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As filed with the Securities and Exchange Commission on October 29, 1997
Registration No. 333-36069
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No.1
to
FORM S-11/A
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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APEX MORTGAGE CAPITAL, INC.
(Exact Name of Registrant as Specified in its Governing Instruments)
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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)
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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)
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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
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, 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. [ ]
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.
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SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED OCTOBER 29, 1997
PROSPECTUS 10,000,000 Shares
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[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 and mortgage loans financed by the net 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"). The Company has no
ownership interest in the Manager.
All of the shares of common stock (the "Common Stock") offered hereby are
being sold by the Company. At the request of the Company, the Underwriters have
reserved an aggregate of up to 750,000 shares of Common Stock for sale at the
initial public offering price to directors, officers and employees of the
Company, TCW and its affiliates. See "Underwriting." 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 "AXM".
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SEE "RISK FACTORS" COMMENCING ON PAGE 15 FOR MATERIAL RISKS THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY. THESE
RISKS INCLUDE:
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. The lack of prior experience of the Company and . Interest rate fluctuations may decrease net interest
the Manager in managing and operating a REIT could income from Mortgage Assets.
adversely affect the Company's business, financial . Failure to successfully manage interest rate risks may
condition and results of operations. adversely affect the Company's results of operations.
. The Company does not currently have any borrowing . The Company intends to significantly leverage its Mortgage
arrangements or commitments from any lenders and may Assets, which may result in net interest and operating losses.
therefore be unable to implement its business strategy.
. The Company's investment and operating policies and
strategies may be changed at any time without the consent
or approval of the Company's stockholders.
. The Company has no identified Mortgage Assets to
purchase and may be unable to acquire Mortgage Assets
on favorable terms and conditions.
. The Manager may be entitled to a significant termination
fee which, if paid, would have a material adverse affect
on the cash available for distribution to the Company's
stockholders.
. The Company is recently formed and currently has only
nominal capitalization.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
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<CAPTION>
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PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
<S> <C> <C> <C>
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PER SHARE.... $ $ $
TOTAL(3)..... $ $ $
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(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, solely to cover over-allotments, if any. If
such over-allotment option is exercised in full, the total Price to Public,
Underwriting Discount and Proceeds to 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 November ___, 1997.
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MERRILL LYNCH & CO.
PAINEWEBBER INCORPORATED
STIFEL, NICOLAUS & COMPANY
INCORPORATED
SUTRO & CO. INCORPORATED
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The date of this Prospectus is , 1997.
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Certain persons participating in the 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" 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. 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.
THE COMPANY HAS PROVIDED PROJECTIONS AND ESTIMATES OF FUTURE PERFORMANCE
IN ORDER TO PROVIDE HYPOTHETICAL EXAMPLES OF THE MAGNITUDE OF THE COMPENSATION
PAYABLE TO THE MANAGER AND THE SIGNIFICANCE OF THE FEE PAYABLE TO THE MANAGER
UPON TERMINATION OR NON-RENEWAL OF THE MANAGEMENT AGREEMENT. SUCH PROJECTIONS
AND ESTIMATES ALSO CONSTITUTE FORWARD-LOOKING STATEMENTS AND ARE BASED UPON
CERTAIN ASSUMPTIONS. ACTUAL EVENTS ARE DIFFICULT TO PREDICT AND MAY BE
MATERIALLY DIFFERENT FROM THOSE ASSUMED.
TABLE OF CONTENTS
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PROSPECTUS SUMMARY............................... 4
The Company.................................... 4
Summary Risk Factors........................... 5
The Manager.................................... 7
Industry Trends................................ 8
Business and Strategy.......................... 9
Mortgage 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 Management Policy.............. 12
Dividend Policy and Distributions.............. 13
The Offering................................... 14
RISK FACTORS..................................... 15
Page
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Lack of Prior Experience....................... 15
No Current Borrowing Arrangements.............. 15
Control by the Company's Board
of Directors of the Company's Operating
Policies and Investment Strategies............ 16
No Current Mortgage Assets..................... 16
Possible Significant Termination Fee
Payable to Manager............................ 16
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2
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Page
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Nominal Capitalization......................... 16
Interest Rate Fluctuations May Decrease
Net Interest Income........................... 17
Failure to Successfully Manage Interest
Rate Risk May Adversely Affect Results
of Operations................................. 17
Substantial Leverage and Potential Net
Income and Operating Losses In Connection
With Borrowings............................... 18
Increased Levels of Prepayments from
Mortgage Assets May Adversely Affect
Net Interest Income........................... 18
Dependence on the Manager and Its
Personnel for Successful Operations........... 19
Conflicts of Interest Between the
Company and the Manager and Its
Affiliates.................................... 19
Failure to Maintain REIT Status Would
Result In the Company Being Subject to
Tax as a Regular Corporation and Reduce
Cash Available for Distribution to
Stockholders.................................. 20
Investment in Short-Term Investments
Pending Acquisition of Mortgage Assets
May Initially Adversely Affect Results
of Operations................................. 21
Failure to Maintain An Exemption from the
Investment Company Act Would Adversely
Affect Results of Operations.................. 21
Absence of Public Market and No Assurance
That a Public Market Will Develop............. 21
Interest Rate Fluctuations May Adversely
Affect the Market Price of the Common Stock... 21
Value of Mortgage Assets May Be Adversely
Affected by Defaults on Underlying Mortgage
Obligations................................... 22
Active Formation and Operation of Competing
Mortgage REITs May Adversely Affect the
Market Price of the Common Stock.............. 22
Adverse Tax Treatment of Excess Inclusion
Income........................................ 22
Value of Mortgage Loans May Be Adversely
Affected by Characteristics of Underlying
Property and Borrower Credit.................. 23
Effect of Future Offerings of Debt and
Equity on Market Price of the Common Stock.... 23
Restrictions on Ownership of the
Common Stock.................................. 24
USE OF PROCEEDS.................................. 25
DIVIDEND AND DISTRIBUTION POLICY................. 25
CAPITALIZATION................................... 26
LIQUIDITY AND CAPITAL RESOURCES..................
BUSINESS AND STRATEGY............................ 26
General........................................ 26
Strategy....................................... 26
Competition for Mortgage Assets................ 29
Description of Mortgage Assets................. 29
Management Policies and Programs............... 35
Asset Acquisition Policy....................... 35
Capital and Leverage Policy.................... 37
Credit Risk Management Policy.................. 39
Asset/Liability Management..................... 40
Interest Rate Risk Management Policy........... 40
Prepayment Risk Management Policy.............. 41
Mortgage Loan Securitization Techniques........ 41
Other Policies................................. 42
Future Revisions in Policies and Strategies.... 42
Legal Proceedings.............................. 42
MANAGEMENT OF THE COMPANY........................ 42
Directors and Executive Officers of the
Company....................................... 42
Executive Compensation......................... 45
Stock Options.................................. 45
Stock Options Outstanding...................... 47
THE MANAGER...................................... 47
The Management Agreement....................... 49
Manager Compensation........................... 52
Expenses....................................... 53
Certain Relationships; Conflicts of Interest... 53
Limits of Responsibility....................... 55
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS
AND MANAGEMENT.................................. 56
FEDERAL INCOME TAX CONSEQUENCES.................. 57
ERISA CONSIDERATIONS............................. 64
DESCRIPTION OF CAPITAL STOCK..................... 64
CERTAIN PROVISIONS OF MARYLAND LAW
AND OF THE COMPANY'S CHARTER AND
BYLAWS......................................... 66
UNDERWRITING..................................... 68
LEGAL MATTERS.................................... 69
EXPERTS.......................................... 69
ADDITIONAL INFORMATION........................... 70
GLOSSARY......................................... 71
AUDITORS' REPORT................................. F-1
BALANCE SHEET.................................... F-2
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3
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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 beginning on page 71. 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 September 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 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 Consequences -- Requirements
for Qualification as a REIT -- Distribution Requirement."
The goal of the Company is to be an efficient investor in mortgage assets.
The Company anticipates that it will 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 "Management Policies and Programs -- Asset Acquisition Policy"
and "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 is a wholly-owned subsidiary of TCW, which was established in 1971.
The Company's investment management team 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 has elected to be externally managed by the Manager, which
has not previously managed a REIT, to take advantage of the existing operational
systems, expertise and economies of scale associated with the Manager's current
business operations. See "Risk Factors--Lack of Prior Experience." The Company
has no ownership interest in the Manager.
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 in combination with
hedging instruments, including interest rate derivative instruments, to obtain
investment characteristics similar to adjustable-rate Mortgage Securities. The
Company generally intends to hold its mortgage assets to maturity. In addition,
the Company may from time to time, depending on market conditions, acquire whole
loans ("Mortgage Loans") from mortgage conduits and mortgage
4
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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, primarily with reverse
repurchase agreements, of up to 92% of total Mortgage Assets. 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 may negatively impact earnings during
periods of rapidly rising short-term interest rates. However, the Company
believes this is the most cost-efficient hedging strategy in the current market
environment. See "Risk Factors -- Interest Rate Fluctuations May Decrease Net
Interest Income."
SUMMARY RISK FACTORS
Each prospective purchaser of the Common Stock offered hereby should review
"Risk Factors" beginning on page 15 for a discussion of material risks that
should be considered before investing in the Common Stock, including, the
following:
. Lack of Prior Experience. The lack of prior experience of the
Company and the Manager in managing and operating a REIT could
adversely affect the Company's business, financial condition and
results of operations.
. No Current Borrowing Arrangements. The Company does not currently have
any borrowing arrangements or commitments from any lenders. If the
Company does not obtain financing arrangements on terms and conditions
satisfactory to the Company, the Company will not have access to
sufficient capital to finance the Company's business strategy as
described herein.
. Control by the Company's Board of Directors of the Company's Operating
Policies and Investment Strategies. The Company's investment,
financing and operating policies and strategies will be determined by
the Company's Board of Directors and may be changed at any time
without the consent or approval of the Company's stockholders. Such
changes may adversely affect the Company's results of operations.
. No Current Mortgage Assets. The Company has not identified any
Mortgage Assets to purchase with the net proceeds of the Offering. The
Company's Net Income will depend on the Manager's ability to acquire
Mortgage Assets on acceptable terms and at favorable spreads over the
Company's borrowing costs. If the Manager is unable to acquire
Mortgage Assets on favorable terms and conditions,the Company's
results of operations will be adversely affected.
. Possible Significant Termination Fee Payable to the Manager. The
Manager may be entitled to a significant termination fee if the
Company does not renew, or elects to terminate, the Management
Agreement
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which, if paid, would have a material adverse effect on the cash
available for distribution to the Company's stockholders and may
result in material net operating losses for the period. See "The
Manager -- Management Agreement."
. Nominal Capitalization. The Company is recently formed and currently
has only nominal capitalization. Consequently the Company's
operations are dependent on the net proceeds of the Offering and
borrowings in order to commence its business operations. See
"Capitalization."
. Interest Rate Fluctuations May Decrease Net Interest Income. The
Company's operations will be affected substantially by prevailing
market interest rates and borrowing costs, which are determined in
large part by market conditions and governmental policies beyond the
control of the Company and the Manager. To the extent the Company's
cost of borrowings rise more rapidly than the yields on its Mortgage
Assets funded by such borrowings, the Company's net interest income
may be reduced or a net loss may result.
. Failure to Successfully Manage Interest Rate Risks May Adversely
Affect Results of Operations. Developing an objective interest rate
risk strategy is complex and no strategy can completely insulate the
Company from risks associated with interest rate changes. Hedging
strategies involve risk and may not be successful in reducing the
Company's exposure to changing interest rates.
. Substantial Leverage and Potential Net Interest and Operating Losses
in Connection With Borrowings. The Company intends to increase
the size of its Mortgage Asset portfolio by employing a leveraging
strategy of borrowing up to 92% against its total Mortgage Asset
portfolio to finance the acquisition of additional Mortgage Assets.
The Company will experience negative cash flow and incur losses if
borrowing costs exceed the income on its Mortgage Assets.
. Increased Levels of Prepayments from Mortgage Assets May Adversely
Affect Net Interest Income. In the event that the Company's Mortgage
Assets are prepaid prior to maturity, the Company may (i) have held
the Mortgage Asset while it was less profitable and lost the
opportunity to receive interest at the fully-indexed rate, (ii) need
to write-off capitalized premium amounts, and (iii) be unable to
acquire new Mortgage Assets to replace the prepaid Mortgage Assets.
Mortgage prepayment rates vary depending on market interest rates.
Changes in prepayments could cause declines in the Company's Net
Income.
. Dependence on the Manager and its Personnel for Successful Operations.
The Company will be dependent on the Manager, and its operations will
depend initially entirely upon the contributions of Philip Barach,
Jeffrey Gundlach, Daniel Osborne and other key personnel of the
Manager. The loss of any key person could have a material adverse
effect on the Company's business.
. Conflicts of Interest Between the Company and the Manager and its
Affiliates. Affiliates of the Manager invest and will continue to
invest in Mortgage Securities on behalf of their clients. As a
consequence, there may be a conflict of interest between the
operations of the Manager and the operations of its Affiliates in the
acquisition and disposition of Mortgage Securities. Such conflicts
may result in decisions and/or allocations of Mortgage Securities by
Affiliates of the Manager which are not in the best interest of the
Company. In addition, the Manager may advise other mortgage-related
entities unaffiliated with the Company.
. Failure to Maintain REIT Status Would Result in Company Being Subject
to Tax as a Regular Corporation. The Company must at all times
maintain substantially all of its investments in, and otherwise
conduct its business in a manner consistent with, the REIT Provisions
of the Code. If the Company fails to qualify as a REIT, it would be
treated as a regular corporation and would be subject to income tax
that would result in a substantial reduction of cash available for
distribution to stockholders of the Company.
6
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. Initial Investment in Short-Term Investments. Following the closing of
the Offering, the Company will initially invest a substantial portion
of the net proceeds from the Offering in Short-Term Investments
pending acquisition of Mortgage Assets. The Company's results of
operations initially may be adversely affected pending purchase of
Mortgage Assets and implementation of its Capital and Leverage Policy.
The Company anticipates that it may take up to 15 months to fully
implement its leverage strategy.
THE MANAGER
The Manager will be responsible for the day-to-day operations of the
Company and will perform such services and activities relating to the Mortgage
Assets and operations of the Company as may be appropriate. 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 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
Programs."
The Manager has not previously managed a REIT. In particular, the Manager
has not previously managed a highly-leveraged pool of Mortgage Assets nor does
the Manager have experience in complying with the asset limitations imposed by
the REIT Provisions of the Code. However, 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. Nevertheless, 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 experience of the Manager and the TCW
Group should not be viewed as an effective gauge for the potential success of
the Company. See "Risk Factors -- Lack of Prior Experience."
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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 of the Company. "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) and any non-cash charges or reserves,
including depreciation, mark-to-market adjustments and unrealized credit loss,
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
(defined as directors who are not affiliated with, employed by or officers or
directors of the Manager or the TCW Group or employed by or officers of the
Company) 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 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 the 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 equal
to the fair market value of the Management Agreement without regard to the
Company's termination or non-renewal 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 termination or no
renewal fee by the Company would adversely affect the cash available for
distribution to the Company's stockholders and may have a material adverse
effect on the Company's operations. See "The Manager -- The Management
Agreement" and "Risk Factors -- Possible Significant Termination Fee Payable to
the Manager."
INDUSTRY TRENDS
The Company believes that there is a shift 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. The Company
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 Fannie Mae, GNMA
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
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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
Consequences -- 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. The Company believes that the current size of the
residential mortgage market will provide it with significant opportunities with
respect to the purchase of Mortgage Assets.
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, 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 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.
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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 Manager's ability to
successfully implement the Company's strategies.
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 in combination 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. 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"), but only on a limited basis
due to the greater risk of loss associated with Mortgage Derivative Securities.
See "Risk Factors -- Failure to Successfully Manage Interest Rate Risks May
Adversely Affect Results of Operations."
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. The Company believes that
future interest rates and mortgage prepayment rates are very difficult to
predict. Therefore, the Company will seek to acquire Mortgage Assets that it
believes will provide competitive returns over a broad range of interest rate
and prepayment scenarios.
The Company will acquire Mortgage Assets that it believes will maximize
returns on capital invested, after considering (i) the amount and nature of the
anticipated cash flows from the Mortgage Asset, (ii) the Company's ability to
pledge the Mortgage Asset to secure collateralized borrowings, (iii) the
increase in the Company's capital requirement 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 of a Mortgage Asset, 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.
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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
The Company 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, the Company will attempt to diversify its Mortgage
Asset portfolio to avoid undue geographic, insurer and other types of
concentrations. 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 anticipates that its investment in Mortgage Loans or other
Mortgage Securities that are not High Quality under the criteria set forth above
("Other Mortgage Assets") will 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 by the Manager to be of comparable quality 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. The Company intends to structure
its Mortgage Asset portfolio to maintain a minimum weighted average rating
(including the Manager'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. 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.
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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, although there can be no
assurance that the Company will be able to so limit such "reset" periods. This
interest rate risk management policy will be reviewed by the Company's Board of
Directors if the Company incurs long-term non-callable borrowings and as market
conditions change. In addition to "reset" periods, the Company also intends to
manage differences in interest rate indices between its Mortgage Assets and
borrowings. See "Risk Factors -- Failure to Successfully Manage Interest Rate
Risks May Adversely Affect Results of Operations."
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 expects that the Manager 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. The Company intends will manage this risk through the
Company's leverage and asset/liability policies.
In all of its interest rate risk management transactions, the Company 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 --
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 the Company believes that 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 Consequences --Requirements for
Qualification As a REIT -- Gross Income Tests."
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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.
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<TABLE>
<CAPTION>
THE OFFERING
<S> <C>
Common Stock Offered..........................................................10,000,000 shares(1)
Common Stock to be Outstanding After the Offering..........................10,000,100 shares(1)(2)
Use of Net Proceeds................................... Purchase of the Company's initial portfolio
of Mortgage Assets (3)
Proposed NYSE Symbol........................................................................."AXM"
</TABLE>
- ----------------
(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 Asset Management Company
("TAMCO") 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 375,000 shares of
Common Stock have been granted to the executive officers of the Company,
employees of the TCW Group and the Unaffiliated Directors of the Company.
See "Management of the Company -- Stock Options."
(3) 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. See "Risk Factors -- Investment in Short-Term Investments
Pending Acquisition of Mortgage Assets May Initially Adversely Affect
Results of Operations."
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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. There is no guarantee of successful
performance of the Company's business strategy or that the Company's 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.
LACK OF PRIOR EXPERIENCE
Neither the Company nor the Manager have previously managed or operated a
REIT or other public company. In particular, the Manager has not previously
managed a highly-leveraged pool of Mortgage Assets nor does the Manager have
experience in complying with the asset limitations imposed by the REIT
Provisions of the Code. This lack of prior experience could adversely affect
the Company's business, financial conditions and results of operations. The
Company will commence substantive operations upon the closing of the Offering
and, accordingly, has not yet developed any financial or operating history or
experienced interest rate fluctuations or market conditions.
NO CURRENT BORROWING ARRANGEMENTS
The Company does not currently have any borrowing arrangements or
commitments from any lenders. If the Manager does not obtain financing
arrangements, the Company will not have access to sufficient capital to finance
the Company's business strategy.
The Manager 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 the Manager's ability to renew or replace
on a continuous basis maturing short-term borrowings. 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 Manager is not able to renew or replace maturing
borrowings, the Manager could be required to sell Mortgage Assets under adverse
market conditions and the Company could incur permanent capital losses as a
result. In addition, in such event, the Manager 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
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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, which may adversely affect the Company's results of
operations.
CONTROL BY THE COMPANY'S BOARD OF DIRECTORS OF THE COMPANY'S OPERATING POLICIES
AND INVESTMENT STRATEGIES
The Company and the Manager have established the operating policies and
strategies set forth in this Prospectus as the operating policies and strategies
of the Company. However, these policies and strategies may be modified or
waived by the Board of Directors without the consent or approval of the
Company's stockholders. The ultimate effect of any such changes is
uncertain. See "Business and Strategy."
NO CURRENT MORTGAGE ASSETS
The Company has not identified any Mortgage Assets to purchase with the net
proceeds of the Offering. The Company's Net Income will depend on the Manager's
ability to acquire Mortgage Assets on acceptable terms and at favorable spreads
over the Company's borrowing costs. If the Manager is unable to acquire Mortgage
Assets, the Company's results of operations will be adversely affected.
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 the Manager 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.
POSSIBLE SIGNIFICANT TERMINATION FEE PAYABLE TO THE MANAGER
The Manager may be entitled to a significant termination fee if the Company
does not renew, or elects to terminate, the Management Agreement, which, if
paid, would have a material adverse affect on the cash available for
distribution to the Company's stockholders and may result in material net
operating losses for the period. Based on certain estimates and assumptions, the
termination fee may be as high as $29.6 million. See "The Manager -- Management
Agreement."
Inasmuch as such valuation will be dependent upon the determination of
an independent appraiser at a future date based upon then applicable facts and
circumstances, no such termination or non-renewal fee can be determined with
mathematical certainty. Any termination or non-renewal fee paid may be
materially greater than the fee set forth above and the Company can provide no
assurance at this time as to the amount of any such fee. See "Risk Factors --
Possible Termination Fee Payable to Manager."
NOMINAL CAPITALIZATION
The Company was recently organized and currently has only nominal
capitalization, currently equal to $1,500 in cash. Consequently the Company's
operations are dependent on the net proceeds of the Offering in order to
commence
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its business operations. Because the Company is only nominally capitalized, it
will not be able to withstand a period of adverse earnings as well as to more
established and better capitalized companies. See "Capitalization."
INTEREST RATE FLUCTUATIONS MAY DECREASE NET INTEREST INCOME
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 Manager acquires Mortgage Assets 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.
The Manager intends to fund a substantial portion of the Company's
acquisitions 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
The Manager will follow a policy intended to minimize the impact 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 the Manager's ability to engage in these hedging
transactions, and may prevent the Manager 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 Manager 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 Manager may be forced to unwind its interest rate derivatives
with such provider and the Company 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.
The adjustable-rate Mortgage Assets that the Manager intends to acquire are
generally subject to periodic and lifetime interest rate caps. The Manager 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 Consequences -- Asset Tests"
and "-- Gross Income Tests." The financial futures contracts and options
thereon in which the Manager 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
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<PAGE>
corresponding cash available for distribution. There can be no assurance that
these hedging techniques 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%.
See "Federal Income Tax Consequences -- 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.
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 Consequences -- Requirements for
Qualification as a REIT."
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. The Manager 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.
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DEPENDENCE ON THE MANAGER AND ITS PERSONNEL 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, primarily
Messrs. Barach, Gundlach and Osborne. 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."
CONFLICTS OF INTEREST BETWEEN THE COMPANY AND THE MANAGER AND ITS AFFILIATES
Affiliates of Manager Will Continue to Invest 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 of Manager Will Invest 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 May Try to Maximize Incentive Compensation and Thereby Increase
Risk to the Company's Mortgage Portfolio. 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.
Conflicts Relating to Manager Rendering 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, without
limitation, 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. In addition, the Management
Agreement does not impose a minimum time commitment that the Manager and its
personnel must devote to providing services to the Company. The 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 by the Manager or its employees on the
management of the Company. See "The Manager -- The Management Agreement."
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FAILURE TO MAINTAIN REIT STATUS WOULD RESULT IN THE COMPANY BEING SUBJECT TO TAX
AS A REGULAR CORPORATION AND REDUCE CASH AVAILABLE FOR DISTRIBUTION TO
STOCKHOLDERS
Limitation on Mortgage Assets to Comply with REIT Requirements. 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 Consequences -- Requirements for Qualification as a REIT." Among
other things, these restrictions may limit the Manager's ability to acquire
certain types of assets that it otherwise would consider desirable, limit the
ability of the Manager 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 cash available for distribution to stockholders.
See "Federal Income Tax Consequences -- Taxation of the Company."
Limitations Imposed by REIT Requirements on Hedging and Investments May
Limit Company's Ability to Hedge. The REIT Provisions of the Code may
substantially limit the ability of the Manager to hedge the Company's 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. 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
Consequences -- 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 Consequences -- Requirements for Qualification as a REIT -- Asset
Tests."
Distribution Requirements to Maintain REIT Status May Require the Company
to Borrow Funds to Make Distributions. 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 of
a return of capital, which would have the effect of reducing the equity of the
Company. See "Federal Income Tax Consequences -- Requirements for Qualification
as a REIT -- Distribution Requirement."
Disqualification as a REIT May Result in Substantial Tax Liability. 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
20
<PAGE>
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 Consequences -- Termination or Revocation of REIT
Status."
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 Capital and
Leverage Policy.
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 AND NO ASSURANCE THAT A PUBLIC MARKET WILL DEVELOP
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."
INTEREST RATE FLUCTUATIONS MAY ADVERSELY AFFECT THE MARKET PRICE OF THE COMMON
STOCK
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 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
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<PAGE>
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.
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.
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 Consequences -- 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 that the Manager enter on
its behalf 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 Consequences -- 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,
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<PAGE>
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 Consequences -- Taxation of
Tax-Exempt Entities."
VALUE OF MORTGAGE LOANS MAY BE ADVERSELY AFFECTED BY CHARACTERISTICS OF
UNDERLYING PROPERTY AND BORROWER CREDIT
Mortgage Loan Credit 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.
Inability to Securitize Mortgage Loans May Result in Additional Risk
Respecting Borrower Defaults. 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.
Possible Limitation of Remedies for Sellers' Breach of Representations and
Warranties with Respect to Mortgage Loans. It is expected that when the Manager
acquires Mortgage Loans on behalf of the Company, 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 expects that it will generally 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.
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,
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or both. The Company is unable to estimate the amount, timing or nature of
additional offerings as they will depend upon market conditions and other
factors.
RESTRICTIONS ON OWNERSHIP OF THE COMMON STOCK
Ability to Issue Preferred Stock May Limit Dividend Rights to Holders of
Common 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 May Limit Market Activity. In order that the
Company may meet the requirements for qualification as a REIT at all times, the
Charter 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 Charter 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."
Requirement That Stockholders Give Notice of 5% Ownership May Limit Market
Activity. 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 May Limit Takeover
Attempts That May Be Beneficial to Stockholders. Certain provisions of the
Maryland General Corporation Law relating to "business combinations" and a
"control share acquisition" and of the Charter 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 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 Charter and Bylaws."
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USE OF PROCEEDS
The net proceeds from the Offering are estimated to be approximately
$__________ ($_________ if the Underwriters' over-allotment option is exercised
in full), assuming an initial public 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 Capital and Leverage Policy 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 Consequences -- 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
non-cash 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 Consequences -- 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 Consequences -- Taxation of Stockholders."
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
initial public offering price per share 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 $0.01 $ $
Authorized--100,000,000 shares
Outstanding--100 shares (as adjusted
10,000,100 shares).................. 1
Additional Paid-in Capital....... $1,499
------ -----------
</TABLE>
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<TABLE>
<S> <C> <C>
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."
LIQUIDITY AND CAPITAL RESOURCES
The Company has been organized to operate so as to qualify as a REIT under
Sections 856 through 860 of the Code in its purchase of Mortgage Assets and, as
such, anticipates distributing annually at least 95% of its Taxable Income.
Cash for such distributions will be generated from the Company's operations.
See "Dividend and Distribution Policy" and "Federal Income Tax Consequences --
Gross Income Tests -- Distribution Requirement."
The principal sources of funds will be the net proceeds of the Offering and
borrowings (primarily reverse repurchase agreements) or the issuance of debt or
additional equity securities. The Company anticipates that it will incur short-
term borrowings immediately after the net proceeds of the Offering have been
invested in the portfolio of Mortgage Assets. The Company's income will consist
primarily of interest and other revenues from its investments in Mortgage
Assets. The Company believes that the net proceeds of the Offering, combined
with the cash flow from operations and the utilization of borrowings, will be
sufficient to enable the Company to meet anticipated liquidity requirements. If
the Company's cash resources are at any time insufficient to satisfy the
Company's liquidity requirements, the Company may be required to liquidate
Mortgage Assets or sell debt or additional equity securities. There is no
assurance that financing will be available to the Company on favorable terms, or
at all. See "Risk Factors -- No Current Borrowing Arrangements."
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
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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, 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 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.
The foregoing strategies wil be implemented by the Manager subject to the
oversight of the Company's Board of Directors. There can be no assurance that
the Manager will successfully implement these strategies. See "Risk Factors" for
a discussion of factors that could affect the Manager's ability to successfully
implement these strategies.
Although there can be no assurance, the Company believes that it
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 Consequences -- Requirements for Qualification as a REIT --
Gross Income Tests."
The Company anticipates that at least 75% of total Mortgage Assets will be
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.
The Company further anticipates that at least 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
authorize the Manager to acquire Inverse Floaters, REMIC Residuals or First Loss
Subordinated Bonds. The Company may authorize the Manager to acquire interest
only, principal only or other Mortgage Derivative Securities that receive a
disproportionate share of interest income
27
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or principal, either as an independent stand-alone investment opportunity or to
assist in the management of prepayment and other risks, but only on a limited
basis due to the greater risk of loss associated with Mortgage Derivative
Securities. See "Risk Factors -- Failure to Successfully Manage Interest Rate
Risks May Adversely Affect Results of Operations."
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 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 Mortgage 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, Fannie Mae, FHLMC,
GNMA 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. The Manager 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. See "Risk Factors -- Control by the Board of
Directors of the Company's Operating Policies and Investment Strategies."
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 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
28
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Operating Losses in Connection with Borrowings" and "-- Interest Rate
Fluctuations May Decrease Net Interest Income."
Hedging Policy. The Company intends to authorize the Manager 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
Manager 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 Consequences -- 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 -- Lack of Prior Experience" - and "Dependence on the Manager and Its
Personnel for Successful Operations."
COMPETITION FOR MORTGAGE ASSETS
The Company 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. The Company
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.
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 Manager for 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.
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<PAGE>
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 "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
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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 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 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
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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
published by the Federal Reserve Board. 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. The
Company anticipates 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 Consequences -- Requirements for Qualification as a
REIT."
Other Mortgage Securities
General. The Company may acquire Other Mortgage Securities or interests
therein if the Manager 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.
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Mortgage Derivative Securities. The Company may acquire Mortgage
Derivative Securities on a limited basis 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 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 generally 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 the Company's 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 the Company's 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
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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.
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 -- Interest
Rate Fluctuations May Decrease Net Interest Income" and "-- No Current Mortgage
Assets."
The Company anticipates that it 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 Mortgage 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
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.
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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.
It is expected that when the Company acquires Mortgage Loans, the seller
will generally 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
generally 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. The Company believes that future interest rates and mortgage
prepayment rates are very difficult to predict. Therefore, the Company will
seek to acquire Mortgage Assets that it believes will provide competitive
returns over a broad range of interest rate and prepayment scenarios.
The Company will acquire Mortgage Assets that it 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 of a Mortgage Asset, potential returns on capital
employed are assessed over the life of the Mortgage Asset and in a variety of
interest rate, yield spread, financing cost, credit loss and prepayment
scenarios.
The Company 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
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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 the
Company 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.
The Company 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 in combination 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 it 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 Consequences --
Taxation of the Company." The Company 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 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 the
Company deems such action advisable. The Company 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 the
Company'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 Consequences -- 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.
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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 the Company's
ability to acquire additional Mortgage Assets during times when the actual
capital base of the Company is less than a required amount defined in 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 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 for the Company's
borrowings.
Acquisition of Mortgage Assets. The Company 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, the Company 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. The Company
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 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 the Company'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 the Company'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 the Manager of the risks inherent
in the Company's balance sheet, including an analysis of the effects of various
scenarios on the Company's net cash 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.
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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
Morgage 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
non-callable 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.
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 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 insure
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 depositary
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 liquidity management
policy is designed to maintain a cushion of equity sufficient to provide
required liquidity to respond to the effects under its borrowing
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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 market relied on by the Company for short-term borrowings
would have a material adverse effect on the Company unless the Company were able
to arrange alternative sources of financing on comparable terms. See "Risk
Factors -- Risks of Substantial Leverage and Potential Net Interest and
Operating Losses in Connection with Borrowings" and "-- Interest Rate
Fluctuations May Decrease Net Interest Income."
Credit Risk Management Policy
The Company will review credit risk and other risks of loss associated with
each investment. In addition, the Company 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'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 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 (Fannie Mae, GNMA 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 among
Privately Issued Certificates.
The Company anticipates that at least 50% of the Company's total Mortgage
Assets will be Agency Certificates or carry a AAA or have a comparable
rating from one of the Rating Agencies. The Company further anticipates that 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. The
Company anticipates that Other Mortgage Assets will 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 to be of comparable
quality to a High Quality Mortgage Security. The Company intends that it will
structure its portfolio to maintain a minimum weighted average rating
(including the Manager'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.
The Company will reveiw 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.
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.
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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, although
there can be no assurance that the Company will be able to limit such "reset"
periods. This policy will be reviewed by the Company's Board of Directors if
the Company incurs long-term non-callable borrowings and as market conditions
change. In addition to "reset" periods, the Company also intends to manage
differences in interest rate indices between its Mortgage Assets and borrowings.
See "Risk Factors -- Failure to Successfully Manage Interest Rate Risks May
Adversely Affect Results of Operations."
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's 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 expects that the Manager will seek 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 mitigate 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. The Company
will manage this risk through the Company's 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 the
Company 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 the Company bearing a level of interest
rate risk that could otherwise be hedged when the Company 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 Consequences -- 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,
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other than Qualified REIT Real Estate Assets) must not exceed 25% of the gross
income of the Company. See "Federal Income Tax Consequences -- Requirements for
Qualification as a REIT -- Gross Income Tests."
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 the Company and the Company's Board of Directors through periodic
review of the impact of a variety of prepayment scenarios on the Company's
revenues, net earnings, dividends, cash flow and net balance sheet market
value.
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. The Company 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
Consequences -- Requirements for Qualification 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 effectively 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
the Company's 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. The Company does
not intend to conduct its securitization activities through the Manager or the
Manager's Affiliates.
41
<PAGE>
OTHER POLICIES
The Company may purchase stock in other mortgage REITs or stock in similar
companies when the Company believes that such purchases will yield attractive
returns on capital employed. When the stock market valuations of such companies
are low in relation to the market value of their assets, the Company believes
that 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 operate in a manner that will not subject it to
regulation under the Investment Company Act. The Company does not currently
intend to (i) originate Mortgage Loans, (ii) offer securities in exchange for
real property, (iii) repurchase or otherwise reacquire its shares or other
securities.
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 interests 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 and the Manager, 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
Joseph J. Galligan 38 Senior Vice President
Michael E. Cahill 46 Secretary
</TABLE>
42
<PAGE>
Mr. Barach is President and Chief Executive Officer 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 Chief of
Investments. Previously, Mr. Barach served as head of Fixed Income Investments
for the State of California Retirement System. Mr. Barach attended the Hebrew
University of Jerusalem, where he received a B.A. degree in International
Relations and an M.B.A. degree 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. 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 Investments Corporation ("ASR"), a
publicly held REIT investing in Mortgage Assets. At ASR, Mr. Osborne was
responsible for asset/liability management and the supervision and preparation
of public 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. Galligan is Senior Vice President of the Company. Prior to joining TCW
in 1991, Mr. Galligan was a Vice President at Smith Barney in the Mortgage-
Backed Specialist Group. Prior to that, he spent five years at First Boston as
Vice President in the same area. In addition, Mr. Galligan spent over three
years at Scudder Stevens & Clark as a Portfolio Manager/Trader. He holds a B.S.
degree in Economics with a concentration in Finance from the Wharton School of
Business at the University of Pennsylvania. Mr. Galligan is a Chartered
Financial Analyst.
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 and, prior to that, with Shenas, Robbins, Shenas & Shaw
in San Diego. He is a member of the state bar of California and of the Province
of Ontario and is admitted to various courts, including the U.S. Supreme Court.
Mr. Cahill holds B.A. degrees in Mathematics and Philosophy from Bishops
University, Quebec, an L.L.M. degree from Harvard University and an L.L.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
</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
43
<PAGE>
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 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.
The Board of Directors of the Company is divided into three classes, with
the number of directors in each class as nearly equal in number as possible.
Each class of directors will contain at least one affiliated director and at
least one Unaffiliated Director. After the initial staggering period, each
director shall serve for a term ending on the date of the third annual meting of
stockholders following the annual meeting at which such director was elected.
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 $10,000, a fee of $1,250 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.
The Management Agreement provides that the Manager will assume principal
responsibility for managing the affairs of the Company. Therefore, 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. See "Risk Factors -- Conflicts of Interest Between the Company and
the Manager and Its Affiliates -- Conflicts Relating to Manager Rendering
Services to Others."
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 closing 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 Charter of the Company provides 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 informed that in the opinion of
the Commission, such indemnification is against public policy as expressed in
the Securities Act and is therefore unenforceable.
The Charter of the Company provides 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
44
<PAGE>
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.
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 of Common Stock. 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 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.
45
<PAGE>
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.
46
<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
INDIVIDUAL GRANTS
-----------------
NUMBER OF PERCENT OF POTENTIAL REALIZABLE VALUE AT
SECURITIES TOTAL ASSUMED ANNUAL RATES OF STOCK
UNDERLYING OPTIONS EXERCISE PRICE APPRECIATION FOR OPTION TERM
OPTIONS GRANTED TO PRICE(2) EXPIRATION ------------------------------------
NAME GRANTED(1) EMPLOYEES ($/SHARE) DATE 5%($) 10%($)
- ---- ---------- ---------- -------- ---------- ---- -----
<S> <C> <C> <C> <C> <C> <C>
Philip A. Barach 40,000 28.6% $15.00(3) (4) $ 377,337 $956,295
Jeffrey E. Gundlach 40,000 28.6% 15.00(3) (4) 377,337 956,295
Daniel K. Osborne 35,000 25.0% 15.00(3) (4) 330,170 836,715
Joseph J. Galligan 25,000 17.9% 15.00(3) (4) 235,835 597,653
Marc I. Stern 30,000 -- 15.00(3) (4) 283,003 717,184
Michael E. Cahill 15,000 -- 15.00(3) (4) 141,501 358,592
Other (5)
115,000 -- 15.00(3) (4) 1,084,843 2,749,206
</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.
(3) Based on an assumed initial public offering price of $15.00. See
"Underwriting."
(4) Options will expire 10 years after the closing of the Offering.
(5) These options will be granted to officers and employees of the Manager.
In addition, upon the closing of the Offering, each Unaffiliated Director
may receive an initial grant of options to purchase up to 25,000 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 Company has no ownership interest in the Manager. The Manager, a
California corporation, is a wholly-owned subsidiary of TCW, which was
established in 1971.
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. 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 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
Programs."
The Manager has not previously managed a REIT. In particular, the Manager
has not previously managed a highly-leveraged pool of Mortgage Assets nor does
the Manager have experience in complying with the asset limitations imposed by
the REIT Provisions of the Code. However, 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. Nevertheless, 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 experience of the Manager and the TCW
Group should not be viewed as an effective gauge for the potential success of
the Company. See "Risk Factors -- Lack of Prior Experience."
47
<PAGE>
The directors and senior executive officers of the Manager are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Robert A. Day 53 Chairman of the Board and Chief
Executive Officer
Thomas E. Larkin, Jr. 57 Vice Chairman of the Board
Marc I. Stern (1) 53 Vice Chairman of the Board
Alvin R. Albe, Jr. 44 Director, Executive Vice President -
Finance and Administration
Michael E. Cahill (1) 46 Secretary, Managing Director and
General Counsel
David K. Sandie 42 Assistant Secretary, Chief Financial Officer
and Managing Director
Hilary G. D. Lord 41 Assistant Secretary, Chief Compliance Officer
and Managing Director
Philip A. Barach (1) 45 Chief Investment Officer -
Investment Grade Fixed Income
Jeffrey E. Gundlach (1) 38 Group Managing Director
Daniel K. Osborne (1) 32 Senior Vice President
</TABLE>
Mr. Day has served as Chairman of the Board and Chief Executive Officer of
the Manager since its inception in 1992. Mr. Day is also Chairman of the Board
and Chief Executive Officer of TCW, Trust Company of the West and TAMCO, as well
as Chairman of the Board of the Oakmont Corporation. In 1971 he founded Trust
Company of the West. Prior to founding Trust Company of the West, Mr. Day was
associated with the investment banking firm of White, Weld & Company in New York
for three years and then formed Cypress Partners. He is Chairman and President
of the W.M. Keck Foundation, a Director of Freeport, McMoRan, Inc., and a
member of the Board of Trustees of Claremont McKenna College. Mr. Day received
a B.A. degree from Claremont McKenna College.
Mr. Larkin has served as a Vice Chairman of the Board of the Manager since
1992. Mr. Larkin is also Chairman of the Board of TFMI (since 1987), Vice
Chairman of TAMCO, Director and President of Trust Company of the West, and
Director, Executive Vice President and Group Managing Director of TCW (all since
1977). Prior to joining TCW in 1977, Mr. Larkin was Vice President and Director
of Client Relations for Crocker Investment Management Corporation. Prior to
that, he was Senior Vice President and Director of Marketing of
Bernstein-Macaulay, Inc. with responsibility for marketing investment management
services. He was previously with Blyth Eastman Dillon as a New Business
Representative in the Employee Benefit Plan Department. Mr. Larkin is a member
of the Board of Trustees of the University of Notre Dame and Mount Saint Mary's
College, is a member of the Board of Directors of the California Pediatric &
Family Medical Center Foundation, the Los Angeles Orthopaedic Hospital, the Los
Angeles Music Center Operating Company, the Heart & Lung Surgery Foundation, the
Los Angeles Sports Council, and the Board of Regents of Children's Hospital of
Los Angeles. He also serves as a member of the Finance Council of the
Archdiocese of Los Angeles and is a member of the Investment Committees of the
Archdiocese of Los Angeles and Loyola Marymount University. Mr. Larkin received
a B.A. degree in Economics from the University of Notre Dame.
Mr. Albe has served as a Director and Executive Vice President - Finance
and Administration of the Manager and TFMI since 1992, and has held the same
positions with TAMCO and Trust Company of the West since 1991. Mr. Albe has also
been Executive Vice President - Finance and Administration of TCW since 1991.
Prior to joining TCW in 1991, Mr. Albe was President of Oakmont Corporation, a
privately held corporation which administers and manages assets for several
families and individuals. Mr. Albe was associated with Oakmont from 1982 to
1991. Before that, he was Manager of Accounting at McMoRan Oil and Gas co., and
a Certified Public Accountant with Arthur Andersen & Co. in New Orleans.
48
<PAGE>
1993. Mr. Albe is a Certified Public Accountant and received a B.S. degree in
Accounting from the University of New Orleans.
Mr. Sandie has served as Managing Director, Chief Financial Officer and
Assistant Secretary of the Manager since 1992. Mr. Sandie has held similar
positions with TFMI since 1987, TCW since 1986, and TAMCO and Trust Company of
the West since 1984. Prior to joining TCW in 1984, Mr. Sandie was an
Audit Manager with Price Waterhouse & Company, where a significant portion of
his audit experience was with financial service organizations. He is a graduate
of the University of California at Los Angeles, with a B.A. degree in Political
Science. He received his M.B.A. degree from the University of Southern
California. Mr. Sandie is a Certified Public Accountant.
Ms. Lord has served as a Managing Director, Chief Compliance Officer and
Assistant Secretary of the Manager since 1992. Ms. Lord also holds such
positions with TFMI, TAMCO and Trust Company of the West. Ms. Lord joined the
TCW Group in 1987, having previously been a corporate and securities attorney
with O'Melveny & Myers. Ms. Lord is a member of the Board of Governors of the
Investment Counsel Association of America (ICAA), is a member of the Legal and
Regulatory Committee of the ICAA and is a member of the National Association of
Compliance Professionals. Ms. Lord is a member of the state bar of California.
Ms. Lord received a B.S. degree in Accounting and Finance from the University of
California at Berkeley and an M.B.A. degree and a J.D. degree from the
University of Chicago.
(1) See "Management of the Company -- Directors and Executive Officers" for
certain biographical information regarding Messrs. Stern, Cahill, 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 the 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
49
<PAGE>
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 the Company anticipates that the Manager
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;
(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;
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<PAGE>
(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;
(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 commercially reasonable 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. Neither the fair market value of the Management
Agreement nor the various factors which the appraiser may find relevant in its
determination of the fair market value can be determined at this time. The
selection of the independent appraiser shall be subject to the approval of the
Unaffiliated Directors. The Manager may be entitled to a significant termination
fee if the Company does not renew or elects to terminate, the Management
Agreement which, if paid, would have a material adverse effect on the cash
available for distribution to the Company's stockholders and may result in
material not operating losses for the period. See "Risk Factors -- Possible
Significant Termination Fee Payable to Manager."
The fair market value of the Management Agreement will be affected by
significant variables including (i) the historical management fees paid to the
Manager, (ii) any projections of future management fees to be paid to the
Manager as prepared by an independent appraiser, (iii) the relative valuations
of agreements similar to the Management Agreement and (iv) other factors, all of
which may be unrelated to the performance of the Manager.
For illustrative purposes only, if the Company terminated or did not renew
the Management Agreement without cause immediately following a full year of
operations in which the Company paid to the Manager total annual compensation
equal to $3,700,000, the termination or non-renewal fee could equal between four
and eight times the total annual compensation paid to the Manager, or
$14,800,000 and $29,600,000, depending on the valuation of the independent
appraiser at the time of the termination or non-renewal, which the Company and
the Manager expect will be influenced by the valuation of the similarly-situated
transactions occurring at or about the same time. If the total annual
compensation amount or valuation multiple used is higher or lower, the
termination or non-renewal fee would be higher or lower, respectively, than the
amounts set forth above. Inasmuch as such valuation will be dependent upon the
determination of an independent appraiser at a future date based upon then
applicable facts and circumstances, no such termination or non-renewal fee can
be determined with mathematical certainty. Any termination or non-renewal fee
paid may be materially greater than the fee set forth above and the Company can
provide no assurance at this time as to the amount of any such fee. See "Risk
Factors -- Possible Termination Fee Payable to Manager."
51
<PAGE>
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.
MANAGER 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) and any non-cash charges or reserves,
including depreciation, mark-to-market adjustments and unrealized credit loss,
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.
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.
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<PAGE>
Although no management fees will be payable to the Manager solely as a
result of the Offering, the net proceeds of the Offering will result in an
increase in the Company's Average Net Invested Capital, and thus, an increase in
the management fees paid to the Manager. See "Risk Factors --Conflicts of
Interest Between the Company and the Manager and Its Affiliates."
Set forth below for illustrative purposes only is a breakdown of management
fees which might be paid to the Manager under hypothetical circumstances. For
purposes of this illustration, the following is assumed: (i) the net proceeds
from the Offering after all underwriting discounts and other Offering costs are
$138,750,000 and (ii) the Company's Net Income (after payment of base
compensation and operating expenses, but prior to the deduction of incentive
compensation) exceeded by $1,000,000, $8,000,000 and $12,000,000, respectively,
the annualized Return on Equity equal to the average Ten-Year U.S. Treasury Rate
plus 1%.
ANNUAL MANAGER COMPENSATION
<TABLE>
<CAPTION>
Base Compensation Incentive Compensation Total Compensation
- ----------------- ---------------------- ------------------
<S> <C> <C>
$1,200,000 $ 300,000 $1,500,000
1,200,000 2,400,000 3,600,000
1,200,000 3,600,000 4,800,000
</TABLE>
The Company emphasizes that the foregoing information is provided for
illustrative purposes only. There will be differences between the Company's
actual Net Income and the compensation paid to the Manager, on the one hand,
and the Net Income and compensation figures set forth above, on the other, and
those differences may be material. There are significant variables in the
determination of actual compensation paid to the Manager, including (i) the
Company's actual Net Income which will be affected by the Company's ability to
execute its leveraging strategy and interest rate fluctuations, plus other
factors and (ii) fluctuations in the average Ten-Year U.S. Treasury Rate, all of
which may be affected by factors unrelated to the performance of the Manager.
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."
Except as set forth in this Prospectus, the Company does not currently
anticipate paying any other fees or compensation to any Affiliate of the
Manager. See " -- Certain Relationships; Conflicts of Interest" below.
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.
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, incurred 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) the cost of money borrowed by the Company
(including interest), taxes and license fees, issuance and transaction costs
incident to the acquisition, disposition and financing of investments, costs
related to hedging transactions, legal, investigatory, accounting and auditing
fees and expenses, consultants' advisory services with respect to REIT and other
compliance matters, the compensation and expenses of the Company's Unaffiliated
Directors, the costs of making distributions and printing and mailing proxies
and reports to stockholders, costs incurred by employees of the Manager for
travel on behalf of the Company, costs incident to the issuance of Mortgage
Securities, costs incident to the accumulation and servicing of Mortgage Loans,
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 officers and the Underwriters, the compensations and
expenses of the Company's custodian, transfer agent and registrar, and any
extraordinary or non-recurring costs or charges incurred by the Company, if any.
The following 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:
(i) all insurance costs incurred by the Company or any subsidiary of the
Company, including any costs to obtain liability or other insurance to indemnify
the Manager and underwriters of any securities of the Company;
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<PAGE>
(ii) expenses connected with payments of dividends or interest or
distributions in any other form made or caused to be made by the Board of
Directors to holders of the securities of the Company or any subsidiary of the
Company;
(iii) all expenses of third-parties pertaining to communications to
holders of equity securities or debt securities of the Company or any subsidiary
of the Company and the other bookkeeping and clerical work necessary in
maintaining relations with holders of such securities and in complying with the
continuous reporting and other requirements of governmental bodies or agencies,
including any costs of computer services in connection with this function, the
cost of printing and mailing certificates for such securities and proxy
solicitation materials and reports to holders of the Company's or any
subsidiary's securities and reports to third-parties required under any
indenture to which the Company or any subsidiary of the Company is a party;
(iv) custodian's, transfer agent's and registrar's fees and charges;
(v) compensation, fees and expenses paid to Unaffiliated Directors of
the Company or any subsidiary of the Company, the cost of director and officer
liability insurance and premiums for fidelity and errors and omissions
insurance;
(vi) legal, accounting and auditing fees and expenses relating to the
Company's or any subsidiary's operations (excluding litigation-related fees and
expenses);
(vii) expenses relating to any office or office facilities maintained by
the Company or any subsidiary of the Company, exclusive of the office of the
Manager;
(viii) travel and related expenses of directors, officers and employees of
the Manager and of directors, officers and employees of the Company or any
subsidiary of the Company who are also directors, officers or employees of the
Manager, incurred in connection with attending meetings of the Board of
Directors or holders of securities of the Company or any subsidiary of the
Company or performing other business activities that relate to the Company or
any subsidiary of the Company, including expenses allocable to such meetings or
business activities; and
(ix) costs associated with computer hardware and software, third-party
information services and office expenses that relate solely to the business
activities of the Company.
Expenses excluded from the expense limitation and wholly payable by the
Company are (but are not limited to) those incurred in connection with the
accumulation and servicing of Mortgage Loans, the issuance and administration of
Mortgage Securities from pools of Mortgage Loans, the raising of capital, the
acquisition of Mortgage assets, interest and hedging expenses, taxes and license
fees, non-cash costs, litigation, costs of investigation in connection with
litigation or threatened litigation, base and incentive management compensation
and 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.
Expenses in excess of the expense limitation will be paid and shall not be
recoverable (by reclassification as compensation or otherwise) 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 Between the Company and the Manager and Its Affiliates"
and "--Future Revisions of Policies and Strategies in Discretion of Board of
Directors."
54
<PAGE>
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 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. See "Risk Factors --Conflicts of Interest Between the Company and
the Manager and Its Affiliates."
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 TAMCO, an Affiliate of the Manager and TCW. The shares
of Common Stock were issued for $1,500 cash in the aggregate. TAMCO has
represented to the Company 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 the Offering.
Directors, officers and employees of the Company, TCW and its Affiliates
are expected to purchase up to 750,000 shares of Common Stock at the closing of
the Offering at a price equal to the initial public offering price. This will
result in the TCW Group's, its employees' and their family members' ownership of
up to 750,100 shares of Common Stock, or up to approximately 7.5% of the total
shares offered hereby, exclusive of the Underwriters' over-allotment option.
Those parties have agreed not to sell any shares of Common Stock or any rights
to acquire Common Stock for at least 180 days after the Company's initial public
offering of shares of Common Stock without the consent of Merrill Lynch & Co.,
but may dispose of the shares of Common Stock any time thereafter. See
"Underwriting." 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 and TCW, will act as a
dealer in connection with the Offering and will receive compensation from the
Underwriters 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 the 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 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. The Manager may also advise other mortgage-related
entities, including REITs, that invest in commercial mortgages and other non-
residential mortgage securities. The ability of the Manager and its officers
and employees to engage in other business activities could reduce the time and
effort spent on the Company. The Management Agreement does not specify a
minimum amount of time or attention that the Manager or its officers or
employees must devote to the Company. See "Risk Factors -- Conflicts of
Interest Between the Company and the Manager and Its Affiliates."
55
<PAGE>
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
Name and Address of of Beneficial Percent of
Beneficial Owner(1)(2)(3) Ownership Class
------------------------- ------------- ----------
<S> <C> <C>
TCW Asset Management Company (4) 100 shares 100%
Officers and Directors as a group (10 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) Does not include share of Common Stock that may be purchased by
directors, officers and employees of the Company, TCW and its Affiliates
in the Offering. See "The Manager -- Certain Relationships; Conflicts of
Interest" and "Underwriting."
(4) Address is: 865 South Figueroa Street, Suite 1800, Los Angeles,
California 90017.
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<PAGE>
FEDERAL INCOME TAX CONSEQUENCES
THE FOLLOWING DISCUSSION SUMMARIZES THE MATERIAL FEDERAL INCOME TAX
CONSEQUENCES 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, including (without limitation)
that this Prospectus accurately reflects the proposed method of operation of 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 Consequences" 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 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 and case law, all of which is subject to change
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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 Charter 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 adversely affect the status of the
shares of stock as "transferable shares" 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 Real Estate 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 Pass-Through
Certificates, interests in real property, interests in Mortgage Loans secured by
real property and interests in REMICs.
On the last day of each calendar quarter, of the investments in securities not
included in the 75% of Assets Test, the value of any one issuer's securities may
not exceed 5% by value of the Company's total assets and the Company may not own
more than 10% of any one issuer's outstanding voting securities. Hedging
contracts (other than those which are Qualified REIT 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 from exceeding 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 for
purposes of the asset tests and the gross income tests, 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.
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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 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 Real Estate 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 the tax imposed
on such income by the Code, less (iii) any "excess noncash income" (the "95%
Distribution Test"). See "Dividend Policy and
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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 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 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 property as
Foreclosure Property on the tax return for the fiscal year in which such
property is acquired.
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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.
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.
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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 -- 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.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES 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
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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
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
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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%.
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, par value $.01 per share, and 50 million shares of preferred
stock, par value $.01 per share, issuable in one or more classes. 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.
The Bylaws provide that 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, a majority of the Unaffiliated
Directors or the stockholders.
REPURCHASE OF SHARES AND RESTRICTIONS ON TRANSFER
Two of the requirements of qualification for the tax benefits accorded by
the REIT Provisions of the Code are that (1) during the last half of each
taxable year not more than 50% in value of the outstanding shares may be owned
directly or indirectly by five or fewer individuals (the "50%/5 stockholder
test") and (2) there must be at least 100 stockholders on 335 days of each
taxable year of 12 months.
In order that the Company may meet these requirements at all times, the
Charter prohibits any person from acquiring or holding, directly or indirectly,
shares of Common Stock in excess of 9.8% (in value or in number of shares,
whichever is more restrictive) 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 preferred 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.
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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 Charter, 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 Charter. 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 Charter 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 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 Charter.
Upon such sale, the interest of the Charitable Beneficiary in the shares sold
shall terminate and the Trustee shall distribute the net proceeds of the sale to
the intended transferee and to the Charitable Beneficiary as follows. The
intended transferee shall receive the lesser of (1) the price paid by the
intended transferee for the shares or, if the intended transferee did not give
value for the shares in connection with the event causing the shares to be held
in the Trust (e.g., in the case of a gift, devise or other such transaction),
the Market Price (as defined below) of the shares on the day of the event
causing the shares to be held in the Trust, and (2) the price per share received
by the Trustee from the sale or other disposition of the shares held in the
Trust. Any net sales proceeds in excess of the amount payable to the intended
transferee shall be immediately paid to the Charitable Beneficiary. In
addition, shares of Common Stock transferred to the Trustee shall be deemed to
have been offered for sale to the Company, or its designee, at a price per share
equal to the lesser of (i) the price per share in the transaction that resulted
in such transfer to the Trust (or, in the case of a devise or gift, the Market
Price at the time of such devise or gift), and (ii) the Market Price on the date
the Company, or its designee, accepts such offer. The Company shall have the
right to accept such offer until the Trustee has sold shares held in the Trust.
Upon such a sale to the Company, the interest of the Charitable Beneficiary in
the shares sold shall terminate and the Trustee shall distribute the net
proceeds of the sale to the intended transferee.
The term "Market Price" on any date shall mean, with respect to any class
or series of outstanding shares of the Company's stock, the Closing Price (as
defined below) for such shares on such date. The "Closing Price" on any date
shall mean the last sale price for such shares, regular way, or, in case no such
sale takes place on such day, the average of the closing bid and asked prices,
regular way, for such shares, in either case as reported in the principal
consolidated transaction reporting system with respect to securities listed or
admitted to trading on the New York Stock Exchange 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.
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All persons who own, directly or indirectly, 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
direct or indirect owner, the number of shares of each class and series of stock
of the Company directly or indirectly owned and a description of the manner in
which such shares are held. Each such direct or indirect owner shall provide to
the Company such additional information as the Company may request in order to
determine the effect, if any, of such 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 CHARTER 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 Charter
and the Bylaws of the Company does not purport to be complete and is subject to
and qualified in its entirety by reference to Maryland law and to the Charter
and the Bylaws of the Company, copies of which are filed as exhibits to the
Registration Statement of which this Prospectus is a part. 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 Charter provides 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 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
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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 charter 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.
INTERESTED PARTY TRANSACTIONS
Pursuant to the Company's Bylaws, the Company will not enter into any
transactions or agreements (other than Employment Agreements) with any director,
officer or Affiliate of the Company except as approved by a majority of the
Company's Board of Directors, including a majority of the Unaffiliated
Directors. The Company has no restrictions on any director, officer or Affiliate
of the Company from engaging for their own account in business activities of the
types conducted or to be conducted by the Company and its Affiliates.
AMENDMENT TO THE CHARTER
The Company reserves the right from time to time to make any amendment to
its Charter, now or hereafter authorized by law, including any amendment which
alters the contract rights, as expressly set forth in the Charter, of any shares
of outstanding stock. The Charter 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 and certain other provisions 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.
DURATION OF THE COMPANY
The Company's Charter provides that the Company shall have a perpetual
duration.
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 two-thirds of all the votes
entitled to be cast on the matter.
ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS
The 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 .
POSSIBLE ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE
CHARTER AND BYLAWS
The business combination provisions and, if the applicable provision in the
is rescinded, the control share acquisition provisions of the MGCL, the
provisions of the Charter on removal of directors and the advance notice
provisions of the 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 Bank of New York 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.
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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. In the event of a default by
one or more of the Underwriters, the commitments of non-defaulting Underwriters
may be increased by the Representatives or the Purchase Agreement may be
terminated, 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, their respective officers and directors and
certain officers, employees and directors of TCW Group Affiliates 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.
At the request of the Company, the Underwriters have reserved up to 750,000
shares of Common Stock for sale (at the initial public offering price) to
affiliates of TCW, their employees and family members, who have expressed an
interest in purchasing such shares. There is no obligation, however, on the part
of any such individuals or entities to purchase any shares of Common Stock. Each
such person has agreed to the restrictions on transfer of the shares of Common
Stock that are described in the preceding paragraph. The number of shares of
Common Stock available for sale to the general public will be reduced to the
extent such persons purchase such reserved shares. Any reserved shares of Common
Stock not so purchased will be offered by the Underwriters to the general public
on the same basis as the other shares of Common Stock offered hereby.
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.
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
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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 and the Manager, subject to certain limitations, have 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
and the Manager 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.
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 from the
Underwriters in connection with the shares of Common Stock it sells. See "Risk
Factors -- Conflicts of Interest Between the Company and the Manager and Its
Affiliates."
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, New York, New York. O'Melveny & Myers LLP and Brown & Wood LLP, will rely
as to certain 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
Consequences" 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.
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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.
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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.
"ASR" means ASR Investments Corporation.
"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 (A)
the Company's retained earnings (taking into account any losses incurred) and
(B) any non-cash charges or reserves, including depreciation, mark-to-market
adjustments and unrealized credit loss, 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
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.
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"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.
"Conforming Mortgage Loans" means conventional Mortgage Loans that either
comply with requirements for 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.
"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 of 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.
"Counsel" means O'Melveny & Myers LLP.
"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.
"11th District Cost of Funds Index" means the index made available monthly
by the Federal Home Loan Bank Board of the cost of funds to members of the
Federal Home Loan Bank 11th District.
"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.
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"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.
"50%/5 Stockholder Test" means the requirement for qualification as a REIT
that 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.
"FIRPTA" means the Foreign Investment in Real Property Tax Act of 1980.
"First Loss Subordinated Bonds" means any bonds that bear the "first loss"
from losses incurred in respect of Mortgage Assets upon foreclosure sales and
other liquidations of underlying mortgaged properties that result in failure to
recover all amounts due on the loans secured thereby.
"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.
"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.
"Inverse Floaters" means a class of CMOs with a coupon rate that moves
inversely to a designated index, such as LIBOR or the 11th District Cost of
Funds Index. Income floaters have coupon rates that typically change at a
multiple of the changes at the relevant index rate. Any rise in the index rate
(as a consequence of an increase in interest rates) causes a drop in the coupon
rate of an Inverse Floater while any drop in the index rate causes an increase
in the coupon of an Inverse Floater.
"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.
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"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.
"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.
"Merrill Lynch & Co." means Merrill Lynch, Pierce, Fenner & Smith
Incorporated.
"Moody's" means Moody's Investors 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 are
Interest Only Derivatives or Principal Only Derivatives 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% Distribution Test"means the stockholder distribution requirement
described in "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT -- Distribution Requirement."
"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
Consequences -- 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 the average of the 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 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.
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"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.
"Purchase Agreement" means the agreement by and between the Company, the
Manager and the Underwriters whereby the Underwriters agree to purchase all of
the shares of Common Stock being sold thereunder if any of such shares are
purchased, subject to the terms and conditions set forth therein.
"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 the Company to generate qualified income for purposes of the
95% 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 Standard & Poor's Ratings Services, a division of
the McGraw-Hill Companies and Moody's Investors Service, Inc.
"REIT" means a real estate investment trust as defined under Section 856 of
the Code.
"REIT Provisions of the Code" means Sections 856 through 860 of the Code.
"REMIC" means a real estate mortgage investment conduit.
"Representatives" means Merrill Lynch & Co., PaineWebber Incorporated,
Stifel, Nicolaus & Company, Incorporated and Sutro & Co. Incorporated.
"Residuals" means the right to receive the remaining or residual cash flows
from a pool of Mortgage Loans or Mortgage Securities after distributing required
amounts to the holders of interests in or obligations backed by such loans or
securities and after payment of any required pool expenses.
"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
the McGraw-Hill Companies.
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"75% of Assets Test" means the asset-based test requiring that on the last
day of each calendar quarter at least 75% of the Company's assets must consist
of Qualified REIT Real Estate Assets, government securities, cash and cash
items, as described in "Federal Income Tax Considerations -- Requirements for
Qualification as a REIT -- Asset Tests."
"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
Consequences -- 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.
"TAMCO" means TCW Asset Managment Company.
"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 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.
"TFMI" means TCW Funds Management, Inc.
"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 Charter, 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.
"25% of Assets Test" means the asset-based tests described in "Federal
Income Tax Considerations -- Requirements for Qualification as a REIT -- Asset
Tests."
"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.
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"Underwriters" means the underwriters listed above under
"Underwriting."
"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.
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[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
Los Angeles, California
September 16, 1997
<PAGE>
APEX MORTGAGE CAPITAL, INC.
BALANCE SHEET
SEPTEMBER 15, 1997
ASSETS
Cash ................................................. . $1,500
======
LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
Stockholder's Equity
<S> <C>
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
CASH
Cash includes cash on hand and deposits in banks. The Company has no cash
equivalents.
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.
STOCK OPTIONS
The Company accounts for stock options to employees and directors of the
Company using the intrinsic value method. All other stock options are accounted
for using the fair value method.
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.
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.
NOTE 5 - STOCK OPTION PLAN
F-3
<PAGE>
The Company has adopted a stock option plan (the "Plan") that provides for
qualified incentive stock options, non-qualified stock options, stock
appreciation rights and dividend equivalent rights. Directors, officers and key
employees of the Company and the Manager are eligible to participate in the 1997
Stock Option Plan. 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 the Company's Common Stock at the time the option is granted. 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.
No options or rights have yet been granted under the 1997 Stock Option
Plan. The Company intends to grant options to purchase 375,000 shares of Common
Stock, effective on the closing of the public offering of Common Stock. The
options will be exercisable one year after the date of grant. The fair value of
the options cannot be determined until the closing of the public offering.
F-4
<PAGE>
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No dealer, salesman or any other person has been authorized to give any
information or to make any representations other than those contained in this
Prospectus in connection with the offer made by this Prospectus and, if given or
made, such information or representations must not be relied upon as having
been authorized by the Company or any of the Underwriters. This Prospectus does
not constitute an offer to sell or the solicitation of any offer to buy any
security other than the shares of Common Stock offered by this Prospectus, nor
does it constitute an offer to sell or a solicitation of any offer to buy the
shares of Common Stock by anyone in any jurisdiction in which such offer or
solicitation is not authorized, or in which the person making such offer or
solicitation is not qualified to do so, or to any person to whom it is unlawful
to make such offer or solicitation. Neither the delivery of this Prospectus nor
any sale made hereunder shall, under any circumstances, create any implication
that information contained herein is correct as of any time subsequent to the
date hereof.
- --------------------------------------------------------------------------------
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TABLE OF CONTENTS
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<TABLE>
<CAPTION>
Page
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<S> <C>
PROSPECTUS SUMMARY................. 4
RISK FACTORS....................... 15
USE OF PROCEEDS.................... 25
DIVIDEND AND DISTRIBUTION POLICY... 25
CAPITALIZATION..................... 26
LIQUIDITY AND CAPITAL RESOURCES.... 26
BUSINESS AND STRATEGY.............. 26
MANAGEMENT OF THE COMPANY.......... 42
THE MANAGER........................ 47
SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT..................... 56
FEDERAL INCOME TAX
CONSIDERATIONS..................... 57
ERISA CONSIDERATIONS............... 64
DESCRIPTION OF CAPITAL STOCK....... 64
CERTAIN PROVISIONS OF MARYLAND
LAW AND OF THE COMPANY'S
CHARTER AND........................ 66
UNDERWRITING....................... 68
LEGAL MATTERS...................... 69
EXPERTS............................ 69
ADDITIONAL INFORMATION............. 70
GLOSSARY........................... 71
</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. THIS IS IN
ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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>
PART II
[INFORMATION NOT REQUIRED IN PROSPECTUS]
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.
AMOUNT TO BE PAID
SEC Registration Fee.............................. $ 55,758
NYSE listing fee.................................. 100,000
NASD filing fee................................... 18,900
Printing and engraving expenses................... *
Legal fees and expenses........................... *
Accounting fees and expenses...................... *
Transfer agent and custodian fees................. *
Miscellaneous..................................... *
Total ........................................... *
* To be provided by amendment.
ITEM 32. SALES TO SPECIAL PARTIES
The securities described in Item 33(a) were initially issued to TCW Capital
Investment Corporation in exchange for cash. These shares have been transferred
to TCW Asset Management Corporation.
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. These
shares have been transferred to TCW Asset Management Corporation.
(b) Pursuant to the exemption provided by Rule 701 promulgated under the
Securities Act, on ______________, 1997, the Company issued options 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 Charter obligates the Company to
indemnify its present and former directors and officers and to pay or reimburse
reasonable expenses for such individuals in advance of the final disposition of
a proceeding to the maximum extent permitted from time to time by Maryland law.
The MGCL permits a corporation to indemnify its present and former directors and
officers, among others, against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by them in connection with any proceeding
to which they may be made a party by reason of their service in those or other
capacities, unless it is established that (a) the act or omission of the
director or officer was material to the matter giving rise to such proceeding
and (i) was committed in bad faith, or (ii) was the result of active and
deliberate dishonesty, (b) the director or officer actually received an improper
personal benefit in money, property or services, or (c) in the case of any
criminal proceeding, the director or officer had reasonable cause to believe
that the act or omission was unlawful. The Bylaws implement the provisions
relating to indemnification contained in the Company's Charter. 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 Charter contains a provision providing for elimination
of the liability of its directors or officers to the Company or its stockholders
for money damages to the maximum extent permitted by Maryland law from time to
time. In addition, the officers, directors, and controlling persons of the
Company are indemnified against certain liabilities by the Company under the
Purchase Agreement relating to this Offering. The Company's Charter and Bylaws
provide, in effect, for the indemnification by the Company of its officers and
directors to the fullest extent permitted by applicable law. The Company will
maintain for the benefit of its officers and directors, officers' and directors'
insurance.
11-1
<PAGE>
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 other schedules have been omitted because they are not
applicable.
(b) Exhibits
*1.1 Form of Underwriting 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
* To be filed by amendment.
** Previously filed
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 persons
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.
11-2
<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 Amendment
No. 1 to the 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 29th day of October, 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>
<CAPTION>
<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
Chief Financial Officer (Principal Financial and
Accounting Officer)
</TABLE>
11-3
<PAGE>
EXHIBIT INDEX
*1.1 Form of Underwriting 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
* To be filed by amendment.
** Previously filed.
11-4
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Pre-effective Amendment No. 1 to Registration
Statement No. 333-36069 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.
DELOITTE & TOUCHE LLP
Los Angeles, California
October 29, 1997
