<PAGE>
As filed with the Securities and Exchange Commission on ________, 1997
Registration No. 333-
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-----------------
APEX MORTGAGE CAPITAL, INC.
(Exact Name of Registrant as Specified in its Governing Instruments)
-----------------
865 South Figueroa Street, Suite 1800, Los Angeles, California 90017;
(213) 244-0000
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
-----------------
Philip A. Barach
Chief Executive Officer
Apex Mortgage Capital, Inc.
865 South Figueroa Street, Suite 1800
Los Angeles, California 90017
(213) 244-0000
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
-----------------
COPIES TO:
PETER T. HEALY, ESQ. KENNETH T. COTE, ESQ.
O'MELVENY & MYERS LLP JONATHAN B. MILLER, ESQ.
EMBARCADERO CENTER WEST BROWN & WOOD LLP
275 BATTERY STREET, SUITE 2600 ONE WORLD TRADE CENTER
SAN FRANCISCO, CALIFORNIA 94111 NEW YORK, NEW YORK 10048
TELEPHONE: (415) 984-8833 TELEPHONE: (212) 839-5300
FACSIMILE: (415) 984-8701 FACSIMILE: (212) 839-5599
-----------------
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, 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 number of the earlier effective registration statement for the same
offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) 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. [ ]
<TABLE>
<CAPTION>
CALCULATION OF REGISTRATION FEE
==============================================================================================================================
TITLE OF SECURITIES AMOUNT BEING PROPOSED MAXIMUM PROPOSED MAXIMUM AGGREGATE AMOUNT OF REGISTRATION FEE
BEING REGISTERED REGISTERED(1) OFFERING PRICE PER OFFERING PRICE(2)
SHARE
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value 11,500,000 $16.00 $184,000,000 $55,757.58
$0.01 per share shares
==============================================================================================================================
</TABLE>
(1) Includes 1,500,000 shares of Common Stock which may be purchased by
the Underwriters to cover over-allotments, if any (the "Underwriting).
(2) Estimated based on a bona fide estimate of the maximum offering price of
$16.00 solely for the purpose of calculating the registration fee pursuant
to Rule 457(a) of the Securities Act of 1933.
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, or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
<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.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED SEPTEMBER 19, 1997
PROSPECTUS 10,000,000 SHARES
- ----------
[LOGO]
APEX MORTGAGE CAPITAL, INC.
COMMON STOCK
_______________
Apex Mortgage Capital, Inc. (the "Company") is a newly organized Maryland
corporation created to invest primarily in high quality, adjustable-rate
mortgage-backed securities financed by the proceeds of this offering (the
"Offering") and by borrowings. The Company's principal business objective is to
generate net income for its stockholders based on the spread between the
interest income on its mortgage assets and the cost of borrowing to finance its
mortgage investment portfolio. The Company will elect to be taxed as a real
estate investment trust ("REIT") under the Internal Revenue Code of 1986, as
amended, and generally will not be subject to federal taxes on its income to the
extent that it distributes its net income to stockholders and maintains its
qualification as a REIT. The Company's operations will be managed by TCW
Investment Management Company (the "Manager"), a wholly owned subsidiary of The
TCW Group, Inc. ("TCW"). TCW, through its affiliates (together, the "TCW
Group"), has more than $50 billion under management, including over $10 billion
of mortgage-backed securities.
All of the shares of common stock (the "Common Stock") offered hereby are
being sold by the Company. The Common Stock offered to the public hereby will
represent substantially all of the equity ownership of the Company.
Prior to the Offering, there has been no public market for the Common
Stock. It is currently estimated that the initial public offering price for the
Common Stock will be between $14.00 and $16.00 per share. See "Underwriting"
for information relating to the determination of the initial public offering
price. Application has been made to list the Common Stock on the New York Stock
Exchange under the symbol "AXX."
_______________
SEE "RISK FACTORS" COMMENCING ON PAGE 16 FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY. THESE RISKS INCLUDE:
. Decrease in net interest income from Mortgage Assets (as herein defined)
due to interest rate fluctuations;
. Failure to successfully manage interest rate risks may adversely affect
results of operations;
. Substantial leverage and potential net interest and operating losses in
connection with borrowings;
. Inability to obtain short-term debt financing may limit acquisition or
require disposition of Mortgage Assets and adversely affect results of
operations;
. Inability to acquire Mortgage Assets with favorable interest rates and
terms would adversely affect net interest income;
. Increased levels of prepayments from Mortgage Assets may adversely affect
net interest income;
. No operating history; performance of the Manager and the TCW Group of
limited relevance in predicting future performance;
. Dependence on key personnel and the Manager for successful operations;
. Conflicts of interest; Manager and its affiliates will continue to purchase
Mortgage Assets for third-party accounts;
. Failure to maintain REIT status would result in the Company being subject
to tax as a regular corporation;
. Failure to maintain an exemption from the Investment Company Act would
adversely affect results of operations;
. Absence of public market; interest rate fluctuations may adversely affect
the market price of the Common Stock;
. Value of Mortgage Assets may be adversely affected by defaults on
underlying mortgage obligations; and
. Investment in Short-Term Investments (as herein defined) pending
acquisition of Mortgage Assets may initially adversely affect results of
operations.
_______________
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>
<CAPTION>
================================================================================
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
PER SHARE........ $ $ $
TOTAL(3)......... $ $ $
================================================================================
</TABLE>
1
<PAGE>
(1) THE COMPANY HAS AGREED TO INDEMNIFY THE SEVERAL UNDERWRITERS AGAINST
CERTAIN LIABILITIES, INCLUDING LIABILITIES UNDER THE SECURITIES ACT OF
1933, AS AMENDED. SEE "UNDERWRITING."
(2) BEFORE DEDUCTING ESTIMATED EXPENSES OF $__________, PAYABLE BY THE COMPANY.
(3) THE COMPANY HAS GRANTED TO THE UNDERWRITERS AN OPTION, EXERCISABLE WITHIN
30 DAYS OF THE DATE HEREOF, TO PURCHASE UP TO AN AGGREGATE OF 1,500,000
ADDITIONAL SHARES OF COMMON STOCK AT THE INITIAL PRICE TO PUBLIC PER SHARE
LESS THE UNDERWRITING DISCOUNT, FOR THE PURPOSE OF COVERING OVER-
ALLOTMENTS, IF ANY. IF SUCH OPTION IS EXERCISED IN FULL, THE TOTAL PRICE
TO PUBLIC, UNDERWRITING DISCOUNT AND PROCEEDS TO THE COMPANY WILL BE
$______, $_______, AND $______, RESPECTIVELY. SEE "UNDERWRITING."
----------------
THE SHARES OF COMMON STOCK ARE BEING OFFERED BY THE SEVERAL UNDERWRITERS,
SUBJECT TO PRIOR SALE, WHEN, AS AND IF ISSUED TO AND ACCEPTED BY THE
UNDERWRITERS AND SUBJECT TO 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 OF COMMON STOCK WILL BE MADE
IN NEW YORK, NEW YORK ON OR ABOUT _________, 1997.
----------------
MERRILL LYNCH & CO.
PAINEWEBBER INCORPORATED
STIFEL, NICOLAUS & COMPANY
INCORPORATED
SUTRO & CO. INCORPORATED
----------------
The date of this Prospectus is ____________, 1997.
2
<PAGE>
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SUCH
TRANSACTIONS MAY INCLUDE STABILIZING THE PURCHASE OF SHARES OF COMMON STOCK TO
COVER SYNDICATE SHORT POSITIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
----------------
CERTAIN INFORMATION CONTAINED IN THIS PROSPECTUS AND THE DOCUMENTS
INCORPORATED BY REFERENCE HEREIN CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, WHICH CAN BE
IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "WILL,"
"SHOULD," "EXPECT," "ANTICIPATE," "ESTIMATE," "INTEND," "CONTINUE," OR
"BELIEVES" OR THE NEGATIVES THEREOF OR OTHER VARIATIONS THEREON OR COMPARABLE
TERMINOLOGY. THE STATEMENTS IN "RISK FACTORS" IN THIS PROSPECTUS CONSTITUTE
CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS, INCLUDING CERTAIN RISKS AND
UNCERTAINTIES, WITH RESPECT TO SUCH FORWARD-LOOKING STATEMENTS THAT COULD CAUSE
THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO DIFFER
MATERIALLY FROM THOSE REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS.
THE COMPANY MAY PROVIDE PROJECTIONS, FORECASTS OR ESTIMATES OF FUTURE
PERFORMANCE OR CASH FLOWS OF THE COMPANY. PROJECTIONS, FORECASTS AND ESTIMATES
ARE ALSO FORWARD-LOOKING STATEMENTS AND WILL BE BASED UPON CERTAIN ASSUMPTIONS.
ACTUAL EVENTS ARE DIFFICULT TO PREDICT AND MAY BE BEYOND THE COMPANY'S CONTROL.
ACTUAL EVENTS MAY DIFFER FROM THOSE ASSUMED. SOME IMPORTANT FACTORS THAT WOULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN ANY FORWARD-LOOKING
STATEMENTS INCLUDE CHANGES IN INTEREST RATES; DOMESTIC AND FOREIGN BUSINESS,
MARKET, FINANCIAL OR LEGAL CONDITIONS; DIFFERENCES IN THE ACTUAL ALLOCATION OF
THE ASSETS OF THE COMPANY FROM THOSE ASSUMED; AND THE DEGREE TO WHICH ASSETS ARE
HEDGED AND THE EFFECTIVENESS OF THE HEDGE, AMONG OTHERS. IN ADDITION, THE DEGREE
OF RISK WILL BE INCREASED BY THE COMPANY'S LEVERAGING OF ITS ASSETS.
ACCORDINGLY, THERE CAN BE NO ASSURANCE THAT ANY ESTIMATED RETURNS OR PROJECTIONS
CAN BE REALIZED OR THAT ACTUAL RETURNS OR RESULTS WILL NOT BE MATERIALLY LOWER
THAN THOSE THAT MAY BE ESTIMATED.
TABLE OF CONTENTS
<TABLE>
<S> <C>
PROSPECTUS SUMMARY..................................................... 5
The Company......................................................... 5
The Manager......................................................... 6
Industry Trends..................................................... 8
Business and Strategy............................................... 9
Mortgage and Assets................................................. 10
Management Policies and Programs.................................... 10
Asset Acquisition Policy............................................ 10
Capital and Leverage Policy......................................... 11
Credit Risk Management Policy....................................... 11
Asset/Liability Management Policies................................. 12
Interest Rate Risk Management Policy................................ 12
Prepayment Risk Policy.............................................. 13
Summary Risk Factors................................................ 13
The Offering........................................................ 15
RISK FACTORS........................................................... 16
General............................................................. 16
Decrease in Net Interest Income From Mortgage Assets Due to
Interest Rate Fluctuations......................................... 16
Failure to Successfully Manage Interest Rate Risks May
Adversely Affect Results of Operations............................. 17
</TABLE>
3
<PAGE>
<TABLE>
<S> <C>
Substantial Leverage and Potential Net Interest and Operating
Losses in Connection with Borrowings................................. 18
Inability to Obtain Short-Term Debt Financing May Limit
Acquisition or Require Disposition of Mortgage Assets and
Adversely Affect Results of Operations................................ 18
Inability to Acquire Mortgage Assets with Favorable Interest
Rates and Terms Would Adversely Affect Net Interest Income............ 19
Increased Levels of Prepayments from Mortgage Assets May
Adversely Affect Net Interest Income.................................. 20
No Operating History; Performance of the Manager and the TCW
Group of Limited Relevance in Predicting Future Performance........... 20
Dependence on Key Personnel and the Manager for Successful
Operations............................................................ 20
Conflicts of Interest; Manager and Its Affiliates Will Continue to
Purchase Mortgage Assets for Third-Party Accounts..................... 21
Failure to Maintain REIT Status Would Result in the Company Being
Subject to Tax As a Regular Corporation............................... 22
Failure to Maintain an Exemption From the Investment Company
Act May Adversely Affect Results of Operations........................ 23
Absence of Public Market; Interest Rate Fluctuations May
Adversely Affect the Market Price of the Common Stock................. 23
Value of Mortgage Assets May Be Adversely Affected By Defaults
on Underlying Mortgage Obligations.................................... 24
Investment in Short-Term Investments Pending Acquisition of
Mortgage Assets May Initially Adversely Affect Results of
Operations............................................................ 24
Formation and Operation of Competing Mortgage REITs.................... 24
Risk of Adverse Tax Treatments of Excess Inclusion Income.............. 25
Value of Mortgage Loans May Be Adversely Affected by
Characteristics of Underlying Properties Borrower Credit.............. 25
Future Revisions in Policies and Strategies at the Discretion
of the Board of Directors............................................. 26
Effect of Future Offerings of Debt and Equity on Market
Price of the Common Stock............................................. 26
Restrictions on Ownership of the Common Stock.......................... 27
USE OF PROCEEDS........................................................... 28
DIVIDEND AND DISTRIBUTION POLICY.......................................... 29
CAPITALIZATION............................................................ 29
BUSINESS AND STRATEGY..................................................... 29
General................................................................ 29
Strategy............................................................... 29
Competition for Mortgage Assets........................................
Description of Mortgage Assets.........................................
Management Policies and Programs.......................................
Asset Acquisition Policy...............................................
Capital and Leverage Policy............................................
Credit Risk Management Policy..........................................
Asset/Liability Management.............................................
Interest Rate Risk Management Policy...................................
Prepayment Risk Management Policy......................................
Mortgage Loan Securitization Techniques................................
Other Policies.........................................................
Future Revisions in Policies and Strategies............................
Legal Proceedings......................................................
MANAGEMENT OF THE COMPANY.................................................
Directors and Officers of the Company..................................
Executive Compensation.................................................
Stock Options..........................................................
Stock Options Outstanding..............................................
THE MANAGER...............................................................
The Management Agreement...............................................
Management Compensation................................................
Expenses...............................................................
Certain Relationships; Conflicts of Interest...........................
Limits of Responsibility...............................................
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............
FEDERAL INCOME TAX CONSIDERATIONS.........................................
ERISA CONSIDERATIONS......................................................
DESCRIPTION OF CAPITAL STOCK..............................................
CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE COMPANY'S
ARTICLES OF INCORPORATION AND BYLAWS.....................................
UNDERWRITING..............................................................
LEGAL MATTERS.............................................................
EXPERTS...................................................................
ADDITIONAL INFORMATION....................................................
GLOSSARY..................................................................
AUDIT REPORT..............................................................
BALANCE SHEET.............................................................
</TABLE>
4
<PAGE>
- --------------------------------------------------------------------------------
PROSPECTUS SUMMARY
The following summary should be read in conjunction with and is qualified
in its entirety by the more detailed information appearing elsewhere in this
Prospectus. Certain capitalized and other terms used herein shall have the
meanings assigned to them in the Glossary. Unless otherwise indicated, the
information in this Prospectus assumes that the Underwriters' over-allotment
option is not exercised. All information concerning The TCW Group, Inc. and its
Affiliates is as of June 30, 1997, except as otherwise indicated.
This Prospectus contains forward-looking statements that inherently involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of the
information set forth under the heading "Risk Factors" and within the Prospectus
generally.
THE COMPANY
Apex Mortgage Capital, Inc. (the "Company"), a Maryland corporation, was
formed on September 15, 1997, primarily to acquire United States agency and
other highly rated, adjustable-rate, single-family real estate mortgage
securities and mortgage loans. The Company intends to structure its portfolio
to maintain a minimum weighted average rating (including the Company's deemed
comparable ratings for unrated mortgage assets based on a comparison to rated
mortgage assets with like characteristics) of at least AA or Aa by Standard &
Poor's Ratings Services ("Standard & Poor's") or Moody's Investors Service, Inc.
("Moody's"), respectively (collectively, the "Rating Agencies"). The Company
will use its equity capital and borrowed funds to seek to generate income based
on the difference between the yield on its mortgage assets and the cost of its
borrowings. 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"). The
Company will not generally be subject to federal taxes on its income to the
extent that it distributes its net income to its stockholders and maintains its
qualification as a REIT. See "Federal Income Tax Considerations--Requirements
for Qualification as a REIT--Distribution Requirement."
The goal of the Company is to be an efficient long-term investor in
mortgage assets. The Company intends to acquire mortgage assets primarily in the
secondary mortgage market through the operational experience and market
relationships of TCW Investment Management Company (the "Manager") and its
affiliates. See "The Manager."
The day-to-day operations of the Company will be managed by the Manager
subject to the direction and oversight of the Company's Board of Directors, a
majority of whom will be unaffiliated with The TCW Group, Inc. ("TCW" and,
together with its subsidiaries and Affiliates, the "TCW Group") or the Manager.
The Manager, a California corporation, is a wholly owned subsidiary of TCW. The
TCW Group is one of the largest employee-owned investment management and
counseling firms in the United States, with over $50 billion under management,
including over $10 billion of mortgage-backed securities. The Company's and the
Manager's management team (collectively, "Management") will be selected members
of the TCW Group's Mortgage-Backed Securities Group (the "MBS Group"), all of
whom have over ten years of experience in raising and managing mortgage capital.
See "Management of the Company -- Directors and Executive Officers" and "The
Manager." The Company believes that it will be the first publicly traded
mortgage REIT whose management comes entirely from an
- --------------------------------------------------------------------------------
5
<PAGE>
- --------------------------------------------------------------------------------
internationally recognized asset management business. The Company has elected
to be externally managed by the Manager to take advantage of the existing
operational systems, expertise and economies of scale associated with the
Manager's current business operations.
The Company's mortgage assets will consist primarily of adjustable-rate
mortgage securities ("Mortgage Securities"), including adjustable-rate
collateralized mortgage obligations ("CMOs"), bearing interest rates that adjust
periodically based on changes in short-term market interest rates. However,
fixed-rate mortgage assets may also be acquired generally when combined with
hedging instruments, including interest rate derivative instruments, to obtain
investment characteristics similar to adjustable-rate Mortgage Securities. In
addition, the Company may from time to time, depending on market conditions,
acquire whole loans ("Mortgage Loans") from mortgage conduits and mortgage loan
originators, which the Company may use as collateral to create its own Mortgage
Securities. Pending full investment in the desired mix of Mortgage Securities
and Mortgage Loans, funds will be committed to certain short-term investments
("Short-Term Investments" and, together with Mortgage Securities and Mortgage
Loans, "Mortgage Assets").
The Company will finance the purchase of its Mortgage Assets with the net
proceeds of the Offering and short-term borrowings of up to 92% of total
Mortgage Assets, primarily with reverse repurchase agreements. The Company will
attempt to structure its borrowings to have interest rate indices and interest
rate adjustment periods that generally correspond (in the aggregate for the
entire portfolio, and not on an asset-by-asset basis) to the interest rate
adjustment indices and interest rate adjustment periods of its Mortgage Assets.
In general, the Company intends to hedge the lifetime cap risk associated
with its adjustable-rate Mortgage Assets. The Company's policy initially will
be to seek to limit the effective interest rate on substantially all of its
liabilities to a rate equal to the weighted average lifetime cap of its
adjustable-rate Mortgage Assets. Under current market conditions, the Company
does not intend to enter into transactions to hedge its periodic cap risk. The
Company currently intends to manage the periodic cap risk through its leverage
and asset/liability policies. This policy may negatively impact earnings during
periods of rapidly rising short-term interest rates. However, the Company
believes this policy is the most cost-efficient hedging strategy in the current
market environment. See "Risk Factors--Decrease in Net Interest Income from
Mortgage Assets Due to Interest Rate Fluctuations."
THE MANAGER
The Manager is a wholly owned subsidiary of TCW. Established in 1971, the
TCW Group is one of the largest employee-owned investment management and
counseling firms in the United States with over 500 employees in six offices
worldwide. The TCW Group's staff includes over 200 investment and
administrative professionals. The professional investment staff includes more
than 50 portfolio managers and analysts, approximately 60 research personnel and
15 traders. The TCW Group engages in investment management as its primary
business and specializes in the management of assets for pension and profit-
sharing funds, endowments and foundations. The TCW Group also specializes in
managing assets for insurance companies, foreign investors, high net worth
individuals and mutual funds for retail investors. The TCW Group offers its
clients more than 50 investment strategies, divided among six major sectors,
including, within the U.S. fixed-income sector, mortgage-backed securities.
The TCW Group has more than $50 billion in assets under management or
committed to management for over 1,200 clients. The MBS Group of the TCW Group
has expertise in mortgage-backed
- --------------------------------------------------------------------------------
6
<PAGE>
- --------------------------------------------------------------------------------
securities and is presently devoted exclusively to managing over $10 billion in
this sector for nearly 100 clients. The members of the MBS Group average
approximately six years of service with the TCW Group. The MBS Group has raised
and managed mortgage capital and managed short-duration Mortgage Assets for over
ten years and currently manages adjustable-rate mortgage holdings of over $3
billion comprised of over 500 individual securities. The MBS Group currently
leverages a portion of certain mortgage portfolios and uses reverse repurchase
agreements with a borrowing base in excess of $700 million.
The Company believes that it will be the first publicly traded mortgage
REIT whose management comes entirely from an internationally recognized asset
management business. The Company believes that, inasmuch as mortgage REITs are
companies that primarily raise and manage mortgage capital, a management team
that has a ten-year history of raising and managing mortgage capital should
assist the Company in successfully competing with banks, savings and loans,
insurance companies and other mortgage REITs. Furthermore, the Company will
seek to benefit from management that is experienced in the secondary mortgage
market and has a broad array of existing relationships in that market.
At all times, the Manager will be subject to the direction and oversight of
the Company's Board of Directors and will have only such functions and authority
as the Company may delegate to it. The Manager will be responsible for the day-
to-day operations of the Company and will perform such services and activities
relating to the Mortgage Assets and operations of the Company as may be
appropriate. The Manager will be primarily involved in two activities: (i)
asset/liability management -- acquisition, financing, hedging, management and
disposition of Mortgage Assets, including credit and prepayment risk management;
and (ii) capital management -- structuring, analysis, capital raising and
investor relations activities. In conducting these activities, the Manager will
formulate operating strategies for the Company, arrange for the acquisition of
Mortgage Assets by the Company, arrange for various types of financing for the
Company, monitor the performance of the Company's Mortgage Assets and provide
certain administrative and managerial services in connection with the operation
of the Company. The Manager will be required to manage the business affairs of
the Company in conformity with the policies that are approved and monitored by
the Company's Board of Directors. The Manager will be required to prepare
regular reports for the Company's Board of Directors, which will review the
Company's acquisitions of Mortgage Assets, portfolio composition and
characteristics, credit quality, performance and compliance with policies
previously approved by the Company's Board of Directors. See "The Manager --
The Management Agreement" and "Business and Strategy -- Management Policies and
Procedures."
Pursuant to a management agreement (the "Management Agreement") between the
Company and the Manager, the Company will pay the Manager annual base management
compensation based on Average Net Invested Capital payable monthly in arrears,
equal to 3/4 of 1% of the Average Net Invested Capital. "Average Net Invested
Capital" means for any period (i) the arithmetic average of the sum of the gross
proceeds of the offerings of its equity securities by the Company, after
deducting any underwriting discounts and commissions and other expenses and
costs relating to such offerings, plus the Company's retained earnings (taking
into account any losses incurred) computed by taking the average of such values
at the end of each month during such period, plus (ii) any unsecured debt
approved by the Unaffiliated Directors to be included in Average Net Invested
Capital. Accordingly, incurring collateralized debt to finance specific
investment purchases does not increase Average Net Invested Capital.
The Company will also pay the Manager, as incentive compensation for each
fiscal quarter, an amount equal to 30% of the Net Income of the Company, before
incentive compensation, in excess of
- --------------------------------------------------------------------------------
7
<PAGE>
- --------------------------------------------------------------------------------
the amount that would produce an annualized Return on Equity equal to the Ten
Year U.S. Treasury Rate (average of weekly average yield to maturity for U.S.
Treasury securities (adjusted to a constant maturity of 10 years), as published
weekly by the Federal Reserve Board during a quarter) plus 1%. A deduction for
the Company's interest expenses for borrowed funds is taken into account in
calculating Net Income. "Return on Equity" is computed for any quarter by
dividing the Company's Net Income for the quarter by its Average Net Worth for
the quarter and has no necessary correlation with the actual distributions
received by stockholders or with an individual investor's actual return on
investment. The incentive compensation calculation and payment to the Manager
will be made quarterly in arrears, and will be subject to an annual adjustment
commencing in the second full calendar year of operations of the Company. See
"The Manager -- Management Compensation" for a more detailed explanation of the
management compensation arrangements and the "Glossary" for definitions of the
terms "Average Net Worth," "Net Income" and "Return on Equity." The Company
believes that this compensation arrangement benefits stockholders because it
ties the Manager's compensation to Return on Equity and, in periods of low
earnings, the Manager's incentive compensation is reduced or eliminated, thereby
lowering the Company's operating expenses.
The Company will enter into the Management Agreement with the Manager at
the closing of the Offering for an initial term of two years. Thereafter, the
Management Agreement will be automatically renewed for additional one-year terms
unless terminated by the Company or the Manager upon written notice. Except in
the case of a termination or non-renewal by the Company for cause, upon
termination or non-renewal of the Management Agreement by the Company, the
Company is obligated to pay the Manager a termination or non-renewal fee. See
"The Manager -- The Management Agreement."
INDUSTRY TRENDS
Management believes fundamental changes are occurring in the mortgage
market, resulting in the shifting of investment capital and Mortgage Assets out
of traditional lending and savings institutions and into the development and
growth of new forms of mortgage banking and investment companies, including
those that qualify as REITs under the Code. Management believes that
traditional mortgage investment companies, such as banks, thrifts and insurance
companies, provide less attractive investment structures for investing in
Mortgage Assets because of the costs associated with regulation and corporate
level taxation. Additionally, with the development of highly competitive
national mortgage markets (which the Company believes is partly due to the
expansion of government sponsored enterprises such as GNMA, Fannie Mae and
FHLMC), local and regional mortgage originators have lost market share to more
efficient mortgage originators who compete nationally. The growth of the
secondary mortgage market, including new securitization techniques, has also
resulted in financing structures that can be utilized efficiently to fund
leveraged mortgage portfolios and better manage interest rate risk. As a REIT,
the Company can generally pass through earnings to stockholders without
incurring an entity-level federal income tax, thereby potentially allowing the
Company to pay higher dividends than traditional financial institutions and
mortgage banking competitors that are subject to federal income tax on their
earnings. See "Federal Income Tax Considerations -- Taxation of the Company."
The residential mortgage market has experienced considerable growth over
the past 15 years with total residential mortgage debt outstanding growing from
approximately $965 billion in 1980 to approximately $3.9 trillion in 1996,
according to the Mortgage Market Statistical Annual for 1997. In addition, the
total residential mortgage debt securitized into Mortgage Securities has grown
from approximately $110 billion in 1980 to approximately $1.9 trillion in 1996,
according to the same source. Management believes that the current size of the
residential mortgage market will provide the Company with significant
opportunities with respect to the purchase of Mortgage Assets.
- --------------------------------------------------------------------------------
8
<PAGE>
- --------------------------------------------------------------------------------
BUSINESS AND STRATEGY
The Company's principal business objective is to produce net interest
income on its Mortgage Assets while maintaining a cost efficient organizational
structure in order to generate Net Income for distribution to its stockholders.
To achieve its business objective and generate dividend yields that provide a
competitive rate of return for stockholders, the Company's strategy is to:
. purchase primarily single-family Mortgage Assets, the majority of which
are currently expected to have adjustable interest rates based on changes in
short-term market interest rates;
. manage the credit risk of its Mortgage Assets through, among other
activities, (i) carefully selecting Mortgage Assets to be acquired, (ii)
complying with the Company's policies with respect to credit risk concentration
which, among other things, will require the Company to maintain a Mortgage
Assets portfolio with a weighted average rating generally equivalent to AA or
better, (iii) actively monitoring the ongoing credit quality and servicing of
its Mortgage Assets, and (iv) maintaining appropriate capital levels and
allowances for possible credit losses;
. finance purchases of Mortgage Assets with the net proceeds of equity
offerings and, to the extent permitted by the Company's Capital and Leverage
Policy (described herein), to utilize leverage to increase potential returns to
stockholders through borrowings (primarily with reverse repurchase agreements)
with interest rates that will also reflect changes in short-term market interest
rates;
. seek to structure its borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate hedged basis,
generally correspond (within 90 days) to the interest rate adjustment indices
and interest rate adjustment periods of the adjustable-rate Mortgage Assets
purchased by the Company;
. utilize interest rate caps, swaps and similar financial instruments to
mitigate the risk of the cost of its variable-rate liabilities exceeding the
earnings on its Mortgage Assets during a period of rising interest rates;
. seek to minimize prepayment risk primarily by structuring a diversified
portfolio with a variety of prepayment characteristics; and
. apply securitization techniques designed to enhance the value and
liquidity of the Company's Mortgage Assets acquired in the form of Mortgage
Loans by securitizing them into Mortgage Securities tailored to the Company's
investment objectives.
See "Business and Strategy -- Management Policies and Programs" below for
further discussion of the Company's strategies. There can be no assurance that
the Company will successfully implement its strategies. See "Risk Factors" for
a discussion of factors that could adversely affect the Company's ability to
successfully implement its strategies.
- --------------------------------------------------------------------------------
9
<PAGE>
- --------------------------------------------------------------------------------
MORTGAGE ASSETS
The Company will primarily acquire United States agency and other High
Quality adjustable-rate Mortgage Assets. "High Quality" shall mean either (i)
Mortgage Securities that are rated A or above by at least one of the Rating
Agencies or (ii) Mortgage Securities that are unrated, but are either
obligations of the United States or obligations guaranteed by the United States
government or an agency or instrumentality of the United States government. The
Company intends to acquire Mortgage Assets in the secondary mortgage market
through the operational experience and market relationships of the Manager and
its affiliates.
The Mortgage Assets to be purchased by the Company will consist primarily
of Mortgage Securities and Mortgage Loans secured by single-family residential
real estate. The Company expects that primarily all of its Mortgage Assets will
bear interest at adjustable rates. However, fixed-rate Mortgage Assets may also
be acquired generally when combined with hedging instruments to obtain
investment characteristics similar to adjustable-rate Mortgage Assets. The
Company anticipates that a significant portion of the Mortgage Assets it
acquires will not be fully indexed (i.e., will bear interest at initial "teaser"
rates).
The Company will generally not acquire inverse floaters, REMIC residuals or
first loss subordinated bonds. On a limited basis, the Company may acquire
mortgage derivative securities, including, but not limited to, interest only,
principal only or other Mortgage Securities that receive a disproportionate
share of interest income, or principal, either as an independent stand-alone
investment opportunity or to assist in the management of prepayment and other
risks (collectively, "Mortgage Derivative Securities").
MANAGEMENT POLICIES AND PROGRAMS
Asset Acquisition Policy
The Company will only acquire Mortgage Assets that are consistent with its
balance sheet guidelines and risk management objectives. Since the intention of
the Company is generally to hold its Mortgage Assets until maturity, the Company
generally will not seek to acquire Mortgage Assets with investment returns that
are attractive only in a limited range of scenarios. Management believes that
future interest rates and mortgage prepayment rates are very difficult to
predict. Therefore, the Company will seek to acquire Mortgage Assets that
Management believes will provide competitive returns over a broad range of
interest rate and prepayment scenarios.
The Company will acquire Mortgage Assets that Management believes will
maximize returns on capital invested, after considering (i) the amount and
nature of the anticipated cashflows from the Mortgage Asset, (ii) the Company's
ability to pledge the Mortgage Asset to secure collateralized borrowings, (iii)
the increase in the Company's capital requirement determined by the Company's
Capital and Leverage Policy resulting from the purchase and financing of the
Mortgage Asset, (iv) the costs of financing, hedging, managing, securitizing and
reserving for the Mortgage Asset, and (v) the Company's credit risk management
policy. Prior to acquisition, potential returns on capital employed are
assessed over the life of the Mortgage Asset and in a variety of interest rate,
yield spread, financing cost, credit loss and prepayment scenarios.
- --------------------------------------------------------------------------------
10
<PAGE>
- --------------------------------------------------------------------------------
Capital and Leverage Policy
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 periods of adverse market conditions. The Company has
established a Capital and Leverage Policy that limits its ability to acquire
additional Mortgage Assets during times when the capital base of the Company is
less than a required amount defined in the Capital and Leverage Policy. In this
way, the use of balance sheet leverage is better controlled. The capital base
required for the purpose of the Capital and Leverage Policy is equal to the
market value of the Company's total Mortgage 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 the Mortgage 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. Under current market conditions, the Company will seek to maintain
a capital base of at least 10% of Mortgage Assets as an operating policy; if the
capital base falls below 8%, the Company will not acquire net additional
Mortgage Assets. In addition, in the event the Company's capital base falls
below 8%, the Manager will present a plan to the Company's Board of Directors to
bring the Company back to its target equity-to-assets ratio. It is anticipated
that in many circumstances this goal will be achieved over time without active
management through the natural process of mortgage principal repayments and
increases in the market values of Mortgage Assets as their coupon rates adjust
upwards to market levels.
Credit Risk Management Policy
Management will review credit risk and other risks of loss associated with
each Mortgage Asset acquisition that is not guaranteed by Fannie Mae, FHLMC or
GNMA and determine the appropriate allocation of capital to apply to such
investment. In addition, Management will attempt to diversify the Company's
Mortgage Asset portfolio to avoid undue geographic, insurer, industry and other
types of concentrations. The Company will attempt to obtain protection from
sellers and servicers against certain risks through representations and
warranties. The Company's Board of Directors will monitor the overall risk of
the Mortgage Asset portfolio and determine appropriate levels of provision for
loss.
The Company anticipates that at least 75% of its Mortgage Assets will be
comprised of High Quality adjustable-rate Mortgage Securities. In addition, the
Company anticipates further that at least 50% of its Mortgage Assets will be
invested in Mortgage Securities that are either rated AAA or have a comparable
rating by at least one of the Rating Agencies or are obligations of or are
guaranteed by the United States government or an agency or instrumentality
thereof. The Company's investment in Mortgage Loans or other Mortgage
Securities that are not High Quality under the criteria set forth above ("Other
Mortgage Assets") shall be limited to 25% of its Mortgage Assets. However, the
Company's investment in Other Mortgage Assets will be restricted to Mortgage
Assets that are unrated or whose ratings have not been updated, but are
determined to be of comparable quality (by the rating standards of at least one
of the Rating Agencies) to a High Quality Mortgage Security. This determination
will be made on the basis of credit or other enhancement features that meet the
High Quality credit criteria as determined by the Manager and approved by the
Company's Board of Directors, including approval by a majority of the
Unaffiliated Directors (defined as directors who are not affiliated with,
employed by or officers or directors of the Manager or the TCW Group). The
Company intends to structure its Mortgage Asset portfolio to maintain a minimum
weighted average rating (including the Company's
- --------------------------------------------------------------------------------
11
<PAGE>
- --------------------------------------------------------------------------------
deemed comparable ratings for unrated Mortgage Assets based on a comparison to
rated Mortgage Securities with like characteristics) of at least AA by at least
one of the Rating Agencies. However, there can be no assurance that such
structure will be achieved. The Company will not be obligated to liquidate any
Mortgage Assets to achieve its desired weighted average rating.
Compliance with the credit risk management policy guidelines shall be
determined at the time of purchase of Mortgage Assets (based on the most recent
valuation utilized by the Company) and will not be affected by events subsequent
to such purchase, including, without limitation, changes in characterization,
value or rating of any specific Mortgage Assets or economic conditions or events
generally affecting any Mortgage Assets of the type held by the Company.
Asset/Liability Management Policies
Interest Rate Risk Management Policy
To the extent consistent with its election to qualify as a REIT, the
Company will follow an interest rate risk management policy intended to mitigate
the negative effects of major interest rate changes. The Company intends to
minimize its interest rate risk from borrowings by attempting to match the
maturity of its borrowings to the interest rate adjustment periods on its
Mortgage Assets. Under normal market conditions, the Company will attempt to
keep the difference between the weighted average time to "reset" on its Mortgage
Assets to the weighted average time to reset on its borrowings to 90 days or
less, taking into account all hedging transactions. This interest rate risk
management policy will be reviewed by the Company's Board of Directors if the
Company incurs long-term noncallable borrowings and as market conditions change.
The Company's interest rate risk management policy is formulated with the
intent to offset the potential adverse effects resulting from rate adjustment
limitations on its Mortgage Assets and the differences between interest rate
adjustment indices and interest rate adjustment periods of its adjustable-rate
Mortgage Assets and related borrowings. The Company anticipates being able to
adjust the average maturity 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 will seek to minimize differences between interest rate adjustment
periods of adjustable-rate Mortgage Assets and related borrowings that may
occur.
In general, the Company intends to mitigate the lifetime cap risk
associated with its adjustable-rate Mortgage Assets. The policy will be to
attempt to limit the effective interest rate on substantially all of the
Company's liabilities as a whole to a rate equal to the weighted average
lifetime cap of its adjustable-rate Mortgage Assets. Under current market
conditions, the Company does not intend to enter into transactions to mitigate
its periodic cap risk. It is intended that the Company will manage this risk
through its leverage and asset/liability policies.
In all of its interest rate risk management transactions, Management will
follow certain procedures designed to limit credit exposure to Counter-parties,
including entering into contracts only with Counter-parties rated investment
grade by a nationally recognized rating service. See "Business and Strategy --
- --------------------------------------------------------------------------------
12
<PAGE>
- --------------------------------------------------------------------------------
Management Policies and Programs -- Asset/Liability Management" and "-- Interest
Rate Risk Management Policy." In addition, all hedging transactions will be
monitored for compliance with the REIT Provisions of the Code and other
applicable laws.
Prepayment Risk Management Policy
The Company's prepayment risk management policy is formulated with the
purpose of mitigating the potential adverse effects resulting from faster than
anticipated prepayment rates on its Mortgage Assets. The Company intends to
invest in Mortgage Assets that on a portfolio basis do not have significant
purchase price premiums. Under normal market conditions, the Company will seek
to keep the aggregate capitalized purchase premium of the Mortgage Assets
portfolio to 3% or less.
Although Management believes it has developed a cost-effective set of
asset/liability management policies to help mitigate interest rate and
prepayment risks, no strategy can completely insulate the Company from the
effects of interest rate changes, prepayments and defaults by Counter-parties.
Further, certain of the federal income tax requirements that the Company must
satisfy to qualify as a REIT limit its ability to fully hedge its interest rate
and prepayment risks. See "Federal Income Tax Considerations -- Requirements for
Qualification As a REIT -- Gross Income Tests."
DIVIDEND POLICY AND DISTRIBUTIONS
To maintain its qualification as a REIT, the Company intends to make annual
distributions to its stockholders of at least 95% of Taxable Income (which does
not necessarily equal net income as calculated in accordance with generally
accepted accounting principals ("GAAP"), determined without regard to the
deduction for dividends paid and by excluding any net capital gains. Any
Taxable Income remaining after the distribution of regular quarterly dividends
will be distributed annually in a special dividend on or prior to the date of
the first regular quarterly dividend payment of the following taxable year. The
dividend policy is subject to revision at the discretion of the Company's Board
of Directors. All distributions in excess of those required for the Company to
maintain REIT status will be made by the Company at the discretion of the Board
of Directors and will depend on the taxable earnings of the Company, its
financial condition and such other factors as the Board of Directors deems
relevant. The Company's Board of Directors has not established a minimum
dividend level.
SUMMARY RISK FACTORS
Each prospective purchaser of the Common Stock offered hereby should review
"Risk Factors" beginning on page 16 for a discussion of certain factors that
should be considered before investing in the Common Stock, including the
following:
. decrease in net interest income from Mortgage Assets due to interest
rate fluctuations;
. failure to successfully manage interest rate risks may adversely affect
results of operations;
. substantial leverage and potential net interest and operating losses in
connection with borrowings;
. inability to obtain short-term debt financing may limit acquisition or
require disposition of Mortgage Assets and adversely affect results of
operations;
- --------------------------------------------------------------------------------
13
<PAGE>
- --------------------------------------------------------------------------------
. inability to acquire Mortgage Assets with favorable interest rates and
terms would adversely affect net interest income;
. increased levels of prepayments from Mortgage Assets may adversely
affect net interest income;
. no operating history; performance of the Manager and the TCW Group of
limited relevance in predicting future performance;
. dependence on key personnel and the Manager for successful operations;
. conflicts of interest; Manager and its affiliates will continue to
purchase Mortgage Assets for third-party accounts;
. failure to maintain REIT status would result in the Company being
subject to tax as a regular corporation;
. failure to maintain an exemption from the Investment Company Act would
adversely affect results of operations;
. absence of public market; interest rate fluctuations may adversely
affect the market price of the Common Stock;
. value of Mortgage Assets may be adversely affected by defaults on
underlying mortgage obligations;
. investment in Short-Term Investments pending acquisition of Mortgage
Assets may initially adversely affect results of operations;
. active formation and operation of competing mortgage REITs may adversely
affect the market price of the Common Stock;
. risk of adverse tax treatment of excess inclusion income;
. value of Mortgage Loans may be adversely affected by characteristics of
underlying properties and borrower credit;
. future revisions in policies and strategies at the discretion of the
Board of Directors;
. effect of future offerings of debt and equity on market price of the
Common Stock; and
. restrictions on ownership of the Common Stock.
- --------------------------------------------------------------------------------
14
<PAGE>
THE OFFERING
Common Stock Offered..................................... 10,000,000 shares(1)
Common Stock to be Outstanding After the Offering ...... 10,000,100 shares(1)(2)
Use of Proceeds...................... Purchase of the Company's initial
portfolio of Mortgage Assets. The
Company may require up to six months to
have the net proceeds of the Offering
fully invested in Mortgage Assets and
up to an additional nine months to
fully implement the leveraging strategy
to increase the Mortgage Asset
investments to its desired level.
Pending full investment in the desired
mix of Mortgage Assets, funds will be
committed to Short-Term Investments
that are expected to provide a lower
net return than the Company hopes to
achieve from its intended primary
Mortgage Asset investments.
Proposed NYSE Symbol.................................................. "AXX"
- ----------------
(1) Assumes that the Underwriters' option to purchase up to an additional
1,500,000 shares to cover over-allotments is not exercised. See
"Underwriting."
(2) Includes 100 shares of Common Stock issued to TCW Capital Investment
Corporation in connection with the initial organization of the
Company. Excludes 1,000,000 shares of Common Stock reserved for
issuance under the Company's 1997 Stock Option Plan. Options to
acquire shares of Common Stock have been granted to the
Manager and Unaffiliated Directors of the Company. See "Management of
the Company--Stock Options."
15
<PAGE>
RISK FACTORS
Before investing in the shares of Common Stock offered hereby, prospective
investors should give special consideration to the information set forth below,
in addition to the information set forth elsewhere in this Prospectus. The
following risk factors are interrelated and, consequently, investors should
treat such risk factors as a whole. This Prospectus may contain forward-looking
statements that may be identified by the use of forward-looking terminology such
as "may," "will," "should," "expect," "anticipate," "estimate," "intend,"
"continue," or "believes" or the negative thereof or other variations thereon or
comparable terminology. The matters set forth under "Risk Factors" constitute
cautionary statements identifying important factors with respect to any forward-
looking statements, including certain risks and uncertainties, that could cause
actual results to differ materially from those in such forward-looking
statements.
An investment in the Company involves various risks, including the risk
that an investor can lose capital. While the Company will strive to attain its
objectives through, among other things, the Manager's research and portfolio
management skills, there is no guarantee of successful performance, that such
objectives can be reached or that a positive return can be achieved. In
addition to the information set forth elsewhere in this Prospectus, the
following risk factors should be considered.
GENERAL
The results of the Company's operations will be affected by various
factors, many of which are beyond the control of Management. The Company's Net
Income will vary primarily as a result of changes in short-term interest rates
and borrowing costs, the behavior of which involve various risks and
uncertainties, and the supply of and demand for Mortgage Assets. Prepayment
rates, interest rates and borrowing costs depend upon the nature and terms of
the Mortgage Assets, the geographic location of the real estate securing the
Mortgage Loans included in or underlying the Mortgage Assets, conditions in
financial markets, the fiscal and monetary policies of the United States
government and the Federal Reserve Board, competition and other factors, none of
which can be predicted with any certainty. Because interest rates fundamentally
affect the Company's activities, the operating results of the Company depend, in
large part, upon the ability of Management to utilize appropriate strategies to
maximize returns to the Company while attempting to minimize risks.
Substantially all of the Company's Mortgage Assets will generate income
based on short-term interest rates, and substantially all of the Company's
borrowings will have maturities of less than one year and will bear interest at
fixed rates over such periods. Consequently, changes in short-term interest
rates may significantly influence the Company's net interest income. While
increases in short-term rates will generally increase the yields on the
Company's adjustable-rate Mortgage Assets, rising short-term rates will also
increase the costs of borrowings by the Company. Interest rate yields will
generally reset more slowly than costs of borrowing and, therefore, 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.
DECREASE IN NET INTEREST INCOME FROM MORTGAGE ASSETS DUE TO INTEREST RATE
FLUCTUATIONS
Interest Rate Caps on Mortgage Assets. Adjustable-rate Mortgage Assets are
typically subject to periodic and lifetime interest rate caps that limit the
amount an adjustable-rate Mortgage Asset's interest rate can change during any
given period, as well as the minimum rate payable. The Company's borrowings
will not be subject to similar restrictions. Hence, in a period of increasing
interest rates, its borrowings could increase without limitation by caps, while
the interest rates on its Mortgage Assets could be so limited. This problem
will be magnified to the extent the Company acquires Mortgage Assets
16
<PAGE>
that are not fully indexed. Further, some adjustable-rate Mortgage Assets may
be subject to periodic payment caps that result in some portion of the interest
being deferred and added to the principal outstanding. This could result in
receipt by the Company of less cash income on its adjustable-rate Mortgage
Assets than is required to pay interest on the related borrowings. These
factors could lower the Company's net interest income or cause a net loss during
periods of rising interest rates, which would negatively impact the Company's
financial condition, cash flows and results of operations.
Borrowings. The Company intends to fund a substantial portion of its
adjustable-rate Mortgage Assets with borrowings that have interest rates based
on indices and repricing terms similar to, but of somewhat shorter maturities
than, the interest rate indices and repricing terms of the Mortgage Assets.
Thus, the Company anticipates that in most cases the interest rate indices and
repricing terms of its Mortgage Assets and its funding sources will not be
identical, thereby creating an interest rate mismatch between assets and
liabilities. While the historical spread between relevant short-term interest
rate indices has been relatively stable, there have been periods, especially
during the 1979-1982 and 1994 interest rate environments, when the spread
between such indices was volatile. During periods of changing interest rates,
such interest rate mismatches could negatively impact the Company's Net Income,
dividend yield and the market price of the Common Stock.
FAILURE TO SUCCESSFULLY MANAGE INTEREST RATE RISKS MAY ADVERSELY AFFECT RESULTS
OF OPERATIONS
Management will follow a policy intended to minimize the impacts of
interest rate changes. However, developing an objective interest rate risk
strategy is complex and no strategy can completely insulate the Company from
risks associated with interest rate changes. In addition, hedging strategies
typically involve transaction costs that increase dramatically as the period
covered by the hedging transaction increases and that also increase during
periods of rising and fluctuating interest rates. The REIT Provisions of the
Code may substantially limit Management's ability to engage in these hedging
transactions, and may prevent Management from effectively implementing hedging
strategies that it determines, absent such restrictions, would best insulate the
Company from the risks associated with changing interest rates.
In the event that the Company purchases interest rate caps or other
interest rate derivatives to hedge against lifetime and periodic rate or payment
caps, and the provider of interest rate derivatives becomes financially unsound
or insolvent, the Company may be forced to unwind its interest rate derivatives
with such provider and may take a loss on such interest rate derivatives.
Further, the Company could suffer the adverse consequences that the hedging
transaction was intended to protect against. Although the Company intends to
purchase interest rate derivatives only from financially sound institutions and
to monitor the financial strength of such institutions on a periodic basis, no
assurance can be given that it can avoid such third-party risks.
The adjustable-rate Mortgage Assets that the Company intends to acquire are
generally subject to periodic and lifetime interest rate caps. The Company may
purchase Mortgage Derivative Securities to seek to mitigate the negative impacts
of those interest-rate caps in a rising interest rate environment. Hedging
techniques involving the use of Mortgage Derivative Securities are highly
complex and may produce volatile returns. The hedging activity of the Company
will also be limited by the asset and sources of income requirements applicable
to the Company as a REIT. See "Federal Income Tax Considerations -- Asset
Tests" and "-- Gross Income Tests." The financial futures contracts and options
thereon in which the Company may invest are subject to periodic margin calls
that would result in additional costs to the Company. Financial futures held at
fiscal year end are also required to be marked to market and valued for tax
purposes, which could result in taxable income to the Company with no
corresponding cash available for distribution. There can be no assurance that
these hedging techniques
17
<PAGE>
will have a beneficial impact on the Net Income of the Company and the dividend
yield of the Common Stock.
SUBSTANTIAL LEVERAGE AND POTENTIAL NET INTEREST AND OPERATING LOSSES IN
CONNECTION WITH BORROWINGS
The Company intends to employ a leveraging strategy of increasing the size
of its Mortgage Assets portfolio by borrowing against its existing Mortgage
Assets to acquire additional Mortgage Assets. By leveraging its Mortgage Assets
in this manner, the Company expects that 90% of its total Mortgage Assets
typically may be financed with borrowed funds. If the ratio of the Company's
borrowings to total Mortgage Assets exceeds 92%, then, except as limited by the
sources of income tests applicable to the Company as a REIT, the Company will
not acquire net additional Mortgage Assets until the capital base exceeds 8%.
In addition, if the capital base falls below 8%, the Manager will present a plan
to the Company's Board of Directors to bring the Company back to it target
equity-to-assets ratio; in many circumstances this goal will be achieved over
time without active management through the natural process of mortgage principal
repayments and increases in Mortgage Assets as their coupon rates adjust upwards
to market levels. See "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT -- Gross Income Tests." The Company is also permitted
under its Bylaws to have unsecured borrowings of up to 300% of its net assets.
If the returns on the Mortgage Assets purchased with borrowed funds fail to
cover the cost of the borrowings, the Company's results of operations would be
adversely affected.
Additionally, the ability of the Company to achieve its investment
objectives will depend on its ability to borrow money on favorable terms, and
there can be no assurance that the Company will be able to do so. As of the
date of this Prospectus, the Company had not entered into any borrowing
arrangements.
A majority of the Company's borrowings are expected to be in the form of
collateralized borrowings, primarily reverse repurchase agreements, which will
be "marked to market" based on the market value of the Mortgage Assets pledged
to secure the specific borrowings at a given time. Certain of the Company's
Mortgage Assets may be cross-collateralized to secure multiple borrowing
obligations of the Company to a particular lender. The Company's leveraging
strategy may create instability in the Company's operations. A decline in the
market value of such Mortgage Assets could limit the Company's ability to borrow
or result in lenders initiating margin calls. The Company could be required to
sell Mortgage Assets under adverse market conditions in order to maintain
liquidity. If these sales were made at prices lower than the carrying value of
the Mortgage Assets, 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 Mortgage Assets, and
resulting loss of the difference between the value of the collateral and the
amount borrowed. To the extent the Company is compelled to liquidate Mortgage
Assets qualifying as Qualified REIT Real Estate Assets to repay borrowings, its
compliance with the REIT rules regarding asset and sources of income
requirements could be negatively affected, ultimately jeopardizing the Company's
status as a REIT. See "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT."
INABILITY TO OBTAIN SHORT-TERM DEBT FINANCING MAY LIMIT ACQUISITION OR REQUIRE
DISPOSITION OF MORTGAGE ASSETS AND ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company will rely on short-term borrowings to fund acquisitions of
Mortgage Assets. Accordingly, the ability of the Company to achieve its
investment objectives depends on its ability to borrow money in sufficient
amounts and on favorable terms and on its ability to renew or replace on a
continuous basis its maturing short-term borrowings. The Company currently has
no commitments with lenders.
18
<PAGE>
In addition, the Company may be dependent upon a few lenders to provide the
primary credit facilities for its Mortgage Asset purchases. Any failure to
obtain or renew adequate funding under these facilities or other financings on
favorable terms could have a material adverse effect on the Company's
operations.
In the event the Company is not able to renew or replace maturing
borrowings, it could be required to sell Mortgage Assets under adverse market
conditions and could incur permanent capital losses as a result. In addition,
in such event, the Company may be required to terminate hedge positions, which
could result in further losses to the Company. Any event or development such as
a sharp rise in interest rates or increasing market concern about the value or
liquidity of a type or types of Mortgage Assets in which the Company's Mortgage
Assets portfolio is concentrated will reduce the market value of the Mortgage
Assets, which would likely cause lenders to require additional collateral. A
number of such factors in combination may cause difficulties for the Company,
including a possible liquidation of a major portion of its Mortgage Assets at
disadvantageous prices with consequent losses, which would have a material
adverse effect on the Company and could render it insolvent.
Substantially all of the Company's Mortgage Assets can be expected to be
pledged to secure reverse repurchase agreements, bank borrowings or other credit
arrangements. Therefore, such Mortgage Assets may not be available to the
stockholders in the event of the liquidation of the Company, except to the
extent that the market value thereof exceeds the amounts due to the Company's
creditors. The market value of the Mortgage Assets will fluctuate as a result
of numerous market factors (including interest rates and prepayment rates) as
well as the supply of and demand for such Mortgage Assets. In the event of the
bankruptcy of a counter-party with whom the Company has a reverse repurchase
agreement, the Company might experience difficulty recovering its pledged
Mortgage Assets.
INABILITY TO ACQUIRE MORTGAGE ASSETS WITH FAVORABLE INTEREST RATES AND TERMS
WOULD ADVERSELY AFFECT NET INTEREST INCOME
The Company's Net Income will depend, in large part, on Management's
ability to acquire Mortgage Assets on acceptable terms and at favorable spreads
over the Company's borrowing costs. As of the date of this Prospectus, no
specific Mortgage Assets have been identified for acquisition by Management.
There can be no assurance that Management will be able to acquire sufficient
amounts of Mortgage Assets at spreads above the Company's cost of funds. In
acquiring Mortgage Assets, the Company will compete with other REITs, investment
banking firms, savings and loan associations, banks, mortgage bankers, insurance
companies, mutual funds, other lenders, GNMA, Fannie Mae, FHLMC and other
entities purchasing Mortgage Assets, some of which have greater financial
resources than the Company. In addition, there are several REITs similar to the
Company, and others may be organized in the future. The effect of the existence
of additional REITs may be to increase competition for the available supply of
Mortgage Assets suitable for purchase by the Company. Increased competition for
the acquisition of eligible Mortgage Assets or a diminution in the supply could
result in higher prices and, thus, lower yields on such Mortgage Assets that
could further narrow the yield spread over borrowing costs.
The availability of Mortgage Assets meeting the Company's criteria is
dependent upon, among other things, the size of and level of activity in the
residential real estate lending market. The size and level of activity in the
residential real estate lending market depend on various factors, including the
level of interest rates, regional and national economic conditions and inflation
and deflation in residential real estate values. To the extent Management is
unable to acquire a sufficient volume of Mortgage Assets meeting the Company's
criteria, the Company's results of operations would be adversely affected.
19
<PAGE>
INCREASED LEVELS OF PREPAYMENTS FROM MORTGAGE ASSETS MAY ADVERSELY AFFECT NET
INTEREST INCOME
Prepayments of Mortgage Assets could adversely affect the Company's results
of operations in several ways. Management anticipates that a substantial
portion of the adjustable-rate Mortgage Assets to be acquired by the Company may
bear initial "teaser" interest rates that are lower than their "fully indexed"
rates (the applicable index plus a margin). In the event that such an
adjustable-rate Mortgage Asset is prepaid prior to or soon after the time of
adjustment to a fully indexed rate, the Company will have held the Mortgage
Asset while it was less profitable and lost the opportunity to receive interest
at the fully indexed rate over the expected life of the adjustable-rate Mortgage
Asset. In addition, the prepayment of any Mortgage Asset that had been
purchased at a premium by the Company would result in the immediate write-off of
any remaining capitalized premium amount and consequent reduction of the
Company's net interest income by such amount. Finally, in the event that the
Company is unable to acquire new Mortgage Assets to replace the prepaid Mortgage
Assets, its financial condition, cash flows and results of operations could be
materially adversely affected.
Prepayment rates generally increase when prevailing interest rates fall
below the interest rates on existing Mortgage Assets. Prepayment experience
also may be affected by the geographic location of the real estate securing the
Mortgage Assets, the assumability of the Mortgage Assets, the ability of the
borrower to obtain or convert to a fixed-rate Mortgage Loan, conditions in the
housing and financial markets, and general economic conditions. The level of
prepayments is also subject to the same seasonal influences as the residential
real estate industry, with prepayments generally being greatest in the summer
months and lower in the winter months.
NO OPERATING HISTORY; PERFORMANCE OF THE MANAGER AND THE TCW GROUP OF LIMITED
RELEVANCE IN PREDICTING FUTURE PERFORMANCE
The Company is newly organized with no operating history and will commence
operations only if the shares of Common Stock offered hereby are sold.
Accordingly, the Company has not yet developed an earnings history or
experienced a wide variety of interest rate fluctuations or market conditions.
Consequently, the Company lacks historical financial results.
The Manager has no experience in managing a REIT. There can be no
assurance that the past experience of the executive officers of the Company and
the Manager will be appropriate to the business of the Company. Further, the
past performance of the Manager and the TCW Group is not indicative of future
results of the Company.
DEPENDENCE ON KEY PERSONNEL AND THE MANAGER FOR SUCCESSFUL OPERATIONS
The Company will be wholly dependent for the selection, structuring and
monitoring of its Mortgage Assets and associated borrowings on the diligence and
skill of its officers and the officers and employees of the Manager. The
Company does not anticipate having employment agreements with its senior
officers, or requiring the Manager to employ specific personnel or dedicate
employees solely to the Company. The Company is also dependent on other key
personnel and on its ability to continue to attract, retain and motivate
qualified personnel. The loss of any key person could have a material adverse
effect on the Company's business, financial condition, cash flows and results of
operations. See "Management of the Company -- Directors and Executive Officers
of the Company" and "The Manager."
20
<PAGE>
CONFLICTS OF INTEREST; MANAGER AND ITS AFFILIATES WILL CONTINUE TO PURCHASE
MORTGAGE ASSETS FOR THIRD-PARTY ACCOUNTS
Affiliates' Management of Investments in Mortgage Securities. The TCW
Group has informed the Company that it has, and expects to continue to purchase
and manage Mortgage Securities in the future for third-party accounts. The TCW
Group will have no obligation to make investment opportunities available to the
Company. As a result, there may be a conflict of interest between the
operations of Manager and the operations of its Affiliates in the acquisition
and disposition of Mortgage Securities. In addition, the TCW Group may from
time to time purchase Mortgage Securities for its own account. Such conflicts
may result in decisions and/or allocations of Mortgage Securities by Affiliates
of the Manager that are not in the best interests of the Company.
Affiliates' Management of Investments in Competing Entities. The TCW Group
has informed the Company that it has purchased, and expects to continue to
purchase equity securities in companies organized for purposes substantially
similar to those of the Company, including competing mortgage REITs, in the
normal course of its investment management business. Any investment by the TCW
Group in competing entities may adversely affect the market price of the Common
Stock.
Manager's Incentive Compensation. In addition to its base management
compensation, the Manager will have the opportunity to earn incentive
compensation under the Management Agreement for each fiscal quarter in an amount
equal to 30% of the Net Income of the Company (before payment of such incentive
compensation) in excess of the amount that would produce an annualized Return on
Equity equal to the Ten-Year U.S. Treasury Rate plus 1%. See "The Manager --
Management Compensation." The Company's ability to achieve the performance
level required for the Manager to earn the incentive compensation is dependent
upon the level and volatility of interest rates, the Company's ability to react
to changes in interest rates and to utilize successfully the operating
strategies described herein, and other factors, many of which are not within the
Manager's control. In evaluating Mortgage Assets for investment and in other
management strategies, an undue emphasis on the maximization of income at the
expense of other criteria, such as preservation of capital, in order to achieve
a higher incentive compensation could result in increased risk to the value of
the Company's Mortgage Asset portfolio.
Management May Render Services to Others. The Management Agreement does
not limit or restrict the right of the Manager or any of its officers,
directors, employees or Affiliates from engaging in any business or rendering
services of any kind to any other person, including the purchase of, or
rendering advice to others purchasing Mortgage Assets that meet the Company's
policies and criteria, except that the MBS Group of the TCW Group will not be
permitted to provide any such services to any residential mortgage REIT other
than the Company. The Manager may also advise other mortgage-related entities,
including REITs, that invest in commercial mortgages or other non-residential
mortgage securities. The ability of the Manager and its employees to engage in
other business activities could reduce the time and effort spent on the
management of the Company. See "The Manager -- The Management Agreement."
TCW Brokerage Services Will Act as Dealer in Offering. TCW Brokerage
Services, an Affiliate of the Manager, will act as a dealer in connection with
the Offering and receive compensation in connection with the shares of Common
Stock it sells. See "Underwriting."
21
<PAGE>
FAILURE TO MAINTAIN REIT STATUS WOULD RESULT IN THE COMPANY BEING SUBJECT TO TAX
AS A REGULAR CORPORATION
General. In order to maintain its qualification as a REIT for federal
income tax purposes, the Company must continually satisfy certain tests with
respect to the sources of its income, the nature and diversification of its
Mortgage Assets, the amount of its distributions to stockholders and the
ownership of its stock. See "Federal Income Tax Considerations -- Requirements
for Qualification as a REIT." Among other things, these restrictions may limit
the Company's ability to acquire certain types of assets that it otherwise would
consider desirable, limit the ability of the Company to securitize Mortgage
Loans for sale to third parties, and require the Company to make distributions
to its stockholders at times when it may deem it more advantageous to utilize
the funds available for distribution for other corporate purposes (such as the
purchase of additional assets or the repayment of debt) or at times that the
Company may not have funds readily available for distribution. Even if the
Company qualifies for taxation as a REIT, it may be subject to certain federal
taxes based on certain activities, which could result in decreased dividend
income available for distribution to stockholders. See "Federal Income Tax
Considerations -- Taxation of the Company."
Limitations on Hedging and Investments. The REIT Provisions of the Code may
substantially limit the ability of the Company to hedge its Mortgage Assets and
the related Company borrowings. The Company must limit its income in each year
from "Qualified Hedges" (together with any other income generated from other
than Qualified REIT Real Estate Assets) to less than 25% of the Company's gross
income. In addition, the Company must limit its aggregate income from hedging
and services from all sources (other than from Qualified REIT Real Estate Assets
or Qualified Hedges) to less than 5% of the Company's gross income each year. As
a result, the Company may have to limit its use of certain hedging techniques
that might otherwise have been advantageous. Any limitation on the Company's use
of hedging techniques may result in greater interest rate risk. The Company
intends to monitor closely any income from such swap or cap agreements so as to
comply with the 5% income limitation. If the Company were to receive income in
excess of the 25% or 5% limitation, it could incur payment of a penalty tax
equal to the amount of income in excess of those limitations, or in the case of
a willful violation, loss of REIT status for federal tax purposes. See "Federal
Income Tax Considerations -- Requirements for Qualification as a REIT -- Gross
Income Tests."
The Company must also ensure that at the end of each calendar quarter at
least 75% of the value of its assets consists of cash, cash items, government
securities and Qualified REIT Real Estate Assets, and of the investments in
securities not included in the foregoing, the Company does not hold more than
10% of the outstanding voting securities of any one issuer and no more than 5%
by value of the Company's assets consists of the securities of any one issuer.
Failure to comply with any of the foregoing tests would require the Company to
dispose of a portion of its assets within 30 days after the end of the calendar
quarter or face loss of REIT status and adverse tax consequences.
See "Federal Income Tax Considerations -- Requirements for Qualification as a
REIT -- Asset Tests."
Distribution Requirements. The Company's operations may from time to time
generate Taxable Income in excess of its Net Income for financial reporting
purposes (such as from amortization of capitalized purchase premiums). The
Company may also experience circumstances in which its Taxable Income is in
excess of cash flows available for distribution to stockholders. To the extent
that the Company does not otherwise have funds available, either situation could
result in the Company's inability to distribute substantially all of its Taxable
Income as required to maintain its REIT status. In either situation, the
Company could be required to borrow funds in order to make the required
distributions that could increase borrowing costs and reduce the yield to
stockholders, to sell a portion of its Mortgage Assets at disadvantageous prices
in order to raise cash for distributions, or make a distribution in the form
22
<PAGE>
of a return of capital, which would have the effect of reducing the equity of
the Company. See "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT -- Distribution Requirement."
Disqualification as a REIT. If the Company should not qualify as a REIT in
any tax year, it would be taxed as a regular domestic corporation and, among
other consequences, distributions to the Company's stockholders would not be
deductible by it in computing its taxable income. Any resulting tax liability
could be substantial and would reduce the amount of cash available for
distribution to the Company's stockholders. In addition, the unremedied failure
of the Company to be treated as a REIT for any one year would disqualify the
Company from being treated as a REIT for four subsequent years. See "Federal
Income Tax Considerations -- Termination or Revocation of REIT Status."
FAILURE TO MAINTAIN AN EXEMPTION FROM THE INVESTMENT COMPANY ACT WOULD ADVERSELY
AFFECT RESULTS OF OPERATIONS
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 in Real Estate"). Under the current interpretation of
the staff of the Commission, in order to qualify for this exemption, the Company
must, among other things, 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
Securities represent all the certificates issued with respect to an underlying
pool of Mortgage Loans, such Mortgage Securities may be treated as securities
separate from the underlying Mortgage Loans and, thus, may not qualify as
Qualifying Interests in Real Estate for purposes of the 55% requirement. The
Company's ownership of certain Mortgage Assets, therefore, may be limited by
the provisions of the Investment Company Act. However, if the Company fails to
qualify for exemption from registration as an investment company, its ability to
use leverage would be substantially reduced, and it would be unable to conduct
its business as described herein. Any such failure to qualify for such
exemption would have a material adverse effect on the Company.
ABSENCE OF PUBLIC MARKET; INTEREST RATE FLUCTUATIONS MAY ADVERSELY AFFECT THE
MARKET PRICE OF THE COMMON STOCK
Prior to the Offering, there has not been a public market for the Common
Stock, and there can be no assurance that a regular trading market for the
shares of Common Stock offered hereby will develop or, if developed, that any
such market will be sustained. In the absence of a public trading market, an
investor may be unable to liquidate his investment in the Company. The initial
public offering price will be determined by the Company and representatives of
the Underwriters. There can be no assurance that the price at which the shares
of Common Stock will sell in the public market after the closing of the Offering
will not be lower than the price at which they are sold by the Underwriters.
See "Underwriting." While there can be no assurance that a market for the
Common Stock will develop, the Company has applied to have the Common Stock
listed on the New York Stock Exchange under the symbol "AXX".
In the event that a public market for the Common Stock exists, it is likely
that the market price of the shares of the Common Stock will be influenced by
any variation between the net yield on the Company's Mortgage Assets and
prevailing market interest rates. The Company's earnings will be derived
primarily from any positive spread between the yield on its Mortgage Assets and
the cost of its borrowings. Such positive spread will not necessarily be larger
in high interest rate environments than
23
<PAGE>
in low interest rate environments. However, in periods of high interest rates,
the Net Income of the Company and, therefore, the dividend yield on the Common
Stock, may be less attractive compared with alternative investments, which could
negatively impact the price of the Common Stock. If the anticipated or actual
net yield on the Company's Mortgage Assets declines or if prevailing market
interest rates rise, thereby decreasing the positive spread between the net
yield on its Mortgage Assets and the cost of its borrowings, the market price of
the Common Stock may be adversely affected.
VALUE OF MORTGAGE ASSETS MAY BE ADVERSELY AFFECTED BY DEFAULTS ON UNDERLYING
MORTGAGE OBLIGATIONS
The Company will bear the risk of loss on any Mortgage Securities it
purchases in the secondary mortgage market or otherwise. However, such Mortgage
Securities will generally be structured with one or more types of credit
enhancement. Such forms of credit enhancement are intended to provide
protection against risk of loss due to default on the underlying Mortgage Loan,
or bankruptcy, fraud and special hazard losses. To the extent third parties
have been contracted to insure against these types of losses, the Company would
be dependent in part upon the creditworthiness and claims-paying ability of the
insurer and the timeliness of reimbursement in the event of a default on the
underlying obligations. Further, the insurance coverage for various types of
losses is limited in amount, and losses in excess of the limitation would be
borne by the Company.
The Company may also purchase Mortgage Assets issued by Fannie Mae, FHLMC
or GNMA. These entities provide guarantees against risk of loss for securities
they issue. Fannie Mae guarantees the scheduled payments of interest and
principal and the full principal amount of any Mortgage Loan foreclosed or
liquidated on its obligations. In the case of GNMA, the timely payment of
principal and interest on its certificates is guaranteed by the full faith and
credit of the United States government. FHLMC guarantees the timely payment of
interest and ultimate collection of principal on its obligations. For Fannie
Mae and FHLMC, payment of principal and interest on its certificates are
guaranteed only by the respective entity and not by the full faith and credit of
the United States government.
INVESTMENT IN SHORT-TERM INVESTMENTS PENDING ACQUISITION OF MORTGAGE ASSETS MAY
INITIALLY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company's results of operations initially may be adversely affected
pending purchase of Mortgage Assets and implementation of its Capital and
Leverage Policy, particularly in the several-month period following the closing
of the Offering, during which time the Company will be primarily invested in
short-term government securities and other Short-Term Investments. The Company
anticipates that it may take up to 15 months to fully implement its leverage
strategy.
ACTIVE FORMATION AND OPERATION OF COMPETING MORTGAGE REITS MAY ADVERSELY AFFECT
THE MARKET PRICE OF THE COMMON STOCK
In addition to existing companies, other companies may be organized for
purposes similar to that of the Company, including companies organized as REITs
focused on purchasing High Quality Mortgage Assets. A proliferation of such
companies may increase the competition for equity capital and thereby adversely
affect the market price of the Common Stock. In addition, adverse publicity
affecting this sector of the capital market or significant operating failures of
a competitor may adversely affect the market price of the Common Stock.
24
<PAGE>
RISK OF ADVERSE TAX TREATMENT OF EXCESS INCLUSION INCOME
In general, dividend income that a Tax-Exempt Entity receives from the
Company should not constitute unrelated trade or business income as defined in
Section 512 of the Code ("UBTI"). If, however, excess inclusion income were
realized by the Company and allocated to stockholders, such income cannot be
offset by net operating losses and, if the stockholder is a Tax-Exempt Entity,
is fully taxable as UBTI under Section 512 of the Code and, as to foreign
stockholders, would be subject to federal income tax withholding without
reduction pursuant to any otherwise applicable income tax treaty. See "Federal
Income Tax Considerations -- Taxation of Stockholders" and "-- Taxation of Tax-
Exempt Entities" for discussions of the treatment of excess inclusion income.
Excess inclusion income would be generated if the Company were to issue debt
obligations with two or more maturities and the terms of the payments on such
obligations bore a relationship to the payments that the Company received on its
Mortgage Assets securing those debt obligations. The Company intends to arrange
its borrowings in a manner to avoid generating significant amounts of excess
inclusion income. The Company does, however, intend to enter into one or more
master reverse repurchase agreements (i) pursuant to which the Company will
issue various reverse repurchase agreements that will have differing maturity
dates, and (ii) that will afford the counter-party lender the right to sell any
of the Company's Mortgage Securities that have been pledged to the counter-party
if the Company were to default on its obligations to that counter-party lender.
There can be no assurance that the Service might not successfully maintain that
any such borrowing arrangements would give rise to excess inclusion income that
would be allocated among stockholders in some appropriate fashion. See "Federal
Income Tax Considerations -- Taxation of Stockholders." Furthermore, certain
types of Tax-Exempt Entities, such as voluntary employee benefit associations
and entities that have borrowed to acquire their shares of Common Stock, may be
required to treat a portion of or all of the dividends they may receive from the
Company as UBTI. See "Federal Income Tax Considerations -- Taxation of Tax-
Exempt Entities."
VALUE OF MORTGAGE LOANS MAY BE ADVERSELY AFFECTED BY CHARACTERISTICS OF
UNDERLYING PROPERTY AND BORROWER CREDIT
Mortgage Loan Risks. A portion of the Company's Mortgage Assets (subject
to the 25% policy on Other Mortgage Assets) may consist of Mortgage Loans.
During the time it holds any Mortgage Loans, the Company will be subject to
increased credit risks, including risks of borrower defaults and bankruptcies
and special hazard losses that are not covered by standard hazard insurance
(such as those occurring from earthquakes or floods). In the event of a default
on any Mortgage Loan held by the Company, the Company will bear the risk of loss
of principal to the extent of any deficiency between the value of the secured
property, less any payments from an insurer or guarantor, and the amount owing
on the Mortgage Loan. Mortgage Loans in default will also cease to be eligible
collateral for borrowings, and will have to be financed by the Company out of
other funds until ultimately liquidated. Although the Company intends to
establish reserves in amounts it believes are adequate to cover these risks, in
view of the Company's lack of operating history, there can be no assurance that
reserves that are established will be sufficient to offset losses on Mortgage
Loans in the future.
Even assuming that properties secured by any Mortgage Loans held by the
Company provide adequate security for such Mortgage Loans, substantial delays
could be encountered in connection with the foreclosure of defaulted Mortgage
Loans, with corresponding delays in the receipt of related proceeds by the
Company. State and local statutes and rules may delay or prevent the Company's
foreclosure on or sale of the mortgaged property and may prevent it from
receiving proceeds sufficient to repay all amounts due on the related Mortgage
Loan. Some properties that may collateralize the Company's Mortgage Loans may
have unique characteristics or may be subject to seasonal factors that could
materially prolong the time period required to resell the property.
25
<PAGE>
Inability to Securitize Mortgage Loans. The Company may acquire and
accumulate (subject to the 25% limitation on Other Mortgage Assets) Mortgage
Loans as part of its investment strategy until a sufficient quantity has been
acquired for securitization into Mortgage Securities. There can be no assurance
that the Company will be successful in securitizing the Mortgage Loans. During
the accumulation period, the Company will be subject to risks of borrower
defaults and bankruptcies, fraud losses and special hazard losses. In the event
of any default under Mortgage Loans held by the Company, the Company will bear
the risk of loss of principal to the extent of any deficiency between the value
of the mortgage collateral and the principal amount of the Mortgage Loan. Also
during the accumulation period, the costs of financing the Mortgage Loans
through reverse repurchase agreements and other borrowings and lines of credit
with warehouse lenders could exceed the interest income on the Mortgage Loans.
It may not be possible or economical for the Company to complete the
securitization of all Mortgage Loans that it acquires, in which case the Company
will continue to hold the Mortgage Loans and bear the risks of borrower defaults
and special hazard losses.
Sellers' Breach of Representations and Warranties with Respect to Mortgage
Loans. It is expected that when the Company acquires Mortgage Loans, the seller
will represent and warrant to the Company that there has been no fraud or
misrepresentation during the origination of the Mortgage Loans and will agree to
repurchase any Mortgage Loan with respect to which there is fraud or
misrepresentation. Although the Company will have recourse to the seller based
on the seller's representations and warranties to the Company, the Company will
be at risk for loss to the extent the seller does not perform its repurchase
obligations.
FUTURE REVISIONS IN POLICIES AND STRATEGIES AT THE DISCRETION OF THE BOARD OF
DIRECTORS
The Company's Board of Directors has established the investment policies,
the operating policies, and the strategies set forth in this Prospectus as the
investment policies, operating policies and strategies of the Company. However,
these policies and strategies may be modified or waived by the Board of
Directors of the Company, subject, in certain cases, to approval by a majority
of the Unaffiliated Directors, without stockholder consent.
EFFECT OF FUTURE OFFERINGS OF DEBT AND EQUITY ON MARKET PRICE OF THE COMMON
STOCK
The Company may in the future increase its capital resources by making
additional offerings of equity and debt securities, including classes of
preferred stock, Common Stock, commercial paper, medium-term notes, CMOs and
senior or subordinated notes. All debt securities, and other borrowings, 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 Common Stock, or both. The Company is unable to estimate
26
<PAGE>
the amount, timing or nature of additional offerings as they will depend upon
market conditions and other factors.
RESTRICTIONS ON OWNERSHIP OF THE COMMON STOCK
Preferred Stock. The authorized capital stock of the Company includes
preferred stock issuable in one or more series. 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. The
preferred stock, if issued, would have a preference on dividend payments that
could affect the ability of the Company to make dividend distributions to the
common stockholders. See "Description of Capital Stock."
9.8% Ownership Restriction. In order that the Company may meet the
requirements for qualification as a REIT at all times, the Articles of
Incorporation prohibits any person from acquiring or holding, directly or
indirectly, shares of capital stock in excess of 9.8% in value of the aggregate
of the outstanding shares of capital stock or in excess of 9.8% (in value or in
number of shares, whichever is more restrictive) of the aggregate of the
outstanding shares of capital stock of the Company. The Articles of
Incorporation further prohibits (i) any person from beneficially or
constructively owning shares of capital stock that would result in the Company
being "closely held" under Section 856(h) of the Code or otherwise cause the
Company to fail to qualify as a REIT, and (ii) any person from transferring
shares of capital stock if such transfer would result in shares of capital stock
being owned by fewer than 100 persons. If any transfer of shares of capital
stock occurs which, if effective, would result in any transfer or ownership
limitations, then that number of shares of capital stock in excess or in
violation of the above transfer or ownership limitations, the beneficial or
constructive ownership of which otherwise would cause such person to violate
such limitations (rounded to the nearest whole shares) shall be automatically
transferred to a Trustee of a Trust for the exclusive benefit of one or more
Charitable Beneficiaries, and the intended transferee shall not acquire any
rights in such shares. Subject to certain limitations, the Company's Board of
Directors may increase or decrease the ownership limitations or waive the
limitations for individual investors. See "Description of Capital Stock--
Repurchase of Shares and Restrictions on Transfer."
Notice of 5% Ownership. Every owner of more than 5% (or such lower
percentage as required by the Code or the regulations promulgated thereunder) of
all classes or series of the Company's capital stock, within 30 days after the
end of each taxable year, is required to give written notice to the Company
stating the name and address of such owner, the number of shares of each class
and series of stock beneficially owned and a description of the manner in which
such shares are held. Each such owner shall provide to the Company such
additional information as the Company may request in order to determine the
effect, if any, of such beneficial ownership on the Company's status as a REIT
and to ensure compliance with the ownership limitations.
The foregoing provisions may inhibit market activity and the resulting
opportunity for the holders of the Common Stock to receive a premium for their
Common Stock that might otherwise exist in the absence of such provisions. Such
provisions also may make the Company an unsuitable investment vehicle for any
person seeking to obtain ownership of more than 9.8% of the outstanding shares
of the Company's Common Stock.
Provisions of Maryland Law Restricting Takeovers. Certain provisions of
the Maryland General Corporation Law relating to "business combinations" and a
"control share acquisition" and of the Articles of Incorporation and Bylaws of
the Company may also have the effect of delaying, deterring or preventing a
takeover attempt or other change in control of the Company that would be
beneficial to
27
<PAGE>
stockholders and might otherwise result in a premium over then prevailing market
prices. Although the Bylaws of the Company contain a provision exempting the
acquisition of Common Stock by any person from the control share acquisition
statute, there can be no assurance that such provision will not be amended or
eliminated at any time in the future. See "Certain Provisions of Maryland Law
and of the Company's Articles of Incorporation and Bylaws."
USE OF PROCEEDS
The net proceeds from the Offering are estimated to be approximately
$__________ ($_________ if the Underwriters' overallotment option is exercised
in full), assuming an initial offering price of $15.00 per share of Common
Stock. The net proceeds from the Offering will be used by the Company to
purchase its initial portfolio of Mortgage Assets.
The Company may require up to six months to have the net proceeds of the
Offering fully invested in Mortgage Assets and up to an additional nine months
to fully implement the leveraging strategy to increase the Mortgage Asset
investments to its desired level. Pending full investment in the desired mix of
Mortgage Assets, funds will be committed to Short-Term Investments that are
expected to provide a lower net return than the Company hopes to achieve from
its intended primary Mortgage Asset investments.
DIVIDEND AND DISTRIBUTION POLICY
The Company intends to distribute substantially all of its net Taxable
Income (which does not ordinarily equal net income as calculated in accordance
with GAAP) to stockholders in each year. The Company intends to declare four
regular quarterly dividends. In addition, Taxable Income, if any, not
distributed through regular quarterly dividends will be distributed annually, at
or near year end, in a special dividend. The dividend policy is subject to
revision at the discretion of its Board of Directors. All distributions will be
made by the Company at the discretion of its Board of Directors and will depend
on the earnings and financial condition of the Company, maintenance of REIT
status and such other factors as the Company's Board of Directors deems
relevant. See "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT -- Distribution Requirement."
In order to qualify as a REIT under the Code, the Company must make
distributions to its stockholders each year in an amount at least equal to (i)
95% of its Taxable Income (before deduction of dividends paid less any net
capital gain), plus (ii) 95% of the excess of the net income from Foreclosure
Property over the tax imposed on such income by the Code, minus (iii) any excess
noncash income. The "Taxable Income" of the Company for any year means the
taxable income of the Company for such year (excluding any net income derived
either from property held primarily for sale to customers or from Foreclosure
Property) subject to certain adjustments provided in the REIT Provisions of the
Code. See "Federal Income Tax Considerations -- Requirements for Qualification
as a REIT -- Distribution Requirement."
It is anticipated that distributions generally will be taxable as ordinary
income to stockholders of the Company, although a portion of such distributions
may be designated by the Company as capital gain or may constitute a return of
capital. The Company will furnish annually to each of its stockholders a
statement setting forth distributions paid during the preceding year and their
characterization as ordinary income, return of capital or capital gains. For a
discussion of the federal income tax treatment of distributions by the Company,
see "Federal Income Tax Considerations -- Taxation of Stockholders."
28
<PAGE>
CAPITALIZATION
The capitalization of the Company, as of September 15, 1997 and as adjusted
to reflect the sale of the shares of Common Stock offered hereby at an assumed
per share price at the mid-point of the offering range set forth on the cover
page of this Prospectus, is as follows:
<TABLE>
<CAPTION>
As Adjusted(1)(2)
Actual (in thousands)
------ ----------------
<S> <C> <C>
Common Stock, par value $.01 $ $
Authorized--100,000,000 shares
Outstanding--100 shares (as adjusted
10,000,100 shares) 1
Additional Paid-in Capital $1,499
------ ----------------
Total
$1,500 $
====== ================
</TABLE>
(1) Before deducting offering expenses estimated to be $_______, payable
by the Company, and assuming no exercise of the Underwriters' over-
allotment option to purchase up to an additional 1,500,000 shares of
Common Stock.
(2) Does not include 1,000,000 shares of Common Stock reserved for
issuance upon exercise of options granted under the Company's 1997
Stock Option Plan. See "Management of the Company -- Stock Options."
BUSINESS AND STRATEGY
GENERAL
The Company was incorporated in Maryland on September 15, 1997 and, upon
the closing of the Offering, will commence its business of purchasing and
holding a portfolio of adjustable-rate Mortgage Assets. The Company intends to
generate income for distribution to its stockholders primarily from the Net
Income on its Mortgage Assets qualifying as Qualified REIT Real Estate Assets.
The Company's Net Income will result primarily from the difference between (i)
the interest income on its Mortgage Asset investments, and (ii) the borrowing
and financing costs of the Mortgage Assets.
STRATEGY
To achieve its business objective and generate dividend yields that provide
a competitive rate of return for its stockholders, the Company's strategy is to:
. purchase primarily single-family Mortgage Assets, the majority of
which are currently expected to have adjustable interest rates based
on changes in short-term market interest rates;
. manage the credit risk of its Mortgage Assets through, among other
activities (i) carefully selecting Mortgage Assets to be acquired,
(ii) complying with the Company's policies with respect to credit
risk concentration which, among other things, require the Company to
maintain a Mortgage Asset portfolio with a weighted average rating
generally equivalent to AA or better, (iii) actively monitoring the
ongoing credit quality and servicing of its Mortgage
29
<PAGE>
Assets, and (iv) maintaining appropriate capital levels and allowances
for possible credit losses;
. finance purchases of Mortgage Assets with the net proceeds of
equity offerings and, to the extent permitted by the Company's
Capital and Leverage Policy, to utilize leverage to increase
potential returns to stockholders through borrowings (primarily with
reverse repurchase agreements) with interest rates that will also
reflect changes in short-term market interest rates;
. seek to structure its borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate
hedged basis, generally correspond (within 90 days) to the interest
rate adjustment indices and interest rate adjustment periods of the
adjustable-rate Mortgage Assets purchased by the Company;
. utilize interest rate caps, swaps and similar financial instruments to
mitigate the risk of the cost of its variable-rate liabilities exceeding
the earnings on its Mortgage Assets during a period of rising interest
rates;
. seek to minimize prepayment risk primarily by structuring a
diversified portfolio with a variety of prepayment characteristics;
and
. apply securitization techniques designed to enhance the value and
liquidity of the Company's Mortgage Assets acquired in the form of
Mortgage Loans by securitizing them into Mortgage Securities that are
tailored to the Company's objectives.
There can be no assurance that the Company will successfully implement its
strategies. See "Risk Factors" for a discussion of factors that could affect
the Company's ability to successfully implement its strategies.
Although there can be no assurance, Management believes that the Company
will be able to generate competitive earnings and dividends while holding
Mortgage Assets of high credit quality and maintaining a disciplined risk-
control profile. The Company will also strive to increase its return to
stockholders over time by: (i) seeking to raise additional capital in order to
increase its ability to invest in additional Mortgage Assets; (ii) striving to
lower its effective borrowing costs through seeking direct funding with
collateralized lenders, in addition to using Wall Street intermediaries, and
investigating the possibility of using collateralized commercial paper and
medium-term note programs; and (iii) improving the efficiency of its balance
sheet structure by investigating the issuance of uncollateralized subordinated
debt and other forms of capital.
Investment Policy. The Company's investment strategy will be to create a
diversified portfolio primarily of High Quality adjustable-rate Mortgage
Securities that, in the aggregate, will preserve the capital base of the Company
and generate income for the Company for distribution to its stockholders. The
Company's Mortgage Assets will be held primarily for investment. The Company
intends generally to buy and hold Mortgage Assets to maturity and, therefore,
will seek to have a low portfolio turnover rate. The Company's ability to sell
Mortgage Assets for gain is restricted by the REIT Provisions of the Code and
the rules, regulations and interpretations of the Service thereunder. See
"Federal Income Tax Considerations -- Requirements for Qualification as a REIT -
- - Gross Income Tests."
The Company will invest primarily (at least 75% of total Mortgage Assets)
in High Quality adjustable-rate Mortgage Securities and Short-Term Investments.
The Mortgage Securities will consist of (i) privately issued mortgage Pass-
Through Certificates as well as Agency Certificates, (ii) certain CMOs and (iii)
Other Mortgage Securities, including certain Mortgage Derivative Securities. At
least
30
<PAGE>
50% of the Company's total Mortgage Assets will be Agency Certificates or carry
a AAA or comparable rating from at least one of the Rating Agencies. The Company
will generally not acquire inverse floaters, REMIC residuals or first loss
subordinated bonds. On a limited basis, the Company may acquire interest only,
principal only or other Mortgage Derivative Securities that receive a
disproportionate share of interest income or principal, either as an independent
stand-alone investment opportunity or to assist in the management of prepayment
and other risks.
The remainder of the Company's investment portfolio, composing not more
than 25% of its total Mortgage Assets, may consist of unrated or rated Mortgage
Assets that are determined by the Manager and the Company's Board of Directors
to be of comparable quality to High Quality Mortgage Securities, including (i)
adjustable-rate Mortgage Loans secured by first liens on single-family (one-to-
four units) residential properties, (ii) Pass-Through Certificates or CMOs
backed by loans on single-family properties, and (iii) Other Mortgage
Securities. The Company intends to securitize substantially all Mortgage Loans
it acquires into High Quality Mortgage Securities that are Qualified REIT Real
Estate Assets that will then be held for investment. Substantially all of the
Company's Mortgage Assets will constitute Qualified REIT Real Estate Assets.
The Company intends to purchase Mortgage Assets from broker-dealers and
banks that regularly make markets in Mortgage Securities. The Company also
intends to purchase Mortgage Securities from a variety of Suppliers of Mortgage
Assets (typically mortgage bankers, savings and loans, investment banking firms,
home builders and other firms involved in originating and packaging Mortgage
Loans). In acquiring Mortgage Assets, the Company will compete with other
REITs, investment banking firms, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, other lenders, GNMA, Fannie Mae,
FHLMC and other entities purchasing Mortgage Assets, some of which have greater
financial resources than the Company. There are several REITs similar to the
Company and others may be organized in the future. The effect of the existence
of additional REITs may be to increase competition for the available supply of
Mortgage Assets suitable for purchase by the Company. There can be no assurance
that the Company will be able to acquire sufficient Mortgage Assets from
Suppliers of Mortgage Assets at spreads above the Company's cost of funds.
The Company's Board of Directors has adopted the investment policies set
forth in this Prospectus as its initial investment policies. The policies may
be changed at any time by the Board of Directors (subject to approval by a
majority of Unaffiliated Directors) without the consent of stockholders. The
Company's Board of Directors will establish and approve (including approval by a
majority of Unaffiliated Directors) at least annually the investment policies of
the Company, which will include investment criteria that each Mortgage Asset
must satisfy to be eligible for investment by the Company. Management must use
such criteria in determining whether to acquire Mortgage Assets on behalf of the
Company. The Company will not purchase any Mortgage Assets from its Affiliates
other than Mortgage Securities that may be purchased from a taxable subsidiary
of the Company that may be formed in connection with the securitization of
Mortgage Loans.
The Company does not intend to enter into any servicing or administrative
agreements (other than the Management Agreement) with the Manager or any
entities affiliated with the Manager. Any changes in this policy would be
subject to approval by the Company's Board of Directors, including by a majority
of the Unaffiliated Directors.
Financing Policy. The Company intends to finance its purchase of Mortgage
Assets initially through equity from the net proceeds of the Offering and,
thereafter, primarily by borrowing against existing Mortgage Assets and using
the net proceeds to acquire additional Mortgage Assets. See "Use
31
<PAGE>
of Proceeds" and "Management Policies and Programs--Capital and Leverage
Policy." The borrowings are expected to be in the form of reverse repurchase
agreements, loan agreements, 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), warehouse lines of credit and other credit facilities. The Company's
borrowings generally will be secured by its Mortgage Assets. The Company's
income will be increased through the use of such borrowings if the cost of the
borrowings is less than the interest earned on the Mortgage Assets purchased
with or securing the borrowed funds. However, during any periods in which this
spread is negative, and the Company's borrowing costs exceed its interest income
on Mortgage Assets purchased with or securing the borrowed funds, the Company
could experience losses. See "Risk Factors--Substantial Leverage and Potential
Net Interest and Operating Losses in Connection with Borrowings" and "--
Decrease in Net Interest Income from Mortgage Assets Due to Interest Rate
Fluctuations."
Hedging Policy. The Company intends to enter into hedging transactions to
mitigate the effects of interest rate fluctuations on its portfolio of Mortgage
Assets and related debt. See " Business and Strategy -- Asset/Liability
Management--Interest Rate Risk Management Policy." These transactions may
include interest rate swaps, the purchase of interest rate caps and futures
contracts and options on futures contracts and the trading of forward contracts
to mitigate the effects of fluctuations in interest rates. The Company may also
purchase Mortgage Derivative Securities and Excess Servicing Rights secured by
interests in real property as a hedging strategy. The Company will not acquire
any Mortgage Derivative Securities or Excess Servicing Rights that do not
qualify as Qualified REIT Real Estate Assets. Accordingly, income from Mortgage
Derivative Securities and Excess Servicing Rights acquired by the Company will
be qualifying income under the 75% and 95% sources of income tests applicable to
the Company as a REIT. The Company intends to carefully monitor its income from
hedging activity in Mortgage Assets that are not Qualified REIT Real Estate
Assets, and may have to limit such activity in order to comply with the REIT
Provisions of the Code and to ensure that it does not realize excessive hedging
income that could result in the Company's disqualification as a REIT. See
"Federal Income Tax Considerations -- Requirements for Qualification as a REIT -
- - Gross Income Tests."
The Manager. The Manager will manage the day-to-day operations of the
Company, subject to the direction and oversight of the Company's Board of
Directors. The Manager's key officers have significant experience in raising
and managing mortgage capital, mortgage finance and the purchase and
administration of Mortgage Assets; however, the Manager has not previously
managed a REIT. See "Management of the Company -- Directors and Executive
Officers" and "The Manager" for biographies and a description of the prior
business experience of the executive officers of the Manager, and "Risk Factors-
- -Dependence on Key Personnel and Manager for Successful Operations."
COMPETITION FOR MORTGAGE ASSETS
Management believes that the principal competition in the business of
acquiring and holding Mortgage Assets are financial institutions such as banks,
savings and loans, life insurance companies, institutional investors such as
mutual funds and pension funds, and certain other mortgage REITs. Management
anticipates that the Company will be able to compete effectively and generate
competitive rates of return for stockholders due to the Manager's expertise in
raising and investing mortgage capital, access to and experience in secondary
mortgage markets, relative freedom to securitize its Mortgage Assets, relatively
low level of operating costs, ability to utilize prudent amounts of leverage
through accessing the wholesale market for collateralized borrowings, freedom
from certain forms of regulation and the tax advantages of its REIT status.
32
<PAGE>
DESCRIPTION OF MORTGAGE ASSETS
The Company intends to invest principally in the following types of
Mortgage Assets subject to the operating restrictions described in "--
Management Policies and Programs" below.
Pass-Through Certificates
General. The Company's investments in Mortgage Assets are expected to be
concentrated in Pass-Through Certificates. The Pass-Through Certificates to be
acquired by the Company will consist primarily of pass-through certificates
issued by Fannie Mae, FHLMC and GNMA, as well as High Quality privately issued
adjustable-rate mortgage pass-through certificates. The Pass-Through
Certificates to be acquired by the Company will represent interests in mortgages
that will be secured primarily by liens on single-family (one-to-four units)
residential properties. The Company may also acquire, within the 25% investment
limitation on Other Mortgage Assets, unrated or rated Pass-Through Certificates
that represent interests in mortgages secured by liens on single-family
properties that are determined by the Manager and the Board of Directors to be
of comparable quality to High Quality Mortgage Securities.
Pass-Through Certificates backed by adjustable-rate Mortgage Loans are
subject to lifetime interest rate caps and to periodic interest rate caps that
limit the amount an interest rate can change during any given period. The
Company's borrowings are generally not subject to similar restrictions. In a
period of increasing interest rates, the Company could experience a decrease in
Net Income or incur losses because the interest rates on its borrowings could
exceed the interest rates on ARM Pass-Through Certificates owned by the Company.
The impact on Net Income of such interest rate changes will depend on the
adjustment features of the Mortgage Assets owned by the Company, the maturity
schedules of the Company's borrowings and related hedging.
Privately Issued ARM Pass-Through Certificates. Privately issued ARM Pass-
Through Certificates are structured similarly to the Fannie Mae, FHLMC and GNMA
pass-through certificates discussed below and are issued by originators of and
investors in Mortgage Loans, including savings and loan associations, savings
banks, commercial banks, mortgage banks, investment banks and special purpose
subsidiaries of such institutions. Privately issued ARM Pass-Through
Certificates are usually backed by a pool of conventional adjustable-rate
Mortgage Loans and are generally structured with credit enhancement such as pool
insurance or subordination. However, privately issued ARM Pass-Through
Certificates are typically not guaranteed by an entity having the credit status
of Fannie Mae, FHLMC or GNMA guaranteed obligations.
Existing Fannie Mae ARM Programs. Fannie Mae is a federally chartered and
privately owned corporation organized and existing under the Federal National
Mortgage Association Charter Act (12 U.S.C. (S) 1716 et seq.). Fannie Mae
provides funds to the mortgage market primarily by purchasing Mortgage Loans on
homes from local lenders, thereby replenishing their funds for additional
lending. Fannie Mae established its first ARM programs in 1982 and currently
has several ARM programs under which ARM certificates may be issued, including
programs for the issuance of securities through REMICs under the Code.
Each Fannie Mae ARM Pass-Through Certificate issued to date has been issued
in the form of a pass-through certificate representing a fractional undivided
interest in a pool of ARMs formed by Fannie Mae. The ARMs included in each pool
are fully amortizing conventional Mortgage Loans secured by a first lien on
either one-to-four family residential properties or multifamily properties. The
original terms to maturities of the Mortgage Loans generally do not exceed 40
years. Currently, Fannie Mae has issued several different series of ARMs. All
of Fannie Mae's series of ARMs are in its lender (or
33
<PAGE>
"swap") mortgage-backed securities program where individual lenders swap pools
of Mortgage Loans that they originated or purchased for a Fannie Mae security
backed by those same Mortgage Loans. Each series bears an initial interest rate
and a margin tied to an index based on all Mortgage Loans in the related pool,
less a fixed percentage representing servicing compensation and Fannie Mae's
guarantee fee. The specified index used in each series has included the One-Year
U.S. Treasury Rate published by the Federal Reserve Board, the 11th District
Cost of Funds Index published by the Federal Home Loan Bank of San Francisco and
other indices. In addition, the majority of series of Fannie Mae ARMs issued to
date have had a monthly, semi-annual or annual interest rate adjustment.
Adjustments to the interest rates on Fannie Mae ARMs are typically subject
to lifetime caps. In addition, some pools contain ARMs that are subject to semi-
annual or annual interest rate change limitations, frequently 1% to 2%,
respectively. Some pools contain ARMs that provide for limitations on the amount
by which monthly payments may be increased but have no limitation on the
frequency or magnitude of changes to the mortgage interest rate of the ARM
except for the lifetime cap. In cases where an increase in the rate cannot be
covered by the amount of the scheduled payment, the uncollected portion of
interest is deferred and added to the principal amount of the ARM. In such
cases, interest paid on the Fannie Mae Certificates is a monthly pass-through of
the amount of interest on each ARM rather than a weighted average pass-through
rate of interest.
Fannie Mae guarantees to the registered holder of a Fannie Mae Certificate
that it will distribute amounts representing scheduled principal and interest
(at the rate provided by the Fannie Mae Certificate) on the Mortgage Loans in
the pool underlying the Fannie Mae 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 Fannie Mae under its guarantees are solely those of Fannie Mae
and are not backed by the full faith and credit of the United States. If Fannie
Mae were unable to satisfy such obligations, distributions to holders of Fannie
Mae Certificates would consist solely of payments and other recoveries on the
underlying Mortgage Loans and, accordingly, monthly distributions to holders of
Fannie Mae Certificates would be affected by delinquent payments and defaults on
such Mortgage Loans.
Existing FHLMC ARM Programs. The Federal Home Loan Mortgage Corporation is
a corporate instrumentality of the United States created pursuant to an Act of
Congress (Title III of the Emergency Home Finance Act of 1970, as amended, 12
U.S.C. (S) 1451-1459), on July 24, 1970. The principal activity of FHLMC
currently consists of the purchase of Conforming Mortgage Loans or participation
interests therein and the resale of the loans and participations so purchased in
the form of guaranteed Mortgage Securities. FHLMC established its first regular
ARM program in 1986 and currently has several regular ARM programs available for
the issuance of ARM certificates and a number of special programs that may be
offered to Mortgage Loan sellers. All of the Mortgage Loans evidenced by FHLMC
Certificates are conventional Mortgage Loans, and therefore are not guaranteed
or insured by, and are not obligations of, the United States or any agency or
instrumentality thereof, other than FHLMC.
Each FHLMC Certificate issued to date has been issued in the form of a
Pass-Through Certificate representing an undivided interest in a pool of ARMs
purchased by FHLMC. The ARMs included in each pool are fully amortizing,
conventional Mortgage Loans with original terms to maturity of up to 40 years
secured by first liens on one-to-four unit family residential properties or
multi-family properties. An ARM certificate issued by FHLMC may be issued under
one of two Cash Programs (comprised of Mortgage Loans purchased from a number of
sellers) or Guarantor Programs (comprised of Mortgage Loans purchased from one
seller in exchange for participation certificates representing interests in the
Mortgage Loans purchased.) The interest rate paid on FHLMC Certificates adjusts
annually on the first
34
<PAGE>
day of the month following the month in which the interest rates on the
underlying Mortgage Loans adjust. The interest rates paid on ARM certificates
issued under FHLMC's standard ARM programs adjust annually in relation to the
One-Year U.S. Treasury Rate as published by the Federal Reserve Board. The
specified index used in each FHLMC series has also included the 11th District
Cost of Funds Index published by the Federal Home Loan Bank of San Francisco and
other indices. Interest rates paid on FHLMC 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 Mortgage
Securities issued to date have had a monthly, semi-annual or annual interest
adjustment. Adjustments in the interest rates paid are generally limited to an
annual increase or decrease of either 1% or 2% and to a lifetime cap of 5% or 6%
over the initial interest rate. Certain FHLMC programs include Mortgage Loans
that allow the borrower to convert the adjustable mortgage interest rate of his
ARM to a fixed rate. ARMs that are converted into fixed-rate Mortgage Loans are
repurchased by FHLMC or by the seller of such Mortgage Loans to FHLMC, at the
unpaid principal balance thereof, plus accrued interest to the due date of the
last adjustable rate interest payment.
Some FHLMC pools contain ARMs that provide for limitations on the amount by
which monthly payments may be increased but have no limitation on the frequency
or magnitude of changes to the mortgage interest rate of the ARM except for the
lifetime cap. In cases where an increase in the rate cannot be covered by the
amount of the scheduled payment, the uncollected portion of interest is deferred
and added to the principal amount of the ARM. In such cases, interest paid on
the FHLMC Certificates is a monthly pass-through of the amount of interest on
each ARM rather than a weighted average pass-through rate of interest.
FHLMC guarantees to each holder of its ARM 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 ARMs, 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.
Existing GNMA ARM Programs. 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 that represent an
interest in a pool of Mortgage Loans 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, states that such guarantees under Section 306(g)
of mortgage-backed certificates of the type that may be purchased by the Company
or pledged as security for a series of Mortgage Securities are authorized to be
made by GNMA and "would constitute general obligations of the United States
backed by its full faith and credit."
The interest rate paid on the certificates issued under GNMA's standard ARM
program adjusts annually in relation to the One-Year U.S. Treasury Rate, as
published by the Federal Reserve Board.
35
<PAGE>
Interest rates paid on GNMA 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 1% and to a lifetime cap of 5%.
CMOs
The Company may, from time to time, invest in variable-rate and short-term
fixed-rate CMOs. CMOs ordinarily are issued in series, each of which consists of
several serially maturing classes ratably secured by a single pool of Mortgage
Loans or Pass-Through Certificates. Generally, principal payments received on
the mortgage-related assets securing a series of CMOs, including prepayments on
such mortgage-related assets, are applied to principal payments on one or more
classes of the CMOs of such series on each principal payment date for such CMOs.
Scheduled payments of principal of and interest on the mortgage-related assets
and other collateral securing a series of CMOs are intended to be sufficient to
make timely payments of interest on such CMOs and to retire each class of such
CMOs by its stated maturity.
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. The Company
will not acquire any CMOs that do not qualify as Qualified REIT Real Estate
Assets.
Mortgage Warehouse Participations
The Company also may from time to time acquire Mortgage Warehouse
Participations as an additional means of diversifying its sources of income,
provided that such investments, together with the Company's investments in Other
Mortgage Assets, will not in the aggregate exceed 25% of its total Mortgage
Assets. These investments are participations in lines of credit to Mortgage
Loan originators that are secured by recently originated Mortgage Loans that are
in the process of being sold to investors. Mortgage Warehouse Participations do
not qualify as Qualified REIT Real Estate Assets. Accordingly, this activity
will be limited by the REIT Provisions of the Code. See "Federal Income Tax
Considerations -- Requirements for Qualification as a REIT."
Other Mortgage Securities
General. The Company may acquire Other Mortgage Securities or interests
therein if Management determines that it will be beneficial to do so and it will
not adversely affect qualification of the Company as a REIT. Such Other
Mortgage Securities may include non-High Quality Mortgage Assets and other
Mortgage Securities collateralized by single-family Mortgage Loans, Mortgage
Warehouse Participations, Mortgage Derivative Securities, Subordinated Interests
and other mortgage-backed and mortgage-collateralized obligations, other than
Pass-Through Certificates and CMOs.
Mortgage Derivative Securities. The Company may acquire Mortgage
Derivative Securities as market conditions warrant, either as an independent
stand-alone investment opportunity or to assist in the management of prepayment
and other risks. Mortgage Derivative Securities provide for the holder to
receive interest only, principal only, or interest and principal in amounts that
are disproportionate to those payable on the underlying Mortgage Loans.
Payments on Mortgage Derivative Securities are highly sensitive to the rate of
prepayments on the underlying Mortgage Loans. In the event of more rapid than
anticipated prepayments on such Mortgage Loans, the rates of return on interests
in Mortgage Derivative Securities representing the right to receive interest
only or a disproportionately large amount of interest ("Interest Only
Derivatives") would be likely to decline. Conversely, the rates of return on
Mortgage
36
<PAGE>
Derivative Securities representing the right to receive principal only or a
disproportionate amount of principal ("Principal Only Derivatives") would be
likely to increase in the event of rapid prepayments.
The Company presently intends to acquire Mortgage Derivative Securities,
including Principal and Interest Only Derivatives. Interest Only Derivatives
may be an effective hedging device since they generally increase in value as
Mortgage Securities representing interests in adjustable-rate mortgages decrease
in value. The Company also may invest in other types of floating-rate
derivatives that are currently available in the market. The Company also may
invest in other Mortgage Derivative Securities that may in the future be
developed if the Board of Directors, including a majority of Unaffiliated
Directors, determines that such investments would be advantageous to the
Company.
The Company will not acquire REMIC residuals or other CMO residuals.
However, the Company may retain residual interests in its own securitizations of
Mortgage Loans. Moreover, the Company will not purchase any Mortgage Derivative
Securities that do not qualify as Qualified REIT Real Estate Assets.
Subordinated Interests. The Company also may acquire Subordinated
Interests, which are classes of Mortgage Securities that are junior to other
classes of such series of Mortgage Securities in the right to receive payments
from the underlying Mortgage Loans. The subordination may be for all payment
failures on the Mortgage Loans securing or underlying such series of Mortgage
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 borrower. The subordination may be for the entire amount
of the series of Mortgage Securities or may be limited in amount.
Any Subordinated Interests acquired by the Company will be limited in
amount and bear yields that 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 only purchase Subordinated Interests that
are consistent with its credit risk management policy and will not purchase any
Subordinated Interests that do not qualify as Qualified REIT Real Estate Assets.
Mortgage Loans
General. The Company intends to acquire and accumulate Mortgage Loans as
part of its investment strategy until a sufficient quantity has been accumulated
for securitization into High Quality Mortgage Securities. The Mortgage Loans
acquired by the Company and not yet securitized, together with the Company's
investments in Other Mortgage Assets, will not constitute more than 25% of its
total Mortgage Assets at any time. All Mortgage Loans will be acquired with the
intention of securitizing them into High Quality Mortgage Securities. However,
there can be no assurance that the Company will be successful in securitizing
the Mortgage Loans. After a pool of Mortgage Loans has been securitized, the
Mortgage Loans will no longer be considered Other Mortgage Assets. To meet the
Company's investment criteria, the Mortgage Loans to be acquired by the Company
will generally conform to the underwriting guidelines established by Fannie Mae,
FHLMC or other credit insurers. Applicable banking laws generally require that
an appraisal be obtained in connection with the original issuance of Mortgage
Loans by the lending institution. The Company does not intend to obtain
additional appraisals at the time of acquiring Mortgage Loans.
37
<PAGE>
The Mortgage Loans may be originated by or purchased from various Suppliers
of Mortgage Assets throughout the United States, such as savings and loan
associations, banks, mortgage bankers, home builders, insurance companies and
other mortgage lenders. The Company may acquire Mortgage Loans directly from
originators and from entities holding Mortgage Loans originated by others. The
Board of Directors of the Company has not established any limits upon the
geographic concentration of Mortgage Loans to be acquired by the Company or the
credit quality of Suppliers of Mortgage Assets. See "Risk Factors -- Decrease
in Net Interest Income from Mortgage Assets Due to Interest Rate Fluctuations"
and "-- Inability to Acquire Mortgage Assets with Favorable Interest Rates and
Terms May Adversely Affect Net Interest Income."
The Company will acquire ARMs. The interest rate on ARMs is typically tied
to an index (such as the One-Year U.S. Treasury Rate published by the Federal
Reserve Board, the 11th District Cost of Funds Index published by the Federal
Home Loan Bank of San Francisco or LIBOR) and is adjustable periodically at
various intervals. Such Mortgage Loans may be subject to lifetime or periodic
interest rate or payment caps.
Conforming and Nonconforming Mortgage Loans. The Company may acquire both
Conforming and Nonconforming Mortgage Loans for securitization. Conforming
Mortgage Loans comply with the requirements for inclusion in a loan guarantee
program sponsored by GNMA, FHLMC or Fannie Mae. Under current regulations, the
maximum principal balance allowed on Conforming Mortgage Loans ranges from
$214,600 for one-unit residential loans ($321,000 for such residential loans
secured by mortgage properties located in either Alaska or Hawaii) to $412,450
for four-unit residential loans ($618,875 for such residential loans secured by
mortgaged properties located in either Alaska or Hawaii). Nonconforming
Mortgage Loans are Mortgage Loans that do not qualify in one or more respects
for purchase by Fannie Mae or FHLMC under their standard programs. The Company
expects that a majority of Nonconforming Mortgage Loans it purchases will be
nonconforming primarily because they have original principal balances which
exceed the requirements for FHLMC or Fannie Mae programs.
Commitments to Mortgage Loan Sellers. The Company may issue commitments
("Commitments") to originators and other sellers of Mortgage Loans who follow
policies and procedures that generally comply with Fannie Mae and FHLMC
regulations and guidelines and that comply with all applicable federal and state
laws and regulations for Mortgage Loans secured by single-family (one-to-four
units) residential properties. In addition, Commitments may be issued for
Agency Certificates as well as privately issued Pass-Through Certificates and
Mortgage Loans. Commitments will obligate the Company to purchase Mortgage
Assets from the holders of the Commitments for a specific period of time, in a
specific aggregate principal amount and at a specified price and margin over an
index. Although the Company may commit to acquire Mortgage Loans prior to
funding, all loans are to be fully funded prior to their acquisition by the
Company. Following the issuance of Commitments, the Company will be exposed to
risks of interest rate fluctuations similar to those risks on its adjustable-
rate Mortgage Assets.
Securitization of Mortgage Loans. The Mortgage Loans will be acquired by
the Company and held until a sufficient quantity has been accumulated for
securitization. During the accumulation period, the Company will be subject to
risks of borrower defaults and bankruptcies, fraud losses and special hazard
losses (such as those occurring from earthquakes or floods) that are not covered
by standard hazard insurance. In the event of a default on any Mortgage Loan
held by the Company, the Company will bear the risk of loss of principal to the
extent of any deficiency between the value of the collateral underlying the
Mortgage Loan and the principal amount of the Mortgage Loan. No assurance can
be given that any such mortgage, fraud or hazard insurance will adequately cover
a loss suffered by the Company. Also during the accumulation period, the costs
of financing the Mortgage Loans through reverse repurchase agreements and other
borrowings and lines of credit with warehouse lenders could exceed the interest
income on the Mortgage Loans. It may not be possible or economical for the
38
<PAGE>
Company to complete the securitization for all Mortgage Loans that the Company
acquires, in which case the Company will continue to bear the risks of borrower
defaults and special hazard losses.
Protection Against Mortgage Loan Risks. It is anticipated that each
Mortgage Loan purchased will have a commitment for mortgage pool insurance from
a mortgage insurance company with a claims-paying ability in one of the two
highest rating categories by either of the Rating Agencies. Mortgage pool
insurance insures the payment of certain portions of the principal and interest
on Mortgage Loans. In lieu of mortgage pool insurance, the Company may arrange
for other forms of credit enhancement such as letters of credit, subordination
of cash flows, corporate guaranties, establishment of reserve accounts or over-
collateralization. The Company expects that all Mortgage Loans to be acquired
will be reviewed by a mortgage pool insurer or other qualified Mortgage Loan
underwriter to ensure that the credit quality of the Mortgage Loans meets the
insurer's guidelines. The Company intends to rely primarily upon the credit
evaluation of such third-party mortgage pool insurer or underwriter issuing the
commitment rather than make its own independent credit review in determining
whether to purchase a Mortgage Loan. Credit losses covered by the pool
insurance policies or other forms of credit enhancement are restricted to the
limits of their contractual obligations and may be lower than the principal
amount of the Mortgage Loan. The pool insurance or credit enhancement will be
issued when the Mortgage Loan is subsequently securitized, and the Company will
be at risk for credit losses on that loan prior to its securitization.
In addition to credit enhancement, the Company anticipates that it will
also obtain a commitment for special hazard insurance on the Mortgage Loans, if
available at reasonable cost, to mitigate casualty losses that are not usually
covered by standard hazard insurance, such as vandalism, war, earthquake and
floods. This special hazard insurance is not in force during the accumulation
period, but is activated instead at the time the Mortgage Loans are pledged as
collateral for the Mortgage Securities. Accordingly, the risks associated with
such special hazard losses exist only between the times the Company purchases a
Mortgage Loan and the inclusion of such Mortgage Loan within a newly created
issue of Mortgage Securities.
It is expected that when the Company acquires Mortgage Loans, the seller
will represent and warrant to the Company that there has been no fraud or
misrepresentation during the origination of the Mortgage Loans. It will agree
to repurchase any loan with respect to which there is fraud or
misrepresentation. The Company will provide similar representations and
warranties when the Company sells or pledges the Mortgage Loans as collateral
for Mortgage Securities. If a Mortgage Loan becomes delinquent and the pool
insurer is able to prove that there was a fraud or misrepresentation in
connection with the origination of the Mortgage Loan, the pool insurer will not
be liable for the portion of the loss attributable to such fraud or
misrepresentation. Although the Company will have recourse to the seller based
on the seller's representations and warranties to the Company, the Company will
be at risk for loss to the extent the seller does not perform its repurchase
obligations.
MANAGEMENT POLICIES AND PROGRAMS
Asset Acquisition Policy
The Company will only acquire those Mortgage Assets that are consistent
with the Company's balance sheet guidelines and risk management objectives.
Since the intention of the Company is generally to hold its Mortgage Assets
until maturity, the Company will generally not seek to acquire Mortgage Assets
with investment returns that are attractive only in a limited range of
scenarios. Management believes that future interest rates and mortgage
prepayment rates are very difficult to predict. Therefore, Management will seek
to acquire Mortgage Assets that it believes will provide competitive returns
over a broad range of interest rate and prepayment scenarios.
39
<PAGE>
The Company will acquire Mortgage Assets that Management believes will
maximize returns on capital invested, after considering (i) the amount and
nature of anticipated cashflows from the Mortgage Asset, (ii) the Company's
ability to pledge the Mortgage Asset to secure collateralized borrowings, (iii)
the increase in the Company's capital requirement determined by the Company's
Capital and Leverage Policy resulting from the purchase and financing of the
Mortgage Asset, (iv) the costs of financing, hedging, managing, scrutinizing,
and reserving for the Mortgage Asset, and (v) the Company's credit management
policy. Prior to acquisition, potential returns on capital employed are assessed
over the life of the Mortgage Asset and in a variety of interest rate, yield
spread, financing cost, credit loss and prepayment scenarios.
Management will also give consideration to balance sheet management and
risk diversification issues. A specific Mortgage Asset that 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 that may exist in the balance sheet, to diversify or concentrate credit
risk, and to meet the cash flow and liquidity objectives Management may
establish for the balance sheet from time to time. The Company will evaluate the
addition of a potential Mortgage Asset and its associated borrowings and hedges
to the balance sheet and the impact that the potential Mortgage Asset would have
on the risk in and returns generated by the Company's balance sheet as a whole
over a variety of scenarios.
Management will focus primarily on the acquisition of adjustable-rate
Mortgage Assets, and believes that currently such products are more attractive
for the Company's purposes than are fixed-rate Mortgage Assets. Although the
cost of hedging a fixed-rate Mortgage Asset to meet the Company's
asset/liability management goals is usually significant, the Company may
purchase fixed-rate Mortgage Assets (generally when combined with hedging
instruments) in the future should the potential returns on capital invested,
after hedging and all other costs, exceed the returns available from other
Mortgage Assets or if the purchase of such Mortgage Assets would serve to
reduce or diversify the risks of the Company's balance sheet.
The Company may from time to time, depending on market conditions, acquire
single-family Mortgage Loans and single-family Mortgage Securities.
The Company may also purchase the stock of other mortgage REITs or similar
companies when Management believes that such purchase 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 Assets
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 intends to acquire new Mortgage Assets, and will also seek to
expand its capital base in order to further increase the Company's ability to
acquire new Mortgage Assets, when the potential returns from new Mortgage Assets
appear attractive relative to the return expectations of stockholders (as
expressed principally by the effective dividend yield of the Common Stock). The
Company may in the future acquire Mortgage Assets by offering its debt or equity
securities in order to acquire such Mortgage Assets.
The Company generally intends to hold Mortgage Assets to maturity. In
addition, the REIT Provisions of the Code limit in certain respects the ability
of the Company to sell Mortgage Assets. See "Federal Income Tax Considerations -
Taxation of the Company." Management may decide to sell Mortgage Assets from
time to time, however, for a number of reasons including, without limitation, to
dispose of a Mortgage Asset as to which credit risk concerns have arisen, to
reduce interest rate risk, to
40
<PAGE>
substitute one type of Mortgage Asset for another to improve yield or to
maintain compliance with the 55% requirement under the Investment Company Act,
and generally to restructure the balance sheet when Management deems such action
advisable. Management will select any Mortgage Assets to be sold according to
the particular purpose such sale will serve. The Company's 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 Assets to be sold.
As a requirement for maintaining REIT status, the Company must distribute
to stockholders annually aggregate dividends equaling at least 95% of its
Taxable Income. See "Federal Income Tax Considerations - Distribution
Requirement." The Company will make additional distributions of capital when the
return expectations of the stockholders (as expressed principally by the
effective dividend yield of its Common Stock) appear to exceed returns
potentially available to the Company through making new investments in Mortgage
Assets. Subject to the limitations of applicable securities and state laws, the
Company can distribute capital by making purchases of its own Common Stock,
through paying down or repurchasing any outstanding uncollateralized debt
obligations, or through increasing the Company's dividend to include a return of
capital.
Capital and Leverage Policy
General. 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. As described below,
the Company has established a Capital and Leverage Policy that limits
Management's ability to acquire additional Mortgage Assets during times when the
actual capital base of the Company is less than a required amount defined in
such Policy, currently an 8% equity ratio. In this way, the use of balance sheet
leverage is better controlled. The actual capital base for the purpose of the
Capital and Leverage Policy is equal to the market value of total Mortgage
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 Mortgage 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 from the Cmopany's borrowings.
Acquisition of Mortgage Assets. Management is prohibited from acquiring net
additional Mortgage Assets during periods when the actual capital base of the
Company is less than the minimum amount required under the Capital and Leverage
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,
if the actual capital base falls below the requirement of the Capital and
Leverage Policy, Management is required to submit to the Company's Board of
Directors a plan to bring the Company back to its target equity-to-assets ratio.
It is anticipated that in many circumstances this goal will be achieved over
time without active management through the natural process of mortgage principal
repayments and increases in the market values of Mortgage Assets as their coupon
rates adjust upwards to market levels. Management anticipates that the actual
capital base is likely to temporarily exceed the capital requirement during
periods following new equity offerings, including the Offering, and during
periods of falling interest rates and that the actual capital base is likely to
fall below the Capital and Leverage Policy requirements during periods of rising
interest rates.
The first component of the Company's Capital and Leverage Policy
requirements is the current aggregate overcollateralization amount, or
"haircut," lenders will require the Company to hold as capital. The haircut for
each Mortgage Asset is determined by the lender based on the risk
characteristics and
41
<PAGE>
liquidity of the particular Mortgage Asset. Haircut levels on individual
borrowings generally range from 3% for Agency Certificates to 20% for certain
Privately Issued Certificates, and are likely to average between 3% and 10% for
the Company as a whole. Should the market value of the pledged Mortgage 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.
The second component of the Company's Capital and Leverage Policy
requirements is the "liquidity capital cushion." The liquidity capital cushion
is an additional amount of capital in excess of the haircut maintained by the
Company in order to help it meet the demands of the lenders for additional
collateral should the market value of its Mortgage Assets decline. The liquidity
capital cushions assigned to the Company's portfolio of Mortgage Assets are
based on Management's assessment of each Mortgage Asset's market price
volatility, credit risk, liquidity and attractiveness for use as collateral by
lenders. This process 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 Assets 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 Company anticipates that at least 50% of the
Mortgage Assets shall be invested in Agency Certificates, AAA (or comparably)
rated adjustable-rate Mortgage Securities or Mortgage Assets with similar
liquidity characteristics. The Company's Board of Directors will review on a
periodic basis various analyses 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 flows, earnings, dividends, liquidity and
net market value. Should the Company's Board of Directors determine that the
minimum required capital base set by the Capital and Leverage Policy is either
too low or too high, the Board of Directors will raise or lower the capital
requirement accordingly.
Under current market conditions, the Company will seek to maintain its
aggregate minimum capital base at approximately 10% of the market value of its
Mortgage Assets. This percentage will fluctuate over time as the composition of
the balance sheet changes, haircut levels required by lenders change, the market
value of the Mortgage Assets change and as liquidity capital cushion percentages
set by the Company's Board of Directors are adjusted over time. However, the
Company's aggregate minimum capital requirement will not fall below 8% of its
Mortgage Assets, taking into account callable debt such as repurchase agreements
subject to margin calls. The Company's policy for aggregate minimum capital
requirements will be reviewed by its Board of Directors upon issuance of any
noncallable debt and as market conditions change.
The Company's Borrowings. Pursuant to the Company's overall business
strategy, a substantial portion of the Company's borrowings will be short-term
or adjustable-rate. The Company's borrowings are expected to be primarily
reverse repurchase agreements (a borrowing device evidenced by an agreement to
sell securities or other Mortgage 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, warehouse lines of credit, Dollar-Roll
Agreements 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 intends to enter into financing transactions
only with institutions that it believes are sound credit risks and to follow
other internal policies designed to limit its credit and other exposure to
financing institutions. The Company will only enter into repurchase agreements
transactions with counter-parties rated investment grade by a nationally
recognized rating service.
42
<PAGE>
The Company anticipates that, upon repayment of each borrowing in the form
of a reverse repurchase agreement, the collateral will immediately be used for
borrowing in the form of a new reverse repurchase agreement. The Company has not
at the present time entered into any commitment agreements under which a lender
would be required to enter into any reverse 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 will enter into reverse repurchase agreements primarily with national
broker-dealers, commercial banks and other lenders that typically offer such
financing. The Company will enter into the collateralized borrowings only with
financial institutions meeting credit standards approved by the Company's Board
of Directors, including a majority of Unaffiliated Directors, and monitor the
financial condition of such institutions on a regular basis.
A reverse repurchase agreement, although structured as a sale and
repurchase obligation, acts as a financing under which the Company effectively
pledges its Mortgage Assets as collateral to secure a short-term loan.
Generally, the other party to the agreement will make the loan in an amount
equal to a percentage of the market value of the pledged collateral. At the
maturity of the reverse repurchase agreement, the Company is required to repay
the loan and, correspondingly, receives back its collateral. While used as
collateral, Mortgage Assets continue to pay principal and interest that inure to
the benefit of the Company. In the event of the insolvency of bankruptcy of the
Company, certain reverse repurchase agreements may qualify for special treatment
under the Bankruptcy Code, the effect of which would be, 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 reverse 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 one of 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 reverse
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.
The Company expects that substantially all of its borrowing agreements will
require the Company to deposit additional collateral in the event the market
value of existing collateral declines, which may require the Company to sell
Mortgage Assets to reduce the 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 Assets, as
described above. However, a major disruption of the reverse repurchase or
other markets relied on by the Company for short-term borrowings would have a
material adverse effect on the Company unless the Company were able to arrange
alternative sources of financing on comparable terms. See "Risk Factors --
Substantial Leverage and Potential Net Interest and Operating Losses in
Connection with Borrowings" and "-- Decrease in Net Interest Income from
Mortgage Assets Due to Interest Rate Fluctuations."
The Company's Bylaws will limit the amount of unsecured debt, excluding
collateralized borrowings such as reverse repurchase agreements, Dollar-Roll
Agreements, warehouse lines of credit and CMOs, to 300% of the Company's common
and preferred equity on a consolidated basis, unless a greater amount is
specifically approved by the Unaffiliated Directors.
43
<PAGE>
Credit Risk Management Policy
Management will review credit risk and other risks of loss associated with
each investment. In addition, Management will seek to diversify the Company's
portfolio of Mortgage Assets to avoid undue geographic, insurer, industry and
certain other types of concentrations. The Company will seek to reduce certain
risks from sellers and servicers through representations and warranties. The
Company's Board of Directors will monitor the overall portfolio risk and
determine appropriate levels of provision for loss.
With respect to its Mortgage Securities, the Company will be exposed to
various levels of credit and special hazard risk, depending on the nature of the
underlying Mortgage Assets and the nature and level of credit enhancements
supporting such securities. Each of the Mortgage Assets acquired by the Company
will have some degree of protection from normal credit losses. Agency
Certificates are covered by credit protection in the form of a 100% guarantee
from a government sponsored entity (GNMA, Fannie Mae or FHLMC). Privately Issued
Certificates represent interests in pools of residential mortgage loans with
partial credit enhancement. Credit loss protection for Privately Issued
Certificates is achieved through the subordination of other interests in the
pool to the interest held by the Company, through pool insurance or through
other means. The degree of credit protection varies substantially amount
Privately Issued Certificates.
At least 50% of the Company's total Mortgage Assets will be Agency
Certificates or carry a AAA or comparable rating from one of the Rating
Agencies. At least 75% of the Company's total Mortgage Assets will be comprised
of Agency Certificates or have at least an A rating from one of the Rating
Agencies. Other Mortgage Assets shall not constitute more than 25% of the
Mortgage Asset portfolio's value; such investments will not be made by the
Company unless they are determined by the Manager and the Company's Board of
Directors to be of comparable quality to a High Quality Mortgage Security. The
Company intends to structure its portfolio to maintain a minimum weighted
average rating (including the Company's deemed comparable ratings for unrated
Mortgage Assets based on a comparison to rated Mortgage Securities with like
characteristics) of at least AA or a comparable rating by at least one of the
Rating Agencies. However, there can be no assurance that such structure will be
achieved and the Company is not obligated to liquidate any assets to
achieve its desired weighted average rating.
Management will review the quality of the Mortgage Loans at the time of
acquisition and on an ongoing basis. During the time it holds Mortgage Loans,
the Company will be subject to risks of borrower defaults and bankruptcies and
special hazard losses (such as those occurring from earthquakes or floods) that
are not covered by standard hazard insurance. However, the Company will
generally obtain credit enhancements such as mortgage pool or special hazard
insurance for its Mortgage Loans, and individual Mortgage Loans may be covered
by FHA insurance, VA guarantees or private mortgage insurance and, to the extent
securitized into Agency Certificates, by such government sponsored entity
obligations or guarantees.
Asset/Liability Management
Interest Rate Risk Management Policy. To the extent consistent with its
election to qualify as a REIT, the Company will follow an interest rate risk
management policy intended to mitigate the negative effects of major interest
rate changes. The Company intends to minimize its interest rate risk from
borrowings by attempting to match the maturity of its debts to the interest rate
adjustment periods on its Mortgage Assets. Under normal market conditions, the
Company will attempt to keep the difference between the weighted average time to
"reset" on its Mortgage Assets to the weighted average time to reset on its
debts to 90 days or less, taking into account all hedging transactions. This
policy will
44
<PAGE>
be reviewed by the Company's Board of Directors if the Company incurs long-term
noncallable borrowings and as market conditions change.
The Company's interest rate risk management policy is formulated with the
intent to offset the potential adverse effects resulting from rate adjustment
limitations on its Mortgage Assets and the differences between interest rate
adjustment indices and interest rate adjustment periods of its adjustable-rate
Mortgage Assets and related borrowings. The Company anticipates being able to
adjust the average maturity 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 Assets and related borrowings that may
occur.
In general, the Company intends to fully hedge the lifetime cap risk
associated with its adjustable-rate Mortgage Assets. The policy will be to
attempt to limit the effective interest rate on substantially all of the
Company's liabilities as a whole to a rate equal to the weighted average
lifetime cap of its adjustable-rate Mortgage Assets. Under current market
conditions the Company does not intend to enter into transactions to mitigate
its periodic cap risk. It is intended that the Company will manage this risk
through its leverage and asset/liability policies.
The Company intends to 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 Mortgage Assets during a period of rising rates. In this way,
the Company intends generally to hedge as much of the interest rate risk as
Management determines is in the best interests of the Company, given the cost of
such hedging transactions and the need to maintain the Company's status as a
REIT. 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 may also, to the extent consistent with its compliance
with the REIT Provisions of the Code and Maryland law, utilize financial futures
contracts, options and forward contracts as a hedge against future interest
rate changes. The Company will not invest in financial futures contracts or
options thereon that would cause the Manager or the Company to have to register
under the Commodities Exchange Act. The Company's hedging strategy may lower the
earnings and dividends of the Company in the short-term in order to further the
objective of maintaining competitive levels of earnings and dividends over the
long-term. The Company does not intend to hedge for speculative purposes.
The Company may elect to conduct a portion of its hedging operations
through one or more subsidiary corporations that 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 Mortgage 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 "Federal
Income Tax Considerations -- Requirements for Qualification as a REIT -- 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 Mortgage Assets,
other than Qualified REIT Real Estate Assets) must not exceed 25% of the gross
income of the Company. See "Federal Income Tax Considerations -- Requirements
for Qualification as a REIT -- Gross Income Tests."
45
<PAGE>
Prepayment Risk Management Policy. The Company will seek 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 Assets with prepayment prohibitions and
penalties, investing in certain Mortgage Security structures that have
prepayment protections, and balancing Mortgage Assets purchased at a premium
with Mortgage Assets purchased at a discount. The Company intends to invest in
Mortgage Assets that on a portfolio basis do not have significant purchase price
premiums. Under normal market conditions, the Company will seek to keep the
aggregate capitalized purchase premium of the portfolio to 3% or less. In
addition, the Company may in the future purchase Principal Only Derivatives to a
limited extent as a hedge against prepayment risks. Prepayment risk will be
monitored by Management and the Company's Board of Directors through periodic
review of the impact of a variety or prepayment scenarios on the Company's
revenues, net earnings, dividends, cash flow and net balance sheet market value.
The Company believes that it has developed a cost-effective
asset/liability management program to mitigate 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 and prepayment risks. Management will monitor carefully, and may have
to limit, its asset/liability management program to assure that the Company does
not realize excessive hedging income, or hold hedging Mortgage Assets having
excess value in relation to total Mortgage 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 "Federal
Income Tax Considerations -- Requirements for Qualifications as a REIT." In
addition, asset/liability management involves transaction costs that increase
dramatically as the period covered by the hedging protection increases.
Therefore, the Company may be prevented from effective hedging its interest rate
and prepayment risks.
MORTGAGE LOAN SECURITIZATION TECHNIQUES
The Company will seek to contract with conduits, financial institutions,
mortgage bankers, investment banks and others to purchase Mortgage Loans that
they are originating. The Company anticipates that it will have sufficient
purchasing power in some circumstances to induce origination firms to originate
Mortgage Loans to the Company's specifications. The Company intends to enhance
the value and liquidity of all the Mortgage Loans it acquires by securitizing
the Mortgage Loans into Mortgage Securities in the manner which will best meet
its own needs.
In addition to creating Mortgage Securities from the Mortgage Loans in
its portfolio, the Company may also from time to time "re-securitize" portions
of its Mortgage Securities portfolio. In a resecuritization transaction,
Mortgage Securities rather than Mortgage Loans are used as collateral to create
new Mortgage Securities. This would typically be done as the Mortgage Loans
underlying the securities improve in credit quality through seasoning, as values
rise on the underlying properties or when the credit quality of a junior class
of Mortgage Security improves due to prepayment of more senior classes. Such
transactions can result in improved credit ratings, higher market values and
lowered borrowing costs.
The Company may conduct its securitization activities through one or more
taxable or Qualified REIT Subsidiaries formed for such purpose.
46
<PAGE>
OTHER POLICIES
The Company intends to operate in a manner that will not subject it to
regulation under the Investment Company Act. The Company does not currently
intend to (i) invest in the securities of other issuers for the purpose of
exercising control over such issuers, (ii) underwrite securities of other
issuers, (iii) originate loans or (iv) offer securities in exchange for real
property.
FUTURE REVISIONS IN POLICIES AND STRATEGIES
The Company's Board of Directors has established the investment policies,
the operating policies and the 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 (including a majority of the Unaffiliated Directors) determines that
such modification or waiver is in the best interest of stockholders. Among other
factors, developments in the market that affect the policies and strategies
mentioned herein or which change the Company's assessment of the market may
cause the Company's Board of Directors to revise its policies and strategies.
However, if such modification or waiver relates to the relationship of, or
any transaction between, the Company and the Manager or any Affiliate of the
Manager, the approval of a majority of the Unaffiliated Directors is also
required.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company or the
Manager is a party or to which any property of the Company or the Manager is
subject. From time to time the TCW Group is involved in litigation in connection
with its operations, including litigation involving the operations of the MBS
Group. Such litigation has included certain senior officers of the TCW Group,
including certain of the officers of the Company, as defendants. The Company
believes that there are no legal proceedings that would materially adversely
affect the Manager's or the Company's executive officers' ability to manage the
Company.
MANAGEMENT OF THE COMPANY
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Philip A. Barach 45 President and Chief Executive Officer
Jeffrey E. Gundlach 38 Chief Investment Officer
Daniel K. Osborne 32 Executive Vice President, Chief
Operating Officer and Chief Financial
Officer
Michael E. Cahill 46 Secretary
</TABLE>
Mr. Barach is President, Chief Executive Officer and a Director of the
Company. Mr. Barach is also a Group Managing Director and Chief Investment
Officer of High Grade Fixed Income of TCW and the Manager. Mr. Barach is a
member of the TCW Group's MBS Group. Mr. Barach joined TCW in 1987 after
being employed by Sun Life Insurance Company, where he was Senior Vice
President and
47
<PAGE>
Chief of Investments. Previously, Mr. Barach served as head of Fixed Income
Investments for the State of California Retirement System. Mr. Barach has
extensive experience in many facets of raising and managing mortgage capital,
mortgage finance, interest rate risk management and hedging. Mr. Barach
attended the Hebrew University of Jerusalem, where he received a B.A. degree in
International Relations and an M.B.A. in Finance.
Mr. Gundlach is Chief Investment Officer and Vice Chairman of the Board of
the Company. Mr. Gundlach is also a Group Managing Director of TCW and the
Manager. Mr. Gundlach has been with the TCW Group since 1985. Previously, Mr.
Gundlach was employed by Transamerica Corporation's Property/Casualty Insurance
division, where he was a Senior Loss Reserve Analyst responsible for investment
discount and funding strategies. Mr. Gundlach is also a member of the TCW
Group's MBS Group. He has extensive experience in many facets of raising and
investing mortgage capital, mortgage finance, interest rate risk management and
hedging. Mr. Gundlach is a graduate of Dartmouth College, holding B.A. degrees
in Mathematics and Philosophy (summa cum laude). He also attended Yale
University as a Ph.D. candidate in Mathematics.
Mr. Osborne is Executive Vice President, Chief Operating Officer and Chief
Financial Officer of the Company. Mr. Osborne is also a Senior Vice President
of TCW and the Manager. Mr. Osborne joined the TCW Group in 1994 as part of the
MBS Group managing fixed income mutual funds. Prior to joining TCW, from 1992
to 1994, Mr. Osborne was a Vice President of ASR Investment Corporation ("ASR"),
a publicly held REIT investing in Mortgage Assets. At ASR, Mr. Osborne was
responsible for asset/liability management and Commission reporting. Prior to
his employment with ASR, Mr. Osborne was a Certified Public Accountant with
Deloitte & Touche LLP specializing in REITs, mortgage securities and publicly
held companies. He holds a B.S. degree in Accounting from Arizona State
University.
Mr. Cahill is the Secretary of the Company. Mr. Cahill is a Managing
Director and General Counsel of TCW and certain of its affiliates. Prior to
joining TCW in 1991, Mr. Cahill was Senior Vice President and General Counsel of
Act III Communications. Previously, he was in private corporate law practice
with O'Melveny & Myers in Los Angeles and prior to that, with Shenas, Robbins,
Shenas & Shaw in San Diego. He is a member of the bars of the state of
California and of the Province of Ontario and is admitted to various courts,
including the U.S. Supreme Court. Mr Cahill holds a B.A. degree from Bishops
University, Quebec, an LL.M. degree from Harvard University and an LL.B. degree
from Osgoode Hall Law School, York University, Toronto.
The directors of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ------------------------------- --- --------------------------------
<S> <C> <C>
Marc I. Stern 53 Chairman of the Board
Jeffrey E. Gundlach (1) 38 Vice Chairman of the Board
Philip A. Barach (1) 45 Director and Assistant Secretary
</TABLE>
(1) See above for certain biographical information regarding Messrs. Barach and
Gundlach.
Mr. Stern is Chairman of the Board of Directors of the Company. Mr. Stern
is Vice Chairman of the Board of Directors of the Manager and TCW Asset
Management Company and a Director of TCW, Trust Company of the West and TCW
Funds Management, Inc. ("TFMI"). Mr. Stern is also President of TCW and TFMI
and Executive Vice President and Group Managing Director of Trust Company of the
West. Mr. Stern is responsible for the TCW Group's international operations and
is Chairman of TCW Americas Development, Inc., TCW Asia, Ltd. and TCW London
International, Limited. Mr. Stern joined the TCW Group in 1990. Previously,
Mr. Stern was President of Broad, Inc., Managing Director and Chief
Administrative Officer of the Henley Group,Inc. and Senior Vice President of
Allied-Signal, Inc. and related entities. Prior to holding such positions, Mr.
Stern was
48
<PAGE>
associated with the law firm of Debevoise & Plimpton. Mr. Stern is also Director
of Qualcomm, Inc. and the Los Angeles Music Center Opera, and a member of the
Board of Trustees of The Salk Institute and Dickinson College. Mr. Stern is a
member of the state bars of New York and New Hampshire. Mr. Stern received a
B.A. degree in Political Science from Dickinson College, an M.A. degree in
Political Science from the Columbia University School of Public Law and
Government, and a J.D. degree from the Columbia University School of Law.
All directors will be elected at each annual meeting of the Company's
stockholders for a term of three years, and hold office until their successors
are elected and qualified. All officers serve at the discretion of the
Company's Board of Directors. Although the Company may have salaried employees,
it currently has no such employees. The Company will pay an annual director's
fee to each Unaffiliated Director of $_______, a fee of $______ for each meeting
of the Board of Directors attended by each Unaffiliated Director and
reimbursement of costs and expenses of all directors for attending such
meetings. Affiliated directors will not be separately compensated by the
Company.
Directors and executive officers of the Company are required to devote only
so much of their time to the Company's affairs as is necessary or required for
the effective conduct and operation of the Company's business. Because the
Management Agreement provides that the Manager will assume principal
responsibility for managing the affairs of the Company, the officers of the
Company, in their capacities as such, are not expected to devote substantial
portions of their time to the affairs of the Company. However, in their
capacities as officers or employees of the Manager, or its Affiliates, they will
devote such portion of their time to the affairs of the Manager as is required
for the performance of the duties of the Manager under the Management Agreement.
The Bylaws of the Company provide that the Board of Directors shall have
not less than three or more than nine members, as determined from time to time
by the existing Board of Directors. The Board of Directors will initially have
seven members consisting of three directors affiliated with the TCW Group and
four Unaffiliated Directors. The Unaffiliated Directors of the Company will be
named prior to the commencement of the Offering. The Bylaws further provide that
except in the case of a vacancy, the majority of the members of the Board of
Directors and of any committee of the Board of Directors will at all times after
the issuance of the shares of Common Stock in this Offering be Unaffiliated
Directors. Vacancies occurring on the Board of Directors among the Unaffiliated
Directors will be filled by the vote of a majority of the directors, including a
majority of the Unaffiliated Directors.
The Bylaws of the Company also provide for three classes of directors with
staggered terms to provide for the election of one class each year. Each class
of directors will contain one affiliated director and at least one Unaffiliated
Director. After the initial staggering period (the first three years), all
directors will serve for a term of three years.
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. Maryland law generally permits
indemnification of directors and officers against certain costs, liabilities and
expenses that any such person may incur by reason of serving in such positions
unless it is proved that: (i) the act or omission of the director or officer
was material to the cause of action adjudicated in the proceeding and was
committed in bad faith or was the result of active and deliberate dishonesty;
(ii) the director or officer actually received an improper personal benefit in
money, property or services; or (iii) in the case of criminal proceedings, the
director or officer had reasonable cause to believe that the act or omission was
unlawful. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers or persons controlling
the Company pursuant to the foregoing provisions, the Company has been
49
<PAGE>
informed that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.
The Articles of Incorporation of the Company 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.
Maryland law authorizes the limitation of liability of directors and officers to
corporations and their stockholders for money damages except (i) to the extent
that it is proved that the person actually received an improper benefit in
money, property, or services for the amount of the benefit or profit in money,
property or services actually received, or (ii) to the extent that a judgment or
other final adjudication adverse to the person 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. Maryland law does not affect the potential liability of directors
and officers to third parties, such as creditors of the Company.
EXECUTIVE COMPENSATION
The Company has not paid, and does not intend to pay, any annual
compensation to the Company's executive officers for their services as executive
officers. However, the Company may from time to time, in the discretion of the
Board of Directors, grant options to purchase shares of the Company's Common
Stock to the Manager, executive officers and directors pursuant to the Company's
1997 Stock Option Plan. See "--Stock Options" below.
STOCK OPTIONS
The Company has adopted a stock option plan (the "1997 Stock Option Plan")
that provides for the grant of both qualified incentive stock options ("ISOs")
that meet the requirements of Section 422 of the Code, and non-qualified stock
options, stock appreciation rights and dividend equivalent rights. ISOs may be
granted to the officers and key employees of the Company, if any. Non-
qualified stock options may be granted to the Manager, directors, officers and
any key employees of the Company and to the directors, officers and key
employees of the Manager. The exercise price for any option granted under the
1997 Stock Option Plan may not be less than 100% of the fair market value of the
shares of Common Stock at the time the option is granted. The purpose of the
1997 Stock Option Plan is to provide a means of performance-based compensation
to the Manager in order to attract and retain qualified personnel and to provide
an incentive to others whose job performance affects the Company. The 1997 Stock
Option Plan will become effective upon the closing of the Offering.
Subject to anti-dilution provisions for stock splits, stock dividends and
similar events, the 1997 Stock Option Plan authorizes the grant of options to
purchase an aggregate of up to 10% of the outstanding shares of the Company's
Common Stock, but not more than 1,000,000 shares of Common Stock. If an option
granted under the 1997 Stock Option Plan expires or terminates, the shares
subject to any unexercised portion of that option will again become available
for the issuance of further options under the 1997 Stock Option Plan. Excluding
the initial stock option grants discussed in the succeeding section, option
grants shall be limited annually to the purchase of the lesser of __% of the
outstanding shares of Common Stock or _______ shares. Unless previously
terminated by the Board of Directors, the 1997 Stock Option Plan will terminate
ten years from its effective date, and no options may be granted under the 1997
Stock Option Plan thereafter.
The 1997 Stock Option Plan will be administered by a committee of the Board
of Directors comprised entirely of Unaffiliated Directors (the "Compensation
Committee"). Options granted under
50
<PAGE>
the 1997 Stock Option Plan will become exercisable in accordance with the terms
of the grant made by the Compensation Committee. The Compensation Committee has
discretionary authority to determine at the time an option is granted whether it
is intended to be an ISO or a non-qualified option, and when and in what
increments shares of Common Stock covered by the option may be purchased.
Under current law, ISOs may not be granted to any director of the Company
who is not also a full-time employee or to directors, officers and other
employees of entities unrelated to the Company. In addition, no options may be
granted under the 1997 Stock Option Plan to any person who, assuming exercise of
all options held by such person, would own or be deemed to own more than 9.8% of
the outstanding shares of Common Stock of the Company.
Each option must terminate no more than ten years from the date it is
granted. Options may be granted on terms providing that they will be exercisable
in whole or in part at any time or times during their respective terms, or only
in specified percentages at stated time periods or intervals during the term of
the option.
The exercise price of any option granted under the 1997 Stock Option Plan
is payable in full (i) by cash, (ii) by surrender of shares of the Company's
Common Stock having a market value equal to the aggregate exercise price of all
shares to be purchased, (iii) by cancellation of indebtedness owed by the
Company to the optionholder, (iv) by any combination of the foregoing, or (v) by
a full recourse promissory note executed by the optionholder. The terms of the
promissory note may be changed from time to time by the Company's Board of
Directors to comply with applicable regulations or other relevant pronouncements
of the Service or the Commission.
The Company's Board of Directors may, without affecting any outstanding
options, from time to time revise or amend the 1997 Stock Option Plan, and may
suspend or discontinue it at any time. However, no such revision or amendment
may increase the number of shares of Common Stock subject to the 1997 Stock
Option Plan (with the exception of adjustments resulting from changes in
capitalization), change the class of participants eligible to receive options
granted under the 1997 Stock Option Plan or modify the period within which or
the terms upon which the options may be exercised without stockholder approval.
51
<PAGE>
STOCK OPTIONS OUTSTANDING
The following table sets forth the stock options granted under the 1997
Stock Option Plan effective on the closing of the Offering.
<TABLE>
<CAPTION>
STOCK OPTION GRANTS IN FISCAL 1997
POTENTIAL REALIZABLE
VALUE AT ASSUMED ANNUAL
INDIVIDUAL GRANTS RATES OF STOCK
-------------------------- PRICE APPRECIATION
OPTIONS EXERCISE FOR OPTION TERM
OPTIONS GRANTED TO PRICE(2) EXPIRATION -----------------------
NAME GRANTED(1) EMPLOYEES ($/SHARE) DATE 5%($) 10%($)
- ----- ---------- ---------- --------- ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
TCW Investment $
Management Company
</TABLE>
(1) The options granted are exercisable starting one year after the date
of grant.
(2) The exercise price and tax withholding obligations incurred upon
exercise of the options may be paid by the option holder by delivering
already owned shares of Company Common Stock, including those which
are issuable upon exercise of the options.
In addition, upon the closing of the Offering, each Unaffiliated Director
may receive an initial grant of options to purchase up to shares of
Common Stock at the initial public offering price. These options will expire
ten years from the effective date of the 1997 Stock Option Plan. Any
Unaffiliated Director newly elected to the Board of Directors thereafter may
receive an identical initial grant at the fair market value on the date of
grant.
THE MANAGER
The Manager is a wholly owned subsidiary of TCW. Established in 1971, the
TCW Group is of one of the largest employee-owned investment management and
counseling firms in the United States with over 500 employees in six offices
worldwide. The TCW Group's staff includes over 200 investment and
administrative professionals. The professional investment staff includes more
than 50 portfolio managers and analysts, approximately 60 research personnel and
15 traders. The TCW Group engages in investment management as its primary
business and specializes in the management of assets for pension and profit-
sharing funds, endowments and foundations. The TCW Group also specializes in
managing assets for insurance companies, foreign investors, high net worth
individuals and mutual funds for retail investors. The TCW Group offers its
clients more than 50 investment strategies, divided among six major sectors,
including, within the U.S. fixed-income sector, mortgage-backed securities.
The TCW Group has more than $50 billion in assets under management or
committed to management for over 1,200 clients. The TCW Group's MBS Group has
expertise in the acquisition and management for third parties of mortgage-backed
securities and is devoted exclusively to managing over $10 billion in this
sector for nearly 100 clients. The members of the MBS Group average
approximately six years of service with the TCW Group. The MBS Group has raised
and managed mortgage capital and managed short-duration Mortgage Assets for over
ten years and currently manages adjustable-rate holdings of over $3 billion
comprised of over 500 individual securities. The MBS Group currently leverages
a portion of certain mortgage portfolios and uses reverse repurchase agreements
with a borrowing base in excess of $700 million.
52
<PAGE>
The Company believes that it will be the first publicly traded mortgage
REIT whose management comes entirely from an internationally recognized asset
management business. The Company believes that inasmuch as mortgage REITs are
companies that primarily raise and manage mortgage capital, a management team
that has a ten-year history of raising and managing mortgage capital should
assist the Company in successfully competing with banks, savings and loans,
insurance companies and other mortgage REITs. Furthermore, the Company will
seek to benefit from management that is experienced in the secondary mortgage
market and has a broad array of existing relationships in that market.
The Manager has not previously managed or operated a REIT. However,
Messrs. Barach and Gundlach have significant experience in raising and managing
mortgage capital, mortgage finance and the purchase and administration of
Mortgage Securities. In addition, Mr. Osborne has significant experience in
mortgage REITS. Further, each executive officer of the Manager that will assist
in managing the Company has at least 10 years of mortgage-related experience.
See "Management of the Company -- Directors and Officers of the Company" for
certain biographical information regarding Messrs. Barach, Gundlach and Osborne.
The address of the Manager is 865 South Figueroa Street, Suite 1800, Los
Angeles, California 90017.
THE MANAGEMENT AGREEMENT
The Company will enter into the Management Agreement with the Manager at
the closing of this Offering for an initial term of two years. The Manager will
be primarily involved in two activities: (i) asset/liability management --
acquisition, financing, hedging, management and disposition of Mortgage Assets,
including credit and prepayment risk management; and (ii) capital management --
oversight of the Company's structuring, analysis, capital raising and investor
relations activities. In conducting these activities, the Manager will
formulate operating strategies for the Company, arrange for the acquisition of
Mortgage Assets by the Company, arrange for various types of financing for the
Company, monitor the performance of the Company's Mortgage Assets and provide
certain administrative and managerial services in connection with the operation
of the Company. The Manager will be required to manage the business affairs of
the Company in conformity with the policies that are approved and monitored by
the Company's Board of Directors. The Manager will be required to prepare
regular reports for the Company's Board of Directors that will review the
Company's acquisitions of Mortgage Assets, portfolio composition and
characteristics, credit quality, performance and compliance with the policies
approved by the Company's Board of Directors.
At all times, the Manager will be subject to the direction and oversight of
the Company's Board of Directors and will have only such functions and authority
as the Company may delegate to it. The Manager will be responsible for the day-
to-day operations of the Company and will perform such services and activities
relating to the Mortgage Assets and operations of the Company as may be
appropriate, including:
(i) serving as the Company's consultant with respect to
formulation of investment criteria and preparation of policy
guidelines by the Company's Board of Directors;
53
<PAGE>
(ii) assisting the Company in developing criteria for Mortgage
Asset purchase commitments that are specifically tailored to the
Company's long-term investment objectives and making available to the
Company its knowledge and experience with respect to Mortgage Assets;
(iii) representing the Company in connection with the purchase
and commitment to purchase or sell Mortgage Assets, including the
accumulation of Mortgage Loans for securitization and the incurrence
of debt;
(iv) arranging for the issuance of Mortgage Securities from a
pool of Mortgage Loans;
(v) furnishing reports and statistical and economic research to
the Company regarding the Company's activities and the services
performed for the Company by the Manager;
(vi) monitoring and providing to the Company's Board of Directors
on an ongoing basis price information and other data, obtained from
certain nationally recognized dealers that maintain markets in
Mortgage Assets identified by the Board of Directors from time to
time, and providing data and advice to the Board of Directors in
connection with the identification of such dealers;
(vii) investing or reinvesting any money of the Company in
accordance with its policies and procedures;
(viii) providing the executive and administrative personnel,
office space and services required in rendering services to the
Company;
(ix) administering the day-to-day operations of the Company and
performing and supervising the performance of such other
administrative functions necessary in the management of the Company as
may be agreed upon by the Manager and the Company's Board of
Directors, including the collection of revenues and the payment of the
Company's debts and obligations and maintenance of appropriate
computer systems to perform such administrative functions;
(x) providing the Company with general data processing, legal and
administrative services to the extent required to implement the
business strategy of the Company;
(xi) counseling the Company in connection with policy decisions
made by the Board of Directors;
(xii) communicating on behalf of the Company with the holders of
the equity and debt securities of the Company as required to satisfy
the reporting and other requirements of any governmental bodies or
agencies and to maintain effective relations with such holders;
(xiii) evaluating and recommending hedging strategies to the
Company's Board of Directors and, upon approval by the Board of
Directors, engaging in hedging activities on behalf of the Company,
consistent with the Company's status as a REIT;
(xiv) supervising compliance with the REIT Provisions of the Code
and maintenance of an exemption from the Investment Company Act;
(xv) qualifying and causing the Company to qualify to do business
in all applicable jurisdictions;
54
<PAGE>
(xvi) causing the Company to retain qualified accountants and tax
experts to assist in developing appropriate accounting procedures and
testing systems and to conduct quarterly compliance reviews;
(xvii) providing all actions necessary for compliance by the
Company with all federal, state and local regulatory requirements
applicable to the Company in respect of its business activities,
including preparing or causing to be prepared all financial statements
required under applicable regulations and contractual undertakings and
all reports and documents, if any, required under the Exchange Act;
(xviii) providing all actions necessary to enable the Company to
make required federal, state and local tax filings and reports and
generally enable the Company to maintain its status as a REIT,
including soliciting stockholders for required information to the
extent provided in the REIT Provisions of the Code;
(xix) performing such other services as may be required from time
to time for management and other activities relating to the assets of
the Company as the Board of Directors shall reasonably request or the
Manager shall deem appropriate under the particular circumstances; and
(xx) complying with and using its best efforts to cause the
Company to comply with all applicable laws.
Following the initial two-year term, the Management Agreement will be
automatically renewed for additional one-year terms, unless terminated by the
Company or the Manager upon written notice. Except in the case of a termination
or non-renewal by the Company for cause, upon termination or non-renewal of the
Management Agreement by the Company, the Company is obligated to pay the Manager
what could be a substantial termination or non-renewal fee. The termination or
non-renewal fee shall be equal to the fair market value of the Management
Agreement without regard to the Company's termination right, as determined by an
independent appraisal. The selection of the independent appraiser shall be
subject to the approval of the Unaffiliated Directors. The payment of such a fee
could adversely affect the results of the Company's operations.
The Management Agreement may be assigned by the Manager to an Affiliate of
TCW without the consent of the Company. The Management Agreement may be
assigned to a non-Affiliate of TCW only with the approval of a majority of the
unaffiliated Directors.
MANAGEMENT COMPENSATION
The Manager will receive annual base management compensation based on the
Average Net Invested Capital of the Company, payable monthly in arrears, equal
to 3/4 of 1% of Average Net Invested Capital. The term "Average Net Invested
Capital" means for any period (i) the arithmetic average of the sum of the gross
proceeds of the offerings of its equity securities by the Company, after
deducting any underwriting discounts and commissions and other expenses and
costs relating to such offerings, plus the Company's retained earnings (taking
into account any losses incurred) computed by taking the average of such values
at the end of each month during such period, plus (ii) any unsecured debt
approved by the Unaffiliated Directors to be included in Average Net Invested
Capital. Accordingly, incurring collateralized debt to finance specific
investment purchases does not necessarily increase Average Net Invested Capital
55
<PAGE>
The Manager shall also be entitled to receive as incentive compensation for
each fiscal quarter, an amount equal to 30% of the Net Income of the Company,
before incentive compensation, in excess of the amount that would produce an
annualized Return on Equity equal to the Ten-Year U.S. Treasury Rate plus 1%.
The incentive compensation calculation and payment will be made quarterly in
arrears. The term "Return on Equity" is calculated for any quarter by dividing
the Company's Net Income for the quarter by its Average Net Worth for the
quarter. For purposes of calculating the incentive compensation payable, the
definition "Return on Equity" is not related to the actual distributions
received by stockholders or to an individual investor's actual return on
investment. For such calculations, the "Net Income" of the Company means the
taxable income of the Company (including net capital gains, if any) before the
Manager's incentive compensation, net operating loss deductions arising from
losses in prior periods and deductions permitted by the Code in calculating
taxable income for a REIT plus the effects of adjustments, if any, necessary to
record hedging and interest transactions in accordance with GAAP. A deduction
for all of the Company's interest expenses for borrowed funds is taken into
account in calculating Net Income. "Average Net Worth" for any period means the
arithmetic average of the sum of the gross proceeds from any offering of its
equity securities by the Company, before deducting any underwriting discounts
and commissions and other expenses and costs relating to the offerings, plus the
Company's retained earnings (without taking into account any losses incurred in
prior periods) computed by taking the average of such values at the end of each
month during such period.
The ability of the Company to achieve an annualized Return on Equity in
excess of the Ten-Year U.S. Treasury Rate plus 1%, and of the Manager to earn
the incentive compensation described in the preceding paragraph, is dependent
upon the level and volatility of interest rates, the Company's ability to react
to changes in interest rates and to utilize successfully the operating
strategies described herein, and other factors, many of which are not within the
Company's or the Manager's control. The Manager's base compensation shall be
calculated by the Manager within 15 days after the end of each month, and such
calculation shall be promptly delivered to the Company. The Company is
obligated to pay the base compensation within 30 days after the end of each
month. The Manager shall compute the quarterly incentive compensation within 45
days after the end of each fiscal quarter, and the Company shall pay the
incentive compensation with respect to each fiscal quarter within 15 days
following the delivery to the Company of the Manager's written statement setting
forth the computation of the incentive compensation for such quarter. The
Company's Board of Directors shall review and approve the base and incentive
compensations paid to the Manager quarterly one quarter in arrears during each
scheduled quarterly Board of Directors meeting. Quarterly incentive compensation
will be subject to an annual adjustment commencing in the second full year of
the Company's operation. See "-- The Management Agreement" above for a
discussion of the termination or non-renewal fee for the Management Agreement.
The Company believes that this compensation arrangement benefits its
stockholders because it ties the Manager's compensation to Return on Equity and,
in periods of low earnings, the Manager's incentive compensation is reduced or
eliminated, thereby lowering the Company's operating expenses.
The Company has adopted a 1997 Stock Option Plan. The Manager and the
directors, officers and any employees of the Company may be granted options
under the Company's 1997 Stock Option Plan. See "Management of the Company --
Stock Options."
EXPENSES
The Company will be required to pay all offering expenses (including
accounting, legal, printing, clerical, personnel, filing and other expenses)
incurred by the Company, the Manager or its Affiliates on behalf of the Company
in connection with the Offering, estimated at $ . This payment will not be
subject to the limitation on expenses to be borne by the Company as described in
the paragraph below.
56
<PAGE>
Subject to the limitations set forth below, the Company will also pay all
operating expenses except those specifically required to be borne by the Manager
under the Management Agreement. The operating expenses required to be borne by
the Manager include the compensation of the Company's officers and the cost of
office space, equipment and other personnel required for the Company's day-to-
day operations. The expenses that will be paid by the Company will include (but
not necessarily be limited to) issuance and transaction costs incident to the
acquisition, disposition and financing of investments, regular legal and
auditing fees expenses, the compensations and expenses of the Company's
Unaffiliated Directors, the costs of printing and mailing proxies and reports to
stockholders, costs incurred by employees of the Manager for travel on behalf of
the Company, costs associated with any computer software or hardware that is
used solely for the Company, costs to obtain liability insurance to indemnify
the Manager, the Company's directors and the Underwriters, and the compensations
and expenses of the Company's custodian and transfer agent, if any. The expenses
required to be paid by the Company that are attributable to its operations shall
be limited to an amount per year equal to the greater of 2% of the Average Net
Invested Capital of the Company or 25% of its Net Income for that year. Expenses
excluded from the expense limitation are those incurred in connection with the
servicing of Mortgage Loans, the issuance and administration of Mortgage
Securities from pools of Mortgage Loans, the accumulation of Mortgage Loans, the
raising of capital, the acquisition of assets, interest expenses, taxes and
license fees, non-cash costs, litigation, the base and incentive management fee
and other extraordinary and non-recurring expenses.The determination of Net
Income for purposes of calculating the expense limitation will be the same as
for calculating the Manager's incentive compensation except that it will include
any incentive compensation payable for such period. The Company, rather than the
Manager, will also be required to pay expenses associated with litigation, the
raising of capital, and other extraordinary or non-recurring expenses.
Expenses in excess of such amount will be paid by the Manager, unless the
Unaffiliated Directors determine that, based upon unusual or non-recurring
factors, a higher level of expenses is justified for such fiscal year. In that
event, such expenses may be recovered by the Manager in succeeding years to the
extent that expenses in succeeding quarters are below the limitation of
expenses. Expense reimbursement will be made monthly, subject to adjustment
at the end of each year.
CERTAIN RELATIONSHIPS; CONFLICTS OF INTEREST
In addition to its base management compensation under the Management
Agreement, the Manager will have the opportunity to earn incentive compensation
for each fiscal quarter in an amount equal to 30% of the Net Income of the
Company (before payment of such incentive compensation) in excess of the amount
that would produce on annualized Return on Equity equal to the Ten-Year U.S.
Treasury Rate plus 1%. Quarterly incentive compensation will be subject to an
annual adjustment commencing in the second full year of the Company's operation.
See "-- Management Compensation" above. In evaluating Mortgage Assets for
investment and in other operating strategies, an undue emphasis on the
maximization of income at the expense of other criteria, such as preservation of
capital, in order to achieve a higher incentive fee could result in increased
risk to the value of the Company's Mortgage Assets portfolio. However, the
Bylaws of the Company provide that the Board of Directors shall evaluate the
performance of the Manager before entering into or renewing any management
arrangement and that the Unaffiliated Directors shall determine at least
annually that the Manager's compensation is reasonable in relation to the nature
and quality of services performed. Any changes in the Company's investment and
operating policies are required to be approved by the Board of Directors,
including a majority of the Unaffiliated Directors. See "Risk Factors --
Conflicts of Interest; Manager and Its Affiliates Will Continue to Purchase
Mortgage Assets for Third-Party Accounts" and "-- Future Revisions of Policies
and Strategies in Discretion of Board of Directors."
The Company, on the one hand, and the Manager and its Affiliates, on the
other, do not presently expect to, but may in the future, enter into a number of
relationships other than those governed by the
57
<PAGE>
Management Agreement, some of which may give rise to conflicts of interest
between the Manager and its Affiliates and the Company. The market in which the
Company will seek to purchase Mortgage Assets is characterized by rapid
evolution of products and services and, thus, there may in the future be
relationships between the Company and the Manager and Affiliates of the Manager
in addition to those described herein. Any such relationships or transactions
will require the approval of the Company's Board of Directors, including a
majority of the Unaffiliated Directors.
Pursuant to the terms of the Management Agreement, the Manager and its
Affiliates will agree on the allocation of Mortgage Securities between the
Company and other accounts over which the Manager and its Affiliates have
control. Pursuant to such allocation, the Manager will base allocation
decisions on the procedures the Manager considers fair and equitable, including,
without limitation, such considerations as investment objectives, restrictions
and time horizon, availability of cash and the amount of existing holdings. In
some cases, some forms of pro rata allocations may be used and, in other cases,
random allocation processes may be used. In other cases, neither may be used.
As of the date of this Prospectus, the Company's 100 shares of Common Stock
outstanding are held by TCW Capital Investment Corporation. The shares of
Common Stock were issued for $1,500 cash. The purchaser of these shares of
Common Stock has represented that the shares of Common Stock were purchased for
investment purposes only and undertaken that they will be sold only pursuant to
a registration statement under the Securities Act, or an applicable exemption
from the registration requirements thereof. TCW may be deemed to control the
Company prior to the closing of this Offering.
The Manager and its employees and the Unaffiliated Directors may also
receive stock options pursuant to the Company's 1997 Stock Option Plan. See
"Management of the Company -- Stock Options."
TCW Brokerage Services, an Affiliate of the Manager, will act as a dealer
in connection with the Offering and will receive compensation for the shares of
Common Stock sold by it. TCW Brokerage Services has not participated in any
negotiations of the Underwriters' compensation or the terms of this Offering.
LIMITS OF RESPONSIBILITY
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to undertake the services called for thereunder and
will not be responsible for any action of the Company's Board of Directors in
following or declining to follow its advice or recommendations. The Manager,
its directors and its officers will not be liable to the Company, any issuer of
Mortgage Securities, any subsidiary of the Company, the Unaffiliated Directors,
the Company's stockholders or any subsidiary's stockholders for acts performed
in accordance with and pursuant to the Management Agreement, except by reason of
acts constituting bad faith, willful misconduct, gross negligence or reckless
disregard of their duties under the Management Agreement. The Manager does not
have significant assets and may not have significant assets in the future.
Consequently, there can be no assurance that the Company would be able to
recover any damages for claims it may have against the Manager.
The Company has agreed to indemnify the Manager, its directors and its
officers with respect to all expenses, losses, damages, liabilities, demands,
charges and claims arising from any acts or omissions of the Manager made in
good faith in the performance of its duties under the Management Agreement. The
Management Agreement does not limit or restrict the right of the Manager or any
of its officers, directors, employees or Affiliates from engaging in any
business or rendering services of any kind to any other person, including the
purchase of, or rendering advice to others purchasing Mortgage Assets that
58
<PAGE>
meet the Company's polices and criteria, except that the MBS Group of the
TCW Group will not be permitted to provide any such services to any residential
mortgage REIT other than the Company. See "Risk Factors -- Conflicts of
Interest; Manager and Its Affiliates Will Continue to Purchase Mortgage Assets
for Third-Party Accounts."
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth certain information as of September 15,
1997, relating to the beneficial ownership of the Company's Common Stock by (i)
all persons known by the Company to beneficially own more than 5% of the
outstanding shares of the Company's Common Stock, (ii) each director of the
Company, and (iii) all officers and directors of the Company as a group.
<TABLE>
<CAPTION>
Amount and
Nature of
Name and Address of Beneficial Percent of
Beneficial Owner(1)(2) Ownership Class
- ----------------------------- ---------- ----------
<S> <C> <C>
TCW Capital Investment
Corporation(3)................ 100 shares 100%
Officers and Directors as a
Group (7 persons)............. --- ---
</TABLE>
(1) Unless otherwise noted, the Company believes that each person named in
the table has sole voting and investment power with respect to all
shares of Common Stock owned by them.
(2) A person is deemed to be the beneficial owner of securities that can
be acquired by such person within 60 days from the date of this
Prospectus upon the exercise of warrants or options. Each beneficial
owner's percentage ownership is determined by assuming that options or
warrants that are held by such person (but not those held by any other
person) and which are exercisable within 60 days from the date of this
Prospectus have been exercised. None of the outstanding options to
acquire Common Stock of the Company are exercisable within 60 days of
this Prospectus.
(3) Address is: 865 South Figueroa Street, Suite 1800, Los Angeles, California
90017.
59
<PAGE>
FEDERAL INCOME TAX CONSIDERATIONS
THE FOLLOWING DISCUSSION SUMMARIZES THE MATERIAL FEDERAL INCOME TAX
CONSIDERATIONS THAT MAY BE RELEVANT TO A PROSPECTIVE HOLDER OF SHARES OF COMMON
STOCK OF THE COMPANY. THIS DISCUSSION IS BASED ON CURRENT LAW. THE FOLLOWING
DISCUSSION IS NOT EXHAUSTIVE OF ALL POSSIBLE TAX CONSIDERATIONS. IT DOES NOT
GIVE A DETAILED DISCUSSION OF ANY STATE, LOCAL OR FOREIGN TAX CONSIDERATIONS,
NOR DOES IT DISCUSS ALL OF THE ASPECTS OF FEDERAL INCOME TAXATION THAT MAY BE
RELEVANT TO A PROSPECTIVE STOCKHOLDER IN LIGHT OF SUCH STOCKHOLDER'S PARTICULAR
CIRCUMSTANCES OR TO CERTAIN TYPES OF STOCKHOLDERS (INCLUDING INSURANCE
COMPANIES, CERTAIN TAX-EXEMPT ENTITIES, FINANCIAL INSTITUTIONS, BROKER/DEALERS,
FOREIGN CORPORATIONS AND PERSONS WHO ARE NOT CITIZENS OR RESIDENTS OF THE UNITED
STATES) SUBJECT TO SPECIAL TREATMENT UNDER FEDERAL INCOME TAX LAWS.
EACH PROSPECTIVE PURCHASER OF COMMON STOCK OF THE COMPANY IS URGED TO
CONSULT WITH HIS OWN TAX ADVISOR REGARDING THE SPECIFIC CONSEQUENCES TO HIM OF
THE PURCHASE, OWNERSHIP AND SALE OF STOCK IN AN ENTITY ELECTING TO BE TAXED AS A
REIT, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSIDERATIONS
OF SUCH PURCHASE, OWNERSHIP, SALE AND ELECTION AND THE POTENTIAL CHANGES IN
APPLICABLE TAX LAWS.
GENERAL
The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussion below summarizes the material
provisions applicable to the Company as a REIT for federal income tax purposes
and to its stockholders in connection with their ownership of shares of Common
Stock. However, it is impractical to set forth in this Prospectus all aspects of
federal, state, local and foreign tax law that may have tax consequences with
respect to an investor's purchase of the Common Stock. The discussion of various
aspects of federal taxation contained herein is based on the Code,
administrative regulations, judicial decisions, administrative rulings and
practice, all of which are subject to change. In brief, if certain detailed
conditions imposed by the Code are met, entities that invest primarily in real
estate assets, including Mortgage Loans, and that otherwise would be taxed as
corporations are, with certain limited exceptions, not taxed at the corporate
level on their taxable income that is currently distributed to their
stockholders. This treatment eliminates most of the "double taxation" (at the
corporate level and then again at the stockholder level when the income is
distributed) that typically results from the use of corporate investment
vehicles. A qualifying REIT, however, may be subject to certain excise and other
taxes, as well as normal corporate tax, on Taxable Income that is not currently
distributed to its stockholders. See "-- Taxation of the Company" below.
The Company plans to make an election to be taxed as a REIT under the Code
commencing with its taxable year ending December 31, 1997.
OPINION OF SPECIAL COUNSEL
O'Melveny & Myers LLP, special tax counsel ("Counsel") to the Company, has
advised the Company in connection with the Offering of the Common Stock and its
election to be taxed as a REIT. Based on existing law and certain
representations made to Counsel by the Company and assuming that the Company
operates in the manner described in this Prospectus, in the opinion of Counsel,
commencing with the Company's taxable year ending December 31,1997, the Company
has been organized in conformity with the requirements for qualification as a
REIT under the Code and the Company's actual and proposed method of operation
described in this Prospectus and as represented by the Company to Counsel will
enable the Company to qualify as a REIT. However, whether the Company will in
fact so qualify will depend on actual operating results and compliance with the
various tests for qualification as a REIT relating to its income, assets,
distributions, ownership and certain administrative matters, the results of
which may not be reviewed by Counsel. Moreover, certain aspects of the Company's
method of operations have not been considered by the courts or the Service.
There can be no assurance that the courts or the Service will agree with this
opinion. In addition, qualification as a REIT depends on future transactions and
events that cannot be known at this time. Accordingly, Counsel is unable to
opine whether the Company will in fact qualify as a REIT under the Code in all
events. In the opinion of Counsel, the section of the Prospectus entitled
"Federal Income Tax Considerations" identifies and fairly summarizes the federal
income tax considerations that are likely to be material to a holder of the
Common Stock and to the extent such summaries involve matters of law, such
statements of law are correct under the Code. Counsel's opinions are based on
various assumptions and on the factual representations of the
60
<PAGE>
Company concerning its business and assets. Accordingly, no assurance can be
given that the actual results of the Company's operation for any one taxable
year will satisfy such requirements. See "--Termination or Revocation of REIT
Status" below.
The opinions of Counsel are based upon existing law including the Internal
Revenue Code of 1986, as amended, existing Treasury Regulations, Revenue
Rulings, Revenue Procedures, proposed regulations and case law, all of which is
subject to change either prospectively or retroactively. Moreover, relevant laws
or other legal authorities may change in a manner that could adversely affect
the Company or its stockholders. Counsel's opinions also are based in part on
the opinion of special Maryland counsel, Ballard Spahr Andrews & Ingersoll, that
the Company is duly organized and existing under Maryland law.
In the event that the Company does not qualify as a REIT in any year, it
will be subject to federal income tax as a domestic corporation and its
stockholders will be taxed in the same manner as stockholders of ordinary
corporations. To the extent that the Company would, as a consequence, be subject
to potentially significant tax liabilities, the amount of earnings and cash
available for distribution to its stockholders would be reduced. See "--
Termination or Revocation of REIT Status" below.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must
meet certain tests which are described immediately below.
Stock Ownership Tests. For all taxable years after the first taxable year
for which a REIT election is made, the Company's shares of Common Stock must be
transferable and must be held by a minimum of 100 persons for at least 335 days
of a 12 month year (or a proportionate part of a short tax year). The Company
must also use the calendar year as its taxable year. In addition, at all times
during the second half of each taxable year, no more than 50% in value of the
shares of any class of the stock of the Company may be owned directly or
indirectly by five or fewer individuals. If, for any taxable year, the Company
complies with regulations requiring the maintenance of records to ascertain
ownership of its outstanding stock and the Company does not know or have reason
to know that it failed to satisfy this test, it will be treated as satisfying
this test for any such taxable year. In determining whether the Company's
shares are held by five or fewer individuals, the attribution rules of Sections
544 of the Code apply. For a description of these attribution rules, see
"Description of Capital Stock." The Company's Articles of Incorporation impose
certain repurchase provisions and transfer restrictions to avoid more than 50%
by value of any class of the Company's stock being held by five or fewer
individuals (directly or constructively) at any time during the last half of any
taxable year. Such repurchase and transfer restrictions will not cause the stock
not to be treated as "transferable" for purposes of qualification as a REIT. The
Company intends to satisfy both the 100 stockholder and 50%/5 stockholder
individual ownership limitations described above for as long as it seeks
qualification as a REIT. See "Description of Capital Stock." The Company uses
the calendar year as its taxable year for income tax purposes.
Asset Tests. On the last day of each calendar quarter at least 75% of the
value of the Company's assets must consist of Qualified REIT Assets, government
securities, cash and cash items (the "75% of Assets Test"). The Company expects
that substantially all of its assets will be Qualified REIT Real Estate Assets.
Qualified REIT Real Estate Assets include interests in real property, interests
in Mortgage Loans secured by real property and interests in REMICs.
On the last day of each calendar quarter, of the investments in securities
not included in the 75% of Assets Test, the value of any one issuer's securities
may not exceed 5% by value of the Company's
61
<PAGE>
total assets and the Company may not own more than 10% of any one issuer's
outstanding voting securities. Hedging contracts (other than those which are
Qualified REIT Real Estate Assets), and certain types of other Mortgage Assets
may be treated as securities of the entity issuing such agreements or interests.
The Company will take measures to prevent the value of such contracts, interests
or assets issued by any one entity to exceed 5% of the value of the Company's
assets as of the end of each calendar quarter. Moreover, pursuant to its
compliance guidelines, the Company intends to monitor closely (on not less than
a quarterly basis) the purchase and holding of the Company's assets in order to
comply with the above assets tests. In particular, as of the end of each
calendar quarter the Company intends to limit and diversify its ownership of
hedging contracts and other Mortgage Securities that do not constitute Qualified
REIT Real Estate Assets to less than 25%, in the aggregate, by value of its
portfolio, to less than 5% by value as to any single issuer, and to less than
10% of the voting stock of any single issuer (collectively the "25% of Assets
Test"). If such limits are ever exceeded, the Company intends to take
appropriate remedial action to dispose of such excess assets within the 30-day
period after the end of the calendar quarter, as permitted under the Code.
When purchasing Mortgage Securities, the Company may rely on opinions of
counsel for the issuer or sponsor of such securities given in connection with
the offering of such securities, or statements made in related offering
documents, for purposes of determining whether and to what extent those
securities (and the income therefrom) constitute Qualified REIT Real Estate
Assets (and income) for purposes of the 75% of Assets Test (and the source of
income tests discussed below). If the Company invests in a partnership, it will
be treated as receiving its share of the income and loss of the partnership and
owning a proportionate share of the assets of the partnership and any income
from the partnership will retain the character that it had in the hands of the
partnership. If the Company forms a taxable affiliate to conduct mortgage
origination and other activities, it will obtain an opinion of counsel that the
proposed organization and ownership of an interest in the taxable affiliate will
not adversely affect the Company's status as a REIT.
Where a failure to satisfy any of the asset tests discussed above results
from an acquisition of securities or other property during a quarter, the
failure can be cured by disposition of sufficient non-qualifying assets within
30 days after the close of such quarter. The Company intends to maintain
adequate records of the value of its assets to determine its compliance with the
asset tests, and intends to take such action as may be required to cure any
failure to satisfy the test within 30 days after the close of any quarter.
Gross Income Tests. The Company must meet two separate income-based tests
for each year in order to qualify as a REIT.
1. THE 75% TEST. At least 75% of the Company's gross income (the "75% of
Income Test") for the taxable year must be derived from the following sources:
(i) rents from real property, (ii) interest (other than interest based in whole
or in part on the income or profits of any person) on obligations secured by
mortgages on real property or on interests in real property; (iii) gains from
the sale or other disposition of interests in real property and real estate
mortgages other than gain from stock in trade, inventory or property held
primarily for sale to customers in the ordinary course of the Company's trade or
business ("Dealer Property"); (iv) dividends or other distributions on shares in
other REITs and, provided such shares are not Dealer Property, gain from the
sale of such shares; (v) abatements and refunds of real property taxes; (vi)
income from the operation, and gain from the sale, of property acquired at or in
lieu of a foreclosure of the mortgage secured by such property or as a result of
a default under a lease of such property ("Foreclosure Property"); (vii) income
received as consideration for entering into agreements to make loans secured by
real property or to purchase or lease real property (including interests in real
property and interests in mortgages on real property) (for
62
<PAGE>
example, commitment fees); and (viii) income attributable to stock or debt
instruments acquired with the proceeds from the sale of stock or certain debt
obligations ("New Capital") of the Company received during the one-year period
beginning on the day such proceeds were received ("Qualified Temporary
Investment Income"). The investments that the Company intends to make (as
described under "Business and Strategy -- Description of Mortgage Assets") will
give rise primarily to mortgage interest qualifying under the 75% of Income
Test.
2. THE 95% TEST. In addition to deriving 75% of its gross income from the
sources listed above, at least an additional 20% of the Company's gross income
for the taxable year must be derived from those sources, or from dividends,
interest or gains from the sale or disposition of stock or other securities that
are not dealer property (the "95% of Income Test"). Income attributable to
Mortgage Warehouse Participations, Mortgage Securities (other than Qualified
REIT Real Estate Assets) that the Company holds directly, dividends on stock
interest on any other obligations not secured by real property, and gains from
the sale or disposition of stock or other securities that are not Qualified REIT
Real Estate Assets will constitute qualified income for purposes of the 95% of
Income Test only, but will not be qualified income for purposes of the 75% of
Income Test. Income from mortgage servicing contracts, loan guarantee fees (or
other contracts under which the Company would earn fees for performing services)
and hedging (other than from Qualified REIT Assets) will not qualify for either
the 95% or 75% of Income Tests. The Company intends to severely limit its
acquisition of any assets or investments the income from which does not qualify
for purposes of the 95% of Income Test. Moreover, in order to help ensure
compliance with the 95% of Income Test and the 75% of Income Test, the Company
intends to limit substantially all of the assets that it acquires to Qualified
REIT Real Estate Assets. The policy of the Company to maintain REIT status may
limit the type of assets, including hedging contracts, that the Company
otherwise might acquire.
For purposes of determining whether the Company complies with the 75% of
Income Test and the 95% of Income Test detailed above, gross income does not
include gross income from "prohibited transactions." A "prohibited transaction"
is one involving a sale of Dealer Property, other than Foreclosure Property. Net
income from "prohibited transactions" is subject to a 100% tax. See "-- Taxation
of the Company" below.
The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions, futures contracts and sales
of Mortgage Assets to comply with the 75% of Income Test and the 95% of Income
Test. See "-- Taxation of the Company" below for a discussion of the potential
tax cost of the Company's selling certain Mortgage Securities on a regular
basis. In order to help insure its compliance with the REIT Provisions of the
Code, the Company will adopt guidelines the effect of which will be to limit its
ability to earn certain types of income, including income from hedging, other
than hedging income from Qualified REIT Real Estate Assets. See "Business and
Strategy -- Asset/Liability Management -- Interest Rate Risk Management Policy."
If the Company fails to satisfy one or both of the 75% or 95% of Income Tests
for any year, it may face either (a) assuming such failure was for reasonable
cause and not willful neglect, a 100% tax on the greater of the amounts of
income by which it failed to comply with the 75% of Income Test or the 95% of
Income Test, reduced by estimated related expenses or (b) loss of REIT status.
There can be no assurance that the Company will always be able to maintain
compliance with the gross income tests for REIT qualification despite its
periodic monitoring procedures. Moreover, there is no assurance that the relief
provisions for a failure to satisfy either the 95% or the 75% of Income Tests
will be available in any particular circumstance.
Distribution Requirement. The Company must distribute to its stockholders
on a pro rata basis each year an amount equal to (i) 95% of its Taxable Income
before deduction of dividends paid and excluding net capital gain, plus (ii) 95%
of the excess of the net income from Foreclosure Property over
63
<PAGE>
the tax imposed on such income by the Code, less (iii) any "excess noncash
income" (the "95% Distribution Test"). See "Dividend Policy and Distributions."
The Company intends to make distributions to its stockholders in amounts
sufficient to meet this 95% distribution requirement. Such distributions must be
made in the taxable year to which they relate or, if declared before the timely
filing of the Company's tax return for such year and paid not later than the
first regular dividend payment after such declaration, in the following taxable
year. A nondeductible excise tax, equal to 4% of the excess of such required
distributions over the amounts actually distributed will be imposed on the
Company for each calendar year to the extent that dividends paid during the year
(or declared during the last quarter of the year and paid during January of the
succeeding year) are less than the sum of (i) 85% of the Company's "ordinary
income," (ii) 95% of the Company's capital gain net income, and (iii) income not
distributed in earlier years.
If the Company fails to meet the 95% Distribution Test as a result of an
adjustment to the Company's tax returns by the Service, the Company by following
certain requirements set forth in the Code, may pay a deficiency dividend within
a specified period that will be permitted as a deduction in the taxable year to
which the adjustment is made. The Company would be liable for interest based on
the amount of the deficiency dividend. A deficiency dividend is not permitted if
the deficiency is due to fraud with intent to evade tax or to a willful failure
to file timely tax return.
Recordkeeping Requirements. A REIT is required to maintain records
regarding the actual and constructive ownership of its shares, and other
information, and within 30 days after the end of its taxable year, to demand
statements from persons owning above a specified level of the REIT's shares
(e.g., if the Company has over 200 but fewer than 2,000 stockholders of record,
from persons holding 1% or more of the Company's outstanding shares of stock and
if the Company has 200 or fewer stockholders of record, from persons holding
1/2% or more of the stock) regarding their ownership of shares. The Company must
maintain, as part of its records, a list of those persons failing or refusing to
comply with this demand. Stockholders who fail or refuse to comply with the
demand must submit a statement with their tax returns setting forth the actual
stock ownership and other information. The Company also is required to maintain
permanent records of its assets as of the last day of each calendar quarter. The
Company intends to maintain the records and demand statements as required by
these regulations.
TERMINATION OR REVOCATION OF REIT STATUS
The Company's election to be treated as a REIT will be terminated
automatically if it fails to meet the requirements described above. In that
event, the Company will not be eligible again to elect REIT status until the
fifth taxable year that begins after the year for which its election was
terminated unless all of the following relief provisions apply: (i) the Company
did not willfully to fail to file a timely return with respect to the
termination taxable year, (ii) inclusion of incorrect information in such return
was not due to fraud with intent to evade tax, and (iii) the Company establishes
that failure to meet requirements was due to reasonable cause and not willful
neglect. The Company may also voluntarily revoke its election, although it has
no intention of doing so, in which event it will be prohibited, without
exception, from electing REIT status for the year to which the revocation
relates and the following four taxable years.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company would be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to stockholders of the Company with
respect to any year in which it fails to qualify as a REIT would not be
deductible by the Company nor would they be required to be made. Failure to
qualify as a REIT would result in the Company's reduction of its distributions
to stockholders in order to pay the resulting taxes. If, after
64
<PAGE>
forfeiting REIT status, the Company later qualifies and elects to be taxed as a
REIT again, the Company could face significant adverse tax consequences.
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, it generally will not
be subject to federal income tax on that portion of its Taxable Income or net
capital gain which is distributed to its stockholders. The Company will,
however, be subject to tax at normal corporate rates upon any Net Income or net
capital gain not distributed. The Company intends to distribute substantially
all of its Taxable Income to its stockholders on a pro rata basis in each year.
See "Dividend and Distribution Policy."
In addition, the Company will also be subject to a tax of 100% of net
income from any prohibited transaction and will be subject to a 100% tax on the
greater of the amount by which it fails either the 75% or 95% of Income Tests,
reduced by approximated expenses, if the failure to satisfy such tests is due to
reasonable cause and not willful neglect and if certain other requirements are
met. The Company may be subject to the alternative minimum tax on certain items
of tax preference.
If the Company acquires any real property as a result of foreclosure, or by
a deed in lieu of foreclosure, it may elect to treat such real properly as
Foreclosure Property. Net income from the sale of Foreclosure Property is
taxable at the maximum federal corporate rate, currently 35%. Income from
Foreclosure Property will not be subject to the 100% tax on prohibited
transactions. The Company will determine whether to treat such real properly as
foreclosure property on the tax return for the fiscal year in which such
properly is acquired.
The Company may securitize Mortgage Loans and sell such Mortgage Securities
through a taxable subsidiary. However, if the Company itself were to sell such
Mortgage Securities on a regular basis, there is a substantial risk that they
would be deemed Dealer Property and that all of the profits from such sales
would be subject to tax at the rate of 100% as income from prohibited
transactions. The Company therefore, intends to make any such sales through a
taxable subsidiary. The taxable subsidiary will form mortgage pools and create
mortgage-backed securities. See "-- Taxable Subsidiaries" below. The taxable
subsidiary will not be subject to this 100% tax on income from prohibited
transactions, which is only applicable to REITs.
The Company may elect to retain and pay income tax on all or a portion of
its net long-term capital gains for any taxable year, in which case the
Company's stockholders would include in their income as long-term capital gains
their proportionate share of such undistributed capital gains. The stockholders
would be treated as having paid their proportionate share of the capital gains
tax paid by the Company, which amounts would be credited or refunded to the
stockholders.
The Company will also be subject to a nondeductible 4% excise tax if it
fails to make timely dividend distributions for each calendar year. See "--
Requirements for Qualification as a REIT -- Distribution Requirement" above.
The Company intends to declare its fourth regular annual dividend during the
final quarter of the year and to make such dividend distribution no later than
31 days after the end of the year in order to avoid imposition of the excise
tax. Such a distribution would be taxed to the stockholders in the year that
the distribution was declared, not in the year paid. Imposition of the excise
tax on the Company would reduce the amount of cash available for distribution to
its stockholders.
65
<PAGE>
TAXABLE SUBSIDIARIES
The Company may, in the future, cause the creation and sale of Mortgage
Securities through a taxable corporation. The Company and one or more persons
or entities will own all of the capital stock of that taxable corporation,
sometimes referred to as a "taxable subsidiary." In order to ensure that the
Company will not violate the prohibition on ownership of more than 10% of the
voting stock of a single issuer and the prohibition on investing more than 5% of
the value of its assets in the stock or securities of a single issuer, the
Company will own only shares of nonvoting preferred stock of that taxable
subsidiary corporation and will not own any of the taxable subsidiary's common
stock. The Company will monitor the value of its investment in the taxable
subsidiary on a quarterly basis to limit the risk of violating any of the tests
that comprise the 25% of Assets Test. In addition, the dividends that the
taxable subsidiary pays to the Company will not qualify as income from Qualified
REIT Real Estate Assets for purposes of the 75% of Income Test, and in all
events would have to be limited, along with the Company's other interest,
dividends, gains on the sale of securities, hedging income, and other income not
derived from Qualified REIT Real Estate Assets to less than 25% of the Company's
gross revenues in each year. The taxable subsidiary will not elect REIT status,
will be subject to income taxation on its net earnings and will generally be
able to distribute only its net after-tax earnings to its stockholders,
including the Company, as dividend distributions. If the taxable subsidiary
creates a taxable mortgage pool, such pool itself will constitute a separate
taxable subsidiary of the taxable subsidiary. The taxable subsidiary would be
unable to offset the income derived from such a taxable mortgage pool with
losses derived from any other activities.
TAXATION OF STOCKHOLDERS
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its stockholders out of
current or accumulated earnings and profits will be includable by the
stockholders as ordinary income for federal income tax purposes unless properly
designated by it as capital gain dividends. In the latter case, the
distributions will be taxable to the stockholders as long-term capital gains.
Distributions of the Company will not be eligible for the dividends
received deduction for corporations. Stockholders may not deduct any net
operating losses or capital losses of the Company.
Any loss on the sale or exchange of shares of the Common Stock held by a
stockholder for six months or less will be treated as a long-term capital loss
to the extent of any capital gain dividend received on the Common Stock held by
such stockholders.
If the Company makes distributions to its stockholders in excess of its
current and accumulated earnings and profits, those distributions will be
considered first a tax-free return of capital, reducing the tax basis of a
stockholder's shares until the tax basis is zero. Such distributions in excess
of the tax basis will be taxable as gain realized from the sale of the Company's
stock.
The Company does not expect to acquire residual interests issued by REMICs.
Such residual interests, if acquired by a REIT, may generate excess inclusion
income. Excess inclusion income cannot be offset by net operating losses of a
stockholder. If the stockholder is a Tax-Exempt Entity, the excess inclusion
income is fully taxable as UBTI. If allocated to a foreign stockholder, the
excess inclusion income is subject to federal income tax withholding without
reduction pursuant to any otherwise applicable tax treaty. Potential investors,
and in particular Tax-Exempt Entities, are urged to consult with their tax
advisors concerning this issue.
66
<PAGE>
The Company intends to finance the acquisition of Mortgage Assets by
entering into reverse repurchase agreements, which are essentially loans secured
by the Company's Mortgage Assets. The Company will seek to enter into master
repurchase agreements with secured lenders known as "counter-parties."
Typically, such master repurchase agreements have cross-collateralization
provisions that afford the counter-party the right to foreclose on the Mortgage
Assets pledged as collateral. If the Service were to successfully take the
position that the cross-collateralization provisions of the master repurchase
agreements result in the Company having issued debt instruments (the reverse
repurchase agreements) with differing maturity dates secured by a pool of
Mortgage Loans, a portion of its income could be characterized as "excess
inclusion income." See "Risk Factors -- Risk of Adverse Tax Treatment of Excess
Inclusion Income."
The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to stockholders of record on a specified
date in such month will be deemed to have been received by the stockholders and
paid by the Company on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year.
TAXATION OF TAX-EXEMPT ENTITIES
In general, a Tax-Exempt Entity that is a stockholder of the Company is not
subject to tax on distributions. The Service has ruled that amounts distributed
by a REIT to an exempt employees' pension trust do not constitute UBTI and thus
should be nontaxable to such a Tax-Exempt Entity. Based on that ruling, but
subject to the discussion of excess inclusion income set forth under "--
Taxation of Stockholders" above, indebtedness incurred by the Company in
connection with the acquisition of real estate assets such as Mortgage Loans
will not cause dividends of the Company paid to a stockholder that is a Tax-
Exempt Entity to be UBTI. However, if a Tax-Exempt Entity has financed the
acquisition of any of its stock in the Company with "acquisition indebtedness"
within the meaning of the Code, distributions on such stock could be treated as
UBTI. Under certain conditions, if a tax-exempt employee pension or profit
sharing trust were to acquire more than 10% of the Company's stock, a portion of
the dividends on such stock could be treated as UBTI.
For social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts, and qualified group legal services plans exempt
from federal income taxation under Code Sections 501(c)(7), (c)(9), (c)(17) and
(c)(20), respectively, income from an investment in the Company will constitute
UBTI unless the organization is able to properly deduct amounts set aside or
placed in reserve for certain purposes so as to offset the UBTI generated by its
investment in the Company. Such entities should review Code Section 512(a)(3)
and should consult their own tax advisors concerning these "set aside" and
reserve requirements.
STATE AND LOCAL TAXES
The Company and its stockholders may be subject to state or local taxation
in various jurisdictions, including those in which it or they transact business
or reside. The state and local tax treatment of the Company and its stockholders
may not conform to the federal income tax consequences discussed above.
Consequently, prospective stockholders should consult their own tax advisors
regarding the effect of state and local tax laws on an investment in the Common
Stock.
67
<PAGE>
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS
The following discussion summarizes certain United States tax consequences
of the acquisition, ownership and disposition of the Common Stock by an initial
purchaser of the Common Stock that, for United States income tax purposes, is
not a "United States person" (a "Foreign Holder"). For purposes of discussion, a
"United States person" means: a citizen or resident of the United States; a
corporation, partnership, or other entity created or organized in the United
States or under the laws of the United States or of any political subdivision
thereof (unless, in the case of a partnership, the Service provides otherwise by
regulations); an estate whose income is includable in gross income for United
States income tax purposes regardless of its source; or, a trust if a court
within the United States is able to exercise primary supervision over the
administration of the trust and one or more United States persons have the
authority to control all substantial decisions of the trust. This discussion
does not consider any specific facts or circumstances that may apply to a
particular Foreign Holder. Prospective investors are urged to consult their tax
advisors regarding the United States tax consequences of acquiring, holding and
disposing of Common Stock, as well as any tax consequences that may arise under
the laws of any foreign, state, local or other taxing jurisdiction.
Dividends. Dividends paid by the Company out of earnings and profits, as
determined for United States income tax purposes, to a Foreign Holder will
generally be subject to withholding of United States federal income tax at the
rate of 30%, unless reduced or eliminated by an applicable tax treaty or unless
such dividends are treated as effectively connected with a United States trade
or business conducted by the Foreign Holder. A Foreign Holder eligible for a
reduction in withholding under an applicable treaty must so notify the Company
by completing the appropriate IRS form. Distributions paid by the Company in
excess of its earnings and profits will be treated as a tax-free return of
capital to the extent of the holder's adjusted basis in his Common Stock, and
thereafter as gain from the sale or exchange of a capital asset as described
below. If it cannot be determined at the time a distribution is made whether
such distribution will exceed the Company's earnings and profits (which, under
most circumstances, will correspond to the Company's Net Income before the
deduction for dividends paid), the distribution will be subject to withholding
at the same rate as dividends. Amounts so withheld, however, will be refundable
or creditable against the Foreign Holder's United States tax liability if the
Company subsequently determines that such distribution was, in fact, in excess
of the earnings and profits of the Company. If the receipt of the dividend is
treated as being effectively connected with the conduct of a trade or business
within the United States by a Foreign Holder, the dividend received by such
holder will be subject to the United States federal income tax on net income
that applies to United States persons generally (and, in addition with respect
to foreign corporate holders and under certain circumstances, the 30% branch
profits tax).
For any year in which the Company qualifies as a REIT, distributions to a
Foreign Holder that are attributable to gain from the sales or exchanges by the
Company of "United States real property interests" will be treated as if such
gain were effectively connected with a United States business and will thus be
subject to tax at the normal capital gain rates applicable to United States
stockholders (subject to applicable alternative minimum tax) under the
provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled to a
treaty exemption. The Company is required to withhold 35% of any distribution
that could be designated by the Company as a capital gains dividend. This amount
may be credited against the Foreign Holder's FIRPTA tax liability.
Gain on Disposition. A Foreign Holder will generally not be subject to
United States federal income tax on gain recognized on a sale or other
disposition of the Common Stock unless (i) the gain is effectively connected
with the conduct of a trade or business within the United States by the Foreign
68
<PAGE>
Holder, (ii) in the case of a Foreign Holder who is a nonresident alien
individual and holds the Common Stock as a capital asset, such holder is present
in the United States for 183 or more days (computed in part by reference to days
present in the 2 prior years) in the taxable year and certain other requirements
are met, or (iii) the Foreign Holder is subject to tax under the FIRPTA rules
discussed below. Gain that is effectively connected with the conduct of a United
States Holder will be subject to the United States federal income tax on net
income that applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits tax) but
will not be subject to withholding. Foreign Holders should consult applicable
treaties, which may provide for different rules.
Gain recognized by a Foreign Holder upon a sale of its Common Stock will
generally not be subject to tax under FIRPTA if the Company is a "domestically
controlled REIT," which is defined generally as a REIT in which at all times
during a specified testing period less than 50% in value of its shares were held
directly or indirectly by non-U.S. persons. Because only a minority of the
Company's stockholders are expected to be Foreign Holders, the Company
anticipates that it will qualify as a "domestically controlled REIT."
Accordingly, a Foreign Holder should not be subject to U.S. tax from gains
recognized upon disposition of the Common Stock. However, because the Common
Stock will be publicly traded, no assurance can be given that the Company will
continue to be a "domestically controlled REIT."
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 Foreign Holder at an address outside the United States.
Payments by a United States office of a broker of the proceeds of a sale of the
Common Stock is subject to both backup withholding at a rate of 31% and
information reporting unless the holder certifies its Foreign Holder status
under penalties of perjury or otherwise establishes an exemption. Information
reporting requirements (but not backup withholding) will also apply to payments
of the proceeds of sales of the Common Stock by foreign offices of United States
brokers, or foreign brokers with certain types of relationships to the United
States, unless the broker has documentary evidence in its records that the
holder is a Foreign Holder and certain other conditions are met, or the holder
otherwise establishes an exemption.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be refunded or credited against the Foreign
Holder's United States federal income tax liability, provided that the required
information is furnished to the 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.
NEW TAX LEGISLATION
On August 5, 1997, President Clinton signed into law the Taxpayer Relief
Act of 1997 (the "1997 Act"). Effective for taxable years beginning after the
date of the enactment of the 1997 Act, the 1997 Act, among other things, (i)
extends the current two-year period during which property acquired at or in lieu
of foreclosure of the mortgage secured by such property (or as a result of a
default under a lease of such property) may be treated as Foreclosure Property
to the close of the third taxable year following the taxable year during which
such property was acquired, (ii) expands the types of interest rate hedges that
may be treated as Qualified Hedges, and (iii) reduces the maximum federal long-
term capital gains rate applicable to individuals to 20%.
69
<PAGE>
ERISA CONSIDERATIONS
In considering an investment in the Common Stock, a fiduciary of a profit-
sharing, pension stock bonus plan, or individual retirement account ("IRA"),
including a plan for self-employed individuals and their employees or any other
employee benefit plan subject to prohibited transaction provisions of the Code
or the fiduciary responsibility provisions of ERISA (an "ERISA Plan") should
consider (a) whether the ownership of Common Stock is in accordance with the
documents and instruments governing such ERISA Plan, (b) whether the ownership
of Common Stock is consistent with the fiduciary's responsibilities and
satisfies the requirements of Part 4 of Subtitle B of Title I of ERISA (where
applicable) and, in particular, the diversification, prudence and liquidity
requirements of Section 404 of ERISA, (c) ERISA's prohibitions in improper
delegation of control over, or responsibility for, "plan assets" and ERISA's
imposition of co-fiduciary liability on a fiduciary who participates in, permits
(by action or inaction) the occurrence of, or fails to remedy a known breach of
duty by another fiduciary and (d) the need to value the assets of the ERISA Plan
annually.
In regard to the "plan assets" issue noted in clause (c) above, Counsel is
of the opinion that, effective as of the date of the closing of the Offering and
the listing of the shares of Common Stock on the New York Stock Exchange, and
based on certain representations of the Company, the Common Stock should qualify
as a "publicly offered security," and, therefore, the acquisition of such Common
Stock by ERISA Plans should not cause the Company's assets to be treated as
assets of such investing ERISA Plans for purposes of the fiduciary
responsibility provisions of ERISA or the prohibited transaction provisions of
the Code. Fiduciaries of ERISA Plans and IRAs should consult with and rely upon
their own advisors in evaluating the consequences under the fiduciary provisions
of ERISA and the Code of an investment in Common Stock in light of their own
circumstances.
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 100 million shares
of Common Stock, $.01 par value, and 50 million shares of preferred stock, $.01
par value, issuable in one or more series. Each share of Common Stock is
entitled to participate equally in dividends when and as declared by the Board
of Directors and in the distribution of assets of the Company upon liquidation.
Each share of Common Stock is entitled to one vote and will be fully paid and
non-assessable by the Company upon issuance. Shares of the Common Stock of the
Company have no preference, conversion, exchange, preemptive or cumulative
voting rights. The authorized capital stock of the Company may be increased and
altered from time to time as permitted by Maryland law.
The preferred stock may be issued from time to time in one or more classes
or series, with such distinctive designations, rights and preferences as shall
be determined by the Company's Board of Directors. Preferred stock would be
available for possible future financings of, or acquisitions by, the Company and
for general corporate purposes without any legal requirement that further
stockholder authorization for issuance be obtained. 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.
The preferred stock, if issued, would have a preference on dividend payments
that could affect the ability of the Company to make dividend distributions to
the common stockholders.
Meetings of the stockholders of the Company are to be held annually and
special meetings may be called by the Board of Directors, the Chairman of the
Board, the President or a majority of the Unaffiliated Directors. The Articles
of Incorporation reserve to the Company the right to amend any provision thereof
in the manner prescribed by law.
70
<PAGE>
REPURCHASE OF SHARES AND RESTRICTIONS ON TRANSFER
Two of the requirements of qualification for the tax benefits accorded by
the REIT Provisions of the Code are that (1) during the last half of each
taxable year not more than 50% in value of the outstanding shares may be owned
directly or indirectly by five or fewer individuals (the "50%/5 stockholder
test") and (2) there must be at least 100 stockholders on 335 days of each
taxable year of 12 months.
In order that the Company may meet these requirements at all times, the
Articles of Incorporation prohibits any person from acquiring or holding,
directly or indirectly, shares of Common Stock in excess of 9.8% in value of the
aggregate of the outstanding shares of Common Stock or in excess of 9.8% (in
value or in number of shares, whichever is more restrictive) of the aggregate of
the outstanding shares of Common Stock of the Company. For this purpose, the
term "ownership" is defined in accordance with the REIT Provisions of the Code
and the constructive ownership provisions of Section 544 of the Code, as
modified by Section 856(h)(1)(B) of the Code. Subject to certain limitations,
the Company's Board of Directors may increase or decrease the ownership
limitations or waive the limitations for individual investors.
For purposes of the 50%/5 stockholder test, the constructive ownership
provisions applicable under Section 544 of the Code attribute ownership of
securities owned by a corporation, partnership, estate or trust proportionately
to its stockholders, partners or beneficiaries, attribute ownership of
securities owned by family members and partners to other members of the same
family, treat securities with respect to which a person has an option to
purchase as actually owned by that person, and set forth application of such
attribution provisions (i.e., "reattribution"). Thus, for purposes of
determining whether a person holds shares of Common Stock in violation of the
ownership limitations set forth in the Articles of Incorporation, many types of
entities may own directly more than the 9.8% limit because such entities' shares
are attributed to its individual stockholders. On the other hand, a person will
be treated as owning not only shares of Common Stock actually or beneficially
owned, but also any shares of Common Stock attributed to such person under the
attribution rules described above. Accordingly, under certain circumstances,
shares of Common Stock owned by a person who individually owns less than 9.8% of
the shares outstanding may nevertheless be in violation of the ownership
limitations set forth in the Articles of Incorporation. Ownership of shares of
Common Stock through such attribution is generally referred to as constructive
ownership. The 100 stockholder test is determined by actual, and not
constructive, ownership. The Company will have greater than 100 stockholders of
record.
The Articles of Incorporation further provides that if any transfer of
shares of Common Stock which, if effective, would result in any person
beneficially or constructively owning shares of Common Stock in excess or in
violation of the above transfer or ownership limitations, then that number of
shares of Common Stock the beneficial or constructive ownership of which
otherwise would cause such person to violate such limitations (rounded to the
nearest whole shares) shall be automatically transferred to a trustee (the
"Trustee") as trustee of a trust (the "Trust") for the exclusive benefit of one
or more charitable beneficiaries (the "Charitable Beneficiary"), and the
intended transferee shall not acquire any rights in such shares. Shares of
Common Stock held by the Trustee shall be issued and outstanding shares of
Common Stock. The intended transferee shall not benefit economically from
ownership of any shares held in the Trust, shall have no rights to dividends,
and shall not possess any rights to vote or other rights attributable to the
shares held in the Trust. The Trustee shall have all voting rights and rights
to dividends or other distributions with respect to shares held in the Trust,
which rights shall be exercised for the exclusive benefit of the Charitable
Beneficiary. Any dividend or other distribution paid to the intended transferee
prior to the discovery by the Company that shares of Common Stock have been
transferred to the Trustee shall be paid with respect to such shares to the
Trustee by the intended
71
<PAGE>
transferee upon demand and any dividend or other distribution authorized but
unpaid shall be paid when due to the Trustee. The Board of Directors of the
Company may, in its discretion, waive these requirements on owning shares in
excess of the ownership limitations.
Within 20 days of receiving notice from the Company that shares of Common
Stock have been transferred to the Trust, the Trustee shall sell the shares held
in the Trust to a person, designated by the Trustee, whose ownership of the
shares will not violate the ownership limitations set forth in the Articles of
Incorporation. Upon such sale, the interest of the Charitable Beneficiary in
the shares sold shall terminate and the Trustee shall distribute the net
proceeds of the sale to the intended transferee and to the Charitable
Beneficiary as follows. The intended transferee shall receive the lesser of (1)
the price paid by the intended transferee for the shares or, if the intended
transferee did not give value for the shares in connection with the event
causing the shares to be held in the Trust (e.g., in the case of a gift, devise
or other such transaction), the Market Price (as defined below) of the shares on
the day of the event causing the shares to be held in the Trust, and (2) the
price per share received by the Trustee from the sale or other disposition of
the shares held in the Trust. Any net sales proceeds in excess of the amount
payable to the intended transferee shall be immediately paid to the Charitable
Beneficiary. In addition, shares of Common Stock transferred to the Trustee
shall be deemed to have been offered for sale to the Company, or its designee,
at a price per share equal to the lesser of (i) the price per share in the
transaction that resulted in such transfer to the Trust (or, in the case of a
devise or gift, the Market Price at the time of such devise or gift), and (ii)
the Market Price on the date the Company, or its designee, accepts such offer.
The Company shall have the right to accept such offer until the Trustee has sold
shares held in the Trust. Upon such a sale to the Company, the interest of the
Charitable Beneficiary in the shares sold shall terminate and the Trustee shall
distribute the net proceeds of the sale to the intended transferee.
The term "Market Price" on any date shall mean, with respect to any class
or series of outstanding shares of the Company's stock, the Closing Price (as
defined below) for such shares on such date. The "Closing Price" on any date
shall mean the last sale price for such shares, regular way, or, in case no such
sale takes place on such day, the average of the closing bid and asked prices,
regular way, for such shares, in either case as reported in the principal
consolidated transaction reporting system with respect to securities listed or
admitted to trading on the New York Stock Exchange or, if such shares are not
listed or admitted to trading on the New York Stock Exchange, as reported on the
principal consolidated transaction reporting system with respect to securities
listed on the principal national securities exchange on which such shares are
listed or admitted to trading or, if such shares are not listed or admitted to
trading on any national securities exchange, the last quoted price, or, if not
so quoted, the average of the high bid and low asked prices in the over-the-
counter market, as reported by the National Association of Securities Dealers,
Inc., Automated Quotation Systems, or, if such system is no longer in use, the
principal other automated quotation system that may then be in use or, if such
shares are not quoted by any such organization, the average of the closing bid
and asked prices as furnished by a professional market maker making a market in
such shares selected by the Company's Board of Directors or, in the event that
no trading price is available for such shares, the fair market value of the
shares, as determined in good faith by the Company's Board of Directors.
Every owner of more than 5%, in the case of 2,000 or more stockholders of
record and 1% in the case of more than 200 but fewer than 2,000 stockholders of
record, of all classes or series of the Company's stock, within 30 days after
the end of each taxable year, is required to give written notice to the Company
stating the name and address of such owner, the number of shares of each class
and series of stock of the Company beneficially owned and a description of the
manner in which such shares are held. Each such owner shall provide to the
Company such additional information as the Company may
72
<PAGE>
request in order to determine the effect, if any, of such beneficial ownership
on the Company's status as a REIT and to ensure compliance with the ownership
limitations.
CERTAIN PROVISIONS OF MARYLAND LAW AND
OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The following summary of certain provisions of the Maryland General
Corporation Law, as amended from time to time (the "MGCL"), and of the Articles
of Incorporation and the Bylaws of the Company does not purport to be complete
and is subject to and qualified in its entirety by reference to Maryland law and
to the Articles of Incorporation and the Bylaws of the Company, copies of which
are filed as exhibits to the Registration Statement of which this Prospectus is
a part. See "Additional Information." For a description of additional
restrictions on transfer of the Common Stock, see "Description of Capital Stock-
- -Repurchase of Shares and Restrictions on Transfer."
REMOVAL OF DIRECTORS
The Articles of Incorporation provide that a director may be removed from
office at any time but only by the affirmative vote of the holders of at least
two-thirds of the votes of the shares entitled to be cast in the election of
directors.
BUSINESS COMBINATIONS
Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, an asset transfer or
issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns 10% or more of the voting power
of the corporation's shares or an affiliate of the corporation who, at any time
within the two-year period prior to the date in question, was the beneficial
owner of 10% or more of the voting power of the then outstanding voting stock of
the corporation (an "Interested Stockholder") or an affiliate of such an
Interested Stockholder are prohibited for five years after the most recent date
on which the Interested Stockholder becomes an Interested Stockholder.
Thereafter, any such business combination must be recommended by the board of
directors of such corporation and approved by the affirmative vote of at least
(a) 80% of the votes entitled to be cast by holders of outstanding shares of
voting stock of the corporation and (b) two-thirds of the votes entitled to be
cast by holders of voting stock of the corporation other than shares held by the
Interested Stockholder with whom (or with whose affiliate) the business
combination is to be effected, unless, among other conditions, the corporation's
common stockholders receive a minimum price (as defined in the MGCL) for their
shares and the consideration is received in cash or in the same form as
previously paid by the Interested Stockholder for its shares. The MGCL does not
apply, however, to business combinations that are approved or exempted by the
board of directors of the corporation prior to the time that the Interested
Stockholder becomes an Interested Stockholder.
CONTROL SHARE ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares of stock owned by the acquiror, by officers or by directors who
are employees of the corporation. "Control shares" are voting shares of stock
which, if aggregated with all other such shares of stock previously acquired by
the acquiror or in respect of which the acquiror is able to exercise or direct
the exercise of voting power (except solely by virtue of a
73
<PAGE>
revocable proxy), 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 the acquiring person is then entitled to vote as a result of
having previously obtained stockholder approval. A "control share acquisition"
means the acquisition of control shares, subject to certain exceptions.
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 of the corporation 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 required 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 the absence of
voting rights for the control shares, as of the date of the last control share
acquisition by the acquiror 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 shares as
determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiror in the control share acquisition.
The control share acquisition statute does not apply (i) to shares acquired
in a merger, consolidation or share exchange if the corporation is a party to
the transaction, or (ii) to acquisitions approved or exempted by the Articles of
Incorporation or Bylaws of the corporation.
The Bylaws of the Company contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of the
Company's shares of Common Stock. There can be no assurance that such provision
will not be amended or eliminated at any time in the future.
AMENDMENT TO THE ARTICLES OF INCORPORATION
The Company reserves the right from time to time to make any amendment to
its Articles of Incorporation, now or hereafter authorized by law, including any
amendment which alters the contract rights as expressly set forth in the
Articles of Incorporation, of any shares of outstanding stock. The Articles of
Incorporation may be amended only by the affirmative vote of holders of shares
entitled to cast not less than a majority of all the votes entitled to be cast
on the matter; provided, however, that provisions on removal of directors may be
amended only by the affirmative vote of holders of shares entitled to cast not
less than two-thirds of all the votes entitled to be cast in the election of
directors.
DISSOLUTION OF THE COMPANY
The dissolution of the Company must be approved by the affirmative vote of
holders of shares entitled to cast not less than a majority of all the votes
entitled to be cast on the matter.
74
<PAGE>
ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS
The Bylaws provide that (a) with respect to an annual meeting of
stockholders, nominations of persons for election to the Board of Directors and
the proposal of business to be considered by stockholders may be made only (1)
pursuant to the Company's notice of the meeting, (2) by the Board of Directors
or, (3) by a stockholder who is entitled to vote at the meeting and has complied
with the advance notice procedures set forth in the Bylaws, and (b) with respect
to special meetings of stockholders, only the business specified in the
Company's notice of meeting may be brought before the meeting of stockholders
and nominations of persons for election to the Board of Directors or (c)
provided that the Board of Directors has determined that directors shall be
elected at such meeting, by a stockholder who is entitled to vote at the meeting
and has complied with the advance notice provisions set forth in the Bylaws.
POSSIBLE ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE
ARTICLES OF INCORPORATION AND BYLAWS
The business combination provisions and, if the applicable provision in the
Bylaws is rescinded, the control share acquisition provisions of the MGCL, the
provisions of the Articles of Incorporation on removal of directors and the
advance notice provisions of the Bylaws could delay, defer or prevent a change
in control of the Company or other transaction that might involve a premium
price for holders of Common Stock or otherwise be in their best interest.
TRANSFER AGENT AND REGISTRAR
The Company intends to appoint Chase Mellon Shareholder Services, 50
California Street, Tenth Floor, San Francisco, California 94111, telephone (415)
954-9510 as its transfer agent and registrar for the Common Stock.
REPORTS TO STOCKHOLDERS
The Company will furnish its stockholders with annual reports containing
audited financial statements and such other periodic reports as it may determine
to furnish or as may be required by law.
75
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in a purchase agreement (the
"Purchase Agreement"), the Company has agreed to sell to each of the
underwriters named below (the "Underwriters"), and each of the Underwriters, for
whom Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch & Co."),
PaineWebber Incorporated, Stifel, Nicolaus & Company, Incorporated and Sutro &
Co. Incorporated are acting as representatives (the "Representatives"), has
severally agreed to purchase from the Company the number of shares of Common
Stock set forth opposite its name below.
Number of
Underwriter Shares
----------- ----------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...........................
PaineWebber Incorporated.......................
Stifel, Nicolaus & Company, Incorporated.......
Sutro & Co. Incorporated....................... __________
Total.................................. 10,000,000
==========
In the Purchase Agreement, the several Underwriters named therein have
agreed, subject to the terms and conditions set forth therein, to purchase all
of the shares of Common Stock being sold pursuant to the Purchase Agreement if
any of such shares of Common Stock are purchased. Under certain circumstances,
the commitments of non-defaulting Underwriters may be increased as set forth in
the Purchase Agreement.
The Representatives have advised the Company that the Underwriters propose
to offer the shares of Common Stock offered hereby to the public initially at
the public offering price set forth on the cover page of this Prospectus and to
certain dealers at such price less a concession not in excess of $_____ per
share of Common Stock, and that the Underwriters may allow, and such dealers may
reallow, a discount not in excess of $____ per share of Common Stock on sales to
certain other dealers. After the initial public offering, the public offering
price, concession and discount may be changed.
The Company has granted to the Underwriters an option exercisable for 30
days after the date hereof to purchase up to an aggregate of 1,500,000
additional shares of Common Stock to cover over-allotments, if any, at the
initial public offering price, less the underwriting discount set forth on the
cover page of this Prospectus. To the extent that the Underwriters exercise
such option, each of the Underwriters will have a firm commitment, subject to
certain conditions, to purchase approximately the same percentage thereof which
the number of shares of Common Stock to be purchased by it shown in the
foregoing table is of the number of shares of Common Stock initially purchased
by the Underwriters.
The Company, the Manager and their respective officers and directors have
agreed not to offer, sell, agree or offer to sell, grant any option to purchase
or otherwise dispose of, any shares of Common Stock or any securities
convertible into or exercisable or exchangeable for shares of Common Stock
directly or indirectly, for a period of 180 days after the date of this
Prospectus without the prior written consent of Merrill Lynch & Co. acting on
behalf of the Underwriters, except that the Company may, without such consent,
grant options or issue shares of Common Stock pursuant to the Company's 1997
Stock Option Plan.
The Representatives of the Underwriters have advised the Company that the
Underwriters do not intend to confirm sales to any account over which they
exercise discretionary authority.
76
<PAGE>
Prior to the Offering, there has been no public market for the Common
Stock. The initial public offering price of the Common Stock will be determined
by negotiations between the Company and the Representatives. Among the factors
considered in such negotiations, in addition to prevailing market conditions,
are the Company's future prospects, the experience of its management, the
economic condition of the financial services industry in general, the demand for
similar securities of companies considered comparable to the Company and other
relevant factors. The initial public offering price set forth on the cover page
of this Prospectus should not, however, be considered an indication of the
actual value of the Common Stock. Such price will be subject to change as a
result of market conditions and other factors. There can be no assurance that
an active trading market will develop for the Common Stock or that the Common
Stock will trade in the public market subsequent to the Offering at or above the
initial public offering price.
Until the distribution of the Common Stock is completed, rules of the
Commission may limit the ability of the Underwriters and certain selling group
members to bid for and 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 through the
exercise of all or part of the over-allotment options described above.
The Representatives may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
shares of Common Stock in the open market to reduce the Underwriters' short
position or to stabilize the price of the Common Stock, they may reclaim the
amount of the selling concession from the Underwriters and selling group members
who sold those shares as part of the Offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might 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 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 has agreed to indemnify the several Underwriters against
certain liabilities, including liabilities under the Securities Act, or to
contribute to payments the Underwriters may be required to make in respect
thereof. The Company intends to purchase insurance that, among other things,
provides coverage for the Company with respect to the foregoing indemnification
and contribution agreement. See "The Manager - Expenses."
Certain of the Underwriters have performed, and may continue to perform,
investment banking, broker-dealer and financial advisory services for the
Company and certain of its Affiliates and have received and will receive
customary compensation therefor.
77
<PAGE>
The Underwriters undertake that the minimum distribution, issuance and
aggregate market value requirements for listing on the New York Stock Exchange
will be achieved in the Offering.
In addition, TCW Brokerage Services, an affiliate of the Manager, will act
as a dealer in connection with the Offering and receive compensation in
connection with the shares of Common Stock it sells. See "Risk Factors --
Conflicts of Interest; Manager and Its Affiliates Will Continue to Purchase
Mortgage Assets for Third-Party Accounts."
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by O'Melveny & Myers LLP, San Francisco, California, and
certain legal matters will be passed upon for the Underwriters by Brown & Wood
LLP. O'Melveny & Myers LLP and Brown & Wood LLP, New York, New York will rely as
to all matters of Maryland law on the opinion of Ballard Spahr Andrews &
Ingersoll, Baltimore, Maryland. In addition, the description of federal income
tax consequences contained in this Prospectus entitled "Federal Income Tax
Considerations" is based upon the opinion of O'Melveny & Myers LLP.
EXPERTS
The balance sheet of Apex Mortgage Capital, Inc. as of September 15, 1997,
included in this Prospectus has been audited by Deloitte & Touche LLP,
independent auditors, as stated in their report appearing herein, and is
included in reliance upon the report of such firm given upon their authority as
experts in accounting and auditing.
ADDITIONAL INFORMATION
Copies of the Registration Statement of which this Prospectus forms a part
and the exhibits thereto are on file at the offices of the Commission in
Washington, D.C., and may be obtained at rates prescribed by the Commission upon
request to the Commission and inspected, without charge, at the offices of the
Commission. The Company will be subject to the informational requirements of
the Exchange Act, and in accordance therewith, will periodically file reports
and other information with the Commission. Such reports and other information
can be inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's regional offices located at Seven World Trade Center, 13th Floor,
New York, New York 10048, and at 500 West Madison Street, Chicago, Illinois
60661. Copies of such material can also be obtained from the Commission at
prescribed rates through its Public Reference Section at 450 Fifth Street, N.W.,
Washington, D.C. 20549. Statements contained in this Prospectus as to the
contents of any contract or other document referred to are not necessarily
complete, and in each instance reference is made to the copy of such contract or
other document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respect by such reference. The Commission
maintains a Website that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission. The address of the site is http://www.sec.gov.
The Company intends to furnish the holders of Common Stock with annual
reports containing financial statements audited by its independent certified
public accountants and with quarterly reports containing unaudited financial
statements for each of the first three quarters of each year.
78
<PAGE>
GLOSSARY
There follows an abbreviated definition of certain capitalized terms used
in this Prospectus.
"Affiliate" means, when used with reference to a specified person, (i) any
person that directly or indirectly controls or is controlled by or is under
common control with the specified person, (ii) any person that is an officer of,
partner in or trustee of, or serves in a similar capacity with respect to, the
specified person or of which the specified person is an officer, partner or
trustee, or with respect to which the specified person serves in a similar
capacity, and (iii) any person that, directly or indirectly, is the beneficial
owner of 5% or more of any class of equity securities of the specified person or
of which the specified person is directly or indirectly the owner of 5% or more
of any class of equity securities.
"Agency Certificates" means GNMA Certificates, Fannie Mae Certificates and
FHLMC Certificates.
"ARM" means either a (i) a Mortgage Security as to which the underlying
mortgage loans feature adjustments of the underlying interest rate at
predetermined times based on an agreed margin to an establish index or (ii) a
Mortgage Loan or any mortgage loan underlying a Mortgage 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 and
lifetime interest rate and/or payment caps.
"Average Net Invested Assets" means for any period (i) the arithmetic
average of the sum of the gross proceeds of the offerings of its equity
securities by the Company, after deducting any underwriting discounts and
commissions and other expenses and costs relating to such offerings, plus the
Company's retained earnings (taking into account any losses incurred) computed
by taking the average of such values at the end of each month during such
period, plus (ii) any unsecured debt approved by the Unaffiliated Directors to
be included in Average Net Invested Capital.
"Average Net Worth" means for any period the arithmetic average of the sum
of the gross proceeds from the offerings of its equity securities by the
Company, before deducting any underwriting discounts and commissions and other
expenses and costs relating to the offerings, plus the Company's retained
earnings (without taking into account any losses incurred in prior periods)
computed by taking the average of such values at the end of each month during
such period.
"Bankruptcy Code" means Title 11 of the United States Code, as amended.
"Capital and Leverage Policy" means the policy of the Company that limits
its ability to acquire additional Mortgage Assets during times when the capital
base of the Company is less than a required amount, as described in this
Prospectus.
"Charitable Beneficiary" means a charitable beneficiary of a Trust.
"Closing Price" on any date shall mean the last sale price for such shares,
regular way, or, in case no such sale takes place on such day, the average of
the closing bid and asked prices, regular way, for such shares, in either case
as reported in the principal consolidated transaction reporting system with
respect to securities listed or admitted to trading on the New York Stock
Exchange or, if such shares are not listed or admitted to trading on the New
York Stock Exchange, as reported on the principal consolidated transaction
reporting system with respect to securities listed on the principal national
79
<PAGE>
securities exchange on which such shares are listed or admitted to trading or,
if such shares are not listed or admitted to trading on any national securities
exchange, the last quoted price, or, if not so quoted, the average of the high
bid and low asked prices in the over-the-counter market, as reported by the
National Association of Securities Dealers, Inc. Automated Quotation Systems,
or, if such system is no longer in use, the principal other automated quotation
system that may then be in use or, if such shares are not quoted by any such
organization, the average of the closing bid and asked prices as furnished by a
professional market maker making a market in such shares selected by the
Company's Board of Directors or, in the event that no trading price is available
for such shares, the fair market value of the shares, as determined in good
faith by the Company's Board of Directors.
"CMOs" means debt obligations (bonds) that are collateralized by mortgage
loans or mortgage certificates other than Mortgage Derivative Securities and
Subordinated Interests. 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 agencies or private issuers in one or more classes with fixed or
variable interest rates, maturities and degrees of subordination that are
characteristics designed for the investment objectives of different bond
purchasers.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commission" means the Securities and Exchange Commission.
"Commitments" means commitments issued by the Company that will obligate
the Company to purchase Mortgage Assets from or sell them to the holders of the
commitment for a specified period of time, in a specified aggregate principal
amount and at a specified price.
"Common Stock" means the Company's shares of Common Stock, $.01 par value
per share.
"Company" means Apex Mortgage Capital, Inc., a Maryland corporation.
"Compensation Committee" means the committee of the Company's Board of
Directors comprised entirely of Unaffiliated Directors that will administer the
1997 Stock Option Plan.
"Control Shares" means voting shares of stock which, if aggregated with all
other shares of stock previously acquired by the acquiror or in respect of which
the acquiror is able to exercise or direct the exercise of voting power (except
solely by virtue of a revocable proxy), 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 if the acquiring person is then entitled to
vote as a result of having previously obtained stockholder approval.
"Control Share Acquisition" means the acquisition of control shares,
subject to certain exceptions.
"Conforming Mortgage Loans" means conventional Mortgage Loans that either
comply with requirements inclusion in credit support programs sponsored by
FHLMC, Fannie Mae or GNMA or are FHA or VA Loans, all of which are secured by
first mortgages or deeds of trust on single-family (one to four units)
residences.
"Counsel" means O'Melveny & Myers LLP.
80
<PAGE>
"Counter-party" means a third-party financial institution with which the
Company enters into an interest rate cap agreement or similar agreement.
"Dealer Property" means real property and real estate mortgages other than
stock in trade, inventory or property held primarily for sale to customers in
the ordinary course of the Company's trade or business.
"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 substantially similar security on a specified future date.
"ERISA" means the Employee Retirement Income Security Act of 1974.
"ERISA Plan" means a pension, profit-sharing, retirement or other employee
benefit plan that is subject to ERISA.
"Excess Servicing Rights" means contractual rights to receive a portion of
monthly mortgage payments of interest remaining after those payments of interest
have already been applied, to the extent required, to Pass-Through Certificates
and the administration of mortgage servicing. The mortgage interest payments
are secured by an interest in real property.
"Excess Shares" means the number of shares of capital stock held by any
person or group of persons in excess of 9.8% of the outstanding shares.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Fannie Mae" means the federally chartered and privately owned corporation
organized and existing under the Federal National Mortgage Association Charter
Act (12 U.S.C., (S)1716 et seq.), formerly known as the Federal National
Mortgage Association.
"Fannie Mae Certificates" means guaranteed mortgage pass-through
certificates issued by Fannie Mae either in certified or book-entry form.
"Federal Reserve Board" means the Board of Governors of the Federal Reserve
System.
"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 Certificates" means mortgage participation certificates issued by
FHLMC, either in certificated or book-entry form.
"FIRPTA" means the Foreign Investment in Real Property Tax Act of 1980.
"Foreclosure Property" means property acquired at or in lieu of foreclosure
of the mortgage secured by such property or a result of a default under a lease
of such property.
81
<PAGE>
"Foreign Holder" means an initial purchaser of the Common Stock that, for
United States income tax purposes, is not a United States person.
"GAAP" means generally accepted accounting principles.
"GNMA" means the Government National Mortgage Association.
"GNMA Certificates" means fully modified pass-through mortgage-backed
certificates guaranteed by GNMA and issued either in certificated or book-entry
form.
"High Quality" means either (i) securities that are rated A or above by at
least one of the Rating Agencies, or (ii) securities that are unrated but are
obligations of the United States or obligations guaranteed by the United States
government or an agency or instrumentality thereof.
"Housing Act" means the National Housing Act of 1934, as amended.
"HUD" means the Department of Housing and Urban Development.
"Interested Stockholder" means any person who beneficially owns 10% or more
of the voting power of a corporation's shares or an affiliate of a corporation
who, at any time within the ten-year period prior to the date in question, was
the beneficial owner of 10% or more of the voting power of the then outstanding
voting stock of the corporation.
"Interest Only Derivatives" means Mortgage Derivative Securities
representing the right to receive interest only or a disproportionately large
amount of interest.
"Investment Company Act" means the Investment Company Act of 1940, as
amended.
"IRAs" means Individual Retirement Accounts.
"ISOs" means qualified incentive stock options granted under the 1997 Stock
Option Plan that meet the requirements of Section 422 of the Code.
"Issuers" means those entities that issue Mortgage Securities, including
trusts or subsidiaries organized by the Company and Affiliates of the Manager.
"Keogh Plans" means H.R. 10 Plans.
"LIBOR" means London-Inter-Bank Offered Rate.
"MGCL" means the Maryland General Corporation Law.
"Management" means the Company's and the Manager's management team.
"Management Agreement" means the agreement by and between the Company and
the Manager whereby the Manager agrees to perform certain services to the
Company in exchange for certain compensation.
"Manager" means TCW Investment Management Company, a California
corporation.
82
<PAGE>
"Market Price" on any date shall mean, with respect to a class or series of
outstanding shares of the Company's stock, the Closing Price for such stock on
such date.
"MBS Group" means the TCW Group's Mortgage-Backed Securities Group.
"Moody's" means Moody's Investor Service, Inc.
"Mortgage Assets" means (i) Mortgage Securities, (ii) Mortgage Loans and
(iii) Short-Term Investments. All Mortgage Securities and Mortgage Loans shall
be Qualified REIT Real Estate Assets.
"Mortgage Derivative Securities" means Mortgage Securities that provide for
the holder to receive interest only, principal only, or interest and principal
in amounts that are disproportionate to those payable on the underlying Mortgage
Loans and may include other derivative instruments.
"Mortgage Loans" means Conforming and Nonconforming Mortgage Loans, FHA
Loans and VA Loans.
"Mortgage Securities" means (i) Pass-Through Certificates, (ii) CMOs, and
(iii) Other Mortgage Securities.
"Mortgage Warehouse Participations" means participations in lines of credit
to mortgage originators that are secured by recently originated Mortgage Loans
that are in the process of being either securitized or sold to permanent
investors.
"Net Income" means the taxable income of the Company before the Manager's
incentive compensation, net operating loss deductions arising from losses in
prior periods and deductions permitted by the Code in calculating taxable income
for a REIT plus the effects of adjustments, if any, necessary to record hedging
and interest transactions in accordance with GAAP.
"New Capital" means the proceeds from the sale of stock or certain debt
obligations.
"95% of Income Test" means the income-based test that the Company must meet
to qualify as a REIT described in paragraph 2 of "Federal Income Tax
Considerations--Requirements for Qualification as a REIT--Gross Income Tests."
"Nonconforming Mortgage Loans" means conventional Mortgage Loans that do
not conform to one or more requirements of FHA, FHLMC, Fannie Mae, GNMA or VA
for participation in one or more of such agencies' mortgage loan credit support
programs, such as the principal amounts financed or the underwriting guidelines
used in making the loan.
"Offering" means the 10,000,000 shares of Common Stock offered through the
Underwriters in connection with this Prospectus.
"One-Year U.S. Treasury Rate" means average of weekly average yield to
maturity for U.S. Treasury securities (adjusted to a constant maturity of one
year) as published weekly by the Federal Reserve Board during a yearly period.
"Other Mortgage Assets" means Mortgage Assets that are unrated or whose
ratings have not been updated, including (i) Mortgage Loans, (ii) Pass-Through
Certificates and CMOs that are not High Quality but are backed by single-family
residential mortgage loans, and (iii) Other Mortgage Securities, that, in each
case, are determined to be comparable to a High Quality Mortgage Security (by
the standards of at least one of the Rating Agencies) on the basis of credit or
other enhancement features that
83
<PAGE>
meet the High Quality Credit criteria as determined by the Manager and approved
by the Company's Board of Directors, including approval by a majority of the
Unaffiliated Directors.
"Other Mortgage Securities" means securities representing interests in, or
secured by mortgages on real property other than Pass-Through Certificates and
CMOs and may include non-High Quality certificates and other securities
collateralized by single-family loans, Mortgage Warehouse Participations,
Mortgage Derivative Securities, Subordinated Interests and other mortgage-backed
and mortgage-collateralized obligations.
"Pass-Through Certificates" means securities (or interests therein) other
than Mortgage Derivative Securities and Subordinated Interests 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. Pass-Through Certificates include Agency
Certificates, as well as other certificates evidencing interests in loans
secured by single-family properties.
"Principal Only Derivatives" means Mortgage Derivative Securities
representing the right to receive principal only or a disproportionate amount of
principal.
"Privately Issued Certificates" means mortgage participation certificates
issued by certain private institutions. These securities entitle the holder to
receive a pass-through of principal and interest payments in the underlying pool
of Mortgage Loans and are issued or guaranteed by the private institution.
"Prohibited Transaction" means a transaction involving a sale of Dealer
Property, other than Foreclosure Property.
"Qualified Hedges" means bona fide interest rate swap or cap agreements
entered into by the Company to hedge variable-rate indebtedness only that the
Company incurred to acquire or carry Qualified REIT Real Estate Assets and any
futures and options, or other investments (other than Qualified REIT Real Estate
Assets) made by the Company to hedge its Mortgage Assets or borrowings that have
been determined by a favorable opinion of counsel to generate qualified income
for purposes of the 95% source of income test applicable to REITs.
"Qualifying Interests in Real Estate" means "mortgages and other liens on
and interests in real estate," as defined in Section 3(c)(5)(C) under the
Investment Company 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.
"Qualified Temporary Investment Income" means income attributable to stock
or debt instruments acquired with new capital of the Company received during the
one-year period beginning on the day such proceeds were received.
"Rating Agencies" means either Standard & Poor's and Moody's Investors
Service, Inc.
"REIT" means a real estate investment trust as defined under Section 856 of
the Code.
84
<PAGE>
"REIT Provisions of the Code" means Sections 856 through 860 of the Code.
"REMIC" means a real estate mortgage investment conduit.
"Return on Equity" means an amount calculated for any quarter by dividing
the Company's Net Income for the quarter by its Average Net Worth for the
quarter.
"Securities Act" means the Securities Act of 1933, as amended.
"Service" means the Internal Revenue Service.
"Servicers" means those entities that perform the servicing functions with
respect to Mortgage Loans or Excess Servicing Rights owned by the Company.
"Standard & Poor's" means Standard & Poor's Ratings Services, a division
of McGraw-Hill.
"75% of Income Test" means the income-based test that the Company must meet
to qualify as a REIT described in paragraph 1 of "Federal Income Tax
Considerations--Requirements for Qualification as a REIT--Gross Income Tests."
"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, 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 (1) year. All Short-Term Investments will be High Quality.
"1997 Stock Option Plan" means the stock option plan adopted by the
Company.
"Subordinated Interests" means a class of Mortgage Securities that is
subordinated to one or more other classes of Mortgage Securities, all of which
classes share the same collateral.
"Suppliers of Mortgage Assets" means mortgage bankers, savings and loan
associations, investment banking firms, banks, home builders, insurance
companies and other concerns or lenders involved in mortgage finance or
originating and packaging mortgage loans, and their Affiliates.
"Tax-Exempt Entity" means a qualified pension, profit-sharing or other
employee retirement benefit plans, Keogh plans, bank commingled trust funds for
such plans, and IRAs, and other similar entities intended to be exempt from
federal income taxation.
"Taxable Income" means for any year the taxable income of the Company for
such year (excluding any net income derived either from property held primarily
for sale to customers or from Foreclosure Property) subject to certain
adjustments provided in the REIT Provisions of the Code.
"TCW" means The TCW Group, Inc.
"TCW Group" means TCW and its subsidiaries and Affiliates.
"Ten-Year U.S. Treasury Rate" means the arithmetic average of the weekly
average yield to maturity for actively traded current coupon U.S. Treasury fixed
interest rate securities (adjusted to a constant maturity of ten years)
published by the Federal Reserve Board during a quarter, or, if such rate
85
<PAGE>
is not published by the Federal Reserve Board, any Federal Reserve Bank or
agency or department of the federal government selected by the Company. If the
Company determines in good faith that the Ten Year U.S. Treasury Rate cannot be
calculated as provided above, then the rate shall be the arithmetic average of
the per annum average yields to maturities, based upon closing asked prices on
each business day during a quarter, for each actively traded marketable U.S.
Treasury fixed interest rate security with a final maturity date not less than
eight nor more than twelve years from the date of the closing asked prices as
chosen and quoted for each business day in each such quarter in New York City by
at least three recognized dealers in U.S. government securities selected by the
Company.
"Trust" means a trust that is the transferee of that number of shares of
Common Stock the beneficial or constructive ownership of which otherwise would
cause a person to acquire or hold, directly or indirectly, shares of Common
Stock in an amount that violates the Company's Articles of Incorporation, which
trust shall be for the exclusive benefit of one or more Charitable
Beneficiaries.
"Trustee" means a trustee of a Trust for the exclusive benefit of a
Charitable Beneficiary.
"UBTI" means "unrelated trade or business income" as defined in Section 512
of the Code.
"Unaffiliated Directors" means those directors that are not affiliated,
directly, or indirectly, with the Manager or the TCW Group, whether by ownership
of, ownership interest in, employment by, any material business or professional
relationship with, or serving as an officer or director of the Manager or the
TCW Group or an affiliated business entity of the Manager or the TCW Group.
"United States Holder" means an initial purchaser of the Common Stock that,
for United States income tax purposes, is a United States person (i.e., is not a
Foreign Holder).
"VA" means the United States Veterans Administration.
"VA Loans" means Mortgage Loans partially guaranteed by the VA under the
Serviceman's Readjustment Act of 1944, as amended.
86
<PAGE>
[LETTERHEAD OF DELOITTE & TOUCHE LLP]
INDEPENDENT AUDITORS' REPORT
To the Stockholder of
Apex Mortgage Capital, Inc.
We have audited the accompanying balance sheet of Apex Mortgage Capital, Inc.
(the "Company") as of September 15, 1997. This financial statement is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement 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 balance sheet is free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the balance sheet. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall balance sheet presentation. We believe that our audit
of the balance sheet provides a reasonable basis for our opinion.
In our opinion, such balance sheet presents fairly, in all material respects,
the financial position of Apex Mortgage Capital, Inc. as of September 15, 1997,
in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
September 16, 1997
<PAGE>
APEX MORTGAGE CAPITAL, INC.
BALANCE SHEET
SEPTEMBER 15, 1997
<TABLE>
<CAPTION>
ASSETS
<S> <C>
Cash ............................................................. $1,500
======
LIABILITIES AND STOCKHOLDER'S EQUITY
Stockholder's Equity
Preferred Stock, par value $0.01 per share; 50,000,000 shares
authorized Common Stock, par value $0.01 per share; 100,000,000 shares
authorized;
100 shares issued and outstanding........................ $ 1
Additional paid-in-capital ........................................ 1,499
------
Total Stockholder's Equity .............................. $1,500
======
</TABLE>
See accompanying notes to balance sheet.
F-2
<PAGE>
APEX MORTGAGE CAPITAL, INC.
NOTES TO BALANCE SHEET
SEPTEMBER 15, 1997
NOTE 1 - THE COMPANY
Apex Mortgage Capital, Inc. (the "Company") was incorporated in Maryland
and was initially capitalized through the sale of 100 shares of Common Stock for
$1,500 on September 15, 1997. The Company will seek to acquire primarily
mortgage-backed securities and may also invest in other real estate related
assets, including mortgage loans.
The Company has had no operations to date other than matters relating to
the organization and start-up of the Company. Accordingly, no statement of
operations is presented.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FEDERAL AND STATE INCOME TAXES
The Company will elect to be taxed as a real estate investment trust under
the Internal Revenue Code of 1986, as amended, and generally will not be subject
to federal and state taxes on its income to the extent it distributes annually
95% of its predistribution taxable income to stockholders and maintains its
qualification as a real estate investment trust.
INCOME RECOGNITION
Income and expenses are to be recorded on the accrual basis of accounting.
NOTE 3 - TRANSACTIONS WITH AFFILIATES
The Company intends to enter into a Management Agreement (the "Management
Agreement") with TCW Investment Management Company (the "Manager"), a wholly
owned subsidiary of The TCW Group, Inc., under which the Manager will manage its
day-to-day operations, subject to the direction and oversight of the Company's
Board of Directors. The Company will pay the Manager annual base management
compensation, payable quarterly, equal to 3/4 of 1% of the Average Net Invested
Capital as further defined in the Management Agreement. The Company will also
pay the Manager, as incentive compensation, an amount equal to 30% of the Net
Income of the Company, before incentive compensation, in excess of the amount
that would produce an annualized Return on Equity equal to the Ten-Year U.S.
Treasury Rate plus 1% as further defined in the Management Agreement.
The Company intends to adopt a stock option plan that provides for the
grant of qualified stock options, non-qualified stock options, stock
appreciation rights and dividend equivalent rights ("Options") under which
Options may be granted to the Manager, directors, officers and any key employees
of the Company and to the directors, officers and key employees of the Manager.
F-3
<PAGE>
NOTE 4 - PUBLIC OFFERING OF COMMON STOCK
The Company is in the process of filing a Registration Statement for the
sale of its common stock. Contingent upon the consummation of the public
offering, the Company will be liable for organization and offering expenses in
connection with the sale of the shares offered.
F-4
<PAGE>
NO DEALER, SALESPERSON, OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS. IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER
TO BUY, THE COMMON STOCK BY ANYONE IN ANY JURISDICTION WHERE, 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 AN IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH
IN THIS PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..........................................................
Risk Factors................................................................
Use of Proceeds.............................................................
Dividend and Distribution Policy............................................
Capitalization..............................................................
Business and Strategy.......................................................
Management of the Company...................................................
The Manager.................................................................
Security Ownership of
Certain Beneficial Owners
and Management..............................................................
Federal Income Tax
Considerations..............................................................
ERISA Considerations........................................................
Description of Capital Stock................................................
Certain Provisions of Maryland
Law and of the Company's
Articles of Incorporation and Bylaws.......................................
Underwriting................................................................
Legal Matters...............................................................
Experts.....................................................................
Additional Information......................................................
Glossary....................................................................
Audit Report................................................................
Balance Sheet...............................................................
</TABLE>
UNTIL __________________, (25 DAYS AFTER THE DATE OF THIS PROSPECTUS) ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
10,000,000 SHARES
[LOGO]
APEX MORTGAGE
CAPITAL, INC.
COMMON STOCK
----------
PROSPECTUS
----------
MERRILL LYNCH & CO.
PAINEWEBBER INCORPORATED
STIFEL, NICOLAUS & COMPANY
INCORPORATED
SUTRO & CO. INCORPORATED
---------------
, 1997
<PAGE>
ITEM 30. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the sale of Common Stock being registered. All amounts are estimates
except the SEC registration fee and the NASD filing fee.
<TABLE>
<CAPTION>
AMOUNT TO BE PAID
<S> <C>
SEC Registration Fee............................ 55,758
NYSE listing fee................................ *
NASD filing fee................................. 18,900
Printing and engraving expenses................. *
Legal fees and expenses......................... *
Accounting fees and expenses.................... *
Transfer agent and custodian fees............... *
Miscellaneous................................... *
Total........................................... *
</TABLE>
* To be provided by amendment.
ITEM 32. SALES TO SPECIAL PARTIES
The securities described in Item 33(a) were issued to TCW Capital
Investment Corporation in exchange for cash.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
(a) Pursuant to the exemption provided by Section 4(2) of the Securities
Act, on September 15, 1997 the Company issued 100 shares of Common Stock for an
aggregate purchase price of $1,500 to TCW Capital Investment Corporation.
(b) Pursuant to the exemption provided by Rule 701 promulgated under the
Securities Act, on ______________, 1997, the Company issued options to
to purchase shares of Common Stock with an exercise price of $ per
share.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
As permitted by the MGCL, the Company's Articles of Incorporation obligate
the Company to indemnify its present and former directors and officers and to
pay or reimburse reasonable expenses for such individuals in advance of the
final disposition of a proceeding to the maximum extent permitted from time to
time by Maryland law. The MGCL permits a corporation to indemnify its present
and former directors and officers, among others, against judgments, penalties,
fines, settlements and reasonable expenses actually incurred by them in
connection with any proceeding to which they may be made a party
II-1
<PAGE>
by reason of their service in those or other capacities, unless it is
established that (a) the act or omission of the director or officer was material
to the matter giving rise to such proceeding and (i) was committed in bad faith,
or (ii) was the result of active and deliberate dishonesty, (b) the director or
officer actually received an improper personal benefit in money, property or
services, or (c) in the case of any criminal proceeding, the director or officer
had reasonable cause to believe that the act or omission was unlawful. The
Bylaws implement the provisions relating to indemnification contained in the
Company's Articles of Incorporation. The MCGL permits the charter of a Maryland
corporation to include a provision limiting the liability of its directors and
officers to the corporation and its stockholders for money damages, except to
the extent that (i) the person actually received an improper benefit or profit
in money, property or services, or (ii) a judgment or other final adjudication
is entered in a proceeding based on a finding that the person's action, or
failure to act, was the result of active and deliberate dishonesty and was
material to the cause of action adjudicated in the proceeding. The Company's
Articles of Incorporation contain a provision providing for elimination of the
liability of its directors or officers to the Company or its stockholders for
money damages to the maximum extent permitted by Maryland law from time to time.
In addition, the officers, directors, and controlling persons of the Company are
indemnified against certain liabilities by the Company under the Purchase
Agreement relating to this Offering. The Company will maintain for the benefit
of its officers and directors, officers' and directors' insurance.
The Purchase Agreement (Exhibit 1.1) also provides for the indemnification
by the Underwriters of the Company, its directors and officers and persons who
control the Company within the meaning of Section 15 of the Securities Act with
respect to certain liabilities, including liabilities arising under the
Securities Act.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements included in the Prospectus are:
Balance sheet at September 15, 1997
Notes to financial statements
All schedules have been omitted because they are not applicable.
(b) Exhibits
<TABLE>
<S> <C>
*1.1 Form of Purchase Agreement
3.1 Articles of Incorporation of the Registrant
*3.2 Bylaws of the Registrant
*5.1 Opinion of Ballard Spahr Andrews & Ingersoll
*8.1 Opinion of O'Melveny & Myers LLP
*10.1 Management Agreement between the Registrant and TCW
Investment Management Company
*10.6 1997 Stock Incentive Plan
*10.8 1997 Outside Directors Stock Option Plan
23.1 Consent of Deloitte & Touche LLP
</TABLE>
II-2
<PAGE>
<TABLE>
<S> <C>
*23.2 Consent of Ballard Spahr Andrews & Ingersoll (included
in Exhibit 5.1)
*23.3 Consent of O'Melveny & Myers LLP (included in Exhibit
8.1)
24.1 Power of Attorney (included on page II-5)
*99.1 Consents to be named as a director pursuant to Rule 438
</TABLE>
* To be filed by amendment.
ITEM 37. UNDERTAKINGS
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing of the Offering certificates in such denominations and registered
in such names as required by the Underwriters to permit prompt delivery to each
purchaser.
Insofar as indemnification by Registrant for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling person of
the Registrant pursuant to the provisions referenced in Item 34 of this
Registration Statement 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 hereunder, the Registrant
will, unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
The undersigned Registrant hereby undertakes:
(1) That for purposes of determining any liability under the Securities
Act, the information omitted from the Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form S-11 and has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereto
duly authorized, in the City of Los Angeles, State of California, on the 19th
day of September, 1997.
APEX MORTGAGE CAPITAL, INC.
By: /s/ PHILIP A. BARACH
------------------------------------------
Philip A. Barach
President and Chief Executive Officer
We, the undersigned directors and officers of Apex Mortgage Capital, Inc.,
do hereby constitute and appoint Philip A. Barach and Daniel K. Osborne, or
either of them, our true and lawful attorneys and agents, to do any and all acts
and things in our name and behalf in our capacities as directors and officers
and to execute any and all instruments for us and in our names in the capacities
indicated below, which said attorneys and agents, or either of them, may deem
necessary or advisable to enable said corporation to comply with the Securities
Act of 1933, as amended, and any rules, regulations, and requirements of the
Securities and Exchange Commission, in connection with this Registration
Statement, including specifically, but without limitation, power and authority
to sign for us or any of us in our names and in the capacities indicated below,
any and all amendments (including post-effective amendment) to this Registration
Statement, or any related registration statement that is to be effective upon
filing pursuant to Rule 462(b) under the Securities Act of 1933, as amended; and
we do hereby ratify and confirm all that the said attorneys and agents, or
either of them, shall do or cause to be done by virtue hereby.
PURSUANT TO REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION
STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED.
<TABLE>
<S> <C> <C>
/s/ MARC I. STERN Chairman of the Board September 19, 1997
---------------------------
Marc I. Stern
/s/ PHILIP A. BARACH President, Chief Executive September 19, 1997
--------------------------- Officer and Director
Philip A. Barach (Principal Executive
Officer)
/s/ JEFFREY E. GUNDLACH Vice Chairman of the Board September 19, 1997
--------------------------- and Chief Investment Officer
Jeffrey E. Gundlach
/s/ DANIEL K. OSBORNE Executive Vice President, September 19, 1997
--------------------------- Chief Operating Officer and
Daniel K. Osborne Chief Financial Officer
(Principal Financial and
</TABLE> Accounting Officer)
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT INDEX
<C> <S>
*1.1 Form of Purchase Agreement
3.1 Articles of Incorporation of the Registrant
*3.2 Bylaws of the Registrant
*5.1 Opinion of Ballard Spahr Andrews & Ingersoll
*8.1 Opinion of O'Melveny & Myers LLP
*10.1 Management Agreement between the Registrant and TCW
Investment Management Company
*10.6 1997 Stock Incentive Plan
*10.8 1997 Outside Directors Stock Option Plan
23.1 Consent of Deloitte & Touche LLP
*23.2 Consent of Ballard Spahr Andrews & Ingersoll (included
in Exhibit 5.1)
*23.3 Consent of O'Melveny & Myers LLP (included in Exhibit
8.1)
24.1 Power of Attorney (included on page II-5)
*99.1 Consents to be named as a director pursuant to Rule 438
</TABLE>
* To be filed by amendment.
II-5
<PAGE>
EXHIBIT 3.1
ARTICLES OF INCORPORATION OF
APEX MORTGAGE CAPITAL, INC.
ARTICLE I
---------
INCORPORATOR
The undersigned, Peter T. Healy, whose post office address is 275 Battery
Street, Suite 2600, San Francisco, California 94111-3305, being at least
eighteen (18) years of age, acting as incorporator does hereby form a
corporation under the General Laws of the State of Maryland.
ARTICLE II
NAME
The name of the corporation (hereinafter called the "Corporation") is:
APEX Mortgage Capital, Inc.
ARTICLE III
PURPOSES
The purpose for which the Corporation is formed is to engage in any lawful
act or activity for which corporations may be organized under the General Laws
of the State of Maryland now or hereafter in force. Subject to, and not in
limitation of the authority of the preceding sentence, upon completion of its
Initial Public Offering (as defined in Article V), the Corporation shall engage
in business as a real estate investment trust (a "REIT") qualifying as such
under Sections 856 through 860 of the Code, as defined below, unless and until
the Board of Directors shall have determined that it is no longer in the best
interests of the Corporation to engage in such business, and shall have taken
the action contemplated in such event by Section 3(b) of Article IX hereof.
The foregoing enumerated purposes and objects shall be in no way limited or
restricted by reference to, or inference from, the terms of the any other clause
of this or any other Article of the Articles of Incorporation of the
Corporation, and each shall be regarded as independent; and they are intended to
be and shall be construed as powers as well as purposes and objects of the
Corporation and shall be in addition to and not in limitation of the general
powers of corporations under the General Laws of the State of Maryland.
1
<PAGE>
ARTICLE IV
PRINCIPAL OFFICE IN MARYLAND AND RESIDENT AGENT
SECTION 1. PRINCIPAL OFFICE. The present address of the principal office of
the Corporation in Maryland is:
PARASEC
c/o Federal Research Corporation
928 North Charles Street, Unit B2
Baltimore, Maryland 21201
SECTION 2. RESIDENT AGENT. The name and address of the resident agent of
the Corporation in Maryland is:
Federal Research Corporation
928 North Charles Street, Unit B2
Baltimore, Maryland 21201
Said resident agent is a Maryland corporation.
ARTICLE V
CAPITAL STOCK
SECTION 1. AUTHORIZED SHARES OF CAPITAL STOCK.
(a) Authorized Shares. The total number of shares of capital stock of
all classes that the Corporation has authority to issue is one hundred and fifty
million (150,000,000) shares of capital stock (par value one cent ($0.01) per
share), consisting of: (i) one hundred million (100,000,000) shares of Common
Stock, par value one cent ($0.01) per share (the "Common Shares"); and (ii)
fifty million (50,000,000) shares of Preferred Stock, par value one cent ($0.01)
per share (the "Preferred Shares") which may be issued in one or more classes as
described in Section 5 of Article V. The Common Shares and each class of the
Preferred Shares shall each constitute a separate class of capital stock of the
Corporation.
The Board of Directors may classify and reclassify any unissued shares
of capital stock in accordance with Section 6 of Article V hereof.
(b) Terminology and Aggregate Par Value. The Common Shares and
Preferred Shares are collectively referred to herein as the "Equity Shares."
The aggregate par value of all the Corporation's authorized Equity Shares having
par value is $1,500,000.
SECTION 2. RESTRICTIONS AND LIMITATIONS ON THE EQUITY SHARES OF THE
CORPORATION.
Subsequent to the date of the Initial Public Offering and until the
Restriction Termination Date (as defined in Article V), all Equity Shares of the
Corporation shall be subject to the following restrictions and limitations:
2
<PAGE>
(a) Definitions. For purposes of this Article V and the
interpretation of the stock legend set forth herein, the following terms shall
have the following meanings:
"Acquire" shall mean the acquisition of Beneficial or Constructive
Ownership of Equity Shares, whether by a Transfer, Non-Transfer Event of by any
other means, including, without limitation, acquisition pursuant to the exercise
of the Acquisition Rights or any other option, warrant, pledge or other security
interest or similar right to acquire Equity Shares, but shall not include the
acquisition of any such rights unless, as a result, the acquiror would be
considered a Beneficial Owner, as defined below.
"Acquisition Rights" shall mean rights to Acquire Equity Shares
pursuant to: (i) the exercise of any option or warrant issued by the Corporation
and outstanding at the opening of business on the first business day following
the closing of the Initial Public Offering (whether exercisable on that day or
not); (ii) any pledge of Equity Shares made pursuant to an agreement executed on
or before the opening of business on the first business day following the
closing of the Initial Public Offering.
"Beneficial Ownership" shall mean ownership of Equity Shares by a
Person who would be treated as an owner of Equity Shares either directly or
indirectly under Section 542(a)(2) of the Code, taking into account, for this
purpose, constructive ownership determined under Section 514 of the Code, as
modified by Section 856(h)(1)(B) of the Code (except where expressly provided
otherwise). The terms "Beneficial Owner," "Beneficially Owns" and "Beneficially
Owned" shall have the correlative meanings.
"Charitable Beneficiary" shall mean, with respect to any Share Trust,
one or more organizations described in each of Section 170(b)(1)(A) (other than
clauses (vii) or (viii) thereof) and Section 170(c)(2) of the Code that are
named by the Share Trustee as the beneficiary or beneficiaries of such Share
Trust, in accordance with the provisions of Section 4(a) of this Article V.
"Code" shall mean the Internal Revenue Code of 1986, as amended and in
effect from time to time, or any successor statute thereto, as interpreted by
the applicable regulations thereunder. Any reference herein to a specific
section or sections of the Code shall be deemed to include a reference to any
corresponding provision of future law.
"Constructive Ownership" shall mean ownership of Equity Shares by a
Person who would be treated as an owner of such Equity Shares either directly or
constructively through the application of Section 318 of the Code, as modified
by Section 856(d)(5) of the Code. The terms "Constructively Own,"
"Constructively Owned" and "Constructive Owner" shall have the correlative
meanings.
"Initial Public Offering" shall mean the closing of the first sale of
Common Shares by the Corporation in an underwritten public offering pursuant to
an effective registration statement for the sale of such Common Shares filed
under the Securities Act of 1933, as amended.
"Market Price" on any date shall mean, with respect to any class or
series of outstanding shares of the Corporation's stock, the Closing Price for
such shares on such date. The "Closing Price" on any date shall mean the last
sale price for such shares, regular way, or, in case no such sale takes place on
such day, the average of the closing bid and asked prices, regular way, for such
shares, in either case as reported in the principal consolidated transaction
reporting system with respect to securities listed or admitted to trading on the
New York Stock Exchange or, if such shares are not listed or admitted to trading
on the New York Stock Exchange, as reported on the principal consolidated
transaction reporting
3
<PAGE>
system with respect to securities listed on the principal national securities
exchange on which such shares are listed or admitted to trading or, if such
shares are not listed or admitted to trading on any national securities
exchange, the last quoted price, or, if not so quoted, the average of the high
bid and low asked prices in the over-the-counter market, as reported by the
National Association of Securities Dealers, Inc., Automated Quotation System,
or, if such system is no longer in use, the principal other automated quotation
system that may then be in use or, if such shares are not quoted by any such
organization, the average of the closing bid and asked prices as furnished by a
professional market maker making a market in such shares selected by the Board
of Directors or, in the event that no trading price is available for such
shares, the fair market value of the shares, as determined in good faith by the
Corporation's Board of Directors.
"Non-Transfer Event" shall mean an event other than a purported
Transfer that would cause any Person to Beneficially Own or Constructively Own
Equity Shares in excess of the Ownership Limit (or would cause the Corporation
to fail to qualify as a REIT), including, without limitation, a change in the
capital structure of the Corporation.
"Ownership Limit" shall initially mean, (i) with respect to the Common
Shares, 9.8% of the lesser of (a) the total number, or (b) the value of the
total number, of outstanding Common Shares or (ii) with respect to the Preferred
Shares, 9.8% of the lesser of (a) the total number, or (b) the value of the
total number, of outstanding Preferred Shares (or such other number or value of
Preferred Shares as the Board of Directors may determine in fixing the terms of
the Preferred Shares).
"Permitted Transferee" shall mean any Person designated as a Permitted
Transferee in accordance with the provisions of Section 4(e) of this Article V.
"Person" shall mean an individual, corporation, partnership, limited
liability company or partnership, estate, trust (including a trust qualified
under Section 401(a) or 501(c)(17) of the Code), a portion of a trust
permanently set aside for or to be used exclusively for the purposes described
in Section 642(c) of the Code, association, private foundation within the
meaning of Section 509(a) of the Code, joint stock company or other entity and
also includes a group as that term is used for purposes of Section 13(d)(3) of
the Securities Exchange Act of 1934, as amended but does not include (i) an
underwriter who participates in the Initial Public Offering or (ii) an
underwriter who participates in any public offering of the Common Shares and/or
Preferred Shares and/or securities convertible into or exchangeable for Common
Shares and/or Preferred Shares subsequent to the Initial Public Offering (a
"Secondary Offering") for a period of sixty (60) days following the purchase by
such underwriter of the Common Shares and/or Preferred Shares and/or securities
convertible into or exchangeable for Common Shares and/or Preferred Shares in
such Secondary Offering.
"Purported Beneficial Transferee" shall mean, with respect to any
purported Transfer that results in Shares-in-Trust as defined below in Section 4
of this Article V, the purported beneficial transferee for whom the Purported
Record Transferee would have Acquired Equity Shares of the Corporation if such
Transfer had been valid under Section 2(b) of this Article V.
"Purported Record Transferee" shall mean, with respect to any
purported Transfer which results in Shares-in-Trust, the Person who would have
been the record holder of the Equity Shares of the Corporation if such Transfer
had been valid under Section 2(b) of this Article V.
"REIT" shall mean a real estate investment trust under Section 856 et
seq. of the Code.
4
<PAGE>
"Restriction Termination Date" shall mean the first day after the date
of the Initial Public Offering on which the Corporation determines pursuant to
Section 3(b) of Article IX and Section 2(i) of this Article V that it is no
longer in the best interests of the Corporation to attempt to, or continue to,
qualify as a REIT.
"Share Trust" shall mean any separate trust created pursuant to
Section 4(a) of this Article V and administered in accordance with the terms of
Section 4 of this Article V, for the exclusive benefit of any Charitable
Beneficiary.
"Shares-in-Trust" shall mean any Equity Shares designated Shares-in-
Trust pursuant to Section 4(a) of this Article V.
"Share Trustee" shall mean the trustee of the Share Trust, which is
selected by the Corporation but not affiliated with the Corporation or the
Charitable Beneficiary, and any successor trustee appointed by the Corporation.
"Transfer" (as a noun) shall mean any sale, transfer, gift,
assignment, devise or other disposition of Equity Shares or the right to vote or
receive dividends on Equity Shares (including without limitation (i) the
granting of any option or entering into any agreement for the sale, transfer or
other disposition of Equity Shares or the right to vote or receive dividends on
Equity Shares or (ii) the sale, transfer, assignment or other disposition or
grant of any Acquisition Rights or other securities or rights convertible into
or exchangeable for Equity Shares, or the right to vote or receive dividends on
Equity Shares), whether voluntary or involuntary, whether of record or
beneficially and whether by operation of law or otherwise. "Transfer" (as a
verb) shall have a correlative meaning.
(b) Ownership Limitation and Transfer Restrictions.
(i) Except as provided in Section 2(f) of this Article V, from and
after the date of the Initial Public Offering and prior to the Restriction
Termination Date: (w) no Person shall Beneficially Own or Constructively Own
Equity Shares in excess of the Ownership Limit; (x) no Person shall Acquire
Equity Shares, if, as a result of such action, the Equity Shares would be
beneficially owned by fewer than 100 Persons (determined without reference to
any rules of attribution under the Code); (y) no Person shall Acquire Equity
Shares or any interest therein if, as a result of such acquisition, the
Corporation would be "closely held" within the meaning of Section 856(h) of the
Code or would otherwise fail to qualify as a REIT, as the case may be; and (z)
no Person shall Acquire Equity Shares or any interest therein if, as a result of
such acquisition, the Corporation would Constructively Own 10% or more of the
ownership interests in a tenant of the Corporation's real property, within the
meaning of Section 856(d)(2)(B) of the Code, or would otherwise fail to qualify
as a REIT, as the case may be.
(ii) Any Transfer that would result in a violation of the
restrictions in Section (b)(i) above, shall be void ab initio as to the
---------
purported Transfer of such number of Equity Shares that would cause the
violation of the applicable restriction in Section (b)(i), and the Purported
Record Transferee (and the Purported Beneficial Transferee, if different) shall
acquire no rights in such Equity Shares.
5
<PAGE>
(c) Automatic Transfer to Share Trust.
(i) If, notwithstanding the other provisions contained in this
Article V, at any time from and after the date of the Initial Public Offering
and prior to the Restriction Termination Date, there is a purported Transfer
or Non-Transfer Event such that any Person would either Beneficially Own or
Constructively Own Equity Shares in excess of the Ownership Limit, then, except
as otherwise provided in Section 2(f) of this Article V, (x) the Purported
Record Transferee (and the Purported Beneficial Transferee, if different) shall
acquire no right or interest (or, in the case of a Non-Transfer Event, the
person holding record title to the Equity Shares Beneficially Owned or
Constructively Owned by such Beneficial Owner or Constructive Owner, shall cease
to own any right or interest) in such number of Equity Shares which would cause
such Purported Record Transferee (and Purported Beneficial Transferee, if
different) to Beneficially Own or Constructively Own Equity Shares in excess of
the Ownership Limit (rounded up to the nearest whole share), (y) such number of
Equity Shares in excess of the Ownership Limit (rounded up to the nearest whole
share) shall be designated Shares-in-Trust and, in accordance with the
provisions of Section 4(a) of this Article V, transferred automatically and by
operation of law to the Share Trust to be held in accordance with Section 4 of
this Article V and (z) such Purported Record Transferee (and the Purported
Beneficial Transferee, if different) shall submit such number of Equity Shares
to the Share Trust for registration in the name of the Share Trustee. Any
Purported Record Transferee (and Purported Beneficial Transferee, if different)
shall acquire no right or interest (or, in the case of a Non-Transfer Event, the
person holding title to the Shares Beneficially Owned or Constructively Owned by
such Beneficial Owner or Constructive Owner, shall cease to own any right or
interest) in such number of Shares which would cause such person to own Shares
in excess of the Ownership Limit. Such transfer to a Share Trust and the
designation of shares as Shares-in-Trust shall be effective as of the close of
business on the business day prior to the date of the Transfer or Non-Transfer
Event, as the case may be.
(ii) If, notwithstanding the other provisions contained in this
Article V, at any time from and after the date of the Initial Public Offering
and prior to the Restriction Termination Date, there is a purported Transfer of
Non-Transfer Event that, if effective, would (i) result in the Equity Shares
being beneficially owned by fewer than 100 persons (determined without reference
to any rules of attribution), (ii) result in the Corporation being "closely
held" within the meaning of Section 856(h) of the Code, (iii) cause the
Corporation to Constructively Own 10% or more of the ownership interests in a
tenant of the Corporation's real property, within the meaning of Section
856(d)(2)(B) of the Code, or (iv) cause the Corporation to otherwise fail to
qualify as a REIT, as the case may be, then (x) the Purported Record Transferee
(and the Purported Beneficial Transferee, if different) shall acquire no right
or interest (or, in the case of a Non-Transfer Event, the person holding record
title to the Equity Shares with respect to which such Non-Transfer Event
occurred, shall cease to own any right or interest) in such number of Equity
Shares, the ownership of which by such Purported Record Transfer (and Purported
Beneficial Transferee, if different) would (A) result in the Equity Shares being
beneficially owned by fewer than 100 Persons (determined without reference to
any rules of attribution), (B) result in the Corporation being "closely held"
within the meaning of Section 856(h) of the Code, (C) cause the Corporation to
Constructively Own 10% or more of the ownership interests in a tenant of the
Corporation's property, within the meaning of Section 856(d)(2)(B) of the Code,
or (D) would otherwise cause the Corporation to fail to qualify as a REIT, as
the case may be, (y) such number of Equity Shares (rounded up to the nearest
whole share) shall be designated Shares-in-Trust and , in accordance with the
provisions of Section 4(a) of this Article V, transferred automatically and by
operation of law to the Share Trust to be held in accordance with Section 4 of
this Article V and (z) the Purported Record Transferee
6
<PAGE>
(and the Purported Beneficial Transferee, if different) shall submit such number
of Equity Shares to the Share Trust for registration in the name of the Share
Trustee.
(d) Remedies for Breach. If the Board of Directors or the Corporation
or its designee shall at any time determine in good faith that a purported
Transfer of Equity Shares has taken place in violation of Section 2(b) of this
Article V or that a Person intends to acquire or has attempted to acquire
beneficial ownership (determined without reference to any rules of attribution),
Beneficial Ownership or Constructive Ownership of any Equity Shares of the
Corporation in violation of Section 2(b) of this Article V, the Board of
Directors or the Corporation or its designee shall take such action as it deems
advisable to refuse to give effect to or to prevent such Transfer or
acquisition, including, but not limited to, refusing to give effect to such
Transfer or acquisition on the books of the Corporation or instituting
proceedings to enjoin such Transfer or acquisition; provided, however, that any
Transfer, attempted Transfer, acquisition or attempted acquisition in violation
of Section 2(b)(i) of this Article V shall automatically result in the transfer
described in Section 2(c) of this Article V, irrespective of any action (or non-
action) by the Board of Directors, except as provided in Section 2(f) of this
Article V.
(e) Notice of Restricted Transfer.
(i) Any Person who acquires or attempts to acquire Equity Shares
in violation of Section 2(b) of this Article V, and any Person who is a
Purported Record Transferee or a Purported Beneficial Transferee of Equity
Shares that are transferred to a Share Trust under Section 2(c) of this Article
V, shall immediately give written notice to the Corporation of such event, shall
submit to the Corporation such number of Equity Shares to be transferred to the
Share Trust and shall provide to the Corporation such other information as the
Corporation may request in order to determine the effect, if any, of such
Transfer or attempted Transfer or such Non-Transfer Event on the Corporation's
status as a REIT.
(ii) From and after the date of the Initial Public Offering and
prior to the Restriction Termination Date every Beneficial Owner or Constructive
Owner of more than 5%, in the case of 2,000 or more stockholders of record, or
1%, in the case of more than 200 but fewer than 2,000 stockholders of record, or
such other percentage as may be provided from time to time in the pertinent
income tax regulations promulgated under the Code, of the number or value of the
outstanding Equity Shares of the Corporation shall, within 30 days after January
1 of each year, give written notice to the Corporation stating the name and
address of such Beneficial Owner or Constructive Owner, the number of Equity
Shares Beneficially or Constructively Owned, and a description of how such
shares are held. Each such Beneficial Owner or Constructive Owner shall provide
to the Corporation such additional information that the Corporation may
reasonably request in order to determine the effect, if any, of such Beneficial
or Constructive Ownership on the Corporation's status as a REIT and to ensure
compliance with the Ownership Limit; and
(iii) From and after the date of the Initial Public Offering and
prior to the Restriction Termination Date, each Person who is a Beneficial Owner
or Constructive Owner of Equity Shares of the Corporation and each Person
(including the stockholder of record) who is holding Equity Shares of the
Corporation for a Beneficial Owner or Constrictive Owner shall provide to the
Corporation such information as the Corporation may reasonably request in order
to determine the Corporation's status as a REIT, to comply with the requirements
of any taxing authority or governmental agency or to determine any such
compliance and to ensure compliance with the Ownership Limit.
7
<PAGE>
(f) Exception. The Board of Directors may, upon receipt of either a
certified copy of a ruling from the Internal Revenue Service or an opinion of
counsel satisfactory to the Board of Directors, but shall in no case be required
to, exempt a Person (the "Exempted Holder") from the Ownership Limit, if the
ruling or opinion concludes that no Person who is an individual as defined in
Section 542(a)(2) of the Code will, as the result of the ownership of Equity
Shares by the Exempted Holder, be considered to have Beneficial Ownership or
Constructive Ownership of an amount of Equity Shares that will violate the
restrictions contained in Sections 2(b)(i)(x), 2(b)(i)(y) and 2(b)(i)(z) of this
Article V; provided, that (i) the Board of Directors obtains such
representations and undertakings from such Person as are reasonably necessary to
ascertain that no individual's Beneficial Ownership of Equity Shares will
violate the Ownership Limit, and (ii) such Person agrees that any violation or
attempted violation will result in such transfer to the Share Trust of Equity
Shares pursuant to Section 2(c) of this Article V. Unless and until a Person is
exempted from the Ownership Limit by the Board of Directors, the Ownership Limit
shall apply to such Person, notwithstanding the fact that if such Person were
otherwise to Acquire Equity Shares in excess of the Ownership Limit, such
Acquisition would not adversely affect the Corporation's qualification as a REIT
under the Code.
(g) Legend. Each certificate for shares of Equity Shares shall bear
substantially the following legend:
"THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO
SIGNIFICANT RESTRICTIONS ON OWNERSHIP AND TRANSFER. EXCEPT AS
OTHERWISE PROVIDED PURSUANT TO THE CHARTER OF THE CORPORATION, NO
PERSON MAY BENEFICIALLY OWN OR CONSTRUCTIVELY OWN (1) COMMON SHARES OF
THE CORPORATION IN EXCESS OF 9.8% OF THE LESSER OF THE TOTAL NUMBER OR
VALUE OF THE OUTSTANDING COMMON SHARES OF THE CORPORATION, (2)
PREFERRED SHARES OF THE CORPORATION IN EXCESS OF 9.8% OF THE LESSER OF
THE TOTAL NUMBER OR VALUE OF THE OUTSTANDING PREFERRED SHARES OF THE
CORPORATION, (3) EQUITY SHARES IF SUCH ACQUISITION WOULD RESULT IN THE
TRUST BEING "CLOSELY HELD" UNDER SECTION 856(h) OF THE CODE, (4)
EQUITY SHARES IF SUCH ACQUISITION WOULD RESULT IN THE EQUITY SHARES
BEING BENEFICIALLY OWNED BY FEWER THAN 100 PERSONS (DETERMINED WITHOUT
REFERENCE TO ANY RULES OF ATTRIBUTION), (5) EQUITY SHARES IF SUCH
ACQUISITION WOULD CAUSE THE CORPORATION TO FAIL TO QUALIFY AS A REAL
ESTATE INVESTMENT TRUST UNDER THE INTERNAL REVENUE CODE OF 1986, AS
AMENDED, OR (6) EQUITY SHARES IN VIOLATION OF ANY OF THE FURTHER
RESTRICTIONS SET FORTH IN THE CORPORATION'S CHARTER. ANY PERSON WHO
ATTEMPTS OR PROPOSES TO BENEFICIALLY OWN OR CONSTRUCTIVELY OWN SHARES
OF EQUITY SHARES IN EXCESS OF THE ABOVE LIMITATIONS MUST IMMEDIATELY
NOTIFY THE CORPORATION IN WRITING. IF AN ATTEMPT IS MADE TO VIOLATE
OR THERE IS A VIOLATION OF THESE RESTRICTIONS (I) ANY PURPORTED
8
<PAGE>
TRANSFER WILL BE VOID AB INITIO AND WILL NOT BE RECOGNIZED BY THE
CORPORATION, (II) THE EQUITY SHARES IN VIOLATION OF THESE
RESTRICTIONS, WHETHER AS A RESULT OF A TRANSFER OR NON-TRANSFER EVENT,
WILL BE TRANSFERRED AUTOMATICALLY AND BY OPERATION OF LAW TO A SHARE
TRUST AND SHALL BE DESIGNATED SHARES-IN-TRUST. ALL TERMS USED IN THIS
LEGEND AND DEFINED IN THE CORPORATION'S CHARTER HAVE THE MEANINGS
PROVIDED IN THE CORPORATION'S CHARTER, AS THE SAME MAY BE AMENDED FROM
TIME TO TIME, A COPY OF WHICH, INCLUDING THE RESTRICTIONS ON OWNERSHIP
AND TRANSFER, WILL BE SENT WITHOUT CHARGE TO EACH STOCKHOLDER WHO SO
REQUESTS."
(h) REIT Qualification. From and after the date of the Initial Public
Offering, the Board of Directors shall use its reasonable best efforts to cause
the Corporation and its stockholders to qualify for United States federal income
tax treatment as a REIT in accordance with the provisions of the Code applicable
to a REIT and shall not take any action which could adversely affect the ability
of the Corporation to qualify as a REIT. In furtherance of the foregoing, the
Board of Directors shall use its reasonable best efforts to take such actions as
are necessary, and may take such actions as in its sole judgment and discretion
are desirable, to preserve the status of the Corporation as a REIT; provided,
however that if it is determined that it is no longer in the best interests of
the Corporation to continue to have the Corporation qualify as a REIT, the
actions required by Article IX Section 3(b) may be taken to terminate the
Corporation's REIT election.
(i) Remedies Not Limited. Subject to Section 7 of this Article V,
nothing contained in this Article shall limit the authority of the Board of
Directors to take such other action as it deems necessary or advisable to
protect the Corporation and the interests of its stockholders in preserving the
Corporation's status as a REIT.
(j) Ambiguity. In the case of an ambiguity in the application of any
of the provisions of this Article V, including any definition contained in
Section 2(a), the Board of Directors shall have the power to determine the
application of the provisions of this Article V with respect to any situation
based on the facts known to it.
(k) Severability. If any provision of this Article V or any
application of any such provision is determined to be invalid by a federal or
state court having jurisdiction over the issue, the validity of the remaining
provisions shall not be affected and other applications of such provision shall
be affected only to the extent necessary to comply with the determination of
such court.
SECTION 3. COMMON SHARES.
Subject to the provisions of Sections 2, 4 and 5 of this Article V,
the Common Shares shall have the following preferences, voting powers,
restrictions, limitations as to dividends and such other rights as may be
afforded by law.
(a) Voting Rights. Except as may otherwise be required by law, each
holder of Common Shares shall have one vote in respect of each Common Share on
all actions to be taken by the
9
<PAGE>
stockholders of the Corporation, and, except as otherwise provided in respect of
any class of stock, hereafter classified or reclassified, the exclusive voting
power for all purposes shall be vested in the holders of the Common Shares.
(b) Dividend Rights. Subject to the provisions of law and any
preferences of any class of stock hereafter classified or reclassified,
dividends, including dividends payable in shares of another class of the
Corporation's stock, may be paid on the Common Shares of the Corporation at such
time and in such amounts as the Board of Directors may deem advisable and the
holders of the Common Shares shall share ratably in any such dividends, in
proportion to the number of Common Shares held by them respectively, on a share
for share basis.
(c) Liquidation Rights. In the event of any liquidation, dissolution
or winding up of the Corporation, whether voluntary of involuntary, the holders
of the Common Shares shall be entitled, after payment or provision for payment
of the debts and other liabilities of the Corporation and the amount to which
the holders of any class of capital stock hereafter classified or reclassified
having a preference on distributions in the liquidation, dissolution or winding
up on the Corporation are entitled, together with the holders of any other class
of capital stock hereafter classified or reclassified not having a preference on
distributions in the liquidation, dissolution or winding up of the Corporation,
to share ratably in the remaining net assets of the Corporation.
(d) Stock Exchange and National Market Transactions. Notwithstanding
any provisions contained herein to the contrary, nothing in these Articles of
Incorporation shall preclude the settlement of any transaction entered into
through the facilities of the New York Stock Exchange, the American Stock
Exchange or other national exchange or the Nasdaq National Market or other
national market system.
SECTION 4. SHARES-IN-TRUST.
(a) Share Trust. Any Equity Shares transferred to a Share Trust and
designated Shares-in-Trust pursuant to Section 2(c) hereof shall be held for the
exclusive benefit of the Charitable Beneficiary. The Corporation shall name a
beneficiary and trustee of each Share Trust within five days after discovery of
the existence thereof. Any transfer to a Share Trust, and subsequent
designation of Equity Shares as Shares-in-Trust, pursuant to Section 2(c) hereof
shall be effective as of the close of business on the business day prior to the
date of the Transfer or Non-Transfer Event that results in the transfer to the
Share Trust. Shares-in-Trust shall remain issued and outstanding Equity Shares
of the Corporation and shall be entitled to the same rights and privileges on
identical terms and conditions as are all other issued and outstanding Equity
Shares of the same class and series. When transferred to the Permitted
Transferee in accordance with the provisions of Section 4(c) hereof, such
Shares-in-Trust shall cease to be designated as Shares-in-Trust.
(b) Dividend Rights. The Trustee, as record holder of Shares-in-
Trust, shall be entitled to receive all dividends and distributions as may be
declared by the Board of Directors on such Equity Shares and shall hold such
dividends or distributions in trust for the benefit of the Charitable
Beneficiary. The Purported Record Transferee (or Purported Beneficial
Transferee, if applicable) with respect to Shares-in-Trust shall repay to the
Share Trustee the amount of any dividends or distributions received by it that
(i) are attributable to any Equity Shares designated as Shares-in-Trust and (ii)
the record date of which was on or after the date that such shares became
Shares-in-Trust. The Corporation shall take all measures that it determines
reasonably necessary to recover the amount of any such dividend
10
<PAGE>
or distribution paid to the Purported Record Transferee (or Purported Beneficial
Transferee, if applicable), including, if necessary, withholding any portion of
future dividends or distributions payable on Equity Shares Beneficially Owned or
Constructively Owned by the Person who, but for the provisions of Section 2(c)
hereof, would Constructively Own or Beneficially Own the Shares-in-Trust; and,
as soon as reasonably practicable following the Corporation's receipt or
withholding thereof, shall pay over to the Share Trustee for the benefit of the
Charitable Beneficiary the dividends so received or withheld, as the case may
be.
(c) Rights Upon Liquidation. In the event of any voluntary or
involuntary liquidation, dissolution or winding up of, or any distribution of
the assets of (other than a dividend), the Corporation, each Trustee of Shares-
in-Trust shall be entitled to receive, ratably with each other holder of Equity
Shares of the same class or series, that portion of the assets of the
Corporation which is available for distribution to the holders of such class and
series of Equity Shares. The Trustee shall distribute to the Purported Record
Transferee the amounts received upon such liquidation, dissolution, or winding
up, or distribution, provided, however, that the Purported Record Transferee
shall not be entitled to receive amounts pursuant to this Section 4(c) in excess
of, in the case of a purported Transfer in which the Purported Record Transferee
gave value for Equity Shares and which Transfer resulted in the transfer of the
shares to the Share Trust, the price per share, if any, such Purported Record
Transferee paid for the Equity Shares and, in the case of a Non-Transfer Event
or Transfer in which the Purported Record Transferee did not give value for such
shares (e.g., if the shares were received through a gift or devise) and which
Non-Transfer Event or Transfer, as the case may be, resulted in the transfer of
shares to the Share Trust, the price per share equal to the Market Price on the
date of such Non-Transfer Event or Transfer. Any remaining amount in such Share
Trust shall be distributed to the Charitable Beneficiary.
(d) Voting Rights. The Share Trustee shall be entitled to vote all
Shares-in-Trust. Any vote by a Purported Record Transferee as a holder of
Equity Shares prior to the discovery by the Corporation that the Equity Shares
are Shares-in-Trust shall, subject to applicable law, be rescinded and shall be
void ab initio with respect to such Shares-in-Trust and the Purported Record
-- ------
Transferee shall be deemed to have given, as of the close of business on the
business day prior to the date of the purported Transfer or Non-Transfer Event
that results in the transfer to the Share Trust of Equity Shares under Section
2(c) hereof, an irrevocable proxy to the Share Trustee to vote the Shares-in-
Trust in the manner in which the Share Trustee, in its sole and absolute
discretion, desires.
(e) Designation of Permitted Transferee. The Share Trustee shall have
the exclusive and absolute right to designate a Permitted Transferee of any and
all Shares-in-Trust. In an orderly fashion so as not materially and adversely
to affect the Market Price of the Shares-in-Trust, the Share Trustee shall
designate any Person as Permitted Transferee, provided, however, that (i) the
Permitted Transferee so designated purchases for valuable consideration (whether
in a public or private sale), at a price as set forth in Section 4(g) hereof,
the Shares-in-Trust and (ii) the Permitted Transferee so designated may acquire
such Shares-in-Trust without such acquisition resulting in a transfer to a Share
Trust and the redesignation of such Equity Shares so acquired as Shares-in-Trust
under Section 2(c) hereof. Upon the designation by the Share Trustee of a
Permitted Transferee in accordance with the provisions of this Section 4(e), the
Share Trustee of a Share Trust shall (i) cause to be transferred to the
Permitted Transferee that number of Shares-in-Trust acquired by the Permitted
Transferee, (ii) cause to be recorded on the books of the Corporation that the
Permitted Transferee is the holder of record of such number of Equity Shares,
(iii) cause the Shares-in-Trust to be cancelled, and (iv) distribute to the
Charitable Beneficiary any and all amounts held with respect to the Shares-in-
Trust after making that payment to the Purported Record Transferee pursuant to
Section 4(f) hereof.
11
<PAGE>
(f) Compensation to Record Holder of Equity Shares that Become Shares-
in-Trust. Any Purported Record Transferee shall be entitled (following
discovery of the Shares-in-Trust and subsequent designation of the Permitted
Transferee in accordance with Section 4(c) hereof) to receive from the Share
Trustee upon the sale or other disposition of such Shares-in-Trust the lesser of
(i) in the case of (a) a purported Transfer in which the Purported Record
Transferee (or Purported Beneficial Transferee, if applicable) gave value for
Equity Shares and which Transfer resulted in the transfer of the shares to the
Share Trust, the price per share, if any, such Purported Record Transferee (or
Purported Beneficial Transferee, if applicable) paid for the Equity Shares, or
(b) a Non-Transfer Event or Transfer in which the Purported Record Transferee
(or Purported Beneficial Transferee, if applicable) did not give value for such
shares (e.g., if the shares were received through a gift or devise) and which
Non-Transfer Event or Transfer, as the case may be, resulted in the transfer of
shares to the Share Trust, the price per share equal to the Market Price on the
date of such Non-Transfer Event or Transfer, and (ii) the price per share
received by the Share Trustee of the Share Trust from the sale or other
disposition of such Shares in Trust in accordance with Section 4(e) or (g)
hereof. Any amounts received by the Share Trustee in respect of such Shares-in-
Trust and in excess of such amounts to be paid the Purported Record Transferee
pursuant to this Section 4(f) shall be distributed to the Charitable Beneficiary
in accordance with the provisions of Section 4(e) hereof. Each Charitable
Beneficiary and Purported Record Transferee (and Purported Beneficial
Transferee, if different) waives any and all claims that each may have against
the Share Trustee and the Share Trust arising out of the disposition of the
Shares-in-Trust, except for claims arising out of the gross negligence or
willful misconduct of, or any failure to make payments in accordance with this
Section 4 by, such Share Trustee or the Corporation.
(g) Purchase Rights in Shares-in-Trust. Shares-in-Trust shall be
deemed to have been offered for sale to the Corporation, or its designee, at a
price per share equal to the lesser of (i) the price per share in the
transaction that created such Shares-in-Trust (or, in the case of devise, gift
or Non-Transfer Event, the Market Price at the time of such devise, gift or Non-
Transfer Event) and (ii) the Market Price on the date the Corporation, or its
designee, accepts such offer. The Corporation shall have the right to accept
such offer for a period of ninety days after the later of (i) the date of the
Non-Transfer Event or purported Transfer which resulted in such Shares-in-Trust
and (ii) the date the Corporation determines in good faith that a Transfer or
Non-Transfer Event resulting in Shares-in-Trust has occurred, if the Corporation
does not receive a notice of such Transfer or Non-Transfer Event pursuant to
Section 2(e) hereof.
SECTION 5. PREFERRED SHARES.
The Preferred Shares may be issued from time to time in one or more
classes. The Board of Directors is expressly authorized, in the resolution or
resolutions providing for the issuance of any wholly unissued class of Preferred
Shares, to fix, state and express the powers, rights, designations, preferences,
qualifications, limitations and restrictions thereof, including without
limitation: the rate of dividends upon which and the times at which dividends
on shares of such class shall be payable and the preference, if any, which such
dividends shall have relative to dividends on shares of any other class or
classes of stock of the Corporation; whether such dividends shall be cumulative
or noncumulative, and if cumulative, the date or dates from which dividends on
shares of such class shall be cumulative; the voting rights, if any, to be
provided for shares of such class; the rights, if any, which the holders of
shares of such class shall have in the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Corporation; the
rights, if any, which the holders of shares of such class shall have to convert
such shares into or exchange such shares for shares of stock of the Corporation,
and the terms and conditions, including price and rate of exchange of such
conversion or exchange; and the
12
<PAGE>
redemption rights (including sinking fund provisions), if any, for shares of
such class; and such other powers, rights, designations, preferences,
qualifications, limitations and restrictions as the Board of Directors may
desire to so fix. The Board of Directors is also expressly authorized to fix
the number of shares constituting such class and to increase or decrease the
number of shares of any class prior to the issuance of shares of that class and
to increase or decrease the number of shares of any class subsequent to the
issuance of shares of that class, but not to decrease such number below the
number of shares of such class then outstanding. In case the number of shares
of any class shall be so decreased, the shares constituting such decrease shall
resume the status which they had prior to the adoption of the resolution
originally fixing the number of shares of such class.
SECTION 6. CLASSIFICATION AND RECLASSIFICATION OF CAPITAL STOCK.
(a) Subject to the foregoing provisions of Article V, the power of the
Board of Directors to classify and reclassify any of the unissued shares of
capital stock shall include, without limitation, subject to the provisions of
the Charter, authority to classify or reclassify any unissued shares of such
stock into a class or classes of preferred stock, preference stock, special
stock or other stock, by determining, fixing, or altering one or more of the
following:
(i) The distinctive designation of such class and the number of
shares to constitute such class, provided that, unless otherwise prohibited by
the terms of such or any other class, the number of shares of any class may be
decreased by the Board of Directors in connection with any classification or
reclassification of unissued shares and the number of shares of such class may
be increased by the Board of Directors in connection with any such
classification or reclassification, and any shares of any class which have been
redeemed, purchased, otherwise acquired or converted into Common Shares or any
other class shall become part of the authorized capital stock and be subject to
classification and reclassification as provided in this Section.
(ii) Whether or not and, if so, the rates, amounts and times at
which, and the conditions under which, dividends shall be payable on shares of
such class, whether any such dividends shall rank senior or junior to or on a
parity with the dividends payable on any other class of stock, and the status of
any such dividends as cumulative, cumulative to a limited extent or non-
cumulative and as participating or non-participating.
(iii) Whether or not shares of such class shall have voting
rights, in addition to any voting rights provided by law and, if so, the terms
of such voting rights.
(iv) Whether or not shares of such class shall have conversion or
exchange privileges and, if so, the terms and conditions thereof, including
provision for adjustment of the conversion or exchange rate in such events or at
such times as the Board of Directors shall determine.
(v) Whether or not shares of such class shall be subject to
redemption and, if so, the terms and conditions of such redemption, including
the date or dates upon or after which they shall be redeemable and the amount
per share payable in case of redemption, which amount may vary under different
conditions and at different redemption dates; and whether or not there shall be
any sinking fund or purchase account in respect thereof, and if so, the terms
thereof.
(vi) The rights of the holders of shares of such class upon the
liquidation, dissolution or winding up of the affairs of, or upon any
distribution of the assets of, the Corporation,
13
<PAGE>
which rights may vary depending upon whether such liquidation, dissolution or
winding up is voluntary or involuntary and, if voluntary, may vary at different
dates, and whether such rights shall rank senior or junior to or on a parity
with such rights of any other class of stock.
(vii) Whether or not there shall be any limitations applicable,
while shares of such class are outstanding, upon the payment of dividends or
making of distributions on, or the acquisition of, or the use of moneys for
purchase or redemption of, any stock of the Corporation, or upon any other
action of the Corporation, including action under this Section, and, if so, the
terms and conditions thereof.
(viii) Any other preferences, rights, restrictions, including
restrictions on transferability, and qualifications of shares of such class, not
inconsistent with law and the Charter of the Corporation.
(b) For the purposes hereof and of any articles supplementary to the
Charter providing for the classification or reclassification of any shares of
capital stock or of any other charter document of the Corporation (unless
otherwise provided in any such articles or document), any class of stock of the
Corporation shall be deemed to rank:
(i) prior to another class either as to dividends or upon
liquidation, if the holders of such class shall be entitled to the receipt of
dividends or of amounts distributable on liquidation, dissolution or winding up,
as the case may be, in preference or priority to holders of such other class;
(ii) on a parity with another class either as to dividends or upon
liquidation, whether or not the dividend rates, dividend payment dates or
redemption or liquidation price per share thereof be different from those of
such others, if the holders of such class of stock shall be entitled to receipt
of dividends or amounts distributable upon liquidation, dissolution or winding
up, as the case may be, in proportion to their respective dividend rates or
redemption or liquidation prices, without preference or priority over the
holders of such other class; and
(iii) junior to another class either as to dividends or upon
liquidation, if the rights of the holders of such class shall be subject or
subordinate to the rights of the holders of such other class in respect of the
receipt of dividends or the amounts distributable upon liquidation, dissolution
or winding up, as the case may be.
SECTION 7. SETTLEMENT.
Nothing in this Article V shall be interpreted to preclude the
settlement of any transaction entered into through the facilities of the New
York Stock Exchange, any other national securities exchange or The Nasdaq
National Market system, but the Equity Shares which are the subject of such
transaction shall continue to be subject to the terms of this Article V
subsequent to such settlement.
14
<PAGE>
ARTICLE VI
THE BOARD OF DIRECTORS
SECTION 1. NUMBER AND QUALIFICATION OF DIRECTORS.
(a) Authorized Number. The business and affairs of the Corporation
shall be managed by a Board of Directors which may exercise all of the powers of
the Corporation except those conferred on, or reserved to, the stockholders
hereunder, under the Bylaws or by law. The number of directors of the
Corporation initially shall be one (1) which number may be increased or
decreased pursuant to the Bylaws of the Corporation but in no event shall be
less than the minimum number required by the general laws of the State of
Maryland. A director need not be a shareholder of the Corporation. Prior to
the effective date of the registration statement relating to the Corporation's
Initial Public Offering, as defined in Article V, the Board of Directors shall
increase the number of directors to three (3) and shall appoint persons to fill
such vacancies pursuant to the Bylaws.
(b) Initial Director. The name of the director who will serve,
together with any subsequently appointed directors, until the first annual
meeting of stockholders and until his successors are elected and qualify is as
follows: Marc I. Stern.
SECTION 2. CLASSIFIED BOARD.
On a date (the "Classification Date") after the number of directors is
increased to three but prior to the effective date of the registration statement
relating to the Corporation's Initial Public Offering, as defined in Article V,
the Board of Directors Board of Directors shall divide the directors (except for
those elected solely by a class of Equity Shares other than Common Shares, if
any) of the Corporation into three classes (each a "Class"), designated "Class
I," "Class II" and "Class III," respectively. The number of directors in each
Class shall be as nearly equal in number as possible. Each director shall serve
for a term ending on the date of the third annual meeting of stockholders
following the annual meeting at which such director was elected; provided,
however, that at the Classification Date, each director in Class I shall serve
for a term ending on the date of the first subsequent annual meeting of
stockholders, each director in Class II shall serve for a term ending on the
date of the second subsequent annual meeting of stockholders; and each director
in Class III shall serve for a term ending on the date of the third subsequent
annual meeting of stockholders; provided, further, that, in accordance with
Maryland law, if the Classification Date falls prior to the first annual meeting
of stockholders, then the initial terms of each initial director shall end on
such date and at their first annual meeting the stockholders shall elect or
reelect, as the case may be, directors to serve the remainder of each classified
term as described above. In accordance with Maryland law, prior to the
Classification Date, each director shall hold office until the next annual
meeting of stockholders and until his or her successor is elected and qualifies.
SECTION 3. REMOVAL OF DIRECTORS.
Any director may be removed with or without cause by the affirmative
vote of stockholders holding not less than 66-2/3% of all votes entitled to be
cast for the election of directors, subject to any rights granted to any class
of Preferred Shares.
15
<PAGE>
SECTION 4. FILLING VACANCIES.
Except in the case of a vacancy on the Board of Directors among the
directors elected by a class of Equity Shares other than Common Shares, any
vacancy on the Board of Directors may be filled by the affirmative vote of the
remaining directors (except that a vacancy which results from an increase in the
number of directors may be filled by a majority of the entire Board of
Directors), and, in the case of a vacancy resulting from the removal of a
director, by the stockholders by the vote of a majority of the votes entitled to
be cast in the election of directors, subject to any rights granted to any class
of Preferred Shares.
SECTION 5. NO CUMULATIVE VOTING.
Stockholders shall not be entitled to cumulative voting rights with
respect to the election of directors.
SECTION 6. RESERVED POWERS OF THE BOARD OF DIRECTORS.
The enumeration and definition of particular powers of the Board of
Directors included in the foregoing provisions of Article VI or the provisions
of Article VII shall in no way be limited or restricted by reference to or
inference from the terms of any other clause of this or any other Article of the
Charter of the Corporation, or construed as or deemed by inference or otherwise
in any manner to exclude or limit any powers conferred upon the Board of
Directors under the General Laws of the State of Maryland now or hereafter in
force.
SECTION 7. INDEPENDENT DIRECTORS.
At all times (except (i) during a period not to exceed sixty (60) days
following the death, resignation, incapacity or removal from office of a
director prior to the expiration of the director's term of office or (ii) prior
to the closing date of the Initial Public Offering and the consummation of all
transactions related thereto), a majority of the directors shall be Independent
Directors.
An Independent Director shall be a natural person who is not: (i) an
officer or employee of the Corporation; or (ii) an Affiliate of (x) any advisor
or manager to the Corporation under an advisory or management agreement; (y) any
subsidiary of the Corporation; (z) or any partnership which is an Affiliate of
the Corporation.
For purposes of this Section 7 of this Article VII, (A) an "Affiliate"
of a person or entity shall mean (i) any person that, directly or indirectly,
controls or is controlled by or is under common control with such person, (ii)
any other person that owns, beneficially, directly or indirectly, five percent
(5%) or more of the outstanding capital shares, shares or equity interests of
such person, or (iii) any officer, director, employee, partner or trustee of
such person or any person controlling, controlled by or under common control
with such person (excluding trustees and persons serving in similar capacities
who are not otherwise an Affiliate of such person), (B) the term "person" means
and includes individuals, corporations, general and limited partnerships, stock
companies or associations, joint ventures, associations companies, trusts,
banks, trust companies, last trusts, business trusts, or other entities and
governments and agencies and political subdivisions thereof, and (C) "control"
(including the correlative meanings of the terms "controlled by" and "under
common control with", as used with respect to any person, shall mean the
possession, directly or indirectly, of the power to direct or cause the
direction of
16
<PAGE>
the management and policies of such person, through the ownership of voting
securities, partnership interests or other equity interests.
Notwithstanding the foregoing requirement that a majority of the
directors be Independent Directors, no action otherwise validly taken by the
Board of Directors during a period in which a majority of its members are not
Independent Directors shall be invalidated or otherwise affected by such
circumstance, nor shall such circumstance subject the directors taking any such
action to a higher standard of care or to liability other than that which would
have applied to such action had a majority of the members of the Board of
Directors been Independent Directors at the time such action was taken.
ARTICLE VII
PROVISIONS FOR DEFINING, LIMITING AND REGULATING
CERTAIN POWERS OF THE CORPORATION AND OF THE
STOCKHOLDERS AND DIRECTORS
The following provisions are hereby adopted for the purpose of
defining, limiting, and regulating the powers of the Corporation and of the
directors and stockholders:
SECTION 1. BOARD AUTHORIZATION OF SHARE ISSUANCES.
The Board of Directors is hereby empowered to authorize the issuance
from time to time of shares of any class of Equity Shares, whether now or
hereafter authorized, or securities convertible into any class of Equity Shares,
whether now or hereafter authorized, for such consideration as may be deemed
advisable by the Board of Directors and without any action by the stockholders.
SECTION 2. NO PREEMPTIVE RIGHTS.
Except as provided by the Board of Directors in authorizing the
issuance of Preferred Shares pursuant to Section 5 of Article V, no holder of
any stock or any other securities of the Corporation, whether now or hereafter
authorized, shall have any preemptive right to subscribe to or purchase (i) any
shares of capital stock of the Corporation, (ii) any warrants, rights, or
options to purchase any such shares, or (ii) any other securities of the
Corporation or obligations convertible into any shares of capital stock of the
Corporation or such other securities or into warrants, rights or options to
purchase any such shares or other securities.
SECTION 3. POWERS OF THE BOARD OF DIRECTORS.
The Board of Directors of the Corporation shall, consistent with
applicable law, have the power in its sole discretion to determine from time to
time in accordance with sound accounting practice or other reasonable valuation
methods what constitutes annual or other net profits, earnings, surplus, or net
assets in excess of capital; to fix and vary from time to time the amount to be
reserved as working capital, or determine that retained earnings or surplus
shall remain in the hands of the Corporation; to set apart out of any funds of
the Corporation such reserve or reserves in such amount or amounts and for such
proper purpose or purposes as it shall determine and to abolish any such reserve
or any part thereof; to distribute and pay distributions or dividends in stock,
cash or other
17
<PAGE>
securities or property, out of surplus or any other funds or amounts legally
available therefor, at such times and to the stockholders of record on such
dates as it may, from time to time, determine; and to determine whether and to
what extent and at what times and places and under what conditions and
regulations the books, accounts and documents of the Corporation, or any of
them, shall be open to the inspection of stockholders, except as otherwise
provided by statute or by the Bylaws of the Corporation, and, except as so
provided, no stockholder shall have any right to inspect any book, account or
document of the Corporation unless authorized so to do by resolution of the
Board of Directors.
SECTION 4. RELATED PARTY TRANSACTIONS.
Without limiting any other procedures available by law or otherwise to
the Corporation, the Board of Directors may authorize any agreement or
transaction with any Person, corporation, association, company, trust,
partnership (limited or general) or other organization, although one or more of
the directors or officers of the Corporation may be a party to any such
agreement or an officer, director, stockholder or member of such other party (an
"Interested Officer/Director"), and no such agreement or transaction shall be
invalidated or rendered void or voidable solely by reason of the existence of
any such relationship if: (i) the existence is disclosed or known to the Board
of Directors, and the contract or transaction is authorized, approved or
ratified by the affirmative vote of a majority of the directors, excluding the
Interested Officers/Directors; or (ii) the existence is disclosed to the
stockholders entitled to vote, and the contract or transaction is authorized,
approved or ratified by a majority of the votes entitled to be cast by the
stockholders, other than the votes of the shares held of record by the
Interested Officers/Directors; or (iii) the contract or transaction is fair and
reasonable to the Corporation. Any Interested Officer/Director of the
Corporation or the stock owned by them or by a corporation, association,
company, trust, partnership (limited or general) or other organization in which
an Interested Officer/Director may have an interest, may be counted in
determining the presence of a quorum at a meeting of the Board of Directors or a
committee of the Board of Directors or at a meeting of the stockholders, as the
case may be, at which the contract or transaction is authorized, approved or
ratified.
ARTICLE VIII
INDEMNIFICATION
AND LIMITATION OF LIABILITY
SECTION 1. INDEMNIFICATION.
(a) Indemnification of Agents. The Corporation shall indemnify, in
the manner and to the fullest extent permitted by law, any person (or the estate
of any person) who is or was a party to, or is threatened to be made a party to,
any threatened, pending or completed action, suit or proceeding, whether or not
by or in the right of the Corporation, and whether civil, criminal,
administrative, investigative or otherwise, by reason of the fact that such
person is or was a director or officer of the Corporation, or such director or
officer is or was serving at the request of the Corporation as a director,
officer, agent, trustee, partner or employee of another corporation,
partnership, joint venture, limited liability company, trust, real estate
investment trust, employee benefit plan or other enterprise. To the fullest
extent permitted by law, the indemnification provided herein shall include
expenses (including attorneys' fees), judgments, fines and amounts paid in
18
<PAGE>
settlement and any such expenses may be paid by the Corporation in advance of
the final disposition of such action, suit or proceeding. The Corporation shall
indemnify other employees and agents to such extent as shall be authorized by
the Board of Directors or the Corporation's Bylaws and be permitted by law. Any
repeal or modification of this Section 1(a) by the stockholders of the
Corporation shall be prospective only, and shall not adversely affect any right
to indemnification or advancement of expenses hereunder existing at the time of
such repeal or modification.
(b) Insurance. The Corporation may, to the fullest extent permitted
by law, purchase and maintain insurance on behalf of any such person against any
liability which may be asserted against such person.
(c) Indemnification Non-Exclusive. The indemnification provided
herein shall not be deemed to limit the right of the Corporation to indemnify
any other person for any such expenses to the fullest extent permitted by law,
nor shall it be deemed exclusive of any other rights to which any person seeking
indemnification from the Corporation may be entitled under any agreement, vote
of stockholders or disinterested directors, or otherwise, both as to action in
such person's official capacity and as to action in another capacity while
holding such office.
SECTION 2. LIMITATION OF LIABILITY.
To the fullest extent permitted by Maryland statutory or decisional
law, as amended or interpreted from time to time, no director or officer of this
Corporation shall be personally liable to the Corporation or its stockholders,
or any of them, for money damages. No amendment of the Charter of the
Corporation or repeal of any of its provisions shall limit or eliminate the
benefits provided to directors and officers under this provision with respect to
any act or omission which occurred prior to such amendment or repeal.
ARTICLE IX
AMENDMENT
SECTION 1. RIGHT TO AMEND CHARTER.
The Corporation reserves the right from time to time to make any
amendments to the Charter which may now or hereafter be authorized by law,
including any amendments changing the terms or contract rights, as expressly set
forth in the Charter, of any of its outstanding stock by classification,
reclassification or otherwise.
SECTION 2. AMENDMENT TO THE CHARTER OF THE CORPORATION.
Notwithstanding any provision of law to the contrary, except as
otherwise specifically provided in Section 3 of this Article IX, the affirmative
vote of a majority of all votes entitled to be cast by the stockholders of the
Corporation shall be sufficient, valid and effective, after due authorization,
approval or advice by the Board of Directors, to approve and authorize any
amendment to the Charter of the Corporation.
19
<PAGE>
SECTION 3. CERTAIN AMENDMENTS REQUIRING SPECIAL STOCKHOLDER VOTE.
(a) Notwithstanding any other provisions of the Charter or Bylaws of
the Corporation (and in addition to any other vote, approval, authorization or
advice (including that of the Board of Directors) that may be required by law,
the Charter or the Bylaws of the Corporation), the affirmative vote of
stockholders holding at least two-thirds (66-2/3%) of all of the votes entitled
to be cast thereon shall be required to amend, alter, change, repeal, or adopt
any provisions inconsistent with, the provisions of this Article IX, Section 2
(classified Board) and Section 3 (removal of directors) of Article VI, Section 5
(no cumulative voting) of Article VI, Section 6 (Independent Directors) of
Article VII, Article VIII (indemnification of directors, officers, employees and
agents and limitation of liability of officers and directors) and Section 2
(preemptive rights) of Article VII. In addition, no term or provisions of the
Charter may be added, amended or repealed in any respect that would, in the
determination of the Board of Directors, cause the Corporation not to qualify as
a REIT under the Code unless, in each such case, such action is approved (in
addition to any other vote, approval, authorization or advice (including that of
the Board of Directors) that may otherwise be required) by the affirmative vote
of the holders of not less than two-thirds (66-2/3%) of all the votes entitled
to be cast on the matter.
(b) The Board of Directors shall take no action to terminate the
Corporation's status as a REIT or to amend the provisions of Article V until
such time as (i) the Board of Directors adopts a resolution recommending that
the Corporation terminate its status as a REIT or amend Article V, as the case
may be, (ii) the Board of Directors presents the resolution at an annual or
special meeting of the stockholders and (iii) such resolution is approved by at
least two-thirds (66-2/3%) of all of the votes entitled to be cast on the
matter.
ARTICLE X
DURATION OF CORPORATION
The duration of the Corporation shall be perpetual.
20
<PAGE>
IN WITNESS WHEREOF, the undersigned has executed these Articles of
Incorporation and acknowledges the same to be his act, and further acknowledges,
under the penalties of perjury, that, to the best of his knowledge, information
and belief, the matters and facts contained herein are true in all material
respects on this ____ day of September, 1997.
By:___________________________________
Peter T. Healy, Esq.
Sole Incorporator
WITNESS:
_____________________________
Patricia A. Strickland
21
<PAGE>
EXHIBIT 23.1
[LETTERHEAD OF DELOITTE & TOUCHE LLP APPEARS HERE]
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of Apex Mortgage Capital,
Inc. on Form S-11 of our report dated September 16, 1997, appearing in the
Prospectus, which is part of this Registration Statement.
We also consent to the reference to us under the heading "Experts" in such
Prospectus.
/s/ Deloitte & Touche LLP
September 16, 1997
