum. From time to time the Company also
intends to securitize Mortgage Loans acquired through the Direct Purchase
Program as part of its overall financing strategy. See "Risk Factors -- Failure
to Implement Company's Leverage Strategy May Adversely Affect Results of
Operations" and "Business -- Funding."
At June 30, 1997 the Company had uncommitted reverse repurchase facilities
to provide over $500 million to finance investments in Mortgage Assets. These
borrowing facilities may be collateralized only by Mortgage Securities. The
Company intends to expand its uncommitted reverse repurchase facilities
following this Offering. Management believes that cash flow from operations, the
proceeds of this Offering and funds available pursuant to reverse repurchase
financing facilities and other credit arrangements will be sufficient to meet
the Company's cash requirements for at least one year following the closing of
this Offering. Thereafter, if the Company's cash resources are insufficient to
satisfy the Company's liquidity requirements, the Company may be required to
sell additional equity or debt securities. There is no assurance that additional
financing will be available to the Company on favorable terms, or at all. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
CAPITAL GUIDELINES
The Company's capital management 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. For this purpose, the
Company has established a "Capital Policy" which limits Management's ability to
acquire additional Mortgage Assets during times when the actual capital base of
the Company is less than a required amount defined in the Capital Policy. In
this way, the use of balance sheet leverage is controlled. The actual capital
base, as defined for the purpose of the Capital Policy, is equal to the market
value of total Mortgage Assets less the book value of total collateralized
borrowings. See "Business -- Capital Guidelines."
The Company assigns to each Mortgage Asset a specified amount of capital to
be maintained against it by aggregating the three component requirements of the
Capital Policy -- the "lender's haircut," the "liquidity capital cushion" and
the "risk-adjusted capital cushion." In addition, the Board of Directors
establishes,
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subject to revision from time to time, an overall maximum leverage ratio for the
Company. The Board of Directors reviews on a periodic basis various analyses
prepared by Management of the risks inherent in the Company's balance sheet,
including an analysis of the effects of various scenarios on the Company's net
cash flow, net income, dividends, liquidity and net market value. Should the
Board of Directors determine in its discretion that the minimum required capital
base is either too low or too high, the Board of Directors will raise or lower
the capital requirement accordingly.
The Company expects that its aggregate minimum capital requirement under
the Capital Policy will range between 8% to 12% of the total market value of the
Company's Mortgage Assets. This percentage will fluctuate over time, and may
fluctuate out of the expected range, as the composition of the balance sheet
changes, haircut levels required by lenders change, the market value of the
Mortgage Assets changes and as the capital cushion percentages set by the Board
of Directors are adjusted over time. The Company will actively monitor and
adjust, if necessary, its Capital Policy, both on an aggregate portfolio level
as well as on an individual pool or Mortgage Loan basis. In monitoring its
Capital Policy, the Company expects to take into consideration current market
conditions and a variety of interest rate scenarios, performance of hedges,
Mortgage Asset performance, credit risk, prepayments and Mortgage Asset
restructurings, general economic conditions, potential issuance of additional
equity, pending Mortgage Asset acquisitions or sales, Mortgage Loan
securitizations and general availability of financing. There can be no assurance
that the Company's capital will be sufficient to protect the Company against
adverse effects from interest rate adjustments or the obligation to sell
Mortgage Assets on unfavorable terms or at a loss. See "Risk Factors -- Interest
Rate Fluctuations May Adversely Affect Net Interest Income" and
"Business -- Capital Guidelines."
RISK MANAGEMENT
Interest Rate Risk Management
To the extent consistent with its election to qualify as a REIT, AMREIT
will implement certain processes and will follow a hedging program intended to
protect the Company against significant unexpected changes in prepayment rates
and interest rates.
The Company will seek to minimize the effects on earnings caused by faster
than anticipated prepayment rates by purchasing Mortgage Assets with prepayment
penalties or which are fully-indexed and have previously experienced periods of
rising or falling interest rates. In particular, the Company intends to include
substantial prepayment penalties in the underwriting guidelines for the tailored
Mortgage Loan products in the Direct Purchase Program. See "Risk
Factors -- Increased Levels of Mortgage Loan Prepayments May Adversely Affect
Net Interest Income."
The Company manages its Mortgage Asset portfolio to offset the potential
adverse effects from (i) lifetime and periodic rate adjustment caps on its
Mortgage Assets, (ii) the differences between interest rate adjustment indices
of its Mortgage Assets and related borrowings, and (iii) the differences between
interest rate adjustment periods of its Mortgage Assets and related borrowings.
The Company generally purchases Mortgage Assets which are fully indexed. The
Company also attempts to structure its acquisitions so that the Mortgage Assets
purchased by the Company have interest rate adjustment indices and adjustment
periods that, on an aggregate basis, correspond closely to the interest rate
adjustment indices and adjustment periods of its anticipated borrowings. In
addition, the Company structures its short term borrowing agreements to have a
range of different maturities (although the majority will be six months or
less). As a result, the Company expects to be able to adjust the average
maturity of its borrowings on an ongoing basis by changing the mix of maturities
as borrowings come due and are renewed. In this way, the Company intends to
reduce the differences between the adjustment periods of its Mortgage Assets and
related borrowings.
The Company recognizes the need to hedge specific interest rate risks
associated with its Mortgage Asset portfolio and will seek the hedging
instrument most appropriate for the specific risk. Currently, all of the
Company's Mortgage Assets are subject to both lifetime interest rate caps and
periodic interest rate caps. The Company actively hedges the lifetime cap risks
associated with its Mortgage Assets. The Company has entered into hedging
transactions with respect to lifetime interest rate caps in order to reduce the
negative impact to the Company's earnings which might otherwise result from a
significant rise in interest rates. The
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Company may enter into additional types of hedging transactions in the future if
Management believes there exists a significant risk to earnings. These types of
hedging transactions may include hedging against risks associated with (i)
periodic interest rate adjustment caps, (ii) Mortgage Assets denominated in
different interest rate indices, such as U.S. Treasury bills and Eurodollars,
and (iii) the difference in timing between interest rate adjustments of its
Mortgage Assets and interest rate adjustments of its borrowings. Management
intends to monitor and evaluate the results of its hedging strategy and to
adjust its hedging strategy as it deems is in the best interest of the Company.
Although Management believes it has developed a cost effective interest
rate risk management program to provide a level of protection against interest
rate risks, developing an effective program is complex and no program can
completely insulate the Company from the effects of interest rate changes.
Further, the cost of hedging transactions and the federal tax laws applicable to
REITs may limit the Company's ability to fully hedge its interest rate risks.
See "Risk Factors -- Failure to Successfully Manage Interest Rate Risks May
Adversely Affect Results of Operations," "Business -- Risk
Management -- Interest Rate Risk Management" and "Federal Income Tax
Considerations -- Requirements for Qualification as a REIT."
Credit Risk Management
The risks presented by each Mortgage Loan acquired under the Direct
Purchase Program will be unique and must be analyzed separately. In order to
reduce the credit risks associated with acquisitions of these Mortgage Loans,
Management will (i) employ a quality control program, (ii) acquire Mortgage
Loans that represent a broad range of moderate risks as opposed to a
concentrated risk, (iii) monitor the credit quality of newly acquired and
existing Mortgage Assets, and (iv) periodically adjust loan loss allowances. The
Company also expects to arrange for servicing of the Direct Purchase Program
Mortgage Loans with servicing entities that have particular expertise and
experience in the types of Mortgage Loans being acquired. See "Risk
Factors -- Value of Mortgage Loans May be Adversely Affected by Characteristics
of Underlying Property and Borrower Credit" and "Business -- Risk
Management -- Credit Risk Management."
THE MANAGER
Pursuant to a Management Agreement, AMREIT has engaged the Manager to
generate and manage the Company's Mortgage Assets and to oversee the day-to-day
operations of the Company, subject to direction by the Company's Board of
Directors. The Manager funded AMREIT at its formation with a $20 million
investment through an intermediary entity. See "The Manager -- Relationship
between the Manager and the Company." Currently, the Manager derives
substantially all of its income from the Company, a majority of which is from
dividends and incentive fees. Accordingly, the success of the Manager is
substantially dependent upon the success of the Company. In addition, the
executive officers of the Company are also the executive officers of the Manager
and also beneficially own an interest in the Manager. See "Management of the
Company -- Conflict of Interest," "Certain Transactions" and "Principal
Stockholders."
The Manager will receive an annual base management fee payable monthly in
an amount generally equal to (a) 1/8 of 1% on Agency Securities and (b) 3/8 of
1% on all other Mortgage Assets. The Company will also pay the Manager, as
incentive compensation for each fiscal quarter, a fee equal to 25% of the net
income of the Company, before deduction of such incentive fee, in excess of the
annualized return on equity equal to the Ten Year U.S. Treasury Rate average
plus 2%. The Management Agreement has an initial term of two years with
automatic one-year renewals. It may be terminated by the Company without cause
only upon each renewal date and may be terminated for cause at any time by
either party. In the event that the Management Agreement is terminated by the
Company without cause, the Company is obligated to pay the Manager a termination
fee pursuant to a specified formula. See "The Manager -- The Management
Agreement."
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SUMMARY RISK FACTORS
Each prospective purchaser of the shares of Common Stock (the "Shares")
offered hereby should review "Risk Factors" beginning on page 11 for a
discussion of certain factors that should be considered before acquiring the
Shares, including the following:
- - Interest Rate Fluctuations May Adversely Affect Net Interest Income. To the
extent the Company's cost of borrowing rises more rapidly than the yields on
Mortgage Assets funded by such borrowings, the Company's net interest income
may be reduced or a net interest loss may result.
- - Increased Levels of Mortgage Loan Prepayments May Adversely Affect Net
Interest Income. In the event that the Company's Mortgage Assets are prepaid,
the Company may (i) have held the Mortgage Asset while it was less profitable
and lost the opportunity to receive interest at the fully indexed rate, (ii)
need to write-off capitalized premium amounts, and (iii) be unable to acquire
new Mortgage Assets to replace the prepaid Mortgage Assets. The Company
experienced higher than expected levels of prepayments in the quarter ended
June 30, 1997. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Results of Operations."
- - Limited Operating History Does Not Predict Future Performance. The Company
began operations in February 1997, and the Company's financial results to date
may not be indicative of future results.
- - Inability to Acquire Mortgage Assets with Favorable Interest Rates and Terms
may Adversely Affect Net Interest Income. The Company's net interest income
will depend on the Company's ability to acquire Mortgage Assets on acceptable
terms and at favorable spreads over the Company's borrowing costs. To the
extent the Company is unable to acquire sufficient Mortgage Loans meeting its
investment criteria, the Company's results of operations may be adversely
affected.
- - Failure to Implement Company's Leverage Strategy May Adversely Affect Results
of Operations. The Company relies on short term borrowings to fund
acquisitions of Mortgage Assets. Any failure to obtain or renew adequate
funding on favorable terms, could have a material adverse effect on the
Company's operations. The Company could be required to sell Mortgage Assets
under adverse market conditions and could incur losses as a result.
- - Failure to Successfully Manage Interest Rate Risks May Adversely Affect
Results of Operations. Developing an objective interest rate risk strategy is
complex and no strategy can completely insulate the Company from risks
associated with interest rate changes. Further, the cost of hedging
transactions and the federal tax laws applicable to REITs may limit the
Company's ability to fully hedge its interest rate risks. In addition, a
provider of interest rate derivatives may become financially unsound or
insolvent, rendering the Company unprotected against interest rate risks.
- - Value of Mortgage Loans May Be Adversely Affected by Characteristics of
Underlying Property and Borrower Credit. In the event of a default on any
Mortgage Loan held by the Company, the Company will bear the risk of loss of
principal and the Mortgage Loan will cease to be eligible collateral for
borrowings. Mortgage Loans acquired pursuant to the Direct Purchase Program
will have certain distinct risk characteristics and will result in increased
credit risk to the Company.
- - Conflicts of Interest; Management Also Employed by and Owns Securities of
Manager. The executive officers of the Company will also be executive
officers, employees and stockholders of the Manager. Emphasis by Management on
maximizing income in order to achieve higher incentive fees for the Manager
could result in increased risk to the value of the Company's Mortgage Asset
portfolio.
- - Dependence on Key Personnel for Successful Operations. The Company's
operations depend in significant part upon the contributions of John Robbins,
Jay Fuller and other key personnel. The loss of any key person could have a
material adverse effect on the Company's business.
- - Failure to Manage Expansion May Adversely Affect Results of Operations. The
Company's expansion as a result of its investment of the net proceeds of this
Offering may cause a significant strain on the Company's
8
<PAGE> 10
and the Manager's financial, management and other resources. If the Company is
unable to manage growth effectively, the Company's business, financial
condition and results of operations may be adversely affected.
- - Real Estate Market Conditions May Adversely Affect Results of Operations. The
Company's business may be adversely affected by periods of economic slowdown
or recession which may be accompanied by declining real estate values.
- - Investments in Mortgage Assets May Be Illiquid. Certain of the Company's
investments may lack a regular trading market and may be illiquid. The
Company's inability to liquidate Mortgage Assets could render it insolvent.
THE OFFERING
<TABLE>
<S> <C>
Common Stock Offered by the Company (1)...... 5,000,000 Shares
Common Stock to be Outstanding after the
Offering (1)(2).............................. 6,614,000 Shares
Use of Proceeds.............................. To fund purchases of Mortgage Assets and for
general corporate purposes. See "Use of
Proceeds."
Proposed NYSE Symbol......................... " "
</TABLE>
- ---------------
(1) Assumes that the Underwriters' option to purchase up to an additional
750,000 shares of Common Stock to cover overallotments is not exercised.
(2) Excludes (i) 315,200 shares of Common Stock reserved for issuance pursuant
to options outstanding under the Company's 1997 Stock Incentive Plan (the
"Incentive Plan") and (ii) 212,800 shares of Common Stock reserved for
issuance pursuant to options to be issued under the Company's 1997 Stock
Option Plan (the "Option Plan") upon the closing of this Offering. See
"Management of the Company" and "Shares Eligible for Future Sale."
9
<PAGE> 11
SUMMARY FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
FEB. 11, 1997 QUARTER FEB. 11, 1997
TO ENDED TO
JUNE 30, 1997 JUNE 30, 1997 MAR. 31, 1997
------------- ------------- -------------
<S> <C> <C> <C>
Statement of Operations Data:
Total interest income................................. $ 3,640 $ 3,334 $ 306
Net interest income................................... 724 568 156
Net income............................................ 584 438 146
Net income per share(1)............................... $ 0.35 $ 0.26 $0.09
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF
JUNE 30, 1997 MAR. 31, 1997
------------- -------------
<S> <C> <C>
Balance Sheet Data:
Mortgage Assets................................................... $ 228,620 $ 152,883
Total assets...................................................... 231,518 161,302
Reverse repurchase agreements..................................... 209,539 141,068
Stockholders' equity.............................................. 20,603 19,948
</TABLE>
- ---------------
(1) See Note 1 to financial Statements for information.
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<PAGE> 12
RISK FACTORS
Before investing in the Shares, prospective investors should give special
consideration to the information set forth below, in addition to the information
set forth elsewhere in this Prospectus. The following risk factors are
interrelated and, consequently, investors should consider such risk factors as a
whole. This Prospectus contains forward looking statements that inherently
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward looking statements as a
result of certain factors. Investors should carefully consider the information
set forth under the heading "Risk Factors."
INTEREST RATE FLUCTUATIONS MAY ADVERSELY AFFECT NET INTEREST INCOME
Substantially all of the Company's Mortgage Assets will have a repricing
frequency of one year or less and therefore are expected to generate income
based on short term interest rates. Substantially all of the Company's
borrowings will have maturities of six months or less and will bear interest
also based on short term rates. The interest rates on the Company's borrowings
may be based on interest rate indices which are different from, and adjust more
rapidly than, the interest rate indices of its related Mortgage Assets.
Consequently, changes in short term interest rates may significantly influence
the Company's net interest income. While increases in short term interest rates
will generally increase the yields on the Company's adjustable-rate Mortgage
Assets, rising short term rates will also increase the cost of borrowings by the
Company. To the extent such costs rise more rapidly than the yields, the
Company's net interest income will be reduced or a net interest loss may result.
Adjustable-rate Mortgage Assets are typically subject to periodic and
lifetime interest rate caps which limit the amount an adjustable-rate Mortgage
Asset interest rate can change during any given period. The Company's borrowings
will not be subject to similar restrictions. Hence, in a period of increasing
interest rates, the cost of the Company's borrowings could increase without
limitation by caps while the yields on the Company's Mortgage Assets could be
limited. Further, some adjustable-rate Mortgage Assets may be subject to
periodic payment caps that result in some portion of the interest being deferred
and added to the principal outstanding. This could result in receipt by the
Company of a lesser amount of cash income on its adjustable-rate Mortgage Assets
than is required to pay interest on the related borrowings, which will not have
such payment caps. These factors could lower the Company's net interest income
or cause a net interest loss during periods of rising interest rates, which
would negatively impact the Company's financial condition and results of
operations.
INCREASED LEVELS OF MORTGAGE LOAN PREPAYMENTS MAY ADVERSELY AFFECT NET INTEREST
INCOME
Prepayments of Mortgage Assets could adversely affect the Company's results
of operations in several ways. The Company anticipates that a portion of the
adjustable-rate Mortgage Assets to be acquired by the Company may bear initial
"teaser" interest rates which are lower than their "fully-indexed" rates (the
applicable index plus margin). In the event that such an adjustable-rate
Mortgage Asset is prepaid prior to or soon after the time of adjustment to a
fullyindexed rate, the Company will have held the Mortgage Asset while it was
less profitable and lost the opportunity to receive interest at the
fully-indexed rate over the expected life of the adjustable-rate Mortgage Asset.
In addition, the prepayment of any Mortgage Asset that had been purchased with a
premium by the Company would result in the immediate write-off of any remaining
capitalized premium amount and consequent reduction of the Company's net
interest income by such amount. Finally, in the event that the Company is unable
to acquire new Mortgage Assets to replace the prepaid Mortgage Assets, the
Company's financial condition and results of operations could be materially
adversely affected.
Mortgage Asset prepayment rates generally increase when new Mortgage Loan
interest rates fall below the interest rates on the adjustable-rate Mortgage
Assets. Prepayment experience also may be affected by the geographic location of
the property securing the adjustable-rate Mortgage Assets, the assumability of
the adjustable-rate Mortgage Assets, the ability of the borrower to obtain or
convert to a fixed-rate loan, conditions in the housing and financial markets
and general economic conditions. The level of prepayments is also subject to the
same seasonal influences as the residential real estate industry with prepayment
rates
11
<PAGE> 13
generally being highest in the summer months and lowest in the winter months.
The Company experienced higher than expected levels of prepayments in the
quarter ended June 30, 1997. Although the Company does not expect prepayment
rates to continue at such levels, there can be no assurance that the Company
will be able to achieve or maintain lower prepayment rates. Accordingly, the
Company's financial condition and results of operations could be materially
adversely affected. See "Business -- Risk Management -- Interest Rate Risk
Management."
It is expected that Mortgage Loans acquired by the Company may contain
provisions restricting prepayments of such Mortgage Loans and require a charge
in connection with the prepayment thereof. Such prepayment restrictions can, but
do not necessarily, provide a deterrent to prepayments. Prepayment charges may
be in an amount which is less than the figure which would fully compensate the
Company for a lower yield upon reinvestment of the prepayment proceeds.
LIMITED OPERATING HISTORY DOES NOT PREDICT FUTURE PERFORMANCE
The Company began operations in February 1997 and, accordingly, has not yet
developed an extensive financial history or experienced a wide variety of
interest rate fluctuations or market conditions. Consequently, the Company's
financial results to date may not be indicative of future results.
Additionally, although Management has considerable expertise in the
acquisition and management of Mortgage Assets, mortgage finance, asset/liability
management and the management of corporations in real estate lending business,
Management has limited experience in managing a REIT and with certain tailored
Mortgage Loan products. There can be no assurance that the past experience of
the Management will be appropriate to the business of the Company.
INABILITY TO ACQUIRE MORTGAGE ASSETS WITH FAVORABLE INTEREST RATES AND TERMS MAY
ADVERSELY AFFECT NET INTEREST INCOME
The Company's net interest income will depend, in large part, on the
Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. There can be no assurance
that the Company will be able to acquire sufficient Mortgage Assets at spreads
above the Company's cost of funds. In acquiring Mortgage Assets, the Company
will compete with investment banking firms, savings and loan associations,
banks, mortgage bankers, insurance companies, mutual funds, other lenders,
federal government sponsored agencies such as GNMA, FNMA and FHLMC, and other
entities purchasing Mortgage Assets, many of which have greater financial
resources than the Company. In addition, there are several REITs similar to the
Company and others may be organized in the future. The effect of the existence
of additional REITs may be to increase competition for the available supply of
Mortgage Assets suitable for purchase by the Company.
The availability of Mortgage Loans meeting the Company's criteria is
dependent upon, among other things, the size of and level of activity in the
residential real estate lending market and, in particular, the demand for
nonconforming Mortgage Loans. The size and level of activity in the residential
real estate lending market depend on various factors, including the level of
interest rates, regional and national economic conditions and inflation and
deflation in residential property values. To the extent that the Company is
unable to acquire sufficient Mortgage Loans meeting its criteria, the Company's
results of operations will be materially adversely affected.
FAILURE TO IMPLEMENT COMPANY'S LEVERAGE STRATEGY MAY ADVERSELY AFFECT RESULTS OF
OPERATIONS
The Company relies on short term borrowings to fund acquisitions of
Mortgage Assets. Accordingly, the ability of the Company to achieve its
investment objectives depends on its ability to borrow money in sufficient
amounts and on favorable terms and on the Company's ability to renew or replace
on a continuous basis its maturing short term borrowings. In addition, the
Company is dependent upon a few lenders to provide the primary credit facilities
for its purchases of Mortgage Assets. Any failure to obtain or renew adequate
funding under these facilities or other financings on favorable terms, could
reduce the Company's net interest income and have a material adverse effect on
the Company's operations. The Company has no long term
12
<PAGE> 14
commitments with its lenders. The Company's current borrowing facilities may be
collateralized only by Mortgage Securities.
In the event the Company is not able to renew or replace maturing
borrowings, the Company could be required to sell Mortgage Assets under adverse
market conditions and could incur losses as a result. In addition, in such
event, the Company may be required to terminate hedge positions, which could
result in further costs to the Company. Any event or development such as a sharp
rise in interest rates or increasing market concern about the value or liquidity
of a type or types of Mortgage Assets in which the Company's Mortgage Asset
portfolio is concentrated will reduce the market value of the Mortgage Assets,
which would likely cause lenders to require additional collateral. A number of
such factors in combination may cause difficulties for the Company, including a
possible liquidation of a major portion of the Company's Mortgage Assets at
disadvantageous prices with consequent losses, which could have a material
adverse effect on the Company and could render it insolvent.
Lenders will have claims on the Company's assets superior to the claims of
the holders of Common Stock and may require that the Company agree to covenants
that could restrict its flexibility in the future and limit the Company's
ability to pay dividends.
FAILURE TO SUCCESSFULLY MANAGE INTEREST RATE RISKS MAY ADVERSELY AFFECT RESULTS
OF OPERATIONS
The Company will follow a program intended to protect against interest rate
changes. However, developing an effective interest rate risk program is complex
and no program can completely insulate the Company from risks associated with
interest rate changes. Further, the cost of hedging transactions and the federal
tax laws applicable to REITs may limit the Company's ability to fully hedge its
interest rate risks. Such federal tax laws may prevent the Company from
effectively implementing hedging strategies that Management determines, absent
such restrictions, would best insulate the Company from the risks associated
with changing interest rates. See "Business -- Risk Management -- Interest Rate
Risk Management."
In the event that the Company purchases interest rate caps or other
interest rate derivatives to hedge against lifetime, periodic rate or payment
caps, and the provider of such caps on interest rate derivatives becomes
financially unsound or insolvent, the Company may be forced to unwind such caps
on its interest rate derivatives with such provider and may take a loss thereon.
Further, the Company could suffer the adverse consequences that the hedging
transaction was intended to protect against. Although the Company intends to
purchase interest rate caps and derivatives only from financially sound
institutions and to monitor the financial strength of such institutions on a
periodic basis, no assurance can be given that the Company can avoid such third
party risks.
Currently, the Company has entered into hedging transactions which seek to
protect only against the Mortgage Loans' lifetime rate caps and not against
periodic or payment caps. In addition, the Company's lifetime cap hedges are for
a two year period which does not begin until the second quarter of 1998.
Accordingly, the Company may not be adequately protected against risks
associated with interest rate changes and such changes could adversely affect
the Company's financial condition and results of operations.
VALUE OF MORTGAGE LOANS MAY BE ADVERSELY AFFECTED BY CHARACTERISTICS OF
UNDERLYING PROPERTY AND BORROWER CREDIT
The Company expects that a portion of its Mortgage Assets will consist of
Mortgage Loans. Accordingly, during the time it holds Mortgage Loans, the
Company will be subject to increased credit risks including risks of borrower
defaults and bankruptcies and special hazard losses that are not covered by
standard hazard insurance (such as those occurring from earthquakes or floods).
In the event of a default on any Mortgage Loan held by the Company, the Company
will bear the risk of loss of principal to the extent of any deficiency between
the value of the secured property, and the amount owing on the Mortgage Loan,
less any payments from an insurer or guarantor. Defaulted Mortgage Loans will
also cease to be eligible collateral for borrowings, and will have to be
financed by the Company out of other funds until ultimately liquidated. Although
the Company intends to establish an allowance for loan losses in amounts
adequate to cover these risks, in view of its limited operating history and lack
of experience with the Direct Loan Program to date, there can be no
13
<PAGE> 15
assurance that any allowance for loan losses which are established will be
sufficient to offset losses on Mortgage Loans in the future. See
"Business -- Investments -- Direct Purchase Program."
The Company anticipates that in the future a substantial portion of its
Mortgage Assets will consist of Mortgage Loans acquired pursuant to the Direct
Purchase Program. These Mortgage Loans will have certain distinct risk
characteristics and generally lack standardized terms, which may complicate
their structure. The underlying properties themselves may be unique and more
difficult to value than typical residential real estate properties. The results
of the Direct Loan Program may also be affected by various factors, many of
which are beyond the control of the Company, such as (i) local and other
economic conditions affecting real estate value, (ii) the ability of tenants to
make lease payments, (iii) the ability of a property to attract and retain
tenants, (iv) interest rate levels and the availability of credit to refinance
such Mortgage Loans at or prior to maturity, and (v) increased operating costs,
including energy costs, real estate taxes and costs of compliance with
regulations.
Even assuming that properties secured by the Mortgage Loans held by the
Company provide adequate security for such Mortgage Loans, substantial delays
could be encountered in connection with the foreclosure of defaulted Mortgage
Loans, with corresponding delays in the receipt of related proceeds by the
Company. State and local statutes and rules may delay or prevent the Company's
foreclosure on or sale of the mortgaged property and may prevent the Company
from receiving net proceeds sufficient to repay all amounts due on the related
Mortgage Loan. In addition, the Company's servicing agent may be entitled to
receive all expenses reasonably incurred in attempting to recover amounts due
and not yet repaid on liquidated Mortgage Loans, thereby reducing amounts
available to the Company. Some properties which will collateralized the
Company's Mortgage Loans may have unique characteristics or may be subject to
seasonal factors which could materially prolong the time period required to
resell the property.
CONFLICTS OF INTERESTS; MANAGEMENT ALSO EMPLOYED BY AND OWNS SECURITIES OF
MANAGER
The Company is subject to conflicts of interest with the Manager and its
executive officers. The executive officers of the Company will also be executive
officers, employees and stockholders of the Manager. Under the Management
Agreement, the Manager will receive an annual base management fee payable
monthly in arrears and the Manager will have the opportunity to earn incentive
compensation under the Management Agreement based on the Company's annualized
net income. The ability of the Company to achieve the performance level required
for the Manager to earn the incentive compensation is dependent upon the level
and volatility of interest rates, the Company's ability to react to changes in
interest rates and to implement the operating strategies described herein, and
other factors, many of which are not within the Company's control. In evaluating
Mortgage Assets for investment and other strategies, an undue emphasis on
maximizing income at the expense of other criteria, such as preservation of
capital, in order to achieve higher incentive compensation for the Manager,
could result in increased risk to the value of the Company's Mortgage Asset
portfolio. See "The Manager -- The Management Agreement -- Management Fees."
The Management Agreement does not limit or restrict the right of the
Manager or any of its officers, directors, employees or affiliates to engage in
any business or to render services of any kind to any other person, including
purchasing, or rendering advice to others purchasing, Mortgage Assets which meet
the Company's policies and criteria, except that the Manager and its officers,
directors, or employees will not be permitted to provide any such services to
any residential mortgage REIT other than the Company.
DEPENDENCE ON KEY PERSONNEL FOR SUCCESSFUL OPERATIONS
The Company's operations depend in significant part upon the contributions
of John Robbins and Jay Fuller. Although these executive officers currently have
employment agreements with the Manager, there can be no assurance of the
continued employment of such officers. The Company is also dependent on other
key personnel and on its ability to continue to attract, retain and motivate
qualified personnel. The loss of any key person could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Management of the Company -- Executive Compensation" and "-- Employment
Contracts and Termination of Employment and Change of Control Arrangements."
14
<PAGE> 16
FAILURE TO MANAGE EXPANSION MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company's expansion as a result of its investment of the net proceeds
of this Offering may cause a significant strain on the Company's and the
Manager's, financial, management and other resources. To manage the Company's
growth effectively, the Company and the Manager must continue to improve and
expand their existing resources and management information systems and attract,
train and motivate qualified personnel. If the Company and the Manager are
unable to manage growth effectively, the Company's financial conditions and
results of operations may be adversely affected.
In order to further develop the Direct Purchase Program, the Manager must
significantly expand its level of operations. The Company's operating results
may be adversely affected if the Company is not able to acquire a significant
amount of Mortgage Loans directly from Correspondents pursuant to the Direct
Purchase Program.
The Company may require up to twelve months to fully implement its
financing strategy and increase its Mortgage Asset investments to the desired
level. Until such level is achieved, the net interest income on the Company's
Mortgage Asset portfolio is expected to be lower than would be the case if its
financing strategy were fully implemented. Further, the Company may acquire new
Mortgage Assets with coupons that are initially low relative to prevailing short
term interest rates. As a result, the Company's interest income may be lower
during periods of rapid growth in the Company's Mortgage Assets.
REAL ESTATE MARKET CONDITIONS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company's business may be adversely affected by periods of economic
slowdown or recession which may be accompanied by declining real estate values.
Any material decline in real estate values reduces the ability of borrowers to
use home equity to support borrowings and increases the loan-to-value ratios of
Mortgage Loans previously made, thereby weakening collateral coverage and
increasing the possibility of a loss in the event of default. In addition,
delinquencies, foreclosures and losses generally increase during economic
slowdowns and recessions.
INVESTMENTS IN MORTGAGE ASSETS MAY BE ILLIQUID
Although the Company expects that a majority of the Company's investments
will be in Mortgage Assets for which a resale market exists, certain of the
Company's investments may lack a regular trading market and may be illiquid. In
addition, during turbulent market conditions, the liquidity of all of the
Company's Mortgage Assets may be adversely impacted. There is no limit to the
percentage of the Company's investments that may be invested in illiquid
Mortgage Assets. In the event the Company required additional cash as a result
of a margin call pursuant to its financing agreements or otherwise, the Company
may be required to liquidate Mortgage Assets on unfavorable terms. The Company's
inability to liquidate Mortgage Assets could render it insolvent.
ADDITIONAL RISK FACTORS
Future Revisions in Policies and Strategies at the Discretion of the Board of
Directors
The Board of Directors has established the investment policies and
operating policies and strategies of the Company set forth in this Prospectus.
However, these policies and strategies may be modified or waived by the Board of
Directors, subject in certain cases to approval by a majority of the directors
who are not executive officers of the Company, without stockholder consent. See
"Business -- Capital Guidelines."
Control by Management and Certain Affiliates
Immediately following the closing of this Offering, the Company's directors
and officers, the Manager and certain of their affiliates will beneficially own
or have the right to control approximately 24% of the Company's outstanding
shares of Common Stock. Accordingly, these stockholders may continue to exert
significant influence over the outcome of most corporate actions requiring
stockholder approval, including the
15
<PAGE> 17
election of directors and the approval of transactions involving a change in
control of the Company. See "Principal Stockholders."
Risk of Fluctuation in Market Price of Common Stock
Prior to this Offering, there has not been a public market for the Common
Stock, and there can be no assurance that a regular trading market for the
Shares offered hereby will develop or, if developed, that any such market will
be sustained. In the absence of a public trading market, an investor may be
unable to liquidate his investment in the Company. The initial public offering
price will be determined by the Company and representatives of the Underwriters.
There can be no assurance that the price at which the Shares sell in the public
market after the closing of this Offering will not be lower than the price at
which they are sold by the Underwriters. See "Underwriting."
In the event that a public market for the Common Stock exists, it is likely
that the market price of the shares of the Common Stock will be influenced by
any variation between the net yield on the Company's Mortgage Assets and
prevailing market interest rates. The Company's net income will be derived
primarily from any positive spread between the yield on the Company's Mortgage
Assets and the cost of the Company's borrowings. Such positive spread will not
necessarily be larger in high interest rate environments than in low interest
rate environments. However, in periods of high interest rates, the net income of
the Company, and therefore the dividend yield on the Common Stock, may be less
attractive compared with alternative investments, which could negatively impact
the price of the Common Stock. If the anticipated or actual net yield on the
Company's Mortgage Assets declines or if prevailing market interest rates rise,
thereby decreasing the positive spread between the net yield on the Mortgage
Assets and the cost of the Company's borrowings, the market price of the Common
Stock may be adversely affected.
Consequences of Failure to Maintain REIT Status
The Company intends at all times to operate so as to qualify as a REIT for
federal income tax purposes. To qualify as a REIT, the Company must satisfy
certain tests related to the nature of its assets and income and it must also
distribute substantially all of its income (as specially defined for these
purposes) to its stockholders. If the Company fails to qualify as a REIT in any
taxable year and certain relief provisions of the Code do not apply, the Company
would be subject to federal income tax as a regular, domestic corporation, and
its stockholders would be subject to tax in the same manner as stockholders of
such corporation. Distributions to stockholders in any years in which the
Company fails to qualify as a REIT would not be deductible by the Company in
computing its taxable income. As a result, the Company could be subject to
income tax liability, thereby significantly reducing or eliminating the amount
of cash available for distribution to its stockholders. Further, the Company
could also be disqualified from re-electing REIT status for the four taxable
years following the year during which it became disqualified.
No assurance can be given that future legislation, regulations,
administrative interpretations or court decisions will not significantly change
the tax laws with respect to the Company's qualification as a REIT or the
federal income tax consequences of such qualification, which changes may reduce
or eliminate the Company's advantage over non-REIT companies. See "Federal
Income Tax Considerations."
Investment Company Act Risk
The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act.
Accordingly, the Company does not expect to be subject to the restrictive
provisions of the Investment Company Act. However, if the Company fails to
qualify for exemption from registration as an investment company, its ability to
use leverage would be substantially reduced, and it would be unable to conduct
its business as described herein. Any such failure to qualify for such exemption
could have a material adverse effect on the Company.
The Investment Company Act exempts entities that are "primarily engaged in
the business of purchasing or otherwise acquiring mortgages and other liens on
and interests in real estate." Under the current interpretation of the staff of
the Securities and Exchange Commission, in order to qualify for this exemption,
16
<PAGE> 18
the Company must maintain at least 55% of its assets directly in Mortgage Loans,
qualifying Mortgage Securities and certain other qualifying interests in real
estate. In addition, unless certain Mortgage Securities represent all the
certificates issued with respect to an underlying pool of Mortgage Loans, such
Mortgage Securities may be treated as securities separate from the underlying
Mortgage Loans and, thus, may not qualify for purposes of the 55% requirement.
Therefore, the Company's ownership of certain Mortgage Assets may be limited by
the provisions of the Investment Company Act.
Affect of Future Offerings of Common Stock on Market Price of Common Stock
The Company may in the future increase its capital resources by making
additional offerings of equity and debt securities, including classes of
preferred stock, Common Stock, commercial paper, medium-term notes, CMOs and
senior or subordinated notes. All debt securities and classes of preferred stock
will be senior to the Common Stock in a liquidation of the Company. The effect
of additional equity offerings may be the dilution of the equity of stockholders
of the Company or the reduction of the price of the Company's Common Stock, or
both. The Company is unable to estimate the amount, timing or nature of
additional offerings as they will depend upon market conditions and other
factors. There can be no assurance that the Company will be able to raise the
capital it will require through such offerings on favorable terms or at all.
Restrictions on Ownership of Common Stock
In order that the Company may meet the requirements for qualification as a
REIT at all times, the Company's Articles of Amendment and Restatement (the
"Charter") prohibits any person from acquiring or holding, directly or
indirectly, shares of Common Stock in excess of 7.8% in value of the aggregate
of the outstanding shares of Common Stock or in excess of 7.8% in value of the
aggregate of the outstanding shares of Common Stock of the Company. The
Company's Charter further prohibits (i) any person from beneficially or
constructively owning shares of Common Stock that would result in the Company
being "closely held" under Section 856(h) of the Internal Revenue Code of 1986,
as amended (the "Code") or otherwise cause the Company to fail to qualify as a
REIT, and (ii) any person from transferring shares of Common Stock if such
transfer would result in shares of Common Stock being owned by fewer than 100
persons. If any transfer of shares of Common Stock occurs which, if effective,
would result in any transfer or ownership limitations, then that number of
shares of Common Stock the beneficial or constructive ownership of which
otherwise would cause such person to violate such limitations (rounded to the
nearest whole shares) shall be automatically transferred to a trustee as trustee
of a trust for the exclusive benefit of one or more charitable beneficiaries,
and the intended transferee shall not acquire any rights in such shares. Subject
to certain limitations, the Board of Directors may increase or decrease the
ownership limitations or waive the limitations for individual investors. See
"Description of Capital Stock -- Repurchase of Shares and Restriction on
Transfer."
Every owner of more than 5% (or such lower percentage as required by the
Code or the regulations promulgated thereunder) of the Company's Common Stock,
within 30 days after the end of each taxable year, is required to give written
notice to the Company stating the name and address of such owner, the number of
shares of Common Stock of the Company beneficially owned and a description of
the manner in which such shares are held. Each such owner shall provide to the
Company such additional information as the Company may request in order to
determine the effect, if any, of such beneficial ownership on the Company's
status as a REIT and to ensure compliance with the ownership limitations.
These provisions may inhibit market activity and the resulting opportunity
for the holders of the Company's Common Stock to receive a premium for their
stock that might otherwise exist in the absence of such provisions. Such
provisions also may make the Company an unsuitable investment vehicle for any
person seeking to obtain ownership of more than 7.8% of the Company's Common
Stock.
Default of Manager under Securities Purchase Agreement; Restrictive Covenants
In connection with the private financing of the Manager and the Company,
the Company, the Manager and MDC REIT Holdings, LLC. ("Holdings") entered into a
Securities Purchase Agreement dated as of
17
<PAGE> 19
February 11, 1997 (the "Securities Purchase Agreement") with the institutional
investors therein (the "Investors") providing for, among other things, the
purchase by the Investors of senior secured notes of Manager due February 11,
2002 (the "Notes"). Pursuant to the Securities Purchase Agreement, the Company
must comply with various covenants, including covenants restricting the
Company's investment, hedging and leverage policies, leverage ratio and
indebtedness levels, and business and tax status. These restrictions may limit
the Company's ability to adequately respond to changing market conditions, even
when such changes may be in the best interest of the Company. See "Certain
Transactions -- Discussion of Securities Purchase Agreement."
If the Manager defaults on its obligations with respect to the Notes, such
default may result in a default and termination of the Management Agreement, in
which case the operations of the Company could be materially and adversely
affected pending either the engagement of a new manager or the development
internally of the resources necessary to manage the operation of the Company. In
addition, Holdings has pledged 1,600,000 shares of its Common Stock of the
Company to secure the Manager's obligations under the Securities Purchase
Agreement. Upon a default under the Securities Purchase Agreement, the pledged
shares will be transferred to the holders of the Notes, who will then have
certain demand registration rights. See "-- Shares Eligible for Future Sale."
Limitations on Acquisition and Change in Control
The Charter and Bylaws of the Company contain a number of provisions, and
the Board of Directors has taken certain actions, that could impede a change of
control in the Company. See "Certain Provisions of Maryland Law and the
Company's Charter and Bylaws -- Certain Anti-Takeover Provisions." These
provisions include the following:
Staggered Board of Directors. The Board of Directors of the Company has
three classes of directors. The staggered terms for directors may adversely
affect the stockholders' ability to change control of the Company, even if a
change in control were in the interest of some, or a majority, of the
stockholders.
Capital Stock. The Charter authorizes the Board of Directors to create new
classes and series of securities and to establish the preferences and rights of
any such classes and series. The issuance of securities by the Board of
Directors pursuant to this Charter provision could have the effect of delaying
or preventing a change of control of the Company, even if a change of control
were in the interest of some, or a majority, of stockholders. See "Description
of Capital Stock."
Statutory Provisions. Under the Maryland General Corporation Law (the
"MGCL"), unless exempted by action of the Board of Directors, certain "business
combinations" between a Maryland corporation and a stockholder holding 19% or
more of the corporation's voting securities (an "Interested Stockholder") are
subject to certain conditions, including approval by a super-majority vote of
all voting stock excluding those held by the Interested Stockholder or affiliate
thereof, and may not occur for a period of five years after the stockholder
becomes an Interested Stockholder. Accordingly, certain business combinations
may be impeded or prohibited, even if such a combination may be in the interest
of some, or a majority, of the Company's stockholders. The MGCL also provides
that "control shares" may be voted only upon approval of two-thirds of the
outstanding stock of the corporation excluding the control shares and shares
held by affiliates of the corporation. Under certain circumstances, the
corporation also may redeem the control shares for cash and, in the event that
control shares are permitted to vote, the other stockholders of the corporation
are entitled to appraisal rights. See "Certain Provisions of Maryland Law and
the Company's Charter and Bylaws -- Business Combinations -- Control Share
Acquisitions."
Shares Eligible for Future Sale
A substantial number of shares of Common Stock outstanding prior to this
Offering and issuable upon exercise of outstanding options will be eligible for
sale in the public market following the closing of this Offering, and such sales
could have an adverse effect on the price of the Company's Common Stock. On the
date of this Prospectus, the 5,000,000 Shares offered hereby (assuming no
exercise of the Underwriters' over-allotment option) will be immediately
eligible for sale in the public market. In addition upon the expiration of
18
<PAGE> 20
lock-up agreements 180 days after the date of this Prospectus, 1,614,000 shares
of Common Stock held by the current stockholders of the Company will become
eligible for sale in the public market, subject in some cases to the volume
restrictions of Rule 144 promulgated under the Securities Act of 1933 (the
"Securities Act"). In addition, the holders of such shares of Common Stock are
entitled to certain rights with respect to the registration of such shares under
the Securities Act. See "Shares Eligible for Future Sale."
Dilution to Stockholders Purchasing in Offering
The initial offering price is higher than the book value per share of
Common Stock. Investors purchasing shares of Common Stock in this Offering will
therefore incur immediate dilution. See "Dilution."
19
<PAGE> 21
THE COMPANY
American Residential Investment Trust, Inc. is a mortgage REIT which
currently invests in residential adjustable-rate Mortgage Securities. Following
this Offering, AMREIT will also invest in Mortgage Loans. The Company has
developed Mortgage Loan products for targeted market segments to be originated
by Correspondents. The Company will then acquire Mortgage Loans directly from
those Correspondents. The Company finances its acquisitions of Mortgage Assets
with equity and secured borrowings. AMREIT expects generally to maintain an
equity-to-assets ratio of approximately 8% to 12% and to earn interest on the
portion of its Mortgage Asset portfolio financed with equity and to earn a net
interest spread on the leveraged portion of its Mortgage Asset portfolio. The
Company is structured as a REIT, and therefore will generally not be subject to
federal taxes at the corporate level on the net income it distributes to its
stockholders. The Company is similar to a bank or savings and loan in its
business purpose, however, it does not collect deposits or incur the overhead
costs related to generating retail Mortgage Loans and it is not subject to a
number of the regulations governing banks and savings and loans. The Company
believes its REIT structure is the most efficient form in which to invest in
adjustable-rate Mortgage Assets.
AMREIT was incorporated on February 11, 1997, through a private equity
funding from the Manager. The Manager was created for the purpose of managing
the day-to-day operations of the Company, subject to direction by the Company's
Board of Directors. The Manager and the Company were financed by McCown De Leeuw
& Co., TCW/Crescent Mezzanine, L.L.C., certain of their respective affiliates
and members of the management team of the Company. The Manager and its
affiliates own 1,614,000 shares of Common Stock of the Company which will
constitute approximately 24% of the outstanding shares of Common Stock of the
Company immediately after the closing of this Offering. In addition, David E. De
Leeuw and George E. McCown, the principals of McCown De Leeuw & Co., currently
serve on the Board of Directors of the Company. Mr. De Leeuw will continue as a
director after the closing of this Offering.
The Company's Management is comprised of former executive officers and
founders of AMRES Mortgage. The management team is lead by John Robbins, former
Chairman and Chief Executive Officer of AMRES Mortgage, and Jay Fuller, former
Executive Vice President and Chief Administrative Officer of AMRES Mortgage. The
management team led AMRES Mortgage from a start-up company to one of the
nation's largest independent mortgage banks with originations of approximately
$9.7 billion and a servicing portfolio of approximately $16.1 billion in 1993,
its last full year of independent operations. On September 14, 1994, AMRES
Mortgage was sold to The Chase Manhattan Corporation for approximately $330
million.
The Company was incorporated in Maryland on February 11, 1997. The
principal executive offices of the Company and the Manager are located at 445
Marine View Avenue, Suite 230, Del Mar, California 92014. The telephone number
is (619) 350-5000.
USE OF PROCEEDS
The net proceeds of this Offering, estimated to be $68.9 million (or $79.4
million if the Underwriters' overallotment option is exercised in full, in each
case assuming a $15.00 per share initial public offering price), together with
borrowings, will be used primarily to purchase Mortgage Assets and otherwise for
general corporate purposes. Pending the purchase of the Mortgage Assets, the net
proceeds of this Offering may be invested in short term investments consistent
with the applicable REIT Provisions of the Code. The Company intends to increase
its investment in Mortgage Assets by borrowing against existing Mortgage Assets
and using the net proceeds therefrom to acquire additional Mortgage Assets. The
Company's borrowings generally will be secured by the Mortgage Assets owned by
the Company. The Company may, but does not expect to, require up to twelve
months to fully implement its financing strategy and increase its Mortgage Asset
investments to the desired level. Until such level is achieved, the net interest
income on the Company's Mortgage Asset portfolio is expected to be lower than
would be the case if its financing strategy were fully implemented.
20
<PAGE> 22
DIVIDEND POLICY AND DISTRIBUTIONS
The Company intends to distribute substantially all of its taxable income
(which does not ordinarily equal net income as calculated in accordance with
GAAP) to its stockholders in each year so as to comply with the REIT Provisions
of the Code. The Company intends to declare regular quarterly dividends. The
dividend policy is subject to revision at the discretion of the Board of
Directors. All distributions will be made by the Company at the discretion of
the Board of Directors and will depend on the taxable income of the Company, the
financial condition of the Company, maintenance of REIT status and such other
factors as the Board of Directors deems relevant. On July 17, 1997 and May 1,
1997, the Company declared dividends of $0.27 and $0.09, respectively, per share
of Common Stock for the quarter ended June 30, 1997 and the period ended March
31, 1997, respectively. There can be no assurance that the Company will generate
sufficient income in the future to declare comparable levels of dividends, or to
declare dividends at all. See "Risk Factors -- Limited Operating History Does
Not Predict Future Performance" "Risk Factors -- Additional Risk
Factors -- Future Revisions in Policies and Strategies at the Discretion of the
Board of Directors" and "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT -- Distribution Requirement."
Distributions to stockholders will generally be taxable as ordinary income,
although a portion of such distributions may be designated by the Company as
capital gain or may constitute a tax-free return of capital. The Company will
annually furnish to each of its stockholders a statement setting forth
distributions paid during the preceding year and their characterization as
ordinary income, capital gains, or return on capital. See "Business -- Certain
Accounting Policies and Procedures" and "Federal Income Tax Considerations --
Taxation of Stockholders."
DIVIDEND REINVESTMENT PLAN
Promptly after closing of this Offering, the Company intends to adopt a
dividend reinvestment plan ("DRP") for stockholders who wish to reinvest their
distributions in additional shares of Common Stock. Stockholders owning 100 or
more shares of Common Stock will be eligible to participate in the DRP. Pursuant
to the DRP, dividends paid with respect to shares of the Company's Common Stock
will be automatically invested in additional shares of Common Stock on the
dividend payment date or not later than 15 days thereafter at 97% of the then
current market price. , the Company's transfer agent, will
act as the trustee and administrator of the DRP (the "Agent"). All dividends and
cash distributions paid with respect to the Common Stock of DRP participants
will be paid directly to the Agent. Dividends not immediately reinvested on the
payment date will be held in a noninterestbearing account pending the investment
in the Common Stock not later than 15 days thereafter. If the dividend paid to
any stockholder is not sufficient to purchase one whole share of Common Stock,
such stockholder will be credited with fractional shares, computed to four
decimal places. DRP 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
dividends generally on the date the Agent credits such Common Stock to the DRP
participant's account, less brokerage commissions and fees, if any, subtracted
from the participant's distribution. See "Federal Income Tax
Considerations -- Taxation of Stockholders."
21
<PAGE> 23
CAPITALIZATION
The capitalization of the Company, as of June 30, 1997, and as adjusted to
reflect the sale of the Shares offered hereby, is as follows:
<TABLE>
<CAPTION>
JUNE 30, 1997
---------------------------
AS
ACTUAL ADJUSTED(1)(2)
-------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Reverse Repurchase Agreements...................................... $209,539 $209,539
Stockholders' Equity:
Preferred Stock, par value $.01 per share; 1,000,000 shares
authorized; no shares issued and outstanding.................. -- --
Common Stock, par value $.01 per share; 3,000,000 shares
authorized; 1,614,000 shares issued and outstanding, actual;
6,614,000 shares issued and outstanding as adjusted(3)........ 16 66
Additional paid-in capital....................................... 20,149 89,024
Cumulative dividends declared.................................... (146) (146)
Retained earnings................................................ 584 584
-------- --------
Total stockholders' equity............................... $ 20,603 $ 89,528
-------- --------
Total capitalization..................................... $230,142 $299,067
======== ========
</TABLE>
- ---------------
(1) After deducting offering expenses estimated to be $1,200,000 payable by the
Company, and assumes no exercise of the Underwriters' over-allotment option
to purchase up to an additional 750,000 shares of Common Stock. Assumes an
initial public offering price of $15.00 per share of Common Stock. See
"Underwriting."
(2) Excludes 315,200 shares of Common Stock reserved for issuance pursuant to
options outstanding as of June 30, 1997 under the Company's Incentive Plan.
(3) The Company's authorized Common Stock and Preferred Stock as of June 30,
1997, was 3,000,000 and 1,000,000 shares, respectively. The total authorized
Capital Stock will be increased to 25,000,000 prior to the closing of this
Offering. See Note 8 of Notes to Financial Statements.
22
<PAGE> 24
DILUTION
The pro forma net tangible book value of the Company, as of June 30, 1997,
was approximately $20.6 million or $12.77 per share of Common Stock. Pro forma
net tangible book value per share of Common Stock is equal to the Company's
total tangible assets less its total liabilities, divided by the number of
outstanding shares of Common Stock. After giving effect to the sale of the
5,000,000 Shares offered by the Company hereby (at an assumed initial public
offering price of $15.00 per share and after deducting the estimated
underwriting discount and commissions and offering expenses), the pro forma net
tangible book value of the Company at June 30, 1997 would have been
approximately $89.5 million or $13.54 per share of Common Stock. This represents
an immediate increase in such net tangible book value of $0.77 per share of
Common Stock to existing stockholders and an immediate dilution of $1.46 per
share of Common Stock to new investors purchasing Shares in this Offering. The
following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share of Common Stock..... $15.00
Pro forma net tangible book value per share of Common Stock as of
June 30, 1997.................................................. 12.77
Increase per share of Common Stock attributable to this
Offering....................................................... 0.77
-----
Pro forma net tangible book value per share of Common Stock
immediately after the closing of this Offering.................... 13.54
------
Dilution per share of Common Stock to new investors................. $ 1.46
======
</TABLE>
The following table summarizes, on a pro forma basis, as of June 30, 1997,
the differences between the number of shares of Common Stock purchased from the
Company, the total consideration paid and the average price paid per share of
Common Stock by the existing holders of Common Stock and by the new investors at
an assumed initial public offering price of $15.00 per share of Common Stock
(See "Underwriting"):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------- --------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............. 1,614,000 24.4% $20,175,000 21.2% $ 12.50
New Investors..................... 5,000,000 75.6 75,000,000 78.8 $ 15.00
--------- ----- ----------- -----
Total................... 6,614,000 100.0% $95,175,000 100.0%
========= ===== =========== =====
</TABLE>
The foregoing tables exclude 315,200 shares of Common Stock reserved for
issuance pursuant to options outstanding as of June 30, 1997 under the Company's
Incentive Plan.
23
<PAGE> 25
SELECTED FINANCIAL DATA
The following selected statement of operations and balance sheet data for
the period from February 11, 1997 (inception) through June 30, 1997, and as of
June 30, 1997 have been derived from the Company's financial statements audited
by KPMG Peat Marwick LLP, independent auditors whose reports with respect
thereto appear elsewhere herein. Such selected financial data should be read in
conjunction with those financial statements and the notes thereto and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" also included elsewhere herein. The following selected financial
data for the period ended March 31 and the quarter ended June 30, 1997 have been
derived from the financial statements of the Company and include adjustments,
consisting only of normal recurring adjustments, which Management considers
necessary for a fair presentation of such financial information for those
periods. Results for the periods ended June 30, 1997 are not necessarily
indicative of results for the year ending December 31, 1997.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
FEBRUARY 11, 1997 FEBRUARY 11, 1997
TO QUARTER ENDED TO
JUNE 30, 1997 JUNE 30, 1997 MARCH 31, 1997
----------------- ------------- -----------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Interest income.................................. $ 3,640 $ 3,334 $ 306
Interest expense................................. 2,916 2,766 150
------ ------ -----
Net interest income.............................. 724 568 156
------ ------ -----
General and administrative expenses.............. 140 130 10
------ ------ -----
Net income....................................... $ 584 $ 438 $ 146
====== ====== =====
Net income per share of Common Stock(1).......... $ 0.35 $ 0.26 $0.09
Dividends per share of Common Stock(2)........... $ 0.09 $ -- $0.09
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF
JUNE 30, 1997 MARCH 31, 1997
------------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Mortgage Assets.................................................. $ 228,620 $152,883
Total assets..................................................... 231,518 161,302
Reverse repurchase agreements.................................... 209,539 141,068
Total liabilities................................................ 210,915 141,354
Stockholders' equity............................................. 20,603 19,948
</TABLE>
- ---------------
(1) See Note 1 to the Financial Statements for information regarding the
calculation of this item.
(2) The level of quarterly dividends is determined by the Board of Directors
based upon its consideration of a number of factors and should not be deemed
indicative of taxable income for the quarter in which declared or future
quarters, or of income calculated in accordance with GAAP. See "Dividend
Policy and Distributions."
24
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Prospectus contains forward-looking statements that inherently involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth in the following section and in "Risk
Factors." The following discussion should be read in conjunction with the
Financial Statements and Notes thereto appearing elsewhere in this Prospectus.
OVERVIEW
All of the Company's income to date has been interest income generated from
its Mortgage Assets and its cash balances ("earning assets"). The Company funds
its acquisitions of earning assets with both its equity capital and with
borrowings. For that portion of the Company's earning assets funded with equity
capital ("equity-funded lending"), net interest income is derived from the
average yield on earning assets. Due to the adjustable-rate nature of its
earning assets, Management expects that income from this source will tend to
increase as short term interest rates rise and will tend to decrease as short
term interest rates fall.
For that portion of the Company's earning assets funded with borrowings
("spread lending"), resulting net interest income is a function of the volume of
spread lending and the difference between the Company's average yield on earning
assets and the cost of borrowed funds and interest rate hedging agreements.
Income from spread lending may initially decrease following an increase in short
term interest rates and then, after a lag period, be restored to its former
level as earning asset yields adjust to market conditions. Income from spread
lending may likewise increase following a fall in short term interest rates, but
then decrease as earning asset yields adjust to the new market conditions after
a lag period. See "Risk Factors -- Interest Rate Fluctuations May Adversely
Affect Net Interest Income" and "Business -- Funding."
Management believes that in a rising short term interest rate environment
the net result of these effects on the Company's spread lending may be, after a
lag period, an overall increase in net interest income relative to what it would
have been otherwise. Similarly, the net result of a falling interest rate
environment may be an overall decrease in net interest income from spread
lending relative to what it would have been otherwise. In each case, however,
the Company will seek to maintain a constant or widening relationship between
the yield on earning assets of the Company and the level of short term interest
rates. There can be no assurance, however, that the Company will be successful
in these efforts.
The Company seeks to generate growth in net income in a variety of ways,
including through (i) issuing new Common Stock and increasing the size of the
earning assets when opportunities in the mortgage market are likely to allow
growth in net income per share of Common Stock, (ii) seeking to improve
productivity by increasing the size of the earning assets at a rate faster than
operating expenses increase, (iii) changing the mix of Mortgage Asset types
among the earning assets in an effort to improve returns, and (iv) increasing
the efficiency with which the Company uses its equity capital over time by
increasing the Company's use of debt when prudent and by issuing subordinated
debt, preferred stock or other forms of debt and equity. There can be no
assurance, however, that the Company's efforts will be successful or that the
Company will increase or maintain its income level. See "Risk Factors -- Limited
Operating History Does Not Predict Future Performance."
Interest Income and the Earning Asset Yield
On average, the Company had $196 million in earning assets during the
quarter ended June 30, 1997. The Company's sole source of income during fiscal
1997 for both equity-funded lending and spread lending was the interest income
earned from these earning assets. As a residential mortgage REIT, the Company
expects to continue to rely on interest income as its primary source of income
in the future. At June 30, 1997, the weighted average net coupon on the Mortgage
Assets was 7.78% per annum based on the amortized cost of the Mortgage Assets.
25
<PAGE> 27
The annualized mortgage principal repayment rate for the Company was 29% in
the quarter ended June 30, 1997. The Company adjusts its rate of premium
amortization monthly based on actual principal repayments received. As a result,
premium amortization accelerates as the rate of principal repayment increases.
This lowers the earning asset yield and reportable net income. See "Risk
Factors -- Increased Levels of Mortgage Loan Prepayments May Adversely Affect
Net Interest Income."
The Company may acquire new Mortgage Assets with coupons that are initially
low relative to prevailing short term interest rates. As a result, the overall
earning asset yield may be temporarily lower during periods of rapid growth in
the Company's Mortgage Assets.
Borrowings
To date, the Company's debt has consisted entirely of borrowings
collateralized by a pledge of the Company's Mortgage Assets. These borrowings
appear on the balance sheet as reverse repurchase agreements. The size of the
market for borrowings of this type is generally measured in the industry in the
trillions of dollars and institutions with high quality pledgable assets such as
banks, savings and loans, brokerage firms, federal agencies and the Federal
Reserve Bank are the largest U.S. borrowers in this market. The Company has
established uncommitted borrowing facilities with 10 lenders in this market in
amounts aggregating at least $500 million. The Company also has in place a line
of credit that it may use to fund cash flow shortages. The Company intends to
expand its uncommitted reverse repurchase agreements following this Offering.
There can be no assurance, however, that the Company will be able to obtain debt
financing in the future under these facilities or otherwise. Further, the
Company's current borrowing facilities may be collateralized only by Mortgage
Securities and may not be used to finance acquisitions of Mortgage Loans
pursuant to the Direct Purchase Program. See "Risk Factors -- Failure to
Implement Company's Leverage Strategy May Adversely Affect Results of
Operations" and "Business -- Fundings."
With the Company's current asset/liability strategy, changes in the
Company's cost of funds are expected to be closely correlated with changes in
the two-month LIBOR interest rate, although the Company may choose to extend the
maturity of its liabilities at any time.
The term to maturity of the Company's borrowings has ranged from one day to
six months, with a weighted average term to maturity of 62 days at quarter
ending June 30, 1997. The weighted average cost of funds for all of the
Company's borrowings was 5.69% per annum as of June 30, 1997.
Net Interest Income from Equity-Funded Lending and Spread Lending
For the purpose of analyzing net interest income, the Company focuses on
the two component activities with respect to its earning assets: equity-funded
lending and spread lending. Each of these two components must be considered
separately when analyzing changes in interest rates, asset/liability strategy,
growth, and other factors.
When analyzing the profitability of equity-funded lending and spread
lending, the Company does not assign specific Mortgage Assets to each type of
lending, but rather assumes that one portion of aggregate earning assets is
funded with equity and another portion of aggregate earning assets is funded
with borrowings. The Company assigns all borrowing and hedging costs to spread
lending and assigns non-earning assets to equity-funded lending.
Management believes equity-funded lending has a large influence on the
Company's profitability relative to financial institutions which have (i) lower
equity-to-assets ratios, (ii) intangible capital, or (iii) significant amounts
of non-earning assets or net working capital on their books.
Liquidity of Mortgage Assets
Liquidity is the Company's ability to convert its Mortgage Assets to cash.
The liquidity of the Company's Mortgage Assets enables the Company to borrow
funds to purchase additional Mortgage Assets and allows the Company to pledge
additional Mortgage Assets to secure existing borrowings should the value of
pledged Mortgage Assets decline. The Company will typically pledge its least
liquid Mortgage Assets for secured
26
<PAGE> 28
borrowings so that the Company's pool of unpledged Mortgage Assets is made up of
its most liquid Mortgage Assets. Unused borrowing capacity will vary over time
as the market value of the Company's Mortgage Assets varies and due to other
factors.
The Company's Mortgage Assets generate liquidity on an ongoing basis
through mortgage principal repayments and net income held prior to payment as
dividends. Should the Company's needs ever exceed these ongoing sources of
liquidity, Management believes that the Company's Mortgage Assets and interest
rate agreements could be sold in most circumstances to raise cash. There can be
no assurance, however, that such Mortgage Assets could be sold on terms
favorable to the Company, or at all. See "Risk Factors -- Investments in
Mortgage Assets May be Illiquid."
Asset/Liability Management and Effect of Changes in Interest Rates
Management continually reviews the Company's asset/liability strategy with
respect to interest rate risk, mortgage prepayment risk, credit risk and the
related issues of capital adequacy and liquidity. The Company seeks attractive
stockholder returns while seeking to maintain a strong balance sheet and pattern
of net income which is stable and growing over time.
The net effect of changes in interest rates, relative changes in one- and
six-month LIBOR rates, changes in short term rates relative to longer term
interest rates, changes in mortgage principal repayment rates, changes in the
market value of Mortgage Assets and interest rate agreements and other factors
cannot be determined in advance. In general, the Company's goal is to stabilize
spread lending income over longer periods of time and allow income from
equity-funded lending to rise as interest rates rise and fall as short term
interest rates fall. If the Company achieves this goal, the Company will
maintain a constant or widening spread over time between its yield on earning
assets and short term interest rates.
Inflation
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 or changes in inflation rates. The Company's financial
statements are prepared in accordance with GAAP and the Company's dividends are
determined by the Company's net income as calculated for tax purposes.
Seasonality
The level of prepayments of the Company's Mortgage Assets is subject to the
same seasonal influences as the residential real estate industry with
prepayments generally being higher in the summer months and lower in the winter
months. Likewise, Management anticipates that originations under the Direct
Purchase Program would parallel these seasonal trends.
RESULTS OF OPERATIONS
Total net income for the Company increased by 200% from approximately
$146,000 in the period ended March 31, 1997, to approximately $438,000 in the
quarter ended June 30, 1997. The growth in net income was directly attributable
to an increase in net interest income. Net interest income grew by 264% between
the period ended March 31, 1997 and the quarter ended June 30, 1997, from
approximately $156,000 to approximately $568,000, respectively. This increase in
net interest income was partially offset by an increase in general and
administrative expenses. From the period ended March 31, 1997 to the quarter
ended June 30, 1997, general and administrative expenses increased from
approximately $10,000 to approximately $130,000.
The growth in net interest income between the period ended March 31, 1997
and the quarter ended June 30, 1997 was due to the increase in the Company's
Mortgage Assets. The Company commenced operations on February 11, 1997, but did
not complete the initial purchase of Mortgage Assets until March 24, 1997.
Therefore, the Company did not earn interest income from Mortgage Assets nor
incur premium amortization or reverse repurchase agreement expense until late in
the period ended March 31. Similarly, the increase in general and administrative
expenses between the period ended March 31, 1997 and the quarter
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ended June 30, 1997 is the result of the Company not starting operations until
the middle of the period ended March 31.
The Company experienced higher than expected levels of prepayments in the
quarter ended June 30, 1997. The annualized mortgage principal prepayment rate
for the Company was 29% in the quarter ending June 30, 1997. Although the
Company does not expect prepayment rates to continue at such levels, there can
be no assurance that the Company will be able to achieve or maintain lower
prepayment rates. Accordingly, the Company's financial condition and results of
operations could be materially adversely affected if prepayments continue at
higher than anticipated levels. See "Business -- Risk Management -- Interest
Rate Risk Management."
The Company was in the process of investing the net proceeds of its initial
sale of privately placed Common Stock through May 15, 1997. Accordingly, the
full impact of the Company's use of proceeds was not realized in operations
until the middle of the quarter ended June 30, 1997. See "Risk Factors --
Limited Operating History Does Not Predict Future Performance."
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity needs result from the long term
investment in Mortgage Assets. Generally, reverse repurchase agreement
borrowings and the issuance of Common Stock provide the Company funding for its
investment needs. To a lesser extent, the Company may use funds available under
its line of credit. See "Business -- Funding."
During the period from February 11, 1997 (commencement of operations)
through June 30, 1997, net cash provided by operating activities was $259,000.
Net cash used in operating activities was negatively impacted by an increase in
accrued interest receivables. There were no Mortgage Assets held at February 11,
1997, and, therefore, the total accrued interest receivables at June 30, 1997
negatively affected cash. Net cash for the period was positively affected by an
increase in accrued interest payable.
Net cash used in investing activities for the period from February 11, 1997
through June 30, 1997 was $229.7 million. Net cash used for the period was
negatively affected by the purchase of Mortgage Assets and positively affected
by principal repayments.
For the period from February 11, 1997 through June 30, 1997, net cash
provided by financing activities was $229.6 million. Net cash provided was
primarily affected by borrowing from reverse repurchase agreements and net
proceeds received from the issuance of Common Stock in the Company's private
placement.
At June 30, 1997 the Company had uncommitted reverse repurchase facilities
to provide over $500 million to finance investments in Mortgage Assets.
Management believes that cash flow from operations, the proceeds of this
Offering and funds available pursuant to reverse repurchase financing facilities
and other credit arrangements will be sufficient to meet the Company's cash
requirements for at least one year following the closing of this Offering.
Thereafter, if the Company's cash resources are insufficient to satisfy the
Company's liquidity requirements, the Company may be required to sell additional
equity or debt securities. There is no assurance that such financing will be
available to the Company on favorable terms, or at all. See "Risk
Factors -- Failure to Implement Company's Leverage Strategy May Adversely Affect
Results of Operations."
RECENT DEVELOPMENTS
For the quarter ended June 30, 1997, the Company generated net income of
approximately $438,000 and net income per share of Common Stock of $0.26. From
the commencement of operations on February 11, 1997 through June 30, 1997, the
Company generated net income of approximately $584,000 and net income per share
of Common Stock of $0.35. At June 30, 1997, the Company held Mortgage Assets
that had a carrying value of approximately $229 million. All Mortgage Assets
held at June 30, 1997, were Agency Securities backed by adjustable-rate single
family residential Mortgage Loans.
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BUSINESS
GENERAL
AMREIT was incorporated in Maryland on February 11, 1997. The Company is a
mortgage REIT which currently invests in residential adjustable-rate Mortgage
Securities and which intends to invest in Mortgage Loans. The Company finances
its acquisitions of Mortgage Assets with equity and secured borrowings. AMREIT
expects generally to maintain an equity-to-assets ratio of approximately 8% to
12%, to earn interest on the portion of its Mortgage Asset portfolio financed
with equity and to earn a net interest spread on the leveraged portion of its
Mortgage Asset portfolio. The Company is structured as a REIT, thereby generally
eliminating federal taxes at the corporate level on income it distributes to
stockholders.
RESIDENTIAL MORTGAGE INDUSTRY
The residential mortgage market has experienced considerable growth over
the past 15 years with total residential mortgage debt outstanding growing from
approximately $965 billion in 1980 to approximately $3.9 trillion in 1996
according to the Mortgage Market Statistical Annual for 1997. In addition, the
total residential mortgage debt securitized into Mortgage Securities has grown
from approximately $110 billion in 1980 to approximately $1.9 trillion in 1996.
Management believes that the current size of the residential mortgage market
will provide the Company with significant opportunities with respect to the
purchase of Mortgage Assets.
INVESTMENTS
AMREIT currently acquires adjustable-rate residential Mortgage Securities
in the capital markets. While the Company expects that a majority of its
Mortgage Assets will continue to be Mortgage Securities, it anticipates that it
will increasingly invest directly in adjustable-rate Mortgage Loans, including
tailored Mortgage Loan products generated through the Direct Purchase Program.
Under the Direct Purchase Program, the Company believes that its experienced
management team can enhance the overall yield of the Mortgage Asset portfolio by
acquiring relatively higher yielding Mortgage Loans and avoiding the cost of
using intermediaries. See "Risk Factors -- Inability to Acquire Mortgage Assets
with Favorable Interest Rates and Terms May Adversely Affect Net Interest
Income."
The Company will only acquire those Mortgage Assets which the Company
believes it has the expertise to evaluate and manage and which are consistent
with the Company's balance sheet guidelines and risk management objectives. The
Company seeks to acquire Mortgage Assets which it believes will generate the
highest returns on capital invested in a broad range of interest rate and
prepayment scenarios. The Company also considers (i) the amount and nature of
anticipated cash flows from the Mortgage Asset, (ii) the Company's ability to
pledge the Mortgage Asset to secure collateralized borrowings, (iii) the
increase in the Company's capital requirement resulting from the purchase and
financing of the Mortgage Asset, as determined pursuant to the Company's Capital
Policy, and (iv) the costs of financing, hedging, managing, servicing,
securitizing and reserving for the Mortgage Asset. Prior to the acquisition of
Mortgage Assets, potential returns on capital employed are assessed over the
life of the Mortgage Asset and in a variety of interest rate, yield spread,
financing cost, credit loss and prepayment scenarios. The Company expects that
substantially all of the Mortgage Assets acquired by it will be adjustable-rate
residential Mortgage Securities and Mortgage Loans.
Capital Markets Program
The Company has purchased and will continue to purchase Mortgage Securities
in the capital markets. These Mortgage Assets generally have a higher level of
liquidity than the Mortgage Loans to be acquired under the Direct Purchase
Program and are expected to provide a stable flow of interest income with
relatively low levels of credit risk. The Mortgage Securities to be acquired by
the Company will be backed by a pool of adjustable-rate Mortgage Loans. These
Mortgage Securities entitle the holder to receive a pass-through of
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principal and interest payments on the underlying pool of Mortgage Loans and
will be Agency Securities or Privately Issued Securities.
From the commencement of operations on February 11, 1997 through June 30,
1997, the Company acquired Mortgage Securities that had a carrying value at June
30, 1997 of approximately $229 million. All Mortgage Securities held by the
Company at June 30, 1997 were Agency Securities evidencing an interest in
adjustable-rate single family residential Mortgage Loans.
Direct Purchase Program
Management intends to leverage its expertise in the residential Mortgage
Loan industry to develop a program for the purchase of Mortgage Loans by the
Company directly from Correspondents. Under the Direct Purchase Program, the
Company will (i) identify segments of the residential Mortgage Loan market that
meet its general criteria for potential originations, (ii) develop tailored
Mortgage Loan products for each market segment, (iii) acquire Mortgage Loans
originated by Correspondents directly from such Correspondents, hence avoiding
certain loan broker or other intermediary fees, and (iv) arrange for the
servicing of the Mortgage Loans by entities experienced in servicing the
particular types of Mortgage Loans involved.
The Company has not begun acquiring Mortgage Loans under the Direct
Purchase Program, and there can be no assurance that the program will be
successfully implemented or that the Mortgage Assets acquired through the
program will be higher yielding than Mortgage Securities. See "Risk Factors --
Inability to Acquire Mortgage Assets with Favorable Interest Rates and Terms May
Adversely Affect Net Interest Income."
Tailored Mortgage Loan Products. Under the Direct Purchase Program, the
Manager will identify segments of the residential Mortgage Loan market that it
determines have the potential for generating Mortgage Loans with higher yields
than other Mortgage Loans with generally comparable risks. These segments
generally are present where there is less competition among Mortgage Loan
originators and, hence, fewer resources available to borrowers. Management has
identified a number of such segments and expects that new opportunities in other
market segments will become available as the Mortgage Loan market continues to
change. These segments typically will include Mortgage Loans that are not
readily available from large, nationally-based loan originators due to factors
related to the loan underwriting process itself (such as the need to value a
complex, mixed use property) or a limited secondary market for resale of such
types of Mortgage Loans.
Management has identified the following segments of the residential
Mortgage Loan market for its initial tailored Mortgage Loan products:
- Small Multifamily Home Mortgage Loans. A small multifamily home Mortgage
Loan will be secured by a first lien on a 5-unit to 20-unit residential
property. The Company's underwriting guidelines for small multifamily
home Mortgage Loans will place emphasis on the appraised value, the
existence and terms of underlying leases, a cash flow analysis, the
condition of the mortgaged property and favorable credit reports.
- Manufactured Housing Mortgage Loans. A manufactured housing Mortgage Loan
will be secured by a first lien on an owner occupied manufactured housing
unit (excluding mobile homes) permanently affixed to a foundation and the
underlying lot. The underwriting of manufactured housing Mortgage Loans
will place emphasis on appraised value (relying on comparable sales),
condition of the property, the quality of the borrower's income and
favorable credit reports.
- Mixed Use Mortgage Loans. A mixed use Mortgage Loan will be secured by a
first lien on a combined commercial and up-to-twelve-unit residential
property. The qualifying commercial uses of the properties will be
generally limited to retail, professional, light industrial or office
use. The underwriting for mixed use Mortgage Loans will place emphasis on
appraised value (relying on comparable sales), condition of the property
(and environmental compliance), cash flow analysis and credit reports
(including credit reports on commercial tenants).
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- Rural Home Mortgage Loans. A rural home Mortgage Loan will be secured by
a first lien on a residential property in a rural area where agricultural
use is present but limited to noncommercial use. The underwriting of
rural home Mortgage Loans will place emphasis on appraised value (relying
on comparable sales), condition of the property, quality of the
borrower's income and favorable credit reports. Rural home Mortgage Loan
amounts will generally be higher with respect to the appraised value of
the residence and the first 5 acres and lower with respect to any
additional acreage.
- Mini-Ranch Home Mortgage Loans. A mini-ranch home Mortgage Loan will be
secured by a first lien on a residential ranch property. The underwriting
of mini-ranch home Mortgage Loans will place emphasis on appraised value
(relying on comparable sales), condition of the property, the quality of
the borrower's income (primarily non-ranch income) and favorable credit
reports. Mini-ranch home Mortgage Loan amounts will generally be higher
with respect to the appraised value of the residence and the first five
acres, and lower with respect to any additional acreage.
- Condominium/Resort Mortgage Loans. A condominium/resort Mortgage Loan
will be secured by a first lien on a vacation property, including those
located in ski, golf and other recreational resort areas. The
underwriting of condominium/resort Mortgage Loans will place emphasis on
appraised value (relying on comparable sales with same complex
comparables preferred), same complex rental history, the quality of the
borrower's income and favorable credit reports.
The Manager has created tailored Mortgage Loan products for the Company's
initial target market segments and has developed loan underwriting guidelines
for Correspondents. Such Mortgage Loan underwriting guidelines will set forth
the various Mortgage Loan characteristics (such as combinations of loan-to-value
levels and credit ranking of borrowers) that the Company is prepared to purchase
from Correspondents. The Company's tailored Mortgage Loan products generally
will be nonconforming, primarily as a result of the property type, and, to a
lesser extent, the borrower's credit characteristics. See "Risk Factors -- Value
of Mortgage Loans May be Adversely Affected by Characteristics of Underlying
Property and Borrower Credit."
Management intends to leverage its experience in the residential mortgage
industry to build a network of Correspondents with expertise in market segments
targeted by the Company. The Manager will make arrangements for the Company to
acquire Mortgage Loans through the Manager's relationships with these
Correspondents. Management has already identified and is working with a number
of Correspondents to generate Mortgage Loans products for its Direct Purchase
Program although it has not yet begun acquiring Mortgage Loans through this
program.
Other Products. In addition to the tailored Mortgage Loan products
described above, the Company may also acquire conforming Mortgage Loans and
nonconforming jumbo Mortgage Loans from Correspondents and purchase Mortgage
Loans on a bulk basis. Conforming Mortgage Loans will consist of (1)
conventional Mortgage Loans that comply with requirements for inclusion in
certain programs sponsored by the FHLMC or FNMA, (2) Mortgage Loans insured by
the Federal Housing Administration ("FHA") and (3) Mortgage Loans partially
guaranteed by the Department of Veterans Affairs ("VA"), that comply with
requirements for inclusion in a pool of Mortgage Loans guaranteed by the GNMA.
The nonconforming Mortgage Loans will be conventional Mortgage Loans that vary
in one or more respects from the requirements for participation in FHLMC or FNMA
programs. The Company expects that substantially all of the nonconforming
Mortgage Loans it purchases outside its target market segments will be
nonconforming primarily because they have original principal balances which
exceed the requirements for FHLMC or FNMA programs and, to a lesser extent,
because they vary in certain other respects from the requirements of such
programs, including the requirements relating to creditworthiness of the
borrowers. The Company may, when opportunities arise, acquire Mortgage Loans on
a bulk basis.
The Company does not expect to acquire or retain residual interests issued
by REMICs. Such residual interests, if acquired by a REIT, would generate excess
inclusion income. See "Federal Income Tax Considerations -- Taxation of
Stockholders."
Pricing. For Mortgage Loans to be acquired from Correspondents on a "flow"
basis (i.e., on a periodic basis shortly after the Mortgage Loans are funded),
the Company expects to frequently set the prices at which
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it will purchase such Mortgage Loans. Mortgage Loans acquired on a bulk basis
will typically be priced on a negotiated basis with Correspondents or pursuant
to a bidding process. In each case, different prices will be established for the
various types of Mortgage Loans to be acquired based on current market
conditions, with price adjustments for any "buy-ups" and "buy-downs" (i.e.,
where the gross margin is higher or lower than the standard margin set forth in
the Company's pricing specifications).
Underwriting. In developing its tailored Mortgage Loan products for the
Direct Purchase Program, the Company will create a matrix of specific
underwriting standards based on various combinations of the underwriting
characteristics described below. Each Correspondent will generally be required
to represent and warrant that all Mortgage Loans originated by it and sold to
the Company have been underwritten in accordance with the Company's specific
underwriting standards as well as standards consistent with those used by
mortgage lenders generally.
Underwriting standards are applied by or on behalf of a lender to evaluate
the borrower's credit standing and repayment ability, and the value and adequacy
of the related mortgaged property as collateral. In general, a prospective
borrower applying for a Mortgage Loan is required to fill out a detailed
application designed to provide to the underwriting officer pertinent credit
information. As part of the description of the borrower's financial condition,
the borrower generally is required to provide a current list of assets and
liabilities and a statement of income and expenses, as well as an authorization
to apply for a credit report which summarizes the borrower's credit history with
local merchants and lenders and any record of bankruptcy. In most cases, an
employment verification is obtained from an independent source (typically the
borrower's employer) which verification reports, among other things, the length
of employment with that organization, the current salary, and whether it is
expected that the borrower will continue such employment in the future. If a
prospective borrower is self-employed, the borrower may be required to submit
copies of signed tax returns. The borrower may also be required to authorize
verification of deposits at financial institutions where the borrower has demand
or savings accounts.
The Company may elect to have the borrower's credit report reviewed, and a
credit score produced, by an independent credit-scoring firm, such as Fair,
Issac and Company ("FICO"). Credit scores estimate, on a relative basis, which
borrowers are most likely to default on Mortgage Loans. Lower scores imply
higher default risks relative to higher scores. FICO scores are empirically
derived from historical credit bureau data and represent a numerical weighing of
a borrower's credit characteristics over a two year period. A FICO score is
generated through the statistical analysis of a number of credit-related
characteristics or variables. Common characteristics include the following: the
number of credit lines (trade lines), payment history, past delinquencies,
severity of delinquencies, current levels of indebtedness, types of credit and
length of credit history. Attributes are the specific values of each
characteristic. A scorecard (the model) is created with weights or points
assigned to each attribute. An individual loan applicant's credit score is
derived by summing together the attribute weights for that applicant.
In determining the adequacy of the mortgaged property as collateral, an
appraisal is made of each property considered for financing. 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 homes, the estimated rental income (if considered
applicable by the appraiser) and the cost of replacing the home. The value of
the property being financed, as indicated by the appraisal, must be such that it
currently supports, and is anticipated to support in the future, the outstanding
Mortgage Loan balance.
Once all applicable employment, credit and property information is
received, a determination generally is made as to whether the prospective
borrower has sufficient monthly income available to meet (i) the borrower's
monthly obligations on the proposed Mortgage Loan (determined on the basis of
the monthly payments due in the year of origination) and other expenses related
to the mortgaged property (such as property taxes and hazard insurance), and
(ii) monthly housing expenses and other financial obligations and monthly living
expenses. The underwriting standards applied by the Correspondent may be
permitted to vary in appropriate cases where factors such as low loan-to-value
ratios or other favorable credit issues exist.
Because certain types of Mortgage Loans which will be acquired by the
Company under the Direct Purchase Program will be recently developed, they may
involve additional uncertainties not present in
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traditional types of Mortgage Loans. The Company expects that these types of
Mortgage Loans may be underwritten primarily upon the basis of loan-to-value
ratios or favorable credit factors rather than on the borrower's credit standing
or income ratios. See "Risk Factors -- Value of Mortgage Loans May Be Adversely
Affected by Characteristics of Underlying Property and Borrower Credit."
Quality Control. The Company has developed a quality control program to
monitor the quality of Mortgage Loan underwriting at the time of acquisition and
on an ongoing basis. All Mortgage Loans purchased by the Company will be subject
to this quality control program. A legal document review of each Mortgage Loan
acquired will be conducted to verify the accuracy and completeness of the
information contained in the mortgage notes, security instruments and other
pertinent documents in the file. A sample of Mortgage Loans originated under the
Direct Purchase Program will normally be submitted to a third party, nationally
recognized underwriting review firm for a compliance check of underwriting and
review of income, asset and appraisal information. For purposes of this
compliance check, Mortgage Loans will be selected by focusing on Mortgage Loans
with higher risk characteristics. In addition, Management expects to conduct
post-acquisition audits to monitor ongoing documentation and servicing
compliance.
Servicing. Management expects to acquire certain of its Mortgage Loans on a
"servicing released" basis (i.e., the Company will acquire both the Mortgage
Loans and the rights to service them) and to act as the servicer of such
Mortgage Loans while they are in the Company's Mortgage Asset portfolio.
Management believes this strategy will have the effect of increasing the yield
to the Company from the Mortgage Loans above what it would otherwise be. The
Company will contract with a subservicer for a fixed dollar fee per Mortgage
Loan per year or a percentage of the outstanding mortgage balance and the right
to hold escrow account balances and retain certain ancillary charges. Management
expects to arrange for servicing of the Mortgage Loans originated through the
Direct Purchase Program with servicing entities that have particular expertise
and experience in the types of Mortgage Loans being acquired. Management does
not expect to acquire mortgage servicing rights with respect to Mortgage Loans
beneficially owned by others.
FUNDING
The Company employs a debt financing strategy to increase its investment in
Mortgage Assets. By using the Company's Mortgage Assets as collateral to borrow
funds, the Company is able to purchase Mortgage Assets with significantly
greater value than its equity. The Company has a targeted ratio of
equity-to-assets of between 8% and 12%, which is generally greater than the
levels of many other companies that invest in Mortgage Assets, including many
commercial banks, savings and loans, FNMA and FHLMC. The Company has borrowing
arrangements with ten financial institutions consisting primarily of large
investment banking firms. At June 30, 1997, the Company had borrowed funds under
reverse repurchase agreements with five of these firms. The Company intends to
expand its uncommitted reverse repurchase agreements following this Offering.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
The Company's financing strategy is designed to maintain a cushion of
equity sufficient to provide required liquidity to respond to the effects under
its borrowing arrangements of interest rate movements and changes in market
value of its Mortgage Assets. However, a major disruption of the reverse
repurchase or other markets relied on by the Company for short term borrowings
would have a material adverse effect on the Company unless the Company was able
to arrange alternative sources of financing on comparable terms. The Company
intends to finance its acquisition of Mortgage Assets primarily through reverse
repurchase agreements and, to a lesser extent, through lines of credit,
securitizations and other financings.
At June 30, 1997, total borrowings outstanding were $209.5 million, with
Mortgage Assets valued at $221.0 million pledged to secure such borrowings.
These borrowings are carried on the balance sheet at historical cost, which
approximates market value. All of the borrowings were pursuant to reverse
repurchase agreements. At June 30, 1997, the weighted average term to maturity
was 62 days and the weighted average borrowing rate was 5.69% per annum. Under
the reverse repurchase agreements outstanding at June 30, 1997, the original
aggregate "haircut," or the percentage by which the market value of the pledged
collateral must exceed the borrowing amount, was 4.4%. The Company anticipates
that, upon repayment of each borrowing,
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the collateral will immediately be used for borrowing pursuant to a new
agreement. However, there can be no assurance that the Company would be able to
borrow additional funds. See "Risk Factors -- Failure to Implement Company's
Leverage Strategy May Adversely Affect Results of Operations."
The Company expects that all of its borrowing agreements will require the
Company to pledge cash or additional Mortgage Assets in the event the market
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 Assets to reduce the borrowings. The Company's current
borrowing facilities may be collateralized only by Mortgage Securities and may
not be used to finance acquisitions of Mortgage Loans pursuant to the Direct
Purchase Program. See "Risk Factors -- Failure to Implement Company's Leverage
Strategy May Affect Results of Operations."
Reverse Repurchase Agreements
The Company finances its portfolio of Mortgage Assets primarily through a
form of borrowing known as reverse repurchase agreements. In a reverse
repurchase agreement transaction, the Company agrees to sell a Mortgage Asset
and simultaneously agrees to repurchase the same Mortgage Asset one to six
months later at a higher price with the price differential representing the
interest expense. These transactions constitute collateralized borrowings for
the Company, based on the market value of the Company's Mortgage Assets. The
Company generally will retain beneficial ownership of the Mortgage Security,
including the right to distributions on the collateral and the right to vote.
Upon a payment default under such agreements, the lending party may liquidate
the collateral.
The Company intends to enter into reverse repurchase agreements primarily
with national broker/dealers, commercial banks and other lenders which typically
offer such financing. The Company does not intend at the present time to enter
into commitment agreements under which the lender would be required to enter
into new reverse repurchase agreements during a specified period of time. The
Manager and the Company will monitor the need for such commitment agreements and
may enter into such commitment agreements in the future if deemed favorable to
the Company. At June 30, 1997 the Company had uncommitted reverse repurchase
facilities to provide over $500 million to finance investments in Mortgage
Assets. See "Risk Factors -- Failure to Implement Company's Leverage Strategy
May Adversely Affect Results of Operations."
In the event of the insolvency or bankruptcy of the Company, the creditor
under reverse repurchase agreements may be allowed to avoid the automatic stay
provisions of the Bankruptcy Code and to foreclose on the collateral agreements
without delay. In the event of the insolvency or bankruptcy of a lender during
the term of a reverse repurchase agreement, the lender may be permitted to
repudiate the contract, and the Company's claim against the lender for damages
therefrom may be treated simply as one of the unsecured creditors. Should this
occur, the Company's claims would be subject to significant delay and, if and
when received, may be substantially less than the damages actually suffered by
the Company.
To reduce its exposure to the credit risk of reverse repurchase agreement
lenders, the Company intends to enter into such agreements with several
different parties and to follow credit exposures policies approved by the Board
of Directors, which include (i) conducting a financial review of each potential
lender, (ii) imposing minimum equity and credit rating (if rated) requirements
on such lenders, and (iii) limiting the percentage of Mortgage Assets that are
the subject of reverse repurchase agreements with a single lender to 45% of the
Company's total Mortgage Assets. Any exceptions to these policies must be
approved by both the Chief Executive Officer and the Chief Operating Officer.
The Company will monitor the financial condition of its reverse repurchase
agreement lenders on a regular basis. Notwithstanding these measures, no
assurance can be given that the Company will be able to avoid such third party
risks.
Lines of Credit
The Company has in place a line of credit facility that it may use to fund
portions of cash flow shortages which may result from prepayments on Mortgage
Loans underlying its Mortgage Securities. Generally, the Company's reverse
repurchase agreements, which are collateralized by the Company's Mortgage
Securities,
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demand immediate receipt of additional collateral to the extent that the value
of the Mortgage Securities is reduced as a result of prepayments. However, the
federal government agencies that issue the Mortgage Securities do not deliver
the proceeds from such prepayments for periods ranging from 10 to 36 days
following the announcement of such prepayments. Accordingly, the Company may be
required to draw on its line of credit for the period between the date the
prepayments are announced and the Company is required to surrender additional
collateral and the date it receives the proceeds from the prepayments. The line
of credit is secured by the proceeds of such prepayments.
Securitizations
The Company intends to securitize from time to time Mortgage Loans acquired
through the Direct Purchase Program as part of its overall financing strategy.
Securitization is the process of pooling Mortgage Loans and issuing equity
securities, such as mortgage pass-through, or debt securities, such as
Collateralized Mortgage Obligations ("CMOs"). The Company intends to securitize
its Mortgage Loans primarily by issuing structured debt. Under this approach,
for accounting purposes the Mortgage Loans so securitized remain on the balance
sheet as assets and the debt obligations (i.e., the CMOs) appear as liabilities.
A structured debt securitization is generally expected to result in substituting
one type of debt financing for another, as proceeds from the structured debt
issuance are applied against preexisting borrowings (i.e., advances under the
warehouse line of credit or borrowings under repurchase agreements). The
structured debt securities issued will constitute non-recourse, long term
financing, the payments on which correspond to the payments on the Mortgage
Loans serving as collateral for the debt. Such financings are not subject to a
margin call if a rapid increase in rates would reduce the value of the
underlying Mortgage Loans and, hence, reduce the liquidity risk to the Company
for the Mortgage Loans so financed.
In addition to securitizing its Mortgage Loans, the Company also plans from
time to time to "re-securitize" portions of its Mortgage Securities portfolio.
In a re-securitization transaction, Mortgage Securities rather than Mortgage
Loans are used as collateral to create new Mortgage Securities. Only those
Mortgage Securities originally issued with (or subsequently downgraded to) a
rating below the two highest rating categories would benefit from
resecuritization. While the Company's investment strategy does not contemplate
purchasing such lower rated Mortgage Securities, the Company anticipates that it
may acquire such types of Mortgage Securities from time to time in connection
with securitizing its own Mortgage Loans as described above. A re-securitization
would typically be carried out when the Mortgage Loans underlying the Company's
Mortgage Securities improve in credit quality through seasoning, as values rise
on the underlying properties, or when the credit quality of a junior class of
Mortgage Security improves due to prepayment of more senior classes. Such
transactions can result in improved credit ratings, higher market values and
lowered borrowing costs. The Company has not engaged in any securitization or
resecuritization transactions to date and there can be no assurances that the
Company will be able to securitize or otherwise finance its Mortgage Loans
acquired pursuant to the Direct Purchase Program.
CAPITAL GUIDELINES
The Company's capital management goal is to strike a balance between the
under-utilization of leverage, which could reduce 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. For
this purpose, the Company has established a "Capital Policy" which limits
Management's ability to acquire additional Mortgage Assets during times when the
actual capital base of the Company is less than a required amount defined in the
Capital Policy. In this way, the use of balance sheet leverage can be better
controlled. The actual capital base, as defined for the purpose of the Capital
Policy, is equal to the market value of total Mortgage Assets less the book
value of total collateralized borrowings. In addition, when the actual capital
base falls below the Capital Policy requirement, management is required to
submit to the Board of Directors a plan for bringing the actual capital base
into compliance with the Capital Policy. It is anticipated that in most
circumstances this goal will be achieved over time without overt Management
action through the natural process of mortgage principal repayments and
increases in the market values of Mortgage Assets as their coupon rates adjust
upwards to market levels. Management anticipates that the actual capital base is
likely to
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<PAGE> 37
exceed the Capital Policy requirement during periods following new equity
offerings and during periods of falling interest rates and that the actual
capital base is likely to fall below the Capital Policy requirement during
periods of rising interest rates.
The Company assigns to each Mortgage Asset a specified amount of capital to
be maintained against it by aggregating three component requirements of the
Capital Policy. The first component of the Company's Capital Policy is the
current aggregate over-collateralization amount or "haircut" the lenders require
the Company to hold as capital. The Company is required to pledge as collateral
Mortgage Assets with a market value that exceeds the amount it borrows. The
haircut for each Mortgage Asset is determined by the lender based on the risk
characteristics and liquidity of that Mortgage Asset. For example, haircut
levels on individual borrowings could range from 3% for Agency Securities to 20%
for certain Mortgage Loans acquired through the Direct Purchase Program.
The second component of the Company's Capital Policy is the "liquidity
capital cushion." The Company expects that substantially all of its borrowing
agreements will require the Company to deposit additional collateral in the
event the market value of existing collateral declines. The liquidity capital
cushion is an additional amount of capital in excess of the haircut maintained
by the Company in order to help the Company meet the demands of the lenders for
additional collateral should the market value of the Company's Mortgage Assets
decline. Alternatively, the Company might sell Mortgage Assets to reduce the
borrowings. See "Risk Factors -- Investments in Mortgage Assets May Be
Illiquid."
The third component of the Company's capital requirement is the "capital
cushion" assigned to each Mortgage Asset based on Management's assessment of the
Mortgage Asset's credit risk. This represents an assessment of the risk of
delinquency, default or loss on individual Mortgage Assets.
Finally, the Board of Directors establishes, subject to revision from time
to time, an overall maximum leverage ratio for the Company. The Board of
Directors reviews on a periodic basis various analyses prepared by Management of
the risks inherent in the Company's balance sheet, including an analysis of the
effects of various scenarios on the Company's net cash flow, net income,
dividends, liquidity and net market value. Should the Board of Directors
determine, in its discretion, that the minimum required capital base is either
too low or too high, the Board of Directors will raise or lower the capital
requirement accordingly.
The Company expects that its aggregate minimum capital requirement under
the Capital Policy will range between 8% to 12% of the total market value of the
Company's Mortgage Assets. This percentage will fluctuate over time, and may
fluctuate out of the expected range, as the composition of the balance sheet
changes, haircut levels required by lenders change, the market value of the
Mortgage Assets changes and as the capital cushion percentages set by the Board
of Directors are adjusted over time. The Company will actively monitor and
adjust, if necessary, its Capital Policy, both on an aggregate portfolio level
as well as on an individual pool or Mortgage Loan basis. In monitoring its
Capital Policy, the Company expects to take into consideration current market
rate conditions and a variety of interest rate scenarios, performance of hedges,
Mortgage Asset performance, credit risk, prepayments and Mortgage Asset
restructuring, general economic conditions, potential issuance of additional
equity, pending Mortgage Asset acquisitions or sales, Mortgage Loan
securitizations and general availability of financing. There can be no assurance
that the Company's capital will be sufficient to protect the Company against
adverse effects from interest rate adjustments or the obligation to sell
Mortgage Assets on unfavorable terms or at a loss. See "Risk Factors -- Interest
Rate Fluctuations May Adversely Affect Net Interest Income."
RISK MANAGEMENT
Prior to acquiring Mortgage Assets, Management gives consideration to
balance sheet management and risk diversification issues. A specific Mortgage
Asset which is being evaluated for potential acquisition is deemed more or less
valuable to the Company to the extent it serves to increase or decrease certain
interest rate or prepayment risks which may exist in the balance sheet, to
diversify or concentrate credit risk, and to meet the cash flow and liquidity
objectives Management may establish for the balance sheet from time to time.
Accordingly, an important part of the Mortgage Asset evaluation process is a
simulation, using the Company's risk management model, of the addition of a
potential Mortgage Asset and its associated
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<PAGE> 38
borrowings and hedgings to the balance sheet and an assessment of the impact
this potential Mortgage Asset acquisition would have on the risks in and returns
generated by the Company's balance sheet as a whole over a variety of scenarios.
Interest Rate Risk Management
To the extent consistent with its election to qualify as a REIT, the
Company will implement certain processes and will follow a hedging program
intended to protect the Company against significant unexpected changes in
prepayment rates and interest rates.
Prepayment Risk Management Process. The Company will seek to minimize the
effects on earnings caused by faster than anticipated prepayment rates by
purchasing Mortgage Assets with prepayment penalties or which are fully-indexed
and have previously experienced periods of rising or falling interest rates. In
particular, the Company intends to include substantial prepayment penalties in
the underwriting guidelines for the tailored Mortgage Loan products in the
Direct Purchase Program. See "Risk Factors -- Increased Levels of Mortgage Loan
Prepayments May Adversely Affect Net Interest Income."
During the quarter ended June 30, 1997, the Company received $10.4 million
in principal payments on its Mortgage Assets. The annualized rate of principal
repayment the Company experienced was 29%. The amortized cost of the Company's
Mortgage Assets at June 30, 1997 was equal to 103.8% of the face value of the
Mortgage Assets. The smaller the level of net premium, the less risk there is
that fluctuations in prepayment rates will affect earnings in the long run. See
"Risk Factors -- Increased Levels of Mortgage Loan Prepayments May Adversely
Affect Net Interest Income" and "Management Discussion and Analysis of Financial
Condition and Results of Operations -- Overview."
Other Processes. The Company manages its Mortgage Asset portfolio to offset
the potential adverse effects from (i) lifetime and periodic rate adjustment
caps on its Mortgage Assets, (ii) the differences between interest rate
adjustment indices of its Mortgage Assets and related borrowings, and (iii) the
differences between interest rate adjustment periods of its Mortgage Assets and
related borrowings. The Company generally purchases Mortgage Assets which are
fully indexed and have previously experienced periods of rising and falling
interest rates. The Company also attempts to structure its acquisitions so that
the Mortgage Assets purchased by the Company have interest rate adjustment
indices and adjustment periods that, on an aggregate basis, correspond closely
to the interest rate adjustment indices and adjustment periods of its
anticipated borrowings. In addition, the Company structures its short term
borrowing agreements to have a range of different maturities (although the
majority will be six months or less). As a result, the Company expects to be
able to adjust the average maturity of its borrowings on an ongoing basis by
changing the mix of maturities as borrowings come due and are renewed. In this
way, the Company intends to reduce the differences between adjustment periods of
Mortgage Assets and related borrowings.
At June 30, 1997, the Company's weighted average Mortgage Assets and
liabilities were matched within a two-month period in terms of adjustment
frequency and speed of adjustment to market conditions. All of the Company's
Mortgage Assets at June 30, 1997, had coupon rates that adjust to market levels
at least annually, with a weighted average term to reset of approximately four
months. All of the Company's borrowings at June 30, 1997, will either mature or
adjust to a market interest rate level within four months of such date. The
borrowings had a weighted average term to rate reset of 62 days at June 30,
1997. Changes in coupon rates earned on Mortgage Assets highly correlated with
changes in LIBOR rates and CMT rates. The rates paid on borrowing generally
correlate with the changes in either LIBOR or FED fund rates (subject to the
effects of periodic and lifetime caps). There can be no assurance that the
Company's processes will protect the Company against interest rate fluctuations
which may adversely affect the Company's net interest income and results of
operations. See "Risk Factors -- Interest Rate Fluctuations May Adversely Affect
Net Interest Income."
Hedging. The Company recognizes the need to hedge specific interest rate
risks associated with its Mortgage Asset portfolio and will seek the hedging
instrument most appropriate for the specific risk. Currently, all of the
Company's Mortgage Assets are subject to both lifetime interest rate caps and
periodic interest rate caps. The Company actively hedges the lifetime cap risks
associated with its Mortgage Assets.
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<PAGE> 39
The Company has entered into hedging transactions with respect to lifetime
interest rate caps in order to reduce the negative impact to the Company's
earnings which might otherwise result from a significant rise in interest rates.
The Company may enter into additional types of hedging transactions in the
future if Management believes there exists a significant risk to earnings. These
types of hedging transactions may include hedging against risks associated with
(i) periodic interest rate adjustment cap, and (ii) Mortgage Assets denominated
in different interest rate indices, such as U.S. Treasury bills and Eurodollars.
Management intends to monitor and evaluate the results of its hedging strategy
and to adjust its hedging strategy as it deems is in the best interest of the
Company.
The cost of the interest rate cap agreements at June 30, 1997 was
approximately $502,000. Cap premiums are amortized from the purchase date
through the effective date of the cap on a straight-line basis. During the
quarter ended June 30, 1997, the cap amortization expense was approximately
$40,000. There was no income from the caps during this period and there were no
sales or termination of caps. During the quarter ended June 30, 1997, net cap
expense equaled approximately 0.02% of the average balance of the Company's
Mortgage Assets and 0.02% of the average balance of the Company's interest
bearing liabilities. For such periods, the net cap expense was approximately 7%
of net interest income. At June 30, 1997, the range of strike rates was 7.52% to
9.95% and the weighted average strike rate was 8.11%. Some of the Company's
interest rate cap agreements have strike rates and/or notional face amounts
which vary over time. The cap agreements do not become effective until the first
half of 1998. All of the interest rate caps reference the one month LIBOR.
Mortgage derivative securities can also be effective hedging instruments in
certain situations as the value and yields of some of these investments tend to
increase as interest rates rise and tend to decrease in value and yields as
interest rates decline, while the experience for others is the converse. As part
of its hedging program the Company will monitor on an ongoing basis the
prepayment risks which arise in fluctuating interest rate environments and
consider alternative methods and costs of hedging such risks, which may include
the use of mortgage derivative securities. The Company intends to limit its
purchases of mortgage derivative securities to investments that qualify as
Qualified REIT Assets so that income from such investments will constitute
qualifying income for purposes of the 95% and 75% Gross Income Tests. To a
lesser extent, the Company may also enter into interest rate swap agreements,
buy and sell financial futures contracts and options on financial futures
contracts and trade forward contracts as a hedge against future interest rate
changes; however, the Company will not invest in these instruments unless the
Company and the Manager are exempt from the registration requirements of the
Commodities Exchange Act or otherwise comply with the provisions of that act.
The REIT Provisions of the Code may restrict the Company's ability to purchase
hedges and may severely restrict the Company's ability to employ other
strategies. In all its hedging transactions, the Company will contract only with
counterparties that the Company believes are sound credit risks. See "Federal
Income Tax Considerations -- Requirements for Qualification as a REIT -- Gross
Income Tests."
Hedging involves transaction and other costs, and such costs increase
dramatically as the period covered by the hedging protection increases and also
increase in periods of rising and fluctuating interest rates. For example, in a
typical interest rate cap agreement, the cap purchaser makes an initial lump sum
cash payment to the cap seller in exchange for the seller's promise to make cash
payments to the purchaser on fixed dates during the contract term if prevailing
interest rates exceed the rate specified in the contract. Because of the cost
involved, the Company may be prevented from effectively hedging its interest
rate risks, without significantly reducing the Company's return on equity.
Certain of the federal income tax requirements that the Company must
satisfy to qualify as a REIT limit the Company's ability to fully hedge its
interest rate and prepayment risks. The Company monitors carefully, and may have
to limit, its asset/liability management program to assure that it does not
realize excessive hedging income, or hold hedging assets having excess value in
relation to total assets, which would result in the Company's disqualification
as a REIT or, in the case of excess hedging income, the payment of a penalty tax
for failure to satisfy certain REIT income tests under the Code, provided such
failure was for reasonable cause. In addition, asset/liability management
involves transaction costs which increase dramatically as the period covered by
the hedging protection increases. Therefore, the Company may be prevented from
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<PAGE> 40
effectively hedging its interest rate and prepayment risks. See "Federal Income
Tax Considerations -- Requirements for Qualification as a REIT."
Although Management believes it has developed a cost-effective interest
rate risk management program to provide a level of protection against interest
rate risks, developing an effective program is complex and no program can
completely insulate the Company from the effects of interest rate changes.
Further, the cost of hedging transactions and the federal tax laws applicable to
REITs may limit the Company's ability to fully hedge its interest rate risks.
See "Risk Factors -- Failure to Successfully Manage Interest Rate Risks May
Adversely Affect Results of Operations" and "Federal Income Tax
Considerations -- Requirements for Qualification as a REIT."
Interest Rate Sensitivity Gap. The interest rate sensitivity gap is a tool
used by financial institutions such as banks and savings and loans to analyze
the possible effects of interest rate changes on net income over time. Time gap
analysis ignores many important factors, however, in the Company's case, it
ignores, among other things, the effect of the Company's hedging activities, the
effect of the periodic and lifetime caps in the Company's Mortgage Assets, and
the effect of changes in mortgage principal repayment rates. Nevertheless, the
gap analysis can provide some useful information on the interest rate risk
profile of a financial institution.
A negative cumulative gap over a particular period means that the amount of
liabilities that will have an expense rate adjusting to prevailing market
conditions during that period will be greater than the amount of Mortgage Assets
that will have an earning rate adjustment. Thus a negative gap implies that
increasing interest rates would result in a falling level of net interest income
during the time period in question, as the cost of funds on the liabilities
would adjust more quickly to the interest rate increase than would the interest
income from the Mortgage Assets. A negative gap also implies that falling
interest rates would result in an increasing level of net interest during the
period in question.
Credit Risk Management
The Company will review credit risks and other risks of loss associated
with each investment and determine the appropriate allocation of capital to
apply to such investment under its Capital Policy. In addition, the Company will
attempt to diversify its Mortgage Asset portfolio to avoid undue geographic,
issuer, industry and certain other types of concentrations. The Company will
attempt to obtain protection against some risks from sellers and servicers
through representations and warranties and other appropriate documentation. The
Board of Directors will monitor the overall portfolio risk and determine
appropriate levels of the allowance for loan losses.
The risks presented by each Mortgage Loan acquired under the Direct
Purchase Program will be unique and must be analyzed separately. In order to
reduce the credit risks associated with acquisitions of these Mortgage Loans,
the Company will (i) employ a quality control program, (ii) acquire Mortgage
Loans that represent a broad range of moderate risks as opposed to a
concentrated risk, (iii) monitor the credit quality of newly acquired and
existing Mortgage Assets, and (iv) periodically adjust the loan loss allowances.
The Company also expects to arrange for servicing of the Direct Purchase Program
Mortgage Loans with servicing entities that have particular expertise and
experience in the types of Mortgage Loans being acquired. See "Risk Factors --
Value of Mortgage Loans May be Adversely Affected by Characteristics of
Underlying Property and Borrower Credit."
With respect to its Mortgage Securities, the Company will be exposed to
levels of credit and special hazard risk, depending on the nature of the
underlying Mortgage Loans and the nature and level of credit enhancements
supporting such Mortgage Securities. Most of the Mortgage Securities acquired by
the Company will have protection from normal credit losses. At June 30, 1997,
100% of the Company's Mortgage Assets were Agency Securities.
Management may decide to sell Mortgage Assets from time to time for a
number of reasons including, without limitation, to dispose of Mortgage Assets
as to which credit risk concerns have arisen, to reduce interest rate risk, to
substitute one type of Mortgage Asset for another to improve yield or to
maintain compliance with the 55% requirement under the Investment Company Act,
and generally to re-structure the
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<PAGE> 41
balance sheet when Management deems such action advisable. The REIT Provisions
of the Code limit in certain respects the ability of the Company to sell
Mortgage Assets. See "Federal Income Tax Considerations -- Requirements of
Qualifications as a REIT -- Gross Income Tests" and "Federal Income Tax
Considerations -- Taxation of the Company."
CERTAIN ACCOUNTING POLICIES AND PROCEDURES
Mortgage Security Accounting Treatment
Because the Company's Mortgage Securities are classified for accounting
purposes as "available for sale" accounting treatment, unrealized fluctuations
in market values of the Mortgage Securities do not impact GAAP or taxable income
but rather are reflected on the balance sheet by changing the carrying value of
the Mortgage Asset and reflecting the change in stockholders' equity under "Net
Unrealized Losses on Assets Available for Sale." As a result of this
mark-to-market accounting treatment, the book value and book value per share of
the Company are likely to fluctuate far more than if the Company used historical
amortized cost accounting. As a result, comparisons with companies that use
historical cost accounting for some or all of their balance sheet may be
misleading.
Unrealized changes in the estimated net market value of Mortgage Assets
have one direct effect on the Company's potential net income and dividends:
positive mark-to-market changes will increase the Company's equity base and
allow the Company to increase its spread lending activities while negative
changes will tend to limit spread lending growth under the Company's Capital
Policy. A very large negative change in the net market value of Mortgage Assets
and interest rate agreements might impair the Company's liquidity position,
requiring the Company to sell Mortgage Assets with the likely result of realized
losses upon sale. See "Risk Factors -- Failure to Implement Company's Leverage
Strategy May Adversely Affect Results of Operations."
Taxable Income and GAAP Income
Income as calculated for tax purposes ("taxable income") differs from
income as calculated according to generally accepted accounting principles
("GAAP income") for various reasons. Interest income differs due to different
methods of calculating the rate of amortization of the premium or discount when
Mortgage Assets are acquired at a price above or below the stated principal
amount of the Mortgages Loans. Credit losses differ between tax and GAAP methods
because the Company takes credit provisions in order to build a credit allowance
for GAAP whereas only actual credit losses are deducted in calculating taxable
income. General and administrative expenses differ due to differing treatment of
leasehold amortization and other items. The Company's largest expense is the
cost of borrowed funds. Interest expense is calculated in the same manner for
GAAP and tax purposes.
These distinctions are important to the Company's stockholders as dividends
are based on taxable income. The Company generally will not pay federal taxes so
long as it meets the REIT Provisions of the Code and distributes dividends to
stockholders in an amount equal to its taxable income. See "Federal Income Tax
Considerations -- Requirements of Qualifications as a REIT."
Taxable Income and Dividends
The Company intends to declare and pay out dividends equal to its taxable
income over time. The Company's current practice is to declare quarterly
dividends per share immediately following the regular March, June, September,
and December meetings of the Board of Directors. In general, the Company has
endeavored to declare a quarterly dividend per share of Common Stock which would
result in the distribution of most or all of the taxable income earned in that
quarter. See "Risk Factors -- Limited Operating History Does Not Predict Future
Performance" and "Dividend Policy and Distributions."
COMPETITION
The Company's net income will depend, in large part, on the Company's
ability to acquire Mortgage Assets on acceptable terms and at favorable spreads
over the Company's borrowing costs. There can be no
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<PAGE> 42
assurance that the Company will be able to acquire sufficient Mortgage Assets at
spreads above the Company's cost of funds. In acquiring Mortgage Assets, the
Company will compete with investment banking firms, savings and loan
associations, banks, mortgage bankers, insurance companies, mutual funds, other
lenders, GNMA, FNMA, FHLMC and other entities purchasing Mortgage Assets, many
of which have greater financial resources than the Company. In addition, there
are several REITs similar to the Company, and others may be organized in the
future. The effect of the existence of additional REITs may be to increase
competition for the available supply of Mortgage Assets suitable for purchase by
the Company.
The availability of Mortgage Loans meeting the Company's criteria is
dependent upon, among other things, the size of and level of activity in the
residential real estate lending market. The size and level of activity in the
residential real estate lending market depend on various factors, including the
level of interest rates, regional and national economic conditions and inflation
and deflation in residential property values. To the extent the Company is
unable to acquire sufficient Mortgage Loans meeting its criteria, the Company's
results of operations will be adversely affected. See "Risk Factors
-- Inability to Acquire Mortgage Assets with Favorable Interest Rates and Terms
May Adversely Affect Net Interest Income."
EMPLOYEES
Currently, the Manager employs the four executive officers of the Company
and three additional employees. The six officers of the Manager have more than
75 years of combined experience in the residential mortgage industry and worked
together previously at AMRES Mortgage. At the closing of this Offering, each
employee of the Manager will also become an employee of the Company. The Manager
is currently in the process of recruiting employees to support the Direct
Purchase Program. See "The Manager."
FACILITIES
The Company's and the Manager's executive offices are located at 445 Marine
View Avenue, Suite 230, Del Mar, California. The Company and the Manager
currently occupy approximately 4,000 square feet of space and the Manager has a
right of first refusal on an additional 2000 square feet at its current location
beginning March 1998. The Manager leases facilities pursuant to a lease expiring
in March 2000. Management believes that these facilities are adequate for the
Company's and the Manager's foreseeable needs.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a
party or to which any property of the Company is subject.
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MANAGEMENT OF THE COMPANY
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The Company was incorporated on February 11, 1997. The following table
presents certain information concerning the directors and executive officers of
the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION(1)
---------------------------------- --- ----------------------------------
<S> <C> <C>
John M. Robbins................... 50 Chairman of the Board, Chief
Executive Officer and Director
Jay M. Fuller..................... 47 President, Chief Operating Officer
and Director
Mark A. Conger.................... 37 Senior Vice President and Chief
Financial Officer
Rollie O. Lynn.................... 43 Senior Vice President, Capital
Markets
David E. De Leeuw(2)(3)........... 53 Director
George E. McCown(4)............... 62 Director
</TABLE>
In addition, the following individuals have been elected directors of the
Company effective immediately following the closing of this Offering:
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------------------------------------------- --- ---------
<S> <C> <C>
H. James Brown, Ph.D.(2)..................................... 56 Director
Ray McKewon(3)............................................... 49 Director
Richard Pratt, Ph.D.(2)...................................... -- Director
Mark J. Riedy, Ph.D.(3)...................................... -- Director
</TABLE>
- ---------------
(1) Each executive officer and director holds the same position with the
Manager. See "The Manager."
(2) Member of the Audit Committee. See "Board Committees."
(3) Member of the Compensation Committee. See "Board Committees."
(4) Mr. McCown will resign as a director of the Company upon the closing of this
Offering.
JOHN M. ROBBINS serves as Chairman of the Board of Directors and Chief
Executive Officer and Director of the Company. Prior to joining the Company Mr.
Robbins was Chairman of the Board of AMRES Mortgage from 1990 until 1994 and
President of AMRES Mortgage from the time he co-founded it in 1983 until 1994.
He also served as Executive Vice President of Imperial Savings Association from
1983 to 1987. Mr. Robbins has worked in the mortgage banking industry since
1973. Mr. Robbins has served two terms on the Board of Governors and the
Executive Committee of the Mortgage Association of America, and has served on
FNMA's National Advisory Board. Mr. Robbins also serves as a director of Pacific
Research & Engineering Corporation, Garden Fresh Restaurant Corporation,
National Bankcard and University of San Diego.
JAY M. FULLER serves as President, Chief Operating Officer and Director of
the Company. Prior to joining the Company Mr. Fuller served as President of
Victoria Mortgage from 1995 to 1996. Mr. Fuller was an Executive Vice President
and Chief Administration Officer of AMRES Mortgage from 1985 to 1994 and Senior
Vice President from 1983 to 1985. In these capacities, at various times, Mr.
Fuller was responsible for, among other things, Mortgage Loan originations and
servicing for AMRES Mortgage. Mr. Fuller has worked in the mortgage banking
industry continuously since 1975. Mr. Fuller currently serves as President of
Friends of Santa Fe Christian Schools.
MARK A. CONGER serves as Senior Vice President and Chief Financial Officer
of the Company. In addition, Mr. Conger has been the sole proprietor of his own
business. Mr. Conger was a Senior Vice President, Finance, of AMRES Mortgage
from 1992 to 1994 responsible for the areas of accounting, treasury and
corporate planning. He was a Vice President of AMRES Mortgage from 1987 to 1992
responsible for corporate planning and human resources. Prior to joining AMRES
Mortgage, Mr. Conger was an Assistant Vice President, Accounting, for Imperial
Savings Association from 1985 to 1987 and an auditor for Peat Marwick from 1981
to 1985. Mr. Conger has worked in the mortgage banking industry for nine years.
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<PAGE> 44
Mr. Conger received a Bachelor of Science degree from the University of Missouri
in 1981 and is a Certified Public Accountant.
ROLLIE O. LYNN serves as Senior Vice President, Capital Markets,
responsible for the areas of portfolio management for the Company. Prior to
joining the Company Mr. Lynn served as Vice President, Capital Markets, of Long
Beach Mortgage Company responsible for managing, hedging and trading the firm's
subprime residential Mortgage Loans. Prior to joining Long Beach Mortgage, Mr.
Lynn served as Vice President, Secondary Marketing, of AMRES Mortgage from 1991
to 1994, as Vice President, Capital Markets, of Imperial Savings from 1988 to
1992, and as Vice President of Great American First Savings Bank of San Diego
from 1985 to 1988. Mr. Lynn has worked in the mortgage banking business
continuously since 1977. Mr. Lynn received two Bachelor of Arts degrees in 1976
from California State University at Chico. Mr. Lynn is a licensed real estate
broker in the State of California.
DAVID E. DE LEEUW serves as a Director of the Company. Mr. De Leeuw is a
co-founder and a Managing Partner of McCown De Leeuw & Co., a private venture
banking firm that buys and builds middle-market companies in partnership with
management teams. Prior to co-founding McCown De Leeuw & Co. in 1984, Mr. De
Leeuw was employed by Citibank as Vice President and Deputy Head of the Merger
and Acquisition Department and as Head of the Leveraged Acquisition Unit, where
he completed numerous acquisitions, divestitures, and leveraged and management
buyouts from 1978 to 1984. Mr. De Leeuw currently serves as a director of Vans,
Inc., Tiara Motorcoach, DEC International, Nimbus CD International, Outsourcing
Solutions, Inc., Pelican, and Aurora Foods.
GEORGE E. MCCOWN serves as a Director of the Company. Mr. McCown is a
co-founder and a Managing Partner of McCown De Leeuw & Co., a private venture
banking firm that buys and builds middle-market companies in partnership with
management teams. Prior to co-founding McCown De Leeuw & Co. in 1984, Mr. McCown
spent 18 years at Boise-Cascade Corporation in a series of general management
positions in the paper, packaging, building materials and real estate divisions.
Mr. McCown sits on the Policy Advisory Boards for the Harvard Joint Center for
Housing Studies, the Center for Real Estate and Urban Economics at the
University of California, Berkeley, and the Center for Economic Policy Research
at Stanford.
In addition to the directors of the Company set forth above, the following
individuals have been elected directors of the Company to become effective upon
the closing of this Offering:
H. JAMES BROWN, PH.D. has served since 1996, as the President and Chief
Executive Officer of the Lincoln Institute of Land Policy, an educational
institution formed to study and teach land policy, including land economics and
land taxation. Prior to 1996, Dr. Brown was a professor at the Kennedy School of
Government at Harvard University from 1970 to 1996. During his tenure at Harvard
University, Dr. Brown served as a director of the Joint Center Housing Studies,
chairman of the City and Regional Planning Program and as a Director of the
State, Local and Intergovernmental Center at Harvard University and MIT/Harvard
University Joint Center for Urban Studies. In addition, Dr. Brown has served as
a Managing Partner of Strategic Property Investments, Inc., a company
specializing in real estate asset management from 1988 to 1991. Dr. Brown also
serves as a director of BMC West Corporation and Pelican Companies, Inc.,
(distributors and retailers of building materials).
RAY MCKEWON is a co-founder and Executive Vice President of Accredited Home
Lenders, a mortgage banking firm founded in 1990 which specializes in sub-prime
credit grade lending. From 1980 to 1990, Mr. McKewon was a managing partner of
the Enterprise Management Company, a venture capital firm that he co-founded and
which provided capital to companies including Dura Pharmaceuticals, Cytotech
(sold to Quidel), Impulse Enterprise, McKewon & Timmins (sold to First
Affiliated), Garden Fresh Restaurants, Intelligent Images (merged into and
renamed Darox) and Sunward Technology (merged into Read-Rite).
RICHARD T. PRATT, PH.D. currently serves as Chairman of Richard T. Pratt
Associates, a position he has held since 1992, performing consulting activities,
including strategic studies for the Federal Home Loan Mortgage Corporation,
on-site consulting for the Housing Section Perform Project in Russia and
Kazakhstan for the U.S. Agency for International Development and various
strategic consultations for private sector institutions. Dr. Pratt is also a
Professor of Finance at the David Eccles School of Business at the University of
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<PAGE> 45
Utah, a position he has held since 1966. From 1983 to 1991, Dr. Pratt served as
the Chairman of Merrill Lynch Mortgage, Inc., a subsidiary of Merrill Lynch &
Company. From 1991 to 1994, Dr. Pratt served as Managing Director of the
Financial Institutions Group of Merrill Lynch. Dr. Pratt also serves as a member
of the Board of Directors of Avigen, a Development Level Gene Therapy Company.
Dr. Pratt was Chairman of the Federal Home Loan Mortgage Corporation from 1981
to 1983, and as Chairman of the Federal Savings and Loan Insurance Corporation
from 1981 to 1983.
MARK J. RIEDY, PH.D. is currently employed as an Ernest W. Hahn Professor
of Real Estate Finance at the University of San Diego. In such capacity, he
teaches courses in real estate finance. Prior to his employment at the
University, Dr. Riedy served as President and Chief Executive Officer of the
National Council of Community Bankers in Washington, D.C. from 1988 to 1992.
From 1987 to 1988, Dr. Riedy served as President and Chief Operating Officer of
the J. E. Robert Companies. Dr. Reidy was President, Chief Operating Officer and
Director of the Federal National Mortgage Association from 1985 to 1986.
TERM OF OFFICE
Effective upon the closing of the Offering, the Board of Directors of the
Company will be divided into three classes. Each class of Directors will consist
of two or three directors who will serve for a one, two or three year period or
until their successors are elected and qualified. Dr. Brown and Mr. McKewon will
be class one Directors whose terms will expire at the Annual Meeting of
Stockholders in 1998, Mr. De Leeuw and Dr. Pratt are class two Directors whose
terms will expire at the Annual Meeting of Stockholders in 1999 and Mr. Fuller,
Mr. Robbins and Dr. Riedy are class three Directors whose terms will expire at
the Annual Meeting of the Stockholders in 2000. Thereafter, Directors will serve
staggered three year terms. Officers are elected by and serve at the discretion
of the Board of Directors.
BOARD COMMITTEES
The Board of Directors has recently appointed a compensation committee (the
"Compensation Committee") which will make recommendations to the Board
concerning salaries and incentive compensation for officers and employees of the
Company. Upon the closing of this Offering the Compensation Committee will
consist of Mr. De Leeuw, Mr. McKewon and Dr. Riedy. The Board of Directors also
has appointed an audit committee (the "Audit Committee") which will review the
results and scope of the audit and another accounting related serves. Upon the
closing of this Offering, the Audit Committee will consist of Dr. Brown, Mr. De
Leeuw and Dr. Pratt.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS.
To date, the Company has had no compensation committee or other committee
performing an equivalent function. No officer or employee of the Company has
participated in deliberations by the Company's Board of Directors concerning
executive officer compensation.
After the closing of this Offering, Mr. McKewon will be a director of the
Company and a member of the compensation committee. Mr. McKewon is an executive
officer and director of Accredited Home Lenders. Mr. Robbins serves as a
Director of Accredited Home Lenders. The Company may acquire Mortgage Loans
pursuant to the Direct Purchase Program from Accredited Home Lenders.
DIRECTOR COMPENSATION
Each outside director of the Company will be paid annual compensation of
$15,000 with an additional $1,000 paid for attendance of a regularly scheduled
meeting and $500 for attendance of a special or committee meeting. All directors
will be reimbursed for any expenses related to attendance at meetings of the
Board of Directors or committees of the Board of Directors. In addition to cash
compensation, it is currently anticipated that each Independent Director of the
Company will receive an initial grant of options to purchase 7,500 shares of the
Common Stock of the Company at fair market value which will vest over a three
year period (one-third every twelve months). Thereafter, following the Annual
Meeting of Stockholders, the Company
44
<PAGE> 46
anticipates making annual grants to each outside director of options to purchase
2,500 shares of the Company's Common Stock which will vest after one year.
LIMITATION OF LIABILITY AND INDEMNIFICATION
As permitted by the MGCL, the Company's Charter obligates the Company to
indemnify its present and former directors and officers and to pay or reimburse
reasonable expenses for such individuals in advance of the final disposition of
a proceeding to the maximum extent permitted from time to time by Maryland law.
The MGCL permits a corporation to indemnify its present and former directors and
officers, among others, against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by them in connection with any proceeding
to which they may be made a party by reason of their service in those or other
capacities, unless it is established that (a) the act or omission of the
director or officer was material to the matter giving rise to such proceeding
and (i) was committed in bad faith or (ii) was the result of active and
deliberate dishonesty, (b) the director or officer actually received an improper
personal benefit in money, property or services, or (c) in the case of any
criminal proceeding, the director or officer had reasonably cause to believe
that the act or omission was unlawful. The Bylaws implement the provisions
relating to indemnification contained in the Company's Charter. Maryland law
permits the charter of a Maryland corporation to include a provision limiting
the liability of its directors and officers to the corporation and its
stockholders for money damages, except to the extent that (i) the person
actually received an improper benefit or profit in money, property or services,
or (ii) a judgment or other final adjudication is entered in a proceeding based
on a finding that the person's action, or failure to act, was the result of
active and deliberate dishonesty and was material to the cause of action
adjudicated in the proceeding. The Company's Charter contains a provision
providing for elimination of the liability of its directors or officers to the
Company or its stockholders for money damages to the maximum extent permitted by
Maryland law from time to time. In addition, the Underwriters are indemnified
against certain liabilities by the Company under the Underwriting Agreement
relating to the Offering. See "Underwriting."
The Company will maintain officers' and directors' insurance for the
benefit of its officers and directors. The Company intends to enter into
indemnity agreements with each of its officers and directors pursuant to which
the Company will indemnify its officers and directors to the fullest extent
allowed by law.
EXECUTIVE COMPENSATION
None of the Company's executive officers received compensation from the
Company or any of its affiliates in 1996. The following table sets forth
information with respect to the estimated compensation for 1997 for the four
executive officers of the Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
1997 LONG-TERM
COMPENSATION
1997 ANNUAL AWARDS
COMPENSATION --------------
(ESTIMATED) SECURITIES
------------------- UNDERLYING
NAME AND PRINCIPAL POSITION SALARY(1) BONUS OPTIONS
------------------------------------------ --------- ----- --------------
<S> <C> <C> <C>
John M. Robbins........................... $ 266,250 (2) 220,000(3)
CEO, Chairman of the Board of Directors
Jay M. Fuller............................. 221,875 (2) 220,000(3)
President and Chief Operating Officer
Mark A. Conger............................ 133,125 (2) 30,400(3)
Senior Vice President and Chief
Financial Officer
Rollie O. Lynn............................ 88,750 (2) 26,400(3)
Senior Vice President, Capital Markets
</TABLE>
45
<PAGE> 47
(1) Includes cash compensation paid or estimated to be paid to employees of the
Company and the Manager. Based on amounts actually paid from February 11,
1997 through July 31, 1997 and estimated payments from August 1, 1997
through December 31, 1997 based on current salary levels. All salary amounts
are currently paid by the Manager. After the closing of this Offering, all
base salary amounts will be paid directly by the Company and reimbursed to
the Company by the Manager. See "The Manager."
(2) Bonuses during years 1997 and 1998 will be paid solely in the discretion of
the Board of Directors of the Company. Thereafter, bonuses will be paid as a
percentage of salary if certain financial objective agreed upon by
management and the Board of Directors are achieved. See "-- Employment
Contracts and Termination of Employment and Change of Control Arrangements".
All bonus amounts are to be paid by the Manager. The Company currently
estimates that each executive officer may be paid a bonus in 1997 equal to
between 75% and 100% of his annualized base salary.
(3) Includes options to purchase 80,000, 80,000, 16,000 and 14,400 shares of
Common Stock to be issued to Mr. Robbins, Mr. Fuller, Mr. Conger and Mr.
Lynn, respectively, at the closing of this Offering pursuant to their
employment agreements. See "-- Employment Contracts and Termination of
Employment and Change of Control Arrangements."
OPTION GRANTS
None of the executive officers of the Company were granted options to
purchase the Company's Common Stock in 1996. The following table sets forth
information concerning stock options granted to the executive officers in 1997.
Each of the stock options is exercisable to purchase Common Stock of the
Company.
OPTION/SAR GRANTS IN 1997
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS IN 1997 POTENTIAL REALIZABLE
---------------------------------------------------- VALUE AT ASSUMED
NUMBER OF % OF TOTAL EXERCISE ANNUAL RATES OF STOCK
SECURITIES OPTIONS/SARS OR PRICE APPRECIATION FOR
UNDERLYING GRANTED TO BASE OPTION TERM
OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION -----------------------
NAME GRANTED (#)(1) 1997 (2) ($/SH) DATE 5%($)(3) 10%($)(3)
- --------------------------------- -------------- ------------ ------ --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
John M. Robbins.................. 140,000(4) 26.5% $12.50 2/11/07 $1,100,568 $2,789,052
80,000(5) 15.2 15.00(6) (7) 754,672 1,912,488
Jay M. Fuller.................... 140,000(4) 26.5 12.50 2/11/07 1,100,568 2,789,052
80,000(5) 15.2 15.00(6) (7) 754,672 1,912,488
Mark A. Conger................... 14,400(8) 2.7 12.50 2/11/07 113,201 286,874
16,000(5) 3.0 15.00(6) (7) 150,934 382,498
Rollie O. Lynn................... 12,000(8) 2.3 12.50 2/11/07 94,334 239,062
14,400(5) 2.7 15.00(6) (7) 135,841 344,248
</TABLE>
- ---------------
(1) Options issued by the Company to date provide for acceleration of vesting at
such time as the Company receives cumulative gross proceeds from all public
or private offerings of at least $150,000,000. In addition, the options
accelerate and become fully vested upon the consummation of a transaction
resulting in a change of control of the Company.
(2) Based on currently outstanding options and options to be issued upon the
closing of this Offering. See "-- Employment Contracts and Termination of
Employment and Change of Control Arrangements."
(3) Amounts represent hypothetical gains that could be achieved for the
respective options if exercised at the end of the option term. The assumed
5% and 10% rates of stock price appreciation are mandated by rules of the
Securities and Exchange Commission and do not represent the Company's
estimate or projection of the future price of the Common Stock. The
potential realizable value set forth in the table is based on the fair
market value of the Common Stock on the date of grant, as determined by the
Board of Directors.
46
<PAGE> 48
(4) Includes options to purchase 140,000 shares of Common Stock and SAR's with
respect to an additional 140,000 shares of Common Stock granted in tandem
with such options. The SARs are for 35% of the difference between the fair
market value of the Common Stock at the time the related option is exercised
and the exercise price, up to a maximum of $20. Options and tandem SARs are
each vested and exercisable as to 20% of the shares of Common Stock with an
additional 20% to vest and become exercisable on February 11 of 1998, 1999,
2000 and 2001.
(5) Options to be granted upon the closing of this Offering. The exercise price
will equal the initial public offering price. These options will vest 20% on
the closing of this Offering with an additional 20% on each anniversary of
the closing of this Offering for four years.
(6) Based on an assumed initial public offering price of $15.00. See
"Underwriting."
(7) Options will expire 10 years after the closing of this Offering.
(8) Options to purchase Common Stock of the Company are vested and exercisable
as to 20% of the shares of Common Stock with an additional 20% to vest and
become exercisable on each of February 11, 1998, 1999, 2000 and 2001.
1997 STOCK INCENTIVE PLAN
The Company's 1997 Stock Incentive Plan (the "Incentive Plan") provides for
the grant of incentive stock options, nonqualified stock options and stock
appreciation rights ("SARs"). The Incentive Plan was adopted on February 11,
1997 (the "Effective Date"), and a total of 315,200 shares of Common Stock have
been reserved for issuance under the Incentive Plan. As of August 1, 1997, a
total of 315,200 shares of Common Stock were subject to outstanding options
under the Incentive Plan at an exercise price of $12.50 per share of Common
Stock. In addition, SARs with respect to an additional 280,000 shares were
outstanding at an exercise price of $12.50 per share of Common Stock. The SARs
were granted in tandem with options and provide the participant with the right
to receive payment equal to 35% of the difference between the fair market value
of a share of Common Stock on the date of the option exercise and the fair
market value of a share of Common Stock on the date of grant. Payment upon the
exercise of the SAR may be made in cash, shares of Common Stock, or any
combination thereof. The Company does not intend to issue any additional options
or SARs under the Incentive Plan.
1997 STOCK OPTION PLAN
The Board of Directors has reserved a total of 354,800 of Common Stock for
issuance under the Company's 1997 Stock Option Plan (the "Option Plan"). The
Option Plan permits the grant of options intended to qualify as incentive stock
options ("ISOs") within the meaning of section 422 of the Internal Revenue Code
of 1986, as amended, as well as nonstatutory stock options. Options to purchase
212,800 shares of Common Stock are reserved for issuance upon the closing of
this Offering and options to purchase 142,000 shares of Common Stock will remain
available for future grant under the Option Plan. Options may be granted to
employees (including officers and directors who are also employees), consultants
and directors and prospective employees, consultants, and directors although
only employees (including officers and directors who are also employees) may
receive ISOs. The exercise price per share of a nonstatutory stock option must
equal at least 85% of the fair market value of a share of Common Stock on the
date of grant, and in the case of an incentive stock option, must be no less
than the fair market value of a share of Common Stock on the date of grant. In
addition, the exercise price for any option granted to an optionee who owns 10%
or more of the total combined voting power of the Company or any parent or
subsidiary of the Company must equal at least 110% of the fair market value of a
share of Common Stock on the date of grant. Generally, options granted under the
Option Plan are immediately exercisable and must be exercised within ten years,
and shares subject to an option generally will vest over four years from the
date of grant. In the event of certain "change in control" transactions
involving the Company, shares subject to options granted under the Option Plan
will become fully vested and exercisable. In addition, the acquiring company may
assume or substitute for such outstanding options.
47
<PAGE> 49
1997 EMPLOYEE STOCK PURCHASE PLAN
A total of 20,000 shares of Common Stock have been reserved for issuance
under the Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan"),
none of which have yet been issued. The Purchase Plan permits eligible employees
to purchase Common Stock at a discount through accumulated payroll deductions.
Employees (including officers and directors who are also employees) are
generally eligible to participate in the Purchase Plan if they are customarily
employed for more than 20 hours per week and 5 months per calendar year. The
Purchase Plan is implemented through sequential offering periods, each of which
is approximately 6 months in duration. However, the initial offering period
under the Purchase Plan will commence on the effective date of this Offering and
will end on July 31, 1998. Participants will purchase shares of Common Stock on
the last day of each offering period. The price at which shares are purchased
under the Purchase Plan is equal to 85% of the fair market value of a share of
Common Stock on the first day of the offering period or the last day of the
offering period, whichever is lower. Employees may end their participation in
the Purchase Plan at any time during an offering period and participation ends
automatically upon the participant's termination of employment.
1997 OUTSIDE DIRECTORS STOCK OPTION PLAN.
A total of 60,000 shares of Common Stock have been reserved for issuance
under the Company's 1997 Outside Directors Stock Option Plan (the "Directors
Plan"). Prior to the effective date of this offering, no options have been
granted under the Directors Plan. The Directors Plan provides for the automatic
grant of nonstatutory stock options to directors of the Company who are not
employees of the Company or any parent or subsidiary of the Company or McCown De
Leeuw & Co. ("Outside Directors"). On the effective date of this offering, each
Outside Director automatically will be granted under the Directors Plan an
option to purchase 7,500 shares of Common Stock, and thereafter, each new
Outside Director elected after the closing of this offering automatically will
be granted on the date of his or her initial election an option to purchase
7,500 shares of Common Stock ("initial options"). Shares of Common Stock subject
to initial options will vest in three equal annual increments following the date
of grant. In addition, each Outside Director, other than an Outside Director who
has served on the Board of Directors for less than six months, will thereafter
be granted automatically an option to purchase 2,500 shares of Common Stock at
each annual meeting of the stockholders provided the Outside Director continues
to serve in such capacity following the annual meeting ("annual options").
Shares of Common Stock subject to annual options will become fully vested one
year after the date of grant. The exercise price per share of Common Stock for
options granted under the Directors Plan will be equal to the fair market value
of a share of Common Stock on the date of grant. Options granted under the
Directors Plan must be exercised within ten years from the date of grant. In the
event of certain "change in control" transactions involving the Company, shares
subject to options granted under the Directors Plan will become fully vested and
exercisable. In addition, the acquiring company may assume or substitute for
such outstanding options.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL
ARRANGEMENTS
The Manager has entered into Employment and Non-Competition Agreements with
Mr. Robbins and Mr. Fuller effective as of February 11, 1997 (the "Employment
Agreements"). The Employment Agreements are for a term of five years, commencing
on February 11, 1997, and provide for a minimum monthly base salary of not less
than $25,000 in the case of Mr. Robbins and $20,833 in the case of Mr. Fuller.
The Employment Agreements also provide for one year's salary to be paid upon
termination of either of such employees without cause. Bonus payments in 1997
and 1998 will be at the discretion of the Board of Directors of the Manager.
Subsequent to 1998, the Employment Agreements provide for payment of a bonus of
up to 100% base salary if certain financial targets and objectives are achieved.
Upon the closing of this Offering, each of Messrs. Robbins and Fuller will be
granted options to purchase 80,000 shares of the Company's Common Stock at an
exercise price equal to the initial public offering price.
Mr. Robbins and Mr. Fuller each purchased stock of the Manager which is
subject to repurchase by the Manager in the event the executive officer
terminates his employment with the Company and the Manager. See "Certain
Transactions."
48
<PAGE> 50
The Manager has also entered into letter agreements with Mr. Conger and Mr.
Lynn which provide for a base compensation of $150,000 and $100,000 per year
respectively. In addition, the agreements provide for bonus payments after 1998
of up to 75% of the employee's base salary if certain financial targets and
objectives are achieved. Mr. Conger and Mr. Lynn were each issued Contingent
Warrants to purchase up to 34,299 shares of the common stock of the Manager at
an exercise price of $0.01 per share (the "Contingent Warrants"). The Contingent
Warrants expire on February 11, 2007, and are exercisable only to the extent
that certain letters of credit which collateralize debt of the Manager are
reduced from their current principal amounts. Mr. Conger and Mr. Lynn were also
issued percentage interests in Holdings initially equal to 1.5% each. These
interests may also vary based upon the extent to which such letters of credit
continue to be outstanding. See "Certain Transactions." Upon the closing of this
Offering, Mr. Conger and Mr. Lynn will be granted options to purchase 16,000
shares and 14,400 shares of the Company's Common Stock, respectively, at an
exercise price equal to the initial public offering price.
All options and SARs granted to date and to be granted at the closing of
this Offering pursuant to the Company's Incentive Plan and Option Plan contain
provisions pursuant to which unvested portions of outstanding options become
immediately exercisable and vested upon a transfer of control of the Company, as
defined under the relevant plan.
Each of the officers of the Manager has modified his employment agreement
with the Manager to allow him to become an employee of the Company upon the
closing of this Offering. The Manager will reimburse the Company on a dollar for
dollar basis for the actual cost to the Company of paying the base salaries of
the officers. See "The Manager -- The Management Agreement."
CONFLICT OF INTEREST
Generally, under applicable state corporate law, a director of a company is
required to first offer to the company corporate opportunities learned of solely
as a result of his or her service as a member of the board of directors.
Maryland law provides that in order for a contract or other transaction between
a corporation and any of its directors or in which a director has a material
financial interest not to be void or voidable (i) the contract or transaction
must be fair and reasonable to the corporation or (ii) the fact of such interest
must be disclosed or known to the board or committee that authorizes, approves
or ratifies the contract or transaction and such authorization, approval or
ratification must be by a vote of the majority of disinterested directors.
The Company's policy is that the approval of the Board of Directors (with
any interested director abstaining) is required for any director, officer,
securityholder or affiliate of the Company (i) to engage for their own account
in realizing upon a corporate opportunity learned of solely as a result of their
service to or representation of the Company or (ii) to have any direct or
indirect pecuniary interest in any investment to be acquired or disposed of by
the Company or in any transaction to which the Company is a party or has an
interest.
49
<PAGE> 51
THE MANAGER
The Manager was created for the purpose of managing the day-to-day
operations of the Company, subject to direction by the Company's Board of
Directors. The Manager and the Company were financed by McCown De Leeuw & Co.,
TCW/Crescent Mezzanine, L.L.C., certain of their respective affiliates and
members of the management team of the Company. The Manager and its affiliates
own 1,614,000 shares of the Common Stock of the Company, which will constitute
approximately 24% of the outstanding shares of the Common Stock of the Company
immediately after the closing of this Offering. In addition, David E. De Leeuw
and George E. McCown, the principals of McCown De Leeuw & Co., currently serve
on the Board of Directors of the Company, one of whom will continue as a
director after the closing of this Offering.
The Manager funded the Company at its formation with a $20 million
investment through an intermediary entity. See "-- Relationship between the
Manager and the Company." Currently, the Manager derives substantially all of
its income from the Company, a majority of which is from dividends and incentive
fees. In addition, the executive officers of the Company are also the executive
officers of the Manager and also beneficially own an interest in the Manager.
Most of the same parties who currently beneficially own the Company also
beneficially own the Manager. See "Management of the Company -- Conflicts of
Interest," "Certain Transactions" and "Principal Stockholders." Management has
expertise in the acquisition and management of Mortgage Assets, mortgage
finance, asset/liability management and the management of corporations in the
real estate lending business. The six officers of the Manager have more than 75
years of combined experience in the residential mortgage industry and worked
together previously as a management team. However, Management has limited
experience in managing a REIT and limited experience with certain tailored
Mortgage Loan products, and there can be no assurance that the past experience
of Management will be appropriate to the business of the Company. At the closing
of this Offering, each employee of the Manager will become an employee of the
Company. The Manager is currently in the process of recruiting employees to
support the Direct Purchase Program.
DIRECTORS AND EXECUTIVE OFFICERS OF THE MANAGER
The following table represents certain information concerning the Directors
and Executive Officers of the Manager:
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------ --- ----------------------------------------------------
<S> <C> <C>
John M. Robbins (1) 50 Chairman of the Board and Chief Executive Officer
Jay M. Fuller (1) 47 President, Chief Operating Officer and Director
Mark A. Conger (1) 37 Senior Vice President and Chief Financial Officer
Rollie O. Lynn (1) 43 Senior Vice President, Capital Markets
David E. De Leeuw (1) 53 Director
George E. McCown (1) 62 Director
Jean-Marc Chapus 38 Director
</TABLE>
- ---------------
(1) See "Management of the Company -- Directors and Executive Officers of the
Company."
JEAN-MARC CHAPUS serves as a Director of the Manager. Mr. Chapus is
currently Managing Director and Portfolio Manager of Trust Company of the West,
a diversified investment management firm, and President of TCW/Crescent
Mezzanine Partners, L.L.C., a private investment fund. From 1991 to 1995, Mr.
Chapus served as a Managing Director and principal of Crescent Capital
Corporation, with primary responsibility for the firm's private lending and
private placement activities. From 1986 to 1991, Mr. Chapus was a First Vice
President at Drexel Burnham Lambert Incorporated in the firm's High Yield and
Corporate Finance Departments. Mr. Chapus is currently a director of Starwood
Lodging Corporation and FirstAmerica Automotive, Inc. Mr. Chapus received his
A.B. in Economics from Harvard College in 1981 and his Masters in Business
Administration from Harvard Business School in 1986.
50
<PAGE> 52
THE MANAGEMENT AGREEMENT
Term of the Management Agreement and Termination Fee
The Company has entered into a Management Agreement with the Manager for an
initial term of two years beginning February 11, 1997. The Management Agreement
is renewed automatically for successive one year periods unless a notice of
non-renewal is timely delivered by the Company. The Company may elect to prevent
the automatic renewal of the Management Agreement only by vote of both a
majority of the Board of Directors and a majority of the directors not
affiliated with the Manager followed by delivery of a written notice of
non-renewal to the Manager at least 60 days prior to the end of the then-current
period of this Management Agreement. The Management Agreement shall terminate at
the expiration of the then-current period in which such notice of non-renewal is
delivered. 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) three times the total of the base and incentive
compensation fees paid to the Manager for the four most recently completed
calendar quarters ending on or prior to the date of termination. In addition,
the Company has the right to terminate the Management Agreement upon the
happening of certain specified events, after notice and opportunity to cure,
including a material breach by the Manager of any provision contained in the
Management Agreement.
Administrative Services Provided by the Manager
The Manager will be responsible for the day-to-day operations of the
Company and will perform such services and activities relating to the assets and
operations of the Company as may be appropriate, including:
(i) serving as the Company's consultant with respect to formulation of
investment criteria and preparation of policy guidelines;
(ii) assisting the Company in developing criteria for Mortgage Asset
purchase commitments that are specifically tailored to the Company's long
term investment objectives and making available to the Company its
knowledge and experience with respect to Mortgage Loan underwriting
criteria;
(iii) representing the Company in connection with the purchase of, and
commitment to purchase, Mortgage Assets, including the formation of
Mortgage Asset purchase commitment criteria;
(iv) arranging for the issuance of Mortgage Securities from pools of
Mortgage Loans and providing the Company with supporting services in
connection with the creation of Mortgage Securities;
(v) furnishing reports and statistical and economic research to the
Company regarding the Company's activities and the performance of the
Manager;
(vi) monitoring and providing to the Board of Directors on an ongoing
basis price information and other data, which price information and other
data shall be obtained from certain nationally recognized dealers and other
entities that maintain markets in Mortgage Assets as selected by the Board
of Directors from time to time, and providing advice to the Board of
Directors to aid the Board of Directors in the selection of such dealers
and other entities;
(vii) administering the day-to-day operations of the Company and
performing and supervising the performance of such other administrative
functions necessary in the management of the Company as may be agreed upon
by the Manager and the Board of Directors, including the collection of
revenues and the payment of the Company's expenses, debts and obligations
and maintenance of appropriate computer services to perform such
administrative functions;
(viii) designating a servicer and/or subservicer for those Mortgage
Loans sold to the Company by originators that have elected not to service
such loans and arranging for the monitoring and administering of such
servicer;
(ix) counseling the Company in connection with policy decisions to be
made by the Board of Directors;
51
<PAGE> 53
(x) evaluating and recommending hedging strategies to the Board of
Directors and, upon approval by the Board of Directors, facilitating the
implementation and monitoring the performance of these strategies;
(xi) supervising compliance with REIT Provisions of the Code and
Investment Company Act status, including setting up a system to monitor
hedging activities on a periodic basis for such compliance;
(xii) establishing quality control procedures for the Mortgage Assets
of the Company, including audits of loan underwriting files and the hiring
of any agents with such particular knowledge and expertise as may be
appropriate to perform any such quality control procedures, and
administering, performing and supervising the performance of the quality
control procedures of the Company and performing and supervising the
performance of such other functions related thereto necessary or advisable
to assist in the performance of such procedures and the attainment of the
purposes thereof;
(xiii) upon request by and in accordance with the directions of the
Board of Directors, investing or reinvesting any money of the Company;
(xiv) conducting, or causing to be conducted, 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;
(xv) providing the Company with data processing, legal and
administrative services to the extent required to implement the business
strategy of the Company;
(xvi) 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 and all reports and documents, if
any, required under the Exchange Act;
(xvii) 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 provided in the REIT
Provisions of the Code;
(xviii) communicating on behalf of the Company with the holders of the
equity and debt securities of the Company as required to satisfy the
reporting and other requirements of any governmental bodies or agencies and
to maintain effective relations with such holders; and
(xix) 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.
Except in certain circumstances, the Manager may not assign its rights and
duties under the Management Agreement, in whole or in part, without the written
consent of the Company and the consent of a majority of the Company's directors
who are not affiliated with the Manager.
Servicing of the Mortgage Loans
The Company expects to acquire certain of its Mortgage Loans on a servicing
released basis and to act as the servicer of such Mortgage Loans while they are
in the Company's Mortgage Asset portfolio. The Company will contract with a
subservicer for a fixed dollar fee per Mortgage Loan per year or a percentage of
the outstanding mortgage balance and the right to hold escrow account balances
and retain certain ancillary charges. The Manager will monitor the servicing of
the Mortgage Loans. Such monitoring will include, but not be limited to, (i)
serving as the Company's consultant with respect to the servicing of Mortgage
Loans, (ii) collection of information and submission of reports pertaining to
the Mortgage Loans and to moneys remitted to the Manager or the Company by any
servicer, (iii) periodic review and evaluation of the performance of each
servicer to determine its compliance with the terms and conditions of the
applicable subservicing or servicing agreement and, if deemed appropriate,
recommending to the Company the
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<PAGE> 54
termination of such agreement, (iv) acting as a liaison between servicers and
the Company and working with servicers to the extent necessary to improve their
servicing performance, (v) review of and recommendations as to fire losses,
easement problems and condemnation, delinquency and foreclosure procedures with
regard to the Mortgage Loans, (vi) review of servicer's delinquency, foreclosure
and other reports on Mortgage Loans, (vii) supervising claims filed under any
mortgage insurance policies, and (viii) enforcing the obligation of any servicer
to repurchase Mortgage Loans from the Company. The Manager may enter into
subcontracts with other parties, including its affiliates, to provide any such
services for the Manager.
Management Fees
The Manager will receive an annual base management fee payable monthly in
arrears of an amount representing the monthly portion of the per annum
percentage of "gross mortgage assets" of the Company and its subsidiaries. The
per annum percentages for calculating the base management fee are equal to (a)
1/8 of 1% of gross mortgage assets of the Company composed of Agency Securities
and (b) 3/8 of 1% of gross mortgage assets other than Agency Securities. The
term "gross mortgage assets" means for any month the aggregate book value of the
consolidated Mortgage Assets of the Company and its subsidiaries, before
allowances for depreciation or bad debts or other similar noncash allowances,
computed at the end of such month prior to any dividend distribution made during
each month.
The Company will also pay to the Manager as incentive compensation for each
fiscal quarter, an amount equal to 25% of the net income of the Company, before
deduction of such incentive compensation, in excess of the annualized return on
equity equal to an average Ten Year U.S. Treasury Rate plus 2%. The incentive
compensation calculation and payment will be made quarterly in arrears. The term
"Return on Equity" is calculated for any quarter by dividing the Company's Net
Income for the quarter by its Average Net Worth for the quarter. For such
calculations, the "Net Income" of the Company means the net income of the
Company determined in accordance with GAAP 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 Net Income. "Average Net
Worth" for any period means (i) $20,165,000 plus (ii) the arithmetic average of
the sum of the gross proceeds from any offering of its equity securities by the
Company, before deducting any underwriting discounts and commissions and other
expenses and costs relating to the offering, plus the Company's 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) computed by taking the daily
average of such values during such period. The definition "Return on Equity" is
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 the Manager will be made before any income
distributions are made to the stockholders of the Company.
The Manager's base fee shall be calculated by the Manager within 15 days
after the end of each month, and such calculation shall be promptly delivered to
the Company. The Company is obligated to pay the amount of the final base fee in
excess of the amount paid to Manager at the beginning of the month pursuant to
the Manager's good faith estimate within 30 days after the end of each month.
The Company shall pay the incentive fee with respect to each fiscal quarter
within 15 days following the delivery to the Company of the Manager's written
statement setting forth the computation of the incentive fee for such quarter.
The Manager shall compute the annual incentive fee within 45 days after the end
of each fiscal year, and any required adjustments shall be paid by the Company
or the Manager within 15 days after the delivery of the Manager's written
computation to the Company.
Expenses
The Company will pay all operating expenses except those specifically
required to be borne by the Manager under the Management Agreement. The
operating expenses required to be borne by the Manager include the compensation
and other employment costs of the Manager's officers in their capacities as such
and the cost of office space and out-of-pocket costs, equipment and other
personnel required for performance of the Company's day-to-day operations. The
expenses that will be paid by the Company will include issuance
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<PAGE> 55
and transaction costs incident to the acquisition, disposition and financing of
investments, regular legal and auditing fees and expenses, the fees and expenses
of the Company's directors, premiums for directors' and officers' liability
insurance, premiums for fidelity and errors and omissions insurance,
subservicing expenses, the costs of printing and mailing proxies and reports to
stockholders, and the fees and expenses of the Company's custodian and transfer
agent, if any. The Company, rather than the Manager, will also be required to
pay expenses associated with litigation and other extraordinary or non-recurring
expenses. Expense reimbursements will be made monthly.
Salary Reimbursements
The Company will employ certain employees of the Manager involved in the
day-to-day operations of the Company, including the Company's executive
officers. The Company will pay the base salaries of such employees and will be
reimbursed monthly by the Manager for all costs incurred with respect to such
payments.
Limits of Responsibility
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Company's Board of Directors in
following or declining to follow its advice or recommendations. The Manager, its
directors, officers, stockholders and employees will not be liable to the
Company, any Mortgage Security issuer, any subsidiary of the Company, the
Unaffiliated Directors, the Company's stockholders or any subsidiary's
stockholders for acts performed in accordance with and pursuant to 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. The Manager is a newly formed company and
does not have significant assets other than its interest in the Management
Agreement. Consequently, there can be no assurance that the Company would be
able to recover any damages for claims it may have against the Manager. The
Company has agreed to indemnify the Manager, and its respective 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. The Management
Agreement does not limit or restrict the right of the Manager or any of its
officers, directors, employees or Affiliates to engage in any business or to
render services of any kind to any other person, including the purchase of, or
rendering advice to others purchasing Mortgage Assets which meet the Company's
policies and criteria, except that the Manager and its officers, directors or
employees will not be permitted to provide for any such services to any
residential mortgage REIT, other than the Company or another REIT sponsored by
the Manager or its Affiliates, which has operating policies and strategies
different in one or more material respects from those of the Company, as
confirmed by a majority of the Unaffiliated Directors of the Company. See "Risk
Factors -- Conflicts of Interest; Management also Employed by and Owns
Securities of Manager."
RELATIONSHIP BETWEEN THE MANAGER AND THE COMPANY
In addition to the contractual relationship between the Manager and the
Company, the Manager also has limited rights in the shares of the Company's
Common Stock held by Holdings, an intermediate holding company. The Manager
contributed $20 million to Holdings which used the funds to acquire the shares
of the Company's Common Stock. In exchange for its contribution to Holdings, the
Manager received a senior right to receive distributions equal to 5% of the
capital contributed by the Manager, compounded quarterly to the extent unpaid.
After payment of the preference amount in full, the Manager has a right to
receive approximately 50% of any remaining distributions in repayment of its
capital contribution. The Manager has also been appointed to oversee the
day-to-day operations of Holdings. However, after payment in full of its
preference amount and return of its capital contribution, the Manager will have
no further rights to distributions from Holdings. Holdings' sole asset is its
shares of the Company's Common Stock and its sole source of income is dividends
declared by the Company.
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<PAGE> 56
CERTAIN TRANSACTIONS
DISCUSSION OF SECURITIES PURCHASE AGREEMENT
The following summary of certain transactions of the Securities Purchase
Agreement between Manager and the Company does not purport to be complete and is
subject to and qualified in its entirety by the Securities Purchase Agreement, a
copy of which is filed as an exhibit to the Registration Statement of which this
Prospectus is a part. When particular provisions or terms used in the Securities
Purchase Agreement are referred to, the actual provisions (including definitions
of terms) are incorporated by reference to such agreement.
In connection with the private financing of the Manager and the Company in
February 1997, the Company, the Manager and Holdings entered into a Securities
Purchase Agreement, dated as of February 11, 1997 (the "Securities Purchase
Agreement"), with the institutional investors therein named (the "Investors")
providing for, among other things, the purchase by the Investors of senior
secured notes due February 11, 2002 (the "Notes") issued by the Manager.
Covenants
The Securities Purchase Agreement contains various covenants of the Company
and the Manager setting forth requirements respecting financial reporting, and
minimum acceptable financial ratio compliance and limitations on operating
activities, among other things, which will apply so long as the Notes remain
outstanding. The following is a general summary of certain covenants affecting
the activities of the Company (as opposed to the Manager).
Limitation on Restricted Payments. The Company shall not make any
investment except "Permitted REIT Investments," as defined in the Securities
Purchase Agreement; provided, however, that any Multifamily Mortgage Assets,
Commercial Mortgage Assets, Derivative Mortgage Securities, Fixed Rate Mortgage
Assets and REMIC residual interests to be acquired, together with any
investments to be made in Permitted REIT Subsidiaries, will not constitute
Permitted REIT Investments to the extent that the aggregate fair market value
thereof on any date, when aggregated with the aggregate fair market value of all
other Multifamily Mortgage Assets, Commercial Mortgage Assets, Derivative
Mortgage Securities, Fixed Rate Mortgage Assets, REMIC residual interests and
investments in Permitted REIT Subsidiaries held on such date, would exceed 5% of
the total fair market value on such date of the Mortgage Assets then held.
Limitation on Transactions with Affiliate. Neither the Company nor the
Manager shall sell, lease, transfer or otherwise dispose of any of its
properties or assets to or purchase any property or assets from, or enter into
any contract, agreement, understanding, loan, advance or guarantee with, or for
the benefit of, an affiliate of either company (an "Affiliate Transaction"),
unless (i) such Affiliate Transaction is on terms that are no less favorable to
such company than those that could have been obtained in a comparable
transaction by such company from an unrelated person, and (ii) with respect to
any Affiliate Transaction (or series of related Affiliate Transactions)
involving or having a potential value of more than $100,000, in addition to
compliance with clause (i), such Affiliate Transaction shall also be approved by
a majority of the disinterested members of the board of directors of the
Manager, and (iii) with respect to any Affiliate Transaction (or series of
related Affiliate Transactions) involving or having a potential value of more
than $2,500,000, in addition to compliance with clauses (i) and (ii), the board
of directors of the Manager shall have obtained an opinion of a nationally
recognized investment banking firm or appraiser to the effect that such
transaction is fair, from a financial point of view, to such company; provided,
however, that the board of directors of the Manager need not obtain such an
opinion in connection with immaterial modifications of the Management Agreement.
Limitation on Dividend and Other Payment Restrictions Affecting
Subsidiaries. The Company shall not, directly or indirectly, create or otherwise
cause or suffer to exist or become effective any consensual encumbrance or
restriction on the ability of the Company to (a) pay dividends or make any other
distributions on its Common Stock or any other interest or participation in, or
measured by its profits, or pay any indebtedness owed to the Manager, (b) make
loans or advances to the Manager or (c) transfer any of its
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<PAGE> 57
properties or assets to the Manager, except for certain limited encumbrances or
restrictions specified in the Securities Purchase Agreement.
Limitation on Capital Expenditures. The Company shall not make or incur
capital expenditures in any fiscal year in an aggregate amount in excess of
$100,000.
Limitation on Business and Tax Status. The Company shall not engage in any
business or activity other than the business of investing in and disposing of
Permitted REIT Investments. Prior to the consummation of a Qualified Public
Equity Offering (which this Offering will constitute), the Company shall not
invest in or hold any B/C Mortgages (i.e., below "A" or "A-") unless the
aggregate fair market value of the investments by the Company in B/C Mortgages
does not exceed 20% of the aggregate fair market value of all of the assets of
the Company. At all times, the Company shall operate and qualify as a REIT under
Section 856 et seq. of the Code, the income of which is taxed pursuant to
Section 857 of the Code.
Leverage Ratio and Indebtedness of the Company. During each calendar month,
the Company shall cause the average of the fifteen REIT Leverage Ratios
calculated on each of the last fifteen days of such calendar month,
respectively, to be less than or equal to the REIT Leverage Ratio Limit. "REIT
Leverage Ratio" means, on any date, the ratio of (a) the total consolidated
indebtedness of the Company on such date (subject to certain exceptions) to (b)
the fair market value (as determined in good faith by the board of directors of
the Company) of all the assets of the Company on such date (other than any such
assets upon which there is a lien that secures any such Permitted REIT
Indebtedness). "REIT Leverage Ratio Limit" means (i) 0.925 during all calendar
months other than the calendar months described in clauses (ii) and (iii) of
this definition, (ii) 0.935 during the sixty days immediately preceding the
anticipated closing date of a Qualified Public Equity Offering and (iii) 0.935
during the first sixty days following such anticipated closing date, if any such
anticipated Qualified Public Equity Offering of REIT is not consummated on or
prior to such anticipated closing date.
The Company shall not, directly or indirectly, incur any indebtedness other
than Permitted REIT Indebtedness, which is defined as any and all forms of
obligations of the Company accounted for as liabilities under GAAP, including
without limitation notes, bonds and Reverse Repurchase Agreements; provided that
such obligations have a maturity of greater than thirty (30) days and either (x)
bear a variable interest rate that resets at least once every six months or (y)
bear a fixed rate of interest and have a maturity of not more than one year;
provided, further that either: (a)(i) under the agreement pursuant to which any
such obligation is incurred, such obligation is secured primarily by Permitted
REIT Investments and the amount of such obligation may not exceed the fair
market value of the collateral as determined under such agreement or (ii) such
obligations are REMIC regular interests or other forms of structured securities
(x) that, in any case, are obligations with recourse limited solely to the
collateral securing such obligations and (y) as to which the fair market value
of the Company's equity interest in the entity issuing such security does not
exceed 5% of the fair market value of the collateral securing such obligations
on the date of incurrence of such obligations; or (b) the obligations constitute
one of the following: (i) trade debt incurred in the ordinary course of
business; (ii) indebtedness secured by permitted liens; (iii) capitalized lease
obligations in an aggregate amount not to exceed at any one time outstanding
$500,000; or (iv) indebtedness of the Company in an amount not exceeding
$1,000,000 at any time outstanding incurred solely for the purchase or financing
of fixed or capital assets acquired by the Company.
Investment, Hedging and Leverage Policy. At least once during each fiscal
year, the Board of Directors of the Company shall adopt a statement of policy
regarding investment of the assets of the Company, the duration of the Company's
assets and liabilities, hedging activities to be conducted by the Company, the
range of leverage ratios to be maintained by the Company and the types of
indebtedness that may be incurred by the Company, which statement of policy
shall be at least as detailed as the similar statement of policy initially
adopted and delivered to the Investors; provided, however, that any material
difference between any policy to be so adopted and the then most recently
adopted policy must be approved by Investors holding a majority interest in the
Notes. At least once during each fiscal year, the Manager shall engage a
professional services firm, which is not an affiliate of the Manager or the
Company, to issue a report (a "REIT Compliance Report") addressed to each of the
Manager, Holdings, the Company and the Investors stating whether the
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Company has complied in all material respects with the then most recently
adopted policy. The Company shall not permit to exist, on a general portfolio
average basis, a repricing differential between the Company's assets and
liabilities of greater than 180 days.
Board of Director Observation Rights. Each of the Investors shall have the
right to have one representative present (whether in person or by telephone) at
all meetings of the Board of Directors (and committees thereof) of the Manager
and the Company; provided that such representative shall not be entitled to vote
at such meetings.
Events of Default. The Securities Purchase Agreement provides for certain
Events of Default including, among other things, breach of a covenant by the
Manager or the Company (subject to a 30-day cure period in certain instances)
and failure by the Company to pay dividends for two consecutive quarters
beginning in October 1997. Upon an Event of Default, the Notes can be
accelerated and the shares of Common Stock of the Company pledged to secure the
Notes can be sold to satisfy the debt. See "Risk Factors -- Additional Risk
Factors -- Default of Manager Under Securities Purchase Agreement; Restrictive
Covenants."
Amendment and Waiver. The Securities Purchase Agreement can be amended, and
waivers of terms and provisions given, by the Investors holding a majority
interest in the Notes.
OTHER TRANSACTIONS
On February 11, 1997, in connection with the founding of the Company,
Holdings, Mr. Robbins and Mr. Fuller each purchased 1.6 million, 8,000 and 6,000
shares of the Company's Common Stock at a price of $12.50 per share in cash.
The Company and the Manager entered into a Management Agreement pursuant to
which the Company pays base and incentive fees to the Manager. The executive
officers and directors of the Company are also executive officers and directors
of the Manager. See "The Manager -- The Management Agreement."
On February 11, 1997, in connection with the founding of the Manager, the
Manager issued the following securities to the Company's officers, directors,
beneficial holders of 5% or more of the Company's Common Stock and their
Affiliates:
- The Manager issued 1,000,000 shares of its common stock to entities
affiliated with McCown De Leeuw & Co. and 127,032 shares to each of Mr.
Robbins and Mr. Fuller. The shares of Manager's common stock were issued
at a purchase price of $0.01 and paid in cash;
- The Manager issued 12% Senior Secured Notes in the principal amount of
$25,000,000 (the "Senior Notes") to entities affiliated with TCW/Crescent
Mezzanine, L.L.C. The Notes were issued at a purchase price equal to
$994.56 per $1000 principal amount, paid in cash;
- The Manager issued warrants to purchase up to 666,667 shares of its
common stock to entities affiliated with TCW/Crescent Mezzanine, L.L.C.
The warrants were purchased on February 11, 1997 at a price of $0.20 per
warrant share paid in cash and have an exercise price of $0.01. The
warrants expire on February 11, 2007; the Company paid TCW/Crescent
Mezzanine, L.L.C. a fee of approximately $500,000 in connection with the
sale and issuance of the Notes and these warrants.
- The Manager issued warrants to purchase up to 17,149; 51,448; 34,299; and
34,299 shares of its common stock to entities affiliated with
TCW/Crescent Mezzanine, L.L.C., entities affiliated with McCown De Leeuw
& Co., Mr. Conger and Mr. Lynn, respectively. The warrants have an
exercise price of $0.01. The warrants expire on February 11, 2007. The
warrants are not currently exercisable and will become exercisable only
to the extent that certain letters of credit issued for the benefit of
the Manager are reduced over a period of four years.
The shares of the Manager's common stock held by Mr. Robbins and Mr. Fuller
are subject to a right of repurchase by the Manager which lapses after the
earlier of February 11, 2002 and the closing of a public offering by the Company
which generates proceeds to the Company, which, when aggregated with the
proceeds of all other public offerings, equals $150 million or more. The
purchase price for the shares of the
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Manager's Common Stock in the event of a repurchase shall be (i) equal to the
book value of the securities in the event that the executive officer's
employment is terminated without cause or in the event that the executive
officer resigns for good cause, (ii) fair market value of the securities in the
case of death, and (iii) a nominal amount in all other circumstances.
In connection with the founding of the Manager and the Company, on February
11, 1997, Holdings issued 0.75%, 2.25%, 1.5% and 1.5% ownership interests to
entities affiliated with TCW/Crescent Mezzanine, L.L.C., entities affiliated
with McCown De Leeuw & Co., Mr. Conger and Mr. Lynn, respectively. These
ownership interests result in the individuals and entities being the beneficial
holders of shares of the Company's Common Stock. See "Principal Stockholders."
The Manager and MCD Management Company II, L.P., ("MCD"), an affiliate of
McCown De Leeuw & Co., have entered into an advisory services agreement pursuant
to which the Manager has accrued an initial fee obligation of $500,000 with an
additional annual fee of $250,000 to be paid by MCD. The annual payments will
begin in March 1998 and continue for a minimum of five years. The initial fee
will be paid only after the Manager has retired certain debt and preferred
equity obligations.
The Company intends to enter into indemnity agreements with each of its
officers and directors. For a description of the limitations of liability
applicable to the Company's officers and directors, see "Management of the
Company -- Limitation of Liability and Indemnification."
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company's Common Stock as of August
10, 1997, and as adjusted to reflect the sale of Common Stock being offered
hereby, by (i) each person known to the Company to beneficially own more than 5%
of the Company's Common Stock, (ii) each director, (iii) each executive officer
and (iv) 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.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
------------------------
AFTER
NUMBER OF SHARES BEFORE OFFERING
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING (1)
- ---------------------------------------------------------- ------------------ ---------- -----------
<S> <C> <C> <C>
MDC REIT Holdings, LLC (2)................................ 1,600,000 99.1% 28.5%
John M. Robbins (3)....................................... 52,000 3.1 *
Jay M. Fuller (3)......................................... 50,000 3.0 *
Mark A. Conger (4)........................................ 6,080 * *
Rollie O. Lynn (5)........................................ 5,280 * *
David E. De Leeuw (6)..................................... -- -- --
George E. McCown (6)...................................... -- -- --
All Directors and Executive Officers as a group
(6 persons) (3)(6)(7)................................... 113,360 6.2 1.7
</TABLE>
- ---------------
* Less than 1%
(1) Assuming no exercise of the Underwriters' over-allotment option.
(2) The address for MDC REIT Holdings, L.L.C. is 445 Marine View Avenue, Suite
230, Del Mar, CA 92014. The Manager is the managing member of Holdings
pursuant to an operating agreement. Accordingly, the Manager may be deemed
to have voting control of the shares of the Company's Common Stock held by
Holdings with respect to ordinary and usual matters. See "The Manager."
Transactions which could result in the disposition of the shares of the
Company's Common Stock require the approval of the members of Holdings
having membership interests which constitute more than 80% of all
membership interests. No single member or group of affiliated members of
Holdings holds 80% of the membership interests of Holdings. The shares of
the Company's Common Stock held by the LLC have been pledged as collateral
to certain entities affiliated with TCW/Crescent Mezzanine, L.L.C. See
"Risk Factors -- Additional Risk Factors -- Default of Manager Under
Securities Purchase Agreement; Restrictive Covenants."
(3) Includes 44,000 shares of Common Stock of the Company issuable upon
exercise of options within 60 days of August 10, 1997, including shares
issuable upon options to be issued at the closing of this Offering. Mr.
Robbins and Mr. Fuller are directors of the Manager. They each disclaim
beneficial ownership of the shares of the Company's Common Stock held by
Holdings. See Note 2 above.
(4) Includes 6,080 shares of Common Stock of the Company issuable upon exercise
of options within 60 days of August 10, 1997, including shares issuable
upon options to be issued at the closing of this Offering.
(5) Includes 5,280 shares of Common Stock of the Company issuable upon exercise
of options within 60 days of August 10, 1997, including shares issuable
upon options to be issued at the closing of this Offering.
(6) Mr. De Leeuw and Mr. McCown are directors of the Manager. They each
disclaim beneficial ownership of the shares of the Company's Common Stock
held by Holdings. See Note 2 above.
(7) Includes 99,360 shares of Common Stock of the Company issuable upon
exercise of options within 60 days of August 10, 1997, including shares
issuable upon the exercise of options to be issued at the closing of this
Offering.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The following summary is a description of provisions of the Company's
Charter and Bylaws with respect to the Company's Capital Stock. This summary
does not purport to be complete and is qualified by reference to the Charter and
Bylaws. Under the Company's Charter and Bylaws, the total number of shares of
all classes of capital stock that the Company has authority to issue is
25,000,000 shares, par value $0.01 per share, initially consisting of 25,000,000
shares of Common Stock. The Board of Directors is authorized to classify or
reclassify any unissued portion of the authorized shares of capital stock to
provide for the issuance of shares in other classes or series, including
Preferred Stock in one or more series. The Company has no current intention to
issue shares of any class or series other than Common Stock.
COMMON STOCK
The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Holders of Common
Stock do not have cumulative voting rights in the election of directors, which
means that holders of more than 50% of the shares of Common Stock voting for the
election of directors can elect all of the directors if they choose to do so and
the holders of the remaining shares cannot elect any directors. Subject to
preferential rights with respect to any outstanding shares of preferred stock,
holders of Common Stock are entitled to receive ratably such dividends as may be
declared by the Board of Directors out of funds legally available therefor. The
shares of Common Stock are not convertible into any other class or series.
Holders of Common Stock do not have preemptive rights, which means they have no
right to acquire any additional shares of Common Stock that may be issued by the
Company at a subsequent date. The outstanding shares of Common Stock are, and
the Shares to be outstanding upon completion of this Offering will be, fully
paid and nonassessable. The Common Stock has been listed for trading on the
.
ADDITIONAL CLASSES AND SERIES OF STOCK
The Board of Directors is authorized to establish one or more classes and
series of stock, including series of preferred stock, from time to time, and to
establish the number of shares in each class or series and to fix the
preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of such class or series, without any further vote or action by the
stockholders, unless such action is required by applicable law or the rules of
any stock exchange or automated quotation system on which the Company's
securities may be listed or traded. The issuance of additional classes or series
of capital stock may have the effect of delaying, deferring or preventing a
change in control of the Company without further action of the stockholders. The
issuance of additional classes or series of capital stock with voting and
conversion rights may adversely affect the voting power of the holders of
capital stock of the Company, including the loss of voting control to others.
The ability of the Board of Directors to issue additional classes or series of
capital stock, while providing flexibility in connection with possible
acquisitions or other corporate purposes, could have the effect of making it
more difficult for a third party to acquire, or of discouraging a third party
from acquiring, a majority of the outstanding voting stock of the Company, even
where such an acquisition may be beneficial to the Company or its stockholders.
REGISTRATION RIGHTS
Upon the closing of this Offering the beneficial holders of approximately
1.6 million shares of Common Stock are entitled to certain rights with respect
to the registration of such shares under the Securities Act. Subject to certain
limitations, if the Company registers any of its securities under the Securities
Act, either for its own account or the account of other security holders, such
holders are entitled to written notice of the registration and are entitled to
include such shares therein, provided, among other conditions, that the
underwriters of any offering have the right to limit the number of such shares
included in the registration. All fees, costs and expenses of such registrations
(other than underwriting discounts and commissions and legal expenses of such
holders) will generally be borne by the Company. In addition, beginning 180 days
after the
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closing of this Offering, certain of such beneficial holders may require, on up
to six occasions, the Company to use its best efforts to file a registration
statement under the Securities Act at the Company's expense with respect to
their shares of Common Stock, subject to certain conditions and limitations.
Further, such holders may require the Company, at the Company's expense, to
register their shares on Form S-3 when such form becomes available to the
Company, subject to certain conditions and limitations.
REPURCHASE OF SHARES AND RESTRICTIONS ON TRANSFER
Two of the requirements of qualification for the tax benefits accorded by
the REIT provisions of the Code are that (1) during the last half of each
taxable year not more than 50% in value of the outstanding shares may be owned
directly or indirectly by five or fewer individuals (the "50%/5 stockholder
test") and (2) there must be at least 100 stockholders on 335 days of each
taxable year of 12 months.
In order that the Company may meet these requirements at all times, the
Charter prohibits any person from acquiring or holding, directly or indirectly,
shares of Common Stock in excess of 7.8% in value of the aggregate of the
outstanding shares of Common Stock or in excess of 7.8% (in value or in number
of shares, whichever is more restrictive) of the aggregate of the outstanding
shares of Common Stock of the Company. For this purpose, the term "ownership" is
defined in accordance with the REIT Provisions of the Code and the constructive
ownership provisions of Section 544 of the Code, as modified by Section
856(h)(1)(B) of the Code.
For purposes of the 50%/5 stockholder test, the constructive ownership
provisions applicable under Section 544 of the Code attribute ownership of
securities owned by a corporation, partnership, estate or trust proportionately
to its stockholders, partners or beneficiaries, attribute ownership of
securities owned by family members and partners to other members of the same
family, treat securities with respect to which a person has an option to
purchase as actually owned by that person, and set forth rules as to when
securities constructively owned by a person are considered to be actually owned
for the application of such attribution provisions (i.e., "reattribution").
Thus, for purposes of determining whether a person holds shares of Common Stock
in violation of the ownership limitations set forth in the Charter, many types
of entities may own directly more than the 7.8% limit because such entities'
shares are attributed to its individual stockholders. For example, it is
contemplated that Holdings and perhaps other corporate investors will own in
excess of 7.8% of the Common Stock outstanding immediately after Closing of this
Offering. On the other hand, a person will be treated as owning not only shares
of Common Stock actually or beneficially owned, but also any shares of Common
Stock attributed to such person under the attribution rules described above.
Accordingly, under certain circumstances, shares of Common Stock owned by a
person who individually owns less than 7.8% of the shares outstanding may
nevertheless be in violation of the ownership limitations set forth in the
Charter. Ownership of shares of the Company's Common Stock through such
attribution is generally referred to as constructive ownership. The 100
stockholder test is determined by actual, and not constructive, ownership. The
Company will have greater than 100 stockholders of record.
The Charter further provides that if any transfer of shares of Common Stock
occurs which, if effective, would result in any person beneficially or
constructively owning shares of Common Stock in excess or in violation of the
above transfer or ownership limitations, then that number of shares of Common
Stock the beneficial or constructive ownership of which otherwise would cause
such person to violate such limitations (rounded to the nearest whole shares)
shall be automatically transferred to a trustee (the "Trustee") as trustee of a
trust (the "Trust") for the exclusive benefit of one or more charitable
beneficiaries (the "Charitable Beneficiary"), and the intended transferee shall
not acquire any rights in such shares. Shares of Common Stock held by the
Trustee shall be issued and outstanding shares of Common Stock. The intended
transferee shall not benefit economically from ownership of any shares held in
the Trust, shall have no rights to dividends, and shall not possess any rights
to vote or other rights attributable to the shares held in the Trust. The
Trustee shall have all voting rights and rights to dividends or other
distributions with respect to shares held in the Trust, which rights shall be
exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend
or other distribution paid to the intended transferee prior to the discovery by
the Company that shares of Common Stock have been transferred to the Trustee
shall be paid with respect to such shares to the Trustee by the intended
transferee upon demand and any dividend or other distribution authorized but
unpaid
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shall be paid when due to the Trustee. The Board of Directors of the Company
may, in their discretion, waive these requirements on owning shares in excess of
the ownership limitations.
Within 20 days of receiving notice from the Company that shares of Common
Stock have been transferred to the Trust, the Trustee shall sell the shares held
in the Trust to a person, designated by the Trustee, whose ownership of the
shares will not violate the ownership limitations set forth in the Charter. Upon
such sale, the interest of the Charitable Beneficiary in the shares sold shall
terminate and the Trustee shall distribute the net proceeds of the sale to the
intended transferee and to the Charitable Beneficiary as follows. The intended
transferee shall receive the lesser of (1) the price paid by the intended
transferee for the shares or, if the intended transferee did not give value for
the shares in connection with the event causing the shares to be held in the
Trust (e.g., in the case of a gift, devise or other such transaction), the
Market Price (as defined below) of the shares on the day of the event causing
the shares to be held in the Trust, and (2) the price per share received by the
Trustee from the sale or other disposition of the shares held in the Trust. Any
net sales proceeds in excess of the amount payable to the intended transferee
shall be immediately paid to the Charitable Beneficiary. In addition, shares of
Common Stock transferred to the Trustee shall be deemed to have been offered for
sale to the Company, or its designee, at a price per share equal to the lesser
of (i) the price per share in the transaction that resulted in such transfer to
the Trust (or, in the case of a devise or gift, the Market Price at the time of
such devise or gift) and (ii) the Market Price on the date the Company, or its
designee, accepts such offer. The Company shall have the right to accept such
offer until the Trustee has sold shares held in the Trust. Upon such a sale to
the Company, the interest of the Charitable Beneficiary in the shares sold shall
terminate and the Trustee shall distribute the net proceeds of the sale to the
intended transferee.
The term "Market Price" on any date shall mean, with respect to any class
or series of outstanding shares of the Company's stock, the Closing Price (as
defined below) for such shares on such date. The "Closing Price" on any date
shall mean the last sale price for such shares, regular way, or, in case no such
sale takes place on such day, the average of the closing bid and asked prices,
regular way, for such shares, in either case as reported in the principal
consolidated transaction reporting system with respect to securities listed or
admitted to trading on the New York Stock Exchange ("NYSE") or, if such shares
are not listed or admitted to trading on the NYSE, as reported on the principal
consolidated transaction reporting system with respect to securities listed on
the principal national securities exchange on which such shares are listed or
admitted to trading or, if such shares are not listed or admitted to trading on
any national securities exchange, the last quoted price, or, if not so quoted,
the average of the high bid and low asked prices in the over-the-counter market,
as reported by the National Association of Securities Dealers, Inc. Automated
Quotation System or, if such system is no longer in use, the principal other
automated quotation system that may then be in use or, if such shares are not
quoted by any such organization, the average of the closing bid and asked prices
as furnished by a professional market maker making a market in such shares
selected by the Board of Directors or, in the event that no trading price is
available for such shares, the fair market value of the shares, as determined in
good faith by the Board of Directors.
Every owner of more than 5%, in the case of 2,000 or more stockholders of
record and 1% in the case of more than 200 but fewer than 2,000 stockholders of
record, of all classes or series of the Company's stock, within 30 days after
the end of each taxable year, is required to give written notice to the Company
stating the name and address of such owner, the number of shares of each class
and series of stock of the Company beneficially owned and a description of the
manner in which such shares are held. Each such owner shall provide to the
Company such additional information as the Company may request in order to
determine the effect, if any, of such beneficial ownership on the Company's
status as a REIT and to ensure compliance with the ownership limitations.
Subject to certain limitations, the Board of Directors may increase or
decrease the ownership limitations. In addition, to the extent consistent with
the REIT Provisions of the Code, the Board of Directors may waive the ownership
limitations for and at the request of certain purchasers in this Offering or
subsequent purchasers.
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The provisions described above may inhibit market activity and the
resulting opportunity for the holders of the Company's Common Stock to receive a
premium for their shares that might otherwise exist in the absence of such
provisions. Such provisions also may make the Company an unsuitable investment
vehicle for any person seeking to obtain ownership of more than 7.8% of the
outstanding shares of Common Stock.
TRANSFER AGENT AND REGISTRAR
will act as the transfer agent and registrar
with respect to the Common Stock.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon the closing of this Offering, the Company will have outstanding
6,614,000 shares of Common Stock. Of the outstanding shares, the 5,000,000
shares of Common Stock to be sold in this Offering will be freely tradable
without restriction or further registration under the Securities Act unless
purchased by "affiliates" of the Company as that term is defined in Rule 144
under the Securities Act.
The remaining 1,614,000 shares of Common Stock to be outstanding upon the
Closing of this Offering will be "restricted securities" as that term is defined
in Rule 144, none of which will become eligible for sale under Rule 144 until
February 11, 1998. As described below, Rule 144 permits resales of restricted
securities subject to certain restrictions.
In general, under Rule 144, as currently in effect, a person (or persons
whose shares are aggregated) who beneficially owned shares for at least one
year, including any person who may be deemed an "affiliate" of the Company,
would be entitled to sell within any three month period a number of such shares
that does not exceed the greater of 1% of the shares of the Company's Common
Stock then outstanding or the average weekly trading volume in the Company's
Common Stock during the four calendar weeks preceding the date on which notice
of the sale is filed with the Commission. A person who is not deemed to have
been an "affiliate" of the Company at any time during the three months preceding
a sale and who has beneficially owned shares for at least two years would be
entitled to sell such shares under Rule 144 without regard to the volume
limitation described above.
Beginning 180 days after the closing of this Offering, the beneficial
holders of the approximately 1.6 million shares of Common Stock currently
outstanding may require the Company to register such shares of sale in the
public market. See "Description of Capital Stock -- Registration Rights."
The Company and its stockholders have agreed with the Underwriters that,
for a period of 180 days following the commencement of this Offering, they will
not sell, contract to sell or otherwise dispose of any shares of Common Stock or
rights to acquired such shares (other than pursuant to employee plans or the
DRP) without the prior written consent of PaineWebber Incorporated.
In addition, upon the closing of this Offering, the Company will have
outstanding options to purchase 528,000 shares of Common Stock and will have
reserved an aggregate of 202,000 additional shares of Common Stock for grant of
future options under the Option Plan and the Directors Plan. The Company has
also reserved 20,000 shares of Common Stock for issuance under the Purchase
Plan. The Company intends to file Registration Statements on form S-8 covering
the shares that have been reserved for issuance under these plans, thus
permitting the resale of such shares in the public market after such stock
options have been exercised.
The Company also intends to adopt the DRP, which will allow stockholders to
have their dividend distributions from the Company automatically reinvested in
additional shares of Common Stock that may be either issued by the Company or
purchased on the open market. To the extent such shares are issued by the
Company, such shares will be registered under the Securities Act, thus
permitting the resale or such shares in the public market. See "Dividend
Reinvestment Plan."
FEDERAL INCOME TAX CONSIDERATIONS
THE FOLLOWING DISCUSSION SUMMARIZES THE MATERIAL FEDERAL INCOME TAX
CONSIDERATIONS THAT MAY BE RELEVANT TO A PROSPECTIVE HOLDER OF SHARES OF STOCK
OF THE COMPANY. THIS DISCUSSION IS BASED ON CURRENT LAW. THE FOLLOWING
DISCUSSION IS NOT EXHAUSTIVE OF ALL POSSIBLE TAX CONSIDERATIONS. IT DOES NOT
GIVE A DETAILED DISCUSSION OF ANY STATE, LOCAL OR FOREIGN TAX CONSIDERATIONS,
NOR DOES IT DISCUSS ALL OF THE ASPECTS OF FEDERAL INCOME TAXATION THAT MAY BE
RELEVANT TO A PROSPECTIVE STOCKHOLDER IN LIGHT OF SUCH STOCKHOLDER'S PARTICULAR
CIRCUMSTANCES OR TO CERTAIN TYPES OF STOCKHOLDERS (INCLUDING INSURANCE
COMPANIES, CERTAIN TAX-EX-
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EMPT ENTITIES, FINANCIAL INSTITUTIONS, BROKER/DEALERS, FOREIGN CORPORATIONS AND
PERSONS WHO ARE NOT CITIZENS OR RESIDENTS OF THE UNITED STATES) SUBJECT TO
SPECIAL TREATMENT UNDER FEDERAL INCOME TAX LAWS.
EACH PROSPECTIVE PURCHASER OF COMMON STOCK OF THE COMPANY SHOULD CONSULT
WITH HIS OR HER OWN TAX ADVISOR REGARDING THE SPECIFIC CONSEQUENCES TO HIM OR
HER OF THE PURCHASE, OWNERSHIP AND SALE OF STOCK IN AN ENTITY ELECTING TO BE
TAXED AS A REIT, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX
CONSIDERATIONS OF SUCH PURCHASE, OWNERSHIP, SALE AND ELECTION AND THE POTENTIAL
CHANGES IN APPLICABLE TAX LAWS.
GENERAL
The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussion below summarizes the material
provisions applicable to the Company as a REIT for federal income tax purposes
and to its stockholders in connection with their ownership of shares of stock of
the Company. However, it is impractical to set forth in this Prospectus all
aspects of federal, state, local and foreign tax law that may have tax
consequences with respect to an investor's purchase of the Company's Common
Stock. The discussion of various aspects of federal taxation contained herein is
based on the Code, administrative regulations, judicial decisions,
administrative rulings and practice, all of which are subject to change. In
brief, if certain detailed conditions imposed by the Code are met, entities that
invest primarily in real estate assets, including Mortgage Loans, and that
otherwise would be taxed as corporations are, with certain limited exceptions,
not taxed at the corporate level on their taxable income that is currently
distributed to their stockholders. This treatment eliminates most of the "double
taxation" (at the corporate level and then again at the stockholder level when
the income is distributed) that typically results from the use of corporate
investment vehicles. A qualifying REIT, however, may be subject to certain
excise and other taxes, as well as normal corporate tax, on Taxable Income that
is not currently distributed to its stockholders. See "-- Taxation of the
Company."
The Company plans to make an election to be taxed as a REIT under the Code
commencing with its taxable year ending December 31, 1997.
OPINION OF SPECIAL COUNSEL
Jeffers, Wilson, Shaff & Falk, LLP ("Special Tax Counsel"), special tax and
ERISA counsel to the Company, has advised the Company in connection with the
offering of the Company's Common Stock and the Company's election to be taxed as
a REIT. Based on existing law and certain representations made to Special Tax
Counsel by the Company and assuming that the Company operates in the manner
described in this Prospectus, in the opinion of Special Tax Counsel, commencing
with the Company's taxable year ending December 31, 1997, the Company has been
organized in conformity with the requirements for qualification as a REIT under
the Code and the Company's actual and proposed method of operation described in
this Prospectus and as represented by the Company to Special Tax Counsel will
enable the Company to qualify as a REIT. However, whether the Company will in
fact so qualify will depend on actual operating results and compliance with the
various tests for qualification as a REIT relating to its income, assets,
distributions, ownership and certain administrative matters, the results of
which may not be reviewed by Special Tax Counsel. Moreover, certain aspects of
the Company's method of operations have not been considered by the courts or the
Service. There can be no assurance that the courts or the Service will agree
with this opinion. In addition, qualification as a REIT depends on future
transactions and events that cannot be known at this time. Accordingly, Special
Tax Counsel is unable to opine whether the Company will in fact qualify as a
REIT under the Code in all events. In the opinion of Special Tax Counsel, the
section of the Prospectus entitled "Federal Income Tax Considerations"
identifies and fairly summarizes the federal income tax considerations that are
likely to be material to a holder of the Common Stock and to the extent such
summaries involve matters of law, such statements of law are correct under the
Code. Special Tax Counsel's opinions are based on various assumptions and on the
factual representations of the Company concerning its business and assets.
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Accordingly, no assurance can be given that the actual results of the Company's
operation for any one taxable year will satisfy such requirements. See
"Termination or Revocation of REIT Status" below.
The opinions of Special Tax Counsel are based upon existing law including
the Internal Revenue Code of 1986, as amended, existing Treasury Regulations,
Revenue Rulings, Revenue Procedures, proposed regulations and case law, all of
which is subject to change either prospectively or retroactively. Moreover,
relevant laws or other legal authorities may change in a manner that could
adversely affect the Company or its stockholders. Special Tax Counsel's opinions
also are based in part on the opinion of special Maryland counsel, Piper &
Marbury, L.L.C., that the Company is duly organized and existing under Maryland
law.
In the event that the Company does not qualify as a REIT in any year, it
will be subject to federal income tax as a domestic corporation and its
stockholders will be taxed in the same manner as stockholders of ordinary
corporations. To the extent that the Company would, as a consequence, be subject
to potentially significant tax liabilities, the amount of earnings and cash
available for distribution to its stockholders would be reduced. See
"Termination or Revocation of REIT Status" below.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must
meet certain tests which are described immediately below.
Stock Ownership Tests
For all taxable years after the first taxable year for which a REIT
election is made, the Company's shares of stock must be transferable and must be
held by a minimum of 100 persons for at least 335 days of a 12 month year (or a
proportionate part of a short tax year). The Company must also use the calendar
year as its taxable year. In addition, at all times during the second half of
each taxable year, no more than 50% in value of the shares of any class of the
stock of the Company may be owned directly or indirectly by five or fewer
individuals. In determining whether the Company's shares are held by five or
fewer individuals, the attribution rules of Sections 544 of the Code apply. For
a description of these attribution rules, see "Description of Capital Stock."
The Company's Articles of Amendment and Restatement impose certain repurchase
provisions and transfer restrictions to avoid more than 50% by value of any
class of the Company's stock being held by five or fewer individuals (directly
or constructively) at any time during the last half of any taxable year. Such
repurchase and transfer restrictions will not cause the stock not to be treated
as "transferable" for purposes of qualification as a REIT. The Company intends
to satisfy both the 100 stockholder and 50%/5 stockholder individual ownership
limitations described above for as long as it seeks qualification as a REIT. See
"Description of Capital Stock." The Company uses the calendar year as its
taxable year for income tax purposes.
Asset Tests
On the last day of each calendar quarter at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government securities,
cash and cash items (the "75% of assets test"). The Company expects that
substantially all of its assets will be Qualified REIT Assets. Qualified REIT
Assets include interests in real property, interests in Mortgage Loans secured
by real property and interests in REMICs.
On the last day of each calendar quarter, of the investments in securities
not included in the 75% of assets test, the value of any one issuer's securities
may not exceed 5% by value of the Company's total assets and the Company may not
own more than 10% of any one issuer's outstanding voting securities. Hedging
contracts (other than those which are Qualified REIT Assets) and certain types
of other Mortgage Assets may be treated as securities of the entity issuing such
agreements or interests. The Company will take measures to prevent the value of
such contracts, interests or assets issued by any one entity to exceed 5% of the
value of the Company's assets as of the end of each calendar quarter. Moreover,
pursuant to its compliance guidelines, the Company intends to monitor closely
(on not less than a quarterly basis) the purchase and holding of the Company's
assets in order to comply with the above assets tests. In particular, as of the
end of each calendar quarter the Company intends to limit and diversify its
ownership of hedging contracts and other mortgage
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securities that do not constitute Qualified REIT Assets to less than 25%, in the
aggregate, by value of its portfolio, to less than 5% by value as to any single
issuer, and to less than 10% of the voting stock of any single issuer
(collectively the "25% of assets limits"). If such limits are ever exceeded, the
Company intends to take appropriate remedial action to dispose of such excess
assets within the 30 day period after the end of the calendar quarter, as
permitted under the Code.
When purchasing mortgage-related securities, the Company may rely on
opinions of counsel for the issuer or sponsor of such securities given in
connection with the offering of such securities, or statements made in related
offering documents, for purposes of determining whether and to what extent those
securities (and the income therefrom) constitute Qualified REIT Assets (and
income) for purposes of the 75% of assets test (and the source of income tests
discussed below). If the Company invests in a partnership, the Company will be
treated as receiving its share of the income and loss of the partnership and
owning a proportionate share of the assets of the partnership and any income
from the partnership will retain the character that it had in the hands of the
partnership. If the Company forms a taxable affiliate to conduct mortgage
origination and other activities, the Company will obtain an opinion of counsel
that the proposed organization and ownership of an interest in the taxable
affiliate will not adversely affect the Company's status as a REIT.
Where a failure to satisfy any of the asset tests discussed above results
from an acquisition of securities or other property during a quarter, the
failure can be cured by disposition of sufficient non-qualifying assets within
30 days after the close of such quarter. The Company intends to maintain
adequate records of the value of its assets to determine its compliance with the
asset tests, and intends to take such action as may be required to cure any
failure to satisfy the test within 30 days after the close of any quarter.
Gross Income Tests
The Company must meet three separate income-based tests for each year in
order to qualify a REIT.
1. The 75% Test. At least 75% of the Company's gross income (the "75% of
income test") for the taxable year must be derived from the following sources:
(i) rents from real property; (ii) interest (other than interest based in whole
or in part on the income or profits of any person) on obligations secured by
mortgages on real property or on interests in real property; (iii) gains from
the sale or other disposition of interests in real property and real estate
mortgages other than gain from stock in trade, inventory or property held
primarily for sale to customers in the ordinary course of the Company's trade or
business ("dealer property"); (iv) dividends or other distributions on shares in
other REITs and, provided such shares are not dealer property, gain from the
sale of such shares; (v) abatements and refunds of real property taxes; (vi)
income from the operation, and gain from the sale, of property acquired at or in
lieu of a foreclosure of the mortgage secured by such property or as a result of
a default under a lease of such property ("foreclosure property"); (vii) income
received as consideration for entering into agreements to make loans secured by
real property or to purchase or lease real property (including interests in real
property and interests in mortgages on real property) (for example, commitment
fees); and (viii) income attributable to stock or debt instruments acquired with
the proceeds from the sale of stock or certain debt obligations ("new capital")
of the Company received during the oneyear period beginning on the day such
proceeds were received ("qualified temporary investment income"). The
investments that the Company intends to make (as described under "Description of
Mortgage Assets") will give rise primarily to mortgage interest qualifying under
the 75% of income test.
2. The 95% Test. In addition to deriving 75% of its gross income from the
sources listed above, at least an additional 20% of the Company's gross income
for the taxable year must be derived from those sources, or from dividends,
interest or gains from the sale or disposition of stock or other securities that
are not dealer property (the "95% of income test"). Income attributable to
Mortgage Warehouse Participations, Mortgage Securities (other than Qualified
REIT Assets) that the Company holds directly, dividends on stock, interest on
any other obligations not secured by real property, and gains from the sale or
disposition of stock or other securities that are not Qualified REIT Assets will
constitute qualified income for purposes of the 95% of income test only, but
will not be qualified income for purposes of the 75% of income test. Income from
mortgage servicing contracts, loan guarantee fees (or other contracts under
which the Company would earn fees for performing services) and hedging (other
than from Qualified REIT Assets) will not qualify for either
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the 95% or 75% of income tests. The Company intends to severely limit its
acquisition of any assets or investments the income from which does not qualify
for purposes of the 95% of income test. Moreover, in order to help ensure
compliance with the 95% of income test and the 75% of income tests, the Company
intends to limit substantially all of the assets that it acquires to Qualified
REIT Assets. The policy of the Company to maintain REIT status may limit the
type of assets, including hedging contracts, that the Company otherwise might
acquire.
For purposes of determining whether the Company complies with the 75% of
income test and the 95% of income test detailed above, gross income does not
include gross income from "prohibited transactions." A "prohibited transaction"
is one involving a sale of dealer property, other than foreclosure property. Net
income from "prohibited transactions" is subject to a 100% tax. See "-- Taxation
of the Company."
3. The 30% of Income Limit. For the 1997 taxable year, the Company must
also derive less than 30% of its gross income from the sale or other disposition
of (i) Qualified REIT Assets held for less than four years, other than
foreclosure property or property involuntarily or compulsorily converted through
destruction, condemnation or similar events, (ii) stock or securities held for
less than one year (including hedges) and (iii) property in a prohibited
transaction (together the "30% of income limit"). As a result of the Company's
having to closely monitor such gains, the Company may have to hold Mortgage
Loans and Mortgage Securities although the Company might otherwise have opted
for the disposition of such assets for short term gains, in order to ensure that
it maintains compliance with the 30% of income limit. Effective with the 1998
taxable year, the 30% of income limit has been repealed from the Code and will
no longer apply. The Company expects to make the election to treat any real
property taken by the Company in foreclosure, or in lieu of foreclosure, of a
Mortgage Loan as foreclosure property.
The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions, futures contracts and sales
of Mortgage Assets to comply with the 75% of income test, the 95% of income test
and, for the 1997 taxable year, the 30% of income limit. See "-- Taxation of the
Company" for a discussion of the potential tax cost of the Company's selling
certain Mortgage Securities on a regular basis. In order to help insure its
compliance with the REIT requirements of the Code, the Company has adopted
guidelines the effect of which will be to limit the Company's ability to earn
certain types of income, including income from hedging, other than hedging
income from Qualified REIT Assets. See "Business -- Risk Management -- Interest
Rate Risk Management."
If the Company fails to satisfy one or both of the 75% or 95% of income
tests for any year, it may face either (a) assuming such failure was for
reasonable cause and not willful neglect, a 100% tax on the greater of the
amounts of income by which it failed to comply with the 75% test of income or
the 95% of income test, reduced by estimated related expenses or (b) loss of
REIT status. There can be no assurance that the Company will always be able to
maintain compliance with the gross income tests for REIT qualification despite
the Company's periodic monitoring procedures. Moreover, there is no assurance
that the relief provisions for a failure to satisfy either the 95% or the 75% of
income tests will be available in any particular circumstance.
Distribution Requirement
The Company must distribute to its stockholders on a pro rata basis each
year an amount equal to (i) 95% of its Taxable Income before deduction of
dividends paid and excluding net capital gain, plus (ii) 95% of the excess of
the net income from foreclosure property over the tax imposed on such income by
the Code, less (iii) any "excess noncash income" (the "95% distribution test").
See "Dividend Policy and Distributions." The Company intends to make
distributions to its stockholders in amounts sufficient to meet this 95%
distribution requirement. 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. A nondeductible excise
tax, equal to 4% of the excess of such required distributions over the amounts
actually distributed will be imposed on the Company for each calendar year to
the extent that 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 (i) 85% of
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the Company's "ordinary income," (ii) 95% of the Company's capital gain net
income plus, and (iii) income not distributed in earlier years.
The Service has ruled that if a REIT's dividend reinvestment plan 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 fair market
value on the distribution date, then such cash distributions qualify under the
95% distribution test. The Company expects that the terms of its DRP will comply
with this ruling. See "Dividend Reinvestment Plan."
If the Company fails to meet the 95% distribution test as a result of an
adjustment to the Company's tax returns by the Service, the Company by following
certain requirements set forth in the Code, may pay a deficiency dividend within
a specified period which will be permitted as a deduction in the taxable year to
which the adjustment is made. 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 timely tax return.
RECORDKEEPING REQUIREMENTS
A REIT is required to maintain records regarding the actual and
constructive ownership of its shares, and other information, and within 30 days
after the end of its taxable year, to demand statements from persons owning
above a specified level of the REIT's shares (e.g., if the Company has over 200
but fewer than 2,000 stockholders of record, from persons holding 1% or more of
the Company's outstanding shares of stock and if the Company has 200 or fewer
stockholders of record, from persons holding 1/2% or more of the stock)
regarding their ownership of shares. The Company must maintain, as part of the
Company's records, a list of those persons failing or refusing to comply with
this demand. Stockholders who fail or refuse to comply with the demand must
submit a statement with their tax returns setting forth the actual stock
ownership and other information. The Company also is required to maintain
permanent records of its assets as of the last day of each calendar quarter. The
Company intends to maintain the records and demand statements as required by
these regulations.
TERMINATION OR REVOCATION OF REIT STATUS
The Company's election to be treated as a REIT will be terminated
automatically if the Company fails to meet the requirements described above. In
that event, the Company will not be eligible again to elect REIT status until
the fifth taxable year which begins after the year for which the Company's
election was terminated unless all of the following relief provisions apply: (i)
the Company did not willfully fail to file a timely return with respect to the
termination taxable year, (ii) inclusion of incorrect information in such return
was not due to fraud with intent to evade tax, and (iii) the Company establishes
that failure to meet requirements was due to reasonable cause and not willful
neglect. The Company may also voluntarily revoke its election, although it has
no intention of doing so, in which event the Company will be prohibited, without
exception, from electing REIT status for the year to which the revocation
relates and the following four taxable years.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company would be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to stockholders of the Company with
respect to any year in which the Company fails to qualify as a REIT would not be
deductible by the Company nor would they be required to be made. Failure to
qualify as a REIT would result in the Company's reduction of its distributions
to stockholders in order to pay the resulting taxes. If, after forfeiting REIT
status, the Company later qualifies and elects to be taxed as a REIT again, the
Company could face significant adverse tax consequences.
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, it generally will not
be subject to federal income tax on that portion of its taxable income or net
capital gain which is distributed to its stockholders. The Company will,
however, be subject to tax at normal corporate rates upon any net income or net
capital gain
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not distributed. The Company intends to distribute substantially all of its
taxable income to its stockholders on a pro rata basis in each year. See
"Dividend Policy and Distributions."
In addition, the Company will also be subject to a tax of 100% of net
income from any prohibited transaction and will be subject to a 100% tax on the
greater of the amount by which it fails either the 75% or 95% of income tests,
reduced by approximated expenses, if the failure to satisfy such tests is due to
reasonable cause and not willful neglect and if certain other requirements are
met. The Company may be subject to the alternative minimum tax on certain items
of tax preference.
If the Company acquires any real property as a result of foreclosure, or by
a deed in lieu of foreclosure, the Company may elect to treat such real property
as "foreclosure property." Net income from the sale of foreclosure property is
taxable at the maximum federal corporate rate, currently 35%. Income from
foreclosure property will not be subject to the 100% tax on prohibited
transactions. The Company will determine whether to treat such real property as
foreclosure property on the tax return for the fiscal year in which such
property is acquired.
The Company may securitize Mortgage Loans and sell such Mortgage Loans
through a taxable subsidiary. However, if the Company itself were to sell such
Mortgage Securities on a regular basis, there is a substantial risk that they
would be deemed "dealer property" and that all of the profits from such sales
would be subject to tax at the rate of 100% as income from prohibited
transactions. The Company therefore intends to make any such sales through a
taxable subsidiary. The taxable subsidiary will form mortgage pools and create
mortgage backed securities. See "Taxable Subsidiaries" The taxable subsidiary
will not be subject to this 100% tax on income from prohibited transactions,
which is only applicable to REITs.
The Company will also be subject to a nondeductible 4% excise tax if it
fails to make timely dividend distributions for each calendar year. See
"Requirements for Qualification as a REIT -- Distribution Requirements." The
Company intends to declare its fourth regular annual dividend during the final
quarter of the year and to make such dividend distribution no later than
thirty-one (31) days after the end of the year in order to avoid imposition of
the excise tax. Such a distribution would be taxed to the stockholders in the
year that the distribution was declared, not in the year paid. Imposition of the
excise tax on the Company would reduce the amount of cash available for
distribution to the Company's stockholders.
TAXABLE SUBSIDIARIES
The Company may, in the future, cause the creation and sale of Mortgage
Securities through a taxable corporation. The Company and one or more persons or
entities will own all of the capital stock of that taxable corporation,
sometimes referred to as a "taxable subsidiary." In order to ensure that the
Company will not violate the prohibition on ownership of more than 10% of the
voting stock of a single issuer and the prohibition on investing more than 5% of
the value of its assets in the stock or securities of a single issuer, the
Company will own only shares of nonvoting preferred stock of that taxable
subsidiary corporation and will not own any of the taxable subsidiary's common
stock. The Company will monitor the value of its investment in the taxable
subsidiary on a quarterly basis to limit the risk of violating any of the tests
that comprise the 25% of assets limits. In addition, the dividends that the
taxable subsidiary pays to the Company will not qualify as income from Qualified
REIT Assets for purposes of the 75% of income test, and in all events would have
to be limited, along with the Company's other interest, dividends, gains on the
sale of securities, hedging income, and other income not derived from Qualified
REIT Assets to less than 25% of the Company's gross revenues in each year. The
taxable subsidiary will not elect REIT status, will be subject to income
taxation on its net earnings and will generally be able to distribute only its
net after-tax earnings to its stockholders, including the Company, as dividend
distributions. If the taxable subsidiary creates a taxable mortgage pool, such
pool itself will constitute a separate taxable subsidiary of the taxable
subsidiary. The taxable subsidiary would be unable to offset the income derived
from such a taxable mortgage pool with losses derived from any other activities.
TAXATION OF STOCKHOLDERS
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its stockholders out of
current or accumulated earnings and profits will be
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includible by the stockholders as ordinary income for federal income tax
purposes unless properly designated by the Company as capital gain dividends. In
the latter case, the distributions will be taxable to the stockholders as
long-term capital gains.
Distributions of the Company will not be eligible for the dividends
received deduction for corporations. Stockholders may not deduct any net
operating losses or capital losses of the Company.
Any loss on the sale or exchange of shares of the stock of the Company held
by a stockholder for six months or less will be treated as a long-term capital
loss to the extent of any capital gain dividend received on the stock held by
such stockholders.
If the Company makes distributions to its stockholders in excess of its
current and accumulated earnings and profits, those distributions will be
considered first a tax-free return of capital, reducing the tax basis of a
stockholder's shares until the tax basis is zero. Such distributions in excess
of the tax basis will be taxable as gain realized from the sale of the Company's
shares.
The Company does not expect to acquire or retain residual interests issued
by REMICs. Such residual interests, if acquired by a REIT, would generate excess
inclusion income. Excess inclusion income cannot be offset by net operating
losses of a stockholder. If the stockholder is a Tax-Exempt Entity, the excess
inclusion income is fully taxable as UBTI. If allocated to a foreign
stockholder, the excess inclusion income is subject to Federal income tax
withholding without reduction pursuant to any otherwise applicable tax treaty.
Potential investors, and in particular Tax Exempt Entities, are urged to consult
with their tax advisors concerning this issue.
The Company intends to finance the acquisition of Mortgage Assets by
entering into reverse repurchase agreements, which are essentially loans secured
by the Company's Mortgage Assets. The Company expects to enter into master
repurchase agreements with secured lenders known as "counterparties." Typically,
such master repurchase agreements have cross-collateralization provisions that
afford the counterparty the right to foreclose on the Mortgage Assets pledged as
collateral. If the Service were to successfully take the position that the
cross-collateralization provisions of the master repurchase agreements result in
the Company having issued debt instruments (the reverse repurchase agreements)
with differing maturity dates secured by a pool of Mortgage Loans, a portion of
the Company's income could be characterized as "excess inclusion income."
Special Tax Counsel has advised the Company that it is more likely than not that
the cross-collateralization provisions of the master repurchase agreements will
not cause the Company to realize excess inclusion income. Nevertheless, in the
absence of any definitive authority on this issue, Special Tax Counsel cannot
give complete assurance.
Stockholders who elect to participate in the Company's DRP generally will
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 stock
purchased with the reinvested dividends, generally on the date that the Agent
credits such stock to the DRP participant's account, plus any brokerage
commissions and fees paid by the Agent.
The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to stockholders of record on a specified
date in such month will be deemed to have been received by the stockholders and
paid by the Company on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year.
TAXATION OF TAX-EXEMPT ENTITIES
In general, a Tax-Exempt Entity that is a stockholder of the Company is not
subject to tax on distributions. The Service has ruled that amounts distributed
by a REIT to an exempt employees' pension trust do not constitute UBTI and thus
should be nontaxable to such a Tax-Exempt Entity. Based on that ruling, but
subject to the discussion of excess inclusion income set forth under the heading
"Taxation of Stockholders," Special Tax Counsel is of the opinion that
indebtedness incurred by the Company in connection with the acquisition of real
estate assets such as Mortgage Loans will not cause dividends of the Company
paid to a stockholder that is a Tax-Exempt Entity to be UBTI, provided that the
Tax-Exempt
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Entity has not financed the acquisition of its stock with "acquisition
indebtedness" within the meaning of the Code. Under certain conditions, if a
tax-exempt employee pension or profit sharing trust were to acquire more than
10% of the Company's stock, a portion of the dividends on such stock could be
treated as UBTI.
For social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts, and qualified group legal services plans exempt
from federal income taxation under Code Sections 501(c)(7), (c)(9), (c)(17) and
(c)(20), respectively, income from an investment in the Company will constitute
UBTI unless the organization is able to properly deduct amounts set aside or
placed in reserve for certain purposes so as to offset the UBTI generated by its
investment in the Company. Such entities should review Code Section 512(a)(3)
and should consult their own tax advisors concerning these "set aside" and
reserve requirements.
STATE AND LOCAL TAXES
The Company and its stockholders 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 stockholders
may not conform to the Federal income tax consequences discussed above.
Consequently, prospective stockholders should consult their own tax advisors
regarding the effect of state and local tax laws on an investment in the Common
Stock.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS
The following discussion summarizes certain United States tax consequences
of the acquisition, ownership and disposition of the Common Stock by an initial
purchaser of the Common Stock that, for United States income tax purposes, is
not a "United States person" (a "Foreign Holder"). For purposes of discussion, a
"United States person" means: a citizen or resident of the United States; a
corporation, partnership, or other entity created or organized in the United
States or under the laws of the United States or of any political subdivision
thereof; or an estate or trust whose income is includible in gross income for
United States income tax purposes regardless of its source. This discussion does
not consider any specific facts or circumstances that may apply to a particular
Foreign Holder prospective investors are urged to consult their tax advisors
regarding the United States tax consequences of acquiring, holding and disposing
of Common Stock, as well as any tax consequences that may arise under the laws
of any foreign, state, local or other taxing jurisdiction.
Dividends
Dividends paid by the Company out of earnings and profits, as determined
for United States income tax purposes, to a Non-United States Holder will
generally be subject to withholding of United States Federal income tax at the
rate of 30%, unless reduced or eliminated by an applicable tax treaty or unless
such dividends are treated as effectively connected with a United States trade
or business conducted by the Foreign Holder. A Foreign Holder eligible for a
reduction in withholding under an applicable treaty must so notify the Company
by completing the appropriate IRS form. Distributions paid by the Company in
excess of its earnings and profits will be treated as a tax-free return of
capital to the extent of the holder's adjusted basis in his Common Stock, and
thereafter as gain from the sale or exchange of a capital asset as described
below. If it cannot be determined at the time a distribution is made whether
such distribution will exceed the Company's earnings and profits (which, under
most circumstances, will correspond to the Company's net income before the
deduction for dividends paid), the distribution will be subject to withholding
at the same rate as dividends. Amounts so withheld, however, will be refundable
or creditable against the Foreign Holder's United States tax liability if the
Company subsequently determines that such distribution was, in fact, in excess
of the earnings and profits of the Company. If the receipt of the dividend is
treated as being effectively connected with the conduct of a trade or business
within the United States by a Foreign Holder, the dividend received by such
holder will be subject to the United States Federal income tax on net income
that applies to United States persons generally (and, in addition with respect
to foreign corporate holders and under certain circumstances, the branch profits
tax).
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For any year in which the Company qualifies as a REIT, distributions to a
Foreign Holder that are attributable to gain from the sales or exchanges by the
Company of "United States real property interests" will be treated as if such
gain were effectively connected with a United States business and will thus be
subject to tax at the normal capital gain rates applicable to United States
stockholders (subject to applicable alternative minimum tax) under the
provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled to a
treaty exemption. The Company is required to withhold 35% of any distribution
that could be designated by the Company as a capital gains dividend. This amount
may be credited against the Foreign Holder's FIRPTA tax liability.
Gain on Disposition
A Foreign Holder will generally not be subject to United States Federal
income tax on gain recognized on a sale or other disposition of the Common Stock
unless (i) the gain is effectively connected with the conduct of a trade or
business within the United States by the Foreign Holder, (ii) in the case of a
Foreign Holder who is a nonresident alien individual and holds the Common Stock
as a capital asset, such holder is present in the United States for 183 or more
days (computed in part by reference to days present in the 2 prior years) in the
taxable year and certain other requirements are met, or (iii) the Foreign Holder
is subject to tax under the FIRPTA rules discussed below. Gain that is
effectively connected with the conduct of a United States Holder will be subject
to the United States Federal income tax on net income that applies to United
States persons generally (and, with respect to corporate holders and under
certain circumstances, the branch profits tax) but will not be subject to
withholding. Foreign Holders should consult applicable treaties, which may
provide for different rules.
Gain recognized by a Foreign Holder upon a sale of its Common Stock will
generally not be subject to tax under FIRPTA if the Company is a "domestically
controlled REIT," which is defined generally as a REIT in which at all times
during a specified testing period less than 50% in value of its shares were held
directly or indirectly by non-U.S. persons. Because only a minority of the
Company's stockholders are expected to be Foreign Holders, the Company
anticipates that it will qualify as a "domestically controlled REIT."
Accordingly, a Foreign Holder should not be subject to U.S. tax from gains
recognized upon disposition of the Common Stock.
Information Reporting and Backup Withholding
Under temporary United States Treasury regulations, United States
information reporting requirements and backup withholding tax will generally not
apply to dividends paid on the Common Stock to a Non-United States Holder at an
address outside the United States. Payments by a United States office of a
broker of the proceeds of a sale of the Common Stock is subject to both backup
withholding at a rate of 31% and information reporting unless the holder
certifies its Foreign Holder status under penalties of perjury or otherwise
establishes an exemption. Information reporting requirements (but not backup
withholding) will also apply to payments of the proceeds of sales of the Common
Stock by foreign offices of United States brokers, or foreign brokers with
certain types of relationships to the United States, unless the broker has
documentary evidence in its records that the holder is a Foreign Holder and
certain other conditions are met, or the holder otherwise establishes an
exemption.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be refunded or credited against the Foreign
Holder's United States Federal income tax liability, provided that the required
information is furnished to the Internal Revenue Service.
These information reporting and backup withholding rules are under review
by the United States Treasury and their application to the Common Stock could be
changed by future regulations.
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ERISA CONSIDERATIONS
In considering an investment in the Common Stock, a fiduciary of a
profit-sharing, pension stock bonus plan, or individual retirement account,
including a plan for self-employed individuals and their employees or any other
employee benefit plan subject to prohibited transaction provisions of the Code
or the fiduciary responsibility provisions of ERISA (an "ERISA Plan") should
consider (a) whether the ownership of Common Stock is in accordance with the
documents and instruments governing such ERISA Plan; (b) whether the ownership
of Common Stock is consistent with the fiduciary's responsibilities and
satisfies the requirements of Part 4 of Subtitle B of Title I of ERISA (where
applicable) and, in particular, the diversification, prudence and liquidity
requirements of Section 404 of ERISA; (c) ERISA's prohibitions in improper
delegation of control over, or responsibility for, "plan assets" and ERISA's
imposition of co-fiduciary liability on a fiduciary who participates in, permits
(by action or inaction) the occurrence of, or fails to remedy a known breach of
duty by another fiduciary; and (d) the need to value the assets of the ERISA
Plan annually.
In regard to the "plan assets" issue noted in clause (c) above, Special Tax
Counsel is of the opinion that, effective as of the date of this Closing of the
Offering and the listing of the shares on the NYSE, and based on certain
representations of the Company, the Common Stock should qualify as a
"publicly-offered security," and, therefore, the acquisition of such Common
Stock by ERISA Plans should not cause the Company's assets to be treated as
assets of such investing ERISA Plans for purposes of the fiduciary
responsibility provisions of ERISA or the prohibited transaction provisions of
the Code. Fiduciaries of ERISA Plans and IRA's should consult with and rely upon
their own advisors in evaluating the consequences under the fiduciary provisions
of ERISA and the Code of an investment in Common Stock in light of their own
circumstances.
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UNDERWRITING
The underwriters named below (the "Underwriters"), represented by
PaineWebber Incorporated, Oppenheimer & Co., Inc., EVEREN Securities, Inc. and
Sutro & Co. Incorporated (the "Representatives"), have severally agreed to
purchase, and the Company has agreed to sell, subject to the terms and
conditions set forth in an underwriting agreement (the "Underwriting
Agreement"), the respective number of shares of Common Stock set forth opposite
their names below:
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERWRITER TO BE PURCHASED
--------------------------------------------------------------------- ----------------
<S> <C>
PaineWebber Incorporated.............................................
Oppenheimer & Co., Inc. .............................................
EVEREN Securities, Inc...............................................
Sutro & Co. Incorporated.............................................
---------
Total...................................................... 5,000,000
</TABLE>
In the Underwriting Agreement, the Underwriters have severally agreed,
subject to the terms and conditions set forth therein, to purchase all of the
shares of Common Stock being sold pursuant to the Underwriting Agreement (other
than those covered by the over-allotment option described below) if any shares
of Common Stock are purchased. The Underwriting Agreement provides that the
obligations of the Underwriters to purchase such shares of Common Stock are
subject to certain conditions precedent. The Underwriting Agreement also
provides that in the event of a default by any Underwriter, the purchase
commitments of the nondefaulting Underwriters may be increased or the
Underwriting Agreement may be terminated.
The Representatives have advised the Company that the Underwriters propose
to offer the shares of Common Stock in part to the public at the initial public
offering price set forth on the cover page of this Prospectus, and in part to
certain securities dealers (who may include the Underwriters) at such price less
a concession not in excess of $ per share of Common Stock, and the
Underwriters and such dealers may reallow to certain dealers a discount not in
excess of $ per share of Common Stock. After commencement of this
Offering, the public offering price, concessions to selected dealers and the
discount to other dealers may be changed by the Representatives. The Common
Stock is offered subject to receipt and acceptance by the Underwriters, and to
certain other conditions, including the right to reject orders in whole or in
part.
The Company has granted the Underwriters an option exercisable for 30 days
after the date hereof to purchase up to 750,000 additional shares of Common
Stock to cover over-allotments, if any, at the initial public offering price
less the underwriting discount and commissions. If the Underwriters exercise
this option, each Underwriter will have a firm commitment, subject to certain
conditions, to purchase approximately the same percentage of such additional
shares of Common Stock as the number of shares of Common Stock to be purchased
by it shown in the foregoing table bears to the shares of Common Stock initially
offered hereby. The Underwriters may purchase such shares of Common Stock only
to cover over-allotments made in connection with this Offering.
The Company has agreed to indemnify the several Underwriters against
certain civil liabilities, including liabilities under the federal securities
laws, or to contribute to payments which the Underwriters may be required to
make in respect thereof.
The Company and the officers and directors of the Company have agreed that,
for a period of 180 days from the date of this Prospectus, they will not,
without the prior written consent of PaineWebber Incorporated, directly or
indirectly, sell, offer to sell, grant any option for the sale of, or otherwise
dispose of any shares of Common Stock or any security convertible into Common
Stock, except pursuant to the DRP or upon exercise of the options outstanding or
to be issued pursuant to the Incentive Plan, the Option Plan or the Outside
Directors Plan or shares of Common Stock to be issued pursuant to the Stock
Purchase Plan.
PaineWebber Incorporated has in the past performed, and may continue to
perform, investment banking, brokerdealer, lending and financial advisory
services for the Company and the Manager and has received
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customary compensation therefor. In connection with this Offering, the Company
has agreed to pay PaineWebber Incorporated an advisory fee equal to 0.5% of the
gross proceeds of the Offering for structural and advisory services rendered in
connection with the Offering. In addition, the Company has a secured repurchase
credit facility and a collateralized line of credit with an affiliate of
PaineWebber Incorporated.
The Representatives have informed the Company that they do not expect the
Underwriters to confirm sales of Common Stock offered by this Prospectus to any
accounts over which they exercise discretionary authority.
Prior to this Offering, there has been no public market for the Common
Stock. Accordingly, the public offering price has been determined by
negotiations between the Company and the Representatives. Among the factors
which were considered in determining the initial public offering price were the
Company's future prospects, the experience of its management, the economic
condition of the financial services industry in general, the general condition
of the equity securities market, the demand for similar securities of companies
considered comparable to the Company and other relevant factors.
The initial public offering price set forth on the cover page of this
Prospectus should not be considered an indication of the actual value of the
Common Stock. The initial public offering price is subject to change as a result
of market conditions and other factors and no assurance can be given that the
Common Stock can be resold at the offering price.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase shares of Common Stock. As
an exception to these rules, the Representatives are permitted to engage in
certain transactions that stabilize the price of Common Stock. Such transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the Common Stock.
In addition, if the Representatives over-allot (i.e., if they sell more
shares of Common Stock than are set forth on the cover page of this Prospectus)
and thereby create a short position in the Common Stock in connection with this
Offering, then the Representatives may reduce that short position by purchasing
Common Stock in the open market. The Representatives may also elect to reduce
any short position by exercising all or part of the over-allotment option
described herein.
The Representatives may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
shares of Common Stock in the open market to reduce the Underwriters' short
position or to stabilize the price of the Common Stock, they may reclaim the
amount of the selling concession from the Underwriters and selling group members
who sold those shares as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might otherwise be in the absence of such purchases. The imposition of a
penalty bid might also have an effect on the price of a security to the extent
that it were to discourage resales of the security by purchasers in the
offering.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the
Representatives will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
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CERTAIN PROVISIONS OF MARYLAND LAW
AND THE COMPANY'S CHARTER AND BYLAWS
The following summary of certain provisions of the MBCL and of the Charter
and the Bylaws of the Company does not purport to be complete and is subject to
and qualified in its entirety by reference to Maryland law and to the Charter
and the Bylaws of the Company, copies of which are filed as exhibits to the
Registration Statement of which this Prospectus is a part.
CERTAIN ANTI-TAKEOVER PROVISIONS
The Charter and the Bylaws of the Company contain certain provisions that
could discourage, impede or impair acquisition of control of the Company by
means of a tender offer, a proxy contest or otherwise. These provisions are
expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
the Company to negotiate first with the Board of Directors. The Company believes
that these provisions increase the likelihood that proposals initially will be
on more attractive terms than would be the case in their absence and increases
the likelihood of negotiations, which might outweigh the potential disadvantages
of discouraging such proposals because, among other things, negotiation of such
proposals might result in improvement of terms. The description set forth below
is a summary only, and is qualified in its entirety by reference to the Charter
and the Bylaws which have been filed was exhibits to the Registration Statement
of which this Prospectus is a part. See "Description of Capital
Stock -- Repurchase of Shares and Restrictions on Transfer" and "Risk
Factors -- Additional Risk Factors -- Limitations on Acquisition and Change in
Control."
STAGGERED BOARD OF DIRECTORS
The Charter and the Bylaws divide the Board of Directors into three classes
of directors, each class constituting approximately one-third of the total
numbers of directors, with the classes serving staggered three-year terms. The
classification of the Board of Directors will make it more difficult for
stockholders to change the composition of the Board of Directors because only a
minority of the directors can be elected at once. The Company believes, however,
that the staggered Board of Directors will help to ensure continuity and
stability of the Company's management and policies. The classification
provisions could also discourage a third party from accumulating the Company's
stock or attempting to obtain control of the Company, even though this attempt
might be beneficial to the Company and some, or a majority, of its stockholders.
Accordingly, under certain circumstances stockholders could be deprived of
opportunities to sell their shares of Common Stock at a higher price than might
otherwise be available.
NUMBER OF DIRECTORS, REMOVAL, FILLING VACANCIES
The Charter and Bylaws provide that, subject to any rights of holders of
preferred stock to elect additional directors under specified circumstances
("Preferred Holders Rights"), the number of directors will be four and may be
changed by a majority of the entire Board of Directors. In addition, the Charter
provides that, subject to any Preferred Holders Rights, and unless the Board of
Directors otherwise determines, any vacancies may be filled by a vote of the
stockholders or a majority of the remaining directors, though less than a
quorum, except vacancies created by the increase in the number of directors,
which only may be filled by a vote of the stockholders or a majority of the
entire Board of Directors. Accordingly, the Board of Directors could temporarily
prevent any stockholder from enlarging the Board of Directors and filling the
new directorship with such stockholder's own nominees. The Charter and the
Bylaws provide that, subject to the rights of any class or series to elect
directors, directors may be removed only for cause upon the affirmative vote of
a majority of holders of all the then outstanding shares of stock entitled to
vote generally in the election of directors, voting together as a single class.
ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER NOMINATIONS AND STOCKHOLDER PROPOSALS
The Charter and the Bylaws establish an advance notice procedure for
stockholders to make nominations of candidates for director or bring other
business before an annual meeting of stockholders of the Company
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<PAGE> 79
(the "Stockholder Notice Procedure"). The Bylaws provide that (i) only persons
who are nominated by, or at the direction of, the Board of Directors, or by a
stockholder who has given timely written notice containing specified information
to the Secretary of the Company prior to the meeting, at which directors are to
be elected, will be eligible for election as directors of the Company and (ii)
at an annual meeting, only such business may be conducted as has been brought
before the meeting by, or at the direction of, the Chairman or the Board of
Directors or by a stockholder who has given timely written notice to the
Secretary of the Company of such stockholder's intention to bring such business
before such meeting. In general, for notice of stockholder nominations or
proposed business (other than business to be included in the Company's Proxy
Statement under the Securities and Exchange Commission's Rule 14a-8) to be
conducted at an annual meeting to be timely, such notice must be received by the
Company not less than 60 days nor more than 90 days prior to the first
anniversary of the previous year's annual meeting. The purpose of requiring
stockholders to give the Company advance notice of nominations and other
business is to afford the Board of Directors a meaningful opportunity to
consider the qualifications of the proposed nominees or the advisability of the
other proposed business and, to the extent deemed necessary or desirable by the
Board of Directors, to inform stockholders and make recommendations about such
nominees or business, as well as to ensure an orderly procedure for conducting
meetings of stockholders. Although the Charter and the Bylaws do not give the
Board of Directors power to block stockholder nominations for the election of
directors or proposals for action, they may have the effect of discouraging a
stockholder from proposing nominees or business, precluding a contest for the
election of directors or the consideration of stockholder proposals if
procedural requirements are not met and deterring third parties from soliciting
proxies for a non-management slate of directors or proposals, without regard to
the merits of such slate or proposals.
RELEVANT FACTORS TO BE CONSIDERED BY THE BOARD OF DIRECTORS
The Charter provides that, in determining what is in the best interest of
the Company in a business combination or certain change of control events, a
director of the Company shall consider the interests of the stockholders of the
Company and, in his or her discretion, also may consider (i) the interests of
the Company's employees, suppliers, creditors and tenants; (ii) the economy of
the nation; (iii) community and societal interests; and (iv) both the longterm
and short-term interests of the Company and its stockholders, including the
possibility that these interests may be best served by the continued
independence of the Company. Pursuant to this provision, the Board of Directors
may consider subjective factors affecting a proposal, including certain
non-financial matters, and on the basis of these considerations may oppose a
business combination or other transaction which, evaluated only in terms of its
financial merits, might be attractive to some, or a majority, of the Company's
stockholders.
RIGHTS TO PURCHASE SECURITIES AND OTHER PROPERTY
The Board of Directors may create and authorize the Company to issue rights
entitling the holders thereof to purchase from the Company shares of capital
stock or other securities or property. The times at which and terms upon which
such rights are to be issued are within the discretion of the Board of
Directors. The provision is intended to confirm the Board of Directors'
authority to issue share purchase rights which could have terms that would
impede a merger, tender offer or other takeover attempt, or other rights to
purchase securities of the Company or any other entity.
BUSINESS COMBINATIONS
The MGCL prohibits certain "business combinations" (including certain
mergers, consolidations, share exchanges, asset transfers, sales, leases,
issuance or reclassification of equity securities and benefits) involving a
Maryland corporation and an "Interested Stockholder." Interested Stockholders
are all persons (i) who beneficially own 10% or more of the voting power of the
corporation's stock or (ii) an affiliate or associate of the corporation who, at
any time within the two-year period prior to the date in question, was an
Interested Stockholder or an affiliate or an associate thereof. Such business
combinations are prohibited for five years after the most recent date on which
the Interested Stockholder became an Interested Stockholder. Thereafter, any
such business combination must be recommended by the board of directors of such
corporation and
78
<PAGE> 80
approved by the affirmative vote of at least (a) 80% of the votes entitled to be
cast by all holders of voting shares of the corporation, and (b) 66 2/3% of the
votes entitled to be cast by all holders of voting shares of the corporation
other than the voting shares held by the Interested Stockholder or an affiliate
or associate of the Interested Stockholder, with whom the business combination
is to be effected, unless, among other things, the corporation's stockholders
receive a minimum price (as defined in the MGCL) for their shares and the
consideration is received in cash or in the same form as previously paid by the
Interested Stockholder for its shares. These provisions of Maryland law do not
apply, however, to business combinations that are approved or exempted by the
board of directors of the corporation prior to the time that the Interested
Stockholder becomes an Interested Stockholder. A Maryland corporation may adopt
an amendment to its charter electing not to be subject to the special voting
requirements of the foregoing legislation. Any such amendment would have to be
approved by the affirmative vote of at least 80% of the votes entitled to be
cast by all holders of outstanding shares of voting stock and 66 2/3% of the
votes entitled to be cast by holders of outstanding shares of voting stock who
are not Interested Stockholders.
CONTROL SHARE ACQUISITIONS
The MGCL provides the "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares of stock owned by the acquiror or by the officers or directors
who are employees of the company. Control shares are voting shares of stock
which, if aggregated with all other shares of stock previously acquired by such
a person, would entitle the acquiror to exercise voting power in electing
directors within one of the following ranges of voting power: (i) 20% or more
but not less than 33 1/3%; (ii) 33 1/3% or more but less than a majority; or
(iii) a majority of all voting power. Control Shares do not include shares of
stock an acquiring person is entitled to vote as a result of having previously
obtained stockholder approval. A control share acquisition means, subject to
certain exceptions, the acquisition of, ownership of or the power to direct the
exercise of voting power with respect to, control shares. A person who has made
or proposed to make a "control share acquisition," upon satisfaction of certain
conditions (including an undertaking to pay expenses), may compel the board of
directors to call a special meeting of stockholders to be held within 50 days of
demand therefor to consider the voting rights of the shares. If no request for a
meeting is made, the corporation may itself present the question at any
stockholders' meeting. If voting rights are not approved at the meeting or if
the acquiring person does not deliver an acquiring person statement as permitted
by the statute, then, subject to certain conditions and limitations, the
corporation may redeem any or all of the control shares (except those for which
voting rights have previously been approved) for fair value determined, without
regard to voting rights, as of the date of the last control share acquisition or
of any meeting of stockholders at which the voting rights of such shares are
considered and not approved. If voting rights for "control shares" are approved
at a stockholders' meeting and the acquiror becomes entitled to vote a majority
of the shares entitled to vote, all other stockholders may exercise appraisal
rights. The fair value of the stock as determined for purposes of such appraisal
rights may not be less than the highest price per share paid in the control
share acquisition, and certain limitations and restrictions otherwise applicable
to the exercise of dissenters' rights do not apply in the context of a "control
share acquisition." The control share acquisition statute does not apply to
stock acquired in a merger, consolidation or stock exchange if the corporation
is a party to the transaction, or to acquisitions previously approved or
exempted by a provision in the charter or by-laws of the corporation. The
limitation on ownership of shares of Common Stock set forth in the Charter, as
well as the provisions of the MGCL, could have the effect of discouraging offers
to acquire the Company and of increasing the difficulty of consummating any such
offer. See "Description of Capital Stock -- Repurchase of Shares and
Restrictions on Transfer."
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed on for the
Company by Gray Cary Ware & Freidenrich, a professional corporation, San Diego,
California as Counsel to the Company in connection with this Offering. Piper &
Marbury, L.L.P. has acted as special Maryland counsel to the Company. Certain
tax matters will be passed on by Jeffers, Wilson, Shaff & Falk, LLP, Irvine,
California as Special Tax Counsel
79
<PAGE> 81
to the Company in connection with this Offering. Certain legal matters will be
passed on for the Underwriters by O'Melveny & Myers LLP, San Francisco,
California. Counsel to the Company, Special Tax Counsel and O'Melveny and Myers
LLP have relied as to all matters of Maryland law on the opinion of special
Maryland counsel to the Company.
EXPERTS
The financial statements of American Residential Investment Trust, Inc. as
of June 30, 1997, and for the period from February 11, 1997 (commencement of
operations) through June 30, 1997, have been included herein in reliance on the
report of KPMG Peat Marwick LLP, independent auditors, appearing elsewhere
herein, and upon the authority of said firm as experts in accounting and
auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C. 20549, a Registration Statement on Form S-11
under the Securities Act of 1933, as amended, with respect to the Common Stock
offered hereby. This Prospectus does not contain all the information set forth
in the Registration Statement and the exhibits and schedules thereto. For
further information with respect to the Company and such Common Stock, reference
is made to the Registration Statement and the exhibits and schedules filed as
part thereof. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and, in
each instance, if such contract or document is filed as an exhibit, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each statement being qualified in all respects by such
reference to such exhibit. The Registration Statement, including exhibits and
schedules thereto, may be inspected without charge at the Commission's principal
office in Washington, D.C., and copies of all or any part thereof may be
obtained from such office after payment of fees prescribed by the Commission.
The Commission maintains a Website that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission. The address of the site is http://www.sec.gov.
80
<PAGE> 82
GLOSSARY
As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.
"AGENCY SECURITIES" means adjustable-rate mortgage participation
certificates issued by FNMA, FHLMC or GNMA. These securities entitle the holder
to receive a pass-through of principal and interest payments on the underlying
pool of Mortgage Loans and are issued or guaranteed by federal government
sponsored agencies.
"CAPITAL CUSHION" is a term defined in the Company's Capital Policy. It
represents the amount assigned to each Mortgage Asset which is adjusted based
upon the Company's assessment of the risk of delinquency, default or loss on
such Mortgage Asset.
"CAPITAL POLICY" means the policy established by the Company which limits
Management's ability to acquire additional assets during such times that the
actual capital base of the Company is less than a required amount defined in the
policy. The required amount is the sum of the haircuts required by the Company's
secured lenders (the required haircut) and the additional capital levels called
for under the policy which are determined with reference to the various risks
inherent in the Company's Mortgage Assets (the liquidity capital cushion).
"CODE" means the Internal Revenue Code of 1968, as amended.
"CORRESPONDENTS" means entities which originate Mortgage Loans for resale
to the Company. The Company's Correspondents may include mortgage banks, savings
and loans, credit unions, commercial banks, institutional mortgage brokers' and
other entities.
"COUPON RATE" means, with respect to Mortgage Assets, the annualized cash
interest income actually received from the asset, expressed as a percentage of
the face value of the asset.
"EARNING ASSETS" means the Company's Mortgage Assets and cash balances.
"EQUITY-FUNDED LENDING" means the portion of the Company's earning assets
acquired using the Company's equity capital.
"FEDERAL FUNDS RATE" means the interest rate that is charged by banks with
excess reserves at a Federal Reserve District Bank to banks needing the money to
meet reserve requirements. The Federal Funds Effective Rate is the average rate
that fed funds were traded at over the course of a day. The Fed will act to
ensure that the Fed Funds rate trades within a range of its Fed Funds Target
Rate, which is set at the FOMC meetings.
"FHA" means the United States Federal Housing Administration.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FNMA" means the Federal National Mortgage Association.
"FULLY-INDEXED RATE" means, with respect to adjustable-rate Mortgage
Assets, the rate that would be paid by the borrower ("GROSS") or received by the
Company as owner of the Mortgage Asset ("NET") if the coupon rate on the
adjustable-rate Mortgage Assets were able to adjust immediately to a market rate
without being subject to adjustment periods, periodic caps, or life caps. It is
equal to the current yield of the adjustable-rate Mortgage Assets index plus the
gross or net margin.
"GAAP" means generally accepted accounting principles.
"GNMA" means the Government National Mortgage Association.
"GROSS ASSETS" means for any month the aggregate book value of the
consolidated assets of the Company and its subsidiaries, before reserves for
depreciation or bad debts or other similar noncash reserves, computed at the end
of such month prior to any dividend distribution made during each month.
"HAIRCUT" means the percentage by which the market value of the pledged
collateral is required by a lender to exceed the borrowing amount in connection
with a collateralized borrowing.
81
<PAGE> 83
"INTEREST RATE ADJUSTMENT INDICES" means, in the case of Mortgage Assets,
any of the objective indices based on the market interest rates of a specified
debt instrument (such as United States Treasury Bills in the case of the
Treasury Index and United States dollar deposits in London in the case of LIBOR)
or based on the average interest rate of a combination of debt instruments (such
as the 11th District Cost of Funds Index), used as a reference base to reset the
interest rate for each adjustment period on the Mortgage Asset, and in the case
of borrowings, is used herein to mean the market interest rates of a specified
debt instrument (such as reverse repurchase agreements for Mortgage Securities)
as well as any of the objective indices described above that are used as a
reference base to reset the interest rate for each adjustment period under the
related borrowing instrument.
"INTEREST RATE ADJUSTMENT PERIOD" means, in the case of Mortgage Assets,
the period of time set forth in the debt instrument that determines when the
interest rate is adjusted and, with respect to borrowings, is used to mean the
term to maturity of a short-term, fixed-rate debt instrument (such as a 30-day
reverse repurchase agreement) as well as the period of time set forth in a
long-term, adjustable-rate debt instrument that determines when the interest
rate is adjusted.
"LIBOR" means London Inter-bank Offered Rate as it may be defined, and for
a period of time specified, in a Mortgage Asset or borrowing of the Company.
"LIFETIME INTEREST RATE CAP" or "LIFE CAP" means the maximum coupon rate
that may accrue during any period over the term of an adjustable-rate Mortgage
Loan or, in the case of a Mortgage Security, the maximum weighted average coupon
rate that may accrue during any period over the term of such Mortgage Security.
"LIQUIDITY CAPITAL CUSHION" is a term defined in the Company's Capital
Policy. It represents a portion of the capital the Company is required to
maintain as part of this policy in order to continue to make asset acquisitions.
The liquidity capital cushion is that part of the required capital based which
is in excess of the Company's haircut requirements.
"MORTGAGE ASSETS" means Mortgage Securities and Mortgage Loans.
"MORTGAGE LOANS" means adjustable-rate mortgage loans secured by
residential or mixed use properties.
"MORTGAGE SECURITIES" means Agency Securities and Privately Issued
Securities.
"NONCONFORMING MORTGAGE LOANS" means conventional single-family and
multifamily Mortgage Loans that do not conform to one or more requirements of
FHLMC or FNMA for participation in one or more of such agencies' mortgage loss
credit support programs.
"PERIODIC INTEREST RATE CAP" or "PERIODIC CAP" means the maximum change in
the coupon rate permissible under the terms of the loan at each coupon
adjustment date. Periodic caps limit both the speed by which the coupon rate can
adjust upwards in a rising interest rate environment and the speed by which the
coupon rate can adjust downwards in a falling rate environment.
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<PAGE> 84
"PRIVATELY ISSUED SECURITIES" means adjustable-rate mortgage participation
certificates issued by certain private institutions. These securities entitle
the holder to receive a pass-through of principal and interest payments on the
underlying pool of Mortgage Loans and are issued or guaranteed by the private
institution.
"REIT" means Real Estate Investment Trust.
"REIT PROVISIONS OF THE CODE" means sections 856 through 860 of the Code.
"REMIC" means Real Estate Mortgage Investment Conduit.
"REVERSE REPURCHASE AGREEMENT" means a borrowing device evidenced by an
agreement to sell securities or other assets to a third-party and a simultaneous
agreement to repurchase them at a specified future date and price, the price
difference constituting the interest on the borrowing.
"SPREAD LENDING" means the portion of the Company's earning assets acquired
using borrowed funds.
"TEN YEAR U.S. TREASURY RATE" for a quarterly period shall mean the
arithmetic average of the weekly per annum Ten Year Average Yields published by
the Federal Reserve Board during such quarter. In the event that the Federal
Reserve Board does not publish a weekly per annum Ten Year Average Yield during
any week in a quarter, then the Ten Year U.S. Treasury Rate for such week shall
be the weekly per annum Ten Year Average Yields published by any Federal Reserve
Bank or by any U.S. Government department or agency selected by the Company for
such week. In the event that the Company determines in good faith that for any
reason the Company cannot determine the Ten Year U.S. Treasury Board for any
quarter as provided above, then the Ten Year U.S. Treasury Rate for such quarter
shall be the arithmetic average of the per annum average yields to maturity
based upon the daily closing bids during such quarter for each of the issues of
actively traded marketable U.S. Treasury fixed interest rate securities (other
than securities which can, at the option of the holder, be surrendered at face
value in payment of any federal estate tax) with a final maturity date not less
than eight (8) nor more than twelve (12) years from the date of each such
quotation, as chosen and for each business day (or less frequently if daily
quotations shall not be generally available) in each such quarterly period in
New York City and quoted to the Company by at least three (3) recognized dealers
in U.S. Government securities selected by the Company.
"VA" means the United States Department of Veterans Affairs.
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<PAGE> 85
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors......................................................... F-2
Balance Sheet.......................................................................... F-3
Statement of Operations................................................................ F-4
Statement of Stockholders' Equity...................................................... F-5
Statement of Cash Flows................................................................ F-6
Notes to Financial Statements.......................................................... F-7
</TABLE>
F-1
<PAGE> 86
When the transaction referred to in Note 8 of the Notes to Financial
Statements has been consummated, we will be in a position to render the
following report.
/s/ KPMG Peat Marwick LLP
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
American Residential Investment Trust, Inc.
Del Mar, California:
We have audited the accompanying balance sheet of American Residential
Investment Trust, Inc. (the Company) as of June 30, 1997 and the related
statements of operations, stockholders' equity and cash flows for the period
from February 11, 1997 (commencement of operations) through June 30, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of June 30,
1997, and the results of its operations and its cash flows for the period from
February 11, 1997 (commencement of operations) through June 30, 1997 in
conformity with generally accepted accounting principles.
San Diego, California
July 16, 1997, except as to Note 8 to the financial statements,
which is as of , 1997.
F-2
<PAGE> 87
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, 1997
-------------
<S> <C>
Cash and cash equivalents....................................................... $ 127
Mortgage Assets available-for-sale.............................................. 228,620
Interest rate agreements........................................................ 502
Accrued interest receivable..................................................... 2,259
Other assets.................................................................... 10
--------
231,518
========
LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES
Reverse repurchase agreements................................................... $ 209,539
Accrued interest payable........................................................ 1,088
Accrued expense and other liabilities........................................... 215
Management fee payable.......................................................... 73
--------
Total liabilities..................................................... 210,915
========
Commitments and contingencies (Note 10)
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share; 1,000,000 shares authorized; no
shares issued and outstanding................................................. $ --
Common Stock, par value $.01 per share; 3,000,000 shares authorized; 1,614,000
shares issued and outstanding................................................. $ 16
Additional paid-in capital...................................................... 20,149
Cumulative dividends declared................................................... (146)
Retained earnings............................................................... 584
--------
Total stockholders' equity............................................ $ 20,603
--------
$ 231,518
========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 88
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
FOR THE PERIOD
FEBRUARY 11, 1997
(COMMENCEMENT OF
OPERATIONS) THROUGH
JUNE 30, 1997
-------------------
<S> <C>
INTEREST INCOME
Mortgage Assets........................................................... $ 3,489
Cash and investments...................................................... 151
------
3,640
INTEREST EXPENSE............................................................ 2,916
------
NET INTEREST INCOME......................................................... 724
OTHER EXPENSES
Management fee............................................................ 69
General and administrative expenses....................................... 71
------
140
------
NET INCOME.................................................................. $ 584
======
NET INCOME PER SHARE OF COMMON STOCK........................................ $ 0.35
Dividends per share of Common Stock......................................... $ 0.09
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 89
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE
------------------ PAID-IN DIVIDENDS RETAINED
SHARES AMOUNT CAPITAL DECLARED EARNINGS TOTAL
--------- ------ ---------- ---------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Initial Capital Contribution,
February 11, 1997................... 1,614,000 $ 16 $ 20,149 $ -- $ -- $20,165
--------- --- ------- ----- ---- -------
Net income............................ -- -- -- -- 584 584
Dividends declared.................... -- -- -- (146) -- (146)
--------- --- ------- ----- ---- -------
Balance, June 30, 1997................ 1,614,000 $ 16 $ 20,149 $ (146) $ 584 $20,603
--------- --- ------- ----- ---- -------
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 90
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
FOR THE PERIOD
FEBRUARY 11, 1997
(COMMENCEMENT OF
OPERATIONS) THROUGH
JUNE 30, 1997
-------------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................ $ 584
Adjustments to reconcile net income to net cash used in operating
activities:
Amortization of mortgage assets premiums............................... 528
Amortization of interest rate cap agreements........................... 40
Increase in accrued interest receivable................................ (2,259)
Increase in other assets............................................... (10)
Increase in accrued interest payable................................... 1,088
Increase in accrued expenses........................................... 288
----------
Net cash provided by operating activities......................... 259
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of Mortgage Assets available-for-sale........................... (239,555)
Principal payments on Mortgage Assets available-for-sale.................. 10,407
Purchase of interest rate cap agreements.................................. (542)
----------
Net cash used in investing activities............................. (229,690)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements......................... 209,539
Net proceeds from stock issuance.......................................... 20,165
Dividends paid............................................................ (146)
----------
Net cash provided by financing activities......................... 229,558
Net increase in cash and cash equivalents................................... 127
Cash and cash equivalents at beginning of period............................ --
----------
Cash and cash equivalents at end of period.................................. $ 127
==========
Supplemental Information
Interest Paid............................................................. $ 1,828
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 91
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
American Residential Investment Trust, Inc. (the "Company"), a newly formed
Maryland corporation, commenced operations on February 11, 1997. The Company was
formed through a private equity funding from its manager, Home Asset Management
Corporation (the "Manager"). The Company operates as a mortgage real estate
investment trust which will elect to be taxed as a real estate investment trust
("REIT") for Federal income tax purposes, which generally will allow the Company
to pass through income to stockholders without payment of corporate level
federal income tax. The Company was formed for the purpose of investing in
residential adjustable-rate mortgage-backed securities and Mortgage Loans. The
Company has developed tailored mortgage loan products for Mortgage Loans to be
originated by and acquired directly from correspondents. The Company finances
its acquisitions of Mortgage Assets with equity and secured borrowings.
Basis of Financial Statement Presentation
The preparation of financial statements in conformity with 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 report amounts of revenue and expenses during the reported
period. Actual results could differ from those estimates.
A summary of the Company's significant accounting policies follows:
Cash and Cash Equivalents
For purposes of the statement of cash flows, cash and cash equivalents
include cash on hand and highly liquid investments with original maturities of
three months or less.
Mortgage Assets
The Company's Mortgage Assets consist of interests in Mortgage Loans which
have been securitized by others prior to acquisition by the Company.
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to
classify its investments as either trading investments, available-for-sale
investments or held-to-maturity investments. Although the Company generally
intends to hold most of its Mortgage Assets until maturity, it may, from time to
time, sell any of its Mortgage Assets as part of its overall management of its
balance sheet. Accordingly, this flexibility requires the Company to classify
all of its Mortgage Assets as available-for-sale. All Mortgage Assets classified
as available-for-sale are reported at fair value, with unrealized gains and
losses excluded from earnings and reported as a separate component of
stockholders' equity.
Unrealized losses on Mortgage Assets that are considered other than
temporary, as measured by the amount of decline in fair value attributable to
factors other than temporary, are recognized in income and the cost basis of the
Mortgage Asset is adjusted. Other than temporary unrealized losses are based on
management's assessment of various factors affecting the Mortgage Assets.
Interest income is accrued based on the outstanding principal amount of the
Mortgage Assets and their contractual terms. Premiums relating to Mortgage
Assets are amortized into interest income over the lives of
F-7
<PAGE> 92
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
the Mortgage Assets using the interest method. Gains or losses on the sale of
Mortgage Assets are based on the specific identification method.
Interest Rate Agreements
The rate the Company pays on its short-term and variable borrowings will
rise and fall without limit as short-term market interest rates fluctuate. The
rate the Company earns on its adjustable rate Mortgage Assets, however, is
limited by periodic and lifetime caps. The cap agreements, in effect, reduce the
effect of the lifetime cap feature so that the yield on the adjustable-rate
Mortgage Securities will continue to rise in high interest rate environments as
the Company's cost of borrowings also continue to rise.
Under the Company's hedging policy the Company does not hedge specific
Mortgage Assets or liabilities, but rather the Company hedges the risk of
overall limitations to its interest income. Interest Rate Agreements, which
include interest rate cap agreements (the "Cap Agreements"), entered into by the
Company are intended to provide income throughout their effective period to
offset potential reduced net interest income under certain rising interest rate
scenarios. The Company periodically evaluates the effectiveness of these hedges
under various interest rate scenarios.
The Company has interest rate agreements which are carried at amortized
cost. The cost of the agreements are amortized over the life of the interest
rate agreements using the straight-line method.
The premium is amortized, or expensed, over the lives of the Cap
Agreements. The Company has credit risk to the extent counterparties to the Cap
Agreements do not perform their obligations under the Cap Agreements. In order
to lessen this risk and to achieve competitive pricing, the Company has entered
into Cap Agreements only with counterparties which are investment grade rated.
Gains and losses on early termination of Interest Rate Agreements, if any, are
amortized as an expense over the remaining term of the original Interest Rate
Agreement, or, if shorter, over the remaining term of associated Mortgage Assets
as adjusted for estimated future principal prepayments.
Unrealized losses on Interest Rate Agreements that are considered other
than temporary are recognized in income and the cost basis of the Interest Rate
Agreement is adjusted. The other than temporary decline is measured as the
amount of the decline in fair value attributable to factors that are other than
temporary. Other than temporary unrealized losses are based on management's
assessment of various factors affecting the interest rate agreements; primarily,
a deterioration of the ability of the counterparty to perform under the terms of
the interest rate agreement.
Income Taxes
The Company has elected to be taxed as a REIT and intends to comply with
the REIT Provisions of the Internal Revenue Code (the "Code") and the
corresponding provisions of State law. Accordingly, the Company will not be
subject to Federal or state income tax to the extent of its distributions to
stockholders. In order to maintain its status as a REIT, the Company is
required, among other requirements, to distribute at least 95% of its taxable
income.
Earnings per Share
Earnings per share are based on the weighted average shares of Common Stock
outstanding plus common equivalent shares outstanding for the period. The
treasury stock method calculation assumes all dilutive stock options and
Warrants are exercised and the funds generated by the exercise are used to buy
back outstanding
F-8
<PAGE> 93
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
Common Stock at the average market price during the reporting period, for
primary earnings per share, or at the end of period market price if higher, for
fully diluted earnings per share.
Recent Accounting Developments
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 125 (SFAS 125), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,"
which supersedes SFAS 122. SFAS 125 provides accounting and reporting standards
for transfers and servicing of financial assets and extinguishments of
liabilities. These standards are based on consistent application of a financial
components approach that focuses on control. Under that approach, after a
transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and the liabilities it has incurred, derecognizes financial
assets when control has been surrendered and derecognizes liabilities when
extinguished. SFAS 125 provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. SFAS 125 requires that liabilities and derivatives incurred or
obtained by transferors as part of a transfer of financial assets be initially
measured at fair value, if practicable. It also requires that servicing assets
and other retained interests in the transferred assets be measured by allocating
the previous carrying amount between the assets sold, if any, and retained
interests, if any, based on their relative fair values at the date of the
transfers. SFAS 125 includes specific provisions to deal with servicing assets
or liabilities. SFAS 125 will be effective for transactions occurring after
December 31, 1996, except for certain transactions which according to Statement
of Financial Accounting Standards No. 127, "Deferral of the Effective Date of
Certain Provisions of FASB 125," will be effective if occurring after December
31, 1997.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("SFAS 128"). "Earnings per Share",
SFAS 128 supersedes APB Opinion No. 15 ("APB 15"), "Earnings per Share" and
specifies the computation, presentation and disclosure requirements for earnings
per share ("EPS") for entities with publicly held common stock or potential
common stock. SFAS 128 will replace the presentation of primary EPS with a
presentation of basic EPS, and fully diluted EPS with diluted EPS. SFAS 128 will
also require dual presentation of basic and diluted EPS on the face of the
income statement for all entities with complex capital structures and requires a
reconciliation of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS computation. This statement is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods; earlier application is not permitted. The
Company has determined that this statement will have no significant impact on
the Company's financial position or results of operations.
NOTE 2. MORTGAGE ASSETS
At June 30, 1997, Mortgage Assets consisted of the following Agency
Securities available-for-sale:
<TABLE>
<CAPTION>
FEDERAL HOME FEDERAL NATIONAL
LOAN MORTGAGE MORTGAGE
CORPORATION ASSOCIATION TOTAL
------------- ---------------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Mortgage Securities available-for-sale, principal....... $ 132,818 $ 87,571 $220,389
Unamortized premium..................................... 4,701 3,530 8,231
-------- ------- --------
Amortized cost.......................................... $ 137,519 $ 91,101 $228,620
======== ======= ========
</TABLE>
F-9
<PAGE> 94
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
At June 30, 1997, all investments in Mortgage Assets consisted of interests
in adjustable rate Mortgage Loans on residential properties. The securitized
interests in pools of adjustable rate mortgages from the Federal Home Loan
Mortgage Corporation and the Federal National Mortgage Association are
guaranteed as to principal and interest. The original maturity of the vast
majority of the Mortgage Assets is over a period of thirty years; the actual
maturity is subject to change based on the prepayments of the underlying
mortgage loans.
At June 30, 1997, the weighted average net coupon on the Mortgage Assets
was 7.78% per annum based on the amortized cost of the assets. All Mortgage
Assets have repricing frequency of one year or less. At June 30, 1997, the
estimated fair value of Mortgage Assets approximated amortized cost.
NOTE 3. INTEREST RATE AGREEMENTS
The amortized cost of the Company's interest rate agreements was $502,000,
net of accumulated amortization of $40,000, at June 30, 1997.
Cap Agreements
The Company had twelve outstanding cap agreements at June 30, 1997.
Potential future earnings from each of these Cap Agreements are based on
variations in the London Interbank Offered Rate ("LIBOR"). The Cap Agreements at
June 30, 1997 have contractually stated notional amounts which vary over the
life of the Cap Agreements. Under these Cap Agreements the Company will receive
cash payments should the agreed-upon reference rate, one month LIBOR, increase
above the strike rates of the Cap Agreements.
All of the adjustable-rate Mortgage Securities and Mortgage Loans are
limited by periodic caps (generally interest rate adjustments are limited to no
more than 1% every six months) and lifetime interest rate caps. At June 30, 1997
the weighted average lifetime cap was 10.324%.
Cap agreements outstanding at June 30, 1997 are as follows:
<TABLE>
<CAPTION>
AVERAGE CAP EXPECTED
NOTIONAL FACE AVERAGE CAP LOW CAP HIGH CAP CAP EXPENSE
YEAR AMOUNT STRIKE RATE STRIKE RATE STRIKE RATE AMORTIZATION
- --------------------------------------- ------------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1997................................... $ -- 0% 0% 0% $ 132
1998................................... 133,903 8.11 7.52 9.95 182
1999................................... 121,284 8.11 7.52 9.95 182
2000................................... 93,179 8.11 7.52 9.95 46
----
Total........................ $ 542
====
</TABLE>
NOTE 4. REVERSE REPURCHASE AGREEMENTS
The Company has entered into reverse repurchase agreements ("Borrowings")
to finance the acquisition of its Mortgage Assets. The maximum aggregate
available under the reverse repurchase agreements at June 30, 1997 is $500
million. These Borrowings are collateralized by a portion of the Company's
Mortgage Assets. At no time were there more than approximately 45% of the
Borrowings with any one investment banking firm. At June 30, 1997, Mortgage
Assets pledged had an estimated fair value of approximately $221 million.
F-10
<PAGE> 95
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
At June 30, 1997, the Company had approximately $210 million of Borrowings
outstanding with a weighted average borrowing rate of 5.69% and a weighted
average remaining maturity of 62 days. The maximum month end balance and the
average balance outstanding for the period February 11, 1997 through June 30,
1997, was $210 million and $151.3 million, respectively. At June 30, 1997, the
Borrowings had the following characteristics:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
----------------------------------------------------------------------
REVERSE
REPURCHASE UNDERLYING WEIGHTED AVERAGE WEIGHTED AVERAGE
LIABILITY COLLATERAL INTEREST RATE MATURITY DATE
---------- ---------- ---------------- -------------------
<S> <C> <C> <C> <C>
PaineWebber...................... $ 21,984 $ 22,588 5.60% July 21, 1997
Morgan Stanley................... 32,012 33,955 5.90 October 6, 1997
Goldman Sachs.................... 85,577 91,863 5.69 September 17, 1997
Freddie Mac...................... 34,316 36,193 5.65 August 21, 1997
Lehman Brothers.................. 35,650 35,980 5.60 July 26, 1997
-------- -------- ----
$209,539 $220,579 5.69% August 31, 1997
======== ======== ====
</TABLE>
NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments as of June 30, 1997, is made in accordance with the requirements of
Statement of Financial Accounting Standards ("SFAS") No. 107, Disclosure About
Fair Value of Financial Instruments, and SFAS 119, Disclosures About Derivative
Financial Instruments and Fair Value of Financial Instruments. The estimated
fair value amounts have been determined by the Company's management using
available market information and appropriate valuation methodologies; however,
considerable judgment is necessarily require to interpret market data to develop
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
<TABLE>
<CAPTION>
AS OF
JUNE 30, 1997
---------------------
CARRYING FAIR
AMOUNT VALUE
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Assets
Cash and cash equivalents............................ $ 127 $ 127
Mortgage Assets available-for-sale................... 228,620 228,620
Interest rate agreements.......................... 502 206
Liabilities
Reserve repurchase agreements........................ $209,539 $209,539
</TABLE>
The following describes the methods and assumptions used by the Company in
estimating fair values.
Cash and Cash Equivalents
The carrying amount for cash and cash equivalents approximates fair value
because these instruments are demand deposits and money market mutual funds and
do not present unanticipated interest rate or credit concerns.
F-11
<PAGE> 96
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
Mortgage Assets Available-for-Sale
The fair value of Mortgage Assets available-for-sale is estimated based on
quoted market prices from dealers and brokers for similar types of Mortgage
Securities.
Interest Rate Agreements
The fair value of interest rate agreements is estimated based on quoted
market prices from dealers and brokers.
Reverse Repurchase Agreements
The fair value of reverse repurchase agreements approximates the carrying
amounts because of the short term maturity of the liabilities.
NOTE 6. STOCK OPTION PLANS
The Company has adopted the 1997 Stock Incentive Plan (the "Incentive
Plan") and the 1997 Stock Option Plan (the "Option Plan") for executive officers
and key employees and has adopted the 1997 Outside Directors Option Plan (the
"Directors Plan") for directors who are not employees of the Company.
The Incentive Plan, the Option Plan and the Directors Plan authorize the
Board of Directors (or a committee appointed by the Board of Directors) to grant
incentive stock options ("ISOs"), as defined under section 422 of the Code,
options not so qualified ("NQSOs"), and stock appreciation rights ("Awards") to
such eligible recipients.
The Incentive Plan was adopted on February 11, 1997 (the "Effective Date"),
and a total of 315,200 shares of Common Stock have been reserved for issuance
under the Incentive Plan. During the period ended June 30, 1997, the Company
granted 315,200 options at an exercise price of $12.50 per share, 216,000 of
which were NQSOs and 99,200 of which were ISOs. All stock options granted under
the Incentive Plan vest the earlier of a four year period from the date of grant
or once the Company issues $150 million of new equity, and will expire within
ten years after the date of grant. As of June 30, 1997, the Company also granted
280,000 stock appreciation rights at an exercise price of $12.50 per share.
Stock appreciation rights were granted in tandem with options.
The Board of Directors has reserved a total of 374,800 and 60,000 shares of
Common Stock for issuance under the Company's Stock Option Plan and Directors
Plan, respectively. Upon the closing of the Company's initial public offering
(the "Offering"), options for 212,800 shares of Common Stock are reserved for
issuance and 162,000 shares of Common Stock will remain available for future
grant under the Option Plan. On the effective date of the Offering, each Outside
Director will be granted under the Directors Plan an option to purchase 7,500
shares of Common Stock.
In November 1995, the FASB issued Statement of Financial Accounting
Standards No. 123 (SFAS 123), "Accounting for Stock Based Compensation." This
statement establishes financial accounting standards for stock-based employee
compensation plans. SFAS 123 permits the Company to choose either a new fair
value based method or the current APB Opinion 25 Intrinsic value based method of
accounting for its stock-based compensation arrangements. SFAS 123 requires pro
forma disclosures of net income (loss) computed as if the fair value based
method had been applied in financial statements of companies that continue to
follow current practice in accounting for such arrangements under Opinion 25.
SFAS 123 applies to all stock-based employee compensation plans in which an
employer grants shares of its stock or other equity instruments to
F-12
<PAGE> 97
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
employees except for employee stock ownership plans. SFAS 123 also applies to
plans in which the employer incurs liabilities to employees in amounts based on
the price of the employer's stock, i.e., stock option plans, stock purchase
plans, restricted stock plans, and stock appreciation rights. The statement also
specifies the accounting for transactions in which a company issues stock
options or other equity instruments for services provided by nonemployees or to
acquire goods or services from the outside suppliers or vendors.
The Company elected to apply the APB Opinion 25 in accounting for its Plan
and, accordingly, no compensation cost has been recognized for its stock options
in the financial statements. Had the Company determined compensation cost based
on the fair value at the grant date for its stock options exercisable under SFAS
No. 123, the Company's net income and income per share for the period February
11, 1997 (commencement of operations) through June 30, 1997 would have decreased
to the pro forma amounts indicated below.
<TABLE>
<CAPTION>
FOR THE PERIOD FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
--------------------------------
(IN THOUSANDS EXCEPT SHARE DATA)
<S> <C>
Net income as reported............................................. $ 584
-----
Pro forma net income............................................... $ 47
-----
Income per share as reported....................................... $ 0.35
-----
Pro forma income per share......................................... $ 0.03
-----
</TABLE>
The derived fair value of the options granted during the period February
11, 1997 (commencement of operations) through June 30, 1997 was approximately
$1.9 million, using the Black-Scholes option pricing model with the following
assumptions; risk-free interest rate of 6.0%, expected life of 10 years, and
expected volatility of 20%.
NOTE 7. STOCKHOLDERS' EQUITY
On February 11, 1997, the Company issued 1,614,000 shares of Common Stock
at a price of $12.50 per share. The Company received proceeds of $20,165,000,
net of issuance costs of $10,000.
On July 17, 1997, the Company declared a dividend of $438,000, or $0.26 per
common share. This dividend was paid on July 17, 1997 to holders record of
Common Stock as of June 30, 1997. On May 1, 1997, the Company declared a
dividend of $146,000, or $0.09 per share of Common Stock. This dividend was paid
on May 1, 1997 to common stockholders of record as of March 31, 1997.
NOTE 8. STOCK SPLIT AND AUTHORIZED SHARES
On August 6, 1997, the Company authorized a 0.8-for-one reverse stock split
of all of the Common Stock. All references in the financial statements to the
number of shares, per share amounts and prices of the Company's Common Stock
have been retroactively restated to reflect the decreased number of shares of
Common Stock outstanding. Prior to the effective date of the Offering, the
Company will increase the number of total authorized Capital Stock shares to
25,000,000 from 4,000,000.
NOTE 9. MANAGEMENT AGREEMENT
Effective February 11, 1997, the Company entered into a Management
Agreement with the Manager for an initial term of two years, to provide
management services to the Company. These services include the purchase,
financing, and administration of Mortgage Loans and Mortgage Securities.
F-13
<PAGE> 98
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
The Manager receives an annual base management fee payable monthly in
arrears of an amount equal to (1) 3/8 of 1% of gross assets of the Company other
than Agency Certificates plus (2) 1/8 of 1% of gross assets composed of Agency
Certificates. A base management fee expense of $69,000 was recorded for the
period from February 11, 1997 (commencement of operations) through June 30,
1997.
The Manager is also entitled to receive as incentive compensation for each
fiscal quarter, an amount equal to 25% of the Net Income of the Company for such
quarter, before deduction of such incentive compensation, in excess of the
amount that would produce an annualized Return on Equity equal to the Ten Year
U.S. Treasury Rate plus 2%. The incentive compensation is calculated for each
fiscal quarter, and paid to the Manager quarterly in arrears before any income
distributions are made to stockholders. No incentive compensation was recorded
for the period from February 11, 1997 (commencement of operation) to June 30,
1997.
NOTE 10. COMMITMENTS AND CONTINGENCIES
As of June 30, 1997, the Company had no outstanding commitments to purchase
or sell Mortgage Assets or to purchase, sell or terminate Interest Rate
Agreements. The Company also had no commitments to enter into additional reverse
repurchase agreements or other borrowings.
F-14
<PAGE> 99
======================================================
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND REPRESENTATION
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE
UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT
RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION
OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary..................... 3
Risk Factors........................... 11
The Company............................ 20
Use of Proceeds........................ 20
Dividend Policy and Distributions...... 21
Dividend Reinvestment Plan............. 21
Capitalization......................... 22
Dilution............................... 23
Selected Financial Data................ 24
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 25
Business............................... 29
Management of the Company.............. 42
The Manager............................ 50
Certain Transactions................... 55
Principal Stockholders................. 59
Description of Capital Stock........... 61
Shares Eligible for Future Sale........ 65
Federal Income Tax Considerations...... 65
ERISA Considerations................... 75
Underwriting........................... 76
Certain Provisions of Maryland Law and
the Company's Charter and Bylaws..... 78
Legal Matters.......................... 80
Experts................................ 81
Additional Information................. 81
Glossary............................... 82
Index to Financial Statements.......... F-1
</TABLE>
UNTIL , ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
======================================================
======================================================
5,000,000 SHARES
[LOGO]
COMMON STOCK
-----------------
PROSPECTUS
-----------------
PAINEWEBBER INCORPORATED
OPPENHEIMER & CO., INC.
EVEREN SECURITIES, INC.
SUTRO & CO. INCORPORATED
, 1997
======================================================
<PAGE> 100
ITEM 30. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the sale of Common Stock being registered. All amounts are estimates except
the SEC registration fee and the New York Stock Exchange ("NYSE") filing fee.
<TABLE>
<CAPTION>
AMOUNT
TO BE
PAID
-----------
<S> <C>
SEC Registration Fee..................................... $ 26,000
NYSE filing fee.......................................... 100,000
Printing and engraving expenses.......................... 125,000
Legal fees and expenses.................................. 350,000
Accounting fees and expenses............................. 125,000
Structuring Fee(1)....................................... 375,000
Blue Sky fees and expenses............................... 5,000
Transfer agent and custodian fees........................ 20,000
Miscellaneous............................................ 74,000
----------
Total.................................................... $ 1,200,000
==========
</TABLE>
- ---------------
(1) $431,250 if the over-allotment option is exercised.
ITEM 32. SALES TO SPECIAL PARTIES
The securities described in Item 33(a) were issued to the Founders of the
Company in exchange for cash.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
(a) Pursuant to the exemption provided by Section 4(2) of the Securities
Act, on February 11, 1997 the Company issued 1,614,000 shares of Common Stock
for an aggregate purchase price of $20,175,000.
(b) Pursuant to the exemption provided by Rule 701 promulgated under the
Securities Act, on February 11, 1997, the Company issued options to purchase
315,200 shares of Common Stock with an exercise price of $12.50 per share.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
As permitted by the Maryland General Corporate Law ("MGCL"), the Company's
Charter obligates the Company to indemnify its present and former directors and
officers and to pay or reimburse reasonable expenses for such individuals in
advance of the final disposition of a proceeding to the maximum extent permitted
from time to time by Maryland law. The MGCL permits a corporation to indemnify
its present and former directors and officers, among others, against judgments,
penalties, fines, settlements and reasonable expenses actually incurred by them
in connection with any proceeding to which they may be made a party by reason of
their service in those or other capacities, unless it is established that (a)
the act or omission of the director or officer was material to the matter giving
rise to such proceeding and (i) was committed in bad faith or (ii) was the
result of active and deliberate dishonesty, (b) the director or officer actually
received an improper personal benefit in money, property or services, or (c) in
the case of any criminal proceeding, the director or officer had reasonable
cause to believe that the act or omission was unlawful. The Bylaws implement the
provisions relating to indemnification contained in the Company's Charter.
Maryland law permits the charter of a Maryland corporation to include a
provision limiting the liability of its directors and officers to the
corporation and its stockholders for money damages, except to the extent that
(i) the person actually received an improper benefit or profit in money,
property or services, or (ii) a judgment or other final adjudication is entered
in a proceeding based on a finding that the person's action, or failure to act,
was the
II-1
<PAGE> 101
result of active and deliberate dishonesty and was material to the cause of
action adjudicated in the proceeding. The Company's Charter contains a provision
providing for elimination of the liability of its directors or officers to the
Company or its stockholders for money damages to the maximum extent permitted by
Maryland law from time to time. In addition, the officers, directors, and
controlling persons of the Company are indemnified against certain liabilities
by the Company under the Underwriting Agreement relating to the Offering. The
Company will maintain for the benefit of its officers and directors, officers'
and directors' insurance.
In addition, the Registrant intends to enter into an Indemnity Agreement
(Exhibit 10.14 hereto) with its officers and Directors. The Underwriting
Agreement (Exhibit 1.1) also provides for indemnification by the Underwriters of
the Company, its Directors and officers and persons who control the Company
within the meaning of Section 15 of the Securities Act with respect to certain
liabilities, including liabilities arising under the Securities Act.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not Applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements included in the Prospectus are:
Balance sheet at June 30, 1997
Statement of Operations for the period from February 11, 1997
(commencement of operations) through June 30, 1997
Statement of Stockholders' Equity for the period from February 11, 1997
(commencement of operations) through June 30, 1997
Statement of Cash Flows for the period from February 11, 1997
(commencement of operations) through June 30, 1997
Notes to financial statements
All schedules have been omitted because they are either not applicable,
not required or the information required has been disclosed in the
financial statements and related notes or otherwise in the Prospectus.
(b) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------------------------
<C> <S>
*1.1 Form of Underwriting Agreement
*3.1 Amended and Restated Articles of Incorporation of the Registrant
*3.2 Amended and Restated Bylaws of the Registrant
*4.1 Registration Rights Agreement dated February 11, 1997.
*5.1 Opinion of Gray Cary Ware & Freidenrich, a Professional Corporation
*5.2 Opinion of Piper & Marbury, LLP
*8.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP
*10.1 Management Agreement between the Registrant and Home Asset Management Corp.
and Amendment thereto
*10.2 Employment and Noncompetition Agreement between Home Asset Management Corp.
dated February 11, 1997 and John Robbins and Amendment thereto
*10.3 Employment and Noncompetition Agreement between Home Asset Management Corp.
and Jay Fuller dated February 11, 1997 and Amendment thereto
</TABLE>
II-2
<PAGE> 102
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------------------------
<C> <S>
*10.4 Mark Conger Employment Letter dated February 11, 1997
*10.5 Rollie Lynn Employment Letter dated February 11, 1997
*10.6 1997 Stock Incentive Plan and forms of option agreement and SAR agreement
*10.7 1997 Employee Stock Option Plan
*10.8 1997 Outside Directors Stock Option Plan
*10.9 Employee Stock Purchase Plan
*10.10 Securities Purchase Agreement between Registrant, Home Asset Management Corp.
and MDC REIT Holdings, LLC dated February 11, 1997
*10.11 Subscription Agreement
*10.12 Line of Credit Agreement dated ,
*10.13 Lease Agreement with Louis and Louis dated March 7, 1997
*10.14 Form of Indemnity Agreement
11.1 Statement of Computations of per share earnings
*23.1 Consent of KPMG Peat Marwick LLP
*23.2 Consent of Gray Cary Ware & Freidenrich (included in Exhibit 5.1)
*23.3 Consent of Piper & Marbury, LLP (included in Exhibit 5.2)
*23.4 Consent of Jeffers, Wilson, Shaff & Falk, LLP (included in Exhibit 8.1)
24.1 Power of Attorney (included on page II-5)
27.1 Financial Data Schedule
99.1 Consents to be named as a director pursuant to Rule 438
</TABLE>
- ---------------
* To be filed by amendment.
ITEM 37. UNDERTAKINGS
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing certificates in such denominations and registered in such names
as required by the Underwriters to permit prompt delivery to each purchaser.
Insofar as indemnification by the Registrant for liabilities arising under
the Securities Act may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions referenced in Item 14 of
this Registration Statement or otherwise, the Registrant has been advised that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act, and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer, or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered hereunder, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
II-3
<PAGE> 103
The undersigned Registrant hereby undertakes:
(1) That for purposes of determining any liability under the
Securities Act, the information omitted from the Prospectus filed as part
of this Registration Statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
For the purpose of determining any liability under the Securities Act, each
post-effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-4
<PAGE> 104
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-11 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereto duly
authorized, in the City of San Diego, State of California, on the 14th day of
August, 1997.
AMERICAN RESIDENTIAL INVESTMENT TRUST,
INC.
By: /s/ JOHN M. ROBBINS
------------------------------------
John M. Robbins
Chairman of the Board and Chief
Executive Officer
We, the undersigned directors and officers of American Residential
Investment Trust, Inc., do hereby constitute and appoint John M. Robbins and
Mark A. Conger, or either of them, our true and lawful attorneys and agents, to
do any and all acts and things in our name and behalf in our capacities as
directors and officers and to execute any and all instruments for us and in our
names in the capacities indicated below, which said attorneys and agents, or
either of them, may deem necessary or advisable to enable said corporation to
comply with the Securities Act of 1933, as amended, and any rules, regulations,
and requirements of the Securities and Exchange Commission, in connection with
this Registration Statement, including specifically, but without limitation,
power and authority to sign for us or any of us in our names and in the
capacities indicated below, any and all amendments (including post-effective
amendment) to this Registration Statement, or any related registration statement
that is to be effective upon filing pursuant to Rule 462(b) under the Securities
Act of 1933, as amended; and we do hereby ratify and confirm all that the said
attorneys and agents, or either of them, shall do or cause to be done by virtue
hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ----------------------------------------------- -------------------------- ----------------
<C> <C> <S>
By: /s/ JOHN M. ROBBINS Chairman of the Board and August 14, 1997
- ----------------------------------------------- Chief Executive Officer
John M. Robbins (Principal Executive
Officer)
By: /s/ MARK A. CONGER Chief Financial Officer August 14, 1997
- ----------------------------------------------- (Principal Financial and
Mark A. Conger Accounting Officer)
By: /s/ JAY M. FULLER Director August 14, 1997
- -----------------------------------------------
Jay M. Fuller
By: /s/ GEORGE MCCOWN Director August 14, 1997
- -----------------------------------------------
George McCown
By: /s/ DAVID DE LEEUW Director August 14, 1997
- -----------------------------------------------
David De Leeuw
</TABLE>
II-5
<PAGE> 105
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ---------------------------------------------------------------------- ------------
<S> <C> <C>
*1.1 Form of Underwriting Agreement
*3.1 Articles of Amendment and Restatement of the Registrant
*3.2 Amended and Restated Bylaws of the Registrant
*4.1 Registration Rights Agreement dated February 11, 1997
*5.1 Opinion of Gray Cary Ware & Freidenrich, a Professional Corporation
*5.2 Opinion of Piper & Marbury, LLP
*8.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP
*10.1 Management Agreement between the Registrant and Home Asset Management
Corp. dated February 11, 1997 and Amendment thereto
*10.2 Employment and Noncompetition Agreement between Home Asset Management
Corp. and John Robbins dated February 11, 1997 and Amendment thereto
*10.3 Employment and Noncompetition Agreement between Home Asset Management
Corp. and Jay Fuller dated February 11, 1997 and Amendment thereto
*10.4 Mark Conger Employment Letter dated February 11, 1997
*10.5 Rollie Lynn Employment Letter dated February 11, 1997
*10.6 1997 Stock Incentive Plan
*10.7 Form of 1997 Stock Option Plan
*10.8 Form of 1997 Outside Directors Stock Option Plan
*10.9 Form of Employee Stock Purchase Plan
*10.10 Securities Purchase Agreement between Registrant, Home Asset
Management Corp. and MDC REIT Holdings, LLC dated February 11, 1997
*10.11 Form of Subscription Agreement dated February 11, 1997
*10.12 Line of Credit Agreement
*10.13 Lease Agreement with Louis and Louis dated March 7, 1997
*10.14 Form of Indemnity Agreement
11.1 Statement of Computations of per share earnings
*23.1 Consent of KPMG Peat Marwick LLP
*23.2 Consent of Gray Cary Ware & Freidenrich (included in Exhibit 5.1)
*23.3 Consent of Piper & Marbury, LLP (included in Exhibit 5.2)
*23.4 Consent of Jeffers, Wilson, Shaff & Falk, LLP (included in Exhibit
8.1)
24.1 Power of Attorney (included on page II-5)
27.1 Financial Data Schedule
99.1 Consents to be named as a director pursuant to Rule 438
</TABLE>
- ---------------
* To be filed by amendment.
<PAGE> 1
EXHIBIT 11.1
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENT REGARDING COMPUTATION OF EARNINGS PER SHARE
(in thousands, except share data)
<TABLE>
<CAPTION>
FOR THE PERIOD
FEBRUARY 11, 1997
(COMMENCEMENT OF
OPERATIONS)
THROUGH
JUNE 30, 1997
----------------
<S> <C>
Net Income Per Share:
Net Income .............................................................. 584
Avg. Number of Shares Outstanding ....................................... 1,614,000
Net effect of dilutive stock options - Based on treasury stock method using
estimated initial public offering price.................................. 52,533
Total average shares ................................................ 1,666,533
Net Income Per Share ................................................ 0.35
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE JUNE 30,
1997 BALANCE SHEET, AND THE STATEMENT OF OPERATIONS FOR THE PERIOD FEBRUARY 11,
1997 (COMMENCEMENT OF OPERATIONS) THROUGH JUNE 30, 1997 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> FEB-11-1997
<PERIOD-END> JUN-30-1997
<CASH> 127
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 228,620
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 0
<ALLOWANCE> 0
<TOTAL-ASSETS> 231,518
<DEPOSITS> 0
<SHORT-TERM> 210,627
<LIABILITIES-OTHER> 288
<LONG-TERM> 0
<COMMON> 20,165
0
0
<OTHER-SE> 438
<TOTAL-LIABILITIES-AND-EQUITY> 231,518
<INTEREST-LOAN> 0
<INTEREST-INVEST> 3,489
<INTEREST-OTHER> 151
<INTEREST-TOTAL> 3,640
<INTEREST-DEPOSIT> 0
<INTEREST-EXPENSE> 2,916
<INTEREST-INCOME-NET> 724
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 140
<INCOME-PRETAX> 584
<INCOME-PRE-EXTRAORDINARY> 584
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 584
<EPS-PRIMARY> 0.35
<EPS-DILUTED> 0.35
<YIELD-ACTUAL> 7.78
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 0
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 0
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<PAGE> 1
EXHIBIT 99.1
CONSENT OF DIRECTOR PURSUANT TO RULE 438
OF THE SECURITIES ACT OF 1933
I hereby consent to serve as a Director of American Residential
Investment Trust, Inc., a Maryland corporation (the "Company"), upon completion
of its initial public offering of Common Stock. I further consent to being named
as a future director of the Company in the Company's Registration Statement on
Form S-11 to be filed with the Securities and Exchange Commission on or about
August 14, 1997.
Dated: August 14, 1997 /s/ Ray McKewon
----------------------- -------------------------------------
Ray McKewon
<PAGE> 2
CONSENT OF DIRECTOR PURSUANT TO RULE 438
OF THE SECURITIES ACT OF 1933
I hereby consent to serve as a Director of American Residential
Investment Trust, Inc., a Maryland corporation (the "Company"), upon completion
of its initial public offering of Common Stock. I further consent to being named
as a future director of the Company in the Company's Registration Statement on
Form S-11 to be filed with the Securities and Exchange Commission on or about
August 14, 1997.
Dated: August 14, 1997 /s/ Richard T. Pratt
----------------------- -------------------------------------
Richard T. Pratt
<PAGE> 3
CONSENT OF DIRECTOR PURSUANT TO RULE 438
OF THE SECURITIES ACT OF 1933
I hereby consent to serve as a Director of American Residential
Investment Trust, Inc., a Maryland corporation (the "Company"), upon completion
of its initial public offering of Common Stock. I further consent to being named
as a future director of the Company in the Company's Registration Statement on
Form S-11 to be filed with the Securities and Exchange Commission on or about
August 14, 1997.
Dated: August 14, 1997 /s/ Mark J. Riedy
----------------------- -------------------------------------
Mark J. Riedy
<PAGE> 4
CONSENT OF DIRECTOR PURSUANT TO RULE 438
OF THE SECURITIES ACT OF 1933
I hereby consent to serve as a Director of American Residential
Investment Trust, Inc., a Maryland corporation (the "Company"), upon completion
of its initial public offering of Common Stock. I further consent to being named
as a future director of the Company in the Company's Registration Statement on
Form S-11 to be filed with the Securities and Exchange Commission on or about
August 14, 1997.
Dated: August 14, 1997 /s/ H. James Brown
----------------------- -------------------------------------
H. James Brown
