<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended: December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___ to ___
Commission File Number: 1-13485
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
(Exact name of Registrant as specified in its Charter)
Maryland 33-0741174
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
445 Marine View Avenue, Suite 230
Del Mar, California 92014
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (619) 350-5000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock ($.01 par value) New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
----- -----
<PAGE> 2
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X ]
At March 3, 1998, the aggregate market value of the voting stock held by
non-affiliates was $77,187,500, based on the closing price of the Common Stock
on the New York Stock Exchange.
As of March 1, 1998, there were 8,114,000 shares of the registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement issued in connection
with the Annual Meeting of Stockholders of the registrant to be held on May 15,
1998, are incorporated herein by reference into Part III.
<PAGE> 3
TABLE OF CONTENTS
PART I
PAGE
<TABLE>
<S> <C>
ITEM 1. BUSINESS........................................................ 1
ITEM 2. PROPERTIES...................................................... 56
ITEM 3. LEGAL PROCEEDINGS............................................... 56
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 56
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.......................... 57
ITEM 6. SELECTED FINANCIAL DATA......................................... 57
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION....................... 60
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET
RISK..................................................................... 63
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................... 63
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..................... 64
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 64
ITEM 11. EXECUTIVE COMPENSATION......................................... 64
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT............................................................... 64
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ................ 65
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K.................................... 65
SIGNATURES
EXHIBIT INDEX
</TABLE>
<PAGE> 4
ITEM 1. BUSINESS
The statements contained in this Form 10-K that are not purely historical are
forward looking statements, including statements regarding the Company's
expectations, hopes, beliefs, intentions, or strategies regarding the future.
Statements which use the words "expects", "will", "may", "anticipates", "goal",
"to be", "intends", "seeks", "strategy" and derivatives of such words are
forward looking statements. These forward looking statements, including
statements regarding changes in the Company's future income, are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward looking statement. It is important to
note that the Company's actual results could differ materially from those in
such forward looking statements. Among the factors that could cause actual
results to differ materially are the factors set forth below under the heading
"Business Risks". In particular, the Company's future income could be affected
by changes in interest rates, changes in levels of prepayments, lack of
available Mortgage Assets which meet the Company's acquisition criteria, the
type of Mortgage Assets acquired by the Company and the credit characteristics
of the borrowers under Mortgage Loans acquired by the Company.
GENERAL
American Residential Investment Trust, Inc. (the "Company") was incorporated in
the State of Maryland on February 6, 1997, and is a real estate investment
trust ("REIT") that invests in residential adjustable-rate Mortgage Securities
and Mortgage Loans (collectively, "Mortgage Assets"). The Company finances its
acquisitions of Mortgage Assets with equity and secured borrowings. The
Company generally earns interest on the portion of its portfolio of Mortgage
Assets financed with equity and earns a net interest spread on the leveraged
portion of its portfolio of Mortgage Assets. The Company is structured as a
real estate investment trust, thereby generally eliminating federal taxes at
the corporate level on income it distributes to stockholders.
The Company has entered into an agreement with Home Asset Management Corp. (the
"Manager") to manage the day-to-day operations of the Company (the "Management
Agreement"). Accordingly, the Company's success depends in significant part on
the Manager. Pursuant to the terms of the Management Agreement, the Manager
advises the Company's Board of Directors with respect to the formulation of
investment criteria and preparation of policy guidelines, and is compensated
based upon the principal amount and type of Mortgage Assets held by the
Company. See "The Management Agreement."
1
<PAGE> 5
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.
The Company believes that the current size of the residential mortgage market
provides the Company with opportunities with respect to the purchase of
Mortgage Assets.
INVESTMENTS
The Company currently acquires adjustable-rate residential Mortgage Securities
in the capital markets and whole Mortgage Loans through bulk purchases from
third parties. The Company also intends to invest in Mortgage Loans acquired
directly from originators through its Freedom Program. See "--Freedom Program."
The Company believes that it can enhance the overall yield of its Mortgage Asset
portfolio by increasingly investing in Mortgage Loans, which generally are
relatively higher yielding than Mortgage Securities.
The Company only acquires those Mortgage Assets which the Company believes it
has the expertise (with the advice of the Manager) to evaluate and manage and
which are consistent with the Company's balance sheet guidelines and risk
management objectives. The Company also considers (i) the amount and nature of
anticipated cash flows from the Mortgage Assets, (ii) the Company's ability to
pledge the Mortgage Assets to secure collateralized borrowings, (iii) the
increase in the Company's capital requirements resulting from the purchase and
financing of the Mortgage Assets, as determined pursuant to the Company's
capital policies, 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 Assets and in a variety of interest
rates, yield spread, financing cost, credit loss, and prepayment scenarios.
The Board of Directors of the Company can revise the Company's investment
policies in its sole discretion, subject to approval by a majority of the
Company's directors who are not employees or officers of the Company. See
"Business Risks - Policies and Strategies May Be Revised at the Discretion of
the Board of Directors."
The Company currently finances acquisitions of Mortgage Assets with short term
borrowings which generally mature in six months or less. Upon maturity, the
Company refinances the Mortgage Assets with new short term borrowings which
then bear interest at the applicable market rate. In the event that the
Company in the future finances acquisitions of Mortgage Assets with long term
borrowings, the Company
2
<PAGE> 6
anticipates that such borrowings will bear interest at rates which also
periodically adjust to the applicable market rate. See "Funding." Accordingly,
the Company's interest expense changes rapidly with changes in the market
interest rates. In order to maintain a margin between the Company's interest
expense and the interest income generated by Mortgage Assets, the Company
generally acquires Mortgage Assets with interest rates that also adjust with
changing market interest rates. Accordingly, the Company expects that
substantially all of the Mortgage Assets acquired by it will be adjustable-rate
rather then fixed-rate Mortgage Assets.
Recent Investment Status
The Company's current investment portfolio is comprised of Mortgage Securities
issued or guaranteed by federal government sponsored agencies ("Agency
Securities") and Mortgage Loans that vary in one or more respects from the
underwriting standards required for participation in FHLMC or FNMA programs
("non-conforming Mortgage Loans"). From the commencement of operations on
February 11, 1997 through December 31, 1997, the Company acquired Mortgage
Assets that had a carrying value at December 31, 1997 of approximately $550
million, consisting of Agency Securities in the amount of $387 million and
Mortgage Loans of $163 million. The original maturity of the 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.
For information regarding the Company's investments as of December 31, 1997,
see Notes 2 and 3 of Notes to Financial Statements.
The Company's Mortgage Securities are securitized interests in pools of
adjustable-rate single family residential Mortgage Loans. Interest and
principal are guaranteed by FNMA or FHLMC. As of December 31, 1997,
approximately 71% of the Company's Mortgage Securities were whole-pool
Mortgage Securities which represent all the certificates issued with respect to
an underlying pool of Mortgage Loans.
The Mortgage Loans held by the Company are non-conforming Mortgage Loans
secured by single family residential properties. The Mortgage Loans are
non-conforming primarily as a result of the credit rating of the borrower and
consist predominantly of "A" and "B" grade Mortgage Loans and to a lesser
extent, "C" and "D" grade Mortgage Loans. See "- Bulk Whole Loan Acquisition
Program." As of March 20, 1998, the Company had acquired Mortgage Loans with
an aggregate carrying value of $381.7 million. The Company expects to acquire
additional Mortgage Loans in the near future.
While the Company does not currently intend to acquire residual interests
issued by REMICs, subordinate interests in Mortgage Securities or interest-only
Mortgage Securities it is not prohibited from doing so under the terms of its
Capital Policy.
3
<PAGE> 7
Residual interests, if acquired by a REIT, would generate excess inclusion
income. See "Federal Income Tax Consequences - Taxation of Stockholders."
Capital Markets Program
The Company has purchased and may continue to purchase Mortgage Securities in
the capital markets. These Mortgage Securities generally have a higher level
of liquidity than the Mortgage Loans currently held by the Company or to be
acquired under the Freedom Program and are expected to provide a relatively
stable flow of interest income with relatively low levels of credit risk
compared to such Mortgage Loans. The Mortgage Securities held by the Company
are backed by a pool of adjustable-rate 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 guaranteed
by federal government sponsored agencies.
Bulk Whole Loan Acquisition Program.
The Company has acquired Mortgage Loans on a bulk basis and may continue to
make bulk acquisitions in the future. All of the Mortgage Loans held by the
Company are non-conforming Mortgage Loans. The Mortgage Loans held by the
Company are Mortgage Loans made to borrowers with credit ratings below the
conforming Mortgage Loan guidelines. In general, the Company places greater
emphasis upon the value of the mortgaged property and, consequently, the
quality of appraisals thereof, and less upon the credit history of the borrower
in underwriting "B" and "C" grade mortgage loans than in underwriting "A" grade
loans. In addition, "B" and "C" grade loans are generally subject to lower
loan-to-value ratios than "A" grade loans. Non-conforming Mortgage Loans
generally are subject to greater frequency of loss and delinquency than
conforming Mortgage Loans. See "Business Risks - Borrower Credit May Decrease
Value of Mortgage Loans." Accordingly, lower credit grade Mortgage Loans
normally bear a higher rate of interest and are subject to higher fees
(including prepayment fees and late payment penalties) than conforming Mortgage
Loans.
Currently, a substantial majority of the Company's Mortgage Loans are "A" and
"B" grade Mortgage Loans, with the balance being comprised of "C" grade and, to
a lesser extent "D" grade Mortgage Loans. The Company grades each Mortgage
Loan based predominantly on the credit rating of the borrower. See
"-Underwriting."
Freedom Program
The Manager intends to leverage the expertise of its executive officers in the
residential Mortgage Loan industry to develop a program for the purchase of
Mortgage Loans by the Company directly from the originators ("Correspondents").
Under the
4
<PAGE> 8
Freedom Program, the Manager will (i) identify segments of the residential
Mortgage Loan market that meet its general criteria for potential originations,
(ii) develop underwriting parameters for Mortgage Loans to be generated in each
market segment, (iii) arrange for the acquisition by the Company of 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. Under the Freedom Program, the
Company expects to acquire mini-bulk packages of Mortgage Loans and individual
Mortgage Loans generated pursuant to the Company's tailored Mortgage Loan
guidelines.
The Manager intends to draw upon the experience of its executive officers 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. The Manager will identify and work
with a number of Correspondents to generate Mortgage Loan products for the
Freedom Program.
The Company anticipates that in the future an increasing portion of its
Mortgage Assets will consist of Mortgage Loans acquired pursuant to the Freedom
Program. However, the Company has only recently begun acquiring Mortgage Loans
under the Freedom Program, and there can be no assurance that the Freedom
Program will be successful or that the Mortgage Loans acquired through the
program will be higher yielding than Mortgage Securities. See "Business Risks
- - Inability to Acquire Mortgage Assets."
Mini-Bulk Loan Acquisitions. Pursuant to the Company's Freedom Program, the
Company intends to acquire packages of Mortgage Loans in aggregate principal
amounts of between $5 million and $30 million. The Mortgage Loans will
generally be non-conforming Mortgage Loans secured by single family residential
properties. The Mortgage Loans are expected to be non-conforming primarily as
a result of the credit rating of the borrower.
Tailored Mortgage Loan Products. Under the Freedom Program, the Manager will
identify market segments of the residential Mortgage Loan market that it
believes 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. The Manager
has identified the following market segments of the residential Mortgage Loan
market for the Company's initial tailored Mortgage Loan products: small
multifamily home Mortgage Loans; manufactured housing Mortgage Loans; mixed use
Mortgage Loans; rural home Mortgage Loans; mini-ranch home Mortgage Loans; and
condominium/resort Mortgage Loans. The
5
<PAGE> 9
Manager expects that new opportunities in other market segments will become
available as the Mortgage Loan market continues to change.
The Mortgage Loan underwriting guidelines for the Company's tailored Mortgage
Loan products set forth the various characteristics (such as combinations of
loan-to value levels and credit ranking of borrowers) for Mortgage Loans that
the Company is prepared to purchase from Correspondents. These Mortgage Loans
generally will be non-conforming, primarily as a result of the property type,
and, to a lesser extent, the borrower's credit characteristics. See "Business
Risks - Borrower Credit May Decrease Value of Mortgage Loans" and
"-Characteristics of Underlying Property May Decrease Value of Mortgage Loans."
Other Products. In addition to the tailored Mortgage Loan products described
above, the Company may also acquire conforming Mortgage Loans and
non-conforming jumbo Mortgage Loans from Correspondents. Conforming Mortgage
Loans meet underwriting guidelines with respect to principal balance, loan
repayment schedule and borrower credit history, as defined by certain
government-sponsored agencies. These Mortgage Loans will consist of (i)
conventional Mortgage Loans that comply with requirements for inclusion in
certain programs sponsored by the FHLMC or FNMA, (ii) Mortgage Loans insured by
the Federal Housing Administration ("FHA") and (iii) 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 non-conforming 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 non-conforming Mortgage Loans
it purchases from Correspondents that are neither mini-bulk acquisitions nor
within the underwriting guidelines of tailored Mortgage Loan products and that
are outside its target market segments will be non-conforming 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 credit rating of
the borrowers.
Mortgage Loan Properties
Although the Company has sought geographic diversification of the properties
which are collateral for the Company's Mortgage Loans, it has not set specific
diversification requirements (whether by state, zip code or other geographic
measure). Concentration in any one area will increase exposure of the
Company's Mortgage Loans to the economic and natural hazard risks associated
with that area. Further, certain properties securing Mortgage Loans may be
contaminated by hazardous substances resulting in reduced property values. If
the Company forecloses on a defaulted Mortgage Loan
6
<PAGE> 10
collateralized by such property, the Company may be subject to environmental
liabilities regardless of whether the Company was responsible for the
contamination. The results of the Company's Mortgage Loan acquisition programs
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 values, (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.
Pricing
Mortgage Loans acquired on a bulk basis have been priced on a negotiated basis
with the sellers. In the future, Mortgage Loans acquired on a bulk or
mini-bulk basis may also be priced pursuant to a bidding process. For tailored
Mortgage Loans to be acquired from Correspondents, the Company expects to
review the prices at which it is purchasing such Mortgage Loans daily with the
Manager and to adjust the prices frequently. 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" or
"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
The Company does not set specific underwriting standards for the acquisition of
Mortgage Loans to be acquired pursuant to bulk purchases. Instead, the Company
reviews the aggregate attributes of a package of Mortgage Loans, as specified
by the Seller of the Mortgage Loans, to determine if the package conforms to
the Company's acquisition criteria. If the Company then elects to purchase a
package of Mortgage Loans, the Company reviews the Mortgage Loan documentation
for conformance to the Seller's specifications. In evaluating a package of
Mortgage Loans to be acquired on a bulk basis, the Company reviews the loan
documentation for between 25% - 100% of the Mortgage Loans to be acquired. To
date, all of the Company's underwriting reviews have been performed by a
nationally recognized third party underwriting review firm. The Company also
obtains representations and warranties from the seller with respect to the
quality and terms of the Mortgage Loans being acquired.
The Company considers a variety of factors in determining whether to acquire a
package of Mortgage Loans. The factors generally considered by the Company
include the credit grade and income history of each borrower, the loan-to-value
ratio for each property, the prepayment penalties for the Mortgage Loans, the
weighted average coupon of the Mortgage Loans and the documentation required
for approval
7
<PAGE> 11
of the Mortgage Loans. The Company may also consider other factors with
respect to any individual package under consideration.
In developing the tailored underwriting guidelines for Mortgage Loans to be
acquired under the Freedom Program, the Manager has created 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"). The Company has not engaged FICO or discussed any
such engagement with 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 and 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.
8
<PAGE> 12
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 dues 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, 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 tailored Mortgage Loans which may be acquired by the
Company under the Freedom Program will be recently developed, they may involve
additional uncertainties not present in traditional types of tailored Mortgage
Loans. The Company expects that these recently developed types of tailored
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 "Business Risks - Borrower Credit May Decrease
Value of Mortgage Loans" and "-Characteristics of Underlying Property May
Decrease Value of Mortgage Loans."
Quality Control
The Manager 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 Mortgage Loans to be acquired will
be conducted to verify the accuracy and completeness of the information
contained in the Mortgage Loan documents, security instruments and other
pertinent documents in the file. A sample of the Mortgage Loans 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
9
<PAGE> 13
Loans with higher risk characteristics. In addition, the Manager expects to
conduct post-acquisition audits to monitor ongoing documentation and servicing
compliance.
Servicing
The Company has acquired Mortgage Loans on both a "servicing released" basis
(i.e., the Company acquired both the Mortgage Loans and the rights to service
them) and on a "servicing retained" basis (i.e. the Company did not acquire the
rights to service the Mortgage Loans). Generally, whether the Mortgage Loans
are acquired on a servicing released or servicing retained basis is determined
pursuant to negotiations with the party selling the Mortgage Loans to the
Company.
The Company has contracted with subservicers to provide servicing for a
percentage of the outstanding mortgage balance and the right to hold escrow
account balances and retain certain ancillary charges. In addition, for a
small percentage of the Mortgage Loans, the Company will pay the subservicer a
fixed dollar fee plus a percentage of the outstanding Mortgage Loan balance and
a percentage of all amounts collected. The Company believes that the
selection of third party sub-servicers was more cost effective than
establishing a servicing department within the Company. However, part of the
Company's responsibility is to continually monitor the performance of the
sub-servicers through monthly performance reviews. Depending on these
sub-servicer reviews, the Company may in the future form a separate collection
group to assist the sub-servicer in the servicing of these loans. The Company
expects to arrange for servicing of the Mortgage Loans with servicing entities
that have particular expertise and experience in the types of Mortgage Loans
being acquired. The Company does not expect to acquire Mortgage Loans
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 thirteen financial institutions consisting primarily of large
investment banking firms. At December 31, 1997, the Company had borrowed funds
under reverse repurchase agreements with seven of these firms. The Company
intends to expand its uncommitted reverse repurchase agreements. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
10
<PAGE> 14
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 the 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 securitizations and, to a lesser extent, through
lines of credit and other financings.
At December 31, 1997, total borrowings outstanding were $451.3 million, with
Mortgage Assets valued at $471.5 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 undertaken pursuant to
reverse repurchase agreements. At December 31, 1997, the weighted average term
to maturity was 39 days and the weighted average borrowing rate was 6.01% per
annum. Under the reverse repurchase agreements outstanding at December 31,
1997, the original aggregate "haircut," or the percentage by which the market
value of the pledged collateral must exceed the borrowing amount, was 5.5%.
The Company anticipates that, upon its repayment of each borrowing, the
collateral will immediately be used for a further borrowing pursuant to a new
reverse repurchase agreement. However, there can be no assurance that the
Company would be able to borrow additional funds.
Currently, the Company's Mortgage Loans are financed by a reverse repurchase
agreement with a term of one month. Upon the expiration of each reverse
repurchase agreement, the Company refinances the debt for an additional one
month period at the new market rate. Accordingly, in a period of increasing
interest rates, the Company's interest expense could increase substantially
prior to the time that the Company's interest income with respect to such
Mortgage Loans increase. See "Risk Management - Other Processes." The Company
has filed a registration statement with the SEC for the securitization of
Mortgage Loans and currently anticipates that it may securitize a significant
portion of its Mortgage Loans. A securitization of the Company's Mortgage
Loans would provide the Company with long term financing for the Mortgage Loans
and could reduce the risk of short term interest rate changes. There can be no
assurance however, that the Company will be able to securitize any of its
Mortgage Loans on favorable terms, or at all.
The Company's reverse repurchase agreements generally 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. Currently only one
of the Company's borrowing facilities may
11
<PAGE> 15
be used to finance Mortgage Loans. The remaining facilities may be
collateralized only by Mortgage Securities. The Company is in negotiations to
increase the number of reverse repurchase agreements that may be used to
finance Mortgage Loans. There can be no assurance, however, that the Company
will successfully enter into such additional agreements or that they will be on
favorable terms to the Company. See "Business Risks - Failure to Implement
Company's Leverage Strategy May Adversely Affect Results of Operations."
Reverse Repurchase Agreements
The Company currently 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 any such reverse repurchase agreement, the lending
party may liquidate the collateral.
The Company has entered into reverse repurchase agreements primarily with
national broker/dealers, commercial banks and other lenders who 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 December 31, 1997 the Company had uncommitted reverse
repurchase facilities to provide over $2.5 billion to finance investments in
Mortgage Assets. See "Business Risks - 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 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
received, may be substantially less than the damages actually suffered by the
Company.
12
<PAGE> 16
To reduce its exposure to credit risk of reverse repurchase agreement lenders,
the Company has entered into such agreements with several different parties and
follows credit exposure 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. Exceptions to these policies that have
occurred from time to time have required approval by both the Chief Executive
Officer and the Chief Operating Officer of the Company. The Company monitors
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 counter party risks.
Securitizations
The Company intends to securitize from time to time Mortgage Loans acquired
through bulk acquisitions and the Freedom Program as part of its overall
financing strategy. Securitization is the process of pooling Mortgage Loans
and issuing equity securities, such as mortgage pass- throughs, 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 sheets 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., borrowings under reverse repurchase agreements). The
structured debt securities issued will constitute limited recourse, long term
financing, the payments on which generally 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.
The decision to issue CMOs will be based on the Company's current and future
investment needs, market conditions and other factors. Each issue of CMOs is
fully payable from the principal and interest payments on the underlying
Mortgage Loans collateralizing such debt, any cash or other collateral required
to be pledged as a condition to receiving the desired rating on the debt, and
any investment income on such collateral. The Company earns the net interest
spread between the interest income on the Mortgage Loans securing the CMOs and
the interest and other expenses associated with the CMO financing. The net
interest spread may be directly impacted by the levels of prepayment of the
underlying Mortgage Loans and, to the extent each CMO class has variable rates
of interest, may be affected by changes in short-term interest rates.
13
<PAGE> 17
If the Company issues CMOs for financing purposes, it will seek an investment
grade rating for such CMOs by a nationally recognized rating agency. To secure
such a rating, it is often necessary to pledge collateral in excess of the
principal amount of the CMOs to be issued, or to obtain other forms of credit
enhancements such as additional mortgage loan insurance. The need for
additional collateral or other credit enhancements depends upon factors such as
the type of collateral provided and the interest rates paid thereon, the
geographic concentration of the mortgaged property securing the Mortgage Loans
and other criteria established by the rating agency. The pledge of additional
collateral would reduce the capacity of the Company to raise additional funds
through short-term secured borrowings or additional CMOs and diminish the
potential expansion of its investment portfolio. As a result, the Company's
objective is to pledge additional collateral for CMOs only in the amount
required to obtain an investment grade rating for the CMOs by a nationally
recognized rating agency. Total credit loss exposure to the Company is limited
to the equity invested in the CMOs at any point in time.
The Company believes that under prevailing market conditions, an issuance of
CMOs receiving other than an investment grade rating would require payment of
an excessive yield to attract investors. No assurance can be given that the
Company will achieve the ratings it plans to seek for the CMOs.
In connection with the securitization of "B" and "C" grade Mortgage Loans, the
levels of subordination required as credit enhancement for the more senior
classes of securities issued in connection therewith would be higher than those
with respect to its "A" grade non-conforming Mortgage Loans. Thus, to the
extent that the Company retains any of the subordinated securities created in
connection with such securitizations and losses with respect to such pools of
"B" and "C" grade Mortgage Loans or Mortgage Loans secured by second liens are
higher than expected, the Company's future earnings could be adversely affected.
In addition to securitizing its Mortgage Loans, the Company also may from time
to time elect 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
re-securitization. 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.
Re-securitizations are expected to be effected as 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
14
<PAGE> 18
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 re-securitization transactions
to date and there can be no assurances that the Company will be able to
securitize or otherwise finance its Mortgage Loans.
Line 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, demand immediate receipt of additional collateral to the extent
that the value of the Mortgage Securities is reduced as a results of
prepayments. However, the federal government agencies that issue the Mortgage
Securities do not deliver the proceeds from such prepayments for periods
ranging from 15 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 with one lender and is
secured by the proceeds of prepayments pursuant to collateral which secures the
Company's borrowings with that lender. 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 could reduce potential returns to
stockholders, and the over-utilization of leverage, which could reduce the
Company's ability to meet its obligations during period of adverse market
conditions. For this purpose, the Company has established a "Capital Policy"
which limits the Company'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 Company believes the
use of balance sheet leverage can be better controlled. For purposes of the
Capital Policy, the actual capital base, 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, the Manager is required to submit to the Board of Directors of the
Company 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 specific action by the Company or the Manager
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. The Company anticipates that
15
<PAGE> 19
the actual capital base is likely to 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 Board
of Directors has the discretion to modify or waive the Company's policies and
restrictions without stockholder consent. Aside from the Capital Policy set by
the Board of Directors, there are no restrictions on the Company's ability to
incur debt and there can be no assurance the level of debt that the Company is
authorized to incur will not be increased by the Board of Directors. See
"Business Risks - Policies and Strategies May Be Revised at the Discretion of
the Board of Directors."
The Company, with the advice of the Manager, 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 10% for certain of the Company's
current Mortgage Loans and 20% for certain Mortgage Loans that may be acquired
through the Freedom Program.
The second component of the Company's Capital Policy is the "liquidity capital
cushion." The Company expects that substantially all of its reverse repurchase
agreements will require the Company to deposit additional collateral in the
event the market value of existing collateral declines. The liquidity cushion
is an additional amount of capital in excess of the haircut maintained by the
Company designed to assist the Company in meeting 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 "Business Risks - 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 the Manager'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, a minimum equity to total assets ratio for the Company pursuant to its
Capital Policy. The Board of Directors reviews on a periodic basis various
analyses prepared by the Manager 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,
16
<PAGE> 20
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 equity capital required under the
Capital Policy will range between 8% to 12% of the total market value of the
Company's Mortgage Assets. As of December 31, 1997, equity capital to total
market value of the Company's Mortgage Assets was approximately 19%. 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 change 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, performance of Mortgage Assets, credit risks,
prepayments of Mortgage Assets, the restructuring of Mortgage Assets, general
economic conditions, potential issuance of additional equity, pending
acquisitions or sales of Mortgage Assets, Mortgage Loan securitizations and the
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 "Business Risks - Sudden Interest Rate
Fluctuations May Reduce Income from Operations."
RISK MANAGEMENT
Prior to arranging the acquisition of Mortgage Assets by the Company, the
Manager 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 the Company may establish for its
balance sheet from time to time. Accordingly, an important part of the Mortgage
Assets evaluation process is a simulation, using the Manager's risk management
model, of the addition of proposed Mortgage Assets and its associated borrowings
and hedgings to the balance sheet and an assessment of the impact any proposed
acquisition of Mortgage Assets 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
has implemented certain processes and follows a hedging program intended to
protect the
17
<PAGE> 21
Company against significant unexpected changes in prepayment rates and interest
rates.
Prepayment Risk Management Process
The Company has sought to minimize the effects on earnings caused by faster
than anticipated prepayment rates by purchasing Mortgage Securities with
prepayment penalties or which are fully-indexed and have previously experienced
period of rising or falling interest rates. In addition, a majority of the
Company's current Mortgage Loans have prepayment penalties. The Company
believes that the prepayment rates of the Company's Mortgage Loans may be
lower than those of its Mortgage Securities, primarily due to three factors:
(i) the substantial prepayment penalties, (ii) the borrower is unlikely to
have as many refinancing options as a borrower with a higher credit rating and
(iii) in declining interest rate environments, the interest rates for
non-conforming Mortgage Loans typically do not decrease as significantly as
conforming Mortgage Loan interest rates, reducing the incentive for the
borrower to refinance. There can be no assurance that the Company's efforts to
reduce prepayment rates will be successful.
The Company also intends to include prepayment penalties in the underwriting
guidelines for the tailored Mortgage Loan products in the Freedom Program. See
"Business Risks - Increased Levels of Mortgage Loan Prepayments May Reduce
Operating Income."
For the period from February 11, 1997 (commencement of operations) through
December 31, 1997, the Company received $38.8 million in principal payments on
its Mortgage Securities. The annualized rate of principal repayment on the
Company experienced was 29.7%. The amortized cost of the Company's Mortgage
Assets at December 31, 1997 was equal to 104.9% of the face value of the
Mortgage Assets. The amortized cost of Agency Securities at December 31, 1997
was equal to 104.0% of face value of the Mortgage Securities and the amortized
cost of Mortgage Loans was equal to 107.1% of face value of the Mortgage Loan.
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 "Management
Discussion and Analysis of Financial Condition and Results of Operations -
Overview."
Other Processes
The Manager attempts to manage the Company's 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 period of its Mortgage Assets and
related borrowings.
18
<PAGE> 22
The Company generally purchases Mortgage Securities which are fully indexed and
have previously experienced periods of rising and falling interest rates. The
Manager also has attempted to structure the Company's acquisitions so that the
Mortgage Securities purchased by the Company have interest rate adjustment
indices and adjustment periods that, on an aggregate basis, correspond as
closely as advisable by the Company to the interest rate adjustment indices and
adjustment periods of its anticipated borrowings. In addition, the Manager
structures the Company's 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 has been 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 Securities and related
borrowings. The Company is not currently employing a similar process with
respect to the Company's Mortgage Loans.
At December 31, 1997, the Company's weighted average Mortgage Securities and
liabilities were matched within a three-month period in terms of adjustment
frequency and speed of adjustment to market conditions. All of the Company's
Mortgage Securities at December 31, 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 used to finance its Mortgage
Securities at December 31, 1997 will either mature or adjust to a market
interest rate level within three months of such date. The borrowings had a
weighted average term to expiration of 50 days at December 31, 1997. Changes in
coupon rates earned on Mortgage Securities highly correlated with changes in
London Interbank Offer Rate ("LIBOR") and constant maturity term rates. The
rates paid on borrowings 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 "Business Risks - Sudden
Interest Rate Fluctuations May Reduce Income From Operations."
At December 31, 1997, the Company's weighted average Mortgage Loans and related
liabilities were matched within an eighteen-month period in terms of adjustment
frequency and speed of adjustment to market conditions. All of the Company's
Mortgage Loans at December 31, 1997 had coupon rates with an initial adjustment
period of between six months and two years from the Mortgage Loan origination
date with a weighted average term to reset of approximately eighteen months.
At December 31, 1997, all of the Company's borrowings used to finance its
Mortgage Loans either matured or adjusted to a market interest rate level
within one month of such date. Since December 31, 1997, the Company has
continued to acquire Mortgage Loans, many of which have initial adjustment
periods of between six months and two
19
<PAGE> 23
years. In anticipation of obtaining long term debt financing for its Mortgage
Loans pursuant to its pending registration statement, the Company continues to
finance its Mortgage Loans with reverse repurchase agreements with one month
maturities. See "Funding." There can be no assurance that the Company will
be able to obtain long term debt financing on favorable terms, or at all. In
the event that market interest rates increase prior to the time that the
Company is able to complete long term debt financing, the Company's net
interest expense with respect to its Mortgage Loans would likely increase
substantially before the Company's interest income with respect to such assets
would increase. See "Business Risks - Sudden Interest Rate Fluctuations May
Reduce Income From Operations."
Hedging
The Company recognizes the need to hedge specific interest rate risks associated
with its Mortgage Asset portfolio and has sought 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. See Note 4 of the Notes to Financial Statements. The Company
actively hedges the lifetime cap risks associated with its Mortgage Securities.
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 caps, (ii) Mortgage Assets
denominated in different interest rate indices, such as U.S. Treasury bills and
Eurodollars and (iii) interest rate swaps or caps or other interest rate hedge
vehicles related to CMO financing transactions. The Manager monitors and
evaluates the results of its hedging strategy and adjusts its hedging strategy
as it deems is in the best interest of the Company.
The amortized cost of the interest rate cap agreements at December 31, 1997 was
approximately $411,000. Cap premiums are amortized from the purchase date
through the effective date of the cap on a straight-line basis. For the period
February 11, 1997 (commencement of operations) through December 31, 1997, the
cap amortization expense was approximately $132,000. There was no income from
the caps during this period and there were no sales or termination of caps. For
the year ended December 31, 1997, net cap expense equaled approximately 0.05% of
the average balance of the Company's Mortgage Assets and 0.06% of the average
balance of the Company's interest bearing liabilities. For such period, the net
cap expense was approximately 4.5% of net interest income. At December 31,
1997, the strike rates ranged between 7.52% and 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
20
<PAGE> 24
which vary over time. The cap agreements do not become effective until the
second quarter 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 securities 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 the Company's hedging program, the Manager 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, as defined below, so that income from
such securities will constitute qualifying income for purposes of the 95% and
75% of income tests, as defined below. The Company does not currently intend
to, but may in the future, 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
"Requirements for Qualification as a REIT - Gross Income Tests."
Hedging involves transaction and other costs, and such costs increase 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 sellers' 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 interest rate cap agreement. 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 Manager monitors carefully, and may have to limit,
the Company's 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
21
<PAGE> 25
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 effectively hedging
its interest rate and prepayment risks. See "Federal Income Tax Consequences -
Requirements for Qualification as a REIT."
In particular, income from hedging the Company's variable rate borrowings
(other than with hedging instruments that are Qualified REIT Assets) qualifies
for the 95% of income test, but not for the 75% of income test, for REIT
qualification. The Company must limit its income from such hedging or the sale
of hedging contracts, along with other types of income that qualifies for the
95% of income test, but not for the 75% of income test, to less than 25% of the
Company's gross revenues. In addition, hedging instruments, such as swaps,
caps, floors, collars, and financial futures contracts, are securities for
purposes of the quarterly asset tests for REIT qualification. The Company must
ascertain that securities, including the hedging instruments (other than
hedging instruments that are Qualified REIT Assets), issued by a single issuer
do not account for 5% or more of the value of the Company's assets as of the
last day of each calendar quarter. The Company does not expect to encounter
material problems complying with these tests.
Although the Company believes that, with the advice of the Manager, 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 "Business Risks - Failure to
Successfully Manage Interest Rate Risks May Adversely Affect Results of
Operations" and "Federal Income Tax Consequences - 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, and, in the Company's case, it ignores, among other factors, the
effect of the Company's hedging activities, the effect of the periodic and
lifetime caps on the Company's Mortgage Assets, and the effect of changes in
mortgage principal repayment rates. Nevertheless, the gap time 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
22
<PAGE> 26
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 reviews with the Manager credit risks and other risks of loss
associated with each investment and determines the appropriate allocation of
capital to apply to such investment under the Company's Capital Policy. In
addition, the Company attempts to diversify its Mortgage Asset portfolio to
avoid undue geographic, issuer, industry and certain other types of
concentrations. The Company has obtained protection against some risks from
sellers and servicers through representations and warranties and other
appropriate documentation. The Board of Directors monitors the overall
portfolio risk and increases the allowance for Mortgage Loan losses when it
believes appropriate.
In order to reduce the credit risks associated with acquisitions of Mortgage
Loans, the Company, with the advice of the Manager (i) employs a quality
control program, (ii) acquires Mortgage Loans that represent a broad range of
moderate risks as opposed to a concentrated risk, (iii) monitors the credit
quality of newly acquired and existing Mortgage Assets, and (iv) periodically
adjusts the Mortgage Loan loss allowances. The Company also has arranged for
servicing of its Mortgage Loans with servicing entities that have particular
expertise and experience in the types of Mortgage Loans acquired. See
"Business Risks - Borrower Credit May Decrease Value of Mortgage Loans" and
"-Characteristics of Underlying Property May Decrease Value of Mortgage Loans."
With respect to its Mortgage Securities, the Company is exposed to levels of
credit and special hazard risks, 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
have protection from normal credit losses. At December 31, 1997, 70% of the
Company's Mortgage Assets were Agency Securities and 30% were Mortgage Loans.
The Company may 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 seek to reduce interest rate risk, to substitute
one type of Mortgage Asset for another to seek to improve yield or to maintain
compliance with the 55% requirement under the Investment Company Act, and
generally to re-structure
23
<PAGE> 27
the 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.
FEDERAL INCOME TAX CONSEQUENCES
The Company intends to elect, with the filing of its first federal corporate
income tax return in 1998, to elect to be a real estate investment trust (a
"REIT") for federal income tax purposes. A corporation qualifying as a REIT
may avoid corporate income taxation by distributing its taxable income to its
stockholders annually. The Company is organized in conformity with the
requirements for qualification and taxation as a REIT under the Internal
Revenue Code of 1986, as amended (the "Code").
The provisions of the Code are highly technical and complex. This summary is
not intended to be a detailed discussion of all applicable provisions of the
Code, the rules and regulations promulgated thereunder, or the administrative
and judicial interpretations thereof. The Company has not obtained a ruling
from the Internal Revenue Service (the "Service") with respect to tax
considerations relevant to its organization or operation, or to an acquisition
of its common stock. This summary is not intended to be a substitute for prudent
tax planning, and each stockholder of the Company is urged to consult its own
tax advisor with respect to these and other federal, state and local tax
consequences of the acquisition, ownership and disposition of shares of the
common stock of the Company and any potential changes in applicable law.
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 in brief 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. 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. The Company uses the calendar year as its
taxable year for income tax purposes.
24
<PAGE> 28
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 as defined in the Code,
government securities, cash and cash items (the "75% of assets test"). The
Company believes that substantially all of its assets are and will continue to
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. See
"Proposed Tax Legislation" below. 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.
Gross Income Tests
The Company satisfy the following income-based tests for each year in order to
qualify as 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 real estate related sources
including: (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 among others. The investments that the Company has made and
intends to make 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 of disposition of stock or other securities that
are not dealer property (the "95% of income test"). Moreover, in order to help
ensure compliance with the 95% of income test and the 75% of income test, 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.
3. The 30% of Income Limit. For each taxable year, the Company is required to
derive less than 30% of its gross income from the sale or disposition of (i)
Qualified
25
<PAGE> 29
REIT Assets held for less than four years, (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"). This provision was repealed
effective January 1, 1998.
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 or 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"). The
Company intends to make distributions to its stockholders in amounts sufficient
to meet the 95% distribution test.
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 the Company's
"ordinary income," (ii) 95% of the Company's capital gain net income plus, and
(iii) income not distributed in earlier years.
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
specified level of the REIT's 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.
26
<PAGE> 30
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 included 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.
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 share 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.
Distributions by 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.
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 unrelated business taxable income. If
allotted 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 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.
PROPOSED TAX LEGISLATION
The 1999 Budget Plan released by the Treasury Department on February 2, 1998
(the "1999 Budget Plan") includes a provision that could adversely affect
certain proposed operations of the Company. That provision would prohibit a
REIT from owning, by vote or value, more than 10% of the capital stock of any
corporation. (The current
27
<PAGE> 31
10% asset test relates only to voting stock.) That proposal is intended to
prevent REITs from conducting through a taxable subsidiary any business that
would be prohibited to the REIT itself. If adopted, this proposal would limit
the ability of the Company to conduct active mortgage origination activities
through taxable subsidiaries.
While the active origination of Mortgage Loans in itself does not violate any
of the income or asset tests for maintaining REIT status, the Service could
attempt to treat the income from frequent sales of Mortgage Loans as subject to
the 100% tax on income from prohibited transactions. "Prohibited transactions"
are defined as sales of property held by the REIT primarily for sale to
customers in the ordinary course of the REIT's business (other than income from
sales of foreclosure property). The regular sale of Mortgage Loans by the
Company or its subsidiaries may be treated as prohibited transactions,
subjecting the Company to the 100% tax. The Treasury Department has proposed
that this new stock ownership limitation for REITs would first be effective
with respect "to stock acquired on or after the date of first committee
action."
The 1999 Budget Plan has been submitted to the Ways and Means Committee of the
U.S. House of Representatives (the "Ways and Means Committee") for review,
which held its first hearing on February 25, 1998, but has not taken any action
to date.
INVESTMENT COMPANY ACT
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 of 1940.
If the Company were to become regulated as an investment company, then the
Company's use of leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interest in
real estate" ("Qualifying Interests"). Under current interpretation of the
staff of the Securities and Exchange Commission, in order to qualify for this
exemption, the Company must maintain at least 55% of its assets directly in
Qualifying Interests. In addition, unless certain mortgage securities
represent all the certificates issued with respect to an underlying pool of
mortgages, such mortgage securities may be treated as securities separate from
the underlying mortgage loans and, thus, may not be considered Qualifying
Interests for purposes of the 55% requirement. As of December 31, 1997, the
Company calculates that it is in compliance with this requirement.
COMPETITION
The Company's net interest income depends, in large part, on the Company's
ability to acquire Mortgage Assets on acceptable terms and at favorable spreads
over
28
<PAGE> 32
the Company's borrowing costs. There can be no assurance that the Company will
continue to 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, FHLMC, FNMA, GNMA 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. As it relates to the
Freedom Program, the Company competes on the basis of product type. The Company
will face competition from companies already established in these markets.
There can be no assurance that the Company will be able to successfully compete
with its competition.
The availability of Mortgage Loans meeting the Company's criteria is dependent
upon, among other things, the size 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 a sufficient number of Mortgage Loans meeting its criteria, the
Company's results of operations will be adversely affected.
EMPLOYEES
Currently, the Company and the Manager each employ six executive officers and
eight additional employees. Each of the executive officers has between 10 and
24 years, and collectively, they have an average of 19 years of experience in
the residential mortgage industry. Four executive officers worked together
previously as a management team.
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 who are
not executive officers or employees of the Company 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 the
29
<PAGE> 33
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. See "Management Fees." In
addition, the Company has the right to terminate the Management Agreement at
any time upon the happening of certain specified events, after notice and an
opportunity to cure, including a material breach by the Manager of any
provision contained in the Management Agreement. Upon such a termination for
cause, no termination fee will be payable to the Manager.
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 the formulation of
investment criteria and the 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
30
<PAGE> 34
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
Mortgage Loans and arranging for the monitoring and administering of such
servicer and subservicer;
(ix) counseling the Company in connection with policy decisions to be made
by the Board of Directors;
(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 the 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 Mortgage 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
31
<PAGE> 35
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 Securities Exchange Act of 1934, as amended;
(xvii) providing all actions necessary to enable the Company to make
required federal, state and local tax filings and reports and to 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
independent 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 Manager will monitor the
servicing of the Mortgage Loans. Such monitoring will include, but not be
limited to, the following: (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 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;
32
<PAGE> 36
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.
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 issuer of Mortgage Securities, any subsidiary of the Company, the
Company's independent 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 independent directors of the
Company. See "Business Risks -- The Company has Significant Conflicts with, and
Is Dependent on, an Affiliate of the Executive Officers of the Company."
Relationship between the Manager and the Company
In addition to the Management Agreement between the Manager and the Company,
the Manager also has limited rights in the shares of the Company's Common Stock
held by MDC REIT Holdings, Inc. ("Holdings") an intermediate holding company.
The Manager contributed $20 million in 1997 to Holdings which used the funds to
33
<PAGE> 37
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 from Holdings equal to 5% per quarter 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.
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.
These fees shall be applicable during the entire operational stage of the
Company's business. The Company will pay to the Manager the following
management fees and incentive compensation:
- 1/8 of 1% per year, to be paid monthly (the "Agency Percentage"), of
the principal amount of Agency Securities;
- 3/8 of 1% per year, to be paid monthly (the "Non-Agency
Percentage"), of the principal amount of all other Mortgage Assets;
and
- 25% of the amount by which the Company's net income (calculated
prior to deduction of this incentive compensation fee) exceeds the
annualized return on equity equal to the average Ten Year U.S.
Treasury Rate plus 2%.
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 credit losses or other similar noncash
allowances, computed at the end of such month prior to any dividend distribution
made during each month.
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
34
<PAGE> 38
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 discount 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 management 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 management fee in excess of the amount paid to the 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.
Termination Fees
The Company may elect to prevent the automatic renewal of the Management
Agreement by vote of both a majority of the Board of Directors and a majority
of the directors who are not executive officers or employees of the Company
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 the 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 at any time upon the happening of certain
specified events, after notice and an opportunity to cure, including a material
35
<PAGE> 39
breach by the Manager of any provision contained in the Management Agreement.
Upon such a termination for cause, no termination fee will be payable to the
Manager.
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 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 employs certain employees of the Manager involved in the
day-to-day operations of the Company, including the Company's executive
officers, so that such employees may maintain certain benefits that are
available only to employees of the Company under the Code. These benefits
include the ability to receive incentive stock options under the 1997 Stock
Option Plan and to participate in the Company's Employee Stock Purchase Plan.
In order to receive the aggregate benefits of the Management Agreement
originally negotiated between the Company and the Manager, the Company pays
the base salaries of such employees and is reimbursed monthly by the
Manager for all costs incurred with respect to such payments.
BUSINESS RISKS
Sudden Interest Rate Fluctuations May Reduce Income From Operations
Substantially all of the Company's Mortgage Assets will have a repricing
frequency of two years or less, and substantially all of the Company's
borrowings will have maturities of six months or less. 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
36
<PAGE> 40
interest rates may significantly influence the Company's net interest income.
While increases in interest rates will generally increase the yields on the
Company's adjustable-rate Mortgage Assets, rising rates will also increase the
cost of borrowings by the Company. To the extent such costs rise more rapidly
than the yields on such Mortgage Assets, 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 Reduce Operating 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 a margin). In the event that such an adjustable-rate
Mortgage Asset is prepaid prior to or soon after the time of adjustment to a
fully-indexed rate, the Company will have held the Mortgage Asset during its
least profitable period 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 Loans, the assumability
of an
37
<PAGE> 41
adjustable-rate Mortgage Loan, the ability of the borrower to obtain or convert
to a fixed-rate Mortgage 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 generally being highest in the summer months and lowest in the
winter months. The Company experienced high levels of prepayments during the
three quarters ended December 31, 1997 and thereafter, and the Company
anticipates that prepayment rates are likely to continue at high levels for an
indefinite period. 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."
Certain 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.
Inability to Acquire Mortgage Assets
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 numerous investment banking firms, savings and loan associations,
banks, mortgage bankers, insurance companies, mutual funds, other lenders,
federal government sponsored agencies such as FHLMC, FNMA and GNMA, 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. As it relates to the
Freedom Program, the Company competes on the basis of product type. The Company
will face competition from others already established in these markets. There
can be no assurance that the Company will be able to successfully compete with
its competition.
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 depends on various factors, including the level of interest
rates, regional and national economic
38
<PAGE> 42
conditions and inflation and deflation in residential property values. To the
extent that the Company is unable to acquire a sufficient amount of Mortgage
Loans meeting its criteria, the Company's results of operations will be
materially adversely affected.
The Company may acquire Mortgage Assets with geographic, issuer, industry and
other types of concentrations. Accordingly, a significant portion of the
Company's Mortgage Assets may be subject to the risks associated with a single
type of occurrence. In the event of such an occurrence, the adverse effects on
the Company's results of operations will be significantly greater than if the
Company's Mortgage Assets were diversified with respect to such factors.
Further, the Company does not intend to acquire residual interests issued by
REMICs, subordinate interests in Mortgage Securities or interest- only Mortgage
Securities, but is not prohibited from doing so under the terms of its Capital
Policy. Investments in these types of Mortgage Assets are highly speculative
and, accordingly, the risk of loss associated with investments in these types
of Mortgage Assets is substantially greater than the risk of loss associated
with the Mortgage Assets currently held by the Company. Any investment in such
high risk Mortgage Assets could materially adversely affect the Company's
financial condition and results of operations. See "Business -- Investments."
Manager's Lack of Prior Experience in Managing a REIT Could Adversely Affect
the Company's Business, Financial Condition and Results of Operations; Limited
Operating History Does Not Necessarily Predict Future Performance of Company
The Manager has limited experience in managing a REIT or with certain tailored
Mortgage Loan products. Although the Company's and the Manager's executive
officers have 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, there can be no assurance that the past
experience of the executive officers will be appropriate to the business of the
Company. The lack of prior experience of the Manager in managing a REIT could
have a material adverse affect on the business, financial condition and results
of operations of the Company. The Company has not yet begun acquiring Mortgage
Loans under the Freedom Program.
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.
39
<PAGE> 43
Failure to Implement Company's Leverage Strategy May Adversely Affect Results
of Operations
The Company currently 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 (i) to borrow money in sufficient
amounts and on favorable terms, (ii) to renew or replace on a continuous basis
its maturing short term borrowings and (iii) to successfully leverage its
Mortgage Assets. 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 commitments with its lenders.
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 the Company's 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. In the event of the insolvency or
bankruptcy of the Company, any creditor under a reverse repurchase agreement
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 received, may be
substantially less than the damages actually suffered by the Company.
Due to the underlying loan to collateral values established by the Company's
lenders, the Company may be subject to calls for additional capital in the
event of adverse market conditions. Such conditions include (i) higher than
expected levels of
40
<PAGE> 44
prepayments on Mortgage Loans and (ii) sudden increases in interest rates. To
the extent that the Company is highly leveraged, it may not be able to meet its
loan to collateral value requirements, which may result in losses to the
Company. There can be no assurance that the Company will not face a call for
additional capital. See "Business -- Funding," and " -- Capital Guidelines."
The Company's Capital Policy, which is set by the Company's Board of Directors,
requires the Company to maintain a minimum equity capital of between 8% and
12%. However, the Company is not subject to additional statutory, regulatory or
third party limitations on incurring debt. Accordingly, there are no
restrictions on the Company's ability to incur debt and there can be no
assurance that the level of debt that the Company is authorized to incur
pursuant to its current Capital Policy will not be increased by the Board of
Directors. See "Policies and Strategies May Be Revised at the Discretion of
the Board of Directors."
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 management
strategy is complex and no management strategy can completely insulate the
Company from risks associated with interest rate changes. In addition, hedging
involves transaction costs. In the event the Company hedges against interest
rate risks, the Company may substantially reduce its net income. Further, 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, 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 Securities lifetime rate caps and not against
periodic rate
41
<PAGE> 45
caps or unexpected payments. 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.
The Company Has Significant Conflicts with, and Is Dependent on, an Affiliate
of the Executive Officers of the Company
The Company is subject to conflicts of interest with the Manager and its
executive officers. The executive officers of the Company generally will also
be executive officers, employees and stockholders of the Manager, and will
therefore be affiliated with the Manager. The Manager will manage the
day-to-day operations of the Company. Accordingly, the Company's success will
depend in significant part on 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 "Management and Termination 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 REIT which invests primarily in residential Mortgage Assets,
other than the Company.
Borrower Credit May Decrease Value of Mortgage Loans
A portion of the Company's Mortgage Assets consist of Mortgage Loans.
Accordingly, during the time it holds Mortgage Loans, the Company is 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
42
<PAGE> 46
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 Mortgage Loan losses in amounts adequate to cover these risks, in
view of its limited operating history and lack of experience with the Company's
current Mortgage Loans and Mortgage Loans that may be acquired pursuant to the
Freedom Program, there can be no assurance that any allowance for Mortgage Loan
losses which are established will be sufficient to offset losses on Mortgage
Loans in the future. See "Business - Investments."
Credit risks associated with non-conforming Mortgage Loans, especially
sub-prime Mortgage Loans, may be greater than those associated with Mortgage
Loans that conform to FNMA and FHLMC guidelines. The principal difference
between non-conforming sub-prime Mortgage Loans and conforming Mortgage Loans
include the applicable loan-to-value ratios, the credit and income histories of
the mortgagors, the documentation required for approval of the mortgagors, the
types of properties securing the Mortgage Loans, loan sizes and the mortgagors'
occupancy status with respect to the mortgaged property. As a result of these
and other factors, the interest rates charged on non-conforming Mortgage Loans
are often higher than those charged for conforming Mortgage Loans. The
combination of different underwriting criteria and higher rates of interest may
lead to higher delinquency rates and/or credit losses for non-conforming as
compared to conforming Mortgage Loans and could have an adverse effect on the
Company to the extent that the Company invests in such Mortgage Loans or
securities secured by such Mortgage Loans.
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 collateralize 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 such properties. See " -- Characteristics of Underlying Property May
Decrease Value of Mortgage Loans."
43
<PAGE> 47
Characteristics of Underlying Property May Decrease Value of Mortgage Loans
The Company anticipates that in the future a portion of its Mortgage Assets
will consist of tailored Mortgage Loans acquired pursuant to the Freedom
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 properties.
Although the Company intends to seek geographic diversification of the
properties which are collateral for the Company's Mortgage Loans, it does not
intend to set specific diversification requirements (whether by state, zip code
or other geographic measure). Concentration in any one geographic area will
increase the exposure of the Company's Mortgage Assets to the economic and
natural hazard risks associated with that area.
Certain properties securing Mortgage Loans may be contaminated by hazardous
substances resulting in reduced property values. If the Company forecloses on a
defaulted Mortgage Loan collateralized by such property, the Company may be
subject to environmental liabilities regardless of whether the Company was
responsible for the contamination. The results of the Company's bulk purchase
program and the Freedom 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 values, (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.
Dependence on Key Personnel for Successful Operations
The Company's operations depend in significant part upon the skill and
experience 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.
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
the Company's initial public offering may cause a significant strain on the
Company's and
44
<PAGE> 48
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 Freedom 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 number
of Mortgage Loans directly from Correspondents pursuant to the Freedom Program.
The Company may require up to six months to complete the implementation of its
financing strategy and increase its investment in Mortgage Assets 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 requires 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.
45
<PAGE> 49
Policies and Strategies May Be Revised at the Discretion of the Board of
Directors
The Board of Directors has established the investment policies, operating
policies and strategies of the Company. These policies and strategies may be
modified or waived by the Board of Directors without stockholder consent.
Further, the Board of Directors is not limited by the Company's Articles of
Amendment and Restatement ("the Charter") or Bylaws in determining the
Company's policies and strategies. Accordingly, investors are not able to
evaluate the credit or other risks which may be applicable to the Mortgage
Assets to be acquired by the Company. A change in the Company's policies and
strategies could adversely affect the Company's business, financial condition
and results of operations.
The Company does not currently intend to (i) issue senior securities, (ii) make
loans to other persons, (iii) invest in the securities of others for the
purpose of exercising control, (iv) underwrite securities of other issuers, (v)
offer securities in exchange for property or (vi) repurchase or otherwise
reacquire its shares or other securities.
The Manager and Certain Affiliates Will Control Approximately 20% of
Outstanding Shares of the Company
The Company's directors and officers, the Manager and certain of their
affiliates beneficially own or have the right to control approximately 20% 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 election
of directors and the approval of transactions involving a change in control of
the Company.
Failure to Maintain REIT Status May Subject Company to Corporate Level Tax
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
46
<PAGE> 50
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 other companies not organized as REITs. See "Federal
Income Tax Considerations."
Market for Common Stock May be Limited and Market Price May Fluctuate
The market price of the Company's Common Stock is likely to be influenced by
any variations 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 greater 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 Company's Common Stock,
may be less attractive compared with alternative investments, which could
negatively impact the price of the Company's Common Stock. If the dividend
yield on the Company's Common Stock declines, or if prevailing market interest
rates rise, the market price of the Company's Common Stock may be adversely
affected. Accordingly, fluctuations in interest rates could have a material
adverse affect on the trading market for the Company's Common Stock. See " --
Sudden Interest Rate Fluctuations May Reduce Income From Operations," "-
Inability to Acquire Mortgage Assets" and "- Failure to Successfully Manage
Interest Rate Risks May Adversely Affect Results of Operations."
Failure to Qualify for Exemption Under Investment Company Act Would Result in
Significant Regulatory Burden
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
47
<PAGE> 51
interests in real estate." Under the current interpretation of the staff of the
Securities and Exchange Commission, in order to qualify for this exemption, 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.
As of August 31, approximately 30% of the Company's Mortgage Securities were
partial-pool Mortgage Securities which may be treated as securities separate
from the underlying Mortgage Loans. Therefore, the Company's ownership of
certain Mortgage Assets may be limited by the provisions of the Investment
Company Act.
Future Offerings of Common Stock May Affect 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. The inability of the Company to obtain needed sources of capital on
favorable terms could have a material adverse affect on the Company. See
"Business -- Funding."
Ownership of Common Stock May be Restricted
In order that the Company may meet the requirements for qualification as a REIT
at all times, the Company's Charter prohibits any person from acquiring or
holding, directly or indirectly, shares of Common Stock in excess of 9.9% 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
48
<PAGE> 52
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.
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 9.9% of the Company's Common Stock.
Further, a violation of the ownership limitations of the Common Stock of the
Company could result in the Company's loss of its REIT status. A loss of its
REIT status could have a material adverse affect on the Company. See " --
Failure to Maintain REIT Status May Subject Company to Corporate Level Tax."
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 Holdings entered into a Securities Purchase Agreement
dated as of 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 the 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,
which could have a material adverse effect on the Company's financial condition
and results of operations.
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
49
<PAGE> 53
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 1.6 million 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.
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 in
control of the Company. 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 cause a change in 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 in control of the Company, even if a change in control
were in the interest of some, or a majority, of the stockholders.
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 10% 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 any
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.
50
<PAGE> 54
These provisions may inhibit market activity and the resulting opportunity for
stockholders of the Company to receive a premium for their shares of the
Company's Common Stock that might otherwise exist if any person were to
attempt to assemble a block of shares of Common Stock in excess of the number
of shares permitted under the Charter. Such provisions also may make the
Company an unsuitable investment vehicle for any person seeking to obtain
ownership of more than 9.9% of the outstanding shares of Common Stock.
EXECUTIVE OFFICERS OF THE COMPANY
The following table presents certain information concerning the executive
officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION(1)
---- ------ -----------
<S> <C> <C>
John M. Robbins(2) ...... 50 Chairman of the Board, Chief
Executive Officer
Jay M. Fuller(2) ....... 47 President, Chief Operating
Officer
Mark A. Conger ......... 38 Executive Vice President and
Chief Financial Officer
John Dahl ............... 44 Executive Vice President,
Capital Markets and Loan
Production
Rollie O. Lynn ......... 44 Senior Vice President,
Capital
Markets
Lisa S. Faulk ........... 40 Senior Vice President,
Operations
</TABLE>
__________
(1) Each executive officer holds the same position with the Manager.
(2) Mr. Robbins and Mr. Fuller are founders of the Company.
JOHN M. ROBBINS has served as Chairman of the Board of Directors and Chief
Executive Officer and Director of the Company since its formation in February
1997. Prior to joining the Company, Mr. Robbins was Chairman of the Board of
American Residential Mortgage Corporation ("AMRES Mortgage"), a mortgage
origination company not affiliated with the Company 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
51
<PAGE> 55
serves as a director of Pacific Research & Engineering Corporation, Garden
Fresh Restaurant Corporation, National Bankcard and the University of San
Diego.
JAY M. FULLER has served as President, Chief Operating Officer and
Director of the Company since its formation in February 1997. 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 has served as Senior Vice President and Chief Financial
Officer of the Company since its formation in February 1997 and recently became
an Executive Vice President. From 1994 through 1997 Mr. Conger was the sole
proprietor and manager of an unrelated 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 KPMG Peat Marwick LLP from 1981 to 1985. Mr. Conger has
worked in the mortgage banking industry for ten years. Mr. Conger received a
Bachelor of Science degree from the University of Missouri in 1981 and is a
Certified Public Accountant.
JOHN DAHL has served as Executive Vice President, Capital Markets and Loan
Production, of the Company since October 1997. Prior to joining the Company,
Mr. Dahl served as Managing Director of First Union Capital Markets Corporation
from 1995 to 1997, responsible for marketing capital markets products and
services to corporate customers and prospects in diversified industries on the
west coast, and the speciality finance industry on a national basis. Prior to
joining First Union, Mr. Dahl served as Managing Director of First Chicago from
1988 to 1995, responsible for marketing financial and operating services to
corporate customers and prospects in the mortgage banking industry. Mr. Dahl
has worked in the real estate and financial services industries continuously
since 1976. Mr. Dahl received his Bachelor of Science degree in 1976 from
Northern Illinois University and his Masters in Business Administration degree
from San Francisco State University in 1979.
ROLLIE O. LYNN has served as Senior Vice President, Capital Markets,
responsible for the areas of portfolio management for the Company since its
formation in February 1997. Prior to joining the Company, Mr. Lynn served as
Vice President, Capital Markets, of Long Beach Mortgage Company responsible for
managing, hedging and
52
<PAGE> 56
trading the firm's sub-prime 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.
LISA S. FAULK has served as Senior Vice President, Operations, of the
Company since October 1997. Prior to joining the Company, Ms. Faulk served as
Vice President, Conduit Underwriting, for Advanta Mortgage Corporation where
she managed the Conduit Division's underwriting, funding and processing
functions in the non-conforming credit markets. Ms. Faulk was Vice President,
Manager Credit Risk Review, for Homefed Bank, Federal Savings Bank from 1984 to
1993.
GLOSSARY
AS USED IN THIS FORM 10-K, THE CAPITALIZED AND OTHER TERMS LISTED BELOW HAVE
THE MEANINGS INDICATED.
"AGENCY SECURITIES" means mortgage participation certificates issued by FHLMC,
FNMA 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 equity reserve 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 Mortgage 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 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 1986, as amended.
53
<PAGE> 57
"COUPON RATE" means, with respect to Mortgage Assets, the annualized cash
interest income annually received from the asset, expressed as a percentage of
the face value of the asset.
"EARNING ASSETS" 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.
"EQUITY-FUNDED LENDING" means the portion of the Company's earning assets
acquired using the Company's equity capital.
"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 Assets ("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.
"GNMA" means the Government National Mortgage Association.
"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 adjustable 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.
54
<PAGE> 58
"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 base which is in
excess of the Company's haircut requirements.
"MORTGAGE ASSETS" means Mortgage Securities and Mortgage Loans.
"MORTGAGE LOANS" means 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 CHLMC 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 adjustable
date. Periodic caps limit both the speed by which the coupon rate can adjust
upwards in a rising interests rat environment and the speed by which the coupon
rate can adjust downwards in a falling rate environment.
"PRIVATELY ISSUED SECURITIES" means 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 PROVISIONS OF THE CODE" means sections 856 through 860 of the Code.
"REMIC" means Real Estate Mortgage Investment Conduit.
"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
"UNCOMMITTED REVERSE REPURCHASE AGREEMENTS" means the credit extended under the
respective reverse repurchase agreement may be withdrawn at any time after each
30-day rolling renewal period, whether the Company is in compliance with the
terms of the reverse repurchase agreement or not.
55
<PAGE> 59
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 Yield 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 Rate 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 nor more than twelve 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 recognized dealers in U.S. Government
securities selected by the Company.
ITEM 2. PROPERTIES
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 7,000 square feet of space. 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.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 1997, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 3, 1997, the stockholders of the Company unanimously approved by
written consent the reservation of an additional One Hundred Twenty Thousand
(120,000) shares of Common Stock, for an aggregate of Four Hundred Seventy Four
Thousand Eight Hundred (474,800) shares, for issuance upon exercise of options
granted under the Company's 1997 Stock Option Plan.
56
<PAGE> 60
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock began trading on October 29, 1997 and is traded on
the New York Stock Exchange under the trading symbol INV. As of December 31,
1997, the Company had 8,114,000 shares of Common Stock issued and outstanding
which was held by 39 holders of record.
The following table sets forth, for the periods indicated, the high, low and
closing sales prices per share of Common Stock as reported on the New York
Stock Exchange composite tape Common Stock.
<TABLE>
<CAPTION>
Stock Prices
------------
1997 High Low Close
---- ---- --- -----
<S> <C> <C> <C>
Fourth Quarter ended December 31, 1997 16 5/8 11 7/16 11 7/8
</TABLE>
The Company intends to pay quarterly dividends and to make such distributions
to its stockholders in amounts such that all or substantially all of its
taxable income in each year (subject to certain adjustments) is distributed so
as to qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the earnings of the Company, financial condition
of the Company, maintenance of REIT status and such other factors as the Board
of Directors may deem relevant from time to time.
The following table sets forth, for the dates indicated, the dividends paid
in 1997:
<TABLE>
<CAPTION>
Cash Dividend
-------------
Date Date Amount
Declared Payable Per Share
-------- ------- ---------
<S> <C> <C>
12/19/97 1/21/98 0.16
10/21/97 10/29/97 0.32
7/17/97 7/17/97 0.27
5/1/97 5/1/97 0.09
</TABLE>
ITEM 6. SELECTED FINANCIAL DATA
Changes in Securities and Use of Proceeds
The Company registered 7,475,000 shares of Common Stock, par value $0.01 (the
"Shares") on registration statement No. 333-33679 which was declared effective
on October 27, 1997 (the "Offering"). 6.5 million shares were sold on October
29, 1997.
57
<PAGE> 61
The Offering terminated prior to the sale of the remaining 975,000 shares which
were subject to an over-allotment option.
The co-managing underwriters of the Offering were PaineWebber Incorporated,
Oppenheimer & Co., Inc., EVEREN Securities, Inc. and Sutro & Co. Incorporated.
The Company registered 7,475,000 Shares with an aggregate offering price of
$112.1 million (or $15.00 per share) and sold 6.5 million shares at an
aggregate offering price of $97.5 million.
Through December 31, 1997, the Company incurred the following expenses in
connection with the Offering:
<TABLE>
<S> <C>
Underwriting discounts and commissions $6,338,000
Expenses paid to underwriters 487,000
Other expenses (audit, legal, etc.) 973,000
---------
Total expenses 7,798,000
=========
</TABLE>
The net offering proceeds to the Company after deducting the total expenses
above were $ 89,702,000.
The Company's use of Net Proceeds through December 31, 1997 was as follows:
<TABLE>
<S> <C>
Acquisition of Mortgage Securities $17,875,000
Acquisition of Mortgage Loans 10,813,000
Prepayment of indebtedness 61,014,000
-----------
Total $89,702,000
===========
</TABLE>
No amounts paid as expenses or pursuant to the use of proceeds described above
were paid directly or indirectly to directors or officers of the Company or
their associates; to persons owning ten percent (10%) or more of the Company's
Common Stock; or to affiliates of the Company.
The Company's use of proceeds through December 31, 1997 substantially conformed
to the intended use of proceeds described in the Company's prospectus related
to the Offering. The Company's intended use of proceeds as stated in its
prospectus was the acquisition of Mortgage Assets and for working capital
purposes. Although the Company has used a substantial portion of the proceeds
to repay debt, the debt repaid was debt incurred to acquire Mortgage Assets.
Because those Mortgage Assets are now funded with equity capital, the Company
may use such Mortgage Assets to help
58
<PAGE> 62
finance the acquisition of additional Mortgage Assets funded with debt.
Accordingly, the Company anticipates that the prepayment of debt is temporary.
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,
respectively, of the Company's Common Stock at an aggregate price of $20
million, $100,000 and $75,000, respectively, paid in cash.
The sale of securities to Holdings, Mr. Robbins and Mr. Fuller was exempt from
registration under the Securities Act pursuant to Section 4(2).
Selected Financial Data
The following selected Statement of Operations and Balance Sheet data for the
period from February 11, 1997 (commencement of operations) through December 31,
1997, and as of December 31, 1997, has been derived from the Company's
financial statements audited by KPMG Peat Marwick LLP, independent auditors,
whose report with respect thereto appears 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 Conditions and Results of Operations" also included elsewhere herein.
<TABLE>
<CAPTION>
For the period February 11, 1997
(commencement of operations) through
December 31, 1997
---------------------------------------------
(dollars in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
<S> <C>
Net interest income $ 2,914
Net income 2,403
Net income per share of common stock - basic 0.83
Net income per share of common stock - diluted 0.82
Average number of shares outstanding 2,879,487
Average number of shares and share equivalents 2,929,009
Dividends declared per share 0.84
Noninterest expense as percent of average assets 0.18%
</TABLE>
<TABLE>
<CAPTION>
As of
BALANCE SHEET DATA: December 31, 1997
-----------------------------------------
(dollars in thousands, except per share data)
<S> <C>
Mortgage securities $ 387,099
Mortgage loans 162,762
Total assets 561,834
Reverse repurchase agreements 451,288
Stockholders' equity 106,569
Number of shares outstanding 8,114,000
</TABLE>
59
<PAGE> 63
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The statements contained in this Form 10-K that are not purely historical are
forward looking statements, including statements regarding the Company's
expectations, hopes, beliefs, intentions or strategies regarding the future.
Among the factors that could cause actual results to differ materially are the
factors set forth above under Item 1 under the heading "Business Risks".
OVERVIEW
All of the Company's income to date has been interest income generated from
its Mortgage Assets and its cash balances (collectively, "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, the Company expects that income from this source
will tend to increase as interest rates rise and will tend to decrease as
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 interest rates and then, after a lag period, be restored to its
former level as earning assets yields adjust to market conditions. Income from
spread lending may likewise increase following a fall in interest rates, but
then decrease as earning assets yields adjust to the new market conditions
after a lag period.
The Company may seek 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) improving 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.
60
<PAGE> 64
Results of Operations
For the quarter end December 31, 1997, the Company generated net income of
approximately $1.3 million and diluted net income per share of Common Stock of
$0.21. From the commencement of operations on February 11, 1997 through
December 31, 1997, the Company generated net income of approximately $2.4
million and diluted net income per share of $0.82. At December 31, 1997 the
Company held Mortgage Securities that had a carrying value of approximately
$387.1 million, including a $3.3 million net unrealized loss recorded as of the
period end. See Note 2 of the Notes to Financial Statements. The Company held
Mortgage Loans with a carrying value of approximately $162.8 million as of
December 31, 1997.
Net income for the Company increased 150% from approximately $519,000 for the
quarter ended September 30, 1997, to approximately $1.3 million for the quarter
ended December 31, 1997. The growth in net income was directly attributable to
an increase in net interest income. Net interest income grew 118% between the
quarter ended September 30, 1997 and the quarter ended December 31, 1997, from
approximately $689,000 to approximately $1.5 million respectively. This
increase in net interest income was partially offset by an increase in general
and administrative expenses. From the quarter ended September 30, 1997 to the
quarter ended December 31, 1997, general and administrative expenses increased
from approximately $170,000 to approximately $202,000.
The growth in net interest income between the quarters ended September 30,
1997 and December 31, 1997 was due to an increase in the Company's Mortgage
Assets during the fourth quarter. Similarly, the increase in general and
administrative expenses between the period ended September 30, 1997 and
December 31, 1997 is primarily the result of the Company's increased management
fees which resulted from the increase in the Company's Mortgage Assets.
The Company experienced high levels of prepayments in the quarter ended
December 31, 1997. The annualized mortgage principal prepayment rate for the
Company was 31.4% in the quarter ending December 31, 1997, and 29.7% for the
period from February 11, 1997 (commencement of operations) through December 31,
1997. Although the level of prepayments of the Company's Mortgage Assets is
generally subject to the same seasonal influences as the residential real
estate industry as a whole, with prepayments generally being higher in the
summer months and lower in the winter months, the Company nevertheless
anticipates that prepayment rates may continue at high levels for an indefinite
period. There can be no assurance that the Company will be able to achieve or
maintain lower prepayment rates or that prepayment rates will not increase.
The Company's financial condition and results of operations could be materially
adversely affected if prepayments continue at high levels.
61
<PAGE> 65
Liquidity and Capital Resources
During the period from February 11, 1997 (commencement of operations) through
December 31, 1997, net cash provided by operating activities was $1.3 million
Net cash provided by operating activities was negatively impacted by an
increase in accrued interest receivable. There were no Mortgage Assets held at
February 11, 1997 and, therefore, the total accrued interest receivables at
December 31, 1997 negatively affected cash. Net cash for the period was
positively affected by an increase in accrued interest payable and other
accrued expenses.
Net cash used in investing activities for the period from February 11, 1997
(commencement of operations) through December 31, 1997 was $555.5 million. Net
cash used for the period was negatively affected by the purchase of Mortgage
Assets in the amount of $431.0 million and by Mortgage Loans in the amount of
$162.8 million and positively affected by principal prepayments.
For the period from February 11, 1997 (commencement of operations) through
December 31, 1997, net cash provided by financing activities was $560.1
million. Net cash provided was primarily from borrowings under reverse
repurchase agreements and net proceeds received from the issuance of Common
Stock in the Company's private placement of Common Stock in February 1997 and
the Company's initial public offering (the "Offering") of 6,500,000 shares of
its Common Stock par value $0.01 per share. The Offering was completed in
November 3, 1997 at an initial offering price of $15.00 per share. The Company
raised $89.7 million in the Offering, net of $6.3 million underwriting discount
and $1.5 million in other offering expenses.
At December 31, 1997 the Company had uncommitted reverse repurchase agreement
facilities in place to provide over $2.5 billion to finance investments in
Mortgage Assets. In addition, the Company has a line of credit with one
counter party to a reverse repurchase agreement. Pursuant to the line of
credit, the Company may borrow the lesser of $25 million and the outstanding
principal and interest receivable balance with the counter party, for a period
of up to 36 days at an interest rate equal to LIBOR plus 0.6%. The line of
credit has no set expiration date.
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.
62
<PAGE> 66
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Not required.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
63
<PAGE> 67
FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT
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> 68
REPORT OF INDEPENDENT AUDITORS
To 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 December 31, 1997 and the related
statements of operations, stockholders' equity and cash flows for the period
from February 11, 1997 (commencement of operations) through December 31, 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 for
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 American Residential Investment
Trust, Inc. as of December 31, 1997, and the results of its operations and its
cash flows for the period from February 11, 1997 (commencement of operations)
through December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
San Diego, California
January 13, 1998
F-2
<PAGE> 69
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
BALANCE SHEET
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
<S> <C>
ASSETS
Cash and cash equivalents $ 5,893
Mortgage securities available for sale 387,099
Mortgage loans held for investment 162,762
Interest rate cap agreements 411
Accrued interest receivable 5,169
Due from affiliate 269
Other assets 231
-----------------
$ 561,834
=================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Reverse repurchase agreements 451,288
Accrued interest payable 1,839
Accrued expense and other liabilities 632
Management fee payable 208
Accrued dividend 1,298
-----------------
Total liabilities 455,265
-----------------
Commitments and contingencies (Note 11)
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;
25,000,000 shares authorized; 8,114,000
shares issued and outstanding 81
Additional paid-in capital 109,786
Unrealized loss on mortgage securities
available for sale (3,300)
Cumulative dividends declared (2,401)
Retained earnings 2,403
-----------------
Total stockholders' equity 106,569
-----------------
$ 561,834
=================
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 70
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENT OF OPERATIONS
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
For the period
February 11, 1997
(commencement of
operations) through
December 31, 1997
<S> <C>
Interest income:
Mortage Assets $12,197
Cash and investments 253
-------
12,450
Interest expense 9,536
-------
Net interest income 2,914
Other expenses:
Management fee 283
General and administrative expenses 228
-------
511
-------
Net income $ 2,403
=======
Net income per share of Common Stock - Basic $ 0.83
Net income per share of Common Stock - Diluted $ 0.82
Dividends per share of Common Stock $ 0.84
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 71
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
Unrealized
Loss
on Mortgage
Additional Securities Cumulative
Common Stock Paid-in Available Dividends Retained
Shares Amount Capital for Sale Declared Earnings Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial capital contribution
February 11, 1997 1,614,000 $ 16 $ 20,149 $ -- $ -- $ -- $ 20,165
---------- ---------- ---------- ---------- ---------- ---------- ----------
Proceeds from sale of stock, net of 6,500,000 65 89,637 89,702
offering costs of $7,798
Unrealized loss on mortgage
securities available for sale (3,300) (3,300)
Net income 2,403 2,403
Dividends declared (2,401) (2,401)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 1997 8,114,000 $ 81 $ 109,786 $ (3,300) $ (2,401) $ 2,403 $ 106,569
========== ========== ========== ========== ========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 72
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENT OF CASH FLOWS
(dollars in thousands)
<TABLE>
<CAPTION>
For the period
February 11, 1997
(commencement of
operations) through
December 31, 1997
-----------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,403
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of premium on mortgage assets 1,797
Amortization of interest rate cap agreements 132
Increase in accrued interest receivable (5,169)
Increase in other assets (231)
Increase in due from affiliate (269)
Increase in accrued interest payable 1,839
Increase in accrued expenses 840
---------
Net cash provided by operating activities 1,342
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage securities available-for-sale (431,037)
Purchases of mortgage loans held for investment (162,762)
Principal payments on mortgage securities available-for-sale 38,841
Purchase of interest rate cap agreements (543)
---------
Net cash used in investing activities (555,501)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements 451,288
Net proceeds from stock issuances 109,867
Dividends paid (1,103)
---------
Net cash provided by financing activities 560,052
Net increase in cash and cash equivalents 5,893
Cash and cash equivalents at beginning of period --
---------
Cash and cash equivalents at end of period $ 5,893
=========
Supplemental Information
Interest Paid $ 7,697
=========
Non Cash Transactions:
Increase in unrealized loss on Mortgage
Securities available for sale $ (3,300)
=========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 73
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS) THROUGH DECEMBER 31, 1997
NOTE 1.
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 finances its acquisitions of Mortgage Assets with equity and
short-term secured borrowings.
Basis of Financial Statement Presentation
The preparation of financial statements in conformity with generally accepted
accounting principles requires management of the Company 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 reported 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.
F-7
<PAGE> 74
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 (Mortgage
Securities) and Mortgage Loans secured by residential properties (Mortgage
Loans).
Mortgage Securities
The Company classifies 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 Securities until
maturity, it may, from time to time, sell any of its Mortgage Securities as
part of its overall management of its balance sheet. Accordingly, this
flexibility requires the Company to classify all of its Mortgage Securities as
available-for-sale. All Mortgage Securities 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 Securities 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 Securities is adjusted. The determination of whether unrealized
losses are other than temporary is based on the management of the Company's
assessment of various factors affecting the Mortgage Securities.
Interest income is accrued based on the outstanding principal amount of the
Mortgage Securities and their contractual terms. Premiums relating to Mortgage
Securities are amortized into interest income over the lives of the Mortgage
Securities using the interest method. Gains or losses on the sale of Mortgage
Securities are based on the specific identification method.
Mortgage Loans Held for Investment
Fair value is estimated based on estimates of proceeds the Company would
receive from the sale of the underlying collateral of each loan. Mortgage
Loans held for investment include various types of adjustable-rate loans
secured by mortgages on single-family residential real estate properties.
Premiums and discounts related to these loans are amortized over their
estimated lives using the interest method. Loans are continually evaluated for
collectibility and, if appropriate, the loan may be placed on non-accrual
states, generally 90 days past due, and previously accrued interest reversed .
As of December 31, 1997, there are no Mortgage Loans placed on non-accrual
status.
F-8
<PAGE> 75
Allowance for Loan Losses
The Company maintains an allowance for losses on Mortgage Loans held for
investment at an amount which it believes is sufficient to provide adequate
protection against future losses in the Mortgage Loans portfolio. The
allowance for losses is determined primarily on the basis of management's
judgment of net loss potential including specific allowances for known impaired
loans, changes in the nature and volume of the portfolio, value of the
collateral and current economic conditions that may affect the borrower's
ability to pay. A provision will be recorded for all loans or portions thereof
deemed to be uncollectible thereby increasing the allowance for loan losses.
Subsequent recoveries on Mortgage Loans previously charged off are credited to
the allowance.
Interest Rate Agreements
The Company uses interest rate cap agreements (the "Cap Agreements") for
interest rate risk protection. The Cap Agreements are purchased primarily to
reduce the Company's exposure to rising interest rates which would increase the
cost of liabilities above the maximum yield which could be earned on the
adjustable rate Mortgage Assets. The Company periodically evaluates the
effectiveness of these Cap Agreements under various interest rate scenarios.
The cost of the Cap Agreements are amortized over the life of the Cap
Agreements using the straight-line method. 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.
Income Taxes
The Company will elect to be taxed as a REIT and intends to comply with 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
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128"). This
F-9
<PAGE> 76
statement replaces the previously reported primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excludes any dilutive effects of options.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. All earnings per share amounts have been restated
to conform to the SFAS No. 128 requirements.
The following table illustrates the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
For the period from
February 11, 1997
(commencement of
operations) through
December 31, 1997
(dollars in thousands
except per share data)
----------------------
<S> <C>
Numerator:
Numerator for basic earnings per share
net earnings $ 2,403
Denominator:
Denominator for basic earnings per share -
weighted average number of common
shares outstanding during the period 2,879,487
Incremental common shares attributable to
exercise of outstanding options
49,522
----------
Denominator for diluted earnings per share 2,929,009
Basic earnings per share $ 0.83
Diluted earnings per share $ 0.82
</TABLE>
NOTE 2. MORTGAGE SECURITIES
At December 31, 1997, the Company's Mortgage Securities consisted of the
following mortgage participation certificates issued or guaranteed by federal
government sponsored agencies:
F-10
<PAGE> 77
<TABLE>
<CAPTION>
Federal Home Federal National
Loan Mortgage Mortgage
Corporation Association Total
----------- ----------- -----
(dollars in thousands)
<S> <C> <C> <C>
Mortgage Securities available- $ 251,201 $ 124,255 $ 375,456
--------- --------- ---------
for-sale, principal
Unamortized premium 9,748 5,195 14,943
Amortized cost 260,949 129,450 390,399
Unrealized loss (2,494) (950) (3,444)
Unrealized gain 53 91 144
--------- --------- ---------
Fair value $ 258,508 $ 128,591 $ 387,099
========= ========= =========
</TABLE>
At December 31, 1997, all investments in Mortgage Securities 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 Association are
guaranteed as to principal and interest. The original maturity is subject to
change based on the prepayments of the underlying mortgage loans.
At December 31, 1997, the weighted average net coupon on the Mortgage
Securities was 7.91% per annum based on the amortized cost of the Mortgage
Securities. All Mortgage Securities have a repricing frequency of one year or
less.
NOTE 3. MORTGAGE LOANS HELD FOR INVESTMENT
The Company purchases certain non-conforming Mortgage Loans to be held as
long-term investments. Mortgage Loans held for investment consist of the
following:
<TABLE>
<CAPTION>
At
December 31, 1997
----------------------
(dollars in thousands)
<S> <C>
Mortgage Loans held for investment, principal $151,949
Unamortized premium 11,573
Allowance for loan losses (760)
--------
$162,762
========
</TABLE>
At December 31, 1997, the weighted average net coupon on the Mortgage Loans was
9.39% per annum. All Mortgage Loans have a repricing frequency of two years or
less. At December 31, 1997, 37% of the collateral was located in California
with no other state representing more than 10%.
F-11
<PAGE> 78
NOTE 4. INTEREST RATE AGREEMENTS
The amortized cost of the Company's interest rate agreements was $411,000
net of accumulated amortization of $132,000 at December 31, 1997.
Cap Agreements
The Company had thirteen outstanding Cap Agreements at December 31, 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 December 31, 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 December 31,
1997 the weighted average cap was 10.32%.
Cap agreements outstanding at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Average Cap
Notional Face Average Cap Low Cap High Cap
Year Amount Strike Rate Strike Rate Strike Rate
---- ------ ----------- ----------- -----------
(dollars in thousands)
<S> <C> <C> <C> <C>
1997 $ -- 0% 0% 0%
1998 133,903 8.11 7.52 9.95
1999 121,284 8.11 7.52 9.95
2000 93,179 8.11 7.52 9.95
</TABLE>
NOTE 5. REVERSE REPURCHASE AGREEMENTS
The Company has entered into uncommitted reverse repurchase agreements,
which may be withdrawn at any time, to finance the acquisition of its Mortgage
Assets. The maximum aggregate amount available under the uncommitted reverse
repurchase agreements at December 31, 1997 is over $2.5 billion. These reverse
repurchase agreements are collaterized by a portion of the Company's Mortgage
Assets. At no time were there more than approximately 45% of the reverse
repurchase agreements with any one investment banking firm. At December 31,
1997, Mortgage Assets pledged had an estimated fair value of approximately $472
million.
At December 31, 1997, the Company had approximately $451 million of reverse
repurchase agreements outstanding with a weighted average borrowing rate of
6.01% per annum and a weighted average remaining maturity of 39 days. The
maximum
F-12
<PAGE> 79
month end balance and the average balance outstanding for the period February
11, 1997 through December 31, 1997, was $451 million and $230.3 million,
respectively. At December 31, 1997, the reverse repurchase agreements had the
following characteristics:
<TABLE>
<CAPTION>
Reverse Weighted Average
Repurchase Underlying Interest Rate Weighted Average
Liability Collateral (per annum) Maturity Date
---------- ---------- ------------- ----------------
(dollars in thousands)
<S> <C> <C> <C> <C>
PaineWebber Incorporated $ 58,198 $ 60,742 5.96% February 14, 1998
Prudential 94,388 97,758 5.74 February 28, 1998
Federal National Mortgage Association 39,932 41,501 5.72 February 2, 1998
Federal Home Loan Mortgage Corporation 41,166 42,555 5.75 February 25, 1998
Lehman Brothers 151,949 162,762 6.47 January 17, 1998
First Boston 57,159 57,886 5.73 February 19, 1998
First Union 8,496 8,308 5.77 February 23, 1998
---------------------------------------------------------------------------
$451,288 $ 471,512 6.01% February 8, 1998
===========================================================================
</TABLE>
At December 31, 1997, the Company had funds available under a $25 million
short-term line of credit at an interest rate equal to LIBOR plus 0.6% secured
by certain receivables related to the Mortgage Assets. The balance under such
line of credit was zero at December 31, 1997.
NOTE 6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments amounts have been determined
by the Company's management using available market information and appropriate
valuation methodologies; however, considerable judgement is necessarily required
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.
F-13
<PAGE> 80
<TABLE>
<CAPTION>
As of
December 31, 1997
----------------------
Carrying Fair
Amount Value
------- -------
(dollars in thousands)
<S> <C> <C>
Assets
Cash and cash equivalents $ 5,893 $ 5,893
Mortgage Securities available-for-sale 387,099 387,099
Mortgage Loans held for investment 162,762 162,762
Interest rate agreements 411 67
Due from affiliate 269 269
Liabilities
Reverse repurchase agreements 451,288 451,288
</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.
Mortgage Securities Available-for-Sale
The fair value for Mortgage Securities available-for-sale is estimated
based on quoted market prices from dealers and brokers for similar types of
Mortgage Securities.
Mortgage Loans Held for Investment
The fair value for Mortgage Loans held for investment is estimated based on
estimates of proceeds the Company would receive from the sale of the underlying
collateral of each loan.
Interest Rate Agreements
The fair value of interest rate agreements is estimated based on quoted
market prices from dealers and brokers.
Due from Affiliate
The fair value of due from affiliate approximates the carrying amount
because of the short term maturity of the asset.
Reverse Repurchase Agreements
The fair value of reverse repurchase agreements approximates the carrying
amounts because of the short term maturity of the liabilities.
F-14
<PAGE> 81
NOTE 7. 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.
During the period from February 11, 1997 (commencement of operations) through
December 31, 1997, the Company granted 759,400 options as follows:
<TABLE>
<CAPTION>
Total Options w/
ISO Non-Qualified Options SAR's
------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997 STOCK INCENTIVE PLAN
February 11, 1997 @ 12.50/share 99,200 216,000 315,200 280,000
1997 STOCK OPTION PLAN
October 27, 1997 @ 15.00/share 104,801 232,999 337,800 --
1997 STOCK OPTION PLAN
December 15, 1997 @ 15.00/share 4,267 72,133 76,400 --
1997 OUTSIDE DIRECTORS STOCK OPTIONS
October 27, 1997 @ 15.00/share -- 30,000 30,000 --
------------------------------------------------------------------
TOTAL OPTIONS ISSUED IN 1997 208,268 551,132 759,400 280,000
==================================================================
</TABLE>
The Incentive Plan was adopted on February 11, 1997 (the "Effective Date"), and
a total 315,200 shares of Common Stock have been reserved for issuance under the
Incentive Plan. As of December 31, 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.
Also, the Company has adopted the 1997 Employee Stock Purchase Plan (the
"Purchase Plan") which permits eligible employees to purchase Common Stock at a
discount through accumulated payroll deductions. No shares were issued under
the Purchase Plan as of December 31, 1997.
F-15
<PAGE> 82
The Board of Directors has reserved a total of 474,800, 60,000 and 20,000
shares of common stock for issuance under the Company's Stock Option Plan,
Directors Plan and Purchase Plan respectively. As of December 31, 1997, 60,600,
30,000 and 20,000 shares were reserved for issuance under the Company's Stock
Option Plan, Directors Plan and Purchase Plan respectively, for future grant.
All stock options granted vest the earlier of a four-year period from the date
of grant or once the Company issues an aggregate of $150 million of new equity,
and will expire within ten years after the date of grant.
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 for 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 employees
except for employees 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 supplies or vendors.
The Company elected to apply the APB Opinion 25 in accounting for its plans:
the 1997 Stock Incentive Plan, 1997 Stock Option Plan, 1997 Employee Stock
Purchase Plan and 1997 Outside Directors Stock Option Plan and, accordingly, no
compensation cost has been recognized 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 December 31, 1997 would have decreased to the pro forma
amounts indicated below.
F-16
<PAGE> 83
<TABLE>
<CAPTION>
For the Period February 11, 1997
(commencement of operations)
through December 31, 1997
(in thousands except share data)
--------------------------------
<S> <C>
Net income as reported $ 2,403
============
Pro forma net income $ 2,277
============
Basic income per share as reported $ 0.83
============
Diluted income per share as reported $ 0.82
============
Pro forma basic income per share $ 0.79
============
Pro forma diluted income per share $ 0.78
============
</TABLE>
The derived fair value of the options granted during the period February 11,
1997 (commencement of operations) through December 31, 1997 was approximately
$423,000, using the Black-Scholes option pricing model with the following
assumptions; risk-free interest rate of 6.0% expected life of 10 years,
expected volatility of 20% and expected dividend yield of 10%.
NOTE 8. STOCKHOLDERS' EQUITY
On February 11, 1997, the Company issued 1,614,000 shares of Common Stock at a
price of $12.50 per share of Common Stock. The Company received proceeds of
$20,165,000, net of issuance costs of $10,000. On November 3, 1997, the Company
issued 6,500,000 shares of Common Stock at a price of $15.00 per share of Common
Stock. The Company received proceeds of $89,702,000, net of issuance costs of
$7,798,000.
On December 19, 1997, the Company declared a dividend of $1.3 million or $0.16
per share. The dividend was paid on January 21, 1998 to holders of record of
Common Stock as of December 31, 1997. On October 21, 1997, the Company declared
a dividend of $519,000 or $0.32 per share of Common Stock. This dividend was
paid on October 29, 1997 to holders of record of Common Stock as of September
30, 1997. On July 17, 1997, the Company declared a dividend of $438,000, or
$0.27 per share of Common Stock. This dividend was paid on July 17, 1997 to
holders of 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 holders of record of Common Stock as of
March 31, 1997.
F-17
<PAGE> 84
NOTE 9. STOCK SPLIT AND AUTHORIZED SHARES
On August 6, 1997, the Company authorized a 0.8-for-one reverse stock split of
all of the outstanding shares of 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. On October 20, 1997,
the Company increased the number of total authorized shares of Capital Stock to
25,000,000 from 4,000,000. Under the articles of incorporation amended on
October 20, 1997, the Company is authorized to issue any class of capital
stock, common stock or preferred stock, up to the aggregate authorized amount
of 25,000,000 shares, all of which has been initially designated as Common
Stock. All unissued shares may be reclassified by the Company's Board of
Directors as one or more series of preferred stock.
NOTE 10. 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.
The Manager receives management fees and incentive compensation as follows:
- 1/8 of 1% per year, to be paid monthly, of the principal amount of
agency securities;
- 3/8 of 1% per year, to be paid monthly, of the principal amount of
all Mortgage Assets other than agency securities; and
- 25% of the amount by which the Company's net income (before
deducting the amount to be paid as incentive compensation) exceeds
the annualized return on equity equal to the average ten year U.S.
Treasury Rate plus 2%.
Management fees of $249,000 were recorded for the period from February 11,1997
(commencement of operations) through December 31, 1997. 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.
Incentive compensation for the period from February 11, 1997 (commencement of
operations) to December 31, 1997 was $34,000.
F-18
<PAGE> 85
The Company employs certain employees of the Manager involved in the day-to-day
operations of the Company, including the Company's executive officers, so that
such employees may maintain certain benefits that are available only to
employees of the Company under the Code. These benefits include the ability to
receive incentive stock options under the 1997 Stock Option Plan and to
participate in the Company's Employee Stock Purchase Plan. In order to receive
the aggregate benefits of the Management Agreement originally negotiated between
the Company and the Manager, the Company pays the base salaries of such
employees and is reimbursed monthly by the Manager for all costs incurred with
respect to such payments. At December 31, 1997, reimbursement amount is
included in due from affiliate.
NOTE 11. COMMITMENTS AND CONTINGENCIES
As of December 31, 1997, the Company had a commitment to purchase approximately
$322 million of Mortgage Loans.
NOTE 12. QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data for 1997 (dollars in thousands except per
share data)
<TABLE>
<CAPTION>
For the Period
February 11, 1997 For the Quarter ended,
to ------------------------------------------------------
March 31, 1997 June 30, 1997 September 30, 1997 December 31, 1997
----------------- ------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Total Interest Income $306 $3,334 $3,750 $5,060
Net Interest Income 156 568 689 1,501
Net Income 146 438 519 1,300
Net Income per share of
Common Stock 0.09 0.26 0.31 0.21
</TABLE>
F-19
<PAGE> 86
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 with respect to directors is incorporated
herein by reference to the information contained under the headings "Election
of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in
the Company's definitive Proxy Statement for the Company's annual meeting of
stockholders to be held May 15, 1998 (the "Proxy Statement"). The information
required with respect to executive officers is set forth in Item 1 of this
report under the caption "Executive Officers of the Company."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the
information contained under the heading "Executive Compensation and Other
Matters" in the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to the
information contained under the heading "Stock Ownership of Certain Beneficial
Owners and Management" in the Company's Proxy Statement.
64
<PAGE> 87
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to the
information contained under the headings "Compensation Committee Interlocks and
Insider Participation" and "Certain Transactions" in the Company's Proxy
Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. The following Financial Statements of the Company are included in
Part II, Item 8 of this Annual Report on Form 10K:
Independent Auditors' Report;
Balance Sheet as of December 31, 1997;
Statement of Operations for the period from February 11, 1997
(commencement of operations) through December 31, 1997;
Statement of Stockholders' Equity for the period from
February 11, 1997
(commencement of operations) through December 31, 1997;
Statement of Cash Flows for the period from February 11, 1997
(commencement of operations) through December 31, 1997;
Notes to Financial Statements.
2. Schedules to Financial Statements.
All financial statement schedules have been omitted because they
are either inapplicable or the information required is provided
in the Company's Financial Statements and Notes thereto, included
in Part II, Item 8 of this Annual Report on Form 10-K.
3. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
*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
*10.1 Management Agreement between the Registrant and Home Asset Management Corp. dated February 11, 1997 and Amendment
thereto
</TABLE>
65
<PAGE> 88
<TABLE>
<S> <C>
*+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 January 7, 1997 and amendment thereto
*+10.5 Rollie Lynn Employment Letter dated January 7, 1997 and amendment thereto
+10.5a John Dahl Employment Letter, as amended
+10.5b Lisa Faulk Employment Letter, as amended
*+10.6 1997 Stock Incentive Plan
*+10.7 Form of 1997 Stock Option Plan, as amended
*+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 Secured Promissory Note dated June 25, 1997
*10.13 Lease Agreement with Louis and Louis dated March 7, 1997
*+10.14 Form of Indemnity Agreement
10.15 Master Repurchase Agreement Governing Purchases and Sales of
Mortgage Loans - Confidential Treatment Requested
21.1 Subsidiaries of Registrant
23.1 Consent of KPMG Peat Marwick LLP
27.1 Financial Data Schedule
</TABLE>
__________
* Incorporated by reference to Registration Statement of Form S-11 (File No.
333-33679)
+ Management Contract or Compensatory Plan
(b) Reports on Form 8-K:
None
66
<PAGE> 89
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 10-K and has duly caused this Form 10-K to be
signed on its behalf by the undersigned, thereto duly authorized, in the City
of San Diego, State of California, on the 1st day of March, 1998.
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
By: /s/ JOHN M. ROBBINS
----------------------------------------
John M. Robbins
Chief Executive Officer
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C> <C>
By: /s/ JOHN M. ROBBINS Chairman of the Board and March 31, 1998
------------------------------------------- Chief Executive Officer
John M. Robbins (Principal Executive
Officer)
By: /s/ MARK A. CONGER Chief Financial Officer March 31, 1998
-------------------------------------------- (Principal Financial and
Mark A. Conger Accounting Officer)
By: /s/ JAMES BROWN Director March 31, 1998
-------------------------------------------
H. James Brown
By: /s/ DAVID DE LEEUW Director March 31, 1998
-------------------------------------------
David De Leeuw
By: /s/ RAY McKEWON Director March 31, 1998
-------------------------------------------
Ray McKewon
By: /s/ RICHARD J. PRATT, Ph.D. Director March 31, 1998
-------------------------------------------
Richard J. Pratt, Ph.D.
By: /s/ MARK J. REIDY, Ph.D. Director March 31, 1998
-------------------------------------------
Mark J. Reidy, Ph.D.
</TABLE>
67
<PAGE> 90
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C>
*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
*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 Noncomposition Agreement between Home Asset
Management Corp. and Jay Fuller dated February 11, 1997 and
Amendment thereto
*+10.4 Mark Conger Employment Letter dated January 7, 1997 and
amendment thereto
*+10.5 Rollie Lynn Employment Letter dated January 7, 1997 and
amendment thereto
+10.5a John Dahl Employment Letter, as amended
+10.5b Lisa Faulk Employment Letter, as amended
*+10.6 1997 Stock Incentive Plan
*+10.7 Form of 1997 Stock Option Plan, as amended
*+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 Secured Promissory Note dated June 25, 1997
*10.13 Lease Agreement with Louis and Louis dated March 7, 1997
*+10.14 Form of Indemnity Agreement
10.15 Master Repurchase Agreement Governing Purchases and Sales of
Mortgage Loans - Confidential Treatment Requested
21.1 Subsidiaries of Registrant
23.1 Consent of KPMG Peat Marwick LLP
27.1 Financial Data Schedule
</TABLE>
- ------------
* Incorporated by reference to Registration Statement on Form S-11 (File No.
333-33679)
+ Management Contract or Compensatory Plan
<PAGE> 1
EXHIBIT 10.5a
Mr. John Dahl
18 Meryton
Irvine, Calif. 92612
Dear John:
As a result of our conversation, I am outlining the proposed terms of your
employment with American Residential and Home Asset Management. We are very
encouraged by your interest and look forward to working together to create a
very exciting company. Please call me after reviewing these terms if you have
any questions.
Position: Executive Vice President
Responsibility: Capital Markets and Loan Production
Base Salary: $175,000.00
Bonus Potential: up to 100% of Base Salary
Options: Initial Grant of 75,000 options at market at time of employment.
-Full vesting upon change of control
-Current vesting and 90 day exercise provision for termination
with out cause
Benefits: Participation in all company programs available to Senior Officers:
401K program [starting in 1998]
company pays 100% of health care and insurance premiums
employee stock purchase program [available after IPO]
employee loan program to purchase AmReit stock [ after IPO]
Severance: one year's salary for termination without cause.
Transition: up to $25,000 of out of pocket expenses associated with a move
to the San Diego area if within 18 months of hire date. You
will be entitled to a signing bonus and a regular bonus for
1997 of $100,000 all of which you have elected
<PAGE> 2
to defer into the Home Asset Management Corporation Executive
Deferred Compensation Plan.
John, again we are very excited about you helping us and look forward to
your response. Feel free to contact me at home over the weekend to discuss any
aspects of this offer.
My home phone number is 619-756-5441 and you have the work number.
We look forward to your response.
Sincerely,
Jay M. Fuller
President
<PAGE> 1
EXHIBIT 10.5b
Ms. Lisa Faulk
4410 Santa Monica Avenue
San Diego, Calif. 92107
Dear Lisa:
As a result of our conversation, I am outlining the proposed terms of your
employment with American Residential and Home Asset Management. We are very
encouraged by your interest and look forward to working together to create a
very exciting company. Please call me after reviewing these terms if you have
any questions.
Position: Senior Vice President
Responsibility: Operations
Reporting Responsibility: To E.V.P of Capital Markets and Production
Base Salary: $120,000.00 per year
Bonus Potential: up to 75% of Base Salary
Options: Initial Grant of 50,000 options at market at time of employment.
-Full vesting upon change of control
-Current vesting and 90 day exercise provision for termination
with out cause
Benefits: Participation in all company programs available to Senior Officers:
401K program [starting in 1998]
company pays 100% of health care and insurance premiums
employee stock purchase program [available after IPO]
employee loan program to purchase AmReit stock [ after IPO]
Severance: six month's salary for termination without cause.
<PAGE> 2
Transition:. Transition payment in the amount of $40,000: payable $20,000 in
Feb. 1998 and $20,000 which you have elected to defer into the
Home Asset Management Corporation Executive Deferred
Compensation Plan. These payments represent bonus for 1997
and signing bonus.
Lisa, again we are very excited about you helping us and look forward to
your response. Feel free to contact me at home over the weekend to discuss any
aspects of this offer.
My home phone number is 619-756-5441 and you have the work number.
We look forward to your response.
Sincerely,
Jay M. Fuller
President
Agreed and Accepted: _____________________
<PAGE> 1
Confidential Treatment Requested - Edited Copies
EXHIBIT 10.15
MASTER REPURCHASE AGREEMENT GOVERNING
PURCHASES AND SALES OF MORTGAGE LOANS
DATED AS OF DECEMBER 16, 1997
BETWEEN
LEHMAN COMMERCIAL PAPER INC.,
AS BUYER
AND
AMERICAN RESIDENTIAL INVESTMENT TRUST
AS SELLER
1. APPLICABILITY
From time to time for a period of [confidential information omitted
and filed separately with SEC] from the date hereof, unless otherwise agreed in
a Confirmation, Lehman Commercial Paper Inc.("Buyer") may, subject to the terms
hereof, enter into transactions upon the request of American Residential
Investment Trust ("Seller") in which Seller agrees to transfer to Buyer Mortgage
Loans against the transfer of funds by Buyer, with a simultaneous agreement by
Buyer to transfer to Seller such Mortgage Loans at a date certain not later than
30 days after the date of transfer or on demand, as specified in the
Confirmation, against the transfer of funds by Seller. Each such transaction
shall be referred to herein as a "Transaction" and shall be governed by this
Agreement and the related Confirmation, unless otherwise agreed in writing.
Notwithstanding anything in this Agreement to the contrary, Buyer shall have no
obligation to enter into any Transaction hereunder. Buyer shall promptly notify
Seller of any determination by Buyer that any of the foregoing has occurred.
2. DEFINITIONS
"Act of Insolvency" means, with respect to any party and its
Affiliates, (i) the filing of a petition, commencing, or authorizing the
commencement of any case or proceeding under any bankruptcy, insolvency,
reorganization, liquidation, dissolution or similar law relating to the
protection of creditors, or suffering any such petition or proceeding to be
commenced by another which is consented to, not timely contested or results in
entry of an order for relief; (ii) the seeking the appointment of a receiver,
trustee, custodian or similar official for such party or an Affiliate or any
substantial part of the property of either, (iii) the appointment of a receiver,
conservator, or manager for such party or an Affiliate by any governmental
agency or authority having the jurisdiction to do so; (iv) the making or
offering by such party or an Affiliate of a composition with its creditors or a
general assignment for the benefit of creditors, (v) the
1
<PAGE> 2
Confidential Treatment Requested - Edited Copies
admission by such party or an Affiliate of such party of its inability to pay
its debts or discharge its obligations as they become due or mature; or (vi)
that any governmental authority or agency or any person, agency or entity acting
or purporting to act under governmental authority shall have taken any action to
condemn, seize or appropriate, or to assume custody or control of, all or any
substantial part of the property of such party or of any of its Affiliates, or
shall have taken any action to displace the management of such party or of any
of its Affiliates or to curtail its authority in the conduct of the business of
such party or of any of its Affiliates.
"Additional Loans" means Mortgage Loans or cash provided by Seller to
Buyer or its designee pursuant to Section 4(a).
"Affiliate" means an affiliate of a party as such term is defined in
the United States Bankruptcy Code in effect from time to time.
"Agency" means FNMA, FHLMC or GNMA.
"Agreement" means this Master Repurchase Agreement Governing
Purchases and Sales of Mortgage Loans between Buyer and Seller, as amended from
time to time.
"`B' Loan" means a Mortgage Loan owned by Seller to a Mortgagor with
a `B' credit history which is underwritten in accordance with originator's
underwriting guidelines for `B' credit Mortgage Loans.
"Balloon Mortgage Loan" means any Mortgage Loan that provided on the
date of origination for scheduled payments by the Mortgagor based upon an
amortization schedule extending beyond its maturity date.
"Business Day" means a day other than (i) a Saturday or Sunday, (ii)
a day in which the Buyer is closed, or (iii) a day in which the New York Stock
Exchange or Buyer is authorized or obligated by law or executive order to be
closed.
"Buyer" has the meaning specified in Section 1.
"`C' Loan" means a Mortgage Loan owned by Seller to a Mortgagor with
a `C' credit history which is underwritten in accordance with originator's
underwriting guidelines for `C' credit Mortgage Loans.
"Collateral" has the meaning specified in Section 6.
"Collateral Amount" means, with respect to any Transaction, the
amount obtained by application of the applicable Collateral Amount Percentage to
the related Repurchase Price for such Transaction.
"Collateral Amount Percentage" means the amount set forth in the
Confirmation which, in any event, (i) shall not be less than (x) [confidential
information omitted and filed separately with SEC] with respect to the Mortgage
Loans in determining whether a Market Value Collateral Deficit exists pursuant
to the first sentence of Section 4(a) hereof; provided however that with
2
<PAGE> 3
Confidential Treatment Requested - Edited Copies
respect to Mortgage Loans that are greater than 30 days Delinquent, such
percentage shall be at least [confidential information omitted and filed
separately with SEC]. and (ii) shall not be less than [confidential information
omitted and filed separately with SEC] with respect to all Mortgage Loans in
determining whether a Securitization Value Collateral Deficit exists pursuant to
the second sentence of Section 4(a) hereof.
"Collateral Deficit" means either a Market Value Collateral Deficit
or a Securitization Value Collateral Deficit.
"Collateral Information" means the following information with respect
to each Mortgage Loan: (i) Seller's loan number , (ii) the Mortgagor's name,
(iii) the address of the Mortgaged Property, (iv) the current interest rate, (v)
the original balance, (vi) current balance as of the last day of the immediately
preceding month, (vii) the paid to date, (viii) the appraisal value of the
Mortgaged Property, (ix) whether interest rate is fixed or adjustable (and if
adjustable, the ARM terms, including the index, spread, adjustment frequency,
next adjustment date, caps and floors), (x) whether the Mortgage Loan is
convertible from ARM to fixed, (xi) the lien position of the Mortgage Loan on
the Mortgaged Property (and if a second lien, the outstanding principal balance
of the first lien), (xii) the occupancy status of the Mortgaged Property
(including whether owner occupied), (xiii) whether the Mortgage Loan is a
Balloon Loan, (xiv) the first payment date, (xv) the maturity date, (xvi) the
principal and interest payment , (xvii) the applicable credit grade and score,
(xviii) the note date, (xix) the Social Security Number of the Mortgagor and
(xx) the note date.
"Confirmation" has the meaning specified in Section 3(a).
"Custodial Agreement" means that custodial agreement, dated as of
December 16, 1997, by and among Buyer, Seller and each Custodian, as applicable.
"Custodial Delivery" means the form executed by the Seller in order
to deliver the Mortgage Loan Schedule and/or the Mortgage File to Buyer or its
designee (including the Custodian) pursuant to Section 7, a form of which is
attached hereto as Exhibit II.
"Custodian" means the custodian under one or more Custodial
Agreements. The initial custodian is either Texas Commerce National Bank or
Bankers Trust Company of California, N.A, as applicable.
"Delinquent" means, with respect to any Mortgage Loan, the period of
time from the date on which a Mortgagor fails to pay an obligation under the
terms of such Mortgage Loan (without regard to any applicable grace periods) to
the date on which such payment is made.
"Event of Default" has the meaning specified in Section 13.
"FHA" means the Federal Housing Administration, an agency within HUD.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
3
<PAGE> 4
Confidential Treatment Requested - Edited Copies
"FHLMC Guide" means the FHLMC Sellers/Servicers Guide, as amended
from time to time.
"First Mortgage" means the Mortgage that is the first lien on the
Mortgaged Property.
"FNMA" means the Federal National Mortgage Association.
"FNMA Guide" means the FNMA Selling, Servicing and MBS Guides, as
amended from time to time.
"GNMA" means the Government National Mortgage Association.
"GNMA Guide" means the GNMA Mortgage-Backed Securities Guide, as
amended from time to time.
"Hedge" means, with respect to any or all of the Purchased Mortgage
Loans, any interest rate swap, cap or collar agreement or similar arrangements
providing for protection against fluctuations in interest rates or the exchange
of nominal interest obligations, either generally or under specific
contingencies, entered into by Seller with Buyer or its Affiliates, and
reasonably acceptable to the Buyer.
"HUD" means the United States Department of Housing and Urban
Development.
"Income" means, with respect to any Purchased Mortgage Loan at any
time, any principal thereof then payable and all interest, dividends or other
distributions payable thereon less any related servicing fee(s) charged by a
subservicer.
"LIBOR" means the London Interbank Offered Rate for one-month United
States dollar deposits as set forth on page 3750 of Telerate and as shown on
Bloomberg ticker "US0001M" as of 11:00 a.m., London time, on the date of
determination.
"Loan-to-Value Ratio" means with respect to any Mortgage Loan as of
any date, the fraction, expressed as a percentage, the numerator of which is the
principal balance of such Mortgage Loan at the date of determination and the
denominator of which is the value of the related Mortgaged Property as set forth
in the appraisal of such Mortgaged Property obtained in connection with the
origination of such Mortgage Loan. For purposes of calculating a Mortgage Loan
secured by a Second Mortgage, the principal balance of the related First
Mortgage as well as the Second Mortgage shall be included in the numerator.
"Market Value" means as of any date with respect to any Mortgage
Loan, the price at which such Mortgage Loan could readily be sold as determined
by Buyer in its sole discretion; provided, however, that Buyer shall not take
into account, for purposes of calculating Market Value, any Mortgage Loan (i)
which has been subject to Transactions for more than [confidential information
omitted and filed separately with
4
<PAGE> 5
Confidential Treatment Requested - Edited Copies
SEC], (ii) which, together with the other Mortgage Loans subject to then
outstanding Transactions, would cause the 30 Day Delinquency Percentage to
exceed [confidential information omitted and filed separately with SEC] or (iii)
the 30+ Delinquency Percentage to exceed [confidential information omitted and
filed separately with SEC], (iv) which are more than 59 days Delinquent, or (v)
with respect to which there is a breach of a representation, warranty or
covenant made by Seller in this Agreement that materially adversely affects
Buyer's interest in such Mortgage Loan and which breach has not been cured.
"Market Value Collateral Deficit" has the meaning specified in
Section 4(a).
"Mortgage" means a mortgage, deed of trust, deed to secure debt or
other instrument, creating a valid and enforceable first or second lien on or a
first or second priority ownership interest in an estate in fee simple in real
property and the improvements thereon, securing a mortgage note or similar
evidence of indebtedness.
"Mortgage File" means the documents specified as the "Mortgage File"
in Section 7(d), together with any additional documents and information required
to be delivered to Buyer or its designee (including the Custodian) pursuant to
this Agreement.
"Mortgage Loan" means (i) a non-securitized whole loan, namely a
conventional mortgage loan secured by a first or second lien on a one to four
family residential property which conform to each originator's underwriting
guidelines (including, without limitation, "B" Loans and "C" Loans) or (ii)
another type of non-securitized whole loan as may be agreed upon in writing by
the parties hereto from time to time.
"Mortgage Loan Schedule" means a schedule of Mortgage Loans attached
to each Trust Receipt, Confirmation and Custodial Delivery.
"Mortgage Note" means a note or other evidence of indebtedness of a
Mortgagor secured by a Mortgage.
"Mortgaged Property" means the real property securing repayment of
the debt evidenced by a Mortgage Note.
"Mortgagee" means the record holder of a Mortgage Note secured by a
Mortgage.
"Mortgagor" means the obligor on a Mortgage Note and the grantor of
the related Mortgage.
"Periodic Payment" has the meaning specified in Section 5(b).
"Person" means an individual, partnership, corporation, joint stock
company, trust or unincorporated organization or a governmental agency or
political subdivision thereof.
"Price Differential" means, with respect to any Transaction hereunder
as of any date, the aggregate amount obtained by daily application of the
Pricing Rate for such Transaction to the Purchase Price for such Transaction on
a 360 day per year basis for the actual number of days during the period
commencing on (and including) the Purchase Date for such Transaction and ending
on (but excluding) the Repurchase Date (reduced by any amount of such Price
Differential previously paid by Seller to Buyer with respect to such
Transaction).
5
<PAGE> 6
Confidential Treatment Requested - Edited Copies
"Pricing Rate" means the per annum percentage rate specified in the
Confirmation for determination of the Price Differential which shall not exceed
LIBOR plus the applicable Pricing Spread.
"Pricing Spread" means the spread as agreed upon from time to time by
the Parties and specified in the related confirmation, but in no event shall it
exceed up to [confidential information omitted and filed separately with SEC].
"Prime Rate" means the rate of interest published by The Wall Street
Journal, northeast edition, as the "prime rate".
"Purchase Date" means the date on which Purchased Mortgage Loans are
transferred by Seller to Buyer or its designee (including the Custodian) as
specified in the Confirmation.
"Purchase Price" means on each Purchase Date, the price at which
Purchased Mortgage Loans are transferred by Seller to Buyer or its designee
(including the Custodian), which, subject to compliance with the collateral
maintenance requirements of Section 4, shall equal the lesser of [confidential
information omitted and filed separately with SEC] of the Market Value and
[confidential information omitted and filed separately with SEC] of the
Securitization Value of such Purchased Mortgage Loans; provided, however, that
the Purchase Price of any Mortgage Loan shall not in any event exceed the
outstanding principal amount thereof.
"Purchased Mortgage Loans" means the Mortgage Loans sold by Seller to
Buyer in a Transaction, any Additional Loans and any Substituted Mortgage Loans.
"Replacement Loans" has the meaning specified in Section 14(b)(ii).
"Repurchase Date" means the date on which Seller is to repurchase the
Purchased Mortgage Loans from Buyer, including any date determined by
application of the provisions of Sections 3 or 14, as specified in the
Confirmation; provided that in no event shall such date be more than 30 days
after the Purchase Date.
"Repurchase Price" means the price at which Purchased Mortgage Loans
are to be transferred from Buyer or its designee (including the Custodian) to
Seller upon termination of a Transaction, which will be determined in each case
(including Transactions terminable upon demand) as the sum of the Purchase Price
and the Price Differential as of the date of such determination decreased by all
cash, Income and Periodic Payments actually received by Buyer pursuant to
Sections 4(a), 5(a) and 5(b), respectively.
"Second Mortgage" means a Mortgage that is a second lien on the
Mortgaged Property.
"Securitization Value" means, as of any date with respect to any
Mortgage Loans, the price at which such Mortgage Loans could be securitized and
sold in a securitization as determined by Buyer in its sole discretion;
provided, however, that Buyer shall not take into account, for purposes of
calculating Securitization Value, any Mortgage Loan (i) which has been subject
to Transactions for more than [confidential information omitted and filed
separately with SEC], (ii) which, together with the other Mortgage Loans subject
to then outstanding
6
<PAGE> 7
Confidential Treatment Requested - Edited Copies
Transactions, would cause 30 Day Delinquency Percentage to exceed [confidential
information omitted and filed separately with SEC] or (iii) the 30+ Delinquency
Percentage to exceed [confidential information omitted and filed separately with
SEC], (iv) which are more than 59 days Delinquent, or (v) with respect to which
there is a breach of a representation, warranty or covenant made by Seller in
this Agreement that materially adversely affects Buyer's interest in such
Mortgage Loan and which breach has not been cured.
"Securitization Value Collateral Deficit" has the meaning specified
in Section 4(a).
"Seller" has the meaning specified in Section 1.
"Servicing Agreement" has the meaning specified in Section 25.
"Servicing Records" has the meaning specified in Section 25.
"Substituted Mortgage Loans" means any Mortgage Loans substituted for
Purchased Mortgage Loans in accordance with Section 9 hereof.
"30 Day Delinquency Percentage" means the fraction, expressed as a
percentage, the numerator of which is the aggregate Purchase Price of Purchased
Mortgage Loans subject to then outstanding Transactions which are up to 30 days
Delinquent and the denominator of which is the aggregate Purchase Price of all
Purchased Mortgage Loans subject to then outstanding Transactions.
"30+ Delinquency Percentage" means the fraction, expressed as a
percentage, the numerator of which is the aggregate Purchase Price of Purchased
Mortgage Loans subject to then outstanding Transactions which are more than 30
days Delinquent and the denominator of which is the aggregate Purchase Price of
all Purchased Mortgage Loans subject to then outstanding Transactions.
"Transaction" has the meaning specified in Section 1.
"Trust Receipt" means a trust receipt issued by Custodian to Buyer
confirming the Custodian's possession of certain mortgage loan files which are
the property of and held by Custodian for the benefit of the Buyer or the
registered holder of such trust receipt.
3. INITIATION; CONFIRMATION; TERMINATION; MAXIMUM TRANSACTION AMOUNTS
(a) An agreement to enter into a Transaction may be entered into
orally or in writing at the initiation of either Buyer or Seller. In any event,
Buyer shall confirm the terms of each Transaction by issuing a written
confirmation to Seller promptly after the parties enter into such Transaction in
the form of Exhibit I attached hereto (a "Confirmation"). Such Confirmation
shall describe the Purchased Mortgage Loans, identify Buyer and Seller and set
forth (i) the Purchase Date, (ii) the Purchase Price, (iii) the Repurchase Date,
unless the Transaction is to be terminable on demand, (iv) the Pricing Rate
applicable to the Transaction, (v) the applicable Collateral Amount Percentages
and (vi) additional terms or conditions not inconsistent with this Agreement.
7
<PAGE> 8
Confidential Treatment Requested - Edited Copies
After receipt of the Confirmation, Seller shall, subject to the provisions of
subsection (c) below, sign the Confirmation and promptly return it to Buyer. The
Purchase Price for any Transaction shall exceed $1,000,000.
(b) Any Confirmation by Buyer shall be deemed to have been received
by Seller on the date actually received by Seller.
(c) Each Confirmation, together with this Agreement, shall be
conclusive evidence of the terms of the Transaction(s) covered thereby unless
objected to in writing by Seller no more than two (2) Business Days after the
date the Confirmation was received by Seller or unless a corrected Confirmation
is sent by Buyer. An objection sent by Seller must state specifically that
writing which is an objection, must specify the provision(s) being objected to
by Seller, must set forth such provision(s) in the manner that the Seller
believes they should be stated, and must be received by Buyer no more than two
(2) Business Days after the Confirmation was received by Seller.
(d) In the case of Transactions terminable upon demand, such demand
shall be made by Buyer or Seller by telephone or otherwise, no later than 1:00
p.m. (New York Time) on the Business Day prior to the day on which such
termination will be effective.
(e) On the Repurchase Date, termination of the Transaction will be
effected by transfer to Seller or its designee of the Purchased Mortgage Loans
(and any Income in respect thereof received by Buyer not previously credited or
transferred to, or applied to the obligations of, Seller pursuant to Section 5)
against the simultaneous transfer of the Repurchase Price to an account of
Buyer. Seller is obligated to obtain the Mortgage Files from Buyer or its
designee at Seller's expense on the Repurchase Date.
(f) With respect to all Transactions hereunder, the aggregate
Purchase Price for all Purchased Mortgage Loans at any one time subject to then
outstanding Transactions shall not exceed [confidential information omitted and
filed separately with SEC].
4. COLLATERAL AMOUNT MAINTENANCE
(a) If at any time the aggregate Market Value of all Purchased
Mortgage Loans subject to all Transactions is less than the aggregate Collateral
Amount for all such Transactions (a "Market Value Collateral Deficit"), then
Buyer may by notice to Seller require Seller to transfer to Buyer or its
designee (including the Custodian) Mortgage Loans ("Additional Loans") or cash,
so that the cash and aggregate Market Value of the Purchased Mortgage Loans,
including any such Additional Loans, will thereupon equal or exceed the
aggregate Collateral Amount. If at any time the aggregate Securitization Value
of all Mortgage Loans subject to Transactions is less than the aggregate
Collateral Amount for all such Transactions (a "Securitization Value Collateral
Deficit"), then Buyer may by notice to Seller require Seller to transfer to
Buyer or its designee (including the Custodian) Additional Loans or cash, so
that the cash and aggregate Securitization Value of such Mortgage Loans,
including any such Additional Loans, will thereupon equal or exceed the
aggregate Collateral Amount.
8
<PAGE> 9
Confidential Treatment Requested - Edited Copies
(b) Notice required pursuant to subsection (a) above may be given by
any means of telecopier or telegraphic transmission. A notice for the payment or
delivery in respect of a Collateral Deficit received before 9:00 a.m. on a
Business Day, local time of the party receiving the notice, must be met not
later than 5:00 p.m. on the Business Day on which the notice was given or as may
be mutually agreed upon in writing by Buyer and Seller, local time of the party
receiving the notice. Any notice given on a Business Day after 9:00 a.m., local
time of the party receiving the notice, shall be met not later than 2:00 p.m.
(New York time) on the following Business Day or as may be mutually agreed upon
in writing by Buyer and Seller. The failure of Buyer, on any one or more
occasions, to exercise its rights under subsection (a) of this Section shall not
change or alter the terms and conditions to which this Agreement is subject or
limit the right of the Buyer to do so at a later date. Buyer and Seller agree
that a failure or delay to exercise its rights under subsections (a) of this
Section shall not limit Buyer's rights under this Agreement or otherwise
existing by law or in any way create additional rights for Seller.
(c) In the event that Seller fails to comply with the provisions of
this Section 4, Buyer shall not enter into any additional Transactions hereunder
after the date of such failure.
5. INCOME PAYMENTS
(a) Where a particular Transaction's term extends over an Income
payment date on the Purchased Mortgage Loans subject to that Transaction such
Income shall be the property of Buyer. Notwithstanding the foregoing, so long as
no Event of Default shall have occurred and be continuing, Seller shall be
entitled to all Income with respect to Purchased Mortgage Loans subject to
Transactions. Upon the occurrence and continuance of an Event of Default, all
Income with respect to Purchased Mortgage Loans subject to Transactions shall be
held in a segregated account established by the Custodian for the benefit of
Buyer and distributed under the Custodial Agreement.
(b) Notwithstanding that Buyer and Seller intend that the
Transactions hereunder be sales to Buyer of the Purchased Mortgage Loans, Seller
shall pay by wire transfer to Buyer the accreted value of the Price Differential
(less any amount of such Price Differential previously paid by Seller to
Buyer)(each such payment, a "Periodic Payment") on the first Business Day of
each month.
(c) Buyer shall offset against the Repurchase Price of each such
Transaction all Income and Periodic Payments actually received by Buyer pursuant
to Sections 5(a) and (b), respectively.
6. SECURITY INTEREST
(a) Buyer and the Seller intend that the Transactions hereunder be
sales to Buyer of the Purchased Mortgage Loans and not loans from Buyer to
Seller secured by the Purchased Mortgage Loans. However, in order to preserve
Buyer's rights under this Agreement in the event that a court or other forum
recharacterizes the Transactions hereunder as loans and as security for the
performance by Seller of all of Seller's obligations to Buyer under this
Agreement and the
9
<PAGE> 10
Confidential Treatment Requested - Edited Copies
Transactions entered into pursuant to this Agreement, Seller grants Buyer a
first priority security interest in the Purchased Mortgage Loans, Servicing
Records, insurance relating to the Purchased Mortgage Loans, Income, any and all
Hedges, any and all custodial accounts and escrow accounts relating to the
Purchased Mortgage Loans and any other contract rights, general intangibles and
other assets relating to the Purchased Mortgage Loans or any interest in the
Purchased Mortgage Loans and the servicing of the Purchased Mortgage Loans and
any and all replacements, substitutions, distributions on or proceeds of any and
all of the foregoing (collectively, the "Collateral").
(b) Seller shall pay all fees and expenses associated with perfecting
Buyer's security interest in the Collateral, including, without limitation, the
cost of filing financing statements under the Uniform Commercial Code and
recording assignments of Mortgage, as and when required by Buyer in its sole
discretion.
(c) Seller covenants to take such further actions as are necessary in
order to perfect Buyer's first priority security interest in the Hedges.
7. PAYMENT, TRANSFER AND CUSTODY
(a) Unless otherwise mutually agreed in writing, all transfers of
funds hereunder shall be in immediately available funds.
(b) On or before each Purchase Date, Seller shall deliver or cause to
be delivered to Buyer or its designee the Custodial Delivery in the form
attached hereto as Exhibit II.
(c) On the Purchase Date for each Transaction, ownership of the
Purchased Mortgage Loans shall be transferred to the Buyer or its designee
(including the Custodian) against the simultaneous transfer of the Purchase
Price to an account of Seller specified in the Confirmation. Seller,
simultaneously with the delivery to Buyer or its designee (including the
Custodian) of the Purchased Mortgage Loans relating to each Transaction hereby
sells, transfers, conveys and assigns to Buyer or its designee (including the
Custodian) without recourse, but subject to the terms of this Agreement, all the
right, title and interest of Seller in and to the Purchased Mortgage Loans
together with all right, title and interest in and to the proceeds of any
related insurance policies.
(d) In connection with each sale, transfer, conveyance and
assignment, on or prior to each Purchase Date with respect to each Mortgage Loan
(or with respect to item (vii) below within five Business Days after the
Purchase Date), the Seller shall deliver or cause to be delivered and released
to the Custodian the following original documents (collectively the "Mortgage
File"), pertaining to each of the Purchased Mortgage Loans identified in the
Custodial Delivery delivered therewith:
(i) the original Mortgage Note bearing all intervening
endorsements, endorsed "Pay to the order of ________ without recourse, and
without representation or warranty, express or implied" and signed in the name
of the last endorsee (the "Last Endorsee") by an authorized officer (in the
event that the Mortgage Loan was acquired by the Last Endorsee in a merger, the
10
<PAGE> 11
Confidential Treatment Requested - Edited Copies
signature must be in the following form: "[the Last Endorsee], successor by
merger to [name of predecessor]"; in the event that the Mortgage Loan was
acquired or originated while doing business under another name, the signature
must be in the following form: "[the Last Endorsee], formerly known as [previous
name]");
(ii) the original of any guarantee executed in connection with
the Mortgage Note (if any);
(iii) the original Mortgage with evidence of recording thereon
or copies certified by Seller to have been sent for recording;
(iv) the originals of all assumption, modification,
consolidation or extension agreements, with evidence of recording thereon or
copies certified by Seller to have been sent for recording;
(v) the original assignment of Mortgage in blank for each
Mortgage Loan, in form and substance acceptable for recording and signed in the
name of the Last Endorsee (in the event that the Mortgage Loan was acquired by
the Last Endorsee in a merger, the signature must be in the following form:
"[the Last Endorsee], successor by merger to [name of predecessor]"; in the
event that the Mortgage Loan was acquired or originated while doing business
under another name, the signature must be in the following form: "[the Last
Endorsee], formerly known as [previous name]");
(vi) the originals of all intervening assignments of mortgage
with evidence of recording thereon or copies certified by Seller to have been
sent for recording;
(vii) the original of any security agreement, chattel mortgage
or equivalent document executed in connection with the Mortgage (if any).
(e) With respect to all of the Mortgage Loans delivered by Seller to
Buyer or its designee (including the Custodian), Seller shall execute an omnibus
power of attorney substantially in the form of Exhibit III attached hereto
irrevocably appointing Buyer its attorney-in-fact with full power to complete
and record the assignment of Mortgage, complete the endorsement of the Mortgage
Note and take such other steps as may be necessary or desirable to enforce
Buyer's rights against such Mortgage Loans, the related Mortgage Files and the
Servicing Records.
(f) Buyer shall deposit the Mortgage Files representing the Purchased
Mortgage Loans, or direct that the Mortgage Files be deposited directly, with
the Custodian. The Mortgage Files shall be maintained in accordance with the
Custodial Agreement.
(g) Any Mortgage Files not delivered to Buyer or its designee
(including the Custodian) are and shall be held in trust by Seller or its
designee for the benefit of Buyer as the owner thereof. Seller or its designee
shall maintain a copy of the Mortgage File and the originals of the Mortgage
File not delivered to Buyer or its designee. The possession of the Mortgage File
by Seller or its designee is at the will of the Buyer for the sole purpose of
servicing the related Purchased Mortgage Loan, and such retention and possession
by the Seller or its designee is in a
11
<PAGE> 12
Confidential Treatment Requested - Edited Copies
custodial capacity only. The books and records (including, without limitation,
any computer records or tapes) of Seller or its designee shall be marked
appropriately to reflect clearly the sale of the related Purchased Mortgage Loan
to Buyer. Seller or its designee (including the Custodian) shall release its
custody of the Mortgage File only in accordance with written instructions from
Buyer, unless such release is required as incidental to the servicing of the
Purchased Mortgage Loans or is in connection with a repurchase of any Purchased
Mortgage Loan by Seller.
8. REHYPOTHECATION OR PLEDGE OF PURCHASED MORTGAGE LOANS
Title to all Purchased Mortgage Loans shall pass to Buyer and Buyer
shall have free and unrestricted use of all Purchased Mortgage Loans. Nothing in
this Agreement shall preclude Buyer from engaging in repurchase transactions
with the Purchased Mortgage Loans or otherwise pledging, repledging,
hypothecating, or rehypothecating the Purchased Mortgage Loans, but no such
transaction shall relieve Buyer of its obligations to transfer Purchased
Mortgage Loans to Seller pursuant to Section 3. Nothing contained in this
Agreement shall obligate Buyer to segregate any Purchased Mortgage Loans
delivered to Buyer by Seller.
9. SUBSTITUTION
(a) Subject to Section 9(b), Seller may, upon one (1) Business Days'
written notice to Buyer, with a copy to Custodian, substitute other Mortgage
Loans for any Purchased Mortgage Loans. Such substitution shall be made by
transfer to Buyer or its designee (including the Custodian) of the Mortgage
Files of such other Mortgage Loans together with a Custodial Delivery and
transfer to Seller or its designee of the Purchased Mortgage Loans requested for
release. After substitution, the substituted Mortgage Loans, shall be deemed to
be Purchased Mortgage Loans subject to the same Transaction as the released
Mortgage Loans.
(b) Notwithstanding anything to the contrary in this Agreement,
Seller may not substitute other Mortgage Loans for any Purchased Mortgage Loans
(i) if after taking into account such substitution, a Collateral Deficit would
occur or (ii) such substitution would cause a breach of any provision of this
Agreement.
10. REPRESENTATIONS AND WARRANTIES
(a) Each of Buyer and Seller represents and warrants to the other
that (i) it is duly authorized to execute and deliver this Agreement, to enter
into the Transactions contemplated hereunder and to perform its obligations
hereunder and has taken all necessary action to authorize such execution,
delivery and performance; (ii) it will engage in such Transactions as principal;
(iii) the person signing this Agreement on its behalf is duly authorized to do
so on its behalf; (iv) this Agreement is legal, valid and binding obligation of
it, enforceable against it in accordance with its terms, (v) no approval,
consent or authorization of the Transactions contemplated by this Agreement from
any federal, state, or local regulatory authority having jurisdiction over it is
required or, if required, such approval, consent or authorization has been or
will, prior to the Purchase Date, be obtained; (vi) the execution, delivery, and
performance of this Agreement and the Transactions hereunder will not violate
any law, regulation, order, judgment, decree,
12
<PAGE> 13
Confidential Treatment Requested - Edited Copies
ordinance, charter, by-law, or rule applicable to it or its property or
constitute a default (or an event which, with notice or lapse of time, or both
would constitute a default) under or result in a breach of any agreement or
other instrument by which it is bound or by which any of its assets are
affected; (vii) it has received approval and authorization to enter into this
Agreement and each and every Transaction actually entered into hereunder
pursuant to its internal policies and procedures; and (viii) neither this
Agreement nor any Transaction pursuant hereto are entered into in contemplation
of insolvency or with intent to hinder, delay or defraud any creditor.
(b) Seller represents and warrants to Buyer that as of the Purchase
Date for the purchase of any Purchased Mortgage Loans by Buyer from Seller and
as of the date of this Agreement and any Transaction hereunder and at all times
while this Agreement and any Transaction hereunder is in full force and effect:
(i) Organization. Seller is duly organized, validly existing and
in good standing under the laws and regulations of the state of Maryland and is
duly licensed, qualified, and in good standing in every state where Seller
transacts business and in any state where any Mortgaged Property is located if
the laws of such state require licensing or qualification in order to conduct
business of the type conducted by Seller therein.
(ii) No Litigation. There is no action, suit, proceeding,
arbitration or investigation pending or threatened against Seller which, either
in any one instance or in the aggregate, may result in any material adverse
change in the business, operations, financial condition, properties or assets of
Seller, or in any material impairment of the right or ability of Seller to carry
on its business substantially as now conducted, or in any material liability on
the part of Seller, or which if adversely determined would affect the validity
of this Agreement or any of the Purchased Mortgage Loans or of any action taken
or to be taken in connection with the obligations of Seller contemplated herein,
or which would be likely to impair materially the ability of Seller to perform
under the terms of this Agreement.
(iii) No Broker. Seller has not dealt with any broker,
investment banker, agent, or other person, except for Buyer, who may be entitled
to any commission or compensation in connection with the sale of Purchased
Mortgage Loans pursuant to this Agreement.
(iv) Good Title to Collateral. Purchased Mortgage Loans shall be
free and clear of any lien, encumbrance or impediment to transfer, and Seller
has good, valid and marketable title and the right to sell and transfer such
Purchased Mortgage Loans to Buyer.
(v) Delivery of Mortgage File. With respect to each Purchased
Mortgage Loans, the Mortgage Note, the Mortgage, the assignment of Mortgage and
any other documents required to be delivered under this Agreement and the
Custodial Agreement for such Mortgage Loan has been delivered to the Custodian.
Seller or its designee is in possession of a complete, true and accurate
Mortgage File with respect to each Mortgage Loan, except for such documents the
originals of which have been delivered to the Custodian.
13
<PAGE> 14
Confidential Treatment Requested - Edited Copies
(vi) Selection Process. The Purchased Mortgage Loans were
selected from among the outstanding mortgage loans in Seller's portfolio as to
which the representations and warranties set forth in this Agreement could be
made and such selection was not made in a manner so as to affect adversely the
interests of Buyer.
(vii) [reserved]
(viii) No Untrue Statements. To the best of Seller's knowledge,
neither this Agreement nor any written statement made, or any report or other
document issued or delivered or to be issued or delivered by Seller pursuant to
this Agreement or in connection with the transactions contemplated hereby
contains any untrue statement of fact or omits to state a fact necessary to make
the statements contained herein or therein not misleading;
(ix) Origination Practices. The origination practices used by
Seller with respect to each Mortgage Loan have been and are in all respects
legal and proper in the mortgage origination business;
(x) Performance of Agreement. Seller does not believe, nor does
it have any reason or cause to believe, that it cannot perform each and every
covenant contained in this Agreement on its part to be performed;
(xi) Seller Not Insolvent. Seller is not, and with the passage
of time does not expect to become, insolvent; and
(xii) No Event of Default. No Event of Default has occurred and
is continuing hereunder.
(c) Seller represents and warrants to the Buyer that each Purchased
Mortgage Loan sold hereunder and each pool of Purchased Mortgage Loans sold in a
Transaction hereunder, as of the related Purchase Date conform to the
representations and warranties set forth in the Seller's Certificate contained
in Exhibit V attached hereto and that each Mortgage Loan delivered hereunder as
Additional Loans or Substituted Mortgage Loans, as of the date of such delivery,
conforms to the representations and warranties set forth in Exhibit V hereto.
Seller further represents and warrants to the Buyer that, as of the date of its
delivery, the Collateral Information with respect to each Purchased Mortgage
Loan is complete, true and correct. It is understood and agreed that the
representations and warranties set forth in Exhibit V hereto, if any, shall
survive delivery of the respective Mortgage File to Buyer or its designee
(including the Custodian).
(d) On the Purchase Date for any Transaction, Buyer and Seller shall
each be deemed to have made all the foregoing representations with respect to
itself as of such Purchase Date.
11. NEGATIVE COVENANTS OF THE SELLER
On and as of the date of this Agreement and each Purchase Date and until this
Agreement is no longer in force with respect to any Transaction, Seller
covenants that it will not:
14
<PAGE> 15
Confidential Treatment Requested - Edited Copies
(a) take any action which would directly or indirectly impair or
adversely affect Buyer's title to or the value of the Purchased Mortgage Loans;
(b) pledge, assign, convey, grant, bargain, sell, set over, deliver
or otherwise transfer any interest in the Purchased Mortgage Loans to any person
not a party to this Agreement nor will the Seller create, incur or permit to
exist any lien, encumbrance or security interest in or on the Purchased Mortgage
Loans except as described in Section 6 of this Agreement;
(c) create, incur or permit to exist any lien, encumbrance or
security interest in or on any of the Collateral without the prior express
written consent of Buyer.
12. AFFIRMATIVE COVENANTS OF THE SELLER
For so long as this Agreement is in effect:
(a) Seller covenants that it will promptly notify Buyer of any
material adverse change in its business operations and/or financial condition;
(b) Seller shall provide Buyer with copies of such documentation as
Buyer may reasonably request evidencing the truthfulness of the representations
set forth in Section 10, including but not limited to resolutions evidencing the
approval of this Agreement by Seller's board of directors or loan committee,
copies of the minutes of the meetings of Seller's board of directors or loan
committee at which this Agreement and the Transactions contemplated by this
Agreement were approved;
(c) Seller shall, at Buyer's request, take all action necessary to
ensure that Buyer will have a first priority security interest in the
Collateral, including, among other things, filing such Uniform Commercial Code
financing statements as Buyer may reasonably request;
(d) Seller shall notify Buyer no later than one (1) Business Day
after obtaining actual knowledge thereof, if any event has occurred that
constitutes an Event of Default with respect to Seller or any event that with
the giving of notice or lapse of time, or both, would become an Event of Default
with respect to Seller;
(e) In the event Seller sells Buyer Mortgage Loans in a Transaction
hereunder, Seller covenants that each Mortgage Loan subject to this Agreement
shall be serviced by an approved seller/servicer in good standing with FNMA,
FHLMC or GNMA, as applicable;
(f) Seller covenants to provide Buyer with a copy of any changes to
Seller's underwriting guidelines prior to the effectiveness of any such change;
(g) [reserved]
(h) Seller covenants, upon request of Buyer after the occurrence of a
Collateral Deficit, to enter into hedging transactions with respect to fixed
rate Purchased Mortgage Loans in order to protect adequately, in the reasonable
judgment of Buyer against interest rate risks;
15
<PAGE> 16
Confidential Treatment Requested - Edited Copies
(i) Seller covenants to provide Buyer on the 1st Business Day of each
month, either by direct modem electronic transmission or via a computer
diskette, the Collateral Information in computer readable format with respect to
all Purchased Mortgage Loans then subject to Transactions;
(j) Seller covenants to have in place, within 30 days of the date
hereof (or as mutually agreed upon by Buyer and Seller), an errors and omissions
insurance policy in an amount equal to $10,000,000 and a blanket fidelity bond
in an amount of $5,000,000.
(k) Seller covenants to provide Buyer with the following financial
and reporting information:
(i) Within 90 days after the last day of its fiscal year,
Seller's audited combined and combining statements of income and statements of
changes in cash flow for such year and balance sheets as of the end of such year
in each case presented fairly in accordance with GAAP, and accompanied, in all
cases, by an unqualified report of KPMG Peat Marwick or any other nationally
recognized independent certified public accounting firm consented to by Buyer
(which consent shall not be unreasonably withheld)
(ii) Within 60 days after the last day of the first three fiscal
quarters in any fiscal year, Seller's combined and combining statements of
income and statements of changes in cash flow for such quarter and balance
sheets as of the end of such quarter presented fairy in accordance with GAAP.
(iii) within 30 days after the last day of each calendar month
an officer's certificate from a senior officer of the Seller addressed to Buyer
certifying that, as of such calendar month, (x) Seller is in compliance with all
of the terms, conditions and requirements of this Agreement, and (y) no Event of
Default exists.
13. EVENTS OF DEFAULT
(a) If any of the following events (each an "Event of Default")
occur, Buyer shall have the rights set forth in Section 14, as applicable:
(i) Seller fails to satisfy or perform any material obligation
or covenant under this Agreement;
(ii) an Act of Insolvency occurs with respect to Seller;
(iii) any representation made by Seller shall have been
incorrect or untrue in any material respect when made or repeated or deemed to
have been made or repeated;
(iv) Seller shall admit its inability to, or its intention not
to, perform any of its obligations hereunder;
(v) any governmental, regulatory, or self-regulatory authority,
including, but not limited to, the Agencies, takes any action to remove, limit,
restrict, suspend or terminate the
16
<PAGE> 17
Confidential Treatment Requested - Edited Copies
rights, privileges, or operations of the Seller or any of its Affiliates,
including suspension as an issuer, lender or seller/servicer of mortgage loans,
which suspension has a material adverse effect on the ordinary business
operations of Seller or Seller's Affiliate, and which continues for more than 24
hours;
(vi) Seller dissolves, merges or consolidates with another
entity (unless (A) it is the surviving party or (B) the entity into which it
mergers has equity and a market value of at least that of the Seller immediately
prior to such merger and such entity expressly assumes the obligations of the
Seller at the time of such merger), or sells, transfers, or otherwise disposes
of a material portion of its business or assets;
(vii) Buyer, in its good faith judgment, believes that there has
been a material adverse change in the business, operations, corporate structure
or financial condition of Seller or that Seller will not meet any of its
obligations under any Transaction pursuant to this Agreement, this Agreement or
any other agreement between the parties;
(viii) Seller is in default under any other agreement to which
it is a party, provided, however, such a default shall not constitute an Event
of Default if the exercise of such remedies as are available to Seller's
counterparty with respect to such default would not result in a material adverse
change in the business operations or financial condition of the Seller;
(ix) A final judgment by any competent court in the United
States of America for the payment of money in an amount of at least $500,000 is
rendered against the Seller, and the same remains undischarged or unpaid for a
period of sixty (60) days during which execution of such judgment is not
effectively stayed;
(x) This Agreement shall for any reason cease to create a valid,
first priority security interest in any of the Purchased Mortgage Loans
purported to be covered hereby;
(xi) A Market Value Collateral Deficit or Securitization Value
Collateral Deficit occurs with respect to Seller or Buyer, as applicable, and is
not eliminated within the time period specified in Section 4(b);
(xii) An "event of default" has occurred pursuant to a Hedge.
(b) In making a determination as to whether an Event of Default has
occurred, the Buyer shall be entitled to rely on reports published or broadcast
by media sources believed by such party to be generally reliable and on
information provided to it by any other sources believed by it to be generally
reliable, provided that such party reasonably and in good faith believes such
information to be accurate and has taken such steps as may be reasonable in the
circumstances to attempt to verify such information.
14. REMEDIES
If an Event of Default occurs with respect to Seller, the following
rights and remedies are available to Buyer:
17
<PAGE> 18
Confidential Treatment Requested - Edited Copies
(i) At the option of Buyer, exercised by written notice to Seller
(which option shall be deemed to have been exercised, even if no notice is
given, immediately upon the occurrence of an Act of Insolvency), the Repurchase
Date for each Transaction hereunder shall be deemed immediately to occur,
(ii) If Buyer exercises or is deemed to have exercised the option
referred to in subsection (a)(i) of this Section,
(A) Seller's obligations hereunder to repurchase all Purchased
Mortgage Loans in such Transactions shall thereupon become immediately due and
payable,
(B) to the extent permitted by applicable law, the Repurchase
Price with respect to each such Transaction shall be increased by the aggregate
amount obtained by daily application of, on a 360 day per year basis for the
actual number of days during the period from and including the date of the
exercise or deemed exercise of such option to but excluding the date of payment
of the Repurchase Price as so increased, (x) the greater of the Prime Rate or
the Pricing Rate for each such Transaction to (y) the Repurchase Price for such
Transaction as of the Repurchase Date as determined pursuant to subsection
(a)(i) of this Section (decreased as of any day by (I) any amounts actually in
the possession of Buyer pursuant to clause (C) of this subsection, (II) any
proceeds from the sale of Purchased Mortgage Loans applied to the Repurchase
Price pursuant to subsection (a)(xii) of this Section, and (III) any amounts
applied to the Repurchase Price pursuant to subsection (a)(iii) of this
Section), and
(C) all Income actually received by the Buyer or its designee
(including the Custodian) pursuant to Section 5 shall be applied to the
aggregate unpaid Repurchase Price owed by Seller.
(iii) After one Business Day's notice to Seller (which notice need
not be given if an Act of Insolvency shall have occurred, and which may be the
notice given under subsection (a)(i) of this Section), Buyer may (A) immediately
sell, without notice or demand of any kind, at a public or private sale and at
such price or prices Buyer may reasonably deem satisfactory any or all Purchased
Mortgage Loans subject to a Transaction hereunder or (B) in its sole discretion
elect, in lieu of selling all or a portion of such Purchased Mortgage Loans, to
give Seller credit for such Purchased Mortgage Loans in an amount equal to the
Market Value of the Purchased Mortgage Loans against the aggregate unpaid
Repurchase Price and any other amounts owing by Seller hereunder. The proceeds
of any disposition of Purchased Mortgage Loans shall be applied first to the
costs and expenses incurred by Buyer in connection with Seller's default; second
to consequential damages, including but not limited to costs of cover and/or
related hedging transactions; third to the Repurchase Price; and fourth to any
other outstanding obligation of Seller to Buyer or its Affiliates.
(iv) The parties recognize that it may not be possible to purchase or
sell all of the Purchased Mortgage Loans on a particular Business Day, or in a
transaction with the same purchaser, or in the same manner because the market
for such Purchased Mortgage Loans may not be liquid. In view of the nature of
the Purchased Mortgage Loans, the parties agree that liquidation of a
Transaction or the underlying Purchased Mortgage Loans does not require a
18
<PAGE> 19
Confidential Treatment Requested - Edited Copies
public purchase or sale and that a good faith private purchase or sale shall be
deemed to have been made in a commercially reasonable manner. Accordingly, Buyer
may elect, in its sole discretion, the time and manner of liquidating any
Purchased Mortgage Loan and nothing contained herein shall (A) obligate Buyer to
liquidate any Purchased Mortgage Loan on the occurrence of an Event of Default
or to liquidate all Purchased Mortgage Loans in the same manner or on the same
Business Day or (B) constitute a waiver of any right or remedy of Buyer.
However, in recognition of the parties' agreement that the Transactions
hereunder have been entered into in consideration of and in reliance upon the
fact that all Transactions hereunder constitute a single business and
contractual relationship and that each Transaction has been entered into in
consideration of the other Transactions, the parties further agree that Buyer
shall use its best efforts to liquidate all Transactions hereunder upon the
occurrence of an Event of Default as quickly as is prudently possible in the
reasonable judgment of Buyer.
(v) Buyer shall, without regard to the adequacy of the security for
the Seller's obligations under this Agreement, be entitled to the appointment of
a receiver by any court having jurisdiction, without notice, to take possession
of and protect, collect, manage, liquidate, and sell the Collateral or any
portion thereof, and collect the payments due with respect to the Collateral or
any portion thereof. Seller shall pay all costs and expenses incurred by Buyer
in connection with the appointment and activities of such receiver.
(vi) Seller agrees that Buyer may obtain an injunction or an order of
specific performance to compel Seller to fulfill its obligations as set forth in
Section 25, if Seller fails or refuses to perform its obligations as set forth
therein.
(vii) Seller shall be liable to Buyer for the amount of all expenses,
reasonably incurred by Buyer in connection with or as a consequence of an Event
of Default, including, without limitation, reasonable legal fees and expenses
and reasonable costs incurred in connection with hedging or covering
transactions.
(viii) Buyer shall have all the rights and remedies provided herein,
provided by applicable federal, state, foreign, and local laws (including,
without limitation, the rights and remedies of a secured party under the Uniform
Commercial Code of the State of New York, to the extent that the Uniform
Commercial Code is applicable, and the right to offset any mutual debt and
claim), in equity, and under any other agreement between Buyer and Seller.
(ix) Buyer may exercise one or more of the remedies available to
Buyer immediately upon the occurrence of an Event of Default and, except to the
extent provided in subsections (a)(i) and (iii) of this Section, at any time
thereafter without notice to Seller. All rights and remedies arising under this
Agreement as amended from time-to-time hereunder are cumulative and not
exclusive of any other rights or remedies which Buyer may have.
(x) In addition to its rights hereunder, Buyer shall have the right
to proceed against any assets of Seller which may be in the possession of Buyer
or its designee (including the Custodian) including the right to liquidate such
assets and to set off the proceeds against monies owed by Seller to Buyer
pursuant to this Agreement. Buyer may set off cash, the proceeds of the
liquidation of the Purchased Mortgage Loans, any Collateral or its proceeds, and
all other sums or
19
<PAGE> 20
Confidential Treatment Requested - Edited Copies
obligations owed by Seller to Buyer against all of Seller's obligations to
Buyer, whether under this Agreement, under a Transaction, or under any other
agreement between the parties, or otherwise, whether or not such obligations are
then due, without prejudice to Buyer's right to recover any deficiency. Any
cash, proceeds, or property in excess of any amounts due, or which Buyer
reasonably believes may become due, to it from Seller shall be returned to
Seller after satisfaction of all obligations of Seller to Buyer.
(xi) Buyer may enforce its rights and remedies hereunder without
prior judicial process or hearing, and Seller hereby expressly waives any
defenses Seller might otherwise have to require Buyer to enforce its rights by
judicial process. Seller also waives any defense Seller might otherwise have
arising from the use of nonjudicial process, enforcement and sale of all or any
portion of the Collateral, or from any other election of remedies. Seller
recognizes that nonjudicial remedies are consistent with the usages of the
trade, are responsive to commercial necessity and are the result of a bargain at
arm's length.
(xii) Buyer and Seller hereby agree that sales of the Purchased
Mortgage Loans shall be deemed to include and permit the sales of Purchased
Mortgaged Loans pursuant to a securities offering.
(xiii) Notwithstanding the foregoing remedies, if the Event of
Default (other than an Event of Default under Section 13(a)(xi)) arises from a
breach of any representation or warranty set forth in Sections 10(b)(iii), (v)
or (ix) or in Exhibit V attached hereto with respect to a Purchased Mortgage
Loan, then Seller may elect, subject to Buyer's written consent (which consent
shall not be unreasonably withheld or delayed), to cure such default by
repurchasing such Mortgage Loan or substituting for such Mortgage Loan within
two (2) Business Days of such Event of Default, provided, however, that Seller
shall not have the right to make the foregoing election if such breach causes a
default with respect to Mortgage Loans that in the aggregate represent ten
percent (10%) or more of the aggregate Purchase Price of all Purchased Mortgage
Loans subject to then outstanding Transactions. The repurchase price for any
such repurchase shall be the outstanding Repurchase Price of such Mortgage Loan,
as the case may be. Any such substitution shall be performed in accordance with
Section 9 of this Agreement.
15. ADDITIONAL CONDITIONS
Seller shall, on the date of the initial Transaction hereunder and,
upon the request of Buyer, on the date of any subsequent Transaction, cause to
be delivered to Buyer, with reliance thereon permitted as to any Person that
purchases the Purchased Mortgage Loan from Buyer in a repurchase transaction, a
favorable opinion or opinions of counsel with respect to the matters set forth
in Exhibit IV attached hereto and evidence of corporate authority each in a form
satisfactory to Buyer and its counsel.
16. SINGLE AGREEMENT
Buyer and Seller acknowledge that, and have entered hereinto and will
enter into each Transaction hereunder in consideration of and in reliance upon
the fact that, all Transactions hereunder constitute a single business and
contractual relationship and that each has been entered
20
<PAGE> 21
Confidential Treatment Requested - Edited Copies
into in consideration of the other Transactions. Accordingly, each of Buyer and
Seller agrees (i) to perform all of its obligations in respect of each
Transaction hereunder, and that a default in the performance of any such
obligations shall constitute a default by it in respect of all Transactions
hereunder, (ii) that each of them shall be entitled to set off claims and apply
property held by them in respect of any Transaction against obligations owing to
them in respect of any other Transactions hereunder and (iii) that payments,
deliveries, and other transfers made by either of them in respect of any
Transaction shall be deemed to have been made in consideration of payments,
deliveries, and other transfers in respect of any other Transactions hereunder,
and the obligations to make any such payments, deliveries, and other transfers
may be applied against each other and netted; provided, however, that the
parties hereto acknowledge and agree that each Purchased Mortgage Loan is
identified and unique and nothing in this Agreement should limit or reduce
Buyer's obligation to deliver the Purchased Mortgage Loans to Seller as and when
provided herein.
17. NOTICES AND OTHER COMMUNICATIONS
Unless another address is specified in writing by the respective
party to whom any written notice or other communication is to be given
hereunder, all such notices or communications shall be in writing or confirmed
in writing and delivered at the respective addresses set forth in the
Confirmation.
18. ENTIRE AGREEMENT; SEVERABILITY
This Agreement together with the applicable Confirmation constitutes
the entire understanding between Buyer and Seller with respect to the subject
matter it covers and shall supersede any existing agreements between the parties
containing general terms and conditions for repurchase transactions involving
Purchased Mortgage Loans. By acceptance of this Agreement, Buyer and Seller
acknowledge that they have not made, and are not relying upon, any statements,
representations, promises or undertakings not contained in this Agreement. Each
provision and agreement herein shall be treated as separate and independent from
any other provision or agreement herein and shall be enforceable notwithstanding
the unenforceability of any such other provision or agreement.
19. NON-ASSIGNABILITY
The rights and obligations of the parties under this Agreement and
under any Transaction shall not be assigned by Seller without the prior written
consent of Buyer. Subject to the foregoing, this Agreement and any Transactions
shall be binding upon and shall inure to the benefit of the parties and their
respective successors and assigns. Nothing in this Agreement express or implied,
shall give to any person, other than the parties to this Agreement and their
successors hereunder, any benefit or any legal or equitable right, power, remedy
or claim under this Agreement.
21
<PAGE> 22
Confidential Treatment Requested - Edited Copies
20. TERMINABILITY
This Agreement shall terminate upon the earlier of (i) written notice
from Seller to Buyer to such effect and (ii) one year from the date of this
Agreement. Notwithstanding any such termination or the occurrence of an Event of
Default, all of the representations and warranties hereunder (including those
made in Exhibit V) shall continue and survive.
21. GOVERNING LAW
THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE
WITH, THE INTERNAL LAWS OF THE STATE OF NEW YORK WITHOUT GIVING
EFFECT TO THE CONFLICT OF LAW PRINCIPLES THEREOF.
22. CONSENT TO JURISDICTION AND ARBITRATION
The parties irrevocably agree to submit to the personal jurisdiction
of the United States District Court for the Southern District of New York, the
parties irrevocably waiving any objection thereto. If, for any reason, federal
jurisdiction is not available, and only if federal jurisdiction is not
available, the parties irrevocably agree to submit to the personal jurisdiction
of the Supreme Court of the State of New York, the parties irrevocably waiving
any objection thereto. Notwithstanding the foregoing two sentences, at either
party's sole option exercisable at any time not later than thirty (30) days
after an action or proceeding has been commenced, the parties agree that the
matter may be submitted to binding arbitration in accordance with the commercial
rules of the American Arbitration Association then in effect in the State of New
York and judgment upon any award rendered by the arbitrator may be entered in
any court having jurisdiction thereof within the City, County and State of New
York; provided, however, that the arbitrator shall not amend, supplement, or
reform in any regard this Agreement or the terms of any Confirmation, the rights
or obligations of any party hereunder or thereunder, or the enforceability of
any of the terms hereof or thereof. Any arbitration shall be conducted before a
single arbitrator who shall be reasonably familiar with repurchase transactions
and the secondary mortgage market in the City, County, and State of New York.
23. NO WAIVERS, ETC.
No express or implied waiver of any Event of Default by either party
shall constitute a waiver of any other Event of Default and no exercise of any
remedy hereunder by any party shall constitute a waiver of its right to exercise
any other remedy hereunder. No modification or waiver of any provision of this
Agreement and no consent by any party to a departure herefrom shall be effective
unless and until such shall be in writing and duly executed by both of the
parties hereto. Any such waiver or modification shall be effective only in the
specific instance and for the specific purpose for which it was given.
22
<PAGE> 23
Confidential Treatment Requested - Edited Copies
24. INTENT
The parties understand and intend that this Agreement and each
Transaction hereunder constitute a "repurchase agreement" and a "securities
contract" as those terms are defined under the relevant provisions of Title 11
of the United States Code, as amended.
25. SERVICING
(a) Notwithstanding the purchase and sale of the Purchased Mortgage
Loans hereby, Seller shall continue to service or cause to be serviced, the
Purchased Mortgage Loans for the benefit of Buyer and, if Buyer shall exercise
its rights to pledge or hypothecate the Purchased Mortgage Loan prior to the
related Repurchase Date pursuant to Section 8, Buyer's assigns; provided,
however, that the obligations of Seller to service or cause to be serviced the
Purchased Mortgage Loans shall cease, at Seller's option, upon the payment by
Seller to Buyer of the Repurchase Price therefor. Seller shall service or cause
to be serviced the Purchased Mortgage Loans in accordance with the servicing
standards maintained by other prudent mortgage lenders with respect to mortgage
loans similar to the Purchased Mortgage Loans.
(b) With respect to Purchased Mortgage Loans for which the Seller
owns servicing rights, Seller agrees that Buyer is the owner of all servicing
records, including but not limited to any and all servicing agreements, files,
documents, records, data bases, computer tapes, copies of computer tapes, proof
of insurance coverage, insurance policies, appraisals, other closing
documentation, payment history records, and any other records relating to or
evidencing the servicing of Purchased Mortgage Loans (the "Servicing Records").
Seller grants Buyer a security interest in all servicing fees and rights
relating to such Purchased Mortgage Loans and all Servicing Records to secure
the obligation of the Seller or its designee to service in conformity with this
Section and any other obligation of Seller to Buyer. Seller covenants to
safeguard such Servicing Records and to deliver them promptly to Buyer or its
designee (including the Custodian) at Buyer's request.
(c) With respect to Purchased Mortgage Loans for which the Seller
owns servicing rights, upon the occurrence and continuance of an Event of
Default, Buyer may, in its sole discretion, (i) sell its right to the Purchased
Mortgage Loans on a servicing released basis or (ii) terminate the Seller as
servicer of the Purchased Mortgage Loans with or without cause, in each case
without payment of any termination fee.
(d) With respect to Purchased Mortgage Loans for which the Seller
owns servicing rights, Seller shall not employ sub-servicers to service the
Purchased Mortgage Loans without the prior written approval of Buyer.
(e) Seller shall cause any sub-servicers engaged by Seller to execute
a letter agreement with Buyer acknowledging Buyer's security interest and
agreeing that, upon notice from Buyer (or the Custodian on its behalf) that an
Event of Default has occurred and in continuing hereunder, it shall deposit all
Income with respect to the Purchased Mortgage Loans in the account specified in
the third sentence of Section 5(a).
23
<PAGE> 24
Confidential Treatment Requested - Edited Copies
26. DISCLOSURE RELATING TO CERTAIN FEDERAL PROTECTIONS
The parties acknowledge that they have been advised that in the case
of Transactions in which one of the parties is an "insured depository
institution" as that term is defined in Section 1831(a) of Title 16 of the
United States Code, as amended, funds held by the financial institution pursuant
to a Transaction hereunder are not a deposit and therefore are not insured by
the Federal Deposit Insurance Corporation, the Savings Association Insurance
Fund or the Bank Insurance Fund, as applicable.
27. NETTING
If Buyer and Seller are "financial institutions" as now or
hereinafter defined in Section 4402 of Title 16 of the United States Code
("Section 4402") and any rules or regulations promulgated thereunder:
(a) All amounts to be paid or advanced by one party to or on behalf
of the other under this Agreement or any Transaction hereunder shall be deemed
to be "payment obligations" and all amounts to be received by or on behalf of
one party from the other under this Agreement or any Transaction hereunder shall
be deemed to be "payment entitlements" within the meaning of Section 4402, and
this Agreement shall be deemed to be a "netting contract" as defined in Section
4402.
(b) The payment obligations and the payment entitlements of the
parties hereto pursuant to this Agreement and any Transaction hereunder shall be
netted as follows. In the event that either party (the "Defaulting Party") shall
fail to honor any payment obligation under this Agreement or any Transaction
hereunder, the other party (the "Nondefaulting Party") shall be entitled to
reduce the amount of any payment to be made by the Nondefaulting Party to the
Defaulting Party by the amount of the payment obligation that the Defaulting
Party failed to honor.
28. MISCELLANEOUS
(a) Time is of the essence under this agreement and all Transactions
and all references to a time shall mean New York time in effect on the date of
the action unless otherwise expressly stated in this Agreement.
(b) Buyer shall be authorized to accept orders and take any other
action affecting any accounts of the Seller in response to instructions given in
writing or orally by telephone or otherwise by any person with apparent
authority to act on behalf of the Seller, and the Seller shall indemnify Buyer,
defend, and hold Buyer harmless from and against any and all liabilities,
losses, damages, costs, and expenses of any nature arising out of or in
connection with any action taken by Buyer in response to such instructions
received or reasonably believed to have been received from the Seller.
(c) If there is any conflict between the terms of this Agreement or
any Transaction entered into hereunder and the Custodial Agreement, this
Agreement shall prevail.
24
<PAGE> 25
Confidential Treatment Requested - Edited Copies
(d) If there is any conflict between the terms of a Confirmation or a
corrected Confirmation issued by the Buyer and this Agreement, the Confirmation
shall prevail.
(e) This Agreement may be executed in counterparts, each of which so
executed shall be deemed to be an original, but all of such counterparts shall
together constitute but one and the same instrument.
(f) The headings in this Agreement are for convenience of reference
only and shall not affect the interpretation or construction of this Agreement.
[Signature page follows.]
25
<PAGE> 26
Confidential Treatment Requested - Edited Copies
IN WITNESS WHEREOF, the parties have entered into this Agreement as
of the date set forth above.
LEHMAN COMMERCIAL PAPER INC.,
Buyer
By: /s/ JONATHON EPSTEIN
------------------------------------
Title: Authorized Signatory
Date:
----------------------------------
AMERICAN RESIDENTIAL INVESTMENT TRUST
Seller
By: /s/ JAY M. FULLER
Title: President
Date:
----------------------------------
26
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF REGISTRANT
1. American Residential Holdings, Inc.
2. American Residential Liberty, Inc.
3. American Residential Eagle, Inc.
<PAGE> 1
EXHIBIT 23.1
Independent Auditors' Consent
The Board of Directors
American Residential Investment Trust, Inc.:
We consent to incorporation by reference in the registration statement (No.
333-48005) on Form S-8 of American Residential Investment Trust, Inc. of our
report dated January 13, 1998, relating to the balance sheet of American
Residential Investment Trust, Inc. as of December 31, 1997, and the related
statements of operations, stockholders' equity and cash flows for the period
from February 11, 1997 (commencement of operations) through December 31, 1997,
which report appears in the December 31, 1997, annual report on Form 10-K of
American Residential Investment Trust, Inc.
/s/ KPMG Peat Marwick LLP
San Diego, California
March 30, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the December
31, 1997 Form 10-K and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 5,893
<SECURITIES> 549,861
<RECEIVABLES> 6,080
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 561,834
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 561,834
<CURRENT-LIABILITIES> 455,265
<BONDS> 0
0
0
<COMMON> 81
<OTHER-SE> 106,488
<TOTAL-LIABILITY-AND-EQUITY> 561,834
<SALES> 0
<TOTAL-REVENUES> 12,450
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 511
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,536
<INCOME-PRETAX> 2,403
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,403
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,403
<EPS-PRIMARY> 0.83
<EPS-DILUTED> 0.82
</TABLE>
