<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 7, 1997
REGISTRATION NO. 333-32913
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 3
TO
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
----------------
ANNALY MORTGAGE MANAGEMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENTS)
1500 HARBOR BLVD.
WEEHAWKEN, NJ 07087
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
----------------
MICHAEL A. J. FARRELL
CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
ANNALY MORTGAGE MANAGEMENT, INC.
1500 HARBOR BLVD.
WEEHAWKEN, NJ 07087
(NAME AND ADDRESS OF AGENT FOR SERVICE)
----------------
COPIES TO:
NANCY H. CORBETT, ESQ. CATHERINE S. GALLAGHER, ESQ.
MORGAN, LEWIS & BOCKIUS LLP ANDREWS & KURTH L.L.P.
101 PARK AVENUE 1701 PENNSYLVANIA AVENUE, N.W.
NEW YORK, NY 10178 WASHINGTON, DC 20006
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
____________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [X]
----------------
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED PROPOSED
AMOUNT MAXIMUM MAXIMUM AMOUNT OF
TITLE OF SECURITIES BEING OFFERING PRICE AGGREGATE REGISTRATION
BEING REGISTERED REGISTERED PER SHARE OFFERING PRICE FEE
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<S> <C> <C> <C> <C>
Common Stock, par value
$.01 per share.......... 8,159,250 shares(1) $12.50(2) $101,990,625(2) $30,906.25(3)
</TABLE>
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(1) Includes up to 1,064,250 shares of Common Stock which the Underwriters
have the option to purchase solely to cover over-allotments.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(a).
(3) This fee was previously paid in connection with the initial filing and the
filing of Amendment No. 1.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES
AND EXCHANGE COMMISSION (THE "COMMISSION"), ACTING PURSUANT TO SAID SECTION
8(A), MAY DETERMINE.
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<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
CROSS-REFERENCE SHEET
<TABLE>
<CAPTION>
FORM S-11 CAPTION IN PROSPECTUS
ITEM NUMBER AND CAPTION OR PAGE REFERENCE
----------------------- ---------------------
<S> <C>
1.Forepart of Registration
Statement and Outside
Front Cover Page of Forepart of Registration Statement; Outside
Prospectus.............. Front Cover Page of Prospectus
2.Inside Front and Outside
Back Cover Pages of Inside Front Cover Page of Prospectus; Outside
Prospectus.............. Back Cover Page of Prospectus
3.Summary Information, Risk
Factors and Ratio of Outside Front Cover Page of Prospectus;
Earnings to Fixed Prospectus Summary; Risk Factors; Business
Charges................. Strategy; Selected Financial Data
4.Determination of Offering Outside Front Cover Page of Prospectus;
Price................... Underwriting
5.Dilution.................. Dilution
6.Selling Security Holders.. Selling Stockholders
7.Plan of Distribution...... Outside Front Cover Page of Prospectus;
Underwriting
8.Use of Proceeds........... Prospectus Summary; Use of Proceeds
9.Selected Financial Data... Selected Financial Data
10.Management's Discussion
and Analysis of
Financial Condition and Management's Discussion and Analysis of
Results of Operations... Financial Condition and Results of Operations
11.General Information as to Prospectus Summary; The Company; Business
Registrant.............. Strategy
12.Policy with Respect to Business Strategy; Description of Capital Stock;
Certain Activities...... Available Information
13.Investment Policies of Prospectus Summary; Business Strategy
Registrant..............
14.Description of Real *
Estate..................
15.Operating Data............ *
16.Tax Treatment of
Registrant and Its Prospectus Summary; Risk Factors; Certain
Security Holders........ Federal Income Tax Considerations; ERISA
Considerations
17.Market Price of and
Dividends on the
Registrant's Common
Equity and Related
Stockholder Matters..... Risk Factors; Distribution Policy
18.Description of Outside Front Cover Page of Prospectus;
Registrant's Securities. Prospectus Summary; Certain Federal Income Tax
Considerations; ERISA Considerations;
Description of Capital Stock
19.Legal Proceedings......... Business Strategy
20.Security Ownership of
Certain Beneficial
Owners and Management... Management; Principal Stockholders
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
FORM S-11 CAPTION IN PROSPECTUS
ITEM NUMBER AND CAPTION OR PAGE REFERENCE
----------------------- ---------------------
<S> <C>
21.Directors and Executive Officers... Management
22.Executive Compensation............. Management
23.Certain Relationships and Related
Transactions..................... Risk Factors; Management
24.Selection, Management and Custody
of Registrant's Investments...... Risk Factors; Business Strategy
25.Policies with Respect to Certain
Transactions..................... Risk Factors; Management
26.Limitations of Liability........... Management; Description of Capital Stock
27.Financial Statements and Index to Financial Statements
Information......................
28.Interests of Named Experts and *
Counsel..........................
29.Disclosure of Commission Position
on Indemnification for Securities
Act Liabilities.................. *
30.Quantitative and Qualitative
Disclosures About Market Risk.... *
</TABLE>
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* Not Applicable
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS SUBJECT TO COMPLETION, DATED OCTOBER 7, 1997
7,095,000 SHARES [LOGO APPEARS HERE]
ANNALY MORTGAGE MANAGEMENT, INC.
COMMON STOCK
----------
Annaly Mortgage Management, Inc. (the "Company") owns and manages a portfolio
of mortgage-backed securities, including mortgage pass-through certificates,
collateralized mortgage obligations and other securities representing interests
in or obligations backed by pools of mortgage loans which can be readily
financed. The Company seeks to generate net income for distribution to
stockholders from the spread between the interest income on its mortgage-backed
securities and the costs of borrowing to finance its acquisition of mortgage-
backed securities. The Company will elect to be taxed as a real estate
investment trust (a "REIT") under the Internal Revenue Code of 1986, as
amended. To ensure that the Company qualifies as a REIT, the shares of common
stock, par value $.01 per share, of the Company (the "Common Stock") offered
hereby (the "Shares") are subject to certain restrictions on ownership and
transferability. See "Description of Capital Stock--Restrictions on Ownership
and Transfer". The Company commenced operations on February 18, 1997 and,
therefore, has a limited operating history. The Company is self-advised and
self-managed.
Of the 7,095,000 Shares being offered hereby, 6,250,000 Shares are being
offered by the Company and 845,000 Shares are being offered by certain
stockholders of the Company (the "Selling Stockholders"). The Company will not
receive any of the proceeds from the sale of Shares by the Selling
Stockholders. Prior to this offering, there has been no public market for the
Common Stock. It is currently estimated that the initial public offering price
will be between $11.50 and $12.50 per Share. See "Underwriting" for a
discussion of the factors to be considered in determining the initial public
offering price. The Company has received approval, subject to official notice
of issuance, to list the Common Stock on the New York Stock Exchange under the
symbol "NLY".
----------
SEE "RISK FACTORS" COMMENCING ON PAGE 13 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SHARES, INCLUDING,
AMONG OTHERS:
. NONE OF THE COMPANY'S OFFICERS HAD MANAGED A REIT PRIOR TO FEBRUARY 18, 1997.
. THE COMPANY'S ASSETS AND BORROWINGS ARE SENSITIVE TO INTEREST RATE CHANGES;
THE COMPANY'S INCOME MAY BE ADVERSELY AFFECTED BY INCREASED BORROWING COSTS
OR DECREASED YIELDS ON THE COMPANY'S MORTGAGE-BACKED SECURITIES.
. THE COMPANY'S ASSETS ARE GENERALLY SUBJECT TO INTEREST RATE CAPS, WHILE THE
COMPANY'S BORROWINGS GENERALLY ARE NOT SIMILARLY RESTRICTED.
. PREPAYMENT RATE CHANGES ON MORTGAGE-BACKED SECURITIES COULD ADVERSELY AFFECT
THE COMPANY'S EARNINGS.
. THE COMPANY'S STRATEGY INVOLVES LEVERAGE; THE COMPANY MAY BE UNABLE TO ATTAIN
THE LEVEL OF LEVERAGE IT DEEMS OPTIMAL.
. HEDGING METHODS EMPLOYED BY THE COMPANY MAY NOT BE EFFECTIVE IN MITIGATING
INTEREST RATE AND PREPAYMENT RISK.
. LOSS OF THE INVESTMENT COMPANY ACT EXEMPTION WOULD ADVERSELY AFFECT THE
COMPANY.
. THE COMPANY MAY BE TAXED AS A CORPORATION IF IT FAILS TO QUALIFY AS A REIT.
----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
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<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS
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<S> <C> <C> <C> <C>
Per Share................ $ $ $ $
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Total.................... $ (3) $ (3) $ (3) $
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</TABLE>
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting."
(2) Before deducting expenses payable by the Company estimated at $700,000.
(3) The Company has granted the several Underwriters a 30-day option to
purchase up to 1,064,250 additional Shares, to cover over-allotments. If
all of such Shares are purchased, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $ , $ and $ , respectively.
See "Underwriting."
The Shares are offered by the Underwriters, subject to receipt and acceptance
by the Underwriters, approval of certain legal matters by counsel for the
Underwriters and certain other conditions. The Underwriters reserve the right
to withdraw, cancel or modify such offer and to reject orders in whole or in
part. It is expected that delivery of the Shares will be made against payment
therefor at the offices of Friedman, Billings, Ramsey & Co., Inc., Arlington,
Virginia, or in book-entry form through the facilities of The Depository Trust
Company on or about October , 1997.
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
SUTRO & CO. INCORPORATED
TUCKER ANTHONY
INCORPORATED
The date of this Prospectus is October , 1997.
<PAGE>
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING STABILIZATION, THE PURCHASE OF COMMON STOCK TO COVER SYNDICATE SHORT
POSITIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PROSPECTUS SUMMARY........................................................ 5
RISK FACTORS.............................................................. 13
Operations Risks......................................................... 13
General................................................................. 13
Lack of REIT Experience................................................. 13
Differences Between Mortgage-Backed Security and Borrowing
Characteristics; the Company's Assets Generally are Subject to Interest
Rate Caps, While the Company's Borrowings Generally are not Similarly
Restricted............................................................. 13
Changes in Prepayment Rates of Mortgage-Backed Securities............... 14
The Company's Strategy Involves Leverage; the Company May be Unable to
Attain the Level of Leverage it Deems Optimal.......................... 15
Decline in Market Value of Mortgage-Backed Securities; Margin Calls and
Defaults............................................................... 15
Increased Borrowing Costs and Failure to Refinance Outstanding
Borrowings Could Adversely Impact the Company's Net Income............. 16
Interest Rate Fluctuations Could Cause a Decrease in Net Interest
Income................................................................. 17
Use of Interest Rate Derivatives for Hedging May Not Be Effective in
Mitigating Interest Rate and Prepayment Risk........................... 17
The Company's Investment Strategy May Involve Credit Risk............... 18
The Company May Not be Able to Acquire Mortgage-Backed Securities at
Favorable Yields; Competition and Supply............................... 18
Limited Guarantees by FHLMC and FNMA.................................... 19
Limitations on Ratings of Mortgage-Backed Securities.................... 19
The Company's Assets May Include Unrated Assets......................... 20
Asset Concentration..................................................... 20
General Risks............................................................ 21
Dependence on Key Personnel............................................. 21
Limited Operating History of the Company................................ 21
Conflicts of Interest................................................... 21
Legal and Other Risks.................................................... 22
Loss of Investment Company Act Exemption Would Adversely Affect the
Company................................................................ 22
Failure to Maintain REIT Status Would Subject the Company to Additional
Tax.................................................................... 23
Potential Characterization of Distributions As UBTI; Taxation of Tax-
Exempt Investors....................................................... 23
Taxable Mortgage Pool Risk; Increased Taxation.......................... 23
Bankruptcy Code Treatment of Repurchase Agreements...................... 24
Future Revisions in Policies and Strategies............................. 24
Lack of Public Market................................................... 24
Common Stock Available for Future Sale.................................. 24
Dilution; Potential Future Offerings.................................... 25
Certain Benefits to Existing Stockholders, Directors and Officers....... 25
Illiquidity of Certain Investments...................................... 26
Issuance of Preferred Stock............................................. 26
Restrictions on Ownership of Capital Stock.............................. 26
Indemnification of Officers and Directors............................... 27
THE COMPANY............................................................... 28
USE OF PROCEEDS........................................................... 28
CAPITALIZATION............................................................ 29
</TABLE>
<TABLE>
<CAPTION>
PAGE
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<S> <C>
DISTRIBUTION POLICY....................................................... 29
DILUTION.................................................................. 30
SELECTED FINANCIAL DATA................................................... 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS............................................................... 33
Overview................................................................. 33
Results of Operations: February 18, 1997 to June 30, 1997................ 33
Net Income Summary...................................................... 33
Taxable Income and GAAP Income.......................................... 34
Interest Income and Average Earning Asset Yield......................... 34
Interest Expense and the Cost of Funds.................................. 35
Net Interest Rate Agreement Expense..................................... 35
Net Interest Income..................................................... 36
Gains and Losses on Sales of Mortgage-Backed
Securities............................................................. 36
Credit Expenses......................................................... 36
General and Administrative Expenses..................................... 36
Net Income and Return on Average Equity................................. 37
Dividends and Taxable Income............................................ 37
Financial Condition...................................................... 37
Mortgage-Backed Securities.............................................. 37
Interest Rate Agreements................................................ 39
Borrowings.............................................................. 39
Liquidity............................................................... 40
Stockholders' Equity.................................................... 40
Leverage................................................................ 41
Asset/Liability Management and Effect of Changes in Interest Rates....... 41
Inflation................................................................ 41
BUSINESS STRATEGY......................................................... 42
General.................................................................. 42
Mortgage-Backed Securities............................................... 43
General................................................................. 43
Unrated Assets.......................................................... 43
Description of Mortgage-Backed Securities............................... 44
FHLMC Certificates...................................................... 44
FNMA Certificates....................................................... 45
GNMA Certificates....................................................... 46
Single-Family and Multifamily Privately Issued Certificates............. 46
Collateralized Mortgage Obligations and Multi-Class Pass-Through Securi-
ties................................................................... 47
Floating Rate Mortgage-Backed Securities................................ 48
Other Floating Rate Instruments......................................... 49
Subordinated Interests.................................................. 49
Mortgage Loans.......................................................... 50
Capital Investment Policy................................................ 50
Asset Acquisitions...................................................... 50
Credit Risk Management.................................................. 52
Capital and Leverage.................................................... 52
Interest Rate Risk Management........................................... 54
Prepayment Risk Management.............................................. 56
Future Revisions in Policies and Strategies.............................. 56
Legal Proceedings........................................................ 56
MANAGEMENT................................................................ 57
Directors and Executive Officers......................................... 57
Certain Relationships; Conflicts of Interest............................. 60
Compensation of Directors and Executive Officers......................... 61
Employment Agreements.................................................... 61
Long-Term Stock Incentive Plan........................................... 62
</TABLE>
3
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Involvement of Officers in Certain Legal Proceedings..................... 64
PRINCIPAL STOCKHOLDERS.................................................... 65
SELLING STOCKHOLDERS...................................................... 68
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS................................. 69
General.................................................................. 69
Stock Ownership Tests................................................... 70
Asset Tests............................................................. 70
Gross Income Tests...................................................... 70
Recent Legislation...................................................... 71
Distribution Requirement................................................ 71
Taxation of the Company.................................................. 71
Taxable Subsidiaries..................................................... 72
Taxation of Stockholders; Common Stock................................... 72
Taxation of Tax Exempt Entities.......................................... 73
State and Local Taxes.................................................... 74
Certain United States Federal Income Tax Considerations Applicable to
Foreign Holders......................................................... 74
Dividends............................................................... 74
Gain on Disposition..................................................... 74
Information Reporting and Backup Withholding............................ 75
ERISA CONSIDERATIONS...................................................... 76
</TABLE>
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Employee Benefit Plans, Tax-Qualified Retirement Plans and IRAs........... 76
Status of the Company under ERISA......................................... 77
DESCRIPTION OF CAPITAL STOCK............................................... 79
General................................................................... 79
Common Stock.............................................................. 79
Voting................................................................... 79
Dividends; Liquidation; Other Rights..................................... 79
Restrictions on Ownership and Transfer.................................... 79
Indemnification........................................................... 81
Limitation of Liability................................................... 81
Control Share Acquisitions................................................ 81
Transfer Agent and Registrar.............................................. 82
COMMON STOCK AVAILABLE FOR FUTURE SALE..................................... 83
Registration Rights....................................................... 84
UNDERWRITING............................................................... 85
LEGAL MATTERS.............................................................. 86
EXPERTS.................................................................... 86
ADDITIONAL INFORMATION..................................................... 87
GLOSSARY................................................................... 88
INDEX TO FINANCIAL STATEMENTS.............................................. F-1
</TABLE>
4
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information appearing throughout the Prospectus. Unless otherwise indicated,
all information in this Prospectus assumes that (i) the offering price of the
Shares (the "Offering Price") is $12.00 per Share and (ii) the Underwriters'
over-allotment option is not exercised. Certain capitalized and other terms
used but not defined herein shall have the meanings set forth in the Glossary
beginning on page 88.
THE COMPANY
GENERAL
Annaly Mortgage Management, Inc., a Maryland corporation (the "Company"),
owns and manages a portfolio of mortgage-backed securities, including mortgage
pass-through certificates ("Pass-Through Certificates"), collateralized
mortgage obligations ("CMOs") and other securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities") which can be readily financed. The Company's principal business
objective is to generate net income for distribution to stockholders from the
spread between the interest income on its Mortgage-Backed Securities and the
costs of borrowing to finance its acquisition of Mortgage-Backed Securities.
The Company will elect to be taxed as a "real estate investment trust" ("REIT")
under the Internal Revenue Code of 1986, as amended (the "Code"). Therefore,
substantially all of its assets consist (and will consist) of Qualified REIT
Real Estate Assets (of the type described in Section 856(c)(6)(B) of the Code).
The Company is self-advised and self-managed.
The Company was organized on November 25, 1996 and commenced operations on
February 18, 1997 with its private placement (the "Private Placement") of
3,600,000 shares of Common Stock, sold at $10 per share. The Company has
financed its purchases of Mortgage-Backed Securities with (i) net proceeds of
approximately $33 million from the Private Placement, (ii) proceeds of $878,000
from the July 31, 1997 sale of 87,800 shares of Common Stock at $10 per share
to certain directors, officers and employees of the Company (the "Direct
Offering"), and (iii) borrowings under repurchase agreements whose interest
rates adjust based on changes in short-term market interest rates. The Company
plans to finance additional purchases of Mortgage-Backed Securities with the
proceeds of this offering (the "Offering"), future offerings and future
borrowings.
CAPITAL INVESTMENT POLICY
Under the Capital Investment Policy adopted by the Company (the "Capital
Investment Policy"), at least 75% of the Company's total assets will be
comprised of "High Quality" Mortgage-Backed Securities and "High Quality"
short- term investments. The term "High Quality" as used herein means
securities (i) which are rated within one of the two highest rating categories
by Standard & Poor's Corporation ("S&P") or at least one other nationally
recognized rating organization (each, a "Rating Agency"), (ii) that are unrated
but are either guaranteed by the United States government or an agency of the
United States government, or (iii) that are unrated or whose ratings have not
been updated but are determined to be of comparable quality to rated High
Quality Mortgage-Backed Securities on the basis of credit enhancement features
that meet the High Quality credit criteria approved by the Company's Board of
Directors. The remainder of the Company's assets, comprising not more than 25%
of total assets, may consist of other Qualified REIT Real Estate Assets which
are unrated or rated less than High Quality but which are at least "investment
grade" (rated "BBB" or better by S&P or the equivalent by another Rating
Agency) or, if not rated, are determined by the Company to be of comparable
credit quality to an investment which is rated "BBB" or better. Prior to
investing in any unrated securities, the Company will follow certain procedures
described under "Business Strategy--Mortgage- Backed Securities--Unrated
Assets." See "Risk Factors--Operations Risks--The Company's Assets May Include
Unrated Assets." Mortgage-Backed Securities to be acquired by the Company may
include, but will not be limited to, Mortgage-Backed Securities backed by
single-family residential mortgage loans ("Single-Family Mortgage Loans") and
Mortgage-Backed Securities backed by loans on multi-family, commercial or other
real estate-related properties.
At June 30, 1997, all of the Mortgage-Backed Securities held by the Company
were "Agency Certificates" which, although not rated, carry an implied "AAA"
rating. "Agency Certificates" consist of mortgage
5
<PAGE>
participation certificates issued by the Federal Home Loan Mortgage Corporation
("FHLMC"), Pass-Through Certificates issued by the Federal National Mortgage
Association ("FNMA"), and fully modified Pass-Through Certificates guaranteed
by the Government National Mortgage Association ("GNMA"). All such Agency
Certificates held by the Company at June 30, 1997 were backed by Single-Family
Mortgage Loans, of which at June 30, 1997, approximately 93% had coupon rates
which adjust over time (subject to certain limitations and lag periods) in
conjunction with changes in short-term interest rates, reflecting the Company's
strategy of investing primarily in adjustable-rate Mortgage-Backed Securities.
The Company intends to continue to invest primarily in adjustable-rate
Mortgage-Backed Securities. The Company may also invest on a limited basis in
mortgage derivative securities representing the right to receive interest only
or a disproportionately large amount of interest. The Company has not and will
not invest in real estate mortgage investment conduit ("REMIC") residuals,
other CMO residuals or any Mortgage-Backed Securities, such as inverse
floaters, which have imbedded leverage as part of their structural
characteristics. At June 30, 1997, the weighted average yield on the Company's
portfolio of earning assets was 6.63%, and the weighted average term to next
rate adjustment was one month. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Mortgage-
Backed Securities."
The Company attempts to structure its borrowings to have interest rate
adjustment indices and interest rate adjustment periods that, on an aggregate
basis, correspond generally (within a range of one to six months) to the
interest rate adjustment indices and periods of the adjustable-rate Mortgage-
Backed Securities owned by the Company. However, the Company is subject to the
risk that periodic rate adjustments on borrowings may be less frequent than
rate adjustments on its Mortgage-Backed Securities. At June 30, 1997, the
weighted average cost of funds for all of the Company's borrowings was 5.64%
and the weighted average term to next rate adjustment of such borrowings was 20
days. See "Risk Factors--Operations Risks--Differences Between Mortgage-Backed
Security and Borrowing Characteristics; the Company's Assets Generally are
Subject to Interest Rate Caps, While the Company's Borrowings Generally are not
Similarly Restricted" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Financial Condition--Borrowings."
The Company generally expects to maintain a ratio of debt-to-equity of
between 8:1 and 12:1, although the ratio may vary from time to time depending
upon market conditions and other factors deemed relevant by management of the
Company. For purposes of calculating this ratio, the Company's equity is equal
to the value of the Company's investment portfolio on a mark-to-market basis,
less the book value of the Company's obligations under repurchase agreements
and other collateralized borrowings. At June 30, 1997, the ratio of debt-to-
equity of the Company was 10:1. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition--Leverage"
and "Business Strategy--Capital Investment Policy--Capital and Leverage."
To the extent consistent with its election to qualify as a REIT, the Company
may enter into hedging transactions to attempt to protect its portfolio of
Mortgage-Backed Securities and related borrowings against the effects of major
interest rate changes. Such hedging would be used to mitigate declines in the
market value of the Company's Mortgage-Backed Securities during periods of
increasing or decreasing interest rates and to limit or cap the rate on the
Company's borrowings. Such transactions would be entered into solely for the
purpose of hedging interest rate or prepayment risk and not for speculative
purposes. These hedging transactions may include interest rate swaps, the
purchase or sale of interest rate collars, caps or floors, and the purchase of
"interest only" Mortgage-Backed Securities. No hedging strategy can totally
eliminate interest rate risk and the Company's ability to enter into such
hedging transactions may be limited by provisions of the Code relating to
qualifying assets and qualifying income and transaction costs associated with
entering into such transactions. To date, the Company has not entered into any
hedging transactions. See "Business Strategy--Capital Investment Policy" and
"Certain Federal Income Tax Considerations."
The Company consistently monitors its Mortgage-Backed Securities and the
income from such assets and, to the extent the Company enters into hedging
transactions in the future, will monitor income from its hedging
6
<PAGE>
transactions as well, so as to ensure at all times that the Company maintains
its qualification as a REIT and its exempt status under the Investment Company
Act of 1940, as amended (the "Investment Company Act"). See "Certain Federal
Income Tax Considerations" and "Risk Factors--Legal and Other Risks."
MANAGEMENT
The executive officers of the Company are Michael A. J. Farrell (director,
Chairman of the Board and Chief Executive Officer), Timothy J. Guba (director,
President and Chief Operating Officer), Wellington J. St. Claire (director and
Vice Chairman of the Board) and Kathryn F. Fagan (Chief Financial Officer and
Treasurer). Messrs. Farrell and Guba and Ms. St. Claire have an average of 15
years' experience in the investment banking and investment management
industries where, in various capacities, they have each managed portfolios of
Mortgage-Backed Securities, arranged collateralized borrowings and utilized
hedging techniques to mitigate interest rate and other risk within fixed-income
portfolios. Ms. Fagan is a certified public accountant and, prior to becoming
Chief Financial Officer and Treasurer of the Company, served as Chief Financial
Officer and Controller of a publicly owned savings and loan association. Since
1994, Messrs. Farrell and Guba and Ms. St. Claire have managed Fixed Income
Discount Advisory Company ("FIDAC"), a registered investment advisor which, at
June 30, 1997, managed, assisted in managing or supervised approximately $500
million in gross assets for a wide array of clients, of which, at such date,
approximately $250 million was managed on a discretionary basis.
Mr. Farrell was previously associated with Citadel Funding Corporation
("Citadel"), a broker-dealer which has since been dissolved. Mr. Farrell was
one of the respondents in an action brought by the National Association of
Securities Dealers, Inc. District Business Conduct Committee for District No. 3
(the "DBCC") against Citadel and certain of its principals, including Mr.
Farrell. The details of this action, and the Offer of Settlement entered into
among DBCC, Citadel and its principals, are described under "Management--
Involvement of Officers in Certain Legal Proceedings."
None of the officers, directors or employees of the Company will receive any
compensation in connection with the Offering. However, the salaries of Messrs.
Farrell and Guba and Ms. St. Claire are based upon the book value of the
Company, subject to certain maximum amounts. As a result, their respective
salaries are expected to increase upon consummation of the Offering. See
"Management--Compensation of Directors and Executive Officers."
CONFLICTS OF INTEREST
As indicated above, certain officers of the Company are also officers of
FIDAC. The exercise by management of its duties on behalf of FIDAC's clients
may create conflicts of interest to the extent that management is presented
with corporate opportunities that may benefit both the Company and such FIDAC
clients. In the event that an investment opportunity arises, such investment
will be allocated to the Company or another entity by determining the entity or
account for which such investment is most suitable. In making such
determination, management will consider the investment strategy and guidelines
of each entity or account with respect to acquisition of assets, leverage,
liquidity and other factors which management shall determine appropriate.
Management believes that through the date hereof, because of the available
supply of Mortgage-Backed Securities, it has been able to acquire assets for
both the Company and FIDAC's clients which satisfy their respective investment
strategies. Any assets which constitute "Qualifying Interests" under the
Investment Company Act (pursuant to the current interpretation of the staff of
the Commission) are considered first for the Company's portfolio. See "Risk
Factors--Legal and Other Risks--Loss of Investment Company Act Exemption Would
Adversely Affect the Company." Any other investments, if there is a limited
supply of Mortgage-Backed Securities for acquisition, will be allocated between
the Company and FIDAC's clients in accordance with their respective investment
strategies and guidelines. To the extent that such assets are equally suitable
for both the Company and FIDAC's clients, management would allocate such assets
pro rata based upon the amount of funds that each entity has available to
invest in the particular asset. On a quarterly basis, management will report to
one or more of the Independent Directors designated by the Company's audit
committee on the allocation of asset acquisitions between the Company and
FIDAC's clients. Such Independent Director or Directors will
7
<PAGE>
review such assets acquisitions to ensure that they have been allocated on a
fair and reasonable basis. See "Risk Factors--General Risks--Conflicts of
Interest" and "Management--Directors and Executive Officers" and "--Certain
Relationships; Conflicts of Interest."
DISTRIBUTION POLICY
To maintain its qualification as a REIT, the Company must distribute
substantially all of its taxable income to stockholders for each year, which
the Company intends to do. The Company also intends to declare regular
quarterly dividends. The Company declared dividends of $0.075 per share (or
$276,000 in the aggregate) for the period from February 18, 1997 (commencement
of operations) to March 31, 1997 and $.255 per share (or $938,400 in the
aggregate) for the second quarter of 1997. The Company also has declared a
dividend of $0.18 per share (or $678,204 in the aggregate) for the two-month
period ended August 31, 1997, which shall be payable on October 23, 1997 to
holders of record of Common Stock as of September 2, 1997. All of these
dividends have been paid out of the Company's net income and, therefore, none
of the dividends declared by the Company to date constitute a return of
capital. See "Distribution Policy" and "Certain Federal Income Tax
Considerations." The Company is considering the adoption of a Dividend
Reinvestment Plan that would allow holders of Common Stock to reinvest
dividends automatically in additional shares of Common Stock, although the
Company has no plans to institute such a Dividend Reinvestment Plan (if at all)
prior to 1998.
Distributions to stockholders will generally be subject to tax as ordinary
income, although a portion of such distributions may be designated by the
Company as capital gain or may constitute a tax-free return of capital. The
Company does not intend to declare dividends that would result in a return of
capital. The Company will annually furnish to each of its stockholders a
statement setting forth distributions paid during the preceding year and their
characterization as ordinary income, capital gains or return of capital. For a
discussion of the Federal income tax treatment of distributions by the Company,
see "Certain Federal Income Tax Considerations--Taxation of Stockholders."
RISK FACTORS
The purchase of the Shares offered hereby is subject to certain risks. See
"Risk Factors." Among such risks are the following:
. Prior to the commencement of operations by the Company on February 18,
1997, none of the Company's officers had any experience in managing a
REIT.
. Interest rate fluctuations may adversely affect the Company's earnings
as a result of potential changes in the spread between the interest
rates paid on its borrowings and the interest rates earned on its
Mortgage-Backed Securities. Mortgage-Backed Securities held by the
Company generally are subject to interest rate caps while the Company's
borrowings generally are not similarly restricted.
. Mortgage prepayment rates vary depending on such factors as mortgage
interest rates, economic outlook and market conditions. Changes in
anticipated prepayment rates may affect the Company's earnings by
changing the speed of amortization of purchase discounts and premiums.
. The Company's strategy of borrowing a substantial portion of the market
value of the Mortgage- Backed Securities to finance the acquisition of
such Mortgage-Backed Securities may result in the Company incurring a
decrease in net interest income and potentially incurring net losses if
returns on Mortgage-Backed Securities are not sufficient to cover
borrowing costs.
. Various factors, including the Company's intent to structure its
investment portfolio to continue to qualify for an exemption from
regulation as an investment company under the Investment Company Act,
may prevent the Company from attaining the level of leverage it deems
optimal, which may cause the Company to be less profitable than it
otherwise would be.
. A decline in the market value of the Mortgage-Backed Securities may
limit the Company's ability to borrow or result in lenders initiating
margin calls, which may require the Company to sell Mortgage- Backed
Securities under adverse market conditions. A decline in market value
and the initiation of margin calls could also result in a default by the
Company under its collateralized borrowings and a liquidation of
collateral.
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<PAGE>
. The Company's business strategy relies on short-term borrowings to fund
Mortgage-Backed Securities with adjustable-rate coupons and long-term
maturities. In the event the Company is not able to renew or replace
maturing borrowings, the Company could be required to sell Mortgage-
Backed Securities under possibly adverse market conditions and could
incur losses as a result.
. The Company's borrowing costs generally correspond to the London
Interbank Offered Rate, as defined in the applicable borrowing
("LIBOR"), or another short-term index, plus or minus a margin. Margins
vary depending upon the lender, the underlying collateral, interest
rates, the availability of financing and other factors. Increased
borrowing costs, resulting from increases in such indices or margins,
could adversely impact the Company's net income.
. Rising short-term rates will increase the Company's borrowing costs to
acquire additional Mortgage- Backed Securities and, to the extent such
costs rise more rapidly than the yields, the Company's net income may be
reduced or a net loss may result.
. Asset/liability management hedging strategies involve risk and may not
be effective in reducing the Company's exposure to interest rate
changes. Moreover, compliance with the REIT Provisions of the Code may
prevent the Company from effectively implementing the strategies that
the Company determines, absent such compliance, would best insulate the
Company from the risks associated with changing interest rates.
. The Company's net income depends on the Company's ability to acquire
Mortgage-Backed Securities at favorable spreads to borrowing costs.
Increased competition for the acquisition of eligible Mortgage-Backed
Securities or a diminution in the available supply could result in
higher prices and thus lower yields on such Mortgage-Backed Securities
which could further narrow the yield spread over borrowing costs.
. The Company commenced operations on February 18, 1997 and therefore has
a limited operating history.
. The obligations of FHLMC under Mortgage Participation Certificates
issued by FHLMC ("FHLMC Certificates") and the obligations of FNMA under
Pass-Through Certificates issued by FNMA ("FNMA Certificates") are
solely those of FHLMC and FNMA, respectively. None of the obligations
evidenced by the FHLMC Certificates nor the obligations evidenced by the
FNMA Certificates is backed by the full faith and credit of the United
States. In addition, FHLMC does not guarantee the timely payment of
scheduled principal of underlying mortgage loans.
. There is no assurance that a rating on a Mortgage-Backed Security will
continue for any given period of time or that a rating will not be
lowered or withdrawn entirely by a Rating Agency if in the Rating
Agency's judgment circumstances so warrant.
. The Company may acquire assets which are not rated by a Rating Agency.
There can be no guarantee that the Company will be able to make an
accurate evaluation of such unrated assets.
. The Company's operations depend in significant part upon the
contributions of its executive officers. The loss of any key person
could have a material adverse effect on the Company's business and
results of operations.
. Certain of the Company's officers and employees are actively involved in
managing other portfolios of mortgage-backed securities and advising
financial institutions. These relationships may create conflicts of
interest for the Company and its officers and employees.
. Under the current interpretation of the staff of the Securities and
Exchange Commission (the "Commission"), in order to qualify for an
exemption from regulation as an investment company under the Investment
Company Act, under certain circumstances the Company will be required to
maintain at least 55% of its assets in certain qualifying interests in
real estate. This restriction may adversely affect the yield to be
obtained by the Company on its portfolio of Mortgage-Backed Securities.
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<PAGE>
. If the Company fails to maintain its qualification as a REIT, the
Company will be subject to Federal income tax as a regular corporation
which would result in a substantial reduction of income available for
dividend payments to stockholders.
. The investment policies and operating policies and strategies of the
Company set forth in this Prospectus may be modified or waived by the
Board of Directors, subject in certain cases to approval by a majority
of the Independent Directors, without stockholder consent. "Independent
Directors" means the directors of the Company who are not officers or
employees of the Company.
THE OFFERING(1)
<TABLE>
<C> <S>
Common Stock Offered by:
The Company...................... 6,250,000 Shares
The Selling Stockholders......... 845,000 Shares
Common Stock to be Outstanding after
the Offering....................... 10,017,800 shares of Common Stock(2)
Use of Proceeds..................... The net proceeds from the sale of the
Shares offered by the Company will be
used, together with borrowings, to
purchase additional Mortgage-Backed
Securities and, pending such use, to
purchase High Quality Short-Term
Investments. None of the proceeds from
the sale of Shares offered by Selling
Stockholders will be contributed to the
Company.
New York Stock Exchange Symbol...... NLY
</TABLE>
- --------
(1) Assumes the Underwriters' over-allotment option to purchase up to an
additional 1,064,250 Shares from the Company is not exercised. See
"Underwriting."
(2) Excludes 500,000 shares of Common Stock (500,890 shares upon consummation
of the Offering) reserved for issuance under the Company's Long-Term Stock
Incentive Plan (the "Incentive Plan"). Options to acquire 348,500 shares
have been granted to directors, officers and employees of the Company
pursuant to the Incentive Plan. See "Management--Long-Term Stock Incentive
Plan."
10
<PAGE>
SUMMARY FINANCIAL INFORMATION
PERIOD FROM FEBRUARY 18, 1997 TO JUNE 30, 1997
(dollars in thousands, except for per share data)
The financial data set forth below should be read in conjunction with the
Financial Statements of the Company and related Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included herein.
<TABLE>
<S> <C>
STATEMENT OF OPERATIONS DATA:
Days in period..................................................... 133
Interest income.................................................... $ 6,509
Interest expense................................................... 5,149
---------
Net interest income................................................ 1,360
Gain on sale of Mortgage-Backed Securities......................... 230
General and administrative expenses (G&A expense).................. 250
---------
Net income......................................................... $ 1,340
=========
Net income per share............................................... $ 0.36
Dividends declared per share....................................... 0.33
BALANCE SHEET DATA AT JUNE 30, 1997:
Mortgage-Backed Securities......................................... $ 364,367
Total assets....................................................... 398,236
Repurchase agreements.............................................. 326,987
Total liabilities.................................................. 365,418
Stockholders' equity............................................... 32,819
Number of common shares outstanding................................ 3,680,000
Interest rate spread............................................... 0.99%
OTHER DATA:
Average total assets............................................... $ 283,100
Average borrowings................................................. 242,027
Average equity..................................................... 33,115
Yield on interest earning assets at June 30, 1997.................. 6.63%
Cost of funds on interest bearing liabilities at June 30, 1997..... 5.64%
Efficiency ratio (G&A expense/net interest income)................. 18.37%
ANNUALIZED FINANCIAL RATIOS(1):
Net interest margin (net interest income/average total assets)..... 1.32%
G&A expense as a percentage of average assets...................... 0.24%
G&A expense as a percentage of average equity...................... 2.07%
Return on average assets........................................... 1.30%
Return on average equity........................................... 11.11%
</TABLE>
- --------
(1) Each ratio has been computed by annualizing the results for the 133-day
period ended June 30, 1997.
11
<PAGE>
This Prospectus contains forward-looking statements. Such forward-looking
statements include, without limitation, statements concerning the Company's
ability to mitigate interest rate, prepayment and other risks and the Company's
ability to grow and become more efficient over time. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the Company
to be materially different from the results of operations or plans expressed or
implied by such forward-looking statements. Among those factors which may
impact the Company's actual results, performance and achievements are changes
in interest rates, changes in the yield curve, changes in prepayment rates, the
availability of Mortgage-Backed Securities for purchase, the availability of
financing and, if available, the terms of any such financing. Although the
Company believes that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of the assumptions could be inaccurate
and, therefore, there can be no assurance that the forward-looking statements
included in this Prospectus will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the results or
conditions described in such forward-looking statements or the objectives and
plans of the Company will be achieved. Investors should review carefully the
more detailed descriptions of risks and uncertainties set forth under the
caption "Risk Factors" in this Prospectus.
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<PAGE>
RISK FACTORS
Before investing in the Common Stock offered hereby, prospective investors
should give special consideration to the information set forth below. This
Prospectus contains forward-looking statements. Disclosure regarding such
forward-looking statements may be found under "Prospectus Summary," "Use of
Proceeds," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business Strategy," as well as within the
Prospectus generally. Actual results could differ materially from those
projected in the forward-looking statements as a result of the risk factors
set forth below and the matters set forth in the Prospectus generally.
OPERATIONS RISKS
GENERAL
The results of the Company's operations are affected by various factors,
many of which are beyond the control of the Company. The results of the
Company's operations depend on, among other things, the level of net interest
income generated by the Company's Mortgage-Backed Securities, the market value
of such Mortgage-Backed Securities and the supply of and demand for such
Mortgage-Backed Securities. The Company's net interest income varies primarily
as a result of changes in short-term interest rates, borrowing costs and
prepayment rates, the behavior of which involves various risks and
uncertainties as set forth below. Prepayment rates, interest rates and
borrowing costs depend on the nature and terms of the Mortgage-Backed
Securities, conditions in financial markets, the fiscal and monetary policies
of the United States government and the Board of Governors of the Federal
Reserve System, international economic and financial conditions, competition
and other factors, none of which can be predicted with any certainty. Since
changes in interest rates may significantly affect the Company's activities,
the operating results of the Company depend, in large part, upon the ability
of the Company to effectively manage its interest rate and prepayment risks
while maintaining its status as a REIT. See "--Use of Interest Rate
Derivatives for Hedging May Not be Effective in Mitigating Interest Rate and
Prepayment Risk," "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Asset/Liability Management and Effect of Changes in
Interest Rates," and "Business Strategy--Capital Investment Policy--Interest
Rate Risk Management."
LACK OF REIT EXPERIENCE
Prior to February 18, 1997, the date upon which the Company commenced
operations, none of the officers of the Company had any experience in managing
a REIT.
DIFFERENCES BETWEEN MORTGAGE-BACKED SECURITY AND BORROWING CHARACTERISTICS;
THE COMPANY'S ASSETS GENERALLY ARE SUBJECT TO INTEREST RATE CAPS, WHILE THE
COMPANY'S BORROWINGS GENERALLY ARE NOT SIMILARLY RESTRICTED
At June 30, 1997, all of the Mortgage-Backed Securities held by the Company
were Agency Certificates backed by Single-Family Mortgage Loans, of which
approximately 93% had coupon rates which adjust over time (subject to certain
limitations and lag periods) in conjunction with changes in short-term
interest rates, such adjustments being based on an objective index such as
LIBOR, the Treasury Index or the CD Rate. It is expected in the future that a
substantial portion of the Company's Mortgage-Backed Securities will consist
of adjustable-rate Pass-Through Certificates ("ARM Certificates") or floating
rate CMOs which also will be subject to periodic interest rate adjustments
based on such objective indices ("Floaters"). "LIBOR" means the London
Interbank Offered Rate as it may be defined, and for a period of time
specified, in a Mortgage-Backed Security or borrowing of the Company.
"Treasury Index" means the monthly/weekly average yield of the benchmark U.S.
Treasury securities, as published by the Board of Governors of the Federal
Reserve System. "CD Rate" means the weekly average of secondary market
interest rates on six-month negotiable certificates of deposit, as published
by the Federal Reserve Board in its Statistical Release H.15(519), Selected
Interest Rates.
Interest rates on the Company's borrowings are expected to continue to be
based on short-term indices. To the extent any of the Company's Mortgage-
Backed Securities are financed with borrowings bearing interest
13
<PAGE>
based on or varying with an index different from that used for the related
Mortgage-Backed Securities, so-called "basis" interest rate risk results. In
such event, if the index used for the Mortgage-Backed Securities is a
"lagging" index that reflects market interest rate changes on a delayed basis,
and the rate borne by the related borrowings reflects market rate changes more
rapidly, the Company's net interest income will be adversely affected in
periods of increasing market interest rates.
The Company's adjustable-rate Mortgage-Backed Securities are subject to
periodic rate adjustments which may not be matched precisely with increases or
decreases in rates borne by the borrowings or financings utilized by the
Company. Accordingly, in a period of increasing interest rates, the Company
could experience a decrease in net interest income or a net loss because the
interest rates on borrowings could adjust faster than the interest rates on
the Company's adjustable-rate Mortgage-Backed Securities.
Interest rates on the Company's Mortgage-Backed Securities are subject
typically to periodic and lifetime interest rate caps which limit the amount
an interest rate can change during any given period. The Company's borrowings
are not subject to similar restrictions. Hence, in a period of rapidly
increasing interest rates, the Company could also experience a decrease in net
interest income or a net loss because the interest rates on borrowings could
increase without limitation while the interest rates on the Company's
Mortgage-Backed Securities (consisting primarily of ARM Certificates and
Floaters) would be limited by caps. While the Company may hedge certain risks
associated with interest rate increases, no hedging strategy can insulate the
Company completely from interest rate risk. To date, the Company has not
entered into any interest rate hedging agreements.
The Company expects that the net effect of these factors, all other factors
being equal, could be to lower the Company's net interest income or cause a
net loss during periods of rapidly rising market interest rates, which could
negatively impact the level of dividend distributions and reduce the market
price of the Common Stock. This reduction in net income, or net loss, could
occur in an increasing interest rate environment as a result of interest rate
increases in borrowings which are more rapid than interest rate increases on
the Company's Mortgage-Backed Securities or as a result of periodic and
lifetime interest rate caps on the Company's Mortgage-Backed Securities.
CHANGES IN PREPAYMENT RATES OF MORTGAGE-BACKED SECURITIES
Prepayment rates on Mortgage-Backed Securities vary from time to time and
may cause changes in the amount of the Company's net interest income.
Prepayments of ARM Certificates and Floaters usually can be expected to
increase when mortgage interest rates fall below the then-current interest
rates on ARMs and decrease when mortgage interest rates exceed the then-
current interest rate on ARMs, although such effects are not predictable.
Prepayment experience also may be affected by the conditions in the housing
and financial markets, general economic conditions and the relative interest
rates on fixed-rate and adjustable-rate mortgage loans underlying Mortgage-
Backed Securities. Some Mortgage-Backed Securities are structured so that
certain classes are provided protection from prepayments for a period of time.
However, in a period of extremely rapid prepayments, during which earlier-
paying classes may be retired faster than expected, the protected classes may
receive unscheduled payments of principal earlier than expected and would have
average lives that, while longer than the average lives of the earlier-paying
classes, would be shorter than originally expected. The Company seeks to
minimize prepayment risk through a variety of means, including structuring a
diversified portfolio with a variety of prepayment characteristics, investing
in certain Mortgage-Backed Security structures which have prepayment
protection, and balancing assets purchased at a premium with assets purchased
at a discount. No strategy, however, can completely insulate the Company from
prepayment risks arising from the effects of interest rate changes. Prepayment
risk may be increased if the Company purchases interest-only strips to protect
against interest rate increases. Certain Mortgage-Backed Securities may have
underlying mortgage loans which are convertible to fixed-rate loans. Since
converted loans are required to be repurchased by the applicable Agency
(FHLMC, FNMA or GNMA) or servicer, the conversion of a loan results, in
effect, in the prepayment of such loan.
Changes in anticipated prepayment rates of Mortgage-Backed Securities could
affect the Company in several adverse ways. A portion of the Mortgage-Backed
Securities to be acquired by the Company may be
14
<PAGE>
recently originated and bear initial interest rates which are lower than their
"fully-indexed" rates (the applicable index plus margin). In the event that
such a Mortgage-Backed Security is prepaid faster than anticipated prior to or
soon after the time of adjustment to a fully-indexed rate, the Company will
experience an adverse effect on its net interest income during the time it
holds such Mortgage-Backed Security compared with holding a fully-indexed
Mortgage-Backed Security and will lose the opportunity to receive interest at
the fully-indexed rate over the expected life of the Mortgage-Backed Security.
In addition, the faster than anticipated prepayment of any Mortgage-Backed
Security that is purchased at a premium by the Company would generally result
in a faster than anticipated write-off of any remaining capitalized premium
amount and consequent reduction of the Company's net interest income by such
amount. At June 30, 1997, a majority of the Company's Mortgage-Backed
Securities had been acquired at a premium. While the effects of prepayments
may be mitigated to the extent the Company acquires Mortgage-Backed Securities
at a discount, to date, a substantial majority of the Company's Mortgage-
Backed Securities have been acquired at a premium, rather than a discount.
THE COMPANY'S STRATEGY INVOLVES LEVERAGE; THE COMPANY MAY BE UNABLE TO ATTAIN
THE LEVEL OF LEVERAGE IT DEEMS OPTIMAL
The Company's financing strategy is designed to increase the size of its
Mortgage-Backed Security investment portfolio by borrowing a substantial
portion (which may vary depending upon the mix of the Mortgage-Backed
Securities in the Company's portfolio and the application of the Company's
Capital Investment Policy requirements to such mix of Mortgage-Backed
Securities) of the market value of its Mortgage-Backed Securities. If the
coupon income on the Mortgage-Backed Securities purchased with borrowed funds
fails to cover the cost of the borrowings, the Company will experience net
interest losses and may experience net losses. Such losses could be increased
substantially as a result of the Company's substantial leverage.
The Company expects generally to maintain a ratio of debt-to-equity of
between 8:1 and 12:1, although the ratio may vary from time to time depending
upon market conditions and other factors deemed relevant by management.
However, the Company is not limited under its Bylaws in respect of the amount
of its borrowings, whether secured or unsecured, and the debt-to-equity ratio
could at times be greater than 12:1. For purposes of calculating the debt-to-
equity ratio, the Company's equity equals the value of the Company's
investment portfolio on a mark-to-market basis less the book value of the
Company's obligations under repurchase agreements and other collateralized
borrowings. At June 30, 1997, the debt-to-equity ratio of the Company was
10:1. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Financial Condition--Leverage" and "Business Strategy--
Capital Investment Policy--Capital and Leverage."
The ability of the Company to achieve its investment objectives depends on
its ability to borrow money in sufficient amounts and on favorable terms.
Through increases in haircuts (i.e., the over-collateralization amount
required by a lender), decreases in the market value of the Company's
Mortgage-Backed Securities, increases in interest rate volatility, changes in
the availability of financing in the market, conditions then applicable in the
lending market and other factors, the Company may not be able to achieve the
degree of leverage it believes to be optimal, which may cause the Company to
be less profitable than it would be otherwise. In addition, as a result of the
Company's intention to structure its investment portfolio to qualify for an
exemption from regulation as an investment company, the Company may be limited
in the types and amounts of Mortgage-Backed Securities it can purchase which,
in turn, may affect the ability of the Company to achieve the degree of
leverage it believes to be optimal.
DECLINE IN MARKET VALUE OF MORTGAGE-BACKED SECURITIES; MARGIN CALLS AND
DEFAULTS
Although, at June 30, 1997 and as of the date hereof, none of the Company's
Mortgage-Backed Securities were or are cross-collateralized to secure multiple
borrowing obligations of the Company to a single lender, the Company's
Mortgaged-Backed Securities may be cross-collateralized in the future. A
decline in the market value of such assets may limit the Company's ability to
borrow or result in lenders initiating margin calls (i.e., requiring a pledge
of cash or additional Mortgage-Backed Securities to re-establish the ratio of
the amount of the borrowing to the value of the collateral). The Company's
fixed-rate Mortgage-Backed Securities generally are more susceptible to margin
calls as increases in interest rates tend to more negatively affect the market
value
15
<PAGE>
of fixed-rate Mortgage-Backed Securities than adjustable-rate Mortgage-Backed
Securities. This remains true despite effective hedging against such
fluctuations as the hedging instruments may not be part of the collateral
securing the collateralized borrowings. Additionally, it may be difficult to
realize the full value of the hedging instrument when desired for liquidity
purposes due to the applicable REIT Provisions of the Code. The Company could
be required to sell Mortgage-Backed Securities under adverse market conditions
in order to maintain liquidity. Such sales may be effected by the Company when
deemed necessary in order to preserve the capital base of the Company. If
these sales were made at prices lower than the amortized cost of the Mortgage-
Backed Securities, the Company would experience losses. A default by the
Company under its collateralized borrowings could also result in a liquidation
of the collateral, including any cross-collateralized assets, and a resulting
loss of the difference between the value of the collateral and the amount
borrowed.
Additionally, in the event of a bankruptcy of the Company, certain
repurchase agreements may qualify for special treatment under the Bankruptcy
Code, the effect of which is, among other things, to allow the creditors under
such agreements to avoid the automatic stay provisions of the Bankruptcy Code
and to liquidate the collateral under such agreements without delay. See "--
Legal and Other Risks--Bankruptcy Code Treatment of Repurchase Agreements."
To the extent the Company is compelled to liquidate Mortgage-Backed
Securities qualifying as Qualified REIT Real Estate Assets to repay
borrowings, the Company may be unable to comply with the REIT Provisions of
the Code regarding assets and sources of income requirements, ultimately
jeopardizing the Company's status as a REIT. The Code does not provide for any
mitigating provisions with respect to the 30% Gross Income Test. Accordingly,
if the Company failed to meet the 30% Gross Income Test, its status as a REIT
would terminate automatically. The 30% Gross Income Test means the requirement
for each taxable year that less than 30% of the Company's gross income is
derived from the sale of Qualified REIT Real Estate Assets held for less than
four years, stock or securities held for less than one year (including certain
interest rate swap and cap agreements entered into to hedge variable rate debt
incurred to acquire Qualified Real Estate Assets) and certain "dealer"
property. Pursuant to recently enacted legislation, the 30% Gross Income Test
has been repealed for taxable years beginning after August 5, 1997. See
"Certain Federal Income Tax Considerations--General--Asset Tests," "--Gross
Income Tests" and "--Recent Legislation."
INCREASED BORROWING COSTS AND FAILURE TO REFINANCE OUTSTANDING BORROWINGS
COULD ADVERSELY IMPACT THE COMPANY'S NET INCOME
Currently, all of the Company's borrowings are collateralized borrowings in
the form of repurchase agreements. The ability of the Company to enter into
repurchase agreements in the future will depend on the market value of the
Mortgage-Backed Securities pledged to secure the specific borrowings, the
availability of financing, and other conditions then applicable in the lending
market. The Company may effect additional borrowings through using other types
of collateralized borrowings, loan agreements, lines of credit, Dollar-Roll
Agreements and other credit facilities with institutional lenders or through
the issuance of debt securities. A "Dollar-Roll Agreement" is an agreement to
sell a security for delivery on a specified future date entered into
simultaneously with an agreement to repurchase the same or a substantially
similar security (with the same coupon and original maturity periods) on a
specified future date. The cost of borrowings under repurchase agreements
generally corresponds to LIBOR plus or minus a margin, although such
agreements may not expressly incorporate a LIBOR index. The cost of borrowings
under other sources of funding which the Company may use may refer or
correspond to other short-term indices, plus or minus a margin. The margins on
such borrowings over or under LIBOR or such other short-term indices may vary
depending on the lender, the nature and liquidity of the underlying
collateral, the movement of interest rates, the availability of financing in
the market and other factors. Increased borrowing costs could adversely impact
the Company's net income.
The Company's business strategy relies primarily on short-term borrowings to
fund Mortgage-Backed Securities with adjustable-rate coupons and long-term
maturities. Thus, the ability of the Company to achieve its investment
objectives depends not only on its ability to borrow money in sufficient
amounts and on favorable terms but also on the Company's ability to renew or
replace on a continuous basis its maturing short-term borrowings. In the event
the Company is not able to renew or replace maturing borrowings, the Company
could
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be required to sell Mortgage-Backed Securities under possibly adverse market
conditions and could incur losses as a result. In addition, in such event, the
Company may be required to terminate any hedging positions, which could result
in further costs to the Company. At the same time, the market value of the
assets in which the Company's liquidity capital is invested may have
decreased. A number of such factors in combination could cause difficulties
for the Company and might result in a liquidation of a major portion of the
Company's Mortgage-Backed Securities at disadvantageous prices with consequent
losses, which could have a material adverse effect on the Company and its
solvency.
Interest Rate Fluctuations Could Cause a Decrease in Net Interest Income
At June 30, 1997, approximately 93% of the Company's Mortgage-Backed
Securities had adjustable interest or pass-through rates based on short-term
interest rates, and substantially all of the Company's borrowings bore
interest at short-term rates and had maturities of less than one year.
Consequently, changes in short-term interest rates may significantly influence
the Company's net interest income. While increases in short-term interest
rates will generally increase the yields on the Company's adjustable-rate
Mortgage-Backed Securities, rising short-term rates will also increase the
costs of borrowings by the Company which will be utilized to fund the
Mortgage-Backed Securities and, to the extent such costs rise more rapidly
than the yields, the Company's net interest income may be reduced or a net
loss may result. Increases in short-term rates relative to long-term rates
could adversely impact the Company's net income. In periods of high interest
rates, the Company's net income may be less than income generated through
alternative investments of equal or lower risk, which could negatively impact
the price of the Common Stock. No assurance can be given as to the amount or
timing of changes in interest rates or their effect on the Company's Mortgage-
Backed Securities or net interest income.
USE OF INTEREST RATE DERIVATIVES FOR HEDGING MAY NOT BE EFFECTIVE IN
MITIGATING INTEREST RATE AND PREPAYMENT RISK
The Company's operating strategy subjects it to interest rate risks as
described under "--Interest Rate Fluctuations Could Cause a Decrease in Net
Interest Income" above. The Company has adopted policies as part of its
Capital Investment Policy intended to protect against interest rate changes
and prepayments. See "Business Strategy--Capital Investment Policy--Interest
Rate Risk Management." The Company may purchase from time to time interest
rate caps, interest rate swaps and similar instruments to attempt to mitigate
the risk of the cost of its variable rate liabilities increasing at a faster
rate than the earnings on its assets during a period of rising rates. However,
it is not expected that such hedging strategies will completely insulate the
Company against interest rate risk. To date, the Company has not entered into
any hedging transactions.
Developing an effective asset/liability management strategy is complex, and
no strategy can completely insulate the Company from risks associated with
interest rate changes and prepayments. In addition, to the extent the Company
engages in hedging, there can be no assurance that the Company's hedging
activities will have the desired beneficial impact on the Company's results of
operations or financial condition. Hedging typically involves costs, including
transaction costs, which increase dramatically as the period covered by the
hedge increases and which also increase during periods of rising and volatile
interest rates. The Company may increase its hedging activity, and thus
increase its hedging costs, during such periods when interest rates are
volatile or rising and hedging costs have increased. Such hedging costs may
cause the Company to conclude that a particular hedging transaction is not
appropriate for the Company, thereby affecting the Company's ability to
mitigate interest rate risk. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Asset/Liability Management and
Effect of Changes in Interest Rates" and "Business Strategy--Capital
Investment Policy--Interest Rate Risk Management."
Federal tax laws applicable to REITs may substantially limit the Company's
ability to engage in asset/liability management transactions. Such Federal tax
laws may prevent the Company from effectively implementing hedging strategies
that the Company determines, absent such restrictions, would best insulate the
Company from the risks associated with changing interest rates and
prepayments. See "Certain Federal Income Tax Considerations--General" and "--
Taxation of the Company". In this regard, the amount of income the Company may
earn from its interest rate caps and other hedging instruments may be subject
to substantial
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limitations under the REIT Provisions of the Code. In particular, income
generated by such instruments is non-qualifying income for purposes of the 75%
Gross Income Test and is income from the sale of a security subject to the 30%
Gross Income Test. Additionally, the Company will treat such income as non-
qualifying income for the 95% Gross Income Test unless it receives advice from
its tax advisors that such income constitutes qualifying income for purposes
of such test. Pursuant to recently enacted legislation, the 30% Gross Income
Test has been repealed for taxable years beginning after August 5, 1997, but
such income would still not qualify for the 75% Gross Income Test or, subject
to the preceding sentence, the 95% Gross Income Test. See "Certain Federal
Income Tax Considerations--General--Gross Income Tests" and "--Recent
Legislation." This determination may result in management electing to have the
Company bear a level of interest rate risk that might otherwise be hedged. The
"75% Gross Income Test" means the requirement for each taxable year that at
least 75% of the Company's gross income must be derived from certain specified
real estate sources including interest income and gain from the disposition of
Qualified REIT Real Estate Assets or "qualified temporary investment income"
(i.e., income derived from "new capital" within one year of the receipt of
such capital). The "95% Gross Income Test" means the requirement for each
taxable year that at least 95% of the Company's gross income for each taxable
year must be derived from sources of income qualifying for the 75% Gross
Income Test, dividends, interest, and gains from the sale of stock or other
securities (including certain interest rate swap and cap agreements entered
into to hedge variable rate debt incurred to acquire Qualified REIT Real
Estate Assets) not held for sale in the ordinary course of business.
If the Company purchases interest rate caps or other interest rate
agreements to hedge against lifetime and periodic rate or payment caps, and
the provider of interest rate agreements becomes financially unsound or
insolvent, the Company may be forced to unwind its interest rate agreements
with such provider and may take a loss on such interest rate agreements.
Although the Company intends to purchase interest rate agreements 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.
THE COMPANY'S INVESTMENT STRATEGY MAY INVOLVE CREDIT RISK
The Company's Capital Investment Policy provides that at least 75% of the
Company's total assets are to be comprised of High Quality Mortgage-Backed
Securities and High Quality Short-Term Investments. "Short-Term Investments"
means short-term bank certificates of deposit, short-term United States
treasury securities, short-term United States government agency securities,
commercial paper, reverse repurchase agreements, short-term CMOs, short-term
asset-backed securities and other similar types of short-term investment
instruments, all of which will have maturities or average lives of less than
one year. The Capital Investment Policy provides that the remainder of the
Company's assets, comprising not more than 25% of total assets, may consist of
Mortgage-Backed Securities and other Qualified REIT Real Estate Assets which
are unrated or rated less than High Quality. The Company's investment strategy
seeks to balance the risk and return potential of its investments in a manner
that attempts to maximize return while minimizing the risk of losses to the
Company through defaults on portfolio obligations. This strategy determines
the relative weightings within the Company's portfolio of Mortgage-Backed
Securities of different ratings. The Company attempts to structure its
portfolio to maintain a minimum weighted average rating (including the
Company's deemed comparable ratings for unrated Mortgage-Backed Securities
based on a comparison to rated Mortgage-Backed Securities with like
characteristics) of its Mortgage-Backed Securities of at least single "A"
under the S&P rating system and at the comparable level under the other rating
systems. There can be no assurance the Company's deemed comparable ratings
will agree with assessments by others as to how such Mortgage-Backed
Securities would be rated. See "--The Company's Assets May Include Unrated
Assets" and "Business Strategy--Mortgage-Backed Securities--Unrated Assets."
In addition, to the extent that the Company invests in High Quality
investments, the yield on such assets may be lower than the yield on lower
rated securities. To date, the Company has invested solely in Agency
Certificates which, although not rated, carry an implied "AAA" rating.
THE COMPANY MAY NOT BE ABLE TO ACQUIRE MORTGAGE-BACKED SECURITIES AT
FAVORABLE YIELDS; COMPETITION AND SUPPLY
The Company's net income depends, in large part, on the Company's ability to
acquire Mortgage-Backed Securities at favorable spreads over the Company's
borrowing costs. In acquiring Mortgage-Backed Securities,
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the Company competes with other REITs, investment banking firms, savings and
loan associations, banks, insurance companies, mutual funds, other lenders,
and other entities purchasing Mortgage-Backed Securities, many of which have
greater financial resources than the Company. In addition, there are several
mortgage 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-Backed Securities suitable
for purchase by the Company. Further, in fluctuating interest rate
environments, the spread between interest rates on adjustable-rate mortgage
loans and interest rates on fixed-rate mortgage loans may decrease, and may
cease to exist or become negative. Under such conditions, mortgagors tend to
favor fixed-rate mortgage loans, thereby decreasing the supply of adjustable-
rate Mortgage-Backed Securities available to the Company for purchase. The
relative availability of adjustable-rate Mortgage-Backed Securities may also
be diminished by a number of other market and regulatory considerations.
There can be no assurance that the Company will be able to continue to
acquire sufficient Mortgage-Backed Securities from mortgage suppliers at
spreads above the Company's cost of funds. The Company will also face
competition for financing sources, and the effect of the existence of
additional mortgage REITs may be to deny the Company access to sufficient
funds to carry out its business strategy and/or to increase the cost of funds
to the Company.
LIMITED GUARANTEES BY FHLMC AND FNMA
As of June 30, 1997, by principal amount, approximately 8.21% of the
Company's Mortgage-Backed Securities were FHLMC Certificates and approximately
67.78% of the Company's Mortgage-Backed Securities were FNMA Certificates.
FHLMC's guarantee to holders of FHLMC Certificates and FNMA's guarantee to
holders of FNMA Certificates are subject to certain limitations.
FHLMC guarantees to each holder of FHLMC Certificates the timely payment of
interest at the applicable pass-through rate and ultimate collection of all
principal on the holder's pro rata share of the unpaid principal balance of
the underlying Mortgage Loans, but does not guarantee the timely payment of
scheduled principal of the underlying Mortgage Loans. The obligations of FHLMC
under its guarantees are solely those of FHLMC and are not backed by the full
faith and credit of the United States. If FHLMC were unable to satisfy such
obligations, distributions to holders of FHLMC Certificates would consist
solely of payments and other recoveries on the underlying Mortgage Loans and,
accordingly, monthly distributions to holders of FHLMC Certificates would be
affected by delinquent payments and defaults on such Mortgage Loans.
FNMA guarantees to the registered holder of a FNMA Certificate that it will
distribute amounts representing scheduled principal and interest (at the rate
provided by the FNMA Certificate) on the Mortgage Loans in the pool underlying
the FNMA Certificate, whether or not received, and the full principal amount
of any such Mortgage Loan foreclosed or otherwise finally liquidated, whether
or not the principal amount is actually received. The obligations of FNMA
under its guarantees are solely those of FNMA and are not backed by the full
faith and credit of the United States. If FNMA were unable to satisfy such
obligations, distributions to holders of FNMA Certificates would consist
solely of payments and other recoveries on the underlying Mortgage Loans and,
accordingly, monthly distributions to holders of FNMA Certificates would be
affected by delinquent payments and defaults on such Mortgage Loans.
LIMITATIONS ON RATINGS OF MORTGAGE-BACKED SECURITIES
A rating is not a recommendation to buy, sell or hold a security, inasmuch
as such rating does not comment as to the market price of the security or the
suitability of the security for a particular investor. There is no assurance
that a rating will continue for any given period of time or that a rating will
not be lowered or withdrawn entirely by a Rating Agency if in its judgment
circumstances so warrant.
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THE COMPANY'S ASSETS MAY INCLUDE UNRATED ASSETS
The Company's Capital Investment Policy provides that the Company's assets
may include certain assets which are unrated but are determined by the Company
to be of comparable quality to rated High Quality Mortgage-Backed Securities
and certain assets which are unrated but are determined by the Company to be
of comparable credit quality to an investment which is at least "investment
grade" (rated "BBB" or better by S&P or the equivalent by another Rating
Agency). Prior to acquiring any such unrated securities, the Company intends
to engage an independent consultant with expertise in rating "investment
grade" securities to assist the Company in evaluating the creditworthiness of
such securities and determining whether such securities are qualified to be
purchased under the Company's Capital Investment Policy. In making such
evaluations, the Company will look at similar criteria utilized by S&P and
other Rating Agencies. Such criteria may include a review of the cash flow and
other characteristics of the security, an analysis of the components of the
security and a valuation of comparable assets. However, the Company is not
expert in evaluating unrated assets, such unrated assets will not carry the
rating of a Rating Agency and there can be no guarantee that the Company or
any independent consultant engaged by the Company will be able to make an
accurate valuation of such unrated assets.
ASSET CONCENTRATION
Although the Company seeks geographic diversification of the properties
underlying the Mortgage-Backed Securities which it acquires, it does not set
specific limitations on the aggregate percentage of underlying properties
which may be located in any one area. Consequently, properties underlying such
Mortgage-Backed Securities may be located in the same or a limited number of
geographical regions. In addition, the Company is not able to determine in all
instances the geographic distribution of the properties underlying its
Mortgage-Backed Securities. As of June 30, 1997, based upon information
available to the Company, the state with the largest concentration of loans
underlying Mortgage-Backed Securities held by the Company was California,
where at least 20% of the loans underlying the Company's Mortgage-Backed
Securities were located, and the state with the second largest concentration
of loans underlying the Company's Mortgage-Backed Securities was Kansas, where
at least 13% of underlying loans were located. If adverse economic, political
or business developments, adverse real estate market conditions or natural
hazard risks affect such regions, the ability of property owners therein
situated to make payments of principal and interest on the underlying
mortgages may be jeopardized. Thus, the properties underlying the Company's
mortgage assets may be subject to a greater risk of default than other
comparable mortgage assets located outside California or Kansas. Based upon
information available to the Company, California and Kansas were the only
states, as of June 30, 1997, in which more than 5% of the loans underlying the
Company's Mortgage-Backed Securities were located; however, the Company is
unable to determine the geographic distribution of 27.86% of the loans
underlying the Company's Mortgage-Backed Securities. Adverse changes in the
economic conditions of the geographic regions in which the properties
underlying the Company's Mortgage-Backed Securities are concentrated likely
would have an adverse effect on real estate values, interest rates and
prepayment rates and increase the risk of default by the obligors on the
underlying mortgage loans; accordingly, the Company's results of operations
could be adversely affected. In addition, to the extent there are defaults on
the Mortgage Loans underlying the Company's Mortgage-Backed Securities, such
defaults could result in prepayments of the Mortgage-Backed Securities which
could adversely affect the Company's net income. See "--Changes in Prepayment
Rates of Mortgage-Backed Securities."
As of June 30, 1997 and as of the date hereof, 100% of the properties
underlying all of the Mortgage-Backed Securities owned by the Company were
single-family (one- to four-unit) properties. While the Company believes that
asset concentration in Mortgage-Backed Securities backed by Single-Family
Mortgage Loans provides less risk than asset concentration in Mortgage-Backed
Securities backed by Multifamily and Commercial Mortgage Loans, a downturn in
the single-family housing market could adversely affect the Company.
Management believes that the risks of geographic and other asset concentration
are mitigated by the current composition of the Company's asset pool. All of
the investment assets currently held by the Company are Agency Certificates
which provide guarantees of the underlying Mortgage Loans. However, in the
future, to the extent the Company's Mortgage-Backed Securities are not Agency
Certificates or otherwise guaranteed or credit enhanced, such
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securities will be exposed to adverse changes in the economic conditions of
the geographic regions in which the properties underlying the Company's
Mortgage-Backed Securities are concentrated.
To the extent that properties underlying the Company's mortgage assets are
located in the same geographical region, such mortgage assets may be subject
to a greater risk of default than other comparable mortgage assets in the
event of adverse economic, political or business developments, adverse real
estate market conditions and natural hazard risks that may affect such region
and, ultimately, the ability of property owners to make payments of principal
and interest on the underlying mortgages. Defaults may result from a number of
factors over which the Company may not have control, including declining
property values, worsening economic conditions and natural disasters. In
addition, to the extent that the underlying loans are concentrated in a
particular geographic region or regions, such as California or Kansas, as set
forth above, the Company could be exposed to a decline in property values,
worsening economic conditions or a natural disaster in the applicable region.
GENERAL RISKS
DEPENDENCE ON KEY PERSONNEL
The Company's operations depend in significant part upon the contributions
of its executive officers who from the date of commencement of operations by
the Company on February 18, 1997 to the present have devoted at least 90% of
their working time to the business of the Company and intend in the future, as
between the Company and FIDAC, to devote at least 90% of their working time to
the Company's business. Although Michael Farrell, Chairman of the Board and
Chief Executive Officer, Timothy Guba, President and Chief Operating Officer
and Wellington St. Claire, Vice Chairman of the Board, currently have
employment agreements with the Company, there can be no assurance of the
continued employment of all such officers. The loss of any key person could
have a material adverse effect on the Company's business and results of
operations. See "Management."
LIMITED OPERATING HISTORY OF THE COMPANY
The Company commenced operations on February 18, 1997 upon consummation of
the Private Placement and, accordingly, has not yet developed an extensive
earnings history or experienced a wide variety of interest rate or market
conditions.
CONFLICTS OF INTEREST
Messrs. Farrell and Guba, and Ms. St. Claire and Jennifer A. Stephens,
Secretary of the Company, are actively involved in managing fixed income
assets for institutional clients through Fixed Income Discount Advisory
Company ("FIDAC"). FIDAC is a registered investment adviser which at June 30,
1997 managed, assisted in managing or supervised approximately $500 million in
gross assets for a wide array of clients, of which, at such date,
approximately $250 million was managed on a discretionary basis. Michael
Farrell is a member of the Board of Directors of the U.S. Dollar Floating Rate
Fund (the "Floating Rate Fund") and FIDAC is the investment adviser to the
Floating Rate Fund. The executive officers of the Company named above have
performed and will continue to perform such services for FIDAC, such
institutional clients and the Floating Rate Fund; however, such officers, who
from the date of commencement of operations by the Company on February 18,
1997 to the present have devoted at least 90% of their working time to the
business of the Company, intend in the future, as between the Company and
FIDAC, to devote at least 90% of their working time to the Company's business.
Their several responsibilities may create conflicts of interest if they are
presented with corporate opportunities that may benefit both the Company and
the Floating Rate Fund and other clients for whom or which FIDAC acts as an
investment adviser. Investment opportunities currently are allocated by
determining the entity or account for which such investment is most suitable.
In making such determination, management considers the investment strategy and
guidelines of each entity or account with respect to acquisition of assets,
leverage, liquidity and other factors which management determines appropriate.
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The Company shares with FIDAC office space and certain office expenses, such
as lease payments, utilities charges and ancillary services performed by
office personnel, at cost on a pro rata basis based on the relative use of
such facilities and services by the Company and FIDAC.
Generally, under Maryland corporate law, a director of a corporation is
required to first offer to the Company corporate opportunities learned of
solely as a result of his or her service as a member of the Board of
Directors. Maryland law provides further that in order for a contract or other
transaction between a corporation and any of its directors or in which a
director has a material financial interest not to be void or voidable: (i) the
contract or transaction must be fair and reasonable to the corporation; or
(ii) the fact of such interest must be disclosed or known to (a) the board or
committee that authorizes, approves or ratifies the contract or transaction
and such authorization, approval or ratification must be by a vote of a
majority of the disinterested directors or (b) the stockholders entitled to
vote on such contract or transaction and the contract or transaction is
authorized, approved and ratified by a majority of the votes cast by
disinterested stockholders entitled to vote. See "Management--Certain
Relationships; Conflicts of Interest."
The Company's policy is that the approval of the Board of Directors (with
any interested director abstaining) is required for any director, officer,
security holder or affiliate of the Company (a) to engage for his or her own
account in realizing upon a corporate opportunity learned of solely as a
result of his or her service to or representation of the Company or (b) to
have any direct or indirect pecuniary interest in any investment to be
acquired or disposed of by the Company or in any transaction to which the
Company is a party or has an interest.
LEGAL AND OTHER RISKS
LOSS OF INVESTMENT COMPANY ACT EXEMPTION WOULD ADVERSELY AFFECT THE COMPANY
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. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or
otherwise acquiring mortgages and other liens on and interests in real estate"
("Qualifying Interests"). Under the current interpretation of the staff of the
Commission, in order to qualify for this exemption, the Company must maintain
at least 55% of its assets directly in mortgage loans, qualifying Pass-Through
Certificates and certain other qualifying interests in real estate. In
addition, unless certain Mortgage-Backed Securities represent all the
certificates issued with respect to an underlying pool of mortgages, such
Mortgage-Backed Securities may be treated as securities separate from the
underlying mortgage loans and, thus, may not qualify as Qualifying Interests
for purposes of the 55% requirement. Therefore, the Company's ownership of
certain Mortgage-Backed Securities may be limited by the provisions of the
Investment Company Act. In addition, in meeting the 55% requirement under the
Investment Company Act, the Company considers mortgage pass-through
certificates issued with respect to an underlying pool as to which the Company
holds all issued certificates as Qualifying Interests. If the Commission, or
its staff, adopts a contrary interpretation with respect to such securities,
the Company could be required to restructure its activities to the extent its
holdings of such mortgage pass-through certificates did not comply with the
interpretation. Such a restructuring could require the sale of a substantial
amount of mortgage pass-through certificates held by the Company at a time it
would not otherwise do so, which sale could occur under adverse market
conditions and the Company could incur losses as a result. Further, in order
to insure that the Company at all times continues to qualify for the above
exemption from the Investment Company Act, the Company may be required at
times to adopt less efficient methods of financing certain of its Mortgage-
Backed Securities than would otherwise be the case and may be precluded from
acquiring certain types of Mortgage-Backed Securities whose yield is somewhat
higher than the yield on Mortgage-Backed Securities that could be purchased in
a manner consistent with the exemption. The net effect of these factors may be
to lower at times the Company's net interest income. 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.
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In the opinion of Morgan, Lewis & Bockius LLP, as of the date hereof, the
Company's portfolio of Mortgage-Backed Securities would qualify the Company
for the exemption described in the preceding paragraph. This opinion is based
on various assumptions relating to the operation of the Company and is
conditioned upon certain representations made by the Company as to certain
factual matters. In addition, the continued qualification of the Company for
this exemption will depend on the Company's ability to meet, on a continuing
basis, the requirements of the exemption.
FAILURE TO MAINTAIN REIT STATUS WOULD SUBJECT THE COMPANY TO ADDITIONAL TAX
In order to maintain its qualification as a REIT for Federal income tax
purposes, the Company must comply with the REIT Provisions of the Code,
including satisfying certain tests with respect to the sources of its income,
the nature and diversification of its assets, the amount of its distributions
to stockholders and the ownership of its stock.
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 a
series of complicated 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 year in which the Company fails to qualify as a REIT would not be
deductible by the Company in computing its taxable income. As a result, the
Company could be subject to income tax liability, thereby significantly
reducing or eliminating the amount of cash available for distribution to its
stockholders. Further, the Company could also be disqualified from re-electing
REIT status for the four taxable years following the year during which it
became disqualified.
No assurance can be given that future legislation, regulations,
administrative interpretations or court decisions will not significantly
change the tax laws with respect to the Company's qualification as a REIT or
the Federal income tax consequences of such qualification, which changes may
reduce or eliminate the Company's competitive advantage over non-REIT
competitors. See "Certain Federal Income Tax Considerations--Taxation of the
Company."
POTENTIAL CHARACTERIZATION OF DISTRIBUTIONS AS UBTI; TAXATION OF TAX-EXEMPT
INVESTORS
In the event that (i) the Company is subject to the rules relating to
taxable mortgage pools (discussed below) or the Company is a "pension-held
REIT," or (ii) a tax-exempt stockholder has incurred indebtedness to purchase
or hold its Common Stock or is not exempt from Federal income taxation under
certain special sections of the Code, distributions to and, in the case of a
stockholder described in (ii), gains realized on the sale of Common Stock by,
such tax-exempt stockholder may be subject to Federal income tax as UBTI
(i.e., "unrelated business taxable income" as defined in section 512 of the
Code). See "Certain Federal Income Tax Considerations--Taxation of Tax-Exempt
Entities."
TAXABLE MORTGAGE POOL RISK; INCREASED TAXATION
A REIT that incurs debt obligations with two or more maturities and which
are secured by assets such as the Mortgage-Backed Securities may be classified
as a "taxable mortgage pool" under the Code if payments required to be made on
such debt obligations bear a relationship to the payments received on such
assets. If the Company were to be subject to the taxable mortgage pool rules,
the Company's status as a REIT would not be impaired but a portion or all of
the taxable income (in excess of a specified return to investors) generated by
the Company's Mortgage-Backed Securities constituting a taxable mortgage pool
may, under regulations to be issued by the Treasury Department, be
characterized as "excess inclusion" income and allocated to the stockholders.
Any such excess inclusion income (i) would not be allowed to be offset by the
net operating losses of a stockholder, and (ii) would be subject to tax as
UBTI to a tax-exempt stockholder. See "Certain Federal Income Tax
Considerations--Taxation of Tax-Exempt Entities."
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The Company does not intend to issue debt obligations with differing
maturities backed by a single pool of Mortgage-Backed Securities, but it does
intend to enter into master repurchase agreements pursuant to which the
Company may borrow funds with differing maturity dates which are cross-
collateralized by specific Mortgage-Backed Securities. The Treasury Department
has issued regulations that adopt a broad view of what may constitute a
taxable mortgage pool including anti-avoidance rules that authorize the IRS to
treat equity interests issued by the Company as debt if such equity interests
correspond to maturity of classes of debt such as the Mortgage-Backed
Securities. The Company does not believe that the master repurchase agreements
or its other financing arrangements should cause the Mortgage-Backed
Securities to be treated as a taxable mortgage pool. No assurances can be
given, however, that the IRS might not successfully maintain that the
Mortgage-Backed Securities collateralizing such master repurchase agreements
constitute a taxable mortgage pool.
BANKRUPTCY CODE TREATMENT OF REPURCHASE AGREEMENTS
In the event of a bankruptcy of the Company, certain repurchase agreements
may qualify for special treatment under the Bankruptcy Code, the effect of
which is, among other things, to allow the creditors under such agreements to
avoid the automatic stay provisions of the Bankruptcy Code and to liquidate
the collateral under such agreements without delay. Conversely, in the event
of the bankruptcy of a party with whom the Company has a repurchase agreement,
the Company might experience difficulty recovering the collateral under such
agreement if it were to be repudiated and the Company's claim against the
bankrupt lender for damages resulting therefrom were to be treated simply as
one of an unsecured creditor. Should this occur, the Company's claims would be
subject to significant delay and recoveries, if and when received, may be
substantially less than the damages actually suffered by the Company. Although
the Company has, and intends to continue to, enter into repurchase agreements
with several different parties and has developed policies to reduce its
exposure to such risks, no assurance can be given that the Company will be
able to avoid such third party risks. See "Business Strategy--Capital
Investment Policy--Capital and Leverage."
FUTURE REVISIONS IN POLICIES AND STRATEGIES
The Board of Directors has established the investment policies and operating
policies and strategies set forth in this Prospectus as the investment
policies and operating policies and strategies of the Company. These policies
and strategies are incorporated in the Capital Investment Policy. However,
these policies and strategies and the Capital Investment Policy may be
modified or waived by the Board of Directors, subject in certain cases to
approval by a majority of the Independent Directors, without stockholder
consent. Although a majority of the Board of Directors will be comprised of
Independent Directors, the initial selection of the Independent Directors was
made by the initial stockholders of the Company who are also officers or
directors of the Company.
LACK OF PUBLIC MARKET
Prior to the Offering, there has been no public market for the Common Stock
or any other securities of the Company. Although the Company has received
approval, subject to official notice of issuance, to have the Common Stock
listed on the New York Stock Exchange, there can be no assurance that an
active trading market will develop or be sustained or that if one does develop
and is sustained, that the market price will equal or exceed the public
offering price set forth on the cover page of this Prospectus. For discussion
of the factors considered in determining the initial public offering price,
see "Underwriting."
COMMON STOCK AVAILABLE FOR FUTURE SALE
Following the closing of the Offering (and assuming that the Underwriters'
over-allotment option is not exercised), there will be outstanding (or
reserved for issuance upon exercise of outstanding options) 10,366,300 shares
of Common Stock, which include (i) 6,250,000 Shares being offered by the
Company hereby, (ii) 3,600,000 shares of Common Stock issued by the Company in
the Private Placement (the "Private Placement Shares"), (iii) 87,800 shares of
Common Stock issued to certain directors, officers and employees of the
Company in the Direct Offering (the "Direct Offering Shares"), (iv) 80,000
shares of Common Stock issued to
24
<PAGE>
founders of the Company (the "Founders' Shares") and (v) 348,500 shares of
Common Stock reserved for issuance upon the exercise of outstanding options.
The Private Placement Shares not being included in the Offering, the Direct
Offering Shares and the Founders' Shares are "restricted securities" within
the meaning of Rule 144 promulgated under the Securities Act ("Rule 144") and
may not be sold in the absence of registration under the Securities Act unless
an exemption from registration is available, including exemptions provided by
Rule 144. Such restricted securities will be available for resale pursuant to
Rule 144 following a holding period ending one year from the date of
acquisition by the holder, subject to the volume limitation of Rule 144 and,
unless held by "affiliates" of the Company (within the meaning of Rule 144),
will become unrestricted two years from the date of acquisition by the holder.
Certain Private Placement Shares are also presently available for resale,
under certain conditions, to institutional "accredited investors" within the
meaning of Regulation D under the Securities Act, "qualified institutional
buyers" within the meaning of Rule 144A under the Securities Act, and to
persons who are not "U.S. persons" within the meaning of Regulation S under
the Securities Act in accordance with Regulation S. In addition, the holders
of the Private Placement Shares have certain registration rights with respect
to such Private Placement Shares. See "Description of Capital Stock--Common
Stock Available for Future Sale--Registration Rights." Purchasers in the
Direct Offering have agreed not to sell their shares of Common Stock purchased
in the Direct Offering for a period of 180 days after the Offering.
As of August 5, 1997, options to purchase 348,500 shares of Common Stock
were outstanding, of which options to purchase 7,500 shares are currently
exercisable; options to purchase 275,000 shares vest in four equal
installments on January 2, 1998, 1999, 2000 and 2001; options to purchase
36,000 shares vest in four equal installments on January 21, 1998, 1999, 2000
and 2001; options to purchase 25,000 shares vest in four equal installments on
January 28, 1998, 1999, 2000 and 2001; and an option to purchase 5,000 shares
vests in four equal installments on June 26, 1998, 1999, 2000 and 2001. None
of the shares of Common Stock underlying the outstanding stock options has
been registered under the Securities Act.
No prediction can be made as to the effect, if any, that future sales of
shares of Common Stock, or the availability of such shares for future sale,
will have on the market price prevailing from time to time. Sales of
substantial amounts of Common Stock, or the perception that such sales could
occur, may affect adversely the prevailing market price of the Common Stock.
DILUTION; POTENTIAL FUTURE OFFERINGS
The initial public offering price per share of Common Stock will exceed the
net tangible book value per share of Common Stock. Accordingly, assuming the
Underwriters' over-allotment option is not exercised, the purchasers of Common
Stock will experience immediate dilution (in the amount of $1.74 per share
based upon an assumed initial public offering price of $12.00 per share) in
the net tangible book value of their equity investment in the Company. See
"Dilution."
The Company may in the future increase its capital resources by making
additional offerings of equity and debt securities, including classes and
series of preferred stock, additional classes and series of common stock,
commercial paper, medium-term notes 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 shares 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.
CERTAIN BENEFITS TO EXISTING STOCKHOLDERS, DIRECTORS AND OFFICERS
Through the date hereof, the Company has issued an aggregate of 3,767,800
shares of Common Stock for an aggregate purchase price of $36,890,000, or
$9.79 per share, paid by the purchasers of such shares. This average per share
purchase price is $2.21 per share less than the assumed Offering Price of
$12.00 per share.
In December 1996, the Company issued 20,000 shares of Common Stock to each
of Michael Farrell, Timothy Guba and Wellington J. St. Claire at a purchase
price of $0.15 per share, or $9,000 in the aggregate.
25
<PAGE>
This purchase price is $11.85 per share less than the assumed Offering Price
of $12.00 per share. On June 30, 1997, the Company issued 87,800 shares of
Common Stock to certain directors, officers and employees of the Company at a
purchase price of $10.00 per share, or $878,000 in the aggregate. This
purchase price is $2.00 per share less than the assumed Offering Price of
$12.00 per share. The unrealized gain on such shares for each director and
officer of the Company, based upon an assumed Offering Price of $12.00 per
share, is as follows: Michael Farrell, $287,000; Timothy Guba, $247,600;
Wellington St. Claire, $243,000; Kathryn Fagan, $2,000; Jennifer Stephens,
$1,000; Kevin Brady, $3,000; Spencer Browne, $15,000; Jonathan Green, $5,000;
John Grace, $50,000; John Lambiase, $20,000; and Donnell Segalas, $10,000.
A total of 100,000 shares of Common Stock was purchased in the Private
Placement by entities for which John Grace, a director of the Company, may be
deemed to have shared or sole voting and dispositive power. The unrealized
gain on such shares, based upon an assumed Offering Price of $12.00 per share,
is $200,000; however, Mr. Grace disclaims beneficial ownership of such shares
in excess of his pecuniary interest. Mr. Grace was not a director of the
Company at the time such shares were purchased.
The Company has also granted to its directors and officers options to
purchase an aggregate of 348,500 shares of Common Stock of the Company with
varying exercise prices. To date, options to acquire 7,500 shares of Common
Stock at an exercise price of $10.00 per share have vested; however, to date,
none of such vested options has been exercised. See "Dilution," "Management--
Directors and Executive Officers," "--Compensation of Directors and Executive
Officers," and "--Long-Term Stock Incentive Plan," and "Principal
Stockholders."
ILLIQUIDITY OF CERTAIN INVESTMENTS
A small portion of the Company's portfolio may be invested in Mortgage-
Backed Securities for which the secondary trading market is not as well
developed as the market for certain other Mortgage-Backed Securities (or which
are otherwise considered less marketable or illiquid). Although the Company
expects that most of the Company's investments will be in Mortgage-Backed
Securities 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-Backed Securities may be adversely impacted. There is no
limit on the percentage of the Company's investments that may be invested in
illiquid Mortgage-Backed Securities.
ISSUANCE OF PREFERRED STOCK
The Articles of Incorporation authorize the Board of Directors to reclassify
any of the unissued shares of authorized capital stock into a class or classes
of preferred stock. The issuance of preferred stock could have the effect of
making an attempt to gain control of the Company more difficult by means of a
merger, tender offer, proxy contest or otherwise. Preferred stock, if issued,
could have a preference on dividend payments over the Common Stock which could
affect the ability of the Company to make dividend distributions to the
holders of Common Stock. At present, the Company has no intention to issue
preferred stock; however, the Company may decide, in the future, to issue
preferred stock based upon its consideration of various factors, including the
Company's determination as to the most efficient method for raising capital
and consideration of the effect which such issuance will have on the Common
Stock.
RESTRICTIONS ON OWNERSHIP OF CAPITAL STOCK
In order that the Company may meet the requirements for qualification as a
REIT, the Articles of Incorporation prohibit any person from acquiring or
holding, directly or constructively, ownership of a number of shares of
capital stock in excess of 9.8% in number of shares or value (the "Ownership
Limit") of the outstanding shares. For this purpose the term "ownership" is
defined as either direct ownership or constructive ownership in accordance
with the constructive ownership provisions of section 544 of the Code. Any
transfer of shares of capital stock that would result in disqualification of
the Company as a REIT or that would (a) create a
26
<PAGE>
direct or constructive ownership of shares of stock in excess of the Ownership
Limit, or (b) from and after the earlier of January 1, 1998 and the date of
closing of the sale of Shares pursuant to the Offering (the "One Hundred
Stockholder Date"), result in the shares of stock being beneficially owned
(within the meaning section 856(a) of the Code) by fewer than 100 persons
(determined without reference to any rules of attribution), or (c) result in
the Company being "closely held" within the meaning of section 856(h) of the
Code, will be null and void, and the intended transferee (the "purported
transferee") will acquire no rights to such shares. Any purported transfer of
shares that would result in a person owning (directly or constructively)
shares in excess of the Ownership Limit (except as otherwise waived by the
Board of Directors) due to the unenforceability of the transfer restrictions
set forth above will constitute "Excess Securities." Excess Securities will be
transferred by operation of law to a trust to be established by the Company
for the exclusive benefit of a charitable organization, until such time as the
trustee of the trust, which shall be a banking institution designated as
trustee by the Company which is unaffiliated with either the Company or the
purported transferee, retransfers the Excess Securities. Subject to the
Ownership Limit, Excess Securities may be transferred by the trust to any
person (if such transfer would not result in Excess Securities) at a price not
to exceed the price paid by the purported transferee (or, if no consideration
was paid by the purported transferee, the fair market value of the Excess
Securities on the date of the purported transfer), at which point the Excess
Securities will automatically cease to be Excess Securities. See "Description
of Capital Stock-- Restrictions on Ownership and Transfer" and "Certain
Federal Income Tax Considerations--General--Stock Ownership Tests."
Subject to certain limitations, the Board of Directors may increase or
decrease the Ownership Limit. In addition, to the extent consistent with the
REIT Provisions of the Code, the Board of Directors has the right, pursuant to
the Company's Articles of Incorporation, to waive the Ownership Limit for and
at the request of a purchaser of the Common Stock. In connection with any such
waiver, the Company may require that the stockholder requesting such a waiver
enter into an agreement with the Company providing for the repurchase by the
Company of shares from the stockholder under certain circumstances to ensure
compliance with the REIT Provisions of the Code. Such repurchase would be at
fair market value as set forth in the agreement between the Company and such
stockholder. The consideration received by the stockholder in such repurchase
might be characterized as the receipt by the stockholder of a dividend from
the Company, and any stockholder entering into such an agreement with the
Company should consult its tax advisor in connection with its entering into
such an agreement. At present, the Company does not intend to waive the
Ownership Limit for any purchaser of shares of the Common Stock.
The provisions described above may inhibit market activity and a resulting
takeover or other transaction in which holders of some or a majority of the
Company's capital stock might receive a premium for their shares or which such
holders might believe to be otherwise in their best interests. Such provisions
also may make the Company an unsuitable investment vehicle for any person
seeking to obtain ownership of more than 9.8% of the outstanding shares of
capital stock. See "Description of Capital Stock--Restrictions on Ownership
and Transfer."
INDEMNIFICATION OF OFFICERS AND DIRECTORS
The Company's Articles of Incorporation limit the liability of its directors
and officers to the Company and its stockholders to the fullest extent
permitted by Maryland law, and the Company's Articles of Incorporation provide
for indemnification of the directors and officers to such extent. See
"Description of Capital Stock--Indemnification" and "--Limitation of
Liability."
27
<PAGE>
THE COMPANY
Annaly Mortgage Management, Inc. (the "Company") was incorporated in the
State of Maryland on November 25, 1996. The Company commenced operations on
February 18, 1997 upon the consummation of the Private Placement. The Company
raised additional capital on July 31, 1997 upon the consummation of the Direct
Offering.
The Company specializes in investing in Mortgage-Backed Securities. Its
principal business objective is to generate net income for distribution to
stockholders from the spread between the interest income on its Mortgage-
Backed Securities and the costs of borrowing to finance its acquisition of
Mortgage-Backed Securities. The Company will elect to be taxed as a REIT.
The Company is self-advised and self-managed. The management of the Company
manages the day-to-day operations, subject to the supervision of the Company's
Board of Directors. Messrs. Farrell and Guba, and Ms. St. Claire, executive
officers of the Company, have an average of 15 years' experience in the
investment banking and investment management industries where, in various
capacities, they have each managed portfolios of Mortgage-Backed Securities,
arranged collateralized borrowings and utilized hedging techniques to mitigate
interest rate and other risk within fixed-income portfolios. Ms. Fagan, the
Company's Chief Financial Officer and Treasurer, has served as Chief Financial
Officer and Controller of a publicly owned savings and loan association. See
"Management."
The Company has an office located at 1500 Harbor Blvd., Weehawken, New
Jersey 07087 which it leases. The telephone number for the Company is (201)
223-1900.
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of 6,250,000
Shares being offered hereby by the Company are estimated to be approximately
$ after deducting the expenses of the Offering. If the Underwriters' over-
allotment option is exercised in full, the net proceeds to the Company are
estimated to be approximately $ . The Company will not receive any proceeds
from the sale of Shares by the Selling Stockholders.
The Company intends to use such net proceeds to acquire additional Mortgage-
Backed Securities. The Company then intends to increase its investment assets
by borrowing against such Mortgage-Backed Securities and using the proceeds to
acquire additional Mortgage-Backed Securities. See "Business Strategy--Capital
Investment Policy--Capital and Leverage."
It is expected that the Company may require from one to four months to
invest fully the proceeds of the Offering in Mortgage-Backed Securities and to
implement fully the Company's leveraging strategy to increase its Mortgage-
Backed Security investments to the desired level. Pending full investment in
the desired mix of Mortgage-Backed Securities, the net proceeds will be
invested in High Quality Short-Term Investments that are expected to provide a
lower net return than the Company hopes to achieve from its intended primary
Mortgage-Backed Security investments.
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<PAGE>
CAPITALIZATION
The capitalization of the Company, at June 30, 1997, as adjusted to reflect
the sale of 87,800 shares of Common Stock at a price of $10.00 per share
pursuant to the Direct Offering, and as adjusted to reflect the sale of the
6,250,000 Shares offered by the Company pursuant to the Offering, is as
follows:
<TABLE>
<CAPTION>
AS ADJUSTED FOR
AS ADJUSTED DIRECT OFFERING
FOR DIRECT AND THE OFFERING
ACTUAL (1) OFFERING (1) (1)(2)
----------- ------------ ----------------
<S> <C> <C> <C>
Common Stock, par value $.01 per
share:
Authorized--100,000,000 shares
Outstanding--3,680,000 shares (as
adjusted, 3,767,800 shares and
10,017,800 shares, respectively).. $ 36,800 $ 37,678 $100,178
Additional Paid-In Capital........... 32,955,104 33,832,226
----------- ----------- --------
Total............................ $32,991,904 $33,869,904 $
=========== =========== ========
</TABLE>
- --------
(1) Does not include 348,500 shares of Common Stock issuable upon the exercise
of options granted pursuant to the Incentive Plan.
(2) Assumes no exercise of the Underwriters' over-allotment option.
DISTRIBUTION POLICY
The Company intends to distribute substantially all of its taxable income
with respect to each year (which does not ordinarily equal net income as
calculated in accordance with GAAP) to its stockholders so as to comply with
the REIT Provisions of the Code. The Company intends to declare regular
quarterly dividends. It is intended that any taxable income remaining after
the distribution of the final regular quarterly dividend each year will be
distributed together with the first regular quarterly dividend payment of the
following taxable year or in a special dividend distributed prior thereto. The
dividend policy is subject to revision at the discretion of the Board of
Directors. All distributions will be made by the Company at the discretion of
the Board of Directors and will depend on the taxable earnings of the Company,
the financial condition of the Company, maintenance of REIT status and such
other factors as the Board of Directors deems relevant. See "Certain Federal
Income Tax Considerations--General--Distribution Requirement."
To date, the Company has declared a dividend of $0.075 per share of Common
Stock (or $276,000 in the aggregate) for the period from February 18, 1997
(commencement of operations) to March 31, 1997, and a dividend of $.255 per
share of Common Stock (or $938,400 in the aggregate) for the second quarter of
1997. The Company has also declared a dividend of $0.18 per share (or $678,004
in the aggregate) for the two-month period ended August 31, 1997, which shall
be payable on October 23, 1997 to holders of record of Common Stock as of
September 2, 1997. All of these dividends have been paid out of the Company's
net income and, therefore, none of the dividends declared by the Company to
date constitute a return of capital. The level of quarterly dividends is based
on a number of factors and should not be deemed indicative of taxable income
for the quarter in which declared or future quarters or of income calculated
in accordance with GAAP. All dividends declared following the closing of the
Offering will be payable to holders of the Common Stock, subject to the terms
of any other class of capital stock that may be issued in the future. See
"Risk Factors--Legal and Other Risks--Dilution; Potential Future Offerings."
Distributions to stockholders will generally be subject to tax as ordinary
income, although a portion of such distributions may be designated by the
Company as capital gain or may constitute a tax-free return of capital. The
Company does not intend to declare dividends that would result in a return of
capital. The Company will annually furnish to each of its stockholders a
statement setting forth distributions paid during the preceding year and their
characterization as ordinary income, capital gains or return of capital. For a
discussion of the Federal income tax treatment of distributions by the
Company, see "Certain Federal Income Tax Considerations--Taxation of
Stockholders."
The Company is considering the adoption of a Dividend Reinvestment Plan that
will allow holders of Common Stock to have their dividends reinvested
automatically in additional shares of Common Stock. The Company has no plans
to adopt such a Dividend Reinvestment Plan (if at all) prior to 1998.
29
<PAGE>
DILUTION
The net tangible book value of the Company at June 30, 1997 was $32.8
million, or $8.92 per share of Common Stock. Net tangible book value per share
represents the total tangible assets of the Company, reduced by the amount of
its total liabilities, and divided by the number of shares of Common Stock
outstanding as of that date.
After giving effect to the net proceeds from the sale of shares of Common
Stock in the Direct Offering on July 31, 1997, and assuming no exercise of any
options granted to directors of the Company which are exercisable at June 30,
1997, the pro forma net tangible book value of the Company at June 30, 1997
would have been $33.7 million, or $8.94 per share.
After giving effect to the net proceeds from the sale of shares in the
Direct Offering on July 31, 1997 and the estimated net proceeds (assuming an
underwriting discount of $0.84 per share and estimated expenses to the Company
of $700,000) to the Company from the sale of the Shares offered by the Company
hereby at an assumed initial public offering price of $12.00 per share, and
assuming no exercise of any options granted to directors of the Company which
were exercisable at June 30, 1997, the pro forma net tangible book value of
the Company at June 30, 1997 would have been $102.7 million or $10.26 per
share of Common Stock. This represents an immediate increase in net tangible
book value of $1.32 per share to existing stockholders and immediate dilution
of $1.74 per share to new investors purchasing Shares in the Offering at an
assumed Offering Price equal to $12.00 per Share.
The following table illustrates this dilution in net tangible book value on
a per-share basis:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per Share................ $12.00
Net tangible book value per share at June 30, 1997........... $8.92
Increase attributable to sale of shares of Common Stock in
the Direct Offering......................................... .02
Increase attributable to purchase of Shares by new investors
in the Offering............................................. 1.32
-----
Pro forma net tangible book value per share of Common Stock
after giving effect to the consummation of the Offering....... $10.26
------
Dilution in net tangible book value per share of Common Stock
to new investors in the Offering.............................. $ 1.74
======
</TABLE>
The following table summarizes on a pro forma basis at June 30, 1997 the
total consideration and the average price per share of Common Stock paid by
(i) existing stockholders at June 30, 1997, (ii) purchasers in the Direct
Offering, and (iii) new investors in the Offering at an assumed Offering Price
of $12.00 per share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------ -------------------- PRICE ^
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing Stockholders at June
30, 1997.................... 3,680,000 36.73% $ 36,012,000 32.19% $ 9.79
Purchasers in the Direct
Offering.................... 87,800 0.88% 878,000 0.78% $10.00
New Investors in the 6,250,000 62.39% 75,000,000 67.03%
Offering.................... ---------- ------ ------------ ------ $12.00
Total...................... 10,017,800 100.00% $111,890,000 100.00%
</TABLE>
The above calculations assume no exercise of the Underwriters' over-
allotment option. The above calculations also assume no exercise of any
outstanding options under the Company's Incentive Plan. As of August 4, 1997,
options to acquire 348,500 shares of Common Stock were outstanding, consisting
of: options to acquire 208,250 shares at an exercise price of $4.00 per share,
which options will vest in four equal installments on January 2, 1998, 1999,
2000 and 2001; options to acquire 66,750 shares at an exercise price of $10.00
per share, which options will vest in four equal installments on January 2,
1998, 1999, 2000 and 2001; options to
30
<PAGE>
acquire 36,000 shares at an exercise price of $10.00 per share, which options
will vest in four equal installments on January 21, 1998, 1999, 2000 and 2001;
options to acquire 25,000 shares at an exercise price of $10.00 per share,
which options will vest in four equal installments on January 28, 1998, 1999,
2000 and 2001; an option to acquire 5,000 shares at an exercise price of
$10.00 per share, which option will vest in four equal installments on June
26, 1998, 1999, 2000 and 2001; and options to acquire 7,500 shares of Common
Stock at an exercise price of $10.00 per share, which options vested on June
26, 1997. See "Management--Long-Term Stock Incentive Plan."
31
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data are derived from the audited financial
statements of the Company for the period from commencement of operations on
February 18, 1997 to June 30, 1997. The selected financial data should be read
in conjunction with the more detailed information contained in the Financial
Statements and Notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this
Prospectus.
PERIOD FROM FEBRUARY 18, 1997 TO JUNE 30, 1997
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<S> <C>
STATEMENT OF OPERATIONS DATA:
Days in period............................................... 133
Interest income.............................................. $ 6,509
Interest expense............................................. 5,149
---------
Net interest income.......................................... 1,360
Gain on sale of mortgage-backed securities................... 230
General and administrative expenses (G&A expense)............ 250
---------
Net income................................................... $ 1,340
=========
Net income per share......................................... $ 0.36
Dividends declared per share................................. 0.33
BALANCE SHEET DATA AT JUNE 30, 1997:
Mortgage-Backed Securities................................... $ 364,367
Total assets................................................. 398,236
Repurchase agreements........................................ 326,987
Total liabilities............................................ 365,418
Stockholders' equity......................................... 32,819
Number of common shares outstanding.......................... 3,680,000
Interest rate spread......................................... 0.99%
OTHER DATA:
Average total assets......................................... $ 283,100
Average borrowings........................................... 242,027
Average equity............................................... 33,115
Yield on interest earning assets at June 30, 1997............ 6.63%
Cost of funds on interest bearing liabilities at
June 30, 1997.............................................. 5.64%
Efficiency ratio (G&A expense/net interest income)........... 18.37%
ANNUALIZED FINANCIAL RATIOS(1):
Net interest margin (net interest income/average total
assets).................................................... 1.32%
G&A expense as a percentage of average assets................ 0.24%
G&A expense as a percentage of average equity................ 2.07%
Return on average assets..................................... 1.30%
Return on average equity..................................... 11.11%
</TABLE>
- --------
(1) Each ratio has been computed by annualizing the results for the 133-day
period ended June 30, 1997
32
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a real estate investment trust ("REIT") which acquires and
manages Mortgage-Backed Securities which can be readily financed. The Company
commenced operations on February 18, 1997 upon the closing of the Private
Placement which resulted in proceeds to the Company of approximately $33
million. The Company received additional proceeds of $878,000 upon the closing
of the Direct Offering on July 31, 1997.
The Company's principal business objective is to generate net income for
distribution to stockholders from the spread between the interest income on
its Mortgage-Backed Securities and the costs of borrowing to finance its
acquisition of Mortgage-Backed Securities. Since the commencement of
operations on February 18, 1997, the Company has been in the process of
building its balance sheet by acquiring Mortgage-Backed Securities. Therefore,
the operating results of the Company reflected in the financial statements
included in this Prospectus should be interpreted in light of this growth
process and are not necessarily representative of what they may be in the
future.
The Company will seek to generate growth in earnings and dividends per share
in a variety of ways, including through (i) issuing new Common Stock and
increasing the size of the balance sheet when opportunities in the market for
Mortgage-Backed Securities are likely to allow growth in earnings per share,
(ii) seeking to improve productivity by increasing the size of the balance
sheet at a rate faster than the rate of increase in operating expenses, (iii)
continually reviewing the mix of Mortgage-Backed Security types on the balance
sheet in an effort to improve risk-adjusted returns, and (iv) attempting to
improve the efficiency of the Company's balance sheet structure through the
issuance of uncollateralized subordinated debt, preferred stock and other
forms of capital, to the extent management deems such issuances appropriate.
RESULTS OF OPERATIONS: FEBRUARY 18, 1997 TO JUNE 30, 1997
The Company's 1997 fiscal year commenced with the start of operations on
February 18, 1997 and will conclude December 31, 1997. The 133-day period from
February 18, 1997 to June 30, 1997 is referred to herein as "the period ended
June 30, 1997."
NET INCOME SUMMARY
For the period ended June 30, 1997, net income was $1,340,059, or $0.36 per
share. Net income per share is computed by dividing net income by the weighted
average number of shares of outstanding Common Stock during the period.
Dividends per share was $0.33 per share, $1,214,400 in total. Taxable income
did not differ from GAAP income for the period. Return on average equity was
11.11% on an annualized basis.
Management's policy is to focus on income and expense measures as a
percentage of equity rather than as a percentage of assets. Therefore,
improvements in asset-based measures such as net interest margin or operating
expenses as a percentage of assets do not necessarily translate into improved
stockholder returns. Improvements in net interest income or operating expenses
as a percentage of equity, however, indicate that the Company is effectively
utilizing its equity capital base. The Company seeks to increase net income as
a percentage of equity consistent with its Capital Investment Policy.
33
<PAGE>
NET INCOME SUMMARY
<TABLE>
<CAPTION>
PERIOD ENDED
JUNE 30, 1997
------------------
(DOLLARS IN
THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C>
Interest Income........................................... $ 6,509
Interest Expense.......................................... 5,149
---------
Net Interest Income....................................... 1,360
Gain on Sale of Mortgage-Backed Securities................ 230
General and Administrative Expenses....................... 250
---------
Net Income................................................ $ 1,340
Average Number of Outstanding Shares...................... 3,680,000
Net Income Per Share...................................... $ 0.36
Average Total Assets...................................... 283,100
Average Equity............................................ 33,115
Annualized Return on Average Assets....................... 1.30%
Annualized Return on Average Equity....................... 11.11%
</TABLE>
TAXABLE INCOME AND GAAP INCOME
For the period ended June 30, 1997, income as calculated for tax purposes
(taxable income) did not differ from income as calculated according to
generally accepted accounting principles (GAAP income). However, such amounts
could differ in the future for various reasons. For example, the Company may
take credit provisions which would affect GAAP income whereas only actual
credit losses are deducted in calculating taxable income. In addition, general
and administrative expenses may differ due to differing treatment of leasehold
amortization, certain stock option expenses and other items. As of June 30,
1997, the Company had not taken credit provisions because all of the Mortgage-
Backed Securities acquired by the Company through June 30, 1997 had been
Agency Certificates which, although not rated, carry an implied "AAA" rating.
The distinction between taxable income and GAAP income is important to the
Company's stockholders because dividends are declared on the basis of taxable
income. While the Company does not pay taxes so long as it satisfies the
requirements for exemption from taxation pursuant to the REIT Provisions of
the Code, each year the Company completes a corporate tax form wherein taxable
income is calculated as if the Company were to be taxed. This taxable income
level determines the amount of dividends the Company can pay out over time.
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
The Company had average earning assets of $275.9 million for the period
ended June 30, 1997. The Company's primary source of income for the period
ended June 30, 1997 was interest income. A portion of income was generated by
gains on sales of Mortgage-Backed Securities. Interest income was $6.5 million
for the period ended June 30, 1997. The yield on average earning assets was
6.44% for the same period. The table below shows the Company's average balance
of cash equivalents and Mortgage-Backed Securities, the yields earned on each
type of earning assets, the yield on average earning assets and interest
income.
AVERAGE EARNING ASSET YIELD
<TABLE>
<CAPTION>
YIELD ON
AVERAGE AVERAGE
AMORTIZED AMORTIZED
COST OF YIELD ON COST OF YIELD ON
AVERAGE MORTGAGE- AVERAGE AVERAGE MORTGAGE- AVERAGE
CASH BACKED EARNING CASH BACKED EARNING INTEREST
EQUIVALENTS SECURITIES ASSETS EQUIVALENTS SECURITIES ASSETS INCOME
----------- ---------- -------- ----------- ---------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
For the Period Ended
June 30, 1997.......... $121 $275,858 $275,979 4.63% 6.44% 6.44% $6,509
</TABLE>
34
<PAGE>
The Constant Prepayment Rate (or "CPR") on the Company's portfolio of
Mortgage-Backed Securities for the period ended June 30, 1997 was 12%. "CPR"
means an assumed rate of prepayment for the Company's Mortgage-Backed
Securities, expressed as an annual rate of prepayment relative to the
outstanding principal balance of the Company's Mortgage-Backed Securities.
This CPR does not purport to be either a historical description of the
prepayment experience of the Company's Mortgage-Backed Securities or a
prediction of the anticipated rate of prepayment of the Company's Mortgage-
Backed Securities. Since a large portion of the Company's assets was purchased
at a premium to par value and only a small portion of the Company's assets was
purchased at a discount to par value, the premium balance in the Company's
portfolio is substantially higher than the discount balance. Principal
prepayments had a negative effect on the Company's earning asset yield for the
period ended June 30, 1997 because the Company adjusts its rates of premium
amortization and discount accretion monthly based on actual payments received.
INTEREST EXPENSE AND THE COST OF FUNDS
The Company anticipates that its largest expense will usually be the cost of
borrowed funds. The Company had average borrowed funds of $242.0 million and
total interest expense of $5.1 million for the period ended June 30, 1997. The
average cost of funds was 5.84% for the same period. Interest expense is
calculated in the same manner for GAAP and tax purposes.
With the Company's current asset/liability management strategy, changes in
the Company's cost of funds are expected to be closely correlated with changes
in short-term LIBOR, although the Company may choose to extend the maturity of
its liabilities at any time. See "Business Strategy--Capital Investment
Policy--Interest Rate Risk Management." The Company's average cost of funds
was 0.15% above one-month LIBOR for the period ended June 30, 1997. The
Company generally has structured its borrowings to adjust with one-month LIBOR
because the Company believes that one-month LIBOR may continue to be lower
than six-month LIBOR in the present interest rate environment. During the
period ended June 30, 1997, average one-month LIBOR, which was 5.69%, was
0.28% lower than average six-month LIBOR, which was 5.91%.
The table below shows the Company's average borrowed funds and average cost
of funds as compared to average one- and average six-month LIBOR.
AVERAGE COST OF FUNDS
<TABLE>
<CAPTION>
AVERAGE AVERAGE COST AVERAGE COST
ONE-MONTH OF FUNDS OF FUNDS
AVERAGE AVERAGE LIBOR RELATIVE RELATIVE TO RELATIVE TO
AVERAGE AVERAGE ONE- SIX- TO AVERAGE AVERAGE AVERAGE
BORROWED INTEREST COST OF MONTH MONTH SIX-MONTH ONE-MONTH SIX-MONTH
FUNDS EXPENSE FUNDS LIBOR LIBOR LIBOR LIBOR LIBOR
-------- -------- ------- ------- ------- -------------- ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the Period Ended
June 30, 1997.......... $242,027 $5,149 5.84% 5.69% 5.97% (0.28)% 0.15% (0.13)%
</TABLE>
NET INTEREST RATE AGREEMENT EXPENSE
For the period ended June 30, 1997, the Company did not enter into any
interest rate agreements. As part of its asset/liability management process,
the Company may enter into interest rate agreements such as interest rate
caps, floors and swaps. These agreements would be entered into to reduce
interest rate risk and would be designed to provide income and capital
appreciation to the Company in the event of certain changes in interest rates.
The Company reviews the need for interest rate agreements on a regular basis
consistent with its Capital Investment Policy. While the Company has
determined, based upon the current interest rate environment and other
relevant factors, that it would not be economically advantageous, at present,
for the Company to enter into interest rate agreements, the Company may enter
into such agreements in the future.
35
<PAGE>
NET INTEREST INCOME
Net interest income, which equals interest income less interest expense,
totaled $1.4 million for the period ended June 30, 1997. Net interest spread,
which equals the yield on the Company's average assets for the period less the
average cost of funds for the period, was 0.60% for the period ended June 30,
1997. Net interest margin, which equals net interest income divided by average
total assets, was 1.32% on an annualized basis. The principal reason that
annualized net interest margin exceeded net interest spread is that average
assets exceeded average liabilities. A portion of the Company's assets are
funded with equity rather than borrowings. The Company did not have any
interest rate agreement expenses for the period ended June 30, 1997.
The table below shows interest income by earning asset type, average earning
assets by type, total interest income, interest expense, average repurchase
agreements, average cost of funds, and net interest income for the period
ended June 30, 1997.
NET INTEREST INCOME
<TABLE>
<CAPTION>
AVERAGE
AMORTIZED
COST OF INTEREST YIELD ON
MORTGAGE- INCOME ON INTEREST AVERAGE AVERAGE
BACKED MORTGAGE- AVERAGE INCOME ON TOTAL INTEREST BALANCE OF AVERAGE NET
SECURITIES BACKED CASH CASH INTEREST EARNING REPURCHASE INTEREST COST OF INTEREST
HELD SECURITIES EQUIVALENTS EQUIVALENTS INCOME ASSETS AGREEMENTS EXPENSE FUNDS INCOME
---------- ---------- ----------- ----------- -------- -------- ---------- -------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
For the Period
Ended June 30,
1997............. $275,858 $6,478 $121 $31 $6,509 6.44% $242,027 $5,149 5.84% $1,360
</TABLE>
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the period ended June 30, 1997, the Company sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $74.5 million for an
aggregate gain of $229,865. The difference between the sale price and the
historical amortized cost of the Mortgage-Backed Securities is a realized gain
and increased income accordingly. The Company does not expect to sell assets
on a frequent basis, but may from time to time sell existing assets to move
into new assets which management believes might have higher risk-adjusted
returns or to manage its balance sheet as part of management's asset/liability
management strategy.
CREDIT EXPENSES
The Company has not experienced credit losses on its portfolio of Mortgage-
Backed Securities to date, but losses may be experienced in the future. At
June 30, 1997, the Company had limited its exposure to credit losses on its
portfolio of Mortgage-Backed Securities by purchasing only Agency Certificates
which, although not rated, carry an implied "AAA" rating.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses ("operating expense" or "G&A expense")
was $249,895 for the period ended June 30, 1997. There were no differences in
the calculation of G&A expense for taxable and GAAP income purposes.
G&A EXPENSE AND OPERATING EXPENSE RATIOS
<TABLE>
<CAPTION>
TOTAL G&A TOTAL G&A
CASH COMP. EXPENSE/AVERAGE EXPENSE/AVERAGE EFFICIENCY
AND BENEFITS OTHER G&A TOTAL G&A ASSETS EQUITY RATIO
EXPENSE EXPENSE EXPENSE (ANNUALIZED) (ANNUALIZED) (ANNUALIZED)
------------ --------- --------- --------------- --------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
For the Period Ended
June 30, 1997.......... $ 140 $ 110 $ 250 0.24% 2.07% 18.37%
</TABLE>
36
<PAGE>
The Company expects G&A expense to increase following the Offering. The
Company plans to hire new employees to expand the Company's capabilities with
respect to acquiring and monitoring its portfolio of Mortgage-Backed
Securities. In addition, certain compensation expenses will increase
commensurate with growth in the Company's equity base. See "Management--
Compensation of Directors and Executive Officers." Despite these increases in
operating expenses, management believes that the Company's operating expenses
over time are likely to grow at a slower rate than its asset or equity base
and thus management believes that the Company's operating expense ratios are
likely to continue to improve over time.
NET INCOME AND RETURN ON AVERAGE EQUITY
Net income was $1.3 million in the period ended June 30, 1997. Return on
average equity was 11.11% on an annualized basis. The table below shows, on an
annualized basis, the Company's net interest income, gain on sale of Mortgage-
Backed Securities and G&A expense each as a percentage of average equity, and
the return on average equity.
COMPONENTS OF RETURN ON AVERAGE EQUITY
<TABLE>
<CAPTION>
GAIN ON SALE OF
MORTGAGE-
BACKED
NET INTEREST SECURITIES/ G&A RETURN ON
INCOME/AVERAGE AVERAGE EXPENSE/AVERAGE AVERAGE
EQUITY EQUITY EQUITY EQUITY
-------------- --------------- --------------- ---------
<S> <C> <C> <C> <C>
For the Period Ended
June 30, 1997 (on an
annualized basis)..... 11.27% 1.91% 2.07% 11.11%
</TABLE>
DIVIDENDS AND TAXABLE INCOME
The Company will elect to be taxed as a REIT under the Code. Accordingly,
the Company intends to distribute substantially all of its taxable income for
each year to stockholders, including income resulting from gains on sales of
Mortgage-Backed Securities. On a cumulative basis through June 30, 1997,
earned taxable income exceeded dividend declarations by $125,659, or $0.03 per
share, based on the number of shares of Common Stock outstanding at period
end.
DIVIDEND SUMMARY
<TABLE>
<CAPTION>
CUMULATIVE
TAXABLE COMMON TAXABLE NET DIVIDENDS DIVIDEND UNDISTRIBUTED
NET SHARES INCOME DECLARED TOTAL PAY-OUT TAXABLE
INCOME OUTSTANDING PER SHARE PER SHARE DIVIDENDS RATIO INCOME
------- ----------- ----------- --------- --------- -------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
For the Period Ended
June 30, 1997.......... $1,340 3,680,000 $0.36 $0.33 $1,214 90.6% $126
</TABLE>
FINANCIAL CONDITION
MORTGAGE-BACKED SECURITIES
All of the Company's Mortgage-Backed Securities at June 30, 1997 were
adjustable-rate or fixed-rate Mortgage-Backed Securities backed by Single-
Family Mortgage Loans. All of the mortgage assets underlying such Mortgage-
Backed Securities were secured with a first lien position with respect to the
underlying single-family properties. At June 30, 1997, all the Company's
Mortgage-Backed Securities were Agency Certificates which carry an implied
"AAA" rating. All of the Company's earning assets are marked-to-market at
liquidation value.
Discount balances are accreted as an increase in interest income over the
life of discount Mortgage-Backed Securities and premium balances are amortized
as a decrease in interest income over the life of premium
37
<PAGE>
Mortgage-Backed Securities. At June 30, 1997, the Company had on its balance
sheet a total of $2,399 of unamortized discount (which is the difference
between the remaining principal value and current historical amortized cost of
Mortgage-Backed Securities acquired at a price below principal value) and a
total of $10.3 million of unamortized premium (which is the difference between
the remaining principal value and the current historical amortized cost of
Mortgage-Backed Securities acquired at a price above principal value).
Mortgage principal repayments received were $13.7 million for the period
ended June 30, 1997, which equals a CPR of 12%. Given the Company's current
portfolio composition, if mortgage principal prepayment rates increase over
the life of the Mortgage-Backed Securities comprising the current portfolio,
all other factors being equal, the Company's net interest income should
decrease during the life of such Mortgage-Backed Securities as the Company
will be required to amortize its net premium balance into income over a
shorter time period. Similarly, if mortgage principal prepayment rates
decrease over the life of such Mortgage-Backed Securities, all other factors
being equal, the Company's net interest income should increase during the life
of such Mortgage-Backed Securities as the Company will amortize its net
premium balance over a longer time period.
The table below summarizes the Company's Mortgage-Backed Securities at June
30, 1997.
MORTGAGE-BACKED SECURITIES
<TABLE>
<CAPTION>
ESTIMATED
FAIR
AMORTIZED ESTIMATED VALUE/ WEIGHTED
PRINCIPAL NET AMORTIZED COST/PRINCIPAL FAIR PRINCIPAL AVERAGE
VALUE PREMIUM COST VALUE VALUE VALUE YIELD
--------- ------- --------- -------------- --------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
At June 30, 1997........ $354, 329 $10,337 $364,666 102.92% $364,367 102.83% 6.63%
</TABLE>
During the period ended June 30, 1997, the Company's Mortgage-Backed
Securities consisted solely of Agency Certificates. However, the Company may
purchase other types of Mortgage-Backed Securities in the future.
The tables below set forth certain characteristics of the Company's
Mortgage-Backed Securities at June 30, 1997. The index level for adjustable-
rate Mortgage-Backed Securities is the weighted average rate of the various
short-term interest rate indices which determine the coupon rate.
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITY CHARACTERISTICS
<TABLE>
<CAPTION>
PRINCIPAL
WEIGHTED VALUE AS
WEIGHTED WEIGHTED AVERAGE WEIGHTED % OF
AVERAGE AVERAGE WEIGHTED TERM WEIGHTED AVERAGE MORTGAGE-
PRINCIPAL COUPON INDEX AVERAGE NET TO NEXT AVERAGE ASSET BACKED
VALUE RATE LEVEL MARGIN ADJUSTMENT LIFETIME CAP YIELD SECURITIES
--------- -------- -------- ----------- ---------- ------------ -------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
At June 30, 1997........ $329,953 7.25% 5.47% 1.78% 1 month 11.22% 6.59% 93.13%
</TABLE>
FIXED-RATE MORTGAGE-BACKED SECURITY CHARACTERISTICS
<TABLE>
<CAPTION>
PRINCIPAL
VALUE AS
WEIGHTED % OF
AVERAGE WEIGHTED MORTGAGE-
PRINCIPAL COUPON AVERAGE BACKED
VALUE RATE ASSET YIELD SECURITIES
--------- -------- ----------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
At June 30, 1997...................... $24,376 8.00% 7.33% 6.87%
</TABLE>
38
<PAGE>
At June 30, 1997, the Company held Mortgage-Backed Securities with coupons
linked to the one- and three- year Treasury Indices, one-month LIBOR and the
six-month CD rate. The table below segments the Company's adjustable-rate
Mortgage-Backed Securities by type of adjustment index, coupon adjustment
frequency and annual and lifetime cap adjustment.
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITIES BY INDEX
<TABLE>
<CAPTION>
1-YEAR 3-YEAR
ONE-MONTH SIX-MONTH TREASURY TREASURY
LIBOR CD RATE INDEX INDEX
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Weighted Average Adjustment Frequency.... 1 mo. 6 mo. 12 mo. 36 mo.
Weighted Average Term to Next Adjustment. 1 mo. 3 mo. 6 mo. 12 mo.
Weighted Average Annual Period Cap....... none 2.00% 1.78% 2.00%
Weighted Average Lifetime Cap............ 9.73% 11.06% 11.82% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities.............. 18.73% 21.59% 52.21% 0.60%
</TABLE>
The table below shows unrealized gains and losses on the Mortgage-Backed
Securities in the Company's portfolio.
UNREALIZED GAINS AND LOSSES
<TABLE>
<CAPTION>
AT JUNE 30,
1997
-----------
(DOLLARS IN
THOUSANDS)
<S> <C>
Unrealized Gain.................................................... $438
Unrealized Loss.................................................... (737)
Net Unrealized Loss................................................ (299)
Net Unrealized Loss as % of Mortgage-Backed Securities Principal
Value............................................................. 0.08%
Net Unrealized Loss as % of Mortgage-Backed Securities Amortized
Cost.............................................................. 0.08%
</TABLE>
INTEREST RATE AGREEMENTS
Interest rate agreements are assets that are carried on a balance sheet at
estimated liquidation value. At June 30, 1997, there were no interest rate
agreements on the Company's balance sheet.
BORROWINGS
To date, the Company's debt has consisted entirely of borrowings
collateralized by a pledge of the Company's Mortgage-Backed Securities. These
borrowings appear on the balance sheet as repurchase agreements. At June 30,
1997, the Company had established uncommitted borrowing facilities in this
market with nineteen lenders in amounts which the Company believes are in
excess of its needs. All of the Company's Mortgage-Backed Securities are
currently accepted as collateral for such borrowings. The Company, however,
limits its borrowings, and thus its potential asset growth, in order to
maintain unused borrowing capacity and thus increase the liquidity and
strength of its balance sheet.
For the period ended June 30, 1997, the term to maturity of the Company's
borrowings has ranged from one day to six months, with a weighted average
original term to maturity of 66 days and a weighted average remaining maturity
of 20 days at June 30, 1997. Many of the Company's borrowings have a cost of
funds which adjust monthly based on a fixed spread over or under one-month
LIBOR or based on the daily Fed Funds rate. As a result, the average term to
the next rate adjustment for the Company's borrowings is typically shorter
than the term to maturity for the Company's Mortgage-Backed Securities. At
June 30, 1997, the weighted average cost of funds for all of the Company's
borrowings was 5.64% and the weighted average term to next rate adjustment was
20 days.
39
<PAGE>
LIQUIDITY
Liquidity, which is the Company's ability to turn non-cash assets into cash,
allows the Company to purchase additional Mortgage-Backed Securities and to
pledge additional assets to secure existing borrowings should the value of
pledged assets decline. Potential immediate sources of liquidity for the
Company include cash balances and unused borrowing capacity. Unused borrowing
capacity will vary over time as the market value of the Company's Mortgage-
Backed Securities varies. The Company's balance sheet also generates liquidity
on an on-going basis through mortgage principal repayments and net earnings
held prior to payment as dividends. Should the Company's needs ever exceed
these on-going sources of liquidity plus the immediate sources of liquidity
discussed above, management believes that the Company's Mortgage-Backed
Securities could in most circumstances be sold to raise cash. The maintenance
of liquidity is one of the goals of the Company's Capital Investment Policy.
Under this policy, asset growth is limited in order to preserve unused
borrowing capacity for liquidity management purposes.
STOCKHOLDERS' EQUITY
The Company uses "available-for-sale" treatment for its Mortgage-Backed
Securities; these assets are carried on the balance sheet at estimated market
value rather than historical amortized cost. Based upon such "available-for-
sale" treatment, the Company's equity base at June 30, 1997 was $32.8 million,
or $8.92 per share. If the Company had used historical amortized cost
accounting, the Company's equity base at June 30, 1997 would have been $33.1
million, or $9.00 per share.
With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact GAAP or taxable income
but rather are reflected on the balance sheet by changing the carrying value
of the asset and reflecting the change in stockholders' equity under "Net
Unrealized Losses on Assets Available for Sale." By accounting for its assets
in this manner, the Company hopes to provide useful information to
stockholders and creditors and to preserve flexibility to sell assets in the
future without having to change accounting methods.
As a result of this mark-to-market accounting treatment, the book value and
book value per share of the Company are likely to fluctuate far more than if
the Company used historical amortized cost accounting. As a result,
comparisons with companies that use historical cost accounting for some or all
of their balance sheet may be misleading.
Unrealized changes in the estimated net market value of Mortgage-Backed
Securities have one direct effect on the Company's potential earnings and
dividends: positive market-to-market changes will increase the Company's
equity base and allow the Company to increase its borrowing capacity while
negative changes will tend to limit borrowing capacity under the Company's
Capital Investment Policy. A very large negative change in the net market
value of the Company's Mortgage-Backed Securities might impair the Company's
liquidity position, requiring the Company to sell assets with the likely
result of realized losses upon sale. "Net Unrealized Losses on Assets
Available for Sale" was $298,761, or 0.08% of the amortized cost of Mortgage-
Backed Securities at June 30, 1997.
The table below shows the Company's equity capital base as reported and on a
historical amortized cost basis at June 30, 1997. The historical cost equity
capital base is influenced by issuances of Common Stock, the level of GAAP
earnings as compared to dividends declared, and other factors. The GAAP
reported equity capital base is influenced by these factors plus changes in
the "Net Unrealized Losses on Assets Available for Sale" account.
STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
GAAP GAAP REPORTED
HISTORICAL NET UNREALIZED REPORTED HISTORICAL EQUITY (BOOK
AMORTIZED COST LOSSES ON ASSETS EQUITY BASE AMORTIZED COST VALUE)
EQUITY BASE AVAILABLE FOR SALE (BOOK VALUE) EQUITY PER SHARE PER SHARE
-------------- ------------------ ------------ ---------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
At June 30, 1997........ $33,118 $299 $32,819 $9.00 $8.92
</TABLE>
40
<PAGE>
LEVERAGE
The Company's debt-to-GAAP reported equity ratio at June 30, 1997 was 10:1.
The Company generally expects to maintain a ratio of debt-to-equity of between
8:1 and 12:1, although the ratio may vary from time to time based upon various
factors, including management's opinion of the level of risk of its assets and
liabilities, the Company's liquidity position, the level of unused borrowing
capacity and over-collateralization levels required by lenders when the
Company pledges assets to secure borrowings.
The target debt-to-GAAP reported equity ratio is determined under the
Company's Capital Investment Policy. Should the actual debt-to-equity ratio of
the Company increase above the target level due to asset acquisition and/or
market value fluctuations in assets, management will cease to acquire new
assets. Management will, at such time, present a plan to its Board of
Directors to bring the Company back to its target debt-to-equity ratio; in
many circumstances, this would be accomplished in time by the monthly
reduction of the balance of Mortgage-Backed Securities through principal
repayments. See "Business Strategy--Capital Investment Policy--Capital and
Leverage."
ASSET/LIABILITY MANAGEMENT AND EFFECT OF CHANGES IN INTEREST RATES
Management continually reviews the Company's asset/liability management
strategy with respect to interest rate risk, mortgage prepayment risk, credit
risk and the related issues of capital adequacy and liquidity. The Company
seeks attractive risk-adjusted stockholder returns while maintaining a strong
balance sheet.
The Company seeks to manage the extent to which net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although it has not done so to date,
the Company may seek to mitigate the potential impact on net income of
periodic and lifetime coupon adjustment restrictions in its portfolio of
Mortgage-Backed Securities by entering into interest rate agreements such as
interest rate caps and interest rate swaps. While the Company has determined,
based upon the current interest rate environment and other relevant factors,
that it would not be economically advantageous, at present, for the Company to
enter into interest rate agreements, the Company may enter into such
agreements in the future.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal repayment rate from an economic point of view by balancing
assets purchased at a premium with assets purchased at a discount. To date,
the aggregate premium exceeds the aggregate discount on Mortgage-Backed
Securities in the Company's portfolio. As a result, prepayments, which result
in the expensing of unamortized premium, will reduce the Company's net income
compared to what net income would be absent such prepayments.
INFLATION
Virtually all of the Company's assets and liabilities are financial in
nature. As a result, interest rates and other factors drive the Company's
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates. The
Company's financial statements are prepared in accordance with GAAP and the
Company's dividends are determined by the Company's net income as calculated
for tax purposes; in each case, the Company's activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
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BUSINESS STRATEGY
GENERAL
The Company's principal business objective is to generate income for
distribution to its stockholders, primarily from the net cash flows on its
Mortgage-Backed Securities qualifying as Qualified REIT Real Estate Assets.
The Company's net cash flows result primarily from the difference between (i)
the interest income on its Mortgage-Backed Security investments and (ii) the
borrowing and financing costs of the Mortgage-Backed Securities. To achieve
its business objective and generate dividend yields, the Company's strategy is
to:
. purchase Pass-Through Certificates, CMOs and other Mortgage-Backed
Securities, substantially all of which are expected to have adjustable
coupon rates based on changes in short-term market interest rates;
. acquire only those Mortgage-Backed Securities which the Company believes
it has the necessary expertise to evaluate and manage, which can be
readily financed and which are consistent with the Company's balance
sheet guidelines and risk management objectives and generally to seek to
acquire assets whose investment returns are attractive in more than a
limited range of scenarios;
. finance purchases of Mortgage-Backed Securities with the proceeds of
equity offerings and, to the extent permitted by the Company's Capital
Investment Policy, to utilize leverage to increase potential returns to
stockholders through borrowings (primarily under repurchase agreements);
. attempt to structure its borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate
basis, generally correspond (within a range of one to six months) to the
interest rate adjustment indices and interest rate adjustment periods of
the adjustable and floating rate Mortgage-Backed Securities purchased by
the Company;
. utilize interest rate caps, swaps and similar instruments to mitigate
the risk of the cost of its variable rate liabilities increasing at a
faster rate than the earnings on its assets during a period of rising
interest rates;
. seek to minimize prepayment risk by structuring a diversified portfolio
with a variety of prepayment characteristics and through other means;
and
. issue new equity or debt and increase the size of the balance sheet when
opportunities in the market for Mortgage-Backed Securities are likely to
allow growth in earnings per share.
The Company believes it is able to obtain cost efficiencies through its
facilities-sharing arrangement with FIDAC and by virtue of management's
experience in managing portfolios of Mortgage-Backed Securities and in
arranging collateralized borrowings. The Company will strive to become even
more cost-efficient over time by:
. seeking to raise additional capital from time to time in order to
increase its ability to invest in Mortgage-Backed Securities as
operating costs are not anticipated to increase as quickly as assets and
because growth will increase the Company's purchasing influence with
suppliers of Mortgage-Backed Securities;
. striving to lower its effective borrowing costs over time through
seeking direct funding with collateralized lenders rather than using
financial intermediaries and investigating the possibility of using
commercial paper and medium term note programs;
. improving the efficiency of its balance sheet structure by investigating
the issuance of uncollateralized subordinated debt, preferred stock and
other forms of capital; and
. utilizing information technology to the fullest extent possible in its
business, which technology the Company believes can be developed to
improve the Company's ability to monitor the performance of its
Mortgage-Backed Securities, improve its ability to assess credit risk,
improve hedging efficiency and lower operating costs.
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MORTGAGE-BACKED SECURITIES
GENERAL
The Company's Capital Investment Policy provides that at least 75% of its
total assets will be comprised of High Quality Mortgage-Backed Securities and
High Quality Short-Term Investments. The term "High Quality" as used herein
means securities (i) which are rated within one of the two highest rating
categories by at least one of the nationally recognized Rating Agencies, (ii)
that are unrated but are either guaranteed by the United States government or
an agency of the United States government, or (iii) that are unrated or whose
ratings have not been updated but are determined to be of comparable quality
to rated High Quality Mortgage-Backed Securities on the basis of credit
enhancement features that meet the High Quality credit criteria approved by
the Company's Board of Directors. To date, all of the Mortgage-Backed
Securities acquired by the Company have been High Quality Mortgage-Backed
Securities which, although not rated, carry an implied "AAA" rating.
In accordance with the Company's Capital Investment Policy, the remainder of
the Company's assets, comprising not more than 25% of total assets, may
consist of Mortgage-Backed Securities and other Qualified REIT Real Estate
Assets which are unrated or rated less than High Quality, but which are at
least "investment grade" (rated "BBB" or better by S&P or the equivalent by
another Rating Agency) or, if not rated, are determined by the Company to be
of comparable credit quality to an investment which is rated "BBB" or better.
See "--Unrated Assets". The foregoing-described Mortgage-Backed Securities,
comprising in the aggregate not more than 25% of the Company's total assets,
are sometimes referred to herein as "Limited Investment Assets." The Company
intends to structure its portfolio to maintain a minimum weighted average
rating (including the Company's deemed comparable ratings for unrated
Mortgage-Backed Securities based on a comparison to rated Mortgage-Backed
Securities with like characteristics) of its Mortgage-Backed Securities of at
least single "A" under the S&P rating system and at the comparable level under
the other rating systems.
Allocation of the Company's investments among the permitted investment types
may vary from time-to-time based on the evaluation by the Company's Board of
Directors of economic and market trends and the Company's perception of the
relative values available from such types of investments, provided that in no
event will the Company's investment in Limited Investment Assets exceed 25% of
the Company's total assets.
The Company acquires only those Mortgage-Backed Securities which the Company
believes it has the necessary expertise to evaluate and manage, which are
consistent with the Company's balance sheet guidelines and risk management
objectives and which the Company believes can be readily financed. Since the
intention of the Company is generally to hold its Mortgage-Backed Securities
until maturity, the Company generally does not seek to acquire assets whose
investment returns are only attractive in a limited range of scenarios. The
Company believes that future interest rates and mortgage prepayment rates are
very difficult to predict. Therefore, the Company seeks to acquire Mortgage-
Backed Securities which the Company believes will provide acceptable returns
over a broad range of interest rate and prepayment scenarios.
The Mortgage-Backed Securities acquired and to be acquired by the Company
consist of (i) Pass-Through Certificates, (ii) CMOs, and (iii) other Mortgage-
Backed Securities, including mortgage derivative securities representing the
right to receive interest only or a disproportionately large amount of
interest. It is expected that the Pass-Through Certificates acquired by the
Company for its investment portfolio will continue to consist primarily of
adjustable-rate Agency Certificates, which include adjustable-rate mortgage
participation certificates issued by FHLMC, mortgage Pass-Through Certificates
issued by FNMA, and fully modified Pass-Through Certificates guaranteed by
GNMA (collectively, "Agency Certificates"). To date, all of the Mortgage-
Backed Securities acquired by the Company have been Agency Certificates. The
Company has not and will not invest in REMIC residuals, other CMO residuals or
Mortgage-Backed Securities, such as inverse floaters, which have imbedded
leverage as part of their structural characteristics.
UNRATED ASSETS
To date, all of the Mortgage-Backed Securities acquired by the Company have
been Agency Certificates which carry an implied "AAA" rating. Prior to
acquiring any unrated securities, the Company intends to engage
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an independent consultant approved by the Company's Board of Directors to
assist the Company in evaluating the creditworthiness of such securities and
determining whether such securities are qualified to be purchased under the
Capital Investment Policy. Such consultant would be required to have expertise
in rating "investment grade" securities and knowledge of, and substantive
business experience (of not less than six years) relating to, the Mortgage-
Backed Securities industry, including experience qualifying low rated and
unrated Mortgage-Backed Securities by application of the criteria employed by
S&P and other Rating Agencies. In making such evaluations, the Company will
utilize the credit evaluation criteria set forth in the then current credit
review models utilized by S&P and other Rating Agencies. Such criteria may
include a review of the cash flow and other characteristics of the security,
an analysis of the components of the security and a valuation of comparable
assets. Depending upon various factors, including the type of security, the
characteristics of the security to be reviewed may include loan to value
ratios, cash flows, payment history, weighted average coupons, weighted
average maturity, underwriting criteria used by the originator and the
structure and amount of credit enhancement. Once an independent consultant has
been approved by the Company's Board of Directors, management of the Company
will have the right to purchase unrated securities recommended by the
consultant without Board approval. However, the Board of Directors will review
all such purchases at the Company's Board meetings which are held at least
quarterly.
DESCRIPTION OF MORTGAGE-BACKED SECURITIES
The Mortgage-Backed Securities in which the Company invests provide funds
for mortgage loans made primarily to residential homeowners. These include
securities which represent interests in pools of mortgage loans made by
lenders such as savings and loan institutions, mortgage bankers and commercial
banks. Pools of mortgage loans are assembled for sale to investors (such as
the Company) by various governmental, government-related and private
organizations.
Interests in pools of Mortgage-Backed Securities differ from other forms of
traditional debt securities, which normally provide for periodic payments of
interest in fixed amounts with principal payments at maturity or specified
call dates. Instead, Mortgage-Backed Securities provide for a monthly payment,
which consists of both interest and principal. In effect, these payments are a
"pass-through" of the monthly interest and principal payments made by the
individual borrower on its residential mortgage loans, net of any fees paid to
the issuer or guarantor of such securities. Additional payments result from
prepayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-backed securities, such as securities issued by GNMA,
are described as "modified pass-through." These securities entitle the holder
to receive all interest and principal payments owed on the mortgage pool, net
of certain fees, regardless of whether or not the mortgagors actually make
mortgage payments when due.
The investment characteristics of pass-through Mortgage-Backed Securities
differ from those of traditional fixed-income securities. The major
differences include the payment of interest and principal on the mortgage-
backed securities on a more frequent schedule, as described above, and the
possibility that principal may be prepaid at any time due to prepayments on
the underlying mortgage loans or other assets. These differences can result in
significantly greater price and yield volatility than is the case with
traditional fixed-income securities.
The occurrences of mortgage prepayments are affected by factors including
the level of interest rates, general economic conditions, the location and age
of the mortgage and other social and demographic conditions. Generally
prepayments on pass-through mortgage-backed securities increase during periods
of falling mortgage interest rates and decrease during periods of rising
mortgage interest rates. Reinvestment of prepayments may occur at higher or
lower interest rates than the original investment, thus affecting the yield of
the Company's investments.
FHLMC CERTIFICATES
FHLMC is a privately owned government-sponsored enterprise created pursuant
to an Act of Congress (Title III of the Emergency Home Finance Act of 1970, as
amended, 12 U.S.C. (S)(S)1451-1459), on July 24, 1970.
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The principal activity of FHLMC currently consists of the purchase of
conventional Conforming Mortgage Loans or participation interests therein and
the resale of the loans and participations so purchased in the form of
guaranteed Mortgage-Backed Securities. FHLMC guarantees to each holder of
FHLMC Certificates the timely payment of interest at the applicable pass-
through rate and ultimate collection of all principal on the holder's pro rata
share of the unpaid principal balance of the related Mortgage Loans, but does
not guarantee the timely payment of scheduled principal of the underlying
Mortgage Loans. The obligations of FHLMC under its guarantees are solely those
of FHLMC and are not backed by the full faith and credit of the United States.
If FHLMC were unable to satisfy such obligations, distributions to holders of
FHLMC Certificates would consist solely of payments and other recoveries on
the underlying Mortgage Loans and, accordingly, monthly distributions to
holders of FHLMC Certificates would be affected by delinquent payments and
defaults on such Mortgage Loans.
FHLMC Certificates may be backed by pools of Single-Family Mortgage Loans or
Multifamily Mortgage Loans. Such underlying Mortgage Loans may have original
terms to maturity of up to 40 years. FHLMC Certificates may be issued under
Cash Programs (composed of Mortgage Loans purchased from a number of sellers)
or Guarantor Programs (composed of Mortgage Loans purchased from one seller in
exchange for participation certificates representing interests in the Mortgage
Loans purchased). FHLMC Certificates may pay interest at a fixed rate or
adjustable rate. The interest rate paid on FHLMC ARM Certificates adjusts
periodically within 60 days prior to the month in which the interest rates on
the underlying Mortgage Loans adjust. The interest rates paid on FHLMC ARM
Certificates issued under FHLMC's standard ARM programs adjust in relation to
the Treasury Index. Other specified indices used in FHLMC ARM programs include
the 11th District Cost of Funds Index published by the Federal Home Loan Bank
of San Francisco, LIBOR and other indices. Interest rates paid on fully-
indexed FHLMC ARM Certificates equal the applicable index rate plus a
specified number of basis points ranging typically from 125 to 250 basis
points. In addition, the majority of series of FHLMC ARM Certificates issued
to date have evidenced pools of Mortgage Loans with monthly, semi-annual or
annual interest adjustments. Adjustments in the interest rates paid are
generally limited to an annual increase or decrease of either 100 or 200 basis
points and to a lifetime cap of 500 or 600 basis points over the initial
interest rate. Certain FHLMC programs include Mortgage Loans which allow the
borrower to convert the adjustable mortgage interest rate to a fixed rate.
ARMs which are converted into fixed-rate Mortgage Loans are repurchased by
FHLMC or by the seller of such loan to FHLMC at the unpaid principal balance
thereof plus accrued interest to the due date of the last adjustable rate
interest payment.
FNMA CERTIFICATES
FNMA is a privately owned, federally chartered corporation organized and
existing under the Federal National Mortgage Association Charter Act (12
U.S.C. (S) 1716 et seq.). FNMA provides funds to the mortgage market primarily
by purchasing home Mortgage Loans from local lenders, thereby replenishing
their funds for additional lending. FNMA guarantees to the registered holder
of a FNMA Certificate that it will distribute amounts representing scheduled
principal and interest (at the rate provided by the FNMA Certificate) on the
Mortgage Loans in the pool underlying the FNMA Certificate, whether or not
received, and the full principal amount of any such mortgage loan foreclosed
or otherwise finally liquidated, whether or not the principal amount is
actually received. The obligations of FNMA under its guarantees are solely
those of FNMA and are not backed by the full faith and credit of the United
States. If FNMA were unable to satisfy such obligations, distributions to
holders of FNMA Certificates would consist solely of payments and other
recoveries on the underlying Mortgage Loans and, accordingly, monthly
distributions to holders of FNMA Certificates would be affected by delinquent
payments and defaults on such Mortgage Loans.
FNMA Certificates may be backed by pools of Single-Family or Multifamily
Mortgage Loans. The original terms to maturities of the Mortgage Loans
generally do not exceed 40 years. FNMA Certificates may pay interest at a
fixed rate or adjustable rate. Each series of FNMA ARM Certificates bears an
initial interest rate and margin tied to an index based on all loans in the
related pool, less a fixed percentage representing servicing compensation and
FNMA's guarantee fee. The specified index used in each such series has
included the Treasury Index, the
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11th District Cost of Funds Index published by the Federal Home Loan Bank of
San Francisco, LIBOR and other indices. Interest rates paid on fully-indexed
FNMA ARM Certificates equal the applicable index rate plus a specified number
of basis points ranging typically from 125 to 250 basis points. In addition,
the majority of series of FNMA ARM Certificates issued to date have evidenced
pools of Mortgage Loans with monthly, semi-annual or annual interest rate
adjustments. Adjustments in the interest rates paid are generally limited to
an annual increase or decrease of either 100 or 200 basis points and to a
lifetime cap of 500 or 600 basis points over the initial interest rate.
Certain FNMA programs include Mortgage Loans which allow the borrower to
convert the adjustable mortgage interest rate of its ARM to a fixed rate. ARMs
which are converted into fixed-rate Mortgage Loans are repurchased by FNMA or
by the seller of such loans to FNMA at the unpaid principal balance thereof
plus accrued interest to the due date of the last adjustable rate interest
payment. Adjustments to the interest rates on FNMA ARM Certificates are
typically subject to lifetime caps and periodic rate or payment caps.
GNMA CERTIFICATES
GNMA is a wholly owned corporate instrumentality of the United States within
the Department of Housing and Urban Development ("HUD"). Section 306(g) of
Title III of the National Housing Act of 1934, as amended (the "Housing Act"),
authorizes GNMA to guarantee the timely payment of the principal of and
interest on certificates which represent an interest in a pool of mortgages
insured by the FHA under the Housing Act or Title V of the Housing Act of
1949, or partially guaranteed by the VA under the Servicemen's Readjustment
Act of 1944, as amended, or Chapter 37 of Title 38, United States Code and
other loans eligible for inclusion in mortgage pools underlying GNMA
Certificates. Section 306(g) of the Housing Act provides that "the full faith
and credit of the United States is pledged to the payment of all amounts which
may be required to be paid under any guaranty under this subsection." An
opinion, dated December 12, 1969, of an Assistant Attorney General of the
United States provides that such guarantees under section 306(g) of GNMA
Certificates of the type which may be purchased or received in exchange by the
Company are authorized to be made by GNMA and "would constitute general
obligations of the United States backed by its full faith and credit."
At present, most GNMA Certificates are backed by Single-Family Mortgage
Loans. The interest rate paid on GNMA Certificates may be fixed rate or
adjustable rate. The interest rate on GNMA Certificates issued under GNMA's
standard ARM program adjusts annually in relation to the Treasury Index.
Interest rates paid on GNMA ARM Certificates typically equal the index rate
plus 150 basis points. Adjustments in the interest rate are generally limited
to an annual increase or decrease of 100 basis points and to a lifetime cap of
500 basis points over the initial coupon rate.
SINGLE-FAMILY AND MULTIFAMILY PRIVATELY-ISSUED CERTIFICATES
Single-Family and Multifamily Privately-Issued Certificates are Pass-Through
Certificates that are not issued by one of the Agencies and that are backed by
a pool of conventional Single-Family or Multifamily Mortgage Loans,
respectively. Single-Family and Multifamily Privately-Issued Certificates are
issued by originators of, investors in, and other owners of Mortgage Loans,
including savings and loan associations, savings banks, commercial banks,
mortgage banks, investment banks and special purpose "conduit" subsidiaries of
such institutions.
While Agency Certificates are backed by the express obligation or guarantee
of one of the Agencies, as described above, Single-Family and Multifamily
Privately-Issued Certificates are generally covered by one or more forms of
private (i.e., nongovernmental) credit enhancements. Such credit enhancements
provide an extra layer of loss coverage in the event that losses are incurred
upon foreclosure sales or other liquidations of underlying mortgaged
properties in amounts that exceed the equity holder's equity interest in the
property and result in Realized Losses. Forms of credit enhancements include,
but are not limited to, limited issuer guarantees, reserve funds, private
mortgage guaranty pool insurance, over-collateralization and subordination.
Subordination is a form of credit enhancement frequently used and involves
the issuance of multiple classes of Senior-Subordinated Mortgage-Backed
Securities. Such classes are structured into a hierarchy of levels for
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purposes of allocating Realized Losses and also for defining priority of
rights to payment of principal and interest. Typically, one or more classes of
Senior Securities are created which are rated in one of the two highest rating
levels by one or more nationally recognized Rating Agencies and which are
supported by one or more classes of Mezzanine Securities and Subordinated
Securities that bear Realized Losses prior to the classes of Senior
Securities. Mezzanine Securities for purposes of this Prospectus will refer to
any classes that are rated below the two highest levels but no lower than a
single "B" level under the S&P rating system (or comparable level under other
rating systems) and are supported by one or more classes of Subordinated
Securities which bear Realized Losses prior to the classes of Mezzanine
Securities. For purposes of this Prospectus, Subordinated Securities will
refer to any class that bears the "first loss" from Realized Losses or that is
rated below a single "B" level (or, if unrated, is deemed by the Company to be
below such level based on a comparison of characteristics of such class with
other rated Subordinated Securities with like characteristics). In some cases,
only classes of Senior Securities and Subordinated Securities are issued. By
adjusting the priority of interest and principal payments on each class of a
given series of Senior-Subordinated Mortgage-Backed Securities, issuers are
able to create classes of Mortgage-Backed Securities with varying degrees of
credit exposure, prepayment exposure and potential total return, tailored to
meet the needs of sophisticated institutional investors.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS PASS-THROUGH SECURITIES
Mortgage-Backed Securities in which the Company may invest may include
collateralized mortgage obligations ("CMOs") and multi-class pass-through
securities. CMOs are debt obligations issued by special purpose entities that
are secured by mortgage-backed certificates, including, in many cases,
certificates issued by government and government-related guarantors,
including, GNMA, FNMA and FHLMC, together with certain funds and other
collateral. Multi-class pass-through securities are equity interests in a
trust composed of mortgage loans or other mortgage-backed securities. Payments
of principal and interest on underlying collateral provide the funds to pay
debt service on the CMO or make scheduled distributions on the multi-class
pass-through securities. CMOs and multi-class pass-through securities may be
issued by agencies or instrumentalities of the U.S. Government or by private
organizations. The discussion of CMOs in the following paragraphs is similarly
applicable to multi-class pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche," is issued at a specific
coupon rate (which, as discussed below, may be an adjustable rate subject to a
cap) and has a stated maturity or final distribution date. Principal
prepayments on collateral underlying a CMO may cause it to be retired
substantially earlier than the stated maturities or final distribution dates.
Interest is paid or accrues on all classes of a CMO on a monthly, quarterly or
semi-annual basis. The principal and interest on underlying mortgages may be
allocated among the several classes of a series of a CMO in many ways. In a
common structure, payments of principal, including any principal prepayments,
on the underlying mortgages are applied to the classes of the series of a CMO
in the order of their respective stated maturities or final distribution
dates, so that no payment of principal will be made on any class of a CMO
until all other classes having an earlier stated maturity or final
distribution date have been paid in full.
Other types of CMO issues include classes such as parallel pay CMOs, some of
which, such as Planned Amortization Class CMOs ("PAC Bonds"), provide
protection against prepayment uncertainty. Parallel pay CMOs are structured to
provide payments of principal on certain payment dates to more than one class.
These simultaneous payments are taken into account in calculating the stated
maturity date or final distribution date of each class which, as with other
CMO structures, must be retired by its stated maturity date or final
distribution date but may be retired earlier. PAC Bonds generally require
payment of a specified amount of principal on each payment date so long as
prepayment speeds on the underlying collateral fall within a specified range.
PAC Bonds are always parallel pay CMOs with the required principal payment on
such securities having the highest priority after interest has been paid to
all classes.
Other types of CMO issues include Targeted Amortization Class CMOs ("TAC
Bonds"), which are similar to PAC Bonds. While PAC Bonds maintain their
amortization schedule within a specified range of prepayment speeds, TAC Bonds
are generally targeted to a narrow range of prepayment speeds or a specified
prepayment
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speed. TAC Bonds can provide protection against prepayment uncertainty since
cash flows generated from higher prepayments of the underlying mortgage-
related assets are applied to the various other pass-through tranches so as to
allow the TAC Bonds to maintain their amortization schedule.
CMOs may be subject to certain rights of issuers thereof to redeem such CMOs
prior to their stated maturity dates, which may have the effect of diminishing
the Company's anticipated return on its investment. Privately-Issued Single-
Family and Multifamily CMOs are supported by private credit enhancements
similar to those used for Privately-Issued Certificates and are often issued
as Senior-Subordinated Mortgage-Backed Securities. The Company will only
acquire CMOs or multi-class pass-through certificates that constitute debt
obligations or beneficial ownership in grantor trusts holding Mortgage Loans,
or regular interests in REMICs, or that otherwise constitute Qualified REIT
Real Estate Assets (provided that the Company has obtained a favorable opinion
of its tax advisor or a ruling from the IRS to that effect).
One or more tranches of a CMO may have coupon rates which reset periodically
at a specified increment over an index such as LIBOR. These adjustable rate
tranches known as "floating rate CMOs" may be backed by fixed or adjustable-
rate mortgages. To date, fixed-rate mortgages have been more commonly utilized
for this purpose. Floating rate CMOs are typically issued with lifetime caps
on the coupon rate thereon. These caps, similar to the caps on adjustable-rate
mortgages described in "Floating Rate Mortgage-Backed Securities" below,
represent a ceiling beyond which the coupon rate on a floating rate CMO may
not be increased regardless of increases in the interest rate index to which
the floating rate CMO is geared.
FLOATING RATE MORTGAGE-BACKED SECURITIES
CMOs in which the Company may invest include floating rate CMOs
("Floaters"). The interest rates on Floaters are reset at periodic intervals
to an increment over some predetermined interest rate index. There are two
main categories of indices: (i) those based on U.S. Treasury securities, and
(ii) those derived from calculated measures such as a cost of funds index or a
moving average of mortgage rates. Commonly utilized indices include the one-
year Treasury rate, the three-month Treasury bill rate, the six-month Treasury
bill rate, rates on long-term Treasury securities, the 11th District Federal
Home Loan Bank Costs of Funds Index, the National Median Cost of Funds, the
one-month or three-month LIBOR, the prime rate of a specific bank, or
commercial paper rates. Some indices, such as the one-year Treasury rate,
closely mirror changes in market interest rate levels. Others, such as the
11th District Home Loan Bank Cost of Funds Index, tend to lag changes in
market rate level. The Company will seek to diversify its investments in
Floaters among a variety of indices and reset periods so that the Company is
not at any one time unduly exposed to the risk of interest rate fluctuations.
In selecting the type of Floaters for investment, the Company will also
consider the liquidity of the market for such Floaters.
The Company believes that Floaters are particularly well-suited to
facilitate its ability to accomplish the Company's investment objective of
high current income, consistent with modest volatility of net asset value,
because the value of the Floaters should remain relatively stable as compared
to that of traditional fixed-rate debt securities paying comparable rates of
interest. While the value of Floaters, like other debt securities, generally
varies inversely with changes in market interest rates (increasing in value
during periods of declining interest rates and decreasing in value during
periods of increasing interest rates), the value of Floaters should generally
be more resistant to price swings than other debt securities because the
interest rates of Floaters move with market interest rates. Accordingly, as
interest rates change, the value of the Company's shares should be more stable
than that of funds which invest primarily in securities backed by fixed-rate
mortgages or in other non-mortgage-backed debt securities, which do not
provide for adjustment in the interest rates thereon in response to change in
interest rates.
Floaters typically have caps, which limit the maximum amount by which the
interest rate may be increased or decreased at periodic intervals or over the
life of the Floater. To the extent that interest rates rise faster than the
allowable caps on Floaters, such Floaters will behave more like fixed-rate
securities. Consequently, interest rate increases in excess of caps can be
expected to cause Floaters to behave more like traditional debt securities
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than adjustable-rate securities and, accordingly, to decline in value to a
greater extent than would be the case in the absence of such caps.
Floaters, like other Mortgage-Backed Securities, differ from conventional
bonds in that principal is to be paid back over the life of Floaters rather
than at maturity. As a result, the holder of the Floaters (i.e., the Company)
receives monthly scheduled payments of principal and interest and may receive
unscheduled principal payments representing prepayments on the underlying
mortgages. When the holder reinvests the payments and any unscheduled
prepayments it receives, it may receive a rate of interest on the reinvestment
which is lower than the rate on the existing Floaters. For this reason,
Floaters are less effective than longer-term debt securities as a means of
"locking in" longer-term interest rates.
Floaters, while having less risk of price decline during periods of rapidly
rising rates than certain fixed-rate Mortgage-Backed Securities of comparable
maturities, could have less potential for capital appreciation than such
securities. In addition, to the extent Floaters are purchased at a premium,
mortgage foreclosures and unscheduled principal prepayments will result in
some loss of the holders' principal investment to the extent of the premium
paid. On the other hand, if Floaters are purchased at a discount, an
unscheduled prepayment of principal could increase total return and accelerate
the recognition of income to the Company and, as a result, could increase the
amount of income received by stockholders to the extent that the Company
distributes such income.
OTHER FLOATING RATE INSTRUMENTS
The Company may also invest in structured floating rate notes issued or
guaranteed by government agencies, such as FNMA and FHLMC. Such instruments
are typically structured to reflect an interest rate arbitrage (i.e., the
difference between the agency's cost of funds and the income stream from
specified assets of the agency) and their reset formulas may provide more
attractive returns than other floating rate instruments. The indices used to
determine resets are the same as those referred to under "--Floating Rate
Mortgage-Backed Securities" above.
SUBORDINATED INTERESTS
The Company may acquire Subordinated Interests which are classes of
Mortgage-Backed Securities that are junior to other classes of such series of
Mortgage-Backed Securities in the right to receive payments from the
underlying mortgages. The subordination is for credit enhancement and may be
for all payment failures on the Mortgage Loans securing or underlying such
series of Mortgage-Backed Securities. The subordination will not be limited to
those resulting from certain types of risks, such as those resulting from war,
earthquake or flood, or the bankruptcy of a mortgagor. The subordination may
be for the entire amount of the series of Mortgage-Backed Securities or may be
limited in amount. The Subordinated Interests held by the Company will be part
of its Limited Investment Assets that in the aggregate will not constitute
more than 25% of the Company's total assets.
It is anticipated that substantially all of the Subordinated Interests which
the Company may acquire will be rated at least investment grade by one of the
Rating Agencies. If not so rated, the Company will establish reserves against
future potential losses in an amount equivalent to the credit enhancement
required to achieve an investment grade credit rating.
Any Subordinated Interests acquired by the Company will be limited in amount
and bear yields which the Company believes are commensurate with the risks
involved. The market for Subordinated Interests is not extensive and may be
illiquid. In addition, the Company's ability to sell Subordinated Interests
will be limited by the REIT Provisions of the Code. Accordingly, the Company
intends to purchase Subordinated Interests for investment purposes only.
Although publicly offered Subordinated Interests generally will be rated, the
risks of ownership will be substantially the same as the ownership of unrated
Subordinated Interests because the rating does not address the possibility
that the Company might suffer a lower than anticipated yield or fail to
recover its initial investment. The Company will not purchase any Subordinated
Interests that do not qualify as Qualified REIT Real Estate Assets.
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MORTGAGE LOANS
The Company may from time to time invest a small percentage of its assets
directly in Single-Family, Multi- Family or Commercial Mortgage Loans. The
Company expects that substantially all of such Mortgage Loans acquired by it
would be ARMs. The interest rate on an ARM is typically tied to an index (such
as LIBOR or the interest rate on United States Treasury Bills), and is
adjustable periodically at various intervals. Such Mortgage Loans are
typically subject to lifetime interest rate caps and periodic interest rate
and/or payment caps. The acquisition of Mortgage Loans generally involves
credit risk. The Company may obtain credit enhancement to mitigate such risk;
however, there can be no assurances that the Company will able to obtain such
credit enhancement or that such credit enhancement will mitigate the credit
risk of the underlying Mortgage Loans.
CAPITAL INVESTMENT POLICY
ASSET ACQUISITIONS
The Company's Capital Investment Policy provides that at least 75% of the
Company's total assets will be comprised of High Quality Mortgage-Backed
Securities and High Quality Short-Term Investments. The remainder of the
Company's assets (comprising not more than 25% of total assets), may consist
of Mortgage-Backed Securities and other Qualified REIT Real Estate Assets
which are unrated or rated less than High Quality but which are at least
"investment grade" (rated "BBB" or better) or, if not rated, are determined by
the Company to be of comparable credit quality to an investment which is rated
"BBB" or better.
The Company structures its portfolio to maintain a minimum weighted average
rating (including the Company's deemed comparable ratings for unrated
Mortgage-Backed Securities based on a comparison to rated Mortgage-Backed
Securities with like characteristics) of its Mortgage-Backed Securities of at
least single "A" under the S&P rating system and at the comparable level under
the other rating systems. To date, all of the Mortgage-Backed Securities
acquired by the Company have been Agency Certificates which, although not
rated, have an implied "AAA" rating.
The Company intends to acquire only those Mortgage-Backed Securities which
the Company believes it has the necessary expertise to evaluate and manage,
which are readily financed and which are consistent with the Company's balance
sheet guidelines and risk management objectives. Since the Company expects to
hold such assets until maturity, the Company generally does not seek to
acquire assets whose investment returns are only attractive in a limited range
of scenarios. The Company believes that future interest rates and mortgage
prepayment rates are very difficult to predict and, as a result, seeks to
acquire Mortgage-Backed Securities which the Company believes provide
acceptable returns over a broad range of interest rate and prepayment
scenarios.
Among the asset choices available to the Company, the Company's policy is to
acquire those Mortgage- Backed Securities which the Company believes generate
the highest returns on capital invested, after considering (i) the amount and
nature of anticipated cash flows from the asset, (ii) the Company's ability to
pledge the asset to secure collateralized borrowings, (iii) the increase in
the Company's capital requirement determined by the Company's Capital
Investment Policy resulting from the purchase and financing of the asset, and
(iv) the costs of financing, hedging, managing and reserving for the asset.
Prior to acquisition, potential returns on capital employed are assessed over
the life of the asset and in a variety of interest rate, yield spread,
financing cost, credit loss and prepayment scenarios.
Management also gives consideration to balance sheet management and risk
diversification issues. A specific asset which is being evaluated for
potential acquisition is deemed more or less valuable to the Company to the
extent it serves to increase or decrease certain interest rate or prepayment
risks which may exist in the balance sheet, to diversify or concentrate credit
risk, and to meet the cash flow and liquidity objectives management may
establish for the Company's balance sheet from time to time. Accordingly, an
important part of the asset evaluation process is a simulation, using the
Company's risk management model, of the addition of a potential asset and its
associated borrowings and hedges to the balance sheet and an assessment of the
impact
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<PAGE>
this potential asset acquisition would have on the risks in and returns
generated by the Company's balance sheet as a whole over a variety of
scenarios.
The Company focuses primarily on the acquisition of adjustable-rate
Mortgage-Backed Securities. The Company has, however, purchased fixed-rate
assets and may continue to do so in the future should management believe that
the potential returns on capital invested, after hedging and all other costs,
clearly exceed the returns available from other assets or if the purchase of
such assets would serve to reduce or diversify the risks of the Company's
balance sheet.
Although it has not yet done so, the Company may purchase the stock of
mortgage REITs or similar companies when the Company believes that such
purchases will yield attractive returns on capital employed. When the stock
market valuations of such companies are low in relation to the market value of
their assets, such stock purchases can be a way for the Company to acquire an
interest in a pool of Mortgage-Backed Securities at an attractive price. The
Company does not, however, presently intend to invest in the securities of
other issuers for the purpose of exercising control or to underwrite
securities of other issuers.
The Company may acquire newly-issued Mortgage-Backed Securities, and also
will seek to expand its capital base in order to further increase the
Company's ability to acquire new assets, when the potential returns from new
investments appear attractive relative to the return expectations of
stockholders. The Company may in the future acquire Mortgage-Backed Securities
by offering its debt or equity securities in exchange for such Mortgage-Backed
Securities.
The Company generally intends to hold Mortgage-Backed Securities for
extended periods. In addition, the REIT Provisions of the Code limit in
certain respects the ability of the Company to sell Mortgage-Backed
Securities. See "Certain Federal Income Tax Considerations--General--Gross
Income Tests" and "--Taxation of the Company." Management may decide to sell
assets from time to time, however, for a number of reasons including, without
limitation, to dispose of an asset as to which credit risk concerns have
arisen, to reduce interest rate risk, to substitute one type of Mortgage-
Backed Security for another to improve yield or to maintain compliance with
the 55% requirement under the Investment Company Act, and generally to re-
structure the balance sheet when management deems such action advisable.
Management selects any Mortgage-Backed Securities to be sold according to the
particular purpose such sale will serve. The Board of Directors has not
adopted a policy that would restrict management's authority to determine the
timing of sales or the selection of Mortgage-Backed Securities to be sold.
The Company does not invest in principal-only interests in Mortgage-Backed
Securities, residual interests, accrual bonds, inverse-floaters, two-tiered
index bonds, cash flow bonds, Mortgage-Backed Securities with imbedded
leverage or Mortgage-Backed Securities that would be deemed unacceptable for
collateralized borrowings, excluding shares in mortgage REITs.
As a requirement for maintaining REIT status, the Company will distribute to
stockholders aggregate dividends equaling at least 95% of its taxable income.
See "Certain Federal Income Tax Considerations--General--Distribution
Requirement." The Company will make additional distributions of capital when
the return expectations of the stockholders appear to exceed returns
potentially available to the Company through making new investments in
Mortgage-Backed Securities. Subject to the limitations of applicable
securities and state corporation laws, the Company can distribute capital by
making purchases of its own capital stock or through paying down or re-
purchasing any outstanding uncollateralized debt obligations.
The Company's asset acquisition strategy may change over time as market
conditions change and as the Company evolves.
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CREDIT RISK MANAGEMENT
The Company has not taken on credit risk to date, but may do so in the
future. In such event, the Company will review credit risk and other risk of
loss associated with each investment and determine the appropriate allocation
of capital to apply to such investment under its Capital Investment Policy.
The Board of Directors will monitor the overall portfolio risk and determine
appropriate levels of provision for loss.
CAPITAL AND LEVERAGE
The Company expects generally to maintain a ratio of debt-to-equity of
between 8:1 and 12:1, although the ratio may vary from time to time depending
upon market conditions and other factors deemed relevant by management,
including the composition of the Company's balance sheet, haircut levels
required by lenders, the market value of the Mortgage-Backed Securities in the
Company's portfolio and "Excess Capital Cushion" percentages (as described
below) set by the Board of Directors from time to time. For purposes of
calculating this ratio, the Company's equity is equal to the value of the
Company's investment portfolio on a mark-to-market basis less the book value
of the Company's obligations under repurchase agreements and other
collateralized borrowings. At June 30, 1997, the Company's ratio of debt-to-
equity was 10:1.
The Company's goal is to strike a balance between the under-utilization of
leverage, which reduces potential returns to stockholders, and the over-
utilization of leverage, which could reduce the Company's ability to meet its
obligations during adverse market conditions. The Company's Capital Investment
Policy limits management's ability to acquire additional assets during times
when the Company's debt-to-equity ratio exceeds 12:1. In this way, the Company
intends that use of balance sheet leverage will be controlled. The actual
capital base as defined for the purpose of this policy is equal to the market
value of total assets less the book value of total collateralized borrowings.
The actual capital base, as so defined, represents the approximate liquidation
value of the Company and approximates the market value of assets that can be
pledged or sold to meet over-collateralization requirements for the Company's
borrowings. The unpledged portion of the Company's actual capital base is
available to be pledged or sold as necessary to maintain over-
collateralization levels for the Company's borrowings.
Management is prohibited from acquiring additional assets during periods
when the actual capital base of the Company is less than the minimum amount
required under the Capital Investment Policy (except when such asset
acquisitions may be necessary to maintain REIT status or the Company's
exemption from the Investment Company Act). In addition, when the actual
capital base falls below the risk-managed capital requirement, management will
be required to submit to the Board a plan for bringing the actual capital base
into compliance with the Capital Investment Policy guidelines. It is
anticipated that in most circumstances this goal will be achieved over time
without overt management action through the natural process of mortgage
principal repayments and increases in the market values of Mortgage-Backed
Securities as their coupon rates adjust upwards to market levels. Management
anticipates that the actual capital base is likely to exceed the risk-managed
capital requirement during periods following new equity offerings and during
periods of falling interest rates and that the actual capital base could fall
below the risk-managed capital requirement during periods of rising interest
rates.
The first component of the Company's capital requirements is the current
aggregate over-collateralization amount or "haircut" the lenders require the
Company to hold as capital. The haircut for each Mortgage-Backed Security is
determined by the lender based on the risk characteristics and liquidity of
that asset. Haircut levels on individual borrowings generally range from 3%
for Agency Certificates to 20% for certain Privately-Issued Certificates, and
the Company anticipates that haircut levels will average 3% to 10% for the
Company as a whole. At June 30, 1997, the weighted average haircut level on
the Company's securities was 3%. Should the market value of the pledged assets
decline, the Company will be required to deliver additional collateral to the
lenders in order to maintain a constant over-collateralization level on its
borrowings.
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The second component of the Company's capital requirement is the "Excess
Capital Cushion." The Excess Capital Cushion is an additional amount of
capital in excess of the haircut maintained by the Company in order to help
the Company meet the demands of the lenders for additional collateral should
the market value of the Company's Mortgage-Backed Securities decline. The
aggregate Excess Capital Cushion equals the sum of liquidity cushion amounts
assigned under the Capital Investment Policy to each of the Company's
Mortgage-Backed Securities. Excess Capital Cushions are assigned to each
Mortgage-Backed Security based on management's assessment of the Mortgage-
Backed Security's market price volatility, credit risk, liquidity and
attractiveness for use as collateral by lenders. The process of assigning
Excess Capital Cushions relies on management's ability to identify and weigh
the relative importance of these and other factors. Consideration is also
given to hedges associated with the Mortgage-Backed Security and any effect
such hedges may have on reducing net market price volatility, concentration or
diversification of credit and other risks in the balance sheet as a whole and
the net cash flows that can be expected to arise from the interaction of the
various components of the Company's balance sheet. The Board of Directors thus
reviews on a periodic basis various analyses prepared by management of the
risks inherent in the Company's balance sheet, including an analysis of the
effects of various scenarios on the Company's net cash flow, earnings,
dividends, liquidity and net market value. Should the Board of Directors
determine that the minimum required capital base set by the Company's Capital
Investment Policy is either too low or too high, the Board of Directors may
raise or lower the capital requirement accordingly.
The Capital Investment Policy stipulates that at least 25% of the capital
base maintained to satisfy the Excess Capital Cushion shall be invested in
Agency Certificates, AAA-rated adjustable-rate Mortgage-Backed Securities or
assets with similar or better liquidity characteristics. To date, 100% of the
Company's Mortgaged-Backed Securities are Agency Certificates, though this may
change in the future.
Pursuant to the Company's overall business strategy, a substantial portion
of the Company's borrowings are short-term or variable-rate. The Company's
borrowings are implemented primarily through repurchase agreements (a
borrowing device evidenced by an agreement to sell securities or other assets
to a third-party and a simultaneous agreement to repurchase them at a
specified future date and price, the price difference constituting interest on
the borrowing), but in the future may also be obtained through loan
agreements, lines of credit, Dollar-Roll Agreements (an agreement to sell a
security for delivery on a specified future date and a simultaneous agreement
to repurchase the same or a substantially similar security on a specified
future date) and other credit facilities with institutional lenders and
issuance of debt securities such as commercial paper, medium-term notes, CMOs
and senior or subordinated notes. The Company enters into financing
transactions only with institutions that it believes are sound credit risks
and follows other internal policies designed to limit its credit and other
exposure to financing institutions.
It is expected that repurchase agreements will continue to be the principal
financing devices utilized by the Company to leverage its Mortgage-Backed
Securities portfolio. The Company anticipates that, upon repayment of each
borrowing in the form of a repurchase agreement, the collateral will
immediately be used for borrowing in the form of a new repurchase agreement.
To date, the Company has entered into uncommitted facilities with nineteen
(19) lenders for borrowings in the form of repurchase agreements. The Company
has not at the present time entered into any commitment agreements under which
the lender would be required to enter into new repurchase agreements during a
specified period of time, nor does the Company presently plan to have
liquidity facilities with commercial banks. The Company, however, may enter
into such commitment agreements in the future if deemed favorable to the
Company. The Company enters into repurchase agreements primarily with national
broker/dealers, commercial banks and other lenders which typically offer such
financing. The Company enters into collateralized borrowings only with
financial institutions meeting credit standards approved by the Company's
Board of Directors, and monitors the financial condition of such institutions
on a regular basis.
A repurchase agreement, although structured as a sale and repurchase
obligation, acts as a financing under which the Company effectively pledges
its Mortgage-Backed Securities as collateral to secure a short-term loan.
Generally, the other party to the agreement makes the loan in an amount equal
to a percentage of the market value of the pledged collateral. At the maturity
of the repurchase agreement, the Company is required to repay
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the loan and correspondingly receives back its collateral. While used as
collateral, Mortgage-Backed Securities continue to pay principal and interest
which inure to the benefit of the Company. In the event of the insolvency or
bankruptcy of the Company, certain repurchase agreements may qualify for
special treatment under the Bankruptcy Code, the effect of which is, among
other things, to allow the creditor under such agreements 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 repurchase agreement, the lender
may be permitted, under applicable insolvency laws, to repudiate the contract,
and the Company's claim against the lender for damages therefrom may be
treated simply as an unsecured creditor. In addition, if the lender is a
broker or dealer subject to the Securities Investor Protection Act of 1970, or
an insured depository institution subject to the Federal Deposit Insurance
Act, the Company's ability to exercise its rights to recover its securities
under a repurchase agreement or to be compensated for any damages resulting
from the lender's insolvency may be further limited by those statutes. These
claims would be subject to significant delay and, if and when received, may be
substantially less than the damages actually suffered by the Company.
Substantially all of the Company's borrowing agreements require the Company
to deposit additional collateral in the event the market value of existing
collateral declines, which may require the Company to sell assets to reduce
the Company's borrowings. The Company's liquidity management policy is
designed to maintain a cushion of equity sufficient to provide required
liquidity to respond to the effects under its borrowing arrangements of
interest rate movements and changes in market value of its Mortgage-Backed
Securities, as described above. However, a major disruption of the repurchase
or other market relied on by the Company for short-term borrowings would have
a material adverse effect on the Company unless the Company were able to
arrange alternative sources of financing on comparable terms. See "Risk
Factors--Operations Risks--The Company's Strategy Involves Leverage; the
Company May be Unable to Attain the Level of Leverage it Deems Optimal" and
"--Interest Rate Fluctuations Could Cause a Decrease in Net Interest Income."
The Company's Bylaws do not limit its ability to incur borrowings, whether
secured or unsecured.
INTEREST RATE RISK MANAGEMENT
To the extent consistent with its election to qualify as a REIT, the Company
follows an interest rate risk management program intended to protect its
portfolio of Mortgage-Backed Securities and related debt against the effects
of major interest rate changes. Specifically, the Company's interest rate risk
management program is formulated with the intent to offset the potential
adverse effects resulting from rate adjustment limitations on its Mortgage-
Backed Securities and the differences between interest rate adjustment indices
and interest rate adjustment periods of its adjustable-rate Mortgage-Backed
Securities and related borrowings. The Company's interest rate risk management
program encompasses a number of procedures, including the following: (i) the
Company attempts to structure its borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate basis,
generally correspond to the interest rate adjustment indices and interest rate
adjustment periods of the adjustable-rate Mortgage-Backed Securities purchased
by the Company, so as to limit any mismatching of such aggregates to a range
of one to six months, and (ii) the Company attempts to structure its borrowing
agreements relating to adjustable-rate Mortgage-Backed Securities to have a
range of different maturities and interest rate adjustment periods (although
substantially all will be less than one year). As a result, the Company
expects to be able to adjust the average maturity/adjustment period of such
borrowings on an ongoing basis by changing the mix of maturities and interest
rate adjustment periods as borrowings come due and are renewed. Through use of
these procedures, the Company intends to minimize any differences between
interest rate adjustment periods of adjustable-rate Mortgage-Backed Securities
and related borrowings that may occur.
Although it has not done so to date, the Company may purchase from time to
time interest rate caps, interest rate swaps, interest rate collars, caps or
floors, "interest only" Mortgage-Backed Securities and similar instruments to
attempt to mitigate the risk of the cost of its variable rate liabilities
increasing at a faster rate than the earnings on its assets during a period of
rising interest rates or to mitigate prepayment risk. In this way, the Company
may hedge as much of the interest rate risk as management determines is in the
best interests of the
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stockholders of the Company, given the cost of such hedging transactions and
the need to maintain the Company's status as a REIT. See "Certain Federal
Income Tax Considerations--General--Gross Income Tests." This determination
may result in management electing to have the Company bear a level of interest
rate risk that could otherwise be hedged when management believes, based on
all relevant facts, that bearing such risk is advisable.
The Company seeks to build a balance sheet and undertake an interest rate
risk management program which is likely, in management's view, to enable the
Company to generate positive earnings and maintain an equity liquidation value
sufficient to maintain operations given a variety of potentially adverse
circumstances. Accordingly, the hedging program addresses both income
preservation, as discussed in the first part of this section, and capital
preservation concerns. With regard to the latter, the Company monitors its
"duration." This is the expected percentage change in market value of the
Company's assets that would be caused by a 1% change in short and long term
interest rates. To monitor duration and the related risks of fluctuations in
the liquidation value of the Company's equity, the Company models the impact
of various economic scenarios on the market value of the Company's Mortgage-
Backed Securities, liabilities and interest rate agreements. See "Risk
Factors--Operations Risks--Interest Rate Fluctuations Could Cause a Decrease
in Net Interest Income." At June 30, 1997, the Company estimates that the
duration of the Company's assets was less than 1%. The Company believes that
the Company's interest rate risk management program will allow the Company to
maintain operations throughout a wide variety of potentially adverse
circumstances. Nevertheless, in order to further preserve the Company's
capital base (and lower its duration) during periods when management believes
a trend of rapidly rising interest rates has been established, management may
decide to enter into or increase hedging activities and/or sell assets. Each
of these types of actions may lower the earnings and dividends of the Company
in the short term in order to further the objective of maintaining attractive
levels of earnings and dividends over the long term.
The Company may elect to conduct a portion of its hedging operations through
one or more subsidiary corporations which would not be a Qualified REIT
Subsidiary and would be subject to Federal and state income taxes. In order to
comply with the nature of asset tests applicable to the Company as a REIT, the
value of the securities of any such subsidiary held by the Company must be
limited to less than 5% of the value of the Company's total assets as of the
end of each calendar quarter and no more than 10% of the voting securities of
any such subsidiary may be owned by the Company. See "Certain Federal Income
Tax Considerations--General--Asset Tests." A taxable subsidiary would not
elect REIT status and would distribute any net profit after taxes to the
Company and its other stockholders. Any dividend income received by the
Company from any such taxable subsidiary (combined with all other income
generated from the Company's assets, other than Qualified REIT Real Estate
Assets) must not exceed 25% of the gross income of the Company. See "Certain
Federal Income Tax Considerations--General--Gross Income Tests." Before the
Company forms any such taxable subsidiary corporation for its hedging
activities, the Company will obtain an opinion of counsel to the effect that
the formation and contemplated method of operation of such corporation will
not cause the Company to fail to satisfy the nature of assets and sources of
income tests applicable to it as a REIT.
The Company believes that it has developed a cost-effective asset/liability
management program to provide a level of protection against interest rate and
prepayment risks. However, no strategy can completely insulate the Company
from interest rate changes, prepayment risks and defaults by counter-parties.
Further, as noted above, certain of the Federal income tax requirements that
the Company must satisfy to qualify as a REIT limit the Company's ability to
fully hedge its interest rate and prepayment risks. The Company monitors
carefully, and may have to limit, its asset/liability management program to
assure that it does not realize excessive hedging income, or hold hedging
assets having excess value in relation to total assets, which would result in
the Company's disqualification as a REIT or, in the case of excess hedging
income, the payment of a penalty tax for failure to satisfy certain REIT
income tests under the Code, provided such failure was for reasonable cause.
See "Certain Federal Income Tax Considerations--General." 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.
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PREPAYMENT RISK MANAGEMENT
The Company seeks to minimize the effects of faster or slower than
anticipated prepayment rates through structuring a diversified portfolio with
a variety of prepayment characteristics, investing in Mortgage-Backed
Securities with prepayment prohibitions and penalties, investing in certain
Mortgage-Backed Security structures which have prepayment protections, and
balancing assets purchased at a premium with assets purchased at a discount.
Prepayment risk is monitored by management and the Board of Directors through
periodic review of the impact of a variety of prepayment scenarios on the
Company's revenues, net earnings, dividends, cash flow and net balance sheet
market value.
FUTURE REVISIONS IN POLICIES AND STRATEGIES
The Board of Directors has established the investment policies and operating
policies and strategies set forth in this Prospectus. The Board of Directors
has the power to modify or waive such policies and strategies without the
consent of the stockholders to the extent that the Board of Directors
determines that such modification or waiver is in the best interests of
stockholders. Among other factors, developments in the market which affect the
policies and strategies mentioned herein or which change the Company's
assessment of the market may cause the Board of Directors to revise the
Company's policies and strategies.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a
party or to which any property of the Company is subject.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME POSITION(S) HELD
---- ----------------
<S> <C>
Michael A. J. Farrell... Chairman of the Board, Chief Executive Officer and Director
Timothy J. Guba......... President, Chief Operating Officer and Director
Wellington J. St.
Claire................. Vice Chairman of the Board and Director
Kathryn F. Fagan........ Chief Financial Officer and Treasurer
Jennifer A. Stephens.... Secretary
Kevin P. Brady(2)(3).... Director
Spencer I. Browne(1)(3). Director
John S. Grace(3)........ Director
Jonathan D. Green(2)(3). Director
John A.
Lambiase(1)(2)(3)...... Director
Donnell A.
Segalas(1)(3).......... Director
</TABLE>
- --------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
(3) Independent Director.
Michael A. J. Farrell, age 46, was elected on December 5, 1996 to serve as
Chairman of the Board and Chief Executive Officer of the Company. Since July
1994, he has been the President and CEO of FIDAC. He is a member of the board
of directors of the U.S. Dollar Floating Rate Fund. Prior to founding FIDAC,
from February 1992 to July 1994, Mr. Farrell served as President of Citadel
Funding Corporation ("Citadel") during which time certain events occurred
which resulted in a proceeding by the DBCC against Citadel and certain of its
principals, including Mr. Farrell. See "--Involvement of Officers in Certain
Legal Proceedings." From April 1990 to January 1992, Mr. Farrell was a
Managing Director for Schroder Wertheim & Co. Inc. in the Fixed Income
Department. In addition to being the former Chairman of the Primary Dealers
Operations Committee of the Public Securities Association (from 1981 through
1985) and its Mortgage Backed Securities Division, he is a former member of
the Executive Committee of its Primary Dealers Division. Prior to his
employment with Schroder Wertheim, Mr. Farrell had been President of L.F.
Rothschild Mortgage Capital, Inc., Vice President of Trading at Morgan Stanley
and Co., Inc., and Senior Vice President of Merrill Lynch and Co., Inc. Mr.
Farrell began his career at E.F. Hutton and Company in 1971. Mr. Farrell has
25 years of experience in fixed income trading, management and operations.
Timothy J. Guba, age 39, was elected on December 5, 1996 to serve as
President, Chief Operating Officer and a director of the Company. Mr. Guba
joined FIDAC in March 1995 as a Senior Vice President, to assist FIDAC's
financial institutional clients with securities financing management. From
April 1991 to December 1994, Mr. Guba worked as a Vice President at Paine
Webber Inc. in its Taxable Fixed Income Department specializing in Mortgage-
Backed Securities. Mr. Guba was President of JPC Brokers Inc., a subsidiary of
Fundamental Brokers, from 1988 through 1991. He was responsible for a staff of
35 employees and a daily transactional volume of over $300 million in
Mortgage-Backed Securities. Mr. Guba was a Senior Vice President at L.F.
Rothschild Mortgage Capital from 1986 to 1988, specializing in trading of
mortgage pass-through certificates, where he established LF Rothschild as a
member in the FNMA and FHLMC selling groups. Mr. Guba began his career in 1980
at Morgan Guaranty Trust Company in the Treasurer's Department trading various
money market instruments. Mr. Guba has a BS in Finance and Business Management
from Cornell University.
Wellington J. St. Claire, age 33, was elected on December 5, 1996 to serve
as Vice Chairman of the Board, and a director of the Company with
responsibility for managing the portfolio of the Company. She has been
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<PAGE>
Senior Vice President of FIDAC since March 1995 and Treasurer since July 1994.
From July 1994 through March 1995, she was a Vice President of FIDAC. Ms. St.
Claire has been the portfolio manager for the Floating Rate Fund since its
inception in August 1994. Prior to joining FIDAC, from March 1992 to July
1994, Ms. St. Claire had been Vice President responsible for asset selection
and financing at Citadel Funding Corporation. Prior to joining Citadel she had
been a trader on the Mortgage-Backed Securities desk at Schroder Wertheim and
Co., Inc. She has attended the New York Institute of Finance for intense
Mortgage-Backed Securities studies.
Kathryn F. Fagan, age 30, was employed by the Company on March 31, 1997 in
the positions of Chief Financial Officer and Treasurer. From June 1, 1992 to
February 28, 1997, Ms. Fagan was Chief Financial Officer and Controller of
First Federal Savings & Loan Association of Opelousas, Louisiana. First
Federal is a publicly-owned savings and loan which converted to the stock form
of ownership during her employment period. Ms. Fagan's responsibilities at
First Federal included all financial reporting, including reports for internal
use and reports required by the Commission and the Office of Thrift
Supervision. Her duties also included asset/liability management, internal
control compliance and the management of First Federal's investment portfolio.
During the period from September 1988 to May 1992, Ms. Fagan was employed as a
bank and savings and loan auditor by John S. Dowling & Company, a corporation
of Certified Public Accountants. Ms. Fagan is a Certified Public Accountant
and has a Masters Degree in Business Administration.
Jennifer A. Stephens, age 26, was elected on December 5, 1996 to serve as
Secretary of the Company. She joined FIDAC at its inception in July 1994 and
became Vice President in March 1995. Ms. Stephens has been the assistant
portfolio manager for the U.S. Dollar Floating Rate Fund since its inception
in August 1994. She has designed several software systems for FIDAC including
portfolio management systems, mortgage-backed security pricing systems,
exposure reporting systems, and accounting systems. Prior to joining FIDAC,
she worked for Citadel Funding Corporation where she assisted in the
management of the funding of mortgage-backed security portfolios.
Kevin P. Brady, age 42, was elected on January 28, 1997 to serve as a
director of the Company. Mr. Brady is the principal of KPB Associates Inc., an
accounting firm which specializes in corporate taxation. Mr. Brady founded KPB
Associates Inc. in December 1993. From July 1986 through November 1993, Mr.
Brady worked for Price Waterhouse LLP in New York City where he specialized in
international tax structures and financial reporting and held a number of
senior management positions. Prior to joining Price Waterhouse LLP, Mr. Brady
worked in the corporate tax department of Merck & Co. Mr. Brady is a Certified
Public Accountant.
Spencer I. Browne, age 47, was elected on January 28, 1997 to serve as a
director of the Company. Mr. Browne has held various executive and management
positions with several publicly traded companies engaged in businesses related
to the residential and commercial mortgage loan industry. From August 1988
until September 1996, Mr. Browne served as President, Chief Executive Officer
and a director of Asset Investors Corporation ("AIC"), a New York Stock
Exchange traded company he co-founded in 1986. He also served as President,
Chief Executive Officer and a director of Commercial Assets, Inc., an American
Stock Exchange traded company affiliated with AIC, from its formation in
October 1993 until September 1996. In addition, from June 1990 until March
1996, Mr. Browne served as President and a director of M.D.C. Holdings, Inc.,
a New York Stock Exchange traded company and the parent company of a major
homebuilder in Colorado.
John S. Grace, age 39, was elected on June 26, 1997 to serve as a director
of the Company. For the past five years, Mr. Grace has been the Chairman of
Sterling Grace Corporation, Co-Chairman of Associated Asset Management, Inc.
and general partner of Anglo American Securities Fund, L.P. Mr. Grace is also
a director of the Cold Spring Harbor Laboratory Association, a genetic
research institute, and a director of Andersen Group, Inc. Mr. Grace has also
served as governor of the Foundation for Advanced Information and Research of
Tokyo, a research center whose membership includes senior executives from
Japanese companies, and as a trustee of the Ford Theater in Washington, D.C.
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<PAGE>
Jonathan D. Green, age 50, was elected on January 28, 1997 to serve as a
director of the Company. Mr. Green has been the President and Chief Executive
Officer of Rockefeller Center Management Corporation ("RCMC") and Rockefeller
Center Development Corporation ("RCDC"), subsidiaries of The Rockefeller Group
("RGI"), from July 1995 to the present. Mr. Green joined RGI in 1980 as
Assistant Vice President and Real Estate Counsel, was appointed Vice
President, Secretary and General Counsel in 1983, and was elected Chief
Corporate Officer in 1991. As President of RCMC, Mr. Green is responsible for
all aspects of RGI's real estate ownership and management interests in
Rockefeller Center in midtown Manhattan. As President of RCDC, Mr. Green
oversees RGI's real estate development projects including the International
Trade Center in Morris County, New Jersey and Rockefeller Plaza West in
midtown Manhattan. Before joining RGI, Mr. Green was affiliated with the New
York City law firm of Thacher, Proffitt & Wood.
John A. Lambiase, age 57, was elected on January 28, 1997 to serve as a
director of the Company. Mr. Lambiase was Managing Director in Global
Operations at Salomon Brothers from 1985 through his retirement in 1991. Mr.
Lambiase joined Salomon in 1979 as Director of Internal Audit. Mr. Lambiase
has served as Chairman of the Mortgage-Backed Securities Clearance
Corporation, a member of the board of directors of Prudential Home Mortgage
and a member of the Board of the National Securities Clearance Corporation,
and was a founding director and Chairman of the Participation Trust Company.
Mr. Lambiase also served on Salomon's Credit Committee. Prior to joining
Salomon, from 1972 through 1979, Mr. Lambiase was President of Loeb Rhodes
Wall Street Settlement Corporation with responsibility for securities
clearance of over 130 member firms. Prior to Loeb Rhodes, Mr. Lambiase had
been the Chief Financial Officer and a General Partner of W.E. Hutton. Mr.
Lambiase is a certified public accountant.
Donnell A. Segalas, age 40, was elected on January 28, 1997 to serve as a
director of the Company. Mr. Segalas is a Senior Partner of Beaconsfield
Capital, L.L.C., a cross border mergers and acquisitions and corporate
financial advisory firm which he co-founded in June 1997. Mr. Segalas is also
Managing Partner of Beaconsfield Partners, L.L.C., a wholly-owned subsidiary
of Beaconsfield Capital, which is engaged in private equity investing in the
United States and Mexico. Prior to his co-founding of Beaconsfield Capital and
Beaconsfield Partners, Mr. Segalas was a Managing Director at Rodman &
Renshaw, Inc. in the Mortgage-Backed Securities Department from 1994 to June
1997. In December 1995, Mr. Segalas was also given the additional
responsibility to manage Rodman & Renshaw's Structured Finance Group. From
1990 to 1994, Mr. Segalas served as Senior Vice President in the Mortgage-
Backed Securities Department at Tucker Anthony, Inc., where he co-managed the
firm's Structured Finance Group. Prior to that time, Mr. Segalas had been a
Senior Vice President at Smith Barney, Inc. and Corporate Vice President at
Drexel Burnham Lambert.
All directors are elected at each annual meeting of the Company's
stockholders for a term of one year, and hold office until their successors
are elected and qualified. All officers serve at the discretion of the Board
of Directors. The Company will pay an annual director's fee to each
Independent Director equal to $10,000 (assuming consummation of the Offering),
a fee of $500 for each meeting of the Board of Directors attended by each
Independent Director (or $250 for any meeting at which the Independent
Director participates by conference telephone call) and reimbursement of costs
and expenses of all directors for attending such meetings. Directors who are
officers of the Company do not receive an annual director's fee.
The Bylaws of the Company provide that, except in the case of a vacancy, a
majority of the members of the Board of Directors and of any committee of the
Board of Directors will at all times be Independent Directors. Vacancies
occurring on the Board of Directors among the Independent Directors will be
filled by a vote of a majority of the directors, including a majority of the
Independent Directors.
The Articles of Incorporation of the Company provide for the indemnification
of the directors and officers of the Company to the fullest extent permitted
by Maryland law. See "Description of Capital Stock--Indemnification." The
Articles of Incorporation of the Company also provide that the personal
liability of any director or officer of the Company to the Company or its
stockholders for money damages is limited to the fullest extent allowed by the
statutory or decisional law of the State of Maryland as amended or
interpreted. See "Description of Capital Stock--Limitation of Liability."
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<PAGE>
CERTAIN RELATIONSHIPS; CONFLICTS OF INTEREST
Michael Farrell, Chairman of the Board and Chief Executive Officer of the
Company, Timothy Guba, President and Chief Operating Officer of the Company,
Wellington St. Claire, Vice Chairman of the Board of the Company, and Jennifer
A. Stephens, Secretary of the Company, are actively involved in the management
of FIDAC. FIDAC is a registered investment adviser which, at June 30, 1997,
managed, assisted in managing or supervised approximately $500 million in
gross assets for a wide array of clients, of which, at such date,
approximately $250 million was managed on a discretionary basis. Michael
Farrell is a member of the Board of Directors of the Floating Rate Fund. FIDAC
is the investment adviser to the Floating Rate Fund. The executive officers of
the Company named above have performed and will continue to perform such
services for FIDAC, such institutional clients and the Floating Rate Fund;
however, such officers intend to continue to devote at least 90% of their time
to the business of the Company.
These responsibilities may create conflicts of interest if such members of
management are presented with corporate opportunities that may benefit both
the Company and the Floating Rate Fund and other clients for which FIDAC acts
as an investment adviser. In the event that an investment opportunity arises,
such investment will be allocated to the Company or another entity by
determining the entity or account for which such investment is most suitable.
In making such determination, management will consider the investment strategy
and guidelines of each entity or account with respect to acquisition of
assets, leverage, liquidity and other factors which management shall determine
appropriate.
Management believes that through the date hereof, because of the available
supply of Mortgage-Backed Securities, it has been able to acquire assets for
both the Company and FIDAC's clients which satisfy their respective investment
strategies. See "Business Strategy--Capital Investment Policy--Asset
Acquisitions." Any assets which constitute "Qualifying Interests" under the
Investment Company Act (pursuant to the current interpretation of the staff of
the Commission) are considered first for the Company's portfolio. See "Risk
Factors--Legal and Other Risks--Loss of Investment Company Act Exemption Would
Adversely Affect the Company." Any other investments, if there is a limited
supply of Mortgage-Backed Securities for acquisition, will be allocated
between the Company and FIDAC's clients in accordance with their respective
investment strategies. To the extent that such assets are equally suitable for
both the Company and FIDAC's clients, management would allocate such assets
pro rata based upon the amount of funds that each entity has available to
invest in the particular assets. On a quarterly basis, management will report
to one or more of the Independent Directors designated by the Company's audit
committee on the allocation of asset acquisitions between the Company and
FIDAC's clients. Such Independent Director or Directors will review such
assets acquisitions to ensure that they have been allocated on a fair and
reasonable basis.
Generally, under Maryland corporate law, a director of a corporation would
be required to first offer to the Company corporate opportunities learned of
solely as a result of his or her service as a member of the Board of
Directors. Maryland law provides further that in order for a contract or other
transaction between a corporation and any of its directors or in which a
director has a material financial interest not to be void or voidable: (i) the
contract or transaction must be fair and reasonable to the corporation; or
(ii) the fact of such interest must be disclosed or known to (a) the board or
committee that authorizes, approves or ratifies the contract or transaction
and such authorization, approval or ratification must be by a vote of the
majority of disinterested directors or (b) the stockholders entitled to vote
and the contract or transaction is authorized, approved and ratified by a
majority of the votes cast by disinterested stockholders entitled to vote.
It is the Company's policy that the approval of the Board of Directors (with
any interested director abstaining) is required for any director, officer,
security holder or affiliate of the Company (a) to engage for his or her own
account in realizing upon a corporate opportunity learned of solely as a
result of his or her service to or representation of the Company or (b) to
have any direct or indirect pecuniary interest in any investment to be
acquired or disposed of by the Company or in any transaction to which the
Company is a party or has an interest.
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<PAGE>
The Company shares with FIDAC office space and certain office expenses, such
as lease payments, utilities charges and ancillary services performed by
office personnel, at cost on a pro rata basis based on the relative use of
such facilities and services by the Company and FIDAC. The Independent
Directors will periodically review leases and other arrangements with FIDAC to
ensure that such arrangements are on an arm's-length basis and to ensure
compliance with the REIT Provisions of the Code.
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
The Company has entered into Employment Agreements with Mr. Farrell, Mr.
Guba and Ms. St. Claire. See "--Employment Agreements." The Employment
Agreements provide for annual salaries to Mr. Farrell, Mr. Guba and Ms. St.
Claire based upon the book value of the Company. Mr. Farrell's Employment
Agreement provides for an annual salary equal to .20% of the book value of the
Company, subject to a maximum per annum amount of $250,000; Mr. Guba's and Ms.
St. Claire's Employment Agreements provide for annual salaries equal to .17%
of the book value of the Company, subject to a maximum per annum amount of
$200,000. The Company's "book value" is defined in the Employment Agreements
as the aggregate amounts reported on the Company's balance sheet as
"Stockholders' Equity", excluding any adjustments for valuation reserves
(i.e., changes in the value of the Company's portfolio of investments as a
result of mark-to-market valuation changes). Base salary is determined
quarterly by the Board of Directors and upon the raising of additional equity.
The maximum salary caps may be raised at the discretion of the Compensation
Committee. Base salary can also be lowered at management's discretion based
upon the Company's cash flow needs. In addition, the Board of Directors has
established a bonus incentive compensation plan for executive officers of the
Company. This program permits the Board of Directors, in its discretion, to
award cash bonuses annually to executive officers of the Company.
On January 2, 1997, the Company granted to each of Mr. Farrell, Mr. Guba and
Ms. St. Claire incentive stock options to purchase 66,750 shares of Common
Stock at an exercise price of $4.00 per share, which options will vest in four
equal installments over a period of four years from the date of grant, subject
to the approval of the Board in its discretion each year. Any options which
have not vested during the four year period commencing from the date of grant
will vest automatically on the fourth anniversary of the date of grant. On
January 2, 1997, the Company also granted to other employees of the Company
incentive stock options to purchase, in the aggregate, 8,000 shares of Common
Stock at an exercise price of $4.00 per share, subject to the vesting
provisions described in this paragraph.
On January 21, 1997, the Company granted to each of Mr. Farrell, Mr. Guba
and Ms. St. Claire incentive stock options to purchase, at an exercise price
of $10.00 per share, a number of shares equal to the product of (i) 2% and
(ii) the number of shares of Common Stock sold in the Private Placement in
excess of 3,000,000 which, upon consummation of the Private Placement on
February 18, 1997, resulted in the grant to each of them of options to
purchase 12,000 shares of Common Stock. Such options are subject to the same
vesting provisions described in the preceding paragraph.
All of the foregoing options were granted pursuant to the Company's Long-
Term Stock Incentive Plan (the "Incentive Plan"). The Incentive Plan also
provides for the award of options to directors who are not officers or
employees of the Company upon their appointment to the Board of Directors and
on June 26 of each year. The Company may, from time to time, grant additional
stock options and other incentive compensation awards to some or all of the
Company's executive officers and employees pursuant to the Incentive Plan or
such other incentive compensation plan which may be adopted by the Company.
See "--Long-Term Stock Incentive Plan."
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with Mr. Farrell, Mr.
Guba and Ms. St. Claire. Each employment agreement provides for a term through
December 31, 1999 and will be automatically extended for an additional year at
the end of each year of the employment agreement, unless either party provides
a prescribed prior written notice to the contrary. Each employment agreement
provides for the initial annual base salary set
61
<PAGE>
forth under the caption "--Compensation of Directors and Executive Officers"
and for participation by the subject officer in the bonus incentive
compensation plan. Each employment agreement provides for the subject officer
to receive his or her base salary and bonus compensation to the date of the
termination of employment by reason of death, disability or resignation and to
receive base compensation to the date of the termination of employment by
reason of a termination of employment for cause as defined in the employment
agreement. Each employment agreement also provides for the subject officer to
receive, in the event that the Company terminates the subject officer's
employment without cause, or if the subject officer resigns for "good reason"
(as defined in the employment agreement, including the occurrence of a "Change
of Control" of the Company as defined in the employment agreement), an amount,
50% payable immediately and 50% payable in monthly installments over the
succeeding twelve months, equal to three times the greater of such officer's
combined maximum salary base and actual bonus compensation for the preceding
fiscal year or the average for the three preceding years of such officer's
combined actual base salary and bonus compensation, subject in each case to a
maximum amount of 1% of the Company's book equity value (exclusive of
valuation adjustments) and a minimum amount of $250,000. Section 280G of the
Code may limit the deductibility of such payments by the Company for Federal
income tax purposes. Each employment agreement also contains a "non-compete"
provision prohibiting the subject officer from managing, controlling,
participating in or operating a competing REIT for a period of one year
following termination of employment following the Company's termination of the
subject officer without cause or resignation of the subject officer for "good
reason" (including a "Change of Control"). Providing services to FIDAC and its
customers is expressly excluded from operation of the "non-compete" provision.
In addition, all outstanding options and Awards (see "--Long-Term Stock
Incentive Plan" below) granted to the subject officer under the Incentive Plan
shall immediately vest upon his or her termination without cause or
termination for "good reason" (including upon a "Change of Control"). "Change
of Control" for purposes of the agreements would include a merger or
consolidation of the Company, a sale of all or substantially all of the assets
of the Company, changes in the identity of a majority of the members of the
Board of Directors of the Company (other than due to the death, disability or
age of a director) or acquisitions of more than 9.8% of the combined voting
power of the Company's capital stock, subject to certain limitations. Each
agreement requires that the subject officer act in accordance with provisions
of Maryland law relating to corporate opportunities as described under the
caption "--Certain Relationships; Conflicts of Interest."
LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted the Incentive Plan to provide officers, directors
and other key employees and consultants of the Company with additional
incentives to exert their best efforts on behalf of the Company, to increase
their proprietary interest in the success of the Company, to award outstanding
performance, and to attract and retain executive personnel of outstanding
ability. The effective date of the Incentive Plan was January 2, 1997.
Awards under the Incentive Plan to officers and other key employees of, and
consultants to, the Company may be granted by the Compensation Committee of
the Board of Directors, which will administer the Incentive Plan. Awards under
the Incentive Plan may include: (i) options to purchase shares of Common
Stock, including incentive stock options, non-qualified stock options or both,
which options may contain automatic reload features; (ii) stock appreciation
rights, whether in conjunction with the grant of stock options or independent
of such grant, or stock appreciation rights that are only exercisable in the
event of a change in control of the Company (as defined in the Incentive Plan)
or upon other events; (iii) restricted stock, in which Common Stock is granted
to participants subject to restrictions on transferability and other
restrictions, which lapse over time; (iv) deferred stock, in which delivery of
Common Stock occurs upon expiration of a deferral period; (v) bonus stock,
consisting of a right to receive Common Stock in an amount determined with
reference to a fixed bonus amount; (vi) dividend equivalents, consisting of a
right to receive cash, other awards, or other property equal in value to
dividends paid with respect to a specified number of shares of Common Stock,
or other periodic payments; or (vii) other awards not otherwise provided for,
the value of which are based in whole or in part upon the value of the Common
Stock. The Compensation Committee is composed of three Independent Directors.
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<PAGE>
The Incentive Plan also provides that each person who becomes a director,
but who is not an officer or employee of the Company, upon appointment to the
Board of Directors will receive a non-discretionary automatic grant of non-
qualified stock options for the purchase of 5,000 shares of Common Stock,
which options shall vest in four equal installments over a period of four
years from the date of grant. Accordingly, on January 28, 1997, firm non-
employee directors of the Company were each granted options to purchase 5,000
shares of Common Stock at an exercise price of $10.00 per share, which options
will vest in four equal installments over a four-year period from the date of
grant and on June 26, 1997, a newly-appointed director was granted options to
purchase 5,000 shares of Common Stock at an exercise price of $10.00 per
share, which options also vest in four equal installments over a four-year
period. In addition, each non-employee director is entitled to receive on June
26 of each year that he or she serves as a director of the Company options to
purchase an additional 1,250 shares of Common Stock, which options shall vest
on the date of grant. Accordingly, on June 26, 1997, the six non-employee
directors of the Company were granted options to purchase an aggregate of
7,500 shares of Common Stock at an exercise price of $10.00 per share. The
exercise price for each share of Common Stock subject to the non-employee
directors' options is equal to the fair market value of the Common Stock on
the date the option is granted.
The flexible terms of the Incentive Plan are intended, among other things,
to permit the Compensation Committee of the Board of Directors, which
administers the Incentive Plan, to impose performance conditions with respect
to any award to officers and key employees, thereby requiring forfeiture of
all or a part of any award if performance objectives are not met, or linking
the time of exercisability or settlement of an award to the achievement of
performance conditions. Awards granted under the Incentive Plan are generally
not assignable or transferable except by the laws of descent and distribution.
The Compensation Committee has the authority under the Incentive Plan, among
other things, to: (i) select the officers and other key employees and
consultants entitled to receive awards under the Incentive Plan; (ii)
determine the form of awards, or combinations thereof, and whether such awards
are to operate on a tandem basis or in conjunction with other awards; (iii)
determine the number of shares of Common Stock or rights covered by an award;
and (iv) determine the terms and conditions of any awards granted under the
Incentive Plan, including, any restrictions or limitations on transfer, any
vesting schedules or the acceleration thereof, and any forfeiture or
termination provisions (or waivers thereof) including, but not limited to, in
connection with a determination that an Incentive Plan participant has been
terminated for cause (as defined in the Incentive Plan). Other than with
respect to the grant of non-discretionary stock options to non-employee
directors as described above, the exercise price at which shares of Common
Stock may be purchased pursuant to the grant of stock options under the
Incentive Plan is required to be determined by the Compensation Committee at
the time of grant in its discretion, which discretion includes the ability to
set an exercise price that is below the fair market value of the shares of
Common Stock covered by such grant at the time of grant. In addition, unless
otherwise provided by the Compensation Committee in an award agreement, all
restrictions relating to the continued performance of services and/or the
achievement of performance objectives will immediately lapse upon a change in
control of the Company.
Subject to anti-dilution provisions for stock splits, stock dividends and
similar events, the total number of shares of Common Stock that are reserved
and available for issuance under the Incentive Plan is the greater of 500,000
or 5% of the total number of shares of Common Stock outstanding on a fully
diluted basis, assuming, if applicable, the conversion of all warrants and
convertible securities into Common Stock. No awards may be granted under the
Incentive Plan to any person who, assuming exercise or settlement of all
options and rights held by such person, would own or be deemed to own more
than 9.8% in number of shares or value of any class of capital stock of the
Company.
The Incentive Plan may be amended, altered, suspended, discontinued, or
terminated by the Board of Directors without stockholder approval unless such
approval is required by law or regulation or under the rules of any stock
exchange or automated quotation system on which the Common Stock is then
listed or quoted.
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<PAGE>
INVOLVEMENT OF OFFICERS IN CERTAIN LEGAL PROCEEDINGS
On November 15, 1994, Citadel Funding Corporation ("Citadel") and certain of
its principals, including Michael A. J. Farrell (the "respondents"), entered
into a Decision and Order of Acceptance of Respondents' Offer of Settlement
(the "DBCC Settlement") with the National Association of Securities Dealers,
Inc. District Business Conduct Committee for District No. 3 (the "DBCC"),
pursuant to which the respondents consented to censure, a fine of $150,000
jointly and severally among the respondents and a thirty calendar day
suspension of Mr. Farrell from being associated with any member of the
National Association of Securities Dealers. The DBCC had alleged in its
complaint against the respondents that Citadel had failed to maintain the
minimum net capital required by Commission Rule 15c3-1 and that Mr. Farrell
had acted in a capacity which required registration as a general securities
principal prior to his qualification as such a principal. The disputed net
capital issue involved a determination as to whether Citadel was acting as
agent or principal in certain transactions and, consequently, whether Citadel
was required to maintain capital against such amounts.
In a statement of mitigating circumstances submitted to the DBCC,
respondents stated that the violations alleged in the DBCC complaint involved
complex and highly technical provisions of the Commission's net capital rule
and that Citadel had acted in reliance upon an opinion from the accounting
firm which it had retained that the transactions in question were not
principal transactions. The respondents further stated that no customer
suffered any harm as a result of any of the violations alleged by the DBCC and
that none of the respondents obtained any monetary benefit as a result of the
alleged violations. Subsequent to the DBCC Settlement, the respondents and
certain other principals of Citadel entered into a settlement agreement
whereby the accounting firm which had provided the opinion agreed to pay a
cash settlement to such respondents and principals.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information as of August 31, 1997,
relating to the beneficial ownership of the Common Stock by (i) all persons
known by the Company to beneficially own more than 5% of the outstanding
shares of the Common Stock, (ii) each executive officer and director of the
Company and (iii) all officers and directors of the Company as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
----------------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT
- ------------------------------------ -------------- -------------
<S> <C> <C>
Michael A. J. Farrell
Annaly Mortgage Management, Inc.
1500 Harbor Blvd.
Weehawken, NJ 07087.................... 45,000 1.2%
Timothy J. Guba
Annaly Mortgage Management, Inc.
1500 Harbor Blvd.
Weehawken, NJ 07087.................... 25,300 *
Wellington J. St. Claire
Annaly Mortgage Management, Inc.
1500 Harbor Blvd.
Weehawken, NJ 07087.................... 23,000 *
Kathryn F. Fagan
Annaly Mortgage Management, Inc.
1500 Harbor Blvd.
Weehawken, NJ 07087.................... 1,000 *
Kevin P. Brady
KPB Associates
12 Macatom Drive
Cranford, NJ 07016-1632................ 2,750(1) *
Spencer I. Browne
World Trade Center
650 South Cherry Street
Denver, CO 80222....................... 8,750(1) *
John S. Grace
55 Brookville Road
P.O. Box 163
Glen Head, NY 11545-0163............... 126,250(1)(2) 3.4%
Jonathan D. Green
Rockefeller Group
1230 Avenue of the Americas
5th Floor
New York, NY 10017..................... 3,750(1) *
John A. Lambiase
1489 Sweetbay Circle
Palm City, FL 34990.................... 11,250(1) *
Donnell A. Segalas
Village Road
New Vernon, NJ 07976................... 6,250(1) *
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
----------------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT
- ------------------------------------ -------------- -------------
<S> <C> <C>
Zweig-DiMenna Associates LLC
900 Third Avenue
30th Floor
New York, NY 10022......................... 205,000(3) 5.4%
Frorer Partners, L.P.
419 Hilbrook Road
Bryn Mawr, PA 19010(4)..................... 250,000 6.6%
Eaton Vance Total Return Portfolio
24 Federal Street
Boston, MA 02110-2512(5)................... 350,000 9.3%
Wellington Management Company, LLP
75 State Street
19th Floor
Boston, MA 02109........................... 350,000(6) 9.3%
Continental Casualty Company
667 Madison Avenue
7th Floor
New York, NY 10021-8087.................... 300,000 8.0%
Kramer Spellman, L.P.
2050 Center Avenue
Suite 300
Fort Lee, NJ 07024......................... 350,000(7) 9.3%
Boston Provident Partners, L.P.
c/o Kramer Spellman, L.P.
2050 Center Avenue
Suite 300
Fort Lee, NJ 07024......................... 210,000(7) 5.6%
All Executive Officers and Directors as a
Group (10 persons)......................... 253,300(1)(2) 6.7%
</TABLE>
- --------
* Represents beneficial ownership of less than one percent of the Common
Stock.
(1) Includes 1,250 shares of Common Stock subject to vested options granted
under the Company's Incentive Plan to each of the following non-employee
directors of the Company: Kevin P. Brady; Spencer I. Browne; John S.
Grace; Jonathan D. Green; John A. Lambiase and Donnell A. Segalas.
(2) Includes 35,000 shares held by Sterling Grace Capital Management, L.P.,
as to which Mr. Grace may be deemed to have sole voting and dispositive
power, and 35,000 shares held by Anglo-American Securities Fund, L.P.,
20,000 shares held by Drake Associates, L.P. and 10,000 shares held by
Diversified Long Term Growth Fund, L.P., as to which Mr. Grace may be
deemed to have shared voting and dispositive power. Mr. Grace disclaims
beneficial ownership of all shares held by such limited partnerships in
excess of his pecuniary interest.
(3) Includes 133,000 shares of Common Stock held by Zweig-DiMenna Partners,
L.P. ("ZD Partners") and 72,000 shares of Common Stock held by Zweig-
DiMenna Special Opportunities, L.P. ("ZD Opportunities"). Zweig-DiMenna
Associates LLC ("ZD Associates") is the general partner of ZD Partners
and ZD Opportunities and, therefore, may be deemed to have voting or
dispositive control of the shares held by ZD Partners and ZD
Opportunities. ZD Associates may be deemed to be affiliated with Zweig-
DiMenna International Managers, Inc. ("ZD International Managers") which
acts as investment manager to Zweig-DiMenna International Ltd. ("ZD
International"). ZD International also owns 145,000 shares of Common
Stock. ZD Associates and ZD International Managers may be deemed to have
voting or
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dispositive control of the shares held by ZD International. Each entity
disclaims beneficial ownership of all shares in excess of its pecuniary
interest.
(4) The general partners of Frorer Partners, L.P. are Frorer Capital
Management, Inc. and Peter H. Frorer. Each general partner disclaims
beneficial ownership in excess of its pecuniary interest.
(5) Eaton Vance Total Return Portfolio is a mutual fund managed by Eaton
Vance Management and, therefore, may be deemed to have voting or
dispositive control of the shares held by Eaton Vance Management.
(6) Wellington Management Company, LLP, ("WMC") is an investment adviser
registered with the Commission under the Investment Advisers Act of 1940,
as amended. WMC, in its capacity as investment adviser, may be deemed to
have beneficial ownership of 350,000 shares of Common Stock that are owned
by numerous investment advisory clients, only one of which, Bay Pond
Partners, L.P., is known to have such interest with respect to more than
5% of the class. WMC, in such capacity, has shared voting power with
respect to 325,500 shares of Common Stock and shared dispositive power
with respect to 350,000 shares of Common Stock.
(7) Kramer Spellman, L.P. serves as general partner to investment
partnerships, including Boston Provident Partners, L.P., and as
discretionary investment manager to managed accounts which, in the
aggregate, own 350,000 shares of Common Stock of the Company. 210,000 of
these 350,000 shares are owned by Boston Provident Partners, L.P. Orin S.
Kramer and Jay Spellman are the general partners of Kramer, Spellman,
L.P. Kramer Spellman, L.P. and Messrs. Kramer and Spellman disclaim
beneficial ownership of all shares held by any entity in excess of their
respective pecuniary interests.
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SELLING STOCKHOLDERS
The following table sets forth the name of each Selling Stockholder, the
aggregate number of shares of Common Stock beneficially owned by each Selling
Stockholder as of August 31, 1997, the aggregate number of shares of Common
Stock registered hereby that each Selling Stockholder is offering pursuant to
this Prospectus, and the aggregate number of shares of Common Stock that will
be beneficially owned by each Selling Stockholder after completion of the
Offering. All of the 845,000 shares of Common Stock offered by Selling
Stockholders are issued and outstanding as of the date of this Prospectus. To
the knowledge of the Company, none of the Selling Stockholders has had within
the past three years any material relationship with the Company or any of its
predecessors or affiliates.
<TABLE>
<CAPTION>
SHARES TO BE
SHARES OFFERED FOR THE SHARES
BENEFICIALLY SELLING BENEFICIALLY
OWNED PRIOR TO STOCKHOLDER'S OWNED AFTER
SELLING STOCKHOLDERS THE OFFERING ACCOUNT THE OFFERING
-------------------- -------------- --------------- ------------
<S> <C> <C> <C>
Argonaut Investment Fund Ltd....... 21,600 21,600 0
Argonaut Partnership, L.P.......... 58,500 58,500 0
CCC Designated Acct. High Yield.... 30,000 30,000 0
C.I. Global Financial Services
Sector............................ 100,000 100,000 0
Continental Casualty Company....... 270,000 270,000 0
Dawson Development Company LP...... 50,000 50,000 0
4-G Investment Group............... 20,000 20,000 0
Gerstentaber Investments, L.P...... 9,900 9,900 0
McColl Partners Limited
Partnership....................... 35,000 35,000 0
Rath Foundation, Inc............... 120,000 60,000 60,000
Turnberry Capital Management, L.P.. 50,000 50,000 0
Vauban Investissement, S.A......... 10,000 10,000 0
West Broadway Partners, LP......... 37,500 37,500 0
West Broadway Partners, Securities. 12,500 12,500 0
Wheaton Securities, Inc............ 5,000 5,000 0
Williamson Investors L.P........... 25,000 25,000 0
WRL Series Fund, Inc. Balanced
Portfolio......................... 50,000 50,000 0
------- ------- ------
Total............................. 905,000 845,000 60,000
======= ======= ======
</TABLE>
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CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The following discussion summarizes certain Federal income tax
considerations to the Company and the purchasers of the Common Stock. Although
the following summary does not purport to describe all of the tax
considerations that may be relevant to a prospective purchaser of Shares, in
the opinion of Morgan, Lewis & Bockius LLP, special tax counsel to the
Company, such summary describes the material United States Federal income tax
consequences to a holder of shares of Common Stock. Such summary also sets
forth the opinion of Morgan, Lewis & Bockius LLP on each material United
States Federal income tax consequence, and sets forth the basis for such
opinions. Such opinions are based upon existing United States Federal income
tax laws, regulations, administrative pronouncements and judicial decisions.
Opinions of tax counsel have no binding effect or official status of any kind,
and no assurance can be given that the conclusions set out below would be
sustained by a court if challenged by the IRS. This discussion does not
address tax considerations applicable to certain types of investors subject to
special treatment under the Federal income tax laws (including financial
institutions, insurance companies, broker-dealers and, except to the extent
discussed below, tax-exempt entities and foreign taxpayers) and it does not
discuss any aspects of state, local or foreign tax law. This discussion
assumes that investors will hold their Common Stock as a "capital asset"
(generally, property held for investment) under the Code. Prospective
investors are advised to consult their tax advisors as to the specific tax
consequences of purchasing, holding and disposing of the Common Stock,
including the application and effect of Federal, state, local and foreign
income and other tax laws.
The Company will elect to become subject to tax as a REIT, for Federal
income tax purposes, commencing with the taxable year ending December 31,
1997. The Board of Directors of the Company currently expects that the Company
will continue to operate in a manner that will permit the Company to maintain
its qualification as a REIT for the taxable year ending December 31, 1997, and
in each taxable year thereafter. This treatment will permit the Company to
deduct dividend distributions to its stockholders for Federal income tax
purposes, thus effectively eliminating the "double taxation" that generally
results when a corporation earns income and distributes that income to its
stockholders in the form of dividends.
In the opinion of Morgan, Lewis & Bockius LLP, special tax counsel to the
Company, the Company will meet the requirements for qualification as a REIT
under the Code commencing with the Company's taxable year ending December 31,
1997, and the Company's current and contemplated method of operation described
in this Prospectus and as represented by the Company will enable it to
continue to satisfy the requirements for such qualification. This opinion is
based on various assumptions relating to the organization and operation of the
Company and is conditioned upon certain representations made by the Company as
to certain factual matters. The continued qualification and taxation of the
Company as a REIT will depend upon the Company's ability to meet, on a
continuing basis, distribution levels and diversity of stock ownership, and
the various qualification tests imposed by the Code as discussed below. This
opinion is based on the law existing and in effect on the date hereof which is
subject to change, possibly retroactively.
There can be no assurance, however, that the Company will qualify as a REIT
in any particular taxable year, given the highly complex nature of the rules
governing REITs, the ongoing importance of factual determinations and the
possibility of future changes in the circumstances of the Company. If the
Company were not to qualify as a REIT in any particular year, it 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. In this event, the Company could be subject to potentially
substantial income tax liability in respect of each taxable year that it fails
to qualify as a REIT, and the amount of earnings and cash available for
distribution to its stockholders could be significantly reduced or eliminated.
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The following is a brief summary of certain technical requirements that the
Company must meet on an ongoing basis in order to qualify, and remain
qualified, as a REIT under the Code:
STOCK OWNERSHIP TESTS
(i) The capital stock of the Company must be transferable, (ii) the capital
stock of the Company must be held by at least 100 persons during at least 335
days of a taxable year of 12 months (or during a proportionate part of a
taxable year of less than 12 months), and (iii) no more than 50% of the value
of such capital stock may be owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include certain entities) at any time
during the last half of the taxable year. Tax-exempt entities, other than
private foundations, certain unemployment compensation trusts and certain
charitable trusts are generally not treated as individuals for these purposes.
The requirements of items (ii) and (iii) above are not applicable to the first
taxable year for which an election to be taxed as a REIT is made. However,
these stock ownership requirements must be satisfied in the Company's second
taxable year and in each subsequent taxable year. The Articles of
Incorporation provide restrictions regarding the transfer of the Company's
shares in order to aid in meeting the stock ownership requirements. See
"Description of Capital Stock--Restrictions on Ownership and Transfer."
ASSET TESTS
The Company must generally meet the following asset tests (the "REIT Asset
Tests") at the close of each quarter of each taxable year:
(a) at least 75% of the value of the Company's total assets must consist
of Qualified REIT Real Estate Assets, government securities, cash and cash
items (the "75% Asset Test"); and
(b) the value of securities held by the Company but not taken into
account for purposes of the 75% Asset Test must not exceed (i) 5% of the
value of the Company's total assets in the case of securities of any one
issuer, or (ii) 10% of the outstanding voting securities of any such
issuer.
At June 30, 1997, 100% of the Company's assets were Qualified REIT Real
Estate Assets. The Company expects that substantially all of its assets will
continue to be Qualified REIT Real Estate Assets. In addition, the Company
does not expect that the value of any security of any one entity would ever
exceed 5% of the Company's total assets, and the Company does not expect to
own more than 10% of any one issuer's voting securities.
The Company monitors closely the purchase, holding and disposition of its
assets in order to comply with the REIT Asset Tests. In particular, the
Company intends to limit and diversify its ownership of any assets not
qualifying as Qualified REIT Real Estate Assets to less than 25% of the value
of the Company's assets and to less than 5%, by value, of any single issuer.
If it is anticipated that these limits would be exceeded, the Company intends
to take appropriate measures, including the disposition of non-qualifying
assets, to avoid exceeding such limits.
GROSS INCOME TESTS
The Company must generally meet the following gross income tests (the "REIT
Gross Income Tests") for each taxable year:
(a) at least 75% of the Company's gross income must be derived from
certain specified real estate sources including interest income and gain
from the disposition of Qualified REIT Real Estate Assets or "qualified
temporary investment income" (i.e., income derived from "new capital"
within one year of the receipt of such capital) (the "75% Gross Income
Test");
(b) at least 95% of the Company's gross income for each taxable year must
be derived from sources of income qualifying for the 75% Gross Income Test,
dividends, interest, and gains from the sale of stock or other securities
(including certain interest rate swap and cap agreements entered into to
hedge variable rate debt incurred to acquire Qualified REIT Real Estate
Assets) not held for sale in the ordinary course of business (the "95%
Gross Income Test"); and
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(c) less than 30% of the Company's gross income is derived from the sale
of Qualified REIT Real Estate Assets held for less than four years, stock
or securities held for less than one year (including certain interest rate
swap and cap agreements entered into to hedge variable rate debt incurred
to acquire Qualified Real Estate Assets) and certain "dealer" property (the
"30% Gross Income Test"). Pursuant to recently enacted legislation, the 30%
Gross Income Test has been repealed for taxable years beginning after
August 5, 1997. See "--Recent Legislation."
The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions and sales of Mortgage-
Backed Securities, to comply with the REIT Gross Income Tests. In particular,
the Company will treat income generated by its interest rate caps and other
hedging instruments as non-qualifying income for purposes of the 95% Gross
Income Test unless it receives advice from its tax advisor that such income
constitutes qualifying income for purposes of such test. Under certain
circumstances, for example, (i) the sale of a substantial amount of Mortgage-
Backed Securities to repay borrowings in the event that other credit is
unavailable or (ii) an unanticipated decrease in the qualifying income of the
Company which may result in the non-qualifying income exceeding 5% of gross
income or a breach of the 30% Gross Income Test, the Company may be unable to
comply with certain of the REIT Gross Income Tests. See "--Taxation of the
Company" for a discussion of the tax consequences of failure to comply with
the REIT Provisions of the Code.
RECENT LEGISLATION
Under legislation which was enacted as part of the Taxpayer Relief Act of
1997, the 30% Gross Income Test has been repealed, facilitating disposition of
Qualified REIT Real Estate Assets or other stock or securities held by the
Company. In addition, the categories of hedges of the Company's liabilities
(incurred to acquire or carry Qualified REIT Real Estate Assets) which may
produce income or gain on sale qualifying under the 95% Gross Income Test has
been expanded to include options, futures contracts, forward rate agreements
or similar financial instruments. However, hedges of the Company's Qualified
REIT Real Estate Assets themselves would still not produce income qualifying
under either the 95% Gross Income Test or the 75% Gross Income Test, limiting
the Company's ability to hedge its interest rate and prepayment risks.
Under the recent legislation, a REIT may elect to retain, rather than
distribute, its net long-term capital gains and pay the tax on such gains,
while its stockholders include their proportionate share of the undistributed
long-term capital gains in income and receive a credit for their share of the
tax paid by the REIT.
This legislation is effective for taxable years of the Company beginning
after August 5, 1997.
DISTRIBUTION REQUIREMENT
The Company must generally distribute to its stockholders an amount equal to
at least 95% of the Company's REIT taxable income before deductions of
dividends paid and excluding net capital gain and certain non-cash income
(including original issue discount and cancellation of indebtedness income).
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, the Company will
generally not be subject to Federal income tax on that portion of its REIT
taxable income or capital gain which is distributed to its stockholders. The
Company will, however, be subject to Federal income tax at normal corporate
income tax rates upon any undistributed taxable income or capital gain.
Notwithstanding its qualification as a REIT, the Company may also be subject
to tax in certain other circumstances. If the Company fails to satisfy either
the 75% or the 95% Gross Income Test, but nonetheless maintains its
qualification as a REIT because certain other requirements are met, it will
generally be subject to a 100% tax on the greater of the amount by which the
Company fails either the 75% or the 95% Gross Income Test. The Company will
also be subject to a tax of 100% on net income derived from any "prohibited
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<PAGE>
transaction," and if the Company has (i) net income from the sale or other
disposition of "foreclosure property" which is held primarily for sale to
customers in the ordinary course of business or (ii) other non-qualifying
income from foreclosure property, it will be subject to Federal income tax on
such income at the highest corporate income tax rate. In addition, if the
Company fails to distribute during each calendar year at least the sum of (i)
85% of its REIT ordinary income for such year and (ii) 95% of its REIT capital
gain net income for such year, the Company would be subject to a 4% Federal
excise tax on the excess of such required distribution over the amounts
actually distributed during the taxable year, plus any undistributed amount of
ordinary and capital gain net income from the preceding taxable year. The
Company may also be subject to the corporate alternative minimum tax, as well
as other taxes in certain situations not presently contemplated.
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 (including any applicable alternative minimum tax) on its
taxable income at the regular corporate income tax rates. Distributions to
stockholders in any year in which the Company fails to qualify as a REIT would
not be deductible by the Company, nor would they generally be required to be
made under the Code. Further, unless entitled to relief under certain other
provisions of the Code, the Company would also be disqualified from re-
electing REIT status for the four taxable years following the year during
which it became disqualified.
The Company intends to monitor on an ongoing basis its compliance with the
REIT requirements described above. In order to maintain its REIT status, the
Company will be required to limit the types of assets that the Company might
otherwise acquire, or hold certain assets at times when the Company might
otherwise have determined that the sale or other disposition of such assets
would have been more prudent.
TAXABLE SUBSIDIARIES
Hedging activities and the creation of Mortgage-Backed Securities through
securitization may be done through a taxable subsidiary of the Company. The
Company and one or more other entities may form and capitalize one or more
taxable subsidiaries. In order to ensure that the Company would not violate
the more than 10% voting stock of a single issuer limitation described above,
the Company would own only nonvoting preferred and common stock and the other
entities would own all of the voting common stock. The value of the Company's
investment in such a subsidiary must also be limited to less than 5% of the
value of the Company's total assets at the end of each calendar quarter so
that the Company can also comply with the 5% of value, single issuer asset
limitation described above under "--General--Asset Tests." The taxable
subsidiary would not elect REIT status and would distribute only net after-tax
profits to its stockholders, including the Company. Before the Company engages
in any hedging or securitization activities or forms any such taxable
subsidiary corporation, the Company will obtain an opinion of its tax advisor
to the effect that such activities or the formation and contemplated method of
operation of such corporation will not cause the Company to fail to satisfy
the REIT Asset and REIT Gross Income Tests.
TAXATION OF STOCKHOLDERS; COMMON STOCK
Distributions (including constructive distributions) made to holders of
Common Stock, other than tax-exempt entities, will generally be subject to tax
as ordinary income to the extent of the Company's current and accumulated
earnings and profits as determined for Federal income tax purposes. If the
amount distributed exceeds a stockholder's allocable share of such earnings
and profits, the excess will be treated as a return of capital to the extent
of the stockholder's adjusted basis in the Common Stock, which will reduce the
stockholder's basis in the Common Stock but not be subject to tax, and
thereafter as a gain from the sale or exchange of a capital asset.
Distributions designated by the Company as capital gain dividends will
generally be subject to tax as long-term capital gain to stockholders, to the
extent that the distribution does not exceed the Company's actual net capital
gain for the taxable year. Distributions by the Company, whether characterized
as ordinary income or as capital gain, are not eligible for the corporate
dividends received deduction. In the event that the Company
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realizes a loss for the taxable year, stockholders will not be permitted to
deduct any share of that loss. Further, if the Company (or a portion of its
assets) were to be treated as a taxable mortgage pool, any "excess inclusion
income" that is allocated to a stockholder would not be allowed to be offset
by a net operating loss of such stockholder. See "Risk Factors--Legal and
Other Risks--Taxable Mortgage Pool Risk; Increased Taxation." Future Treasury
Department regulations may require that the stockholders take into account,
for purposes of computing their individual alternative minimum tax liability,
certain tax preference items of the Company.
Dividends declared during the last quarter of a taxable year and actually
paid during January of the following taxable year are generally treated as if
received by the stockholder on December 31 of the taxable year in which
declared and not on the date actually received. In addition, the Company may
elect to treat certain other dividends distributed after the close of the
taxable year as having been paid during such taxable year, but stockholders
will be treated as having received such dividend in the taxable year in which
the distribution is actually made.
Upon a sale or other disposition of the Common Stock, a stockholder will
generally recognize a capital gain or loss in an amount equal to the
difference between the amount realized and the stockholder's adjusted basis in
such stock, which gain or loss will be long-term if the stock has been held
for more than one year. Any loss on the sale or exchange of a share of Common
Stock held by a stockholder for six months or less will generally be treated
as a long-term capital loss to the extent of any long-term capital gain
dividends received by such stockholder with respect to such share of its
stock.
The Company is required under the Code to demand annual written statements
from the record holders of designated percentages of its capital stock
disclosing the actual and constructive ownership of such stock and to maintain
permanent records showing the information it has received as to the actual and
constructive ownership of such stock and a list of those persons failing or
refusing to comply with such demand.
In any year in which the Company does not qualify as a REIT, distributions
made to its stockholders would be taxable in the same manner discussed above,
except that no distributions could be designated as capital gain dividends,
distributions would be eligible for the corporate dividends received
deduction, the excess inclusion income rules would not apply to the
stockholders, and stockholders would not receive any share of the Company's
tax preference items. In such event, however, the Company could be subject to
potentially substantial Federal income tax liability, and the amount of
earnings and cash available for distribution to its stockholders could be
significantly reduced or eliminated.
TAXATION OF TAX-EXEMPT ENTITIES
Subject to the discussion below regarding a "pension-held REIT," a tax-
exempt stockholder is generally not subject to tax on distributions from the
Company or gain realized on the sale of the Common Stock, provided that such
stockholder has not incurred indebtedness to purchase or hold its Common
Stock, that its shares are not otherwise used in an unrelated trade or
business of such stockholder, and that the Company, consistent with its
present intent, does not hold a residual interest in a REMIC that gives rise
to "excess inclusion" income as defined under section 860E of the Code. If the
Company were to be treated as a "taxable mortgage pool," however, a
substantial portion of the dividends paid to a tax-exempt stockholder may be
subject to tax as UBTI. Although the Company does not believe that the
Company, or any portion of its assets, will be treated as a taxable mortgage
pool, no assurance can be given that the IRS might not successfully maintain
that such a taxable mortgage pool exists. See "Risk Factors--Legal and Other
Risks--Taxable Mortgage Pool Risk; Increased Taxation."
If a qualified pension trust (i.e., any pension or other retirement trust
that qualifies under section 401(a) of the Code) holds more than 10% by value
of the interests in a "pension-held REIT" at any time during a taxable year, a
substantial portion of the dividends paid to the qualified pension trust by
such REIT may constitute UBTI. For these purposes, a "pension-held REIT" is
any REIT (i) that would not have qualified as a REIT but for the provisions of
the Code which look through qualified pension trust stockholders to the
qualified pension trust's
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beneficiaries in determining ownership of stock of the REIT and (ii) in which
at least one qualified pension trust holds more than 25% by value of the
interests of such REIT or one or more qualified pension trusts (each owning
more than a 10% interest by value in the REIT) hold in the aggregate more than
50% by value of the interests in such REIT. Assuming compliance with the
Ownership Limit provisions described in "Description of Capital Stock--
Restrictions on Ownership and Transfer," it is unlikely that pension plans
will accumulate sufficient stock to cause the Company to be treated as a
pension-held REIT.
Distributions to certain types of tax-exempt stockholders exempt from
Federal income taxation under sections 501 (c) (7), (c) (9), (c) (17), and (c)
(20) of the Code may also constitute UBTI, and such prospective investors
should consult their tax advisors concerning the applicable "set aside" and
reserve requirements.
STATE AND LOCAL TAXES
The Company and its stockholders may be subject to state or local taxation
in various jurisdictions, including those in which it or they transact
business or reside. The state and local tax treatment of the Company and its
stockholders may not conform to the Federal income tax consequences discussed
above. Consequently, prospective stockholders should consult their own tax
advisors regarding the effect of state and local tax laws on an investment in
the Common Stock.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS
The following discussion summarizes certain United States Federal tax
consequences of the acquisition, ownership and disposition of the Common Stock
by a purchaser of the Common Stock that, for United States Federal income tax
purposes, is not a "United States person" (a "Non-United States Holder"). For
purposes of this discussion, a "United States person" means: a citizen or
resident of the United States; a corporation, partnership, or other entity
created or organized in the United States or under the laws of the United
States or of any political subdivision thereof; or an estate or trust whose
income is includible in gross income for United States Federal income tax
purposes regardless of its source. This discussion does not consider any
specific facts or circumstances that may apply to a particular Non-United
States Holder. Prospective investors are urged to consult their tax advisors
regarding the United States Federal tax consequences of acquiring, holding and
disposing of Common Stock, as well as any tax consequences that may arise
under the laws of any foreign, state, local or other taxing jurisdiction.
DIVIDENDS
Dividends paid by the Company out of earnings and profits, as determined for
United States Federal income tax purposes, to a Non-United States Holder will
generally be subject to withholding of United States Federal income tax at the
rate of 30%, unless reduced or eliminated by an applicable tax treaty or
unless such dividends are treated as effectively connected with a United
States trade or business. Distributions paid by the Company in excess of its
earnings and profits will be treated as a tax-free return of capital to the
extent of the holder's adjusted basis in his Common Stock, and thereafter as
gain from the sale or exchange of a capital asset as described below. If it
cannot be determined at the time a distribution is made whether such
distribution will exceed the earnings and profits of the Company, the entire
distribution will be subject to withholding at the same rate as dividends.
Amounts so withheld, however, will be refundable or creditable against the
Non-United States Holder's United States Federal tax liability if it is
subsequently determined that such distribution was, in fact, in excess of the
earnings and profits of the Company. If the receipt of the dividend is treated
as being effectively connected with the conduct of a trade or business within
the United States by a Non-United States Holder, the dividend received by such
holder will be subject to the United States Federal income tax on net income
that applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits tax).
GAIN ON DISPOSITION
A Non-United States Holder will generally not be subject to United States
Federal income tax on gain recognized on a sale or other disposition of the
Common Stock unless (i) the gain is effectively connected with
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the conduct of a trade or business within the United States by the Non-United
States Holder, (ii) in the case of a Non-United States Holder who is a
nonresident alien individual and holds the Common Stock as a capital asset,
such holder is present in the United States for 183 or more days in the
taxable year and certain other requirements are met, or (iii) the Non-United
States Holder is subject to tax under the FIRPTA rules discussed below. Gain
that is effectively connected with the conduct of a trade or business within
the United States by a Non-United States Holder will be subject to the United
States Federal income tax on net income that applies to United States persons
generally (and, with respect to corporate holders and under certain
circumstances, the branch profits tax) but will not be subject to withholding.
Non-United States Holders should consult applicable treaties, which may
provide for different rules.
The Company does not expect to hold assets that would be treated as "United
States real property interests" under the provisions of the Foreign Investment
in Real Property Tax Act of 1980 ("FIRPTA"). Therefore, the FIRPTA provisions
relating to certain distributions to foreign persons and to certain gains
realized by foreign persons on the sale of stock should not apply to non-
United States Holders of the Common Stock.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Under temporary United States Treasury regulations, United States
information reporting requirements and backup withholding tax will generally
not apply to dividends paid on the Common Stock to a Non-United States Holder
at an address outside the United States. Payments by a United States office of
a broker of the proceeds of a sale of the Common Stock is subject to both
backup withholding at a rate of 31% and information reporting unless the
holder certifies its Non-United States Holder status under penalties of
perjury or otherwise establishes an exemption. Information reporting
requirements (but not backup withholding) will also apply to payments of the
proceeds of sales of the Common Stock by foreign offices of United States
brokers, or foreign brokers with certain types of relationships to the United
States, unless the broker has documentary evidence in its records that the
holder is a Non-United States Holder and certain other conditions are met, or
the holder otherwise establishes an exemption.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be refunded or credited against the Non-United
States Holder's United States Federal income tax liability, provided that the
required information is furnished to the Internal Revenue Service.
These information reporting and backup withholding rules are under review by
the United States Treasury and their application to the Common Stock could be
changed by future regulations.
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ERISA CONSIDERATIONS
The following is a summary of material considerations arising under the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the
prohibited transaction provisions of Section 4975 of the Code that may be
relevant to a prospective purchaser of the Shares. The discussion does not
purport to deal with all aspects of ERISA or Section 4975 of the Code that may
be relevant to particular stockholders (including plans subject to Title I of
ERISA, other retirement plants and IRAs subject to the prohibited transaction
provisions of Section 4975 of the Code, and governmental plans or church plans
that are exempt from ERISA and Section 4975 of the Code but that may be
subject to state law requirements) in light of their particular circumstances.
The discussion is based on current provisions of ERISA and the Code,
existing and currently proposed regulations under ERISA and the Code, the
legislative history of ERISA and the Code, existing administrative rulings of
the Department of Labor ("DOL") and reported judicial decisions. No assurance
can be given that legislative, judicial, or administrative changes will not
affect the accuracy of any statements herein with respect to transactions
entered into or contemplated prior to the effective date of such changes.
A FIDUCIARY MAKING THE DECISION TO INVEST IN SHARES ON BEHALF OF A
PROSPECTIVE PURCHASER THAT IS AN EMPLOYEE BENEFIT PLAN, A TAX-QUALIFIED
RETIREMENT PLAN OR AN IRA SHOULD CONSULT ITS OWN LEGAL ADVISOR REGARDING THE
SPECIFIC CONSIDERATIONS ARISING UNDER ERISA, SECTION 4975 OF THE CODE AND
STATE LAW WITH RESPECT TO THE PURCHASE, OWNERSHIP OR SALE OF THE COMMON STOCK
BY SUCH PLAN OR IRA.
EMPLOYEE BENEFIT PLANS, TAX-QUALIFIED RETIREMENT PLANS AND IRAS
Each fiduciary of a pension, profit-sharing, retirement or other employee
benefit plan (a "Plan") subject to Title I of ERISA should consider carefully
whether an investment in Shares is consistent with the fiduciary's fiduciary
responsibilities under ERISA. In particular, the fiduciary requirements of
Part 4 of Title I of ERISA require a Plan's investment to be (i) prudent and
in the best interests of the Plan, its participants and its beneficiaries,
(ii) diversified in order to minimize the risk of large losses, unless it is
clearly prudent not to do so, and (iii) authorized under the terms of the
Plan's governing documents (provided the documents are consistent with ERISA).
In determining whether an investment in all Shares is prudent for purposes of
ERISA, the appropriate fiduciary of a Plan should consider all of the facts
and circumstances, including whether the investment is reasonably designed, as
a part of the Plan's portfolio for which the fiduciary has investment
responsibility, to meet the objectives of the Plan, taking into consideration
the risk of loss and opportunity for gain (or other return) from the
investment and the diversification, cash flow and funding requirements of the
Plan's portfolio. A fiduciary also should take into account the nature of the
Company's business, the management of the Company, the length of the Company's
operating history and the fact that certain investment assets may not have
been identified yet.
The fiduciary of an IRA or of a qualified retirement plan not subject to
Title I of ERISA because it is a governmental or church plan or because it
does not cover common law employees (a "Non-ERISA Plan") should consider that
such an IRA or Non-ERISA Plan may only make investments that are authorized by
the appropriate governing documents and under applicable state law.
Fiduciaries of Plans and persons making the investment decision for an IRA
or other Non-ERISA Plan should consider the application of the prohibited
transaction provisions of ERISA and the Code in making their investment
decision. A "party in interest" or "disqualified person" with respect to a
Plan or with respect to a Plan or IRA subject to Code Section 4975 is subject
to (i) an initial 10% excise tax on the amount involved in any prohibited
transaction involving the assets of the Plan or IRA and (ii) an excise tax
equal to 100% of the amount involved if any prohibited transaction is not
corrected. If the disqualified person who engages in the transaction is the
individual on behalf of whom an IRA is maintained (or his beneficiary), the
IRA will lose its tax-exempt status and its assets will be deemed to have been
distributed to such individual in a taxable
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distribution (and no excise tax will be imposed) on account of the prohibited
transaction. In addition, a fiduciary who permits a Plan to engage in a
transaction that the fiduciary knows or should know is a prohibited
transaction may be liable to the Plan for any loss the Plan incurs as a result
of the transaction or for any profits earned by the fiduciary in the
transaction.
STATUS OF THE COMPANY UNDER ERISA
The following section discusses certain principles that apply in determining
whether the fiduciary requirements of ERISA and the prohibited transaction
provisions of ERISA and the Code apply to an entity because one or more
investors in the equity interests of the entity is a Plan or is a Non-ERISA
Plan or IRA subject to Section 4975 of the Code. A Plan fiduciary also should
consider the relevance of those principles to ERISA's prohibition on improper
delegation of control over or responsibility for "plan assets" and ERISA's
imposition of co-fiduciary liability on a fiduciary who participates in,
permits (by action or inaction) the occurrence of, or fails to remedy a known
breach by another fiduciary.
If the assets of the Company are deemed to be "plan assets" under ERISA, (i)
the prudence standards and other provisions of Part 4 of Title I of ERISA
would be applicable to any transactions involving the Company's assets, (ii)
persons who exercise any authority over the Company's assets, or who provide
investment advice to the Company, would (for purposes of the fiduciary
responsibility provisions of ERISA) be fiduciaries of each Plan that acquires
Common Stock, and transactions involving the Company's assets undertaken at
their direction or pursuant to their advice might violate their fiduciary
responsibilities under ERISA, especially with regard to conflicts of interest,
(iii) a fiduciary exercising investment discretion over the assets of a Plan
to cause it to acquire or hold the Shares could be liable under Part 4 of
Title I of ERISA for transactions entered into by the Company that do not
conform to ERISA standards of prudence and fiduciary responsibility, and (iv)
certain transactions that the Company might enter into in the ordinary course
of its business and operations might constitute "prohibited transactions"
under ERISA and the Code.
Regulations of the DOL defining "plan assets" (the "Plan Asset Regulations")
generally provide that when a Plan or Non-ERISA Plan or IRA acquires a
security that is an equity interest in an entity and the security is neither a
"public-offered security" nor a security issued by an investment company
registered under the Investment Company Act of 1940, the Plan's or IRA's
assets include both the equity interest and an undivided interest in each of
the underlying assets of the issuer of such equity interest, unless one or
more exceptions specified in the Plan Asset Regulations are satisfied.
The Plan Asset Regulations define a publicly-offered security as a security
that is "widely-held," "freely transferable," and either part of a class of
securities under the Exchange Act, or sold pursuant to an effective
registration statement under the Securities Act (provided the securities are
registered under the Exchange Act within 120 days after the end of the fiscal
year of the issuer during which the offering occurred). The Shares are being
sold in an offering registered under the Securities Act and will be registered
under the Exchange Act. The Plan Asset Regulations provide that a security is
"widely held" only if it is part of a class of securities that is owned by 100
or more investors independent of the issuer and of one another. A security
will not fail to be widely held because the number of independent investors
falls below 100 subsequent to the initial public offering as a result of
events beyond the issuer's control. The Company anticipates that upon
completion of the Offering, the Common Stock will be "widely held."
The Plan Asset Regulations provide that whether a security is "freely
transferable" is a factual question to be determined on the basis of all
relevant facts and circumstances. The Plan Asset Regulations further provide
that where a security is part of an offering in which the minimum investment
is $10,000 or less (as is the case with the Offering), certain restrictions
ordinarily will not, alone or in combination, affect a finding that such
securities are freely transfer able. Generally, the restrictions on transfer
enumerated in the Plan Asset Regulations as not affecting that finding
include, among others: (i) any restriction on or prohibition against any
transfer or assignment that would result in the termination or
reclassification of an entity for federal or state tax purposes, or that
otherwise would violate any federal or state law or court order, (ii) any
requirement that advance notice
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of a transfer or assignment be given to the issuer, (iii) any administrative
procedure that establishes an effective date, or an event (such as completion
of an offering), prior to which a transfer or assignment will not be
effective, and (iv) limitation or restriction on transfer or assignment that
is not imposed by the issuer or a person acting on behalf of the issuer. The
Company believes that the restrictions imposed under the Articles of
Incorporation on the transfer of the Company's stock will not result in the
failure of the Shares to be "freely transferable." However, no assurance can
be given that the DOL or the Treasury Department will not reach a contrary
conclusion.
Assuming that the Common Stock will be "widely held" and that no other facts
and circumstances other than those referred to in the preceding paragraph
exist that restrict transferability of the Shares, the Shares should be
publicly offered securities and the assets of the Company should not be deemed
to be "plan assets" of any Plan, IRA or Non-ERISA Plan that invests in the
Shares.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company consists of 100,000,000 shares
of Common Stock. Assuming the sale by the Company of 6,250,000 Shares in the
Offering, 10,017,800 shares of Common Stock will be outstanding upon
consummation of the Offering.
COMMON STOCK
VOTING
Each holder of Common Stock is entitled to one vote for each share held of
record on each matter submitted to a vote of holders of Common Stock of the
Company. The Company's Articles of Incorporation do not provide for cumulative
voting and, accordingly, the holders of a majority of the outstanding shares
of Common Stock have the power to elect all directors to be elected each year.
The Company's bylaws provide that annual meetings of the stockholders of the
Company are to be held each calendar year on such date as shall be determined
by the Board of Directors or the President, and special meetings may be called
by a majority of the Board of Directors, by the Chairman of the Board of
Directors, by a majority of the Independent Directors, by the President or
generally by stockholders entitled to cast at least 25% of the votes which all
stockholders are entitled to cast at the meeting. The Articles of
Incorporation of the Company may be amended in accordance with Maryland law,
subject to certain limitations set forth in the Articles of Incorporation.
DIVIDENDS; LIQUIDATION; OTHER RIGHTS
The holders of shares of Common Stock are entitled to receive dividends
when, as, and if declared by the Board of Directors out of funds legally
available therefor. The right of holders of Common Stock to receive dividends
shall be subject and subordinate to the rights of holders of preferred stock
or other senior stock as may be authorized by the Company. In the event of
liquidation, dissolution or winding up of the Company, the holders of Common
Stock will share ratably in all assets of the Company remaining after the
payment of liabilities and the payment of all liquidation and other preference
amounts to holders of such classes of preferred stock or other senior stock as
may be authorized by the Company. There are no preemptive or other
subscription rights, conversion rights, or redemption or sinking fund
provisions with respect to shares of Common Stock.
RESTRICTIONS ON OWNERSHIP AND TRANSFER
In order that the Company may meet the requirements for qualification as a
REIT, the Articles of Incorporation prohibit any person from acquiring or
holding, directly or constructively, ownership of a number of shares of
capital stock in excess of 9.8% (the "Ownership Limit") of the outstanding
shares. See "Certain Federal Income Tax Considerations--General--Stock
Ownership Tests." For this purpose the term "ownership" generally means either
direct ownership or constructive ownership in accordance with the constructive
ownership provisions of section 544 of the Code.
The constructive ownership provisions of section 544 of the Code, generally
attribute ownership of securities owned by a corporation, partnership, estate
or trust proportionately to its stockholders, partners or beneficiaries;
attribute ownership of securities owned by family members to other members of
the same family; and set forth rules as to when securities constructively
owned by a person are considered to be actually owned for the application of
such attribution provisions (i.e., "reattribution"). For purposes of
determining whether a person holds or would hold capital stock in excess of
the Ownership Limit, a person will thus be treated as owning not only shares
of capital stock actually owned, but also any shares of capital stock
attributed to such person under the attribution rules described above.
Accordingly, a person who individually owns less than 9.8% of the shares
outstanding may nevertheless be in violation of the Ownership Limit.
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Any transfer of shares of capital stock that would result in
disqualification of the Company as a REIT or that would (a) create a direct or
constructive ownership of shares of capital stock in excess of the Ownership
Limit, or (b) from and after the One Hundred Stockholder Date, result in the
shares of capital stock being beneficially owned (within the meaning of
section 856(a) of the Code) by fewer than 100 persons (determined without
reference to any rules of attribution), or (c) result in the Company being
"closely held" within the meaning of section 856(h) of the Code, will be null
and void, and the intended transferee (the "purported transferee") will
acquire no rights to such shares. The foregoing restrictions on
transferability and ownership will not apply if the Board of Directors
determines that it is no longer in the best interests of the Company to
continue to qualify as a REIT.
Any purported transfer of shares of capital stock that would result in a
purported transferee owning (directly or constructively) shares of capital
stock in excess of the Ownership Limit (except as otherwise waived by the
Board of Directors as set forth below) due to the unenforceability of the
transfer restrictions set forth above will constitute "Excess Securities."
Excess Securities be transferred by operation of law to a trust to be
established by the Company for the exclusive benefit of a charitable
organization, until such time as the trustee of the trust, which shall be a
banking institution designated as trustee by the Company which is unaffiliated
with either the Company or the purported transferee, retransfers the Excess
Securities. While the Excess Securities are held in trust, the purported
transferee will not be entitled to vote or to share in any dividends or other
distributions with respect to such securities. Subject to the Ownership Limit,
Excess Securities may be transferred by the trust to any person (if such
transfer would not result in Excess Securities) at a price not to exceed the
price paid by the purported transferee (or, if no consideration was paid by
the purported transferee, the fair market value of the Excess Securities on
the date of the purported transfer), at which point the Excess Securities will
automatically cease to be Excess Securities.
From and after a purported transfer of Excess Securities, the purported
transferee shall cease to be entitled to distributions, voting rights and
other benefits with respect to such shares of the capital stock except the
right to payment of the purchase price for the shares of capital stock or the
retransfer of securities as provided above. Any dividend or distribution paid
to a purported transferee on Excess Securities prior to the discovery by the
Company that such shares of capital stock have been transferred in violation
of the provisions of the Company's Articles of Incorporation shall be repaid
to the Company upon demand. If the foregoing transfer restrictions are
determined to be void, invalid or unenforceable by a court of competent
jurisdiction, then the purported transferee of any Excess Securities may be
deemed, at the option of the Company, to have acted as an agent on behalf of
the Company in acquiring such Excess Securities and to hold such Excess
Securities on behalf of the Company.
All certificates representing shares of capital stock will bear a legend
referring to the restrictions described above.
Any person who acquires shares in violation of the Articles of
Incorporation, or any person who is a purported transferee such that Excess
Securities results, must immediately give written notice or, in the event of a
proposed or attempted transfer that would be void as set forth above, give at
least 15 days prior written notice to the Company of such event and shall
provide to the Company such other information as the Company may request in
order to determine the effect, if any, of such transfer on the Company's
status as a REIT. In addition, every record owner of more than 5.0% (during
any period in which the number of stockholders of record is 2,000 or more) or
1.0% (during any period in which the number of stockholders of record is
greater than 200 but less than 2,000) or 1/2% (during any period in which the
number of stockholders is 200 or less) of the number or value of the
outstanding shares of capital stock of the Company must give an annual written
notice to the Company by January 31, stating the name and address of the
record owner, the number of shares held and describing how such shares are
held. Further, each stockholder shall upon demand be required to disclose to
the Company in writing such information with respect to the direct and
constructive ownership of shares of capital stock as the Board of Directors
deems reasonably necessary to comply with the REIT Provisions of the Code, to
comply with the requirements of any taxing authority or governmental agency or
to determine any such compliance.
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Subject to certain limitations, the Board of Directors may increase or
decrease the Ownership Limit. In addition, to the extent consistent with the
REIT Provisions of the Code, the Board of Directors has the right, pursuant to
the Company's Articles of Incorporation, to waive the Ownership Limit for and
at the request of a purchaser of the Company's Common Stock. In connection
with any such waiver, the Company may require that the stockholder requesting
such a waiver enter into an agreement with the Company providing for the
repurchase by the Company of shares from the stockholder under certain
circumstances to ensure compliance with the REIT Provisions of the Code. Such
repurchase would be at fair market value as set forth in the agreement between
the Company and such stockholder. The consideration received by the
stockholder in such repurchase might be characterized as the receipt by the
stockholder of a dividend from the Company, and any stockholder entering into
such an agreement with the Company should consult its tax advisor in
connection with its entering into such an agreement. At present, the Company
does not intend to waive the Ownership Limit for any purchaser of shares of
the Company's Common Stock.
The provisions described above may inhibit market activity and the resulting
opportunity for the holders of the Company's capital stock to receive a
premium for their shares that might otherwise exist in the absence of such
provisions. Such provisions also may make the Company an unsuitable investment
vehicle for any person seeking to obtain ownership of more than 9.8% of the
outstanding shares of capital stock.
INDEMNIFICATION
The Company's Articles of Incorporation obligate the Company to indemnify
its directors and officers and to pay or reimburse expenses for such
individuals in advance of the final disposition of a proceeding to the maximum
extent permitted from time to time by Maryland law. The Corporations and
Associations Article of the Annotated Code of Maryland (the "Maryland General
Corporation Law") permits a corporation to indemnify its present and former
directors and officers, among others, against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by them in connection
with any proceeding to which they may be made a party by reason of their
service in those or other capacities, unless it is established that (a) the
act or omission of the director or officer was material to the matter giving
rise to the proceeding and (i) was committed in bad faith, or (ii) was the
result of active and deliberate dishonesty, or (b) the director or officer
actually received an improper personal benefit in money, property or services,
or (c) in the case of any criminal proceeding, the director or officer had
reasonable cause to believe that the act or omission was unlawful.
LIMITATION OF LIABILITY
The Maryland General Corporation Law permits the charter of a Maryland
corporation to include a provision limiting the liability of its directors and
officers to the corporation and its stockholders for money damages, except to
the extent that (i) it is proved that the person actually received an improper
benefit or profit in money, property or services, or (ii) a judgment or other
final adjudication is entered in a proceeding based on a finding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's Articles of Incorporation contain a provision
providing for elimination of the liability of its directors and officers to
the Company or its stockholders for money damages to the maximum extent
permitted by Maryland law from time to time.
CONTROL SHARE ACQUISITIONS
The Maryland General Corporation Law provides that "control shares" of a
corporation acquired in a "control share acquisition" have no voting rights
except to the extent approved by a vote of two-thirds of the votes entitled to
be cast on the matter, excluding shares of stock owned by the acquiror or by
officers or directors who are employees of the corporation. "Control shares"
are voting shares of stock which, if aggregated with all other shares of stock
previously acquired by such a person, would entitle the acquiror to exercise
voting power in electing directors within one of the following ranges of
voting power: (i) one-fifth or more but less than one-third, (ii) one-third or
more but less than a majority, or (iii) a majority or more of all voting
power. "Control shares" do not include shares of stock the acquiring person is
then entitled to vote as a result of having
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previously obtained stockholder approval. A "control share acquisition" means,
subject to certain exceptions, the acquisition of, ownership of, or the power
to direct the exercise of voting power with respect to, control shares.
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an
acquiring person statement as permitted by the statute, then, subject to
certain conditions and limitations, the corporation may redeem any or all of
the "control shares" (except those for which voting rights have previously
been approved) for fair value determined, without regard to voting rights, as
of the date of the last control share acquisition or of any meeting of
stockholders at which the voting rights of such shares are considered and not
approved. If voting rights for "control shares" are approved at a stockholders
meeting and the acquiror becomes entitled to vote a majority of the shares
entitled to vote, all other stockholders may exercise appraisal rights. The
fair value of the stock as determined for purposes of such appraisal rights
may not be less than the highest price per share paid in the control share
acquisition, and certain limitations and restrictions otherwise applicable to
the exercise of dissenters' rights do not apply in the context of "control
share acquisitions."
The "control share acquisition" statue does not apply to stock acquired in a
merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by a provision of the
Articles of Incorporation or bylaws of the corporation adopted prior to the
acquisition of the shares.
TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services, L.L.C., 450 West 33rd Street, 15th Floor,
New York, New York 10001 (telephone number : (800) 851-9677), is the transfer
agent and registrar with respect to the Common Stock of the Company (the
"Transfer Agent").
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COMMON STOCK AVAILABLE FOR FUTURE SALE
Following the closing of the Offering (and assuming that the Underwriters'
over-allotment option is not exercised), the Company will have outstanding (or
reserved for issuance upon exercise of outstanding options) 10,366,300 shares
of Common Stock, which include (i) 6,250,000 Shares being offered by the
Company hereby, (ii) 3,600,000 shares of Common Stock sold in the Private
Placement, (iii) 87,800 shares of Common Stock sold to certain directors,
officers and employees of the Company in the Direct Offering (the "Direct
Offering Shares"), (iv) 80,000 shares of Common Stock issued to founders of
the Company (the "Founders' Shares") and (v) 348,500 shares of Common Stock
reserved for issuance upon the exercise of outstanding options. The Common
Stock issued in the Offering will be freely tradeable by persons other than
"affiliates" of the Company (as defined under Rule 144 promulgated under the
Securities Act) without restriction under the Securities Act, subject to
certain limitations on ownership set forth in the Articles of Incorporation.
See "Description of Capital Stock--Restrictions on Ownership and Transfer."
Private Placement Shares not being included in the Offering, the Direct
Offering Shares and the Founders' Shares are "restricted" securities within
the meaning of Rule 144 and may not be sold in the absence of registration
under the Securities Act unless an exemption from registration is available,
including exemptions contained in Rule 144. As described below, the Company
has granted certain holders registration rights with respect to their shares
of Common Stock.
In general, under Rule 144 as currently in effect, if one year has elapsed
since the later of the date of acquisition of restricted shares from the
Company or any affiliate of the Company, as that term is defined under Rule
144, the holder thereof is entitled to sell within any three-month period a
number of shares that does not exceed the greater of 1% of the then
outstanding Common Stock or the average weekly trading volume of the Common
Stock during the four calendar weeks preceding the date on which notice of the
sale is filed with the Commission. Sales under Rule 144 also are subject to
certain manner of sale provisions, notice requirements and the availability of
current public information about the Company. If two years have elapsed since
the date of acquisition of restricted shares from the Company or from any
affiliate of the Company, and the holder thereof is deemed not to have been an
affiliate of the Company at any time during the three months preceding a sale,
such person would be entitled to sell such shares in the public market under
Rule 144(k) without regard to the volume limitations, manner of sale
provisions, public information requirements or notice requirements. Certain
Private Placement Shares are also presently available for resale, under
certain conditions, to institutional "accredited investors" within the meaning
of Regulation D under the Securities Act, "qualified institutional buyers"
within the meaning of Rule 144A under the Securities Act, and to persons who
are not "U.S. persons" within the meaning of Regulation S under the Securities
Act. The directors, officers and employees of the Company have agreed not to
sell any shares of Common Stock held by them for a period of 180 days
following the closing of the Offering without the consent of the
Representatives.
As of August 5, 1997, options to purchase 348,500 shares of Common Stock
were outstanding, of which options to purchase 7,500 shares are currently
exercisable; options to purchase 275,000 shares vest in four equal
installments on January 2, 1998, 1999, 2000 and 2001; options to purchase
36,000 shares vest in four equal installments on January 21, 1998, 1999, 2000
and 2001; options to purchase 25,000 shares vest in four equal installments on
January 28, 1998, 1999, 2000 and 2001; and an option to purchase 5,000 shares
vests in four equal installments on June 26, 1998, 1999, 2000 and 2001. None
of the shares of Common Stock underlying the outstanding stock options has
been registered under the Securities Act.
No prediction can be made as to the effect, if any, that future sales of
shares, or the availability of shares for future sale, will have on the market
price prevailing from time to time. Sales of substantial amounts of Common
Stock, or the perception that such sales could occur, may affect adversely
prevailing market prices of the Common Stock.
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REGISTRATION RIGHTS
Pursuant to a Registration Rights Agreement entered into between the Company
and Friedman, Billings, Ramsey & Co., Inc., as initial purchaser, in
connection with the Company's Private Placement, holders of Private Placement
Shares are entitled to certain rights with respect to registration of the
Private Placement Shares under the Securities Act. Such holders are entitled
to include Private Placement Shares held by them in either of the Company's
first two registered securities offerings (other than in connection with a
merger or pursuant to a registration statement on Form S-8, S-4 or a
comparable registration statement), subject to certain conditions, including
the right of the Company to exclude such Private Placement Shares from a
registered offering if the managing underwriter advises the Company that in
its opinion the number of securities requested to be included in the offering
exceeds the number that can be sold in such offering.
In addition, if the Company has registered securities under the Securities
Act on two separate occasions and, on either occasion, the Private Placement
Shares were excluded from such offering, holders of greater than 50% of the
restricted Private Placement Shares have the right, on one occasion, to
require the Company to prepare and file with the Commission a registration
statement and such other documents as may be necessary so as to permit a
public offering and sale of the restricted Private Placement Shares.
The foregoing registration rights are not applicable in the event that
holders of Private Placement Shares who are not affiliated with the Company
are able to resell all of such shares without restrictions on transfer in
accordance with Rule 144 of the Securities Act or any other applicable
exemption.
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UNDERWRITING
Subject to the terms and conditions set forth in the underwriting agreement
(the "Underwriting Agreement") among the Company, the Selling Stockholders and
Friedman, Billings, Ramsey & Co., Inc. ("FBR"), Sutro & Co. Incorporated and
Tucker Anthony Incorporated as representatives (in such capacity, the
"Representatives") for each of the underwriters named below (the
"Underwriters"), the Company and the Selling Stockholders have agreed to sell,
and each of the Underwriters has severally agreed to purchase the number of
Shares offered hereby set forth below opposite its name.
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
----------- ----------------
<S> <C>
Friedman, Billings, Ramsey & Co., Inc. .....................
Sutro & Co. Incorporated....................................
Tucker Anthony Incorporated.................................
---------
Total..................................................... 7,095,000
=========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to purchase all the Shares offered hereby if any
are purchased.
The Underwriters, through the Representatives, have advised the Company that
they propose initially to offer the Shares to the public at the public
offering price set forth on the cover page of this Prospectus and to certain
dealers at such offering price less a concession not to exceed $ per share
of Common Stock. The Underwriters may allow and such dealers may reallow a
concession not to exceed $ per share of Common Stock to certain other
dealers. After the Shares are released for sale to the public, the offering
price and other selling terms may be changed by the Underwriters. The Shares
are offered subject to receipt and acceptance by the Underwriters, and to
certain other conditions, including the right to reject orders in whole or in
part.
The Company has granted to the Underwriters an option exercisable during a
30-day period after the date hereof to purchase, at the initial offering price
less underwriting discounts and commissions, up to an additional 1,064,250
Shares of Common Stock for the sole purpose of covering over-allotments, if
any. To the extent that the Underwriters exercise such option, each of the
Underwriters will have a firm commitment, subject to certain conditions, to
purchase a number of the additional shares of Common Stock proportionate to
such Underwriter's initial commitment as shown in the foregoing table.
The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain civil liabilities, including liabilities
under the Securities Act, or to contribute to payments the Underwriters may be
required to make in respect thereof.
In connection with the Offering, the Company has agreed to reimburse FBR for
up to $75,000 of the fees and expenses of legal counsel to the Underwriters.
Additionally, the Company has agreed to grant to FBR for a period of one year
the right of first refusal to act as exclusive or lead underwriter or
placement agent in connection with public or private offerings of securities
or securitizations by the Company, and as exclusive financial advisor in
connection with any merger or sale of substantially all of the assets of the
Company. Fees to be paid to FBR in connection with any such transaction would
be subject to mutual agreement between the Company and FBR and consistent with
customary fees paid in similar transactions.
FBR served as the initial purchaser in connection with the Private Placement
for which it received an initial purchaser's discount equal to $2,520,000.
Prior to the Offering, there has been no public market for the Common Stock.
The initial public offering price will be determined by negotiation between
the Company and the Representatives. Among the factors to be considered in
making such determination will be the history of, and the prospects for, the
industry in which the
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Company competes, an assessment of the skills of the Company's management and
the Company's prospects for future earnings, the general conditions of the
economy and the securities market and the prices of offerings by similar
issuers. However, there can be no assurance that the price at which the shares
of Common Stock will sell in the public market after the Offering will not be
lower than the price at which they are sold by the Underwriters.
The Representatives have informed the Company that the Underwriters do not
intend to confirm sales of the Shares offered hereby to any accounts over
which they exercise discretionary authority.
Until the distribution of the Shares is completed, rules of the Commission
may limit the ability of the Underwriters and certain selling group members to
bid for or purchase the Common Stock. As an exception to these rules, the
Representatives are permitted to engage in certain transactions that stabilize
the price of the Common Stock. Such transactions consist of bids or purchases
for the purpose of pegging, fixing or maintaining the price of the Common
Stock.
If the Underwriters create a short position in the Common Stock in
connection with the Offering, i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus, the Representatives
may reduce that short position by purchasing Common Stock in the open market.
The Representatives may also elect to reduce any short position by exercising
all or part of the over-allotment option described above.
The Representatives may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
Common Stock in the open market to reduce the Underwriters' short position or
to stabilize the price of the Common Stock, they may reclaim the amount of the
selling concession from the Underwriters and selling group members who sold
those shares of Common Stock as part of the Offering.
In general, purchases of securities for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher
than it might be in the absence of such purchases. The imposition of a penalty
bid might also have an effect on the price of a security to the extent that it
were to discourage resales of the security.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the Common Stock. In
addition, neither the Company nor any of the Underwriters makes any
representation that the Representatives will engage in such transactions or
that such transactions, once commenced, will not be discontinued without
notice.
The Company and the Company's directors and executive officers have agreed
not to offer, sell or contract to sell or otherwise dispose of any Common
Stock of the Company without the prior consent of the Representatives for a
period of 180 days from the date of consummation of the Offering.
LEGAL MATTERS
Certain legal matters in connection with the issuance of the Shares will be
passed on for the Company by Morgan, Lewis & Bockius LLP, New York, New York.
Certain legal matters will be passed on for the Underwriters by Andrews &
Kurth L.L.P., Washington, D.C.
EXPERTS
The Balance Sheet of the Company at June 30, 1997, and the Statements of
Operations, Stockholders' Equity and Cash Flows for the period from February
18, 1997 (commencement of operations) to June 30, 1997, included in this
Prospectus have been included herein in reliance on the report of Deloitte &
Touche LLP, independent certified public accountants, given on the authority
of that firm as experts in accounting and auditing.
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ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-11 (File No. 333-32913) under the Securities Act with respect to the Common
Stock offered hereby. This Prospectus does not contain all of the information
set forth in the Registration Statement and the exhibits thereto. For further
information with respect to the Company and the Common Stock, reference is
hereby made to such Registration Statement and the exhibits thereto.
Statements contained in this Prospectus as to the contents of any contract or
other document are not necessarily complete; however, the summary descriptions
provided in the Prospectus accurately describe the material provisions of such
contracts or documents. In each instance, reference is made to the copy of
such contract or document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. Copies
of the Registration Statement, including all exhibits thereto, can be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, Room 1400, Chicago, Illinois 60606 and at 7
World Trade Center, Suite 1300, New York, New York 10048. Copies of such
material can be obtained from the Public Reference Section of the Commission
at 450 Fifth Street, Washington, D.C. 20549, at prescribed rates. The
Commission also maintains a web site that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission, including the Company. The address of the
Commission's website is http://www.sec.gov.
The Company intends to furnish to its stockholders annual reports containing
audited financial statements and an opinion thereon expressed by the Company's
independent auditors as well as quarterly reports for the first three fiscal
quarters of each fiscal year containing unaudited condensed financial
statements.
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GLOSSARY
As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.
"Accredited Investor" has the meaning set forth in Rule 501(a)(1), (2), (3)
or (7) under the Securities Act.
"Agency" means GNMA, FNMA or FHLMC.
"Agency Certificates" means GNMA Certificates, FNMA Certificates and FHLMC
Certificates.
"amortized cost" means, with respect to Mortgage-Backed Securities, the
purchase price as adjusted for subsequent amortization of discount or premium
and for principal repayments.
"ARM" means a Mortgage Loan or any mortgage loan underlying a Mortgage-
Backed Security that features adjustments of the underlying interest rate at
predetermined times based on an agreed margin to an established index. An ARM
is usually subject to periodic interest rate and/or payment caps and a
lifetime interest rate cap.
"ARM Certificate" means an adjustable-rate Pass-Through Certificate.
"Articles of Incorporation" means the Company's Articles of Incorporation,
as amended and restated by the Company's Articles of Amendment and
Restatement, filed with the State of Maryland.
"Bankruptcy Code" means Title 11 of the United State Code, entitled
"Bankruptcy."
"Board" or "Board of Directors" means the Board of Directors of the Company.
"Capital Investment Policy" means the policy established by the Company,
including a majority of the Independent Directors, establishing guidelines for
management relating to asset acquisitions, credit risk management, capital and
leverage, interest rate risk management and prepayment risk management, as
more fully described under "Business Strategy--Capital Investment Policy."
"capital stock" means the Common Stock and any additional classes of capital
stock authorized by the Board of Directors in the future.
"carrying value" means the value placed on an asset or liability for balance
sheet presentation purposes. With respect to Mortgage-Backed Securities and
interest rate cap agreements, the carrying value equals management's estimate
of the bid-side market value of that asset. Management will generally base its
estimate on the lowest of third-party bid-side indications of market value
obtained on a regular basis from firms making a market in or lending against
such assets. With respect to all other balance sheet items, carrying value
equals amortized cost.
"CD Rate" means the weekly average of secondary market interest rates on
six-month negotiable certificates of deposit, as published by the Federal
Reserve Board in its Statistical Release H.15(519), Selected Interest Rates.
"Citadel" means Citadel Funding Corporation, a dissolved Colorado
corporation.
"CMOs" or "Collateralized Mortgage Obligations" means adjustable- or fixed-
rate debt obligations (bonds) that are collateralized by Mortgage Loans or
mortgage certificates. CMOs are structured so that principal and interest
payments received on the collateral are sufficient to make principal and
interest payments on the bonds. Such bonds may be issued by United States
government sponsored entities or private issuers in one or more classes with
fixed or adjustable interest rates, maturities and degrees of subordination
which are characteristics designed for the investment objectives of different
bond purchasers.
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"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Mortgage Loans" means Mortgage Loans secured by commercial
property.
"Commission" means the Securities and Exchange Commission.
"Common Stock" means the Company's shares of Common Stock, par value $0.01
per share.
"Company" means Annaly Mortgage Management, Inc., a Maryland corporation.
"Conforming Mortgage Loans" means Single-Family Mortgage Loans that either
comply with requirements for inclusion in credit support programs sponsored by
FHLMC or FNMA or are FHA or VA Loans.
"coupon rate" means, with respect to Mortgage-Backed Securities, the
annualized cash interest income actually received from the asset, expressed as
a percentage of the face value of the asset.
"CPR" means an assumed rate of prepayment for the Company's Mortgage-Backed
Securities, expressed as an annual rate of prepayment relative to the
outstanding principal balance of the Company's Mortgage-Backed Securities. CPR
does not purport to be either a historical description of the prepayment
experience of the Company's Mortgage-Backed Securities or a prediction of the
anticipated rate of prepayment of the Company's Mortgage-Backed Securities.
"DBCC" means the National Association of Securities Dealers, Inc. District
Business Conduct Committee for District No. 3.
"DBCC Settlement" means the Decision and Order of Acceptance of Respondents'
Offer of Settlement dated November 15, 1994 entered into by Citadel and
certain of its principals with the DBCC.
"Direct Offering" means the Company's sale on July 31, 1997 of an aggregate
of 87,800 shares of Common Stock to certain directors, officers and employees
of the Company.
"Direct Offering Shares" means the 87,800 shares of Common Stock sold to
certain directors, officers and employees of the Company in the Direct
Offering.
"DOL" means the Department of Labor.
"Dollar-Roll Agreement" means an agreement to sell a security for delivery
on a specified future date and a simultaneous agreement to repurchase the same
or a substantially similar security (with the same coupon and original
maturity periods) on a specified future date.
"duration" means the expected percentage change in the market value of the
Company's assets that would be caused by a 1% change in short and long term
interest rates.
"efficiency ratio" means general and administrative expenses as a percentage
of net interest income.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"ERISA Plan" means a pension, profit-sharing, retirement or other employee
benefit plan which is subject to Title I of ERISA.
"Excess Securities" means shares of capital stock representing ownership,
directly or constructively, in excess of 9.8%, in number of shares or value,
of any class of shares of the outstanding capital stock (except as otherwise
waived by the Board of Directors).
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"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Excess Capital Cushion" is a term defined in the Company's Capital
Investment 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 Excess Capital Cushion is that part of the required capital
base which is in excess of the Company's haircut requirements
"face value" means, with respect to Mortgage-Backed Securities, the
outstanding principal balance of Mortgage Loans or Mortgage-Backed Securities
comprising the Mortgage-Backed Securities. In the absence of credit losses,
the face value equals the sum of the principal repayments that will be
received by the Company over the life of the Mortgage-Backed Security.
"FBR" means Friedman, Billings, Ramsey & Co., Inc.
"Federal Reserve Board" means the Board of Governors of the Federal Reserve
System.
"Fed Funds Rate" means the interest rate charged by banks with excess
reserves at a Federal Reserve System district bank to banks needing overnight
loans to meet reserve requirements.
"FHA" means the United States Federal Housing Administration.
"FHA Loans" means Mortgage Loans insured by the FHA.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FHLMC ARM Certificates" means adjustable-rate FHLMC Certificates.
"FHLMC Certificates" means mortgage participation certificates issued by
FHLMC, either in certificated or book-entry form.
"FIDAC" means Fixed Income Discount Advisory Company, a Delaware
corporation.
"Floaters" means adjustable-rate CMOs.
"Floating Rate Fund" means the U.S. Dollar Floating Rate Fund, Ltd., a
British Virgin Islands corporation and an open-end investment company.
"FNMA" means the Federal National Mortgage Association.
"FNMA ARM Certificates" means adjustable-rate FNMA Certificates.
"FNMA Certificates" means mortgage pass-through certificates issued by FNMA,
either in certificated or book-entry form.
"Founders' Shares" means the 80,000 shares of Common Stock issued to
founders of the Company in December 1996.
"fully-indexed rate" means, with respect to ARMs, the rate that would be
paid by the borrower ("gross") or received by the Company as owner of the
Mortgage Asset ("net") if the coupon rate on the ARM 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 ARM index
plus the gross or net margin.
"GAAP" means generally accepted accounting principles.
"GNMA" means the Government National Mortgage Association.
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"GNMA ARM Certificates" means adjustable-rate GNMA Certificates.
"GNMA Certificates" means fully modified pass-through mortgage-backed
certificates guaranteed by GNMA and issued either in certificated or book-
entry form.
"gross margin" means, with respect to ARMs, the coupon rate to be paid by
the borrower. The term "gross" is used to differentiate payments made by the
borrower with the lower "net" payments actually received by the Company after
the acquisition of a Mortgage Asset. The difference between the gross margin
and the net margin reflects loan servicing fees and other pre-determined
contractual deductions. The fully-indexed gross coupon rate equals the current
yield on the ARM index (six month LIBOR, one year Treasury, etc.) plus the
gross margin. The actual coupon rate paid by the borrower may be lower than
the fully-indexed gross rate at the initiation of the loan if originated at a
"teaser rate" or during periods of rising interest rates due to the
limitations of the ARM adjustment schedule and the periodic and life caps. If
so, the coupon rate paid by the borrower would move towards the fully-indexed
gross rate over time.
"haircut" means the over-collateralization amount required by a lender in
connection with a collateralized borrowing.
"High Quality" means (i) securities which are rated within one of the two
highest rating categories by at least one of the nationally recognized rating
agencies, (ii) securities that are unrated but are guaranteed by the United
States government or an agency of the United States government, or (iii)
securities that are unrated or whose ratings have not been updated but are
determined to be of comparable quality to rated High Quality Mortgage-Backed
Securities on the basis of credit enhancement features that meet the High
Quality credit criteria approved by the Company's Board of Directors.
"Housing Act" means the National Housing Act of 1934, as amended.
"HUD" means the Department of Housing and Urban Development.
"Incentive Plan" means the Company's Long-Term Stock Incentive Plan.
"Independent Director" means a director of the Company who is not an officer
or employee of the Company.
"interest-only strip," "interest only security" or "IO" means a type of
Mortgage-Backed Security which receives a portion of the interest payments
from an underlying pool of mortgage loans but will receive little or no
principal payments and hence will have little or no face value. The market
value and yield of an IO are unusually sensitive to the prepayment rates
experienced on and anticipated for the underlying pool of mortgage loans. The
market values and yields of IOs may increase as interest rates increase and,
in certain conditions, IOs may act in a counter-cyclical manner as compared to
other Mortgage-Backed Securities.
"interest rate adjustment indices" means, in the case of Mortgage-Backed
Securities, 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 repurchase
agreements for Mortgage-Backed Securities) as well as any of the objective
indices described above that are used as a reference base to reset the
interest rate for each adjustment period under the related borrowing
instrument.
"interest rate adjustment period" means, in the case of Mortgage-Backed
Securities, 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 repurchase
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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.
"interest rate agreement" means an agreement, such as an interest rate swap
cap, collar or floor, entered into for the purpose of hedging risks associated
with changes in interest rates.
"Investment Company Act" means the Investment Company Act of 1940, as
amended.
"IRS" means the United States Internal Revenue Service.
"LIBOR" means the London Interbank Offered Rate as it may be defined, and
for a period of time specified, in a Mortgage-Backed Security or borrowing of
the Company.
"lifetime interest rate cap" or "life cap" means in the case of a Mortgage
Loan that is an ARM, the maximum coupon rate that may accrue during any period
over the term of such Mortgage Loan as stated in the governing instruments
evidencing such Mortgage Loan, and in the case of a Mortgage-Backed Security
evidencing ARMs, the maximum weighted average coupon rate that may accrue
during any period over the term of such Mortgage-Backed Security as stated in
the governing instruments thereof.
"Limited Investment Assets" means assets of the Company, comprising not more
than 25% of total assets, which are unrated or rated less than High Quality.
"Maryland General Corporation Law" means the Corporations and Associations
Article of the Annotated Code of Maryland.
"Mezzanine Securities" means Mortgage-Backed Securities rated below the two
highest levels but no lower than a single "B" level under the S&P rating
system (or comparable level under other rating systems) which are supported by
one or more classes of Subordinated Securities which bear Realized Losses
prior to the classes of Mezzanine Securities.
"Mortgage Loans" means Single-Family Mortgage Loans, Multifamily Mortgage
Loans and Commercial Mortgage Loans.
"Mortgage-Backed Securities" means (i) Pass-Through Certificates, and (ii)
CMOs.
"Multifamily Mortgage Loans" means Mortgage Loans secured by multifamily (in
excess of four units) residential property.
"Multifamily Privately-Issued Certificates" means Privately-Issued
Certificates evidencing ownership interests in a pool of Multifamily Mortgage
Loans.
"Multifamily CMOs" means CMOs that are collateralized by Multifamily
Mortgage Loans.
"net margin" is part of the calculation of the coupon rate to be received by
the Company as owner of an ARM. The term "net" is used to differentiate
payments actually received by the Company from a Mortgage Asset from the
higher "gross" payment made by the borrower. The difference between the gross
margin and the net margin reflects loan servicing fees and other pre-
determined contractual deductions. The fully-indexed net rate equals the
current yield on the ARM index (six month LIBOR, one year Treasury, etc.) plus
the net margin. The actual coupon rate received by the Company may be lower
than the fully-indexed net rate at the initiation of the loan if originated at
a "teaser rate" or during periods of rising interest rates due to the
limitations of the ARM adjustment schedule and the periodic and life caps. If
so, the coupon rate received by the Company would move towards the fully-
indexed net coupon rate over time.
the "95% Gross Income Test" means the requirement for each taxable year that
at least 95% of the Company's gross income for each taxable year must be
derived from sources of income qualifying for the 75%
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Gross Income Test, dividends, interest, and gains from the sale of stock or
other securities (including certain interest rate swap and cap agreements
entered into to hedge variable rate debt incurred to acquire Qualified REIT
Real Estate Assets) not held for sale in the ordinary course of business.
"Non-ERISA Plan" means a Plan that does not cover common law employees.
"Non-United States Holder" means a purchaser of the Common Stock that, for
United States Federal income tax purposes, is not a "United States person."
the "Offering" or this "Offering" means the offering of Common Stock covered
by this Prospectus.
the "Offering Price" means the price per share of Common Stock in the
Offering.
"One Hundred Stockholder Date" means the earlier of (i) January 1, 1998 and
(ii) the date of closing of the sale of Shares pursuant to the Offering.
"Ownership Limit" means 9.8% of the outstanding shares of capital stock, as
may be increased or reduced by the Board of Directors of the Company.
"Pass-Through Certificates" means securities (or interests therein),
including Agency Certificates and Privately-Issued Certificates, evidencing
undivided ownership interests in a pool of Mortgage Loans, the holders of
which receive a "pass-through" of the principal and interest paid in
connection with the underlying Mortgage Loans in accordance with the holders'
respective, undivided interests in the pool.
"period ended June 30, 1997" means the period from the commencement of
operations by the Company on February 18, 1997 through June 30, 1997.
"periodic interest rate cap" or "periodic cap" means, with respect to ARMs,
the maximum change in the coupon rate permissible under the terms of the loan
at each coupon adjustment date. Periodic caps limit both the speed by which
the coupon rate can adjust upwards in a rising interest rate environment and
the speed by which the coupon rate can adjust downwards in a falling rate
environment.
"Plan" means a pension, profit-sharing, retirement or other employee benefit
plan which is subject to ERISA.
"Plan Asset Regulations" means regulations of the DOL defining "plan
assets."
"Private Placement" means the sale by the Company on February 18, 1997 of
3,600,000 shares of Common Stock in an offering exempt from registration under
the Securities Act and state securities laws.
"Private Placement Shares" means the 3,600,000 shares of Common Stock issued
by the Company in the Private Placement.
"Privately-Issued Certificates" means privately-issued Pass-Through
Certificates issued by a third party issuer which is not an Agency
Certificate.
"Prospectus" means this Prospectus.
"PTE" means a U.S. Department of Labor Prohibited Transaction Exemption.
"purported transferee" means the intended transferee in connection with any
transfer of shares of capital stock that would result in disqualification of
the Company as a REIT or that would (a) create a direct or constructive
ownership of shares of stock in excess of the Ownership Limit, (b) result in
the shares of stock being beneficially owned (within the meaning section
856(a) of the Code) by fewer than 100 persons (determined
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without reference to any rules of attribution), or (c) result in the Company
being "closely held" within the meaning of section 856(h) of the Code.
"Qualified Institutional Buyer" has the meaning set forth in Rule 144A under
the Securities Act.
"Qualified REIT Real Estate Assets" means Pass-Through Certificates,
Mortgage Loans, Agency Certificates, and other assets of the type described in
section 856(c) (6)(B) of the Code.
"Qualified REIT Subsidiary" means a corporation whose stock is entirely
owned by the REIT at all times during such corporation's existence.
"Qualifying Interests" means "mortgages and other liens on and interests in
real estate," as defined in section 3(c)(5)(C) under the Investment Company
Act.
"rating" means (i) the rating assigned to an asset by one or more of the
four nationally recognized rating agencies as adjusted to the rating scale
under the S&P rating system, (ii) in the case of assets rated differently by
such rating agencies, the rating deemed by management to most appropriately
reflect such asset's credit quality or (iii) for unrated assets, the Company's
deemed comparable rating.
"Rating Agency" means S&P or another nationally recognized rating agency.
"Realized Losses" means losses incurred in respect of Mortgage-Backed
Securities upon foreclosure sales and other liquidations of underlying
mortgaged properties that result in failure to recover all amounts due on the
loans secured thereby.
"Regulation D" means Regulation D (Rules 501-506) promulgated under the
Securities Act.
"Regulation S" means Regulation S (Rules 901-904) promulgated under the
Securities Act.
a "REIT" means a Real Estate Investment Trust.
"REIT Provisions of the Code" means sections 856 through 860 of the Code.
"REMIC" means Real Estate Mortgage Investment Conduit.
"Representatives" means Friedman, Billings, Ramsey & Co., Inc., Sutro & Co.
Incorporated and Tucker Anthony Incorporated, as the representatives for the
Underwriters in connection with the Offering.
"repurchase agreement" means a borrowing device evidenced by an agreement to
sell securities or other assets to a third-party and a simultaneous agreement
to repurchase them at a specified future date and price, the price difference
constituting the interest on the borrowing.
"residuals" means the right to receive the remaining or residual cash flows
from a pool of Mortgage Loans or Mortgage-Backed Securities after distributing
required amounts to the holders of interests in or obligations backed by such
loans or securities and after payment of any required pool expenses.
"Rule 144" means Rule 144 under the Securities Act.
"Rule 144A" means Rule 144A under the Securities Act.
"S&P" means Standard & Poor's Corporation, a New York corporation.
"Securities Act" means the Securities Act of 1933, as amended.
"Selling Stockholders" means stockholders of the Company who are offering
Shares for sale to the public in the Offering.
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"Senior Securities" means a class of Mortgage-Backed Security that has a
prior right to receive principal and/or interest from the underlying pool of
Mortgage Loans.
"Senior-Subordinated Mortgage-Backed Securities" means a series of Pass-
Through Certificates or CMOs in which one or more classes have a prior right
to receive principal and/or interest payments from the underlying pool of
Mortgage Loans.
the "75% Asset Test" at the close of each quarter of each taxable year means
the requirement that at least 75% of the value of the Company's total assets
must consist of Qualified REIT Real Estate Assets, government securities, cash
and cash items.
the "75% Gross Income Test" means the requirement for each taxable year that
at least 75% of the Company's gross income must be derived from certain
specified real estate sources including interest income and gain from the
disposition of Qualified REIT Real Estate Assets or "qualified temporary
investment income" (i.e., income derived from "new capital" within one year of
the receipt of such capital).
"Shares" means the shares of Common Stock being offered pursuant to the
Offering.
"Short-Term Investments" means the short-term bank certificates of deposit,
short-term United States treasury securities, short-term United States
government agency securities, commercial paper, reverse repurchase agreements,
short-term CMOs, short-term asset-backed securities and other similar types of
short-term investment instruments, all of which will have maturities or
average durations of less than one year.
"Single-Family Mortgage Loans" means Mortgage Loans secured by single-family
(one- to four-units) residential property.
"Single-Family Privately-Issued Certificates" means Privately-Issued
Certificates evidencing ownership interests in a pool of Single-Family
Mortgage Loans.
"Single-Family CMOs" means CMOs that are collateralized by Single-Family
Mortgage Loans.
"Subordinated Interests" means a class of Mortgage-Backed Securities that is
subordinated to one or more other classes of Mortgage-Backed Securities, all
of which classes share the same collateral.
"Subordinated Securities" means any class that bears the "first loss" from
Realized Losses or that is rated below a single "B" level (or, if unrated, is
deemed by the Company to be below such level).
"Tax-Exempt Entity" means a qualified pension, profit-sharing or other
employee retirement benefit plan, Keogh plans, bank commingled trust funds for
such plans, individual retirement accounts and other similar entities intended
to be exempt from Federal income taxation.
the "30% Gross Income Test" is the requirement for each taxable year that
less than 30% of the Company's gross income is derived from the sale of
Qualified REIT Real Estate Assets held for less than four years, stock or
securities held for less than one year (including certain interest rate swap
and cap agreements entered into to hedge variable rate debt incurred to
acquire Qualified Real Estate Assets) and certain "dealer" property.
"Transfer Agent" means ChaseMellon Shareholder Services, LLC, acting as
transfer agent and registrar with respect to the Common Stock of the Company.
"Treasury Department" means the United States Department of the Treasury.
"Treasury Index" means the weekly average yield of the benchmark U.S.
Treasury securities, as published by the Board of Governors of the Federal
Reserve System.
"UBTI" means "unrelated business taxable income" as defined in section 512
of the Code.
95
<PAGE>
"Underwriters" means the underwriters named in this Prospectus acting as
underwriters in the Offering.
"Underwriting Agreement" means the Underwriting Agreement among the Company,
the Selling Stockholders and the Representatives on behalf of the
Underwriters.
"United States person" means a citizen or resident of the United States; a
corporation, partnership, or other entity created or organized in the United
States or under the laws of the United States or of any political subdivision
thereof; or an estate or trust whose income is includible in gross income for
United States Federal income tax purposes regardless of its source.
"VA" means the United States Department of Veterans Affairs.
"VA Loans" means Mortgage Loans partially guaranteed by the VA under the
Servicemen's Readjustment Act of 1944, as amended.
96
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
INDEPENDENT AUDITORS' REPORT.......................................... F-2
FINANCIAL STATEMENTS:
Balance Sheet--June 30, 1997........................................ F-3
Statement of Operations for the period February 18, 1997 (Commence-
ment of Operations) through June 30, 1997.......................... F-4
Statement of Stockholders' Equity for the period February 18, 1997
(Commencement of Operations) through June 30, 1997................. F-5
Statement of Cash Flows for the period February 18, 1997 (Commence-
ment of Operations) through June 30, 1997.......................... F-6
Notes to Financial Statements....................................... F-7-F-11
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders ofAnnaly Mortgage Management, Inc.
We have audited the accompanying balance sheet of Annaly Mortgage
Management, Inc. as of June 30, 1997, and the related statements of
operations, stockholders' equity and cash flows for the period February 18,
1997 (commencement of operations) through June 30, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at June 30, 1997 and the
results of its operations and its cash flows for the period February 18, 1997
(commencement of operations) through June 30, 1997 in conformity with
generally accepted accounting principles.
Deloitte & Touche LLP New York, New York
July 31, 1997
F-2
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
BALANCE SHEET
JUNE 30, 1997
<TABLE>
<S> <C>
ASSETS
Cash and cash equivalents...................................... $ 28,005
Receivable for Mortgage-Backed Securities sold................. 31,885,170
Mortgage-Backed Securities--Net................................ 364,367,237
Accrued interest receivable.................................... 1,945,577
Other assets................................................... 10,195
------------
TOTAL ASSETS................................................... $398,236,184
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements.......................................... $326,987,090
Payable for Mortgage-Backed Securities purchased............... 35,060,243
Accrued interest payable....................................... 2,404,224
Dividends payable.............................................. 938,400
Accounts payable............................................... 27,634
------------
Total liabilities............................................. 365,417,591
============
Stockholders' Equity:
Common stock: par value $.01 per share; 100,000,000 authorized,
3,680,000 shares issued and outstanding....................... 36,800
Additional paid-in capital..................................... 32,955,104
Unrealized losses on Mortgage-Backed Securities................ (298,761)
Retained earnings.............................................. 125,450
------------
Total stockholders' equity.................................... 32,818,593
============
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..................... $398,236,184
============
</TABLE>
See notes to financial statements.
F-3
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF OPERATIONS
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS) THROUGH
JUNE 30, 1997
<TABLE>
<S> <C>
INTEREST INCOME:
Mortgage-Backed Securities........................................ $6,478,162
Money market account.............................................. 30,745
----------
Total interest income............................................. 6,508,907
INTEREST EXPENSE:
Repurchase agreements............................................. 5,148,817
----------
NET INTEREST INCOME................................................. 1,360,090
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES.......................... 229,865
GENERAL AND ADMINISTRATIVE EXPENSES................................. 249,896
----------
NET INCOME.......................................................... $1,340,059
==========
Net income per share................................................ $ 0.36
==========
Average number of shares outstanding................................ 3,680,000
==========
</TABLE>
See notes to financial statements.
F-4
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
JUNE 30, 1997
<TABLE>
<CAPTION>
COMMON ADDITIONAL
STOCK PAID-IN UNREALIZED RETAINED
PAR VALUE CAPITAL LOSS EARNINGS TOTAL
--------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE, FEBRUARY 18,
1997................... $ 800 $ 11,200 $ -- $ (209) $ 11,791
Issuance of common
stock................. 36,000 32,943,904 -- -- 32,979,904
Available for sale se-
curities--Fair value
adjustment............ -- -- (298,761) -- (298,761)
Net income............. -- -- -- 1,340,059 1,340,059
Dividends declared--
$0.33 per share....... -- -- -- (1,214,400) (1,214,400)
------- ----------- --------- ----------- -----------
BALANCE, JUNE 30, 1997.. $36,800 $32,955,104 $(298,761) $ 125,450 $32,818,593
======= =========== ========= =========== ===========
</TABLE>
See notes to financial statements.
F-5
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF CASH FLOWS
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS) THROUGH
JUNE 30, 1997
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...................................................... $ 1,340,059
Adjustments to reconcile net income to net cash provided by op-
erating activities:
Amortization of mortgage premiums and discounts, net........... 622,679
Gain on sale of Mortgage-Backed Securities..................... (229,865)
Increase in accrued interest receivable........................ (1,945,577)
Increase in other assets....................................... (8,745)
Increase in accrued interest payable........................... 2,404,224
Increase in accrued expenses and other liabilities............. 27,414
------------
Net cash provided by operating activities.................... 2,210,189
------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities.......................... (418,416,100)
Proceeds from sale of Mortgage-Backed Securities................ 42,872,029
Principal payments on Mortgage-Backed Securities................ 13,660,333
Purchase of furniture........................................... (1,451)
------------
Net cash used in investing activities........................ (361,885,189)
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements............................. 785,260,090
Principal payments on repurchase agreements..................... (458,273,000)
Net proceeds from private placement equity offering............. 32,979,904
Dividends paid.................................................. (276,000)
------------
Net cash provided by financing activities.................... 359,690,994
------------
NET INCREASE IN CASH AND CASH EQUIVALENTS........................ 15,994
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD................... 12,011
------------
CASH AND CASH EQUIVALENTS, END OF PERIOD......................... $ 28,005
============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid................................................... $ 2,744,593
============
NONCASH FINANCING ACTIVITIES:
Unrealized losses on available-for-sale securities, net......... $ 298,761
============
Dividends declared, not yet paid................................ $ 938,400
============
</TABLE>
See notes to financial statements.
F-6
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on November 25, 1996. The Company commenced its operations of
purchasing and managing an investment portfolio of primarily adjustable-rate
Mortgage-Backed Securities on February 18, 1997, upon receipt of the net
proceeds from the private placement of equity capital (see Note 5).
A summary of the Company's significant accounting policies follows:
Cash and Cash Equivalents--Cash and cash equivalents includes cash on hand
and money market funds. The carrying amounts of cash equivalents approximates
their value.
Mortgage-Backed Securities--The Company invests primarily in mortgage pass-
through certificates, collateralized mortgage obligations and other Mortgage-
Backed Securities representing interests in or obligations backed by pools of
mortgage loans (collectively, "Mortgage-Backed Securities").
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company
to classify its investments as either trading investments, available-for-sale
investments or held-to-maturity investments. Although the Company generally
intends to hold most of its Mortgage-Backed Securities until maturity, it may,
from time to time, sell any of its Mortgage-Backed Securities as part of its
overall management of its balance sheet. Accordingly, this flexibility
requires the Company to classify all of its Mortgage-Backed Securities as
available-for-sale. All assets classified as available-for-sale are reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of stockholders' equity.
Unrealized losses on Mortgage-Backed 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-Backed Securities is adjusted.
Interest income is accrued based on the outstanding principal amount of the
Mortgage-Backed Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Mortgage-Backed Securities are amortized
into interest income over the lives of the securities using the effective
yield method.
Mortgage-Backed Securities transactions are recorded on the date the
securities are purchased or sold. Purchases of newly issued securities are
recorded when all significant uncertainties regarding the characteristics of
the securities are removed, generally shortly before settlement date. Realized
gains and losses on Mortgage-Backed Securities transactions are determined on
the specific identification basis.
Credit Risk--At June 30, 1997, the Company has limited is exposure to credit
losses on its portfolio of Mortgage-Backed Securities by only purchasing
securities from Federal Home Loan Mortgage Corporation ("FHLMC"), Federal
National Mortgage Association ("FNMA"), or Government National Mortgage
Association ("GNMA"). The payment of principal and interest on the FHLMC and
FNMA Mortgage-Backed Securities are guaranteed by those respective agencies
and the payment of principal and interest on the GNMA Mortgage-Backed
Securities are backed by the full-faith-and-credit of the U.S. government. At
June 30, 1997, all of the Company's Mortgage-Backed Securities have an implied
"AAA" rating.
F-7
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
Income Taxes--The Company has elected to be taxed as a Real Estate
Investment Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code") with respect thereto.
Accordingly, the Company will not be subjected to Federal income tax to the
extent of its distributions to stockholders and as long as certain asset,
income and stock ownership tests are met.
Net Income per Share--Net income per share is computed by dividing net
income by the weighted average number of common shares and common share
equivalents (e.g., stock options), if dilutive, outstanding during the period.
The Company had no dilutive common stock equivalents outstanding during the
period.
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of June 30, 1997, which are carried at
their fair value:
<TABLE>
<CAPTION>
FEDERAL FEDERAL GOVERNMENT
HOME LOAN NATIONAL NATIONAL TOTAL
MORTGAGE-BACKED MORTGAGE MORTGAGE MORTGAGE MORTGAGE
SECURITIES CORPORATION ASSOCIATION ASSOCIATION ASSETS
- --------------- ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Mortgage-Backed
Securities, gross....... $29,076,869 $240,120,747 $85,130,964 $354,328,580
Unamortized discount..... (2,399) -- -- (2,399)
Unamortized premium...... 674,285 7,573,379 2,092,153 10,339,817
----------- ------------ ----------- ------------
Amortized cost........... 29,748,755 247,694,126 87,223,117 364,665,998
Gross unrealized gains... 20,475 339,916 77,792 438,183
Gross unrealized losses.. (101,590) (401,427) (233,927) (736,944)
----------- ------------ ----------- ------------
Estimated fair value..... $29,667,640 $247,632,615 $87,066,982 $364,367,237
=========== ============ =========== ============
</TABLE>
At June 30, 1997, all investments in Mortgage-Backed Securities consist of
securities backed by mortgage loans secured by single-family residential
housing. All of the securities acquired, as of June 30, 1997, are securitized
by either FHLMC, FNMA or GNMA. The original maturity of 87% of the Mortgage-
Backed Securities is over a period of thirty years; the actual maturity is
subject to change based on the prepayments of the underlying mortgage loans.
The adjustable rate Mortgage-Backed Securities are limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every six
months) and lifetime caps. At June 30, 1997, the weighted average lifetime cap
was 11%.
During the period ended June 30, 1997, the Company realized $229,865 in
gains from sales of Mortgage-Backed Securities. There were no losses on sales
of Mortgage-Backed Securities during the period.
F-8
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
3. REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements to finance most of its
Mortgage-Backed Securities. The repurchase agreements are secured by the
market value of the Company's Mortgage-Backed Securities and bear interest
rates that have historically moved in close relationship to LIBOR.
As of June 30, 1997, the Company had outstanding $326,987,090 of repurchase
agreements with a weighted average borrowing rate of 5.64% and a weighted
average remaining maturity of 20 days. At June 30, 1997, Mortgage-Backed
Securities actually pledged had an estimated fair value of $364,367,237.
At June 30, 1997, the repurchase agreements had the following remaining
maturities:
<TABLE>
<S> <C>
Within 30 days............................ $281,097,090
30 to 90 days............................. 45,890,000
------------
$326,987,090
============
</TABLE>
4. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at June 30, 1997. FASB Statement No.
107, Disclosures About Fair Value of Financial Instruments, defines the fair
value of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced or liquidation sale:
<TABLE>
<CAPTION>
CARRYING
AMOUNT FAIR VALUE
------------ ------------
<S> <C> <C>
Mortgage-Backed Securities.. $364,665,999 $364,367,237
</TABLE>
The fair values of the Company's Mortgage-Backed Securities are based on
market prices provided by certain dealers who make markets in these financial
instruments. The fair values reported reflect estimates and may not
necessarily be indicative of the amounts the Company could realize in a
current market exchange. Cash and cash equivalents, interest receivable,
repurchase agreements and other liabilities are reflected in the financial
statements at their amortized cost, which approximates their fair value
because of the short-term nature of these instruments.
5. COMMON STOCK
During the period the Company completed a private placement of equity
capital. The Company received net proceeds of $32,979,904 from an issuance of
3,600,000 shares of common stock.
During the Company's period ending June 30, 1997, the Company declared
dividends to shareholders totaling $.33 per share, of which $.075 was paid
during the period and $.255 was paid on July 23, 1997.
For Federal income tax purposes, $.06 of the dividend was long-term capital
gains and all other dividends paid for the period are ordinary income to the
Company's stockholders.
F-9
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
6. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a Long-Term Stock Incentive Plan for executive
officers, key employees and nonemployee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the Board of Directors
to grant awards, including incentive stock options as defined under section
422 of the Code ("ISOs") and options not so qualified ("NQSOs"). The Incentive
Plan authorizes the granting of options or other awards for an aggregate of
the greater of 500,000 shares or 5% of the outstanding shares of the Company's
common stock.
The Company adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation cost for the Incentive Plan has been determined
based on the fair value at the grant date for awards consistent with the
provisions of SFAS No. 123. For the Company's pro forma net earnings, the
compensation cost will be amortized over the four year vesting period of the
options. The Company's net earnings per share would have been reduced to the
pro forma amounts indicated below:
<TABLE>
<S> <C>
Net earnings--as reported................... $1,340,059
Net earnings--pro forma..................... 1,249,778
Earnings per share--as reported............. $0.36
Earnings per share--pro forma............... $0.34
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in the period ended June 30, 1997: dividend yield
of 10%; expected volatility of 25%; risk-free interest rate of 6.07%; and
expected lives of four years.
Information regarding options is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SHARES EXERCISE PRICE
------- --------------
<S> <C> <C>
Granted (311,000 ISOs, 37,500 NQSOs).................... 348,500 $6.42
Exercised............................................... -- --
Expired................................................. -- --
Outstanding, end of period.............................. 348,500 $6.42
======= =====
Weighted average fair value per share of options granted $ 2.07
during the period (per share).......................... =======
</TABLE>
The following table summarizes information about stock options outstanding:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-----------------------------------
WEIGHTED AVERAGE WEIGHTED
RANGE OF OPTIONS REMAINING AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE (YRS.) EXERCISE PRICE
--------------- ----------- ----------------------- --------------
<S> <C> <C> <C>
$ 4.00 208,250 4.0 $ 4.00
10.00 140,250 3.8 10.00
------------ ------- --- ------
$4.00-$10.00 348,500 3.9 $ 6.42
============ ======= === ======
</TABLE>
The vesting for the options is as follows: 7,500 options vested as of June
26, 1997. The remainder of the options will vest in four equal annual
installments beginning in 1998 and ending in 2001.
F-10
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
7. SUBSEQUENT EVENT
The Company raised additional capital on July 31, 1997 upon the consummation
of the sale of an aggregate of 87,800 shares, totaling $878,000, of Common
Stock to directors, officers and employees of the Company.
8. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of the quarterly results of operations.
<TABLE>
<CAPTION>
PERIOD ENDED
MARCH 31, JUNE 30,
1997 1997
------------ ----------
<S> <C> <C>
Interest income from Mortgage-Backed Securities and
cash.............................................. $1,060,692 $5,448,215
Interest expense on repurchase agreements.......... 713,120 4,435,697
---------- ----------
Net interest income.............................. 347,572 1,012,518
Gain on sale of Mortgage-Backed Securities......... -- 229,865
General and administrative expenses................ 64,047 185,849
---------- ----------
Net income......................................... $ 283,525 $1,056,534
========== ==========
Net income per share............................... $0.08 $0.28
========== ==========
Average number of shares outstanding............... 3,680,000 3,680,000
========== ==========
</TABLE>
F-11
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH IN-
FORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, THE SELLING STOCKHOLDERS OR ANY OF THE UNDERWRITERS. THIS PRO-
SPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY SECURITY OTHER THAN THE SHARES OFFERED BY THIS PROSPECTUS, NOR DOES IT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY THE SHARES
OFFERED HEREBY IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE IN-
FORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR
THAT THERE HAS NOT BEEN A CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF.
----------------
SUMMARY TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 5
Risk Factors.............................................................. 13
The Company............................................................... 28
Use of Proceeds........................................................... 28
Capitalization............................................................ 29
Distribution Policy....................................................... 29
Dilution.................................................................. 30
Selected Financial Data................................................... 32
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 33
Business Strategy......................................................... 42
Management................................................................ 57
Principal Stockholders.................................................... 65
Selling Stockholders...................................................... 68
Certain Federal Income Tax Considerations................................. 69
ERISA Considerations...................................................... 76
Description of Capital Stock.............................................. 79
Common Stock Available for Future Sale.................................... 83
Underwriting.............................................................. 85
Legal Matters............................................................. 86
Experts................................................................... 86
Additional Information.................................................... 87
Glossary.................................................................. 88
Index to Financial Statements............................................. F-1
</TABLE>
UNTIL , 1997, ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECU-
RITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DE-
LIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UN-
SOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
7,095,000 SHARES
[LOGO APPEARS HERE]
ANNALY MORTGAGE
MANAGEMENT, INC.
COMMON STOCK
----------------
PROSPECTUS
----------------
FRIEDMAN, BILLINGS, RAMSEY
& CO., INC.
SUTRO & CO. INCORPORATED
TUCKER ANTHONY
INCORPORATED
OCTOBER , 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses expected to be incurred in connection with the issuance and
distribution of the securities being registered are as set forth below. All
such expenses, except for the Securities Exchange Commission ("SEC" or the
"Commission") registration fee, the NASD filing fee and the New York Stock
Exchange listing fee, are estimated:
<TABLE>
<S> <C>
SEC Registration Fee............................................ $ 30,906.25
NASD Filing Fee................................................. $ 10,699.06
New York Stock Exchange Listing Fee............................. $ 95,657.38
Legal Fees and Expenses......................................... $250,000.00
Accounting Fees and Expenses.................................... $ 80,000.00
Blue Sky Qualification Fees and Expenses (including counsel
fees).......................................................... $ 6,000.00
Printing Fees................................................... $150,000.00
Transfer Agent and Registrar Fees............................... $ 15,000.00
Miscellaneous................................................... $ 50,000.00
-----------
Total......................................................... $688,262.69
===========
</TABLE>
ITEM 32. SALES TO SPECIAL PARTIES.
On July 31, 1997, the Registrant sold 87,800 shares of Common Stock to
certain directors, officers and employees of the Company at a price of $10.00
per share of Common Stock or $878,000 in the aggregate. The foregoing shares
were sold without registration under the Securities Act of 1933, as amended,
in reliance on the exemption provided by Section 4(2) thereof.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
On December 10, 1996, the Registrant issued 20,000 shares of Common Stock to
each of Timothy J. Guba and Wellington St. Claire in exchange for an aggregate
cash purchase price of $3,000 paid by each of them. On December 17, 1996, the
Registrant issued 20,000 shares to Michael A.J. Farrell in exchange for an
aggregate cash purchase price of $3,000. On December 18, 1996, the Registrant
issued 20,000 shares to the Bellfiore Trust in exchange for an aggregate cash
purchase price of $3,000. The foregoing shares of Common Stock were sold
without registration under the Securities Act of 1933, as amended (the
"Securities Act"), in reliance on the exemption provided by Section 4(2)
thereof.
On February 18, 1997, the Registrant sold an aggregate of 3,600,000 shares
of Common Stock to purchasers who were either "Qualified Institutional Buyers"
(as defined in Rule 144A under the Securities Act), or institutional
"accredited investors" (as defined in Rule 501(a)(1), (2), (3) or (7) under
the Securities Act), or to purchasers who were not U.S. persons (as defined in
Regulation S under the Securities Act) pursuant to offers and sales that
occurred outside the United States within the meaning of Regulation S under
the Securities Act. The foregoing shares of Common Stock were sold without
registration under the Securities Act in reliance on the exemptions provided
by Sections 4(1) and 4(2) thereof and Rule 144A, Regulation D and Regulation S
thereunder. The purchasers in the offering paid $10.00 per share of Common
Stock or $36,000,000 in the aggregate. The shares of Common Stock were sold
initially to Friedman, Billings, Ramsey & Co., Inc., as the initial purchaser
in the offering (the "Initial Purchaser"), for a purchase price of $9.30 per
share, or $33,480,000 in the aggregate, and resold by the Initial Purchaser to
the purchasers in the offering. The Initial Purchaser's discount in the
offering was $.70 per share, or $2,520,000 in the aggregate.
II-1
<PAGE>
On July 31, 1997, the Registrant sold 87,800 shares of Common Stock to
certain directors and officers of the Company at a price of $10.00 per share
of Common Stock or $878,000 in the aggregate. The foregoing shares were sold
without registration under the Securities Act in reliance on the exemption
provided by Section 4(2) thereof.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 2-418 of the Corporations and Associations Article of the Annotated
Code of Maryland (the "Maryland General Corporation Law") provides that a
Maryland corporation may indemnify any director of the corporation and any
person who, while a director of the corporation, is or was serving at the
request of the corporation as director, officer, partner, trustee, employee,
or agent of another foreign or domestic corporation, partnership, joint
venture, trust, or other enterprise or employee benefit plan, is made a party
to any proceeding by reason of service in that capacity unless it is
established that the act or omission of the director was material to the
matter giving rise to the proceeding and was committed in bad faith or was the
result of active and deliberate dishonesty; or the director actually received
an improper personal benefit in money, property or services; or, in the case
of any criminal proceeding, the director had reasonable cause to believe that
the act or omission was unlawful. Indemnification may be against judgments,
penalties, fines, settlements, and reasonable expenses actually incurred by
the director in connection with the proceeding, but if the proceeding was one
by or in the right of the corporation, indemnification may not be made in
respect of any proceeding in which the director shall have been adjudged to be
liable to the corporation. Such indemnification may not be made unless
authorized for a specific proceeding after a determination has been made, in
the manner prescribed by the law, that indemnification is permissible in the
circumstances because the director has met the applicable standard of conduct.
On the other hand, the director must be indemnified for expenses if he has
been successful in the defense of the proceeding or as otherwise ordered by a
court. The law also prescribes the circumstances under which the corporation
may advance expenses to, or obtain insurance or similar protection for,
directors.
The law also provides for comparable indemnification for corporate officers
and agents.
The Registrant's Articles of Incorporation provide that its directors and
officers shall, and its agents in the discretion of the Board of Directors
may, be indemnified to the fullest extent required or permitted from time to
time by the laws of Maryland.
The Maryland General Corporation Law permits the charter of a Maryland
corporation to include a provision limiting the liability of its directors and
officers to the corporation and its stockholders for money damages except to
the extent that (i) it is proved that the person actually received an improper
benefit or profit in money, property or services for the amount of the benefit
or profit in money, property or services actually received, or (ii) a judgment
or other final adjudication is entered in a proceeding based on a finding that
the person's action, or failure to act, was the result of active and
deliberate dishonesty and was material to the cause of action adjudicated in
the proceeding. The Company's Articles of Incorporation contain a provision
providing for elimination of the liability of its directors and officers to
the Company or its stockholders for money damages to the maximum extent
permitted by Maryland law from time to time.
Policies of insurance may be obtained and maintained by the Company under
which its directors and officers will be insured, within the limits and
subject to the limitations of the policies, against certain expenses in
connection with the defense of, and certain liabilities which might be imposed
as a result of, actions, suits or proceedings to which they are parties by
reason of being or having been such directors of officers.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
II-2
<PAGE>
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements:
The financial statements of the Registrant at June 30, 1997, and for the
period from February 18, 1997 (commencement of operations) through June 30,
1997, are included in the Prospectus. All schedules are omitted because
they are not applicable or not required.
(b) Exhibits:
<TABLE>
<C> <S>
1.1 Form of Underwriting Agreement*
3.1 Articles of Incorporation of the Registrant*
3.2 Articles of Amendment and Restatement of the Articles of Incorporation of
the Registrant*
3.3 Bylaws of the Registrant, as amended*
4.1 Specimen Common Stock Certificate*
5.1 Opinion of Morgan, Lewis & Bockius LLP (including consent of such firm)
8.1 Opinion of Morgan, Lewis & Bockius LLP, as to certain tax matters
(including consent of such firm)
10.1 Purchase Agreement, dated February 12, 1997, between the Registrant and
Friedman, Billings, Ramsey & Co., Inc. ("FBR")*
10.2 Registration Rights Agreement, dated February 12, 1997, between the
Registrant and FBR*
10.3 Long-Term Stock Incentive Plan*
10.4 Employment Agreement, effective as of January 27, 1997, between the
Company and Michael A.J. Farrell*
10.5 Employment Agreement, effective as of January 27, 1997, between the
Company and Timothy J. Guba*
10.6 Employment Agreement, effective as of January 27, 1997, between the
Company and Wellington J. St. Claire*
10.7 Form of Master Repurchase Agreement*
10.8 Form of Purchase Agreement between the Company and the purchasers in the
Direct Offering*
23.1 Consent of Morgan, Lewis & Bockius LLP (included in Exhibits 5.1 and 8.1)
23.2 Consent of Deloitte & Touche L.L.P.*
24.1 Power of Attorney (included on page II-4)
</TABLE>
- --------
* Previously filed.
ITEM 37. UNDERTAKINGS
The Registrant hereby undertakes to provide to the Underwriters specified in
the Underwriting Agreement at the closing certificates in such denominations
and registered in such names as required by the Underwriters to permit prompt
delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Commission, such indemnification
is against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities
being registered, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to court of
appropriate jurisdiction in the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the
final adjudication of such issue.
The undersigned Registrant hereby undertakes that: (1) for purposes of
determining any liability under the Securities Act, the information omitted
from the form of Prospectus filed as part of this Registration Statement in
reliance upon Rule 430A and contained in a form of Prospectus filed by the
Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities
Act shall be deemed to be part of this Registration Statement as of the time
it was declared effective; and (2) for the purpose of determining liability
under the Securities Act, each post-effective amendment that contains a form
of Prospectus shall be deemed to be a new Registration Statement relating to
the securities offered therein and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 3 to the registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the
City of New York, State of New York on the 7th day of October, 1997.
Annaly Mortgage Management, Inc.
/s/ Michael A. J. Farrell
By: _________________________________
MICHAEL A. J. FARRELL
CHIEF EXECUTIVE OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO. 3 TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS
IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
* Director
- ----------------------------------- October 7, 1997
KEVIN P. BRADY
* Director
- ----------------------------------- October 7, 1997
SPENCER I. BOWNE
/s/ Kathryn F. Fagan Chief Financial
- ----------------------------------- Officer and Treasurer October 7, 1997
KATHRYN F. FAGAN (principal financial
and accounting
officer)
/s/ Michael A. J. Farrell Chairman of the
- ----------------------------------- Board, Chief October 7, 1997
MICHAEL A. J. FARRELL Executive Officer
and Director
(principal executive
officer)
* Director
- ----------------------------------- October 7, 1997
JOHN S. GRACE
* Director
- ----------------------------------- October 7, 1997
JONATHAN D. GREEN
/s/ Timothy J. Guba President, Chief
- ----------------------------------- Operating Officer October 7, 1997
TIMOTHY J. GUBA and Director
* Director
- ----------------------------------- October 7, 1997
JOHN A. LAMBIASE
* Director
- ----------------------------------- October 7, 1997
DONNELL A. SEGALAS
/s/ Wellington J. St. Claire Vice Chairman of the
- ----------------------------------- Board and Director October 7, 1997
WELLINGTON J. ST. CLAIRE
/s/ Michael A. J. Farrell
*By: ______________________________
MICHAEL A. J. FARRELL
(ATTORNEY-IN-FACT)
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
PAGE
EXHIBIT NO. DESCRIPTION OF DOCUMENT NUMBER
----------- ----------------------- ------
<C> <S> <C>
1.1 Form of Underwriting Agreement*
3.1 Articles of Incorporation of the Registrant*
3.2 Articles of Amendment and Restatement of the Articles of
Incorporation of the Registrant*
3.3 Bylaws of the Registrant, as amended*
4.1 Specimen Common Stock Certificate*
5.1 Opinion of Morgan, Lewis & Bockius LLP (including consent
of such firm)
8.1 Opinion of Morgan, Lewis & Bockius LLP, as to certain tax
matters (including consent of such firm)
10.1 Purchase Agreement, dated February 12, 1997, between the
Registrant and Friedman, Billings, Ramsey & Co., Inc.
("FBR")*
10.2 Registration Rights Agreement, dated February 12, 1997,
between the Registrant and FBR*
10.3 Long-Term Stock Incentive Plan*
10.4 Employment Agreement, effective as of January 27, 1997,
between the Company and Michael A.J. Farrell*
10.5 Employment Agreement, effective as of January 27, 1997,
between the Company and Timothy J. Guba*
10.6 Employment Agreement, effective as of January 27, 1997,
between the Company and Wellington J. St. Claire*
10.7 Form of Master Repurchase Agreement*
10.8 Form of Purchase Agreement between the Company and the
purchasers in the Direct Offering*
23.1 Consent of Morgan, Lewis & Bockius LLP (included in
Exhibits 5.1 and 8.1)
23.2 Consent of Deloitte & Touche L.L.P.*
24.1 Power of Attorney (included on page II-4)
</TABLE>
- --------
* Previously filed.
II-5
<PAGE>
EXHIBIT 5.1
October 7, 1997
Annaly Mortgage Management, Inc.
1500 Harbor Boulevard
Weehawken, NJ 07087
Re: Issuance of Shares Pursuant to Registration Statement on Form S-11
------------------------------------------------------------------
Ladies and Gentlemen:
We have acted as special counsel to Annaly Mortgage Management, Inc., a Maryland
corporation (the "Company"), in connection with the preparation and filing with
the Securities and Exchange Commission under the Securities Act of 1933, as
amended (the "Act"), of a Registration Statement on Form S-11, as amended to
date (the "Registration Statement"), relating to the public offering of up to an
aggregate of 8,159,250 shares (including 845,000 shares to be sold by certain
selling stock holders and up to 1,064,250 shares subject to an over-allotment
option granted by the Company to the underwriters) (collectively the "Shares")
of the Company's Common Stock, par value $.01 per share.
In so acting, we have examined originals, or copies certified or otherwise
identified to our satisfaction, of the Amendment and Restatement of Articles
of Incorporation of the Company, the By-Laws of the Company, as amended to date,
and such other documents, records, certificates and other instruments as in our
judgment are necessary or appropriate for purposes of this opinion.
Based on the foregoing, we are of the opinion that the Shares have been duly
authorized by the Company and, when issued and paid for as contemplated by the
Registration Statement, will be duly and validly issued and fully paid and non-
assessable.
We render this opinion as members of the Bar of the State of Maryland.
<PAGE>
Annaly Mortgage Management, Inc.
October 7, 1997
Page 2
We consent to the use of this opinion as an exhibit to the Registration
Statement and to the use of our name under the captions "Legal Matters" and
"Risk Factors - Legal and Other Risks - Loss of Investment Company Net Exemption
Would Adversely Affect the Company" in the Registration Statement. In giving
this consent, we do not admit that we are acting within the category of persons
whose consent is required under Section 7 of the Act.
Very truly yours,
/s/Morgan, Lewis & Bockius LLP
- ------------------------------------
Morgan, Lewis & Bockius LLP
<PAGE>
EXHIBIT 8.1
October 7, 1997
Annaly Mortgage Management, Inc.
1500 Harbor Blvd.
Weehawken, NJ 07087
Re: Annaly Mortgage Management, Inc. --
Registration Statement on Form S-11 filed
with the Securities and Exchange Commission
(File No. 333-32913)
-------------------------------------------
Ladies and Gentlemen:
We have acted as special tax counsel to Annaly Mortgage Management, Inc., a
Maryland corporation (the "Company"), in connection with the proposed issuance
by the Company of up to an aggregate of 8,159,250 shares (including 845,000
shares to be sold by certain selling stockholders and up to 1,064,250 shares
subject to an over-allotment option granted by the Company to the underwriters)
of the Company's Common Stock, par value $.01 per share, pursuant to a
registration statement of the Company on Form S-11 (Registration No. 333-32913),
as amended to the date hereof (the "Registration Statement"). Capitalized terms
used herein and not otherwise defined herein have the respective meanings
ascribed to them in the Registration Statement.
In connection with the foregoing, we have examined originals or copies
satisfactory to us of all such corporate records, agreements, instruments and
other documents as we have deemed relevant and necessary as a basis for the
opinion hereinafter expressed. In such examination, we have assumed the
genuineness of all signatures, the authenticity of all documents submitted to us
as originals and the conformity with the original documents of all documents
submitted to us as copies. We understand and assume that (i) any agreement
which we have examined will represent the valid and binding obligation of the
respective parties thereto, enforceable in accordance with its respective terms,
and the entire agreement between the parties with respect to the subject matter
thereof, (ii) the parties to each such agreement will comply with all of their
respective covenants, agreements and undertakings contained therein, and (iii)
the transactions provided for by each such agreement will be carried out in
accordance with its terms.
Our opinion is based upon existing United States federal income tax laws,
regulations, administrative pronouncements and judicial decisions. All such
authorities are subject to change, either prospectively or retroactively. No
assurance can be provided as to the effect of any such change upon our opinion.
<PAGE>
Annaly Mortgage Management, Inc.
October 7, 1997
Page 2
Based upon and subject to the foregoing, we are of the opinion that:
1. The Company will meet the requirements for qualification as a REIT under
the Code commencing with the Company's taxable year ending the December 31,
1997, and the Company's current and contemplated method of operation described
in the Prospectus and as represented by the Company will enable it to continue
to satisfy the requirements for such qualification. This opinion is based on
various assumptions relating to the organization and operation of the Company
and is conditioned upon certain representations made by the Company as to
certain factual matters. The continued qualification and taxation of the
Company as a REIT will depend upon the Company's ability to meet, on a
continuing basis, distribution levels and diversity of stock ownership, and the
various qualification tests imposed by the Code.
2. The descriptions of matters of law and legal conclusions set forth in the
Registration Statement under the heading "Certain Federal Income Tax
Considerations" are our opinion and we hereby affirm the tax opinions of counsel
as set forth under such heading. While such descriptions discuss the material
anticipated United States federal income tax consequences applicable to the
Company and certain stockholders, they do not purport to discuss all federal
income tax consequences and our opinion is limited to those federal income tax
considerations specifically discussed therein.
In giving the foregoing opinion, we express no opinion other than as to the
federal income tax law of the United States of America.
We are furnishing this letter in our capacity as special tax counsel to the
Company and this letter is not to be used, circulated, quoted or otherwise
referred to for any other purpose, except as set forth below.
We hereby consent to the filing of this opinion as an Exhibit to the
Registration Statement and we further consent to the use of our name under the
caption "Certain Federal Income Tax Considerations" in the Registration
Statement. In giving such consent, we do not thereby concede that we are within
the category of persons whose consent is required under Section 7 of the
Securities Act of 1933, as amended, or the rules and regulations of the
Securities and Exchange Commission issued thereunder or that we are "experts"
within the meaning of such act, rules and regulations.
Very truly yours,
/s/Morgan, Lewis & Bockius LLP
- ------------------------------------
Morgan, Lewis & Bockius LLP
