<PAGE>
15,000,000 SHARES
LASER MORTGAGE MANAGEMENT, INC.
COMMON STOCK
LASER Mortgage Management, Inc. (the "Company") is a specialty finance
company, organized in September 1997, that will invest primarily in
mortgage-backed securities and mortgage loans. The Company will elect to be
taxed as a real estate investment trust (a "REIT") under the Internal Revenue
Code of 1986, as amended. LASER Advisers Inc., a Delaware corporation and
registered investment adviser, will manage the day-to-day operations of the
Company, subject to the supervision of the Company's Board of Directors.
All of the 15,000,000 shares of common stock, $.001 par value (the "Common
Stock"), offered pursuant to this Prospectus are being offered by the Company
(the "Offering"). Prior to the Offering, there has been no market for the Common
Stock. The Company's Common Stock has been approved for listing on the New York
Stock Exchange (the "NYSE") and will trade under the symbol LMM.
--------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 13 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE COMMON STOCK,
INCLUDING, AMONG OTHERS:
- The Company was organized in September 1997 and has no operating history,
no assets, no identified investments and no established financing sources
- The Manager has conflicts of interest, including those with other accounts
it manages and an incentive fee that may encourage speculative investments
- On November 29, 1993, the Chief Executive Officer of the Company and the
Manager consented to the entry of a cease-and-desist order issued against
him by the Securities and Exchange Commission arising out of trading
activities in Mortgage Securities
- The Company is totally reliant on the Manager, which has significant
operating discretion, including as to the use of proceeds of the Offering
and the Company's operating policies and strategies
- Interest rate fluctuations may decrease or eliminate net income from the
Company's investments
- The Company's investments are expected to be highly leveraged; there are
no limitations on borrowings
- The Company can suffer significant losses on investments in IOs, Sub IOs,
Inverse IOs and other Mortgage Derivatives from rapid prepayments during
periods of interest rate declines
- The Company will invest in non-real estate assets, including
non-investment grade high yield corporate debt that experiences high
default rates, credit losses and liquidity risks
- The Company will engage in complex hedging strategies and will have no
significant credit risk or hedging policies
- The Company will purchase Mortgage Loans and non-guaranteed Mortgage
Securities that are subject to credit risks
- Stockholders will be subject to significant potential dilution from future
equity offerings
- Failure to maintain REIT status would subject the Company to corporate tax
and an excise penalty tax and would reduce earnings and cash available for
distribution to stockholders
- The Board of Directors determines the Company's operating policies and
strategies which may be changed without stockholder consent
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE COMMISSION
OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY (2)
<S> <C> <C> <C>
Per Share....................................... $15.00 $1.0125 $13.9875
Total (3)....................................... $225,000,000 $15,187,500 $209,812,500
</TABLE>
(SEE FOOTNOTES ON NEXT PAGE)
The shares of Common Stock are offered subject to prior sale, when, as and
if delivered to, and accepted by, the Underwriters and subject to certain
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 at the offices of Bear,
Stearns & Co. Inc., 245 Park Avenue, New York, New York 10167 on or about
December 2, 1997.
--------------------------
BEAR, STEARNS & CO. INC.
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
EVEREN SECURITIES, INC.
STIFEL, NICOLAUS & COMPANY
INCORPORATED
NOVEMBER 26, 1997
<PAGE>
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"). See "UNDERWRITING."
(2) Before deducting expenses payable by the Company, estimated to be
$1,400,000.
(3) The Company has granted the several Underwriters a 30-day option to purchase
up to 2,250,000 additional shares of Common Stock to cover over-allotments,
on the same terms and conditions as set forth above. If all such shares of
Common Stock are purchased, the total Price to Public, Underwriting Discount
and Proceeds to Company, before expenses of the Offering, will be
$258,750,000, $17,465,625 and $241,284,375, respectively. See
"UNDERWRITING."
------------------------
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS AND THE
IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
CERTAIN STATEMENTS CONTAINED IN THIS PROSPECTUS CONSTITUTE "FORWARD-LOOKING
STATEMENTS" WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY
SUCH AS "MAY," "WILL," "EXPECT," "ANTICIPATE," "ESTIMATE" OR "CONTINUE" OR THE
NEGATIVE 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. THESE FORWARD-LOOKING STATEMENTS
SPEAK ONLY AS OF THE DATE OF THIS PROSPECTUS. THE COMPANY DISCLAIMS ANY
OBLIGATION OR UNDERTAKING TO DISSEMINATE ANY UPDATES OR REVISIONS TO ANY
FORWARD-LOOKING STATEMENT CONTAINED HEREIN TO REFLECT ANY CHANGE IN THE
COMPANY'S EXPECTATIONS WITH REGARD THERETO OR ANY CHANGE IN EVENTS, CONDITIONS
OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PROSPECTUS SUMMARY............................. 5
RISK FACTORS................................... 13
Conflicts of Interest of the Manager........... 13
Newly-Organized Corporation; No Established
Financing.................................... 14
No Identified Assets; Discretionary Use of
Proceeds..................................... 14
Cease-and-Desist Order Against Chief Executive
Officer...................................... 14
Total Reliance on the Manager; Termination of
the Management Agreement..................... 14
Results of Operations Adversely Affected by
Factors Beyond Company's Control............. 15
Substantial Leverage Can Result in Net Interest
and Operating Losses......................... 15
LEVERAGING STRATEGY........................ 15
BORROWING RISKS; MARGIN CALLS.............. 16
No Restriction on the Incurrence of Additional
Indebtedness................................. 16
Risk of Potential Future Offerings; Dilution... 16
Interest Rate Fluctuations Will Affect Value of
Mortgage Assets and Net Income............... 17
GENERAL.................................... 17
FAILURE TO MANAGE MISMATCH BETWEEN
LONG-TERM ASSETS AND SHORT-TERM
FUNDING.................................. 17
INVERTED YIELD CURVE ADVERSELY AFFECTS
INCOME................................... 17
INCREASED PREPAYMENT RATES WILL REDUCE
VALUE OF MORTGAGE ASSETS................. 18
Consequences and Costs of Hedging
Transactions................................. 18
Competition for Mortgage Assets at Favorable
Yields and for Financing..................... 19
Value of CMO's May Be Adversely Affected by
Prepayments on Underlying Collateral......... 20
Value of Mortgage Derivatives May Be Reduced or
Eliminated Due to Interest Rate Fluctuations;
No Limit on Mortgage Derivatives............. 20
Value of Subordinate Interests May be Adversely
Affected by Losses on Underlying Mortgage
Loans........................................ 21
Investment in Non-Real Estate Assets Subject to
Liquidity and Credit Risks; Limit on Such
Assets May Change Without Stockholder
Approval..................................... 21
Possible Losses on Mortgage Loans During
Warehousing Period........................... 22
Lack of Access to Securitizations Would
Adversely Affect the Company................. 23
Credit Risks................................... 23
Failure to Maintain REIT Status Would Subject
Company to Corporate Tax and Penalty Tax..... 23
Pledged Assets and Risk of Bankruptcy in
Reverse Repurchase Agreements................ 24
Possible Environmental Liabilities............. 24
<CAPTION>
PAGE
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<S> <C>
Failure to Maintain Investment Company Act
Exemption Would Adversely Affect Results of
Operations................................... 24
Taxable Mortgage Pool Risk; Increased Taxation
to Tax Exempt Entities and Other Investors... 25
Phantom Income May Result in Additional Tax
Liability.................................... 25
Ownership Limitation May Restrict Business
Combination Opportunities.................... 26
Plans Should Consider ERISA Risks of Investing
in Common Stock.............................. 27
Preferred Stock May Prevent Change in
Control...................................... 27
Lack of Operating Policies; Board of Directors
May Change Policies Without Stockholder
Consent...................................... 27
Lack of Policy Regarding Hedging or Credit
Risk; Future Revisions in Policies and
Strategies................................... 27
Lack of Accounting and Testing Systems......... 27
Limitation on Liability of Directors and
Officers and Manager Indemnification......... 28
No Prior Trading Market; Failure to Develop or
Sustain an Active Trading Market............. 28
Interest Rate Volatility May Adversely Affect
Common Stock Price........................... 28
Illiquidity of Mortgage Loans, Subordinate
Interests and Mortgage Derivatives Could
Cause Losses................................. 28
Benefits to Existing Stockholder, Directors and
Officers..................................... 29
USE OF PROCEEDS................................ 30
CAPITALIZATION................................. 31
DISTRIBUTION POLICY............................ 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS................................... 33
General........................................ 33
Leverage....................................... 33
Hedging........................................ 33
Liquidity and Capital Resources................ 33
Inflation...................................... 34
Certain Accounting Policies and Procedures..... 34
MORTGAGE SECURITY ACCOUNTING TREATMENT..... 34
MORTGAGE LOAN ACCOUNTING TREATMENT......... 34
TAXABLE INCOME AND GAAP INCOME............. 34
BUSINESS....................................... 35
General........................................ 35
Investment Strategy............................ 35
Operating Policies and Strategies.............. 36
CAPITAL AND LEVERAGE POLICIES.............. 36
SHORT-TERM BORROWING....................... 37
SECURITIZATION............................. 38
HEDGING ACTIVITIES......................... 39
INTEREST RATE RISK MANAGEMENT STRATEGY..... 40
Employees...................................... 40
Facilities..................................... 40
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Legal Proceedings.............................. 40
DESCRIPTION OF PROPOSED ASSETS................. 41
Mortgage Loans................................. 41
Pass-Through Certificates...................... 42
FHLMC CERTIFICATES......................... 42
FNMA CERTIFICATES.......................... 43
GNMA CERTIFICATES.......................... 44
PRIVATELY-ISSUED CERTIFICATES.............. 44
CMOs........................................... 44
Mortgage Derivatives........................... 44
Subordinate Interests.......................... 45
Other Fixed-Income Assets...................... 46
THE MANAGER.................................... 47
Cease-and-Desist Order Against Chief Executive
Officer...................................... 48
The Management Agreement....................... 48
Management Fees................................ 50
Stock Options and Deferred Common Stock
Awards....................................... 51
Limits of Responsibility....................... 51
THE COMPANY.................................... 53
Directors and Executive Officers............... 53
Committees of the Board of Directors........... 53
Compensation of Directors...................... 54
Executive Compensation......................... 54
Stock Incentive Plan........................... 54
Grants of Awards............................... 57
Compensation Committee Interlocks.............. 57
CERTAIN RELATIONSHIPS AND RELATED PARTY
TRANSACTIONS AND CONFLICTS OF INTEREST....... 58
PRINCIPAL STOCKHOLDERS......................... 60
DIVIDEND REINVESTMENT AND DIRECT PURCHASE
PLAN......................................... 61
FEDERAL INCOME TAX CONSIDERATIONS.............. 63
General........................................ 63
Requirements for Qualification................. 64
STOCK OWNERSHIP TESTS...................... 64
ASSET TESTS................................ 64
GROSS INCOME TESTS......................... 65
Distribution Requirement....................... 66
Taxation of the Company........................ 67
Taxation of Stockholders....................... 68
Taxation of Stockholders on the Disposition of
the Common Stock............................. 70
Capital Gains and Losses....................... 70
Information Reporting Requirement and Backup
Withholding.................................. 70
Taxation of Tax-Exempt Stockholders............ 70
Taxation of Non-U.S. Stockholders.............. 71
State and Local Taxes.......................... 72
ERISA CONSIDERATIONS........................... 73
Employee Benefit Plans, Tax-Qualified
Retirement Plans and IRA's................... 73
Status of the Company Under ERISA.............. 73
CERTAIN CHARACTERISTICS OF MORTGAGE LOANS AND
REAL PROPERTY INVESTMENTS.................... 76
General........................................ 76
<CAPTION>
PAGE
-----
<S> <C>
Types of Mortgage Instruments.................. 76
Leases and Rents............................... 76
SECONDARY FINANCING: DUE-ON-ENCUMBRANCE
PROVISIONS............................... 77
DUE-ON-SALE PROVISIONS..................... 77
Condemnation and Insurance..................... 77
Foreclosure.................................... 78
GENERAL.................................... 78
JUDICIAL FORECLOSURE....................... 78
NON-JUDICIAL FORECLOSURE/POWER OF SALE..... 78
EQUITABLE LIMITATIONS ON ENFORCEABILITY OF
CERTAIN PROVISIONS....................... 78
POST-SALE REDEMPTION....................... 79
ANTI-DEFICIENCY LEGISLATION................ 79
Bankruptcy Laws................................ 80
Default Interest and Limitations on
Prepayments.................................. 81
Environmental Risks............................ 81
GENERAL.................................... 81
CERCLA..................................... 82
CERTAIN OTHER FEDERAL AND STATE LAWS....... 82
SUPERLIEN LAWS............................. 83
ADDITIONAL CONSIDERATIONS.................. 83
ENVIRONMENTAL SITE ASSESSMENTS............. 83
Applicability of Usury Laws.................... 83
Americans with Disabilities Act................ 83
CERTAIN PROVISIONS OF MARYLAND LAW AND THE
COMPANY'S CHARTER AND BYLAWS................. 84
Certain Anti-Takeover Provisions............... 84
Staggered Board of Directors................... 84
Number of Directors, Removal, Filling
Vacancies.................................... 84
Advance Notice Provisions for Stockholder
Nominations and Stockholder Proposals........ 84
Rights to Purchase Securities and Other
Property..................................... 85
Indemnification................................ 85
Limitation of Liability........................ 85
Business Combinations.......................... 86
Control Share Acquisitions..................... 86
DESCRIPTION OF CAPITAL STOCK................... 88
General........................................ 88
Common Stock................................... 88
Preferred Stock................................ 88
Registration Rights............................ 88
Standstill Agreement........................... 89
Repurchase of Shares and Restrictions on
Transfer..................................... 89
Transfer Agent and Registrar................... 91
SHARES ELIGIBLE FOR FUTURE SALE................ 92
UNDERWRITING................................... 93
PRIVATE PLACEMENT.............................. 95
LEGAL MATTERS.................................. 95
EXPERTS........................................ 95
ADDITIONAL INFORMATION......................... 96
GLOSSARY....................................... 97
INDEPENDENT AUDITORS' REPORT................... F-1
APPENDIX A--PAST PERFORMANCE RESULTS........... A-1
</TABLE>
4
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION INCLUDED ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED,
THE INFORMATION CONTAINED IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITERS'
OVER-ALLOTMENT OPTION IS NOT EXERCISED. ANY DEFINED TERMS USED HEREIN AND NOT
OTHERWISE DEFINED SHALL HAVE THE MEANINGS GIVEN IN THE GLOSSARY.
AN INVESTMENT IN THE COMMON STOCK IS HIGHLY SPECULATIVE. IN ADDITION TO THE
OTHER INFORMATION IN THIS PROSPECTUS, INVESTORS SHOULD CAREFULLY CONSIDER THE
RISK FACTORS SET FORTH IN THIS SUMMARY AND "RISK FACTORS" BEGINNING ON PAGE 13.
THE COMPANY
GENERAL
LASER Mortgage Management, Inc. (the "Company") is a specialty finance
company, organized in September 1997, that will invest primarily in
mortgage-backed securities and mortgage loans. The mortgage-backed securities
will include mortgage pass-through certificates, collateralized mortgage
obligations and other securities representing interests in, or obligations
backed by, pools of mortgage loans (collectively, the "Mortgage Securities").
The mortgage loans will be secured by first or second liens on single-family
residential, multi-family residential, commercial or other real property (the
"Mortgage Loans" and, together with the Mortgage Securities, the "Mortgage
Assets"). See "DESCRIPTION OF PROPOSED ASSETS."
The Company will seek to generate net income for distribution to
stockholders from the spread between the interest income earned on its
investment portfolio and the cost of financing and hedging the portfolio. The
Company will elect to be taxed as a real estate investment trust (a "REIT")
under the Internal Revenue Code of 1986, as amended (the "Code"). The Company
generally will not be subject to federal income tax provided that it distributes
its income to its stockholders and maintains its qualification as a REIT. See
"FEDERAL INCOME TAX CONSIDERATIONS." LASER Advisers Inc. (the "Manager"), which
specializes in managing investments in Mortgage Securities for institutions and
other sophisticated investors, will manage the Company's day-to-day operations.
The Manager is a newly-organized registered investment adviser. See "APPENDIX
A--Past Performance Results."
The Company's principal executive offices are located at 51 John F. Kennedy
Parkway, Short Hills, New Jersey 07078. Its telephone number is (973) 912-8770.
INVESTMENT STRATEGY
The Company's investment strategy will be to create and manage an investment
portfolio, principally of Mortgage Assets, that, in combination with financing
and hedging activities, will be designed to generate income for distribution to
its stockholders while preserving the Company's capital base.
The Company intends to acquire the following types of investments: (i) fixed
and adjustable rate mortgage pass-through certificates ("Pass-Through
Certificates"), which are securities collateralized by pools of Mortgage Loans
issued and sold to investors by private, non-governmental issuers ("Privately-
Issued Certificates") or by various U.S. government agencies or
instrumentalities, such as the Federal Home Loan Mortgage Corporation ("FHLMC"),
the Federal National Mortgage Association ("FNMA") and the Government National
Mortgage Association ("GNMA") (collectively, "Agency Certificates"); (ii)
collateralized mortgage obligations ("CMOs"), which are fixed and adjustable
rate debt obligations collateralized by Mortgage Loans or Pass-Through
Certificates; (iii) Mortgage Loans, which will be pooled and securitized to
provide long-term, non-recourse financing for the Company; (iv) mortgage
derivative securities ("Mortgage Derivatives"), including interest-only
securities ("IOs") which receive only certain interest payments from a pool of
Mortgage Securities or Mortgage Loans; (v) subordinate interests
5
<PAGE>
("Subordinate Interests"), which are classes of Mortgage Securities junior to
other classes of Mortgage Securities in the right to receive payments from the
underlying Mortgage Loans; and (vi) other fixed-income securities in an amount
not to exceed 5% of total assets. Initially, the Company intends to invest at
least 65% of its assets in fixed-rate securities. See "DESCRIPTION OF PROPOSED
ASSETS." Consistent with the Company's policy of maintaining its status as a
REIT for federal income tax purposes, substantially all of the Company's assets
will consist of real estate assets of the type described in Section 856(c)(6)(B)
of the Code ("Qualified Real Estate Assets").
The Company will invest at least 70% of its total assets (the "70% Asset
Group") in, (i) securities which are rated within one of the two highest ratings
categories by one of the nationally recognized rating agencies (the "Rating
Agencies"), (ii) securities which are unrated but are guaranteed by the U.S.
government or an agency or instrumentality thereof, or (iii) Mortgage Loans to
borrowers who would otherwise meet FHLMC, FNMA or GNMA guidelines, except with
respect to the size of the loans. The Company intends to securitize
substantially all the Mortgage Loans it acquires by issuing structured debt,
such as CMOs, and to retain Subordinate Interests in the pools of Mortgage Loans
it securitizes.
The remainder of the Company's assets, not to exceed 30% of its total assets
(the "30% Asset Group"), is expected to consist of Mortgage Loans, other than
those included in the 70% Asset Group, retained Subordinate Interests and
fixed-income securities, other than those included in the 70% Asset Group, that
are primarily Qualified Real Estate Assets but also will include non-investment
grade high yield corporate debt. To attempt to minimize the potentially higher
level of credit and liquidity risk of these securities, the Company will limit
its investments in, and diversify its portfolio of, securities in the 30% Asset
Group. Only such retained Subordinate Interests of securitized Mortgage Loans
(and not the entire pools of Mortgage Loans) will be considered in determining
the proportion of assets qualifying in the 70% Asset Group and in the 30% Asset
Group held by the Company.
The Company's policy is to acquire those Mortgage Assets which it believes
are likely to generate the highest returns on capital invested, after
considering (i) the amount and nature of anticipated cash flows from the asset,
(ii) the Company's ability to pledge the asset to secure collateralized
borrowings, (iii) the capital requirements resulting from the purchase and
financing of the asset, and (iv) the costs of financing, hedging and managing
the asset. Prior to acquisition, potential returns on capital employed will be
assessed over the life of the asset and in a variety of interest rate, yield
spread, financing cost, credit loss and prepayment scenarios. See "RISK
FACTORS--Lack of Operating Policies; Board of Directors May Change Policies
Without Stockholder Consent."
RISK FACTORS
Prior to making an investment decision, prospective investors should
carefully consider all of the information set forth in this Prospectus and, in
particular, should evaluate the risk factors set forth in "RISK FACTORS." These
risks include, among others:
- The Company was organized in September 1997 and has no operating history,
no assets, no identified investments and no established financing sources.
- The Manager has conflicts of interest, including those arising from the
Manager's management of the accounts of its other clients and the fact
that the Manager will be entitled to receive an incentive fee that may
encourage speculative investments.
- On November 29, 1993, the Chief Executive Officer of the Company and the
Manager consented to the entry of a cease-and-desist order issued against
him by the Securities and Exchange Commission (the "Commission") arising
out of trading activities in Mortgage Securities.
- The Company is totally reliant on the Manager, which has significant
operating discretion, including as to the use of proceeds of the Offering
and the Company's operating policies and strategies.
6
<PAGE>
- Interest rate fluctuations may decrease or eliminate net income from the
Company's investments.
- The Company's investments are expected to be highly leveraged; there are
no limitations on the Company's borrowings.
- The Company can suffer significant losses on investments in IOs, Sub IOs,
Inverse IOs and other Mortgage Derivatives from rapid prepayments during
periods of interest rate declines.
- The Company will invest in non-real estate assets, including
non-investment grade high yield corporate debt that experiences high
default rates, credit losses and liquidity risks.
- The Company will engage in complex hedging strategies and will have no
significant credit risk or hedging policies.
- The Company will purchase Mortgage Loans and non-guaranteed Mortgage
Securities that are subject to credit risks; credit losses will reduce or
eliminate the value of and income from such Mortgage Assets.
- Stockholders will be subject to significant potential dilution from future
equity offerings of the Company.
- Failure to maintain REIT status would subject the Company to corporate tax
and an excise penalty tax and would reduce earnings and cash available for
distribution to stockholders.
- The Board of Directors determines the Company's operating policies and
strategies which may be changed without stockholder consent.
- The Company will be subject to the risk of possible environmental
liabilities.
CAPITAL AND LEVERAGE POLICIES
The Company's operations are expected to be highly leveraged. Initially, the
Company intends to finance its acquisition of Mortgage Assets through the
proceeds of the Offering and, thereafter, primarily by borrowing against or
"leveraging" its existing portfolio and using the proceeds to acquire additional
Mortgage Assets. See "RISK FACTORS--Substantial Leverage Can Result in Net
Interest and Operating Losses." The Company expects to incur debt such that it
will maintain an equity-to-assets ratio of between 6% to 10%, although the
actual ratio may be higher or lower from time to time depending on market
conditions and other factors deemed relevant by the Manager, subject to the
review of the Company's Board of Directors.
HEDGING AND RISK MANAGEMENT
The Company will endeavor to protect itself against interest rate
fluctuations through its asset acquisition, borrowing and hedging strategies.
The Company's asset acquisition and borrowing strategies are intended to offset
the potential adverse effects resulting from the differences between fixed-rates
or other limitations on coupon rate adjustment, such as interest rate caps,
associated with its investment portfolio, and the shorter term variable nature
of the Company's related borrowings. The Company intends to enter into hedging
transactions in an effort to further protect its portfolio of Mortgage Assets
and related debt from interest rate fluctuations. These transactions may include
interest rate swaps, the purchase or sale of interest rate collars, caps or
floors, options and IOs. There can be no assurance that the Company's hedging
activities will have the desired beneficial impact on the Company's results of
operations or financial condition. Hedging involves risk and typically involves
costs, including transaction costs, and risks associated with the enforceability
of agreements underlying derivative transactions, business failure of
counterparties and illiquidity of hedging instruments. See "RISK
FACTORS"--Consequences and Costs of Hedging Transactions" and
"BUSINESS--Operating Policies and Strategies."
7
<PAGE>
The Company intends to manage the credit risk associated with its investment
portfolio by maintaining a substantial portion of its assets in the 70% Asset
Group, investing in a diversified portfolio of investments included in the 30%
Asset Group and regularly monitoring the credit risk associated with its
investment portfolio. See "BUSINESS--Investment Strategy."
THE MANAGER
The day-to-day business and investment affairs of the Company will be
managed by the Manager, subject to the supervision of the Company's Board of
Directors. The Manager, a newly-organized entity and a registered investment
adviser under the Investment Advisers Act of 1940, as amended (the "Advisers
Act"), specializes in managing investments in Mortgage Securities for
institutions and other sophisticated investors. The Manager employs
professionals who have significant experience in mortgage finance and in the
purchase and administration of Mortgage Securities; however, neither the Manager
nor its investment professionals have previously managed a REIT. Michael L.
Smirlock, Ph.D., the President and Chief Executive Officer of the Manager and
Chairman of the Board, Chief Executive Officer and President of the Company, and
the Manager's other investment professionals, each have at least ten years'
experience in mortgage research, mortgage finance and investment management. The
Manager's investment professionals currently manage over $300 million of capital
invested primarily in $3.9 billion of Mortgage Securities. See "THE MANAGER."
In 1993, Mr. Smirlock consented to the entry of a cease-and-desist order
issued against him by the Commission arising out of Mortgage Securities trading
activities supervised by Mr. Smirlock. See "RISK FACTORS--Cease-and-Desist Order
Against Chief Executive Officer" and "THE MANAGER--Cease-and-Desist Order
Against Chief Executive Officer."
PAST PERFORMANCE
Accounts managed by Mr. Smirlock and other investment professionals of the
Manager have employed, since 1994, an investment strategy similar to the
strategy to be employed in managing the Company's investments. "APPENDIX A--Past
Performance Results" sets forth the composite performance record achieved for
these accounts. This data is presented (i) without deduction of fees, (ii) net
of actual fees and (iii) as adjusted to give effect to the Company's fee
structure. Performance figures also are compared to a variety of fixed-income
indices. While past performance does not guarantee, and is not necessarily
indicative of, future results, potential investors should review this
information carefully. See "APPENDIX A--Past Performance Results."
MANAGEMENT AGREEMENT
The Company will enter into a management agreement (the "Management
Agreement") with the Manager pursuant to which the Manager, subject to the
supervision of the Company's Board of Directors, will formulate operating
strategies for the Company, oversee the acquisition of assets by the Company,
arrange for various types of financing for the Company (including the issuance
of CMOs), monitor the performance of the Company's assets and provide certain
administrative and managerial services in
8
<PAGE>
connection with the Company's operations. For its performance of these services,
the Manager will receive an annual base management fee, payable monthly, as set
forth below:
<TABLE>
<CAPTION>
ANNUAL BASE MANAGEMENT FEE AS A
PERCENTAGE OF AVERAGE STOCKHOLDERS'
AVERAGE STOCKHOLDERS' EQUITY EQUITY
- ---------------------------------------- ----------------------------------------
<S> <C>
$0 to $500 million...................... 1.0%
$500 million to $1 billion.............. $5 million plus 0.8% of amounts in
excess of $500 million
$1 billion or more...................... $9 million plus 0.6% of amounts in
excess of $1 billion
</TABLE>
The Manager also will receive a quarterly incentive fee in an amount equal
to 20% of the Net Income of the Company for the preceding fiscal quarter, in
excess of the amount that would produce an annualized Return on Average
Stockholders' Equity for such fiscal quarter equal to the Ten-Year U.S. Treasury
Rate plus 1%. The Board of Directors of the Company, with the approval of a
majority of the Company's Board of Directors who are unaffiliated with the
Manager (the "Independent Directors"), is authorized to change the fees from
time to time as agreed with the Manager. The Manager will be reimbursed for
certain out-of-pocket expenses incurred on behalf of the Company. See "THE
MANAGER--Management Fees."
CONFLICTS OF INTEREST OF THE MANAGER
The Company is subject to conflicts of interest involving the Manager and
its Affiliates because, among other reasons, (i) the Manager is permitted to
advise accounts of other clients, and many investments appropriate for the
Company also will be appropriate for these accounts and (ii) the incentive fee,
which is based on income of the Company, may create an incentive for the Manager
to recommend investments with greater income potential, which generally are
riskier or more speculative, than would be the case if its fee did not include a
"performance" component. Nevertheless, the Manager intends to conduct its
operations in a manner that will minimize the negative effect of any conflicts
of interest. Furthermore, a majority of the Company's Board of Directors must be
Independent Directors. The Independent Directors must approve any amendment to
the Management Agreement and will monitor the Company's investments, borrowings
and operations. See "RISK FACTORS--Conflicts of Interest of the Manager."
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Board of Directors in following or
declining to follow its advice or recommendations. The Manager and its directors
and officers will not be liable to the Company, any subsidiary of the Company,
the Independent Directors, the Company's stockholders or any subsidiary's
stockholders for acts performed in accordance with and pursuant to the
Management Agreement, except by reason of acts constituting bad faith, willful
misconduct, gross negligence or reckless disregard of their duties under the
Management Agreement. The Company has agreed to indemnify the Manager and its
directors and officers with respect to all expenses, losses, damages,
liabilities, demands, charges and claims arising from acts of the Manager not
constituting bad faith, willful misconduct, gross negligence or reckless
disregard of duties, performed in good faith in accordance with and pursuant to
the Management Agreement.
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Following the Offering, the structure and relationships of the Company, the
Manager and the Affiliated Funds will be as follows:
[LOGO]
- ------------------------
(1) The executive officers of the Company will be officers and employees of the
Manager. Mr. Smirlock, the Company's and the Manager's Chief Executive
Officer and President, has purchased 6,000 shares, and has agreed to
purchase an additional 67,000 shares of Common Stock from the Company. See
"--Certain Benefits to Existing Stockholder, Directors and Officers" and
"PRINCIPAL STOCKHOLDERS."
(2) A majority of the equity of the Manager is owned by Mr. Smirlock. The
remaining equity of the Manager is owned by Appaloosa Partners Inc. Mr.
Tepper, a Director of the Company and the Manager, owns all of the equity
of Appaloosa Partners Inc.
(3) The Manager holds a 1% general partnership interest in Fund A.
(4) Substantially all of the assets of Funds A, B, C and D are invested,
directly or indirectly, in the Master Fund which serves as a trading
vehicle. The Master Fund currently has, and the Manager currently manages,
over $300 million of capital invested primarily in $3.9 billion of Mortgage
Securities similar to those in which the Company will be investing. See
"APPENDIX A--Past Performance Results."
CERTAIN BENEFITS TO EXISTING STOCKHOLDER, DIRECTORS AND OFFICERS
Through the date hereof, Michael L. Smirlock, the Company's Chief Executive
Officer and President, has purchased 6,000 shares of Common Stock at an average
price of $2.50 per share in connection with the Company's formation and has
agreed to purchase from the Company 67,000 shares of Common Stock at the initial
public offering price in the Private Placement, or an aggregate of 73,000 shares
of Common Stock for an aggregate purchase price of $1,020,005, or $13.97 per
share. This average price per share is less than the initial offering price of
$15.00 per share.
The Company also has received irrevocable commitments to purchase a total of
5,013,999 shares in the Private Placement. The purchasers in the Private
Placement have agreed to purchase the shares of Common Stock at a purchase price
equal to the initial public offering price. Of the 5,013,999 shares sold in the
Private Placement, (i) Mr. Smirlock has committed to purchase 67,000 shares,
(ii) David A. Tepper, a Director of the Company and the Manager, has committed
to purchase 103,000 shares and (iii) Frederick N. Khedouri, a proposed Director
of the Company and a Senior Managing Director of Bear, Stearns & Co.
10
<PAGE>
Inc. ("Bear Stearns"), one of the Representatives, has committed to purchase
10,000 shares. In addition, a total of 714,235 shares of Common Stock will be
purchased by entities over which Mr. Tepper may be deemed to have shared or sole
voting and dispositive power. See "PRINCIPAL STOCKHOLDERS" and "PRIVATE
PLACEMENT."
The Company has granted to its directors, officers, employees and
consultants options to purchase an aggregate of 778,000 shares of Common Stock
(which includes options to purchase 748,000 shares of Common Stock granted to
directors, officers and employees of the Manager) at an exercise price equal to
the initial public offering price. The Company has also granted 400,000 shares
of deferred Common Stock to certain of its directors and officers. See "THE
MANAGER--Stock Options and Other Awards" and "THE COMPANY--Stock Incentive
Plan."
The Company will enter into the Management Agreement with the Manager
pursuant to which the Manager will be entitled to receive an annual base
management fee, a quarterly incentive fee and a non-competition fee in the event
of termination without cause or nonrenewal. Mr. Smirlock, the Chief Executive
Officer, President and majority stockholder of the Manager, is also the Chairman
of the Board, Chief Executive Officer and President of the Company. David A.
Tepper, a Director and indirect minority stockholder of the Manager, is also a
Director of the Company. See "THE MANAGER--The Management Agreement."
An Affiliated Fund has entered into a total rate of return swap (the "Total
Return Swap") with a broker-dealer which provides that the Affiliated Fund will
bear the economic benefit and risk of directly holding the 666,666 shares of the
Company's Common Stock purchased by such broker-dealer in the Private Placement.
TAX STATUS OF THE COMPANY
The Company intends to qualify and will elect to be taxed as a REIT under
the REIT Provisions of the Code commencing with its short taxable year ending
December 31, 1997. If the Company qualifies as a REIT, the Company generally
will not be subject to federal corporate income tax on taxable income that is
distributed to its stockholders. See "RISK FACTORS--Failure to Maintain REIT
Status Would Subject Company to Corporate Tax and Penalty Tax," "FEDERAL INCOME
TAX CONSIDERATIONS--Taxation of the Company" and "DESCRIPTION OF CAPITAL
STOCK--Repurchase of Shares and Restrictions on Transfer."
DISTRIBUTION POLICY
To maintain its qualification as a REIT, the Company must distribute
substantially all of its taxable income to stockholders each year, which the
Company intends to do. Each year, the Company intends to make four regular
quarterly distributions. To the extent necessary to maintain its qualification
as a REIT in any particular year, the Company will declare a fifth, special
distribution. The Company has adopted a Dividend Reinvestment and Direct
Purchase Plan that will allow stockholders to reinvest their distributions
automatically in additional shares of Common Stock. See "DISTRIBUTION POLICY"
and "DIVIDEND REINVESTMENT AND DIRECT PURCHASE PLAN."
11
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock Offered Hereby (1).............. 15,000,000 shares
Common Stock to be Outstanding
after the Offering (1)(2).................. 20,019,999 shares
Use of Proceeds.............................. The Company intends to use the net proceeds
of the Offering principally to acquire
Mortgage Assets. See "USE OF PROCEEDS."
NYSE Symbol.................................. LMM
</TABLE>
- ------------------------
(1) Assumes that the Underwriters' option to purchase up to an additional
2,250,000 shares to cover over-allotments is not exercised.
(2) Includes 5,013,999 shares subscribed for in the Private Placement, but does
not include 2,066,666 shares reserved for issuance under the Company's Stock
Incentive Plan. Options to acquire 778,000 shares at the initial public
offering price have been granted to employees, officers, directors and
consultants of the Company and the Manager. The Company has also granted
400,000 shares of deferred Common Stock to certain of its directors and
officers. See "THE COMPANY--Stock Incentive Plan" and "PRIVATE PLACEMENT."
12
<PAGE>
RISK FACTORS
AN INVESTMENT IN THE COMMON STOCK INVOLVES VARIOUS RISKS. IN ADDITION TO THE
OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE
CAREFULLY CONSIDERED IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE
PURCHASING THE SHARES OF COMMON STOCK OFFERED HEREBY.
CONFLICTS OF INTEREST OF THE MANAGER
The Company is subject to conflicts of interest involving the Manager. The
executive officers of the Company will be officers and employees of the Manager.
A majority of the Company's directors have no business affiliations with the
Manager, but were initially selected by the Manager. Michael L. Smirlock, the
Chief Executive Officer, President and a Director of the Company, is the owner
of a majority of the capital stock of the Manager. David A. Tepper, a Director
of the Company, is the indirect owner of a minority of the capital stock of the
Manager. Moreover, several members of the Board of Directors of the Company are
directors of the Manager. See "CERTAIN RELATIONSHIPS AND RELATED PARTY
TRANSACTIONS AND CONFLICTS OF INTEREST."
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; except that,
during the term of the Management Agreement; the Manager may not manage another
publicly-traded mortgage REIT or any additional private investment fund that
invest primarily in Mortgage Assets and follow investment strategies and
policies similar to those employed by the Company without the prior approval of
the Independent Directors. The Manager and its officers and employees advise and
manage private investment funds (the "Affiliated Funds") which invest in
Mortgage Securities. The ability of the Manager and its officers and employees
to engage in other business activities could reduce the time and effort the
Manager spends on managing the Company's investment portfolio. The Manager and
its officers and employees also may receive fees in connection with any
investment by the Affiliated Funds in the Company. In addition, the incentive
fee payable to the Manager by the Affiliated Funds or other clients may be
higher than the fee paid by the Company, creating additional conflicts of
interest.
Many investments appropriate for the Company also will be appropriate for
the accounts of other clients the Manager advises, including the Affiliated
Funds. The Manager will act in a manner which it considers fair and equitable in
allocating investment opportunities among the Company and the other accounts it
manages. Situations may arise in which the investment activities of the other
accounts may disadvantage the Company, such as the inability of the market to
fully absorb orders for the purchase or sale of particular securities placed by
the Manager for the Company and its other accounts at prices and in quantities
which would be obtained if the orders were being placed only for the Company.
The Manager, however, will not permit the Affiliated Funds or its other clients
to sell securities or other assets to or purchase securities or other assets
from the Company nor will any Affiliated Fund or other clients of the Manager
enter into derivative transactions with the Company. The Manager may aggregate
orders of the Company with orders for its other accounts. Such aggregation of
orders may not always be to the benefit of the Company with regard to the price
or quantity executed. The Manager will not reallocate assets among the Company
and the Affiliated Funds.
The incentive fee payable to the Manager is based upon the income received
by the Company. This may create an incentive for the Manager to recommend
investments with greater income potential, which generally are riskier or more
speculative than would be the case if its fees did not include a "performance"
component. Such incentives may result in increased risk to the value of the
Company's investment portfolio.
The Company has agreed that if it terminates the Management Agreement
without cause or the Board of Directors fails to approve a continuation of the
Management Agreement, or the Company engages another person to manage a portion
of its assets or to manage assets internally with personnel other than those
previously employed by the Manager, the Manager will be entitled to receive a
"Non-Competition Payment" in an amount equal to the fair market value of the
Management Agreement
13
<PAGE>
(without giving effect to any termination and assuming it is renewed in
accordance with its terms), to be determined in accordance with the provisions
of the Management Agreement.
NEWLY-ORGANIZED CORPORATION; NO ESTABLISHED FINANCING
The Company was organized in September 1997 and, therefore, has no operating
history and will commence operations only if it receives the proceeds of the
Offering and the Private Placement. The results of the Company's operations
depend on many factors, including the availability of opportunities for the
acquisition of assets, the level and volatility of interest rates, conditions in
the financial markets and economic conditions. The Company has not established
any lines of credit or collateralized financing facilities. There can be no
assurance that the Company will be able to obtain adequate financing and, if
such financing is available, that it will be available on favorable terms.
Furthermore, no assurance can be given that the Company will be able
successfully to operate its business as described in this Prospectus.
NO IDENTIFIED ASSETS; DISCRETIONARY USE OF PROCEEDS
The Company has not yet purchased or entered into any commitments to
purchase any Mortgage Assets or other securities. The Manager will exercise
significant discretion in investing and allocating the proceeds of the Offering
and the Private Placement.
CEASE-AND-DESIST ORDER AGAINST CHIEF EXECUTIVE OFFICER
On November 29, 1993, Mr. Smirlock consented to the entry of a
cease-and-desist order (the "Order") issued pursuant to Sections 203(f), 203(k)
and 206(2) (the anti-fraud provisions) of the Investment Advisers Act of 1940,
as amended (the "Advisers Act"), against him by the Commission in connection
with certain securities transactions executed between December 1992 and February
1993 while Mr. Smirlock was Chief Investment Officer for Goldman, Sachs Asset
Management ("GSAM"). The Commission found that Mr. Smirlock caused and aided and
abetted violations of the Advisers Act by (i) causing to be executed a series of
purchase transactions in Mortgage Securities for which he failed to promptly
prepare order tickets allocating the securities to specific client accounts and
(ii) causing to be executed two Mortgage Securities transactions between client
accounts without obtaining independent evaluations of the prices at which he
instructed the transactions to be executed in order to ensure that the best
price and execution were obtained for the clients. The Commission found that Mr.
Smirlock caused and aided and abetted violations of these recordkeeping
provisions by failing to write tickets allocating trades on the days the trades
were executed. The Commission (i) ordered Mr. Smirlock to cease and desist from
committing or causing any violation of the provisions of the Advisers Act set
forth in the Order, (ii) suspended him from association with any broker, dealer,
investment adviser, investment company or municipal securities dealer for a
three-month period and (iii) required him to pay a penalty of $50,000.
Contemporaneously with the entry of the Order, Mr. Smirlock submitted an Offer
of Settlement to the Commission, which the Commission accepted, in which he
consented to the Commission's entry of the Order, without admitting or denying
the findings set forth therein. GSAM had become aware of serious violations of
its internal compliance policies and reported these violations to the
Commission. In March 1993, following its report to the Commission, GSAM
suspended Mr. Smirlock's trading activities. Mr. Smirlock resigned from GSAM and
Goldman, Sachs & Co. effective November 30, 1993. No limitations will be imposed
on Mr. Smirlock's activities in his roles at the Manager and the Company in
light of this proceeding and the Order. See "THE MANAGER--Cease-and-Desist Order
Against Chief Executive Officer."
TOTAL RELIANCE ON THE MANAGER; TERMINATION OF THE MANAGEMENT AGREEMENT
The Company's day-to-day operations will be administered by the Manager,
subject to the supervision of the Company's Board of Directors. Thus, the
Company is totally reliant on the services of the Manager and its officers,
directors and employees for the success of the Company. The Manager will have
significant operating discretion, including as to the use of proceeds of the
Offering and in developing the Company's operating policies. The Company is
subject to the risk that the Manager will terminate the Management Agreement and
that no suitable replacement will be found to manage the Company. The Company
and the
14
<PAGE>
Manager may terminate the Management Agreement at any time upon 60 days' written
notice to the other party. The Company would be materially and adversely
affected if it were unable to engage an appropriate replacement for the Manager.
The Manager and its investment professionals have no prior experience in
managing a REIT, and there can be no assurance that the past experience of the
Manager's investment management personnel will be appropriate to the Company's
business or strategy. 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, except that during the term of the agreement, the Manager will not serve
as an investment adviser to any other publicly-traded mortgage REIT, or any
additional private investment fund that invests primarily in Mortgage Assets and
follows investment strategies and policies similar to those employed by the
Company without the written approval of the Independent Directors. In addition,
the Management Agreement does not impose a minimum time commitment that the
Manager and its personnel must make in providing services to the Company. The
ability of the Manager and its employees to engage in other business activities
could reduce the time and effort spent by the Manager and its employees on the
management of the Company. See "THE MANAGER."
RESULTS OF OPERATIONS ADVERSELY AFFECTED BY FACTORS BEYOND COMPANY'S CONTROL
The Company's results of operations can be adversely affected by various
factors, many of which are beyond the control of the Company, and will depend
on, among other things, the level of net interest income generated by, and the
market value of, the Company's investment portfolio. The Company's net interest
income and results of operations will vary primarily as a result of fluctuations
in short-term interest rates, borrowing costs and prepayment rates. The
Company's results of operations also will depend upon the Company's ability to
protect against the adverse effects of such fluctuations as well as credit
risks. Interest rates, prepayment rates, credit risks, borrowing costs and
credit losses depend upon the nature and terms of the Mortgage Assets and other
securities, conditions in financial markets, the fiscal and monetary policies of
the U.S. government and the Board of Governors of the Federal Reserve System,
international economic and financial conditions and competition, none of which
can be predicted with any certainty. Because changes in interest rates may
significantly affect the Company's investment activities, the operating results
of the Company will depend, in large part, upon the ability of the Company to
manage its interest rate, prepayment rate and credit risks effectively while
maintaining its status as a REIT. See "-- Consequences and Costs of Hedging
Transactions," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS" and "BUSINESS--Operating Policies and Strategies."
SUBSTANTIAL LEVERAGE CAN RESULT IN NET INTEREST AND OPERATING LOSSES
LEVERAGING STRATEGY
The Company intends to borrow against, or "leverage," its Mortgage Assets in
order to acquire additional Mortgage Assets, generally through the use of
reverse repurchase agreements, dollar roll agreements, Mortgage Loan
securitizations, loan agreements, lines of credit, commercial paper borrowings
and other credit facilities. The Company expects to incur debt such that it will
maintain an equity-to-assets ratio of between 6% to 10%, although the actual
ratio may be higher or lower from time to time, depending on market conditions
and other factors deemed relevant by the Manager, subject to the review of the
Company's Board of Directors. The equity-to-assets ratio is total stockholders'
equity, determined in accordance with GAAP, as a percentage of total assets. For
purposes of calculating the equity-to-assets ratio, the Company's total assets
include the value of the Company's investment portfolio on a marked-to-market
basis. For purchased Mortgage Assets, the Company obtains market quotes for its
Mortgage Assets from independent broker-dealers that make markets in securities
similar to those in the Company's portfolio or from pricing services approved by
the Company's Independent Directors. The Company's total
15
<PAGE>
stockholders' equity, for purposes of this calculation, equals the Company's
stockholders' equity determined in accordance with GAAP. See
"BUSINESS--Operating Policies and Strategies--Capital and Leverage Policies" and
"BUSINESS--Operating Policies and Strategies--Securitization."
Leverage can reduce the net income available for distributions to
stockholders. If the interest income on the Mortgage Assets purchased with
borrowed funds fails to cover the cost of the borrowings, the Company will
experience net interest losses and may experience net losses. Such losses could
be increased substantially as a result of the leveraging strategy. The
percentage of leverage will vary depending on the Company's estimate of the
stability of the portfolio's cash flow. To the extent changes in market
conditions cause the cost of such financing to increase relative to the income
that can be derived from the assets acquired, the Company may reduce the amount
of leverage it utilizes.
The ability of the Company to achieve its investment objectives depends on
its ability to borrow money in sufficient amounts and on favorable terms. The
Company may not be able to achieve the degree of leverage it believes to be
optimal due to increases in "haircuts" (I.E., the collateral required by a
lender in excess of the amount borrowed), decreases in the market value of the
Company's Mortgage Assets, increases in interest rate volatility, changes in the
availability of financing in the market, conditions then applicable in the
lending market and other factors. This may cause the Company to be less
profitable than it would otherwise be and, in some cases, to experience losses.
BORROWING RISKS; MARGIN CALLS
A substantial portion of the Company's borrowings are expected to be in the
form of collateralized borrowings, primarily reverse repurchase agreements. The
amount borrowed under a reverse repurchase agreement is based on the market
value of the Mortgage Assets pledged to secure specific borrowings. Under
adverse market conditions, the value of pledged Mortgage Assets would decline,
and lenders could initiate margin calls (I.E., the Company could be required to
post additional collateral or to reduce the amount borrowed to restore the ratio
of the amount of the borrowing to the value of the collateral). The Company may
be required to sell Mortgage Assets to reduce the amount borrowed. 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 also could result in a liquidation of the collateral.
If the Company is forced to liquidate Mortgage Assets that qualify as Qualified
Real Estate Assets to repay borrowings, there can be no assurance that it will
be able to maintain compliance with the REIT Provisions of the Code regarding
asset and source of income requirements. See "FEDERAL INCOME TAX
CONSIDERATIONS--Requirements for Qualification."
NO RESTRICTION ON THE INCURRENCE OF ADDITIONAL INDEBTEDNESS
The Company's investment policy and operating strategy does not restrict the
Company from incurring additional indebtedness. The Company is not subject to
any other restriction on the incurrence of additional indebtedness. The Company
intends to borrow against or "leverage" its Mortgage Assets in order to acquire
additional Mortgage Assets. The Company expects to incur debt such that it will
maintain an equity-to-assets ratio of between 6% to 10%, although the actual
ratio may be higher or lower from time to time depending on market conditions
and other factors deemed relevant by the Manager, subject to the review of the
Company's Board of Directors. See "--Substantial Leverage Can Result in Net
Interest and Operating Losses--Leveraging Strategy."
RISK OF POTENTIAL FUTURE OFFERINGS; DILUTION
The Company, in the future, may increase its capital resources by making
offerings of additional equity and debt securities, including classes and series
of preferred stock, additional classes and series of common stock, commercial
paper, medium-term notes and senior or subordinated notes. All debt securities
and classes of preferred stock will be senior to the Common Stock in a
liquidation of the Company. The effect of additional equity offerings (including
issuances under the Dividend Reinvestment and Direct Purchase Plan) may be to
dilute the equity of stockholders of the Company or to reduce the
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<PAGE>
price of shares of the Common Stock, or both. The Company is unable to estimate
the amount, timing or nature of additional offerings as they will depend upon
market conditions and other factors.
INTEREST RATE FLUCTUATIONS WILL AFFECT VALUE OF MORTGAGE ASSETS AND NET INCOME
GENERAL
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
considerations and other factors beyond the control of the Company. Interest
rate fluctuations can adversely affect the income and value of the Company in
many ways and present a variety of risks, including the risk of a mismatch
between asset yields and borrowing rates, reshaping of the yield curve and
changing prepayment rates. The Company intends to enter into hedging
transactions in an effort to protect its portfolio of Mortgage Assets and
related debt from interest rate fluctuations. See "--Consequences and Costs of
Hedging Transactions."
FAILURE TO MANAGE MISMATCH BETWEEN LONG-TERM ASSETS AND SHORT-TERM FUNDING
The Company's operating results will depend in large part on differences
between the income from its Mortgage Assets and its borrowing costs. The Company
anticipates that at least 65% of its Mortgage Assets will have interest payment
rates (I.E., coupon rates) which remain fixed for periods of 30 years or more
until their maturity. The Company intends to fund a substantial portion of its
Mortgage Assets with borrowings having interest rates (I.E., borrowing rates)
that reset more frequently, usually monthly or quarterly. If interest rates
rise, borrowing rates (and borrowing costs) of the Company are expected to rise
more quickly than coupon rates (and investment income) on the Company's Mortgage
Assets. This would decrease the Company's net income (or result in a net loss)
and the mark-to-market value of the Company's net assets, and would be expected
to decrease the market price of the Company's Common Stock. Although the Company
intends to invest primarily in fixed-rate Mortgage Assets, the Company also may
own adjustable rate Mortgage Assets. The coupon rates of adjustable rate
Mortgage Assets normally fluctuate with reference to a specific rate index. The
Company intends to fund these adjustable rate Mortgage Assets with borrowings
having borrowing rates which reset monthly or quarterly. To the extent that
there is a difference between (i) the interest rate index used to determine the
coupon rate of the adjustable rate Mortgage Asset (asset index) and (ii) the
interest rate index used to determine the borrowing rate for the Company's
related financing (borrowing index), the Company will bear a "basis" interest
rate risk. If the borrowing index rises more than the asset index, the net
income of the Company would be decreased. Additionally, the Company's adjustable
rate Mortgage Assets may be subject to periodic rate adjustment limitations and
periodic and lifetime rate caps which limit the amount that the coupon rate can
change during any given period. In a period of increasing interest rates, the
Company could experience a decrease in net income or a net loss because its
borrowing rates may adjust and rise more quickly than the coupon rates on its
adjustable rate Mortgage Assets. No assurance can be given as to the amount or
timing of changes in interest rates or their effect on the Company's Mortgage
Assets, their valuation or income derived therefrom. During periods of changing
interest rates, coupon rate and borrowing rate mismatches could negatively
impact the Company's net income, distribution yield and the market price of the
Common Stock. Interest rate fluctuations resulting in interest expense exceeding
interest income would result in the Company incurring operating losses.
INVERTED YIELD CURVE ADVERSELY AFFECTS INCOME
The relationship between short-term and long-term interest rates is often
referred to as the "yield curve." Ordinarily, short-term interest rates are
lower than long-term interest rates. If short-term interest rates rise
disproportionately relative to long-term interest rates (a flattening of the
yield curve), the borrowing costs of the Company may increase more rapidly than
the interest income earned on its assets. Because borrowings will likely bear
interest at short-term rates (such as LIBOR) and Mortgage Assets will likely
bear interest at medium-term to long-term rates (such as those calculated based
on the Ten-Year U.S. Treasury Rate), a flattening of the yield curve will tend
to decrease the Company's net income and the mark-to-market value of its net
assets. Additionally, to the extent cash flows from long-term assets that
17
<PAGE>
return scheduled and unscheduled principal are reinvested in other long-term
assets, the spread between the coupon rates of long-term assets and short-term
borrowing rates may decline and also may tend to decrease the net income and
mark-to-market value of the Company's net assets. It is also possible that
short-term interest rates may adjust relative to long-term interest rates such
that the level of short-term rates exceeds the level of long-term rates (a yield
curve inversion). In this case, borrowing costs may exceed the interest income
and operating losses would be incurred.
INCREASED PREPAYMENT RATES WILL REDUCE VALUE OF MORTGAGE ASSETS
The value of Mortgage Assets may be affected substantially by prepayment
rates on the related Mortgage Loans. Prepayments are unscheduled payments of
principal made by mortgage borrowers, who generally are permitted to prepay
their borrowings at any time. Mortgage Securities traders have statistically
modelled borrower prepayment patterns over time, and Mortgage Securities
typically are valued based on these models and estimated prepayments. Actual
prepayments may vary significantly from estimates and, as a result, Mortgage
Security prices may fluctuate significantly as expectations of prepayment rates
change. Prepayment risk must be considered in conjunction with the credit risk
associated with certain Mortgage Assets. See "--Possible Losses on Mortgage
Loans During Warehousing Period" and "--Credit Risks."
Prepayment rates on Mortgage Assets are influenced by changes in current
interest rates and a variety of economic, geographic and other factors beyond
the control of the Company and cannot be predicted with certainty. In periods of
declining mortgage interest rates, prepayments on Mortgage Assets generally
increase. If general interest rates decline as well, the proceeds of such
prepayments received during such periods are likely to be reinvested by the
Company in assets yielding less than the yields on the Mortgage Assets that were
prepaid. In addition, the mark-to-market value of the Mortgage Assets may,
because of the risk of prepayment, benefit less than other fixed-income
securities from declining interest rates. Conversely, in periods of rising
interest rates, prepayments on Mortgage Assets generally decrease; therefore,
the Company will not have the proceeds from prepayments available to invest in
assets with higher yields. If interest rates decrease and prepayment rates
increase, the Company may fail to recoup fully its cost of acquisition of
certain investments.
The Company may acquire classes of Mortgage Securities that are entitled to
no (or only nominal) payments of principal, but only to payments of interest,
such as IOs. The yield to maturity of IOs is very sensitive to the rate of
prepayments on the underlying Mortgage Loans. If the rate of prepayments is
faster than anticipated, the yield on IOs will be negatively affected, and, in
extreme cases, the IO investment could become worthless. Some IOs bear interest
at a floating rate that varies inversely with (and often at a multiple of)
changes in a specified interest rate index ("Inverse IOs"). Therefore, the yield
to maturity of an Inverse IO is extremely sensitive to changes in the related
index. The Company also expects to invest in subordinated IOs ("Sub IOs").
Interest amounts otherwise allocable to Sub IOs generally are used to make
payments on more senior classes or to fund a reserve account for the protection
of senior classes until overcollateralization occurs or the balance in the
reserve account reaches a specified level. The yield to maturity of Sub IOs is
very sensitive not only to default losses but also to the rate and timing of
prepayment on the underlying loans. See "BUSINESS--Operating Policies and
Strategies." Under certain interest rate and prepayment scenarios, the Company
may fail to recoup fully the cost of acquiring IOs, Inverse IOs and Sub IOs.
CONSEQUENCES AND COSTS OF HEDGING TRANSACTIONS
The Company intends to enter into hedging transactions in an effort to
protect its portfolio of Mortgage Assets and related debt from interest rate
fluctuations. These transactions may include interest rate swaps, the purchase
or sale of interest rate collars, caps or floors, options and IOs. There can be
no assurance that the Company's hedging activities will have the desired
beneficial impact on the Company's results of operations or financial condition.
Moreover, no hedging activity can completely insulate the Company from the risks
associated with changes in interest rates and prepayment rates.
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Hedging involves risk and typically involves costs, including transaction
costs. Such costs increase dramatically as the period covered by the hedging
increases and during periods of rising and volatile interest rates. The Company
may increase its hedging activity and, thus, increase its hedging costs, during
such periods when interest rates are volatile or rising and hedging costs have
increased. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS--Hedging" and "BUSINESS--Operating Policies and
Strategies--Hedging Activities."
The Company intends generally to hedge as much of the interest rate risk as
the Manager determines is in the best interests of the stockholders of the
Company given the cost of such hedging transactions and the need to maintain the
Company's status as a REIT. The Company has not established specific policies as
to the extent of the hedging transactions in which it will engage; however, the
Independent Directors will be responsible for reviewing at their regular
meetings the extent and effect of hedging activities. The amount of income the
Company may earn from its hedging instruments is subject to substantial
limitations under the REIT Provisions of the Code. In particular, when the
Company earns income under such instruments, it will seek advice from Special
Tax Counsel as to whether such income constitutes qualifying income for purposes
of the 95% Gross Income Test and as to the proper characterization of such
arrangements for purposes of the REIT Asset Tests. The "95% Gross Income Test"
means the requirement for each taxable year that at least 95% of the Company's
gross income for each taxable year must be derived from certain specified real
estate sources including interest income and gain from the disposition of
Qualified Real Estate Assets or "qualified temporary investment income" (I.E.,
income derived from "new capital" within one year of the receipt of such
capital), dividends, interest and gains from the sale of stock or other
securities (including certain interest rate swap or cap agreements, options,
forward rate agreements and similar financial instruments entered into to reduce
the interest rate risk with respect to debt incurred to acquire Qualified Real
Estate Assets) not held for sale in the ordinary course of business. See
"FEDERAL INCOME TAX CONSIDERATIONS--Requirements for Qualification--Gross Income
Tests." This determination may result in the Manager electing to have the
Company bear a level of interest rate risk that could otherwise be hedged when
the Manager believes, based on all relevant facts, that bearing such risk is
advisable to maintain the Company's status as a REIT.
Hedging instruments often are not traded on regulated exchanges, guaranteed
by an exchange or its clearing house, or regulated by any U.S. or foreign
governmental authorities. Consequently, there are no requirements with respect
to record keeping, financial responsibility or segregation of customer funds and
positions. Furthermore, the enforceability of agreements underlying derivative
transactions may depend on compliance with applicable statutory and commodity
and other regulatory requirements, and, depending on the identity of the
counterparty, applicable international requirements. The business failure of a
counterparty with which the Company has entered into a hedging transaction will
most likely result in a default. The default of a party with which the Company
has entered into a hedging transaction may result in the loss of unrealized
profits and force the Company to cover its resale commitments, if any, at the
then current market price. Although generally the Company will seek to reserve
for itself the right to terminate its hedging positions, it may not always be
possible to dispose of or close out a hedging position without the consent of
the counterparty, and the Company may not be able to enter into an offsetting
contract in order to cover its risk. There can be no assurance that a liquid
secondary market will exist for hedging instruments purchased or sold, and the
Company may be required to maintain a position until exercise or expiration,
which could result in losses.
COMPETITION FOR MORTGAGE ASSETS AT FAVORABLE YIELDS AND FOR FINANCING
The Company's net income depends, in large part, on the Company's ability to
acquire Mortgage Assets at favorable spreads over the Company's borrowing costs.
In acquiring Mortgage Assets, the Company competes with other mortgage REITs,
specialty finance companies, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, institutional investors, investment
banking firms, other lenders, FHLMC, FNMA, GNMA and other entities purchasing
Mortgage Assets. In addition, there are several mortgage REITs with asset
acquisition objectives similar to the Company, and
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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. Many of the Company's competitors for
Mortgage Assets may have access to greater capital and other resources and may
have other advantages over the Company.
There can be no assurance that the Company will be able to obtain financing
at borrowing rates below the asset yields of its Mortgage Assets. In such event,
the Company may incur losses or may be forced to reduce the size of its Mortgage
Asset portfolio. The Company will face competition for financing sources which
may limit the availability of, and affect the cost of, funds to the Company.
VALUE OF CMOS MAY BE ADVERSELY AFFECTED BY PREPAYMENTS ON UNDERLYING COLLATERAL
CMOs are a series of bonds or certificates, each of which typically consists
of several classes with different maturities and often complex priorities of
payment, secured by a single pool of Mortgage Loans, Pass-Through Certificates,
other CMOs or other Mortgage Assets. Principal prepayments on collateral
underlying a CMO may cause it to be retired substantially earlier than the
stated maturities or final distribution dates. The principal and interest on
underlying Mortgages Loans may be allocated among the several classes of a
series of a CMO in many ways. Depending on the type of CMOs in which the Company
invests, the investment may be more sensitive to interest rate fluctuations and
prepayment rates than other types of Mortgage Securities. See "DESCRIPTION OF
PROPOSED ASSETS."
VALUE OF MORTGAGE DERIVATIVES MAY BE REDUCED OR ELIMINATED DUE TO INTEREST RATE
FLUCTUATIONS; NO LIMIT ON MORTGAGE DERIVATIVES
The Company may acquire an unlimited amount of Mortgage Derivatives,
including IOs, Inverse IOs, Sub IOs and floating rate Mortgage Derivatives.
Payments on and the market value of Mortgage Derivatives are highly sensitive to
the rate of prepayments on the underlying Mortgage Loans and are highly
sensitive to interest rate fluctuations. IOs provide for the holder to receive
no (or only nominal) payments of principal, but only payments of interest.
Payments on IOs are highly sensitive to the rate of prepayment on the underlying
Mortgage Loans. In periods of declining interest rates, rates of prepayments on
the Mortgage Loans generally increase, and if the rate of prepayments is faster
than anticipated, then the yield on IOs will be adversely affected. Under some
prepayment and interest rate scenarios, the Company may not be able to recoup
fully the cost of acquiring an IO, Inverse IO or Sub IO and, consequently, will
incur a loss on its investment.
In higher than expected prepayment and/or declining interest rate
environments, the ability to utilize Inverse IOs and Sub IOs as capital for
collateralized borrowings will be impaired. To the extent that Inverse IOs and
Sub IOs decrease in value, the Company likely will be required by its lenders to
provide additional capital for borrowings collateralized with Inverse IOs and
Sub IOs to compensate for the decline in their market value. If additional
capital is unavailable, the Company may be forced to liquidate securities into
illiquid markets and incur losses. Additionally, in such environments, lenders
may require additional capital as a percentage of the market value of the
Inverse IOs or Sub IOs (a higher capital "haircut") or may not provide
collateralized funding of Inverse IOs or Sub IOs. The requirement for additional
capital to support collateralized funding or the inability to obtain
collateralized borrowing of Inverse IOs or Sub IOs will reduce the Company's
liquidity and will require it to obtain more expensive funding.
Some IOs in which the Company may invest, such as Inverse IOs, bear interest
at a floating rate that varies inversely to (and often at a multiple of) changes
in a specific index. The Company also may invest in inverse floating rate
Mortgage Derivatives which are similar in structure and risk to Inverse IOs,
except they generally are issued with a greater stated principal amount than
Inverse IOs. The Company may invest in Inverse IOs for the purpose of, among
other things, hedging its portfolio of IOs. The yield to maturity of an Inverse
IO is extremely sensitive to changes in the related index.
The Company also expects to invest in Sub IOs, a class of securities for
which interest generally is withheld and used to make principal payments on more
senior classes or to fund a reserve account for the
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protection of senior classes until overcollateralization or the balance in the
reserve account reaches a specified level. Interest on a Sub IO generally will
be paid only after the overcollaterization or the balance in the reserve account
reaches the specified level. Sub IOs provide credit support to the senior
classes, and thus bear substantial credit risk. Moreover, because Sub IOs
receive only interest payments, their yields are extremely sensitive to the rate
of prepayments (including prepayments as a result of defaults) on the underlying
Mortgage Loans. In addition, Sub IOs often generate taxable income in excess of
cash received.
The Company may invest in variable and floating rate securities that provide
for a periodic adjustment in the interest rate paid on the other obligations.
The Company may not be able to match these periodic rate adjustments with
increases or decreases in rates borne by the borrowings or financings utilized
by the Company. Accordingly, in a period of increasing interest rates, the
Company could experience a decrease in net interest income or a net loss because
the interest rates on borrowings could adjust faster than the interest rates of
the Company's floating rate securities. See "DESCRIPTION OF PROPOSED ASSETS."
VALUE OF SUBORDINATE INTERESTS MAY BE ADVERSELY AFFECTED BY LOSSES ON UNDERLYING
MORTGAGE LOANS
The Company intends to retain a Subordinate Interest in the pools of
Mortgage Loans it securitizes and to acquire Subordinate Interests in pools of
Mortgage Loans securitized by others. Subordinate Interests bear significant
credit risks because they are structured to absorb losses from defaults or
foreclosures on the related Mortgage Loan collateral before losses are allocated
to more senior classes. Subordinate Interests will be more sensitive than other
Mortgage Securities to the frequency and the severity of losses on the
underlying Mortgage Loans. Loss frequency will depend upon a number of factors,
including economic conditions and interest rate fluctuations, beyond the control
of the Company. There can be no assurance that the Company's investment in a
Subordinate Interest will be returned in full or at all. See "DESCRIPTION OF
PROPOSED ASSETS."
INVESTMENT IN NON-REAL ESTATE ASSETS SUBJECT TO LIQUIDITY AND CREDIT RISKS;
LIMIT ON SUCH ASSETS MAY CHANGE WITHOUT STOCKHOLDER APPROVAL
The Company may invest up to 5% of the total assets in other fixed income
assets. This 5% limit may be changed from time to time at the discretion of the
Board of Directors, with the approval of the Independent Directors but without a
vote of stockholders. These other fixed-income assets may include securities
issued or guaranteed by foreign governments, non-investment grade high yield
corporate debt (commonly referred to as "junk bonds") and non-real estate loans.
Investing in securities issued by foreign governments or foreign companies
involves considerations and potential risks not typically associated with
investing in obligations issued by the U.S. government, agencies thereof and
domestic corporations. Such obligations are often unsecured and are subject to
greater credit and liquidity risk than is typically associated with investment
grade corporate obligations. They are also subject to, and may be adversely
affected by, risks associated with political and economic uncertainty,
fluctuations of currency exchange rates, lower levels of disclosure and
regulation in foreign securities markets than in the United States, risks of
nationalization, expropriation, confiscatory taxation, taxation of income earned
in foreign nations or other taxes imposed with respect to investments in foreign
nations, foreign exchange controls (which may include suspension of the ability
to transfer currency from a given country and repatriation of investments) and
uncertainties as to the status, interpretation and application of laws. In
addition, there is often less publicly available information about foreign
issuers than those in the United States. Foreign issuers may not be subject to
uniform accounting, auditing and financial reporting standards and auditing
practices, and even in the case of issuers that are subject to uniform standards
and practices, such standards and practices will generally not be comparable to
those applicable to U.S. companies.
Junk bonds are generally unsecured, may be subordinated to other obligations
of the issuer and generally have greater credit and liquidity risk than is
typically associated with investment grade corporate obligations. Junk bonds are
often issued in connection with leveraged acquisitions or recapitalizations in
which the issuers incur a substantially higher amount of indebtedness than the
level at which they had
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previously operated. High-yield debt obligations have historically experienced
greater default rates than has been the case for investment grade securities.
Investing in a non-real estate loans involves greater liquidity risk because
they are generally not traded in organized exchange markets but are traded by
banks and other institutional investors. In some cases, non-real estate loans
are subject to greater credit risks than is typically associated with investment
grade corporate obligations. Such loans may be subject to, and may be adversely
affected by, risks associated with lender liability. In addition, such loans may
be sold without recourse to the selling institutions, and the selling
institutions will generally make no representations and warranties about the
underlying loan, the borrower, the documentation of the loans or any collateral
securing the loans. See "DESCRIPTION OF PROPOSED ASSETS."
POSSIBLE LOSSES ON MORTGAGE LOANS DURING WAREHOUSING PERIOD
The Company intends to acquire and accumulate Mortgage Loans for
securitization as part of its investment strategy. The Manager, in its
discretion, will determine the quantity of Mortgage Loans sufficient for
securitization (which generally will be at least $100 million) after discussions
with potential underwriters, rating agencies and monoline insurers and an
evaluation of the costs of securitization. During the accumulation period, the
Company will be subject to risks of borrower defaults, bankruptcies, fraud and
losses and special hazard losses that are not covered by standard hazard
insurance. However, prior to securitization, the Company generally does not
intend to obtain credit enhancements such as mortgage pool or hazard insurance.
Typically, third parties insure against these types of losses, and the Company
would be dependent on the creditworthiness of the insurer and timeliness of the
reimbursement in the event of a default on the underlying obligations. Further,
the insurance coverage for various type of losses is limited in amount, and
losses in excess of the limitation would be the responsiblity of the Company. 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 or warehousing period, the costs of
financing and hedging the Mortgage Loans could exceed the interest income on the
Mortgage Loans. No assurance can be given that any mortgage, fraud or hazard
insurance will adequately cover a loss suffered by the Company. It may not be
possible or economical for the Company to securitize all of the Mortgage Loans
which it acquires, in which case the Company will continue to hold the Mortgage
Loans and bear the risks of borrower defaults, bankruptcies, fraud losses and
special hazard losses. Furthermore, if the Company retains a Subordinate
Interest in the securitizations, it will retain many of these risks. See
"DESCRIPTION OF PROPOSED ASSETS--Mortgage Loans" and "CERTAIN CHARACTERISTICS OF
MORTGAGE LOANS AND REAL PROPERTY INVESTMENTS."
The Company expects that when it acquires Mortgage Loans, the seller of the
Mortgage Loans (the "Mortgage Seller") generally 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 loan with
respect to which there is fraud or misrepresentation. Although the Company will
have recourse to the Mortgage Seller based on the Mortgage Seller's
representations and warranties to the Company, the Company will be at risk for
loss to the extent the Mortgage Seller does not or cannot perform its repurchase
obligations. The Company intends to acquire third party insurance, to the extent
that it is available at a reasonable price, for such risks. If the Company is
unable or fails to acquire such insurance, the Company would be relying solely
on the value of the collateral underlying the Mortgage Loans.
In addition, substantial delays could be encountered in connection with the
foreclosure of defaulted Mortgage Loans, with corresponding delays in the
receipt of related proceeds by the Company. State and local statutes and rules
may delay or prevent the Company's foreclosure on or sale of the mortgaged
property and may prevent the Company from receiving new proceeds sufficient to
repay all amounts due on the related Mortgage Loan. Moreover, the Company's
servicing agent may be entitled to receive all expenses reasonably incurred in
attempting to recover amounts due and not yet repaid on liquidated Mortgage
Loans, thereby reducing amounts available to the Company.
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LACK OF ACCESS TO SECURITIZATIONS WOULD ADVERSELY AFFECT THE COMPANY
The Company intends to rely upon securitizations of Mortgage Loans to
generate cash proceeds for the purchase of additional Mortgage Loans. Several
factors will affect the Company's ability to complete securitizations, including
conditions in the securities markets generally, conditions in the
mortgage-backed securities market specifically, the credit quality of the
Company's portfolio of Mortgage Loans and the Company's ability to obtain credit
enhancement. If the Company were unable to successfully securitize a sufficient
amount of Mortgage Loans, then the Company would have to rely on other, more
expensive short-term methods of financing, or curtail or reduce its acquisition
of Mortgage Loans. There can be no assurance that the Company will be able to
successfully securitize any Mortgage Loans which it acquires or, if it is not
successful, that the Company will obtain financing alternatives to
securitization or that if such financing is available, that it will be available
on favorable terms.
CREDIT RISKS
The Company intends to invest primarily in Mortgage Securities and Mortgage
Loans which would be classified in the 70% Asset Group, as well as Mortgage
Loans and Mortgage Securities that constitute the 30% Asset Group. The Company's
investment strategy will seek to balance the risk and return potential of its
investments in a manner that attempts to maximize return while minimizing the
risk of loss to the Company through adverse events, including, without
limitation, credit and prepayment events that may decrease the income earned
from, and value of, the portfolio. The Company will not perform an independent
credit review of the Mortgage Loans it intends to purchase.
FAILURE TO MAINTAIN REIT STATUS WOULD SUBJECT COMPANY TO CORPORATE TAX AND
PENALTY TAX
The Company intends to operate in such a manner as to qualify as a REIT for
federal income tax purposes. Although the Company does not intend to request a
ruling from the Service as to its REIT status, upon consummation of the
Offering, the Company will receive an opinion of its Special Tax Counsel that,
based on certain assumptions and representations, it will so qualify. Investors
should be aware, however, that opinions of counsel are not binding on the
Service or any court. The REIT qualification opinion only represents the view of
Special Tax Counsel to the Company based on counsel's review and analysis of
existing law, which includes no controlling precedent. Furthermore, both the
validity of the opinion and the continued qualification of the Company as a REIT
will depend on the Company's satisfaction of certain asset, income,
organizational, distribution and stockholder ownership requirements on a
continuing basis. If the Company were to fail to qualify as a REIT in any
taxable year, the Company would be subject to federal income tax (including any
applicable alternative minimum tax) on its taxable income at regular corporate
rates, and distributions to stockholders would not be deductible by the Company
in computing its taxable income and the Company may be subject to a 4% federal
excise tax. Any such corporate tax liability could be substantial and would
reduce the amount of cash available for distribution to stockholders, which in
turn could have an adverse impact on the value of, and trading prices for, the
Common Stock. Unless entitled to relief under certain Code provisions, the
Company also would be disqualified from taxation as a REIT for the four taxable
years following the year during which the Company ceased to qualify as a REIT.
See "FEDERAL INCOME TAX CONSIDERATIONS."
The Company must distribute at least 95% of its net taxable income annually
(excluding any net capital gain and certain non-cash income) to avoid corporate
income taxation of the earnings that it distributes (the "95% Distribution
Requirement"). In addition, the Company will be subject to a 4% non-deductible
excise tax on the amount, if any, by which certain distributions paid by it with
respect to any calendar year are less than the sum of (i) 85% of its ordinary
income for that year, (ii) 95% of its capital gain net income for that year, and
(iii) 100% of its undistributed taxable income from prior years.
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The Company intends to make distributions to its stockholders to comply with
the 95% Distribution Requirement and to avoid the nondeductible excise tax.
However, differences in timing between the recognition of taxable income and the
actual receipt of cash could require the Company to borrow funds or sell assets
on a short-term basis to satisfy the 95% Distribution Requirement or to avoid
the non-deductible excise tax. The requirement to distribute a substantial
portion of the Company's net taxable income could cause the Company (i) to sell
assets in adverse market conditions, (ii) to distribute amounts that represent a
return of capital, or (iii) to distribute amounts that would otherwise be spent
on future investments or repayment of debt.
Gain from the disposition of any asset held primarily for sale to customers
in the ordinary course of business generally will be subject to a 100% tax.
PLEDGED ASSETS AND RISK OF BANKRUPTCY IN REVERSE REPURCHASE AGREEMENTS
Substantially all of the Mortgage Assets will be pledged to secure reverse
repurchase agreements, bank borrowings or other credit arrangements, including
securitizations. Therefore, such Mortgage Assets may not be available to the
stockholders in the event of the liquidation of the Company, except to the
extent that the market value thereof exceeds the amounts due to the Company's
creditors. The market value of the Mortgage Assets will fluctuate as a result of
numerous market factors (including interest rates and prepayment rates) as well
as the supply of and demand for such assets. In the event of the bankruptcy of a
party with whom the Company has a reverse repurchase agreement, the Company
could experience difficulty recovering the pledged assets under such agreement
if it were to be repudiated and the Company's claim against the bankrupt lender
for damages resulting therefrom were to be treated simply as one of an unsecured
creditor. Should this occur, the Company's claims would be subject to
significant delay and any recoveries, if and when received, may be substantially
less than the damages actually suffered by the Company. Although the Company
intends to enter into reverse repurchase agreements with several different
parties and has developed policies to reduce its exposure to such risks, no
assurance can be given that the Company will be able to avoid such third party
risks. See "BUSINESS--Operating Policies and Strategies--Capital and Leverage
Policies."
POSSIBLE ENVIRONMENTAL LIABILITIES
The Company may become subject to environmental risks when taking an
interest in real property upon foreclosure of a Mortgage Loan. Such
environmental risks include the risk of the diminution of the value of a
contaminated property or liability for the costs of compliance with
environmental regulatory requirements or the costs of clean-up or other remedial
actions. The costs of investigation, remediation or removal of hazardous
substances could be substantial. These compliance or clean-up costs could exceed
the value of the property or the amount of the Mortage Loan. There can be no
assurance that the Company will not incur any material costs or liabilites with
respect to such matters. See "CERTAIN CHARACTERISTICS OF MORTGAGE LOANS AND REAL
PROPERTY INVESTMENTS--Environmental Risks."
FAILURE TO MAINTAIN INVESTMENT COMPANY ACT EXEMPTION WOULD ADVERSELY AFFECT
RESULTS OF OPERATIONS
The Company believes that it will not be, and intends to conduct its
operations so as not to become, regulated as an "investment company" under the
Investment Company Act of 1940, as amended (the "Investment Company Act"). The
Investment Company Act exempts entities that, directly or through majority-owned
subsidiaries, are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate"
("Qualifying Interests"). Under current interpretations by the Staff of the
Commission, to qualify for this exemption, the Company, among other things, must
maintain at least 55% of its assets in Qualifying Interests (the "55%
Requirement") and also may be required to maintain an additional 25% in
Qualifying Interests or other real estate-related assets. The assets that the
Company may acquire, therefore, may be limited by the provisions of the
Investment Company Act. In connection with its acquisition of Subordinated
Interests, the Company intends, where appropriate, to obtain foreclosure rights
with respect to the underlying Mortgage Loans, although there can be no
assurance that it will be able to do so on acceptable terms. As a result of
obtaining such rights,
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the Company believes that the related Subordinated Interests will constitute
Qualifying Interests for the purpose of the Investment Company Act. In addition,
in meeting the 55% Requirement, the Company intends to consider Privately-Issued
Certificates issued with respect to an underlying pool as to which the Company
holds all issued certificates as Qualifying Interests. The Company does not
intend, however, to seek an exemptive order, no-action letter or other form of
interpretive guidance from the Commission or its staff on these positions. If
the Commission or its Staff were to take a different position with respect to
whether such Subordinate Interests or Privately-Issued Certificates constitute
Qualifying Interests, the Company could, among other things, be required either
(a) to change the manner in which it conducts its operations to avoid being
required to register as an investment company or (b) to register as an
investment company, either of which could have a material adverse effect on the
Company and the market price of the Common Stock.
TAXABLE MORTGAGE POOL RISK; INCREASED TAXATION TO TAX EXEMPT ENTITIES AND OTHER
INVESTORS
A REIT (or a segregated portion thereof) that incurs debt obligations with
two or more maturities and which are secured by assets such as the Mortgage
Assets may be classified as a "taxable mortgage pool" under the Code if payments
required to be made on such debt obligations bear a relationship to the payments
received on such assets. If the Company were to be subject to the taxable
mortgage pool rules, a portion or all of the taxable income (in excess of a
specified return to investors) generated by the Mortgage Assets constituting a
taxable mortgage pool may be characterized, under regulations to be issued by
the Treasury Department, as "excess inclusion" income and allocated to the
stockholders. Any such excess inclusion income (i) would not be allowed to be
offset by the net operating losses of a stockholder, (ii) would be subject to
tax as UBTI to a tax-exempt stockholder and (iii) would be subject to a 30%
withholding tax in the case of a Non-U.S. Stockholder. See "FEDERAL INCOME TAX
CONSIDERATIONS-- Taxation of Tax-Exempt Stockholders."
The Company intends to enter into master reverse repurchase agreements
pursuant to which the Company may borrow funds with differing maturity dates
which are cross-collateralized by specific Mortgage Assets. The Treasury
Department has issued regulations that adopt a broad view of what may constitute
a taxable mortgage pool including anti-avoidance rules that authorize the
Service to treat equity interests issued by the Company as debt if such equity
interests correspond to maturities of classes of debt such as the Mortgage
Assets. The Company has been advised by Special Tax Counsel that master reverse
repurchase agreements and its other financing arrangements may be structured,
and the Company intends to structure master repurchase agreements and other
financing arrangements, in a manner which should not cause the Mortgage Assets
to be treated as a taxable mortgage pool. No assurance can be given, however,
that the Company will be able to structure master repurchase agreements in this
manner or that the Service might not successfully maintain that the REIT or the
Mortgage Assets collateralizing such master reverse repurchase agreements
constitute a taxable mortgage pool.
PHANTOM INCOME MAY RESULT IN ADDITIONAL TAX LIABILITY
The Company's investment in Subordinate Interests and certain types of
Mortgage Securities may cause it under certain circumstances to recognize
taxable income in excess of its economic income ("phantom income") and to
experience an offsetting excess of economic income over its taxable income in
later years. As a result, stockholders, from time to time, may be required to
treat distributions that economically represent a return of capital, as taxable
dividends. Such distributions would be offset in later years by distributions
representing economic income that would be treated as returns of capital for
federal income tax purposes (or by losses). Accordingly, if the Company
recognizes phantom income, its stockholders may be required to pay federal
income tax with respect to such income on an accelerated basis, (I.E., before
such income is realized by the stockholders in an economic sense). Taking into
account the time value of money, such an acceleration of federal income tax
liabilities would cause stockholders to receive an after-tax rate of return on
an investment in the Company that would be less than the after-tax rate of
return on an investment with an identical before-tax rate of return that did not
generate phantom income. In general, as the ratio of the Company's phantom
income to its total income increases, the after-
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tax rate of return received by a taxable stockholder of the Company will
decrease. See "FEDERAL INCOME TAX CONSIDERATIONS."
OWNERSHIP LIMITATION MAY RESTRICT BUSINESS COMBINATION OPPORTUNITIES
For the Company to maintain its qualification as a REIT, not more than 50%
in value of its outstanding shares of capital stock may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities). For the purpose, among others, of preserving the Company's
REIT status, the Charter generally prohibits direct or indirect ownership by any
person of more than 9.8% of the number of outstanding shares of Common Stock
(the "Ownership Limit"). For this purpose, the term "ownership" is defined as
either direct ownership or constructive ownership in accordance with the
constructive ownership provisions of Section 544 of the Code. Any transfer of
shares of capital stock that would result in disqualification of the Company as
a REIT or that would (a) create a direct or constructive ownership of shares of
stock in excess of the Ownership Limit, (b) result in the shares of stock being
beneficially owned (within the meaning Section 856(a) of the Code) by fewer than
100 persons (determined without reference to any rules of attribution), or (c)
result in the Company being "closely held" within the meaning of Section 856(h)
of the Code (a "purported transfer"), will be null and void, and the intended
transferee (the "purported transferee") will acquire no rights to such shares.
Any purported transfer of shares that would result in a person owning (directly
or constructively) shares in excess of the Ownership Limit (except as otherwise
waived by the Board of Directors) due to the unenforceability of the transfer
restrictions set forth above will constitute "Excess Securities." Excess
Securities will be transferred by operation of law to a trust to be established
by the Company for the exclusive benefit of a charitable organization, until
such time as the trustee of the trust, which shall be a banking institution
designated as trustee by the Company, which is unaffiliated with either the
Company or the purported transferee, retransfers the Excess Securities. Subject
to the Ownership Limit, Excess Securities may be transferred by the trust to any
person (if such transfer would not result in Excess Securities) at a price not
to exceed the lesser of (i) the price paid by the purported transferee or (ii)
the fair market value of the Excess Securities on the date of the purported
transfer, at which point the Excess Securities will automatically cease to be
Excess Securities. See "DESCRIPTION OF CAPITAL STOCK-- Repurchase of Shares and
Restriction on Transfer" and "FEDERAL INCOME TAX CONSIDERATIONS-- Requirements
for Qualifications."
Subject to certain limitations, the Board of Directors may increase or
decrease the Ownership Limit. In addition, to the extent consistent with the
REIT Provisions of the Code, the Board of Directors has the right, in its sole
discretion and pursuant to the Company's Charter, to waive the Ownership Limit
for, and at the request of, a purchaser of the Common Stock. However, the
Company's Board of Directors has waived the Ownership Limitation for certain
institutional investors participating in the Private Placement. See "DESCRIPTION
OF CAPITAL STOCK" and "PRIVATE PLACEMENT." In connection with any such waiver,
the Company may require that the stockholder requesting such a waiver enter into
an agreement with the Company providing for the repurchase by the Company of
shares from the stockholder under certain circumstances to ensure compliance
with the REIT Provisions of the Code. Such repurchase would be at fair market
value as set forth in the agreement between the Company and such stockholder.
The consideration received by the stockholder in such repurchase might be
characterized as the receipt by the stockholder of a dividend from the Company,
and any stockholder entering into such an agreement with the Company should
consult its tax advisor in connection with its entering into such an agreement.
The provisions described above may inhibit market activity and any takeover
or other transaction in which holders of some or a majority of the Company's
capital stock might receive a premium for their shares or which such holders
might believe to be otherwise in their best interests. Such provisions also may
make the Company an unsuitable investment vehicle for any person seeking to
obtain ownership of more than 9.8% of the outstanding shares of capital stock.
See "DESCRIPTION OF CAPITAL STOCK--Repurchase of Shares and Restrictions on
Transfer."
In addition, certain provisions of the Maryland General Corporation Law (the
"MGCL") relating to "business combinations" and of the Charter and Bylaws may
also have the effect of delaying, deterring or
26
<PAGE>
preventing a takeover attempt or other change in control of the Company which
may be beneficial to stockholders and might otherwise result in a premium over
then prevailing market prices. See "CERTAIN PROVISIONS OF MARYLAND LAW AND THE
COMPANY'S CHARTER AND BYLAWS."
PLANS SHOULD CONSIDER ERISA RISKS OF INVESTING IN COMMON STOCK
Fiduciaries of employee benefit plans subject to Title I of the Employee
Retirement Income Security Act of 1974, as amended ("ERISA"), should consider
the ERISA fiduciary investment standards before authorizing an investment by a
plan in the Common Stock. In addition, fiduciaries of employee benefit plans or
other retirement arrangements (such as an individual retirement account ("IRA")
or certain H.R. 10 Plans or Keogh plans) which are subject to Title I of ERISA,
and/or Section 4975 of the Code, as well as any entity, including an insurance
company general account, whose underlying assets include plan assets by reason
of a plan or account investing in such entity, should consult with their legal
counsel to determine whether an investment in the Common Stock will cause the
assets of the Company to be considered plan assets pursuant to the plan asset
regulations set forth at 29 C.F.R. Section 2510.3-101, thereby subjecting the
Plan to the prohibited transaction rules and the Company's assets to the
fiduciary investment standards of ERISA, or cause the excise tax provisions of
Section 4975 of the Code, to apply to the Company's assets, unless some
exception or exemption granted by the Department of Labor applies to the
acquisition, holding or transfer of the Common Stock. See "ERISA
CONSIDERATIONS."
PREFERRED STOCK MAY PREVENT CHANGE IN CONTROL
The Charter authorizes the Board of Directors to issue up to 25,000,000
shares of preferred stock and to establish the preferences and rights of any
shares of preferred stock issued. Although the Company has no current intention
to issue any series of preferred stock in the foreseeable future, the issuance
of any series of preferred stock could have the effect of delaying or preventing
a change in control of the Company even if a majority of the holders of the
Company's Common Stock believed such change of control was in their best
interest. See "DESCRIPTION OF CAPITAL STOCK--Preferred Stock."
LACK OF OPERATING POLICIES; BOARD OF DIRECTORS MAY CHANGE POLICIES WITHOUT
STOCKHOLDER CONSENT
The Company currently does not have specific operating guidelines. Any
operating policies, including investment and operating policies and other
policies with respect to acquisitions, financing, growth, operations, debt and
distributions will be determined by its Board of Directors. The Board of
Directors may amend or revise these and other policies, or approve transactions
that deviate from these policies, from time to time without a vote of the
holders of the Common Stock. The effect of any such changes may be positive or
negative. The Company cannot change its policy of seeking to maintain its
qualification as a REIT without the approval of the holders of two-thirds of the
outstanding shares of Common Stock.
LACK OF POLICY REGARDING HEDGING OR CREDIT RISK; FUTURE REVISIONS IN POLICIES
AND STRATEGIES
The Board of Directors has not established any significant credit risk or
hedging policy; consequently, the Manager will exercise broad discretion
concerning credit risk and hedging strategies. The investment policies and
operating policies and strategies of the Company set forth in this Prospectus
may be modified or waived by the Board of Directors, subject in certain cases to
approval by a majority of the Independent Directors.
LACK OF ACCOUNTING AND TESTING SYSTEMS
Because the Company is newly formed and will only commence operations upon
consummation of the Offering, the Board of Directors and the Company's officers
have not established internal accounting controls or testing systems. The
Manager will cause the Company to retain independent accountants and tax experts
to assist in developing appropriate accounting and testing procedures. The
failure to successfully develop and implement such internal systems would have a
material adverse effect on the integrity of the Company's books and records and
increases the possibility that the Company may inadvertently fail the REIT asset
and/or income tests or the 55% Requirement, either of which would have a
material adverse effect on the value of the Company's Common Stock and its
ability to maintain its status as a REIT.
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LIMITATION ON LIABILITY OF DIRECTORS AND OFFICERS AND MANAGER INDEMNIFICATION
The Charter of the Company contains a provision which, subject to certain
exceptions, eliminates the liability of a director or officer to the Company or
its stockholders for monetary damages for any breach of duty as a director or
officer. This provision does not eliminate such liability to the extent that it
is proved that the director or officer actually received an improper benefit or
profit or to the extent that it is found that the act or omission of the
director or officer resulted from active or deliberate dishonesty.
The Company will indemnify the Manager and its officers and directors from
any action or claim brought or asserted by any party by reason of any allegation
that the Manager or one or more of its officers or directors is otherwise
accountable or liable for the debts or obligations of the Company or its
Affiliates. In addition, the Manager and its officers and directors will not be
liable to the Company, and the Company will indemnify the Manager and its
officers and directors, for acts performed pursuant to the Management Agreement,
except for claims arising from acts constituting bad faith, willful misconduct,
gross negligence or reckless disregard of their duties under the Management
Agreement. See "THE MANAGER--Limits of Responsibility."
NO PRIOR TRADING MARKET; FAILURE TO DEVELOP OR SUSTAIN AN ACTIVE TRADING MARKET
Prior to the Offering, there has been no public market for the Common Stock.
The Company's Common Stock has been approved for listing on the NYSE. However,
there can be no assurance that an active trading market will develop or be
sustained after the Offering or that if such a market develops, the market price
will not decline below the public offering price. The initial public offering
price of the Common Stock was determined through negotiations between the
Company and the Representatives of the Underwriters, and may not be indicative
of future market prices. See "UNDERWRITING."
INTEREST RATE VOLATILITY MAY ADVERSELY AFFECT COMMON STOCK PRICE
It is likely that the market price of the Common Stock will be influenced by
any variation between the net yield on the Company's investment portfolio and
prevailing market interest rates and by the market's perception of the Company's
ability to achieve earnings growth. The Company's earnings will be derived
primarily from any positive spread between the yield on the Company's investment
portfolio and the cost of the Company's borrowings. The positive spread between
the yield on the Company's investment portfolio and the cost of borrowings will
not necessarily be larger in high interest rate environments than in low
interest rate environments. Accordingly, in periods of high interest rates, the
net income of the Company, and therefore the distribution 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 investment portfolio declines or if prevailing market
interest rates rise, thereby decreasing the positive spread between the net
yield on the investment portfolio and the cost of the Company's borrowings, the
market price of the Common Stock may be adversely affected. In addition, if the
market prices of other mortgage REIT stocks decline for any reason, or the value
of the Company's investment portfolio declines, the market price of the Common
Stock may be adversely affected. During any period when the market price of the
Common Stock has been adversely affected due to any of the foregoing reasons,
the liquidity of the Common Stock may be negatively impacted and investors who
may desire or be required to sell their shares may experience losses.
ILLIQUIDITY OF MORTGAGE LOANS, SUBORDINATE INTERESTS AND MORTGAGE DERIVATIVES
COULD CAUSE LOSSES
A portion of the Company's portfolio will be invested in Mortgage Loans,
Subordinate Interests and Mortgage Derivatives for which the secondary trading
market is not as well developed as the market for certain other Mortgage Assets,
such as Agency Certificates (or which are otherwise considered less marketable
or illiquid). Although the Company expects that most of the Company's
investments will be in Mortgage Assets for which a resale market exists, certain
of the Company's investments may lack a regular trading market and may be
illiquid. In addition, during adverse market conditions, the liquidity of all of
the Company's Mortgage Assets may be adversely impacted. There is no limit on
the percentage of the Company's investments that may be invested in illiquid
assets.
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BENEFITS TO EXISTING STOCKHOLDER, DIRECTORS AND OFFICERS
Through the date hereof, Michael L. Smirlock, the Company's Chief Executive
Officer and President, has purchased and agreed to purchase from the Company an
aggregate of 73,000 shares of Common Stock (of which 6,000 shares of Common
Stock were issued at an average price of $2.50 per share in connection with the
Company's formation and 67,000 shares of Common Stock will be purchased at the
initial public offering price in the Private Placement) for an aggregate
purchase price of $1,020,005, or $13.97 per share. This average price per share
is less than the initial public offering price of $15.00 per share.
The Company has also received irrevocable commitments to purchase a total of
5,013,999 shares in the Private Placement. The purchasers in the Private
Placement have agreed to purchase the shares of Common Stock at a purchase price
equal to the initial public offering price. Of the 5,013,999 shares sold in the
Private Placement, (i) Mr. Smirlock has committed to purchase 67,000 shares,
(ii) David A. Tepper, a Director of the Company and the Manager has committed to
purchase 103,000 shares and (iii) Frederick N. Khedouri, a proposed director of
the Company and a Senior Managing Director of Bear Stearns, one of the
Representatives, has committed to purchase 10,000 shares. In addition, a total
of 714,235 shares of Common Stock will be purchased by entities for which Mr.
Tepper may be deemed to have shared or sole voting and dispositive power. See
"PRINCIPAL STOCKHOLDERS" and "PRIVATE PLACEMENT."
The Company has granted to its directors, officers, employees and
consultants options to purchase an aggregate of 778,000 shares of Common Stock
(which includes options to purchase 748,000 shares of Common Stock granted to
directors, officers and employees of the Manager) at an exercise price equal to
the initial public offering price. The Company has also granted 400,000 shares
of deferred Common Stock to certain of its directors and officers. See "THE
MANAGER--Stock Options and Other Awards" and "THE COMPANY--Stock Incentive
Plan."
The Company will enter into the Management Agreement with the Manager
pursuant to which the Manager will be entitled to receive an annual base
management fee and a quarterly incentive fee. Mr. Smirlock, the Chief Executive
Officer, President and majority stockholder of the Manager, is also the Chairman
of the Board, Chief Executive Officer and President of the Company. David A.
Tepper, a director and indirect minority stockholder of the Manager, is also a
Director of the Company. See "THE MANAGER--The Management Agreement."
An Affiliated Fund has entered into a Total Return Swap with a broker-dealer
which provides that the Affiliated Fund will bear the economic benefit and risk
of directly holding the 666,666 shares of the Company's Common Stock purchased
by such broker-dealer in the Private Placement.
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<PAGE>
USE OF PROCEEDS
The net proceeds to the Company of the Offering are estimated to be $208.4
million, (or $239.9 million, if the Underwriters' over-allotment option is
exercised in full). The Company will receive an additional $74.1 million in net
proceeds from the Private Placement.
The Company intends to use the net proceeds of the Offering principally to
acquire Mortgage Assets. The proceeds received from the Private Placement also
will be used to acquire Mortgage Assets. The Company then intends to increase
its investment assets by borrowing against the Mortgage Assets and using the
proceeds to acquire additional Mortgage Assets and other portfolio securities.
The Company expects to require approximately two months to implement
substantially its investment strategy and to reach the desired leverage level.
Pending full investment in the desired mix of assets, the net proceeds of
the Offering will be invested in short-term investments that are rated
investment-grade by one or more of the Rating Agencies. These investments are
expected to provide a lower net return than the Company expects to achieve from
its investments in Mortgage Assets.
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<PAGE>
CAPITALIZATION
The capitalization of the Company as of September 25, 1997 and as adjusted
to reflect the sale of the shares of Common Stock offered hereby, is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 25, 1997
------------------------
AS
ACTUAL ADJUSTED(1)(2)
--------- -------------
(IN THOUSANDS)
<S> <C> <C>
Stockholders' equity:
Preferred Stock, par value $.01; authorized Preferred
Stock--25,000,000 shares; none outstanding....................... $ -- $ --
Common Stock, par value $.001; authorized Common Stock--75,000,000
shares; 6,000 shares outstanding; 20,019,999 shares, as
adjusted(3)...................................................... 0 20
Additional paid-in capital........................................... 15 282,489
--------- -------------
Total.......................................................... $ 15 $ 282,509
--------- -------------
--------- -------------
</TABLE>
- ------------------------
(1) Includes 5,013,999 shares of Common Stock subscribed for in the Private
Placement. See "PRIVATE PLACEMENT."
(2) After deducting offering and organizational expenses estimated to be
$1,400,000 payable by the Company, and assuming no exercise of the
Underwriters' over-allotment option to purchase up to an additional
2,250,000 shares of Common Stock.
(3) Does not include 2,066,666 shares reserved for issuance under the Company's
Stock Incentive Plan. Options to acquire 778,000 shares at the initial
public offering price (866,000 shares of Common Stock if the over-allotment
option is exercised in full) have been granted to employees, officers,
directors and consultants of the Company and the Manager. The Company has
also granted 400,000 shares of deferred Common Stock to certain of its
directors and officers. See "THE COMPANY--Stock Incentive Plan."
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<PAGE>
DISTRIBUTION POLICY
The Company intends to distribute substantially all of its taxable income
(which generally does not equal net income as calculated in accordance with
generally accepted accounting principles ("GAAP")) to its stockholders each year
to maximize the tax benefits of its REIT status. The Company intends to make
distributions on the Common Stock quarterly. To the extent necessary to maintain
its qualification as a REIT, for any year the Company will make a fifth special
distribution. The distribution policy is subject to revision, and all
distributions will be made by the Company, at the discretion of the Board of
Directors, and distributions will depend on, among other things, the taxable
earnings of the Company, the financial condition of the Company, maintenance of
REIT status and such other factors as the Board of Directors deems relevant. See
"FEDERAL INCOME TAX CONSIDERATIONS--Distribution Requirement."
To qualify as a REIT under the Code, the Company must make distributions to
its stockholders each year in an amount at least equal to (i) 95% of its Taxable
Income before deduction of dividends paid (less any net capital gain), plus (ii)
95% of the excess of the net income from foreclosure property over the tax
imposed on such income by the Code, minus (iii) any excess noncash income. The
"Taxable Income" of the Company for any year means the taxable income of the
Company for such year (excluding any net income derived either from property
held primarily for sale to customers or from foreclosure property) subject to
certain adjustments provided in the REIT Provisions of the Code.
Distributions to stockholders will generally be subject to tax as ordinary
income, although a portion of such distributions may be designated by the
Company as capital gain or may constitute a tax-free return of capital. The
Company will furnish annually to each of its stockholders a statement setting
forth distributions paid during the preceding year and their characterization as
ordinary income, capital gains or return of capital. For a discussion of the
federal income tax treatment of distributions by the Company, see "FEDERAL
INCOME TAX CONSIDERATIONS."
The Company has adopted a Dividend Reinvestment and Direct Purchase Plan
that will allow stockholders to reinvest their dividends automatically in
additional shares of Common Stock. See "DIVIDEND REINVESTMENT AND DIRECT
PURCHASE PLAN."
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company was organized in September 1997 and has no operating history and
will commence operations only if it receives the proceeds of the Offering and
the Private Placement. The Company's day-to-day operations will be managed by
the Manager, subject to the supervision of the Board of Directors. The Manager
and its investment professionals have no prior experience in managing a REIT,
and the past performance of the Manager's investment management personnel in
respect of the Affiliated Funds is not necessarily representative of what the
Manager's performance may be in the future or with respect to managing the
Company. See "APPENDIX A--Past Performance Results" concerning past performance
of the Manager's investment professionals.
The Company intends to generate net income for distribution to stockholders
from the spread between the interest income earned on its investment portfolio
and borrowing and hedging costs. The Company's results of operations will be
affected by various factors, many of which are beyond the control of the
Company, including the availability of opportunities for the acquisition of
assets, the level and volatility of interest rates, conditions in the financial
markets and other economic conditions.
The Company has been organized and will elect to qualify as a REIT under the
Code and, as such, anticipates distributing at least 95% of its taxable income
annually, subject to certain adjustments. Cash for such distributions is
expected to be generated from the Company's operations, although the Company
also may borrow funds to make distributions.
The Company may experience high volatility in net interest income from
quarter to quarter and year to year, primarily as a result of fluctuations in
interest rates, borrowing costs, reinvestment opportunities and prepayment
rates. Because changes in interest rates may significantly affect the Company's
activities, the operating results of the Company will depend, in large part,
upon the ability of the Company to manage its interest rate, prepayment and
credit risks effectively while maintaining its status as a REIT. See
"BUSINESS--Operating Policies and Strategies."
LEVERAGE
The Company intends to employ a leveraging strategy of borrowing against
existing Mortgage Assets to acquire additional Mortgage Assets, generally
through the use of reverse repurchase agreements, dollar roll agreements,
Mortgage Loan securitizations, loan agreements, lines of credit, commercial
paper borrowings and other credit facilities. The Company also may issue debt in
the public market to the extent the Manager deems appropriate. Leverage can
reduce the net income available for distributions to stockholders. To the extent
that changes in market conditions cause the cost of such financing to increase
relative to the income that can be derived from the assets acquired, the Company
may reduce the amount of leverage it utilizes. The Company also intends to
securitize substantially all the Mortgage Loans it acquires primarily by issuing
structured debt, such as CMOs, and retaining a Subordinate Interest.
HEDGING
To the extent consistent with its REIT election, the Company intends to
enter into hedging transactions to protect its portfolio of Mortgage Assets and
related debt from interest rate fluctuations. These transactions may include
interest rate swaps, the purchase or sale of interest rate collars, caps or
floors, options, Mortgage Derivatives and other hedging instruments. See
"BUSINESS--Operating Policies and Strategies--Capital and Leverage Policies."
LIQUIDITY AND CAPITAL RESOURCES
Since the Company is newly-formed and has not yet commenced operations, it
has not yet established any lines of credit or collateralized financing
facilities. The Company has conducted preliminary discussions with potential
lenders and believes, on the basis of these discussions, that it will be able to
obtain financings in amounts and at interest rates consistent with the Company's
financing objectives.
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Management believes that the net proceeds of the Offering and the Private
Placement, combined with the cash flow from operations and borrowings, will be
sufficient to enable the Company to meet its anticipated liquidity and capital
requirements. See "USE OF PROCEEDS" and "BUSINESS--Operating Policies and
Strategies."
INFLATION
Virtually all of the Company's assets and liabilities will be financial in
nature. As a result, interest rates are expected to influence the Company's
performance more directly than inflation. While changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates,
interest rates ordinarily increase during periods of high or increasing
inflation and decrease during periods of low or declining inflation.
Accordingly, management believes that the Company's financial condition and
results of operations will be influenced by inflation to the extent interest
rates are affected by inflation.
CERTAIN ACCOUNTING POLICIES AND PROCEDURES
MORTGAGE SECURITY ACCOUNTING TREATMENT
Because a substantial portion of the Company's Mortgage Securities will be
classified for accounting purposes as "trading securities," unrealized
fluctuations in market values of the Mortgage Securities will change income
calculated according to GAAP ("GAAP income"), but not taxable income. As a
result of this mark-to-market accounting treatment, the book value and book
value per share of the Company are likely to fluctuate far more than if the
Company used amortized cost accounting. As a result, comparisons with companies
using historical cost accounting may be misleading.
Positive mark-to-market changes will increase the Company's equity base and
allow the Company to increase its spread lending activities while negative
changes will limit spread lending growth under the Company's leveraging
strategy. A very large negative change in the net market value of Mortgage
Assets and interest rate agreements might impair the Company's liquidity
position, requiring the Company to sell Mortgage Assets.
MORTGAGE LOAN ACCOUNTING TREATMENT
Substantially all of the Company's Mortgage Loans will be classified for
accounting purposes as "held for long-term investment," and accordingly, the
Company will use amortized cost to value such Mortgage Loans. Holding the
Mortgage Loans as investments allows the Company to record income as interest is
earned.
TAXABLE INCOME AND GAAP INCOME
Taxable income differs from GAAP income for certain reasons. Certain
Mortgage Securities and Mortgage Derivatives will be marked-to-market for GAAP,
but not tax purposes. Interest income differs due to different methods of
calculating the rate of amortization of the premium or discount when Mortgage
Securities are acquired at a price above or below the stated principal amount of
the underlying Mortgage Loans. Treatment of credit losses differs between tax
and GAAP methods because the Company takes credit provisions in order to make
reserves for credit losses, whereas only actual credit losses are deducted in
calculating taxable income. General and administrative expenses differ due to
differing treatment of leasehold amortization and other items. The Company's
largest expense will likely be the cost of borrowed funds. Interest expense
generally will be calculated in the same manner for GAAP and tax purposes.
These distinctions are relevant to the Company's stockholders because
distributions are based on taxable income as is the incentive fee paid to the
Manager. The Company generally will not pay federal taxes so long as it meets
the requirements of the REIT Provisions of the Code and makes distributions to
stockholders an amount equal to its taxable income. See "FEDERAL INCOME TAX
CONSIDERATIONS-- Requirements for Qualification."
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<PAGE>
BUSINESS
GENERAL
The Company is a specialty finance company, organized in September 1997,
that will invest primarily in Mortgage Securities and Mortgage Loans. The
Mortgage Securities will include Pass-Through Certificates, CMOs and other
securities representing interests in, or obligations backed by, pools of
Mortgage Loans. The Mortgage Loans will be secured by first or second liens on
single-family residential, multi-family residential, commercial or other real
property. See "DESCRIPTION OF PROPOSED ASSETS."
The Company will seek to generate net income for distribution to
stockholders from the spread between the interest income earned on its
investment portfolio and the cost of financing and hedging the portfolio. The
Company will elect to be taxed as a REIT under the Code. The Company generally
will not be subject to federal income tax provided that it distributes its
income to its stockholders and maintains its qualification as a REIT. See
"FEDERAL INCOME TAX CONSIDERATIONS." LASER Advisers Inc., which specializes in
managing investments in Mortgage Securities for institutions and other
sophisticated investors, will manage the Company's day-to-day operations. The
Manager is a newly organized registered investment adviser. See "APPENDIX
A--Past Performance Results."
INVESTMENT STRATEGY
The Company's investment strategy will be to create and manage an investment
portfolio, principally of Mortgage Assets, that, in combination with financing
and hedging activities, will be designed to generate income for distribution to
its stockholders while preserving the Company's capital base.
The Company intends to acquire the following types of investments: (i) fixed
and adjustable rate Privately-Issued Certificates and Agency Certificates; (ii)
CMOs; (iii) Mortgage Loans, which will be pooled and securitized to provide
long-term, non-recourse financing for the Company; (iv) Mortgage Derivatives,
including IOs; (v) Subordinate Interests; and (vi) other fixed-income securities
which are non-Qualified Real Estate Assets, in an amount not to exceed 5% of
total assets. See "DESCRIPTION OF PROPOSED ASSETS." Consistent with the
Company's policy of maintaining its status as a REIT for federal income tax
purposes, substantially all of the Company's assets will consist of Qualified
Real Estate Assets.
The Company will invest at least 70% of its total assets in (i) securities
which are rated within one of the two highest ratings categories by one of the
Rating Agencies or (ii) securities which are unrated but are guaranteed by the
U.S. government or an agent or instrumentality thereof or (iii) Mortgage Loans
to borrowers who would otherwise meet FHLMC, FNMA or GNMA guidelines, except
with respect to the size of the loans. The Company intends to securitize
substantially all the Mortgage Loans it acquires by issuing structured debt,
such as CMOs, and to retain Subordinate Interests in the pools of Mortgage Loans
it securitizes.
The remainder of the Company's total assets, not to exceed 30%, is expected
to consist of Mortgage Loans (other than those included in the 70% Asset Group),
retained Subordinate Interests and fixed-income securities (other than those
included in the 70% Asset Group) that are primarily Qualified Real Estate Assets
but also will include non-investment grade high yield corporate debt. To attempt
to minimize the potentially higher level of credit and liquidity risk of these
securities, the Company will limit its investments in, and diversify its
portfolio of, securities in the 30% Asset Group. Only such retained Subordinate
Interests of securitized Mortgage Loans (and not the entire pools of Mortgage
Loans) will be considered in determining the proportion of assets classified
within the 70% Asset Group and the 30% Asset Group held by the Company.
References to ratings of Mortgage Assets apply only at the time a
transaction is entered into by the Company. Any subsequent change in a rating
assigned to a Mortgage Asset or change in the percentage of Company assets
invested in certain Mortgage Assets or other instruments resulting from market
fluctuations or other changes in the Company's total assets will not require the
Company to dispose of an investment. If different Rating Agencies assign
different ratings to the same Mortgage Assets, the Company will determine which
rating it believes most accurately reflects the Mortgage Asset's quality and
risk at that time. A rating is not a recommendation to buy, sell or hold a
security, inasmuch as such rating
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does not comment as to the market price of the security or the suitability of
the security for a particular investor. There is no assurance that a rating will
continue for any given period of time or that a rating will not be lowered or
withdrawn entirely by a Rating Agency if, in its judgment, circumstances so
warrant.
The REIT Provisions of the Code limit, in certain respects, the ability of
the Company to sell Mortgage Assets. See "FEDERAL INCOME TAX CONSIDERATIONS."
However, from time to time, Mortgage Assets may be sold for a number of reasons,
including to dispose of an 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, to maintain compliance with the 55% Requirement under
the Investment Company Act, and generally to restructure the balance sheet when
the Manager deems such action advisable. The Manager 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
Manager'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 intends to
distribute to stockholders aggregate distributions equaling at least 95% of its
Taxable Income. See "FEDERAL INCOME TAX CONSIDERATIONS." The Company could make
additional distributions of capital when the return expectations of the
stockholders appear to exceed returns potentially available to the Company
through making new investments in Mortgage Assets. Subject to the limitations of
applicable state securities and corporation laws, the Company may distribute
capital by making purchases of its own capital stock or making distributions in
excess of earnings.
The Company's asset acquisition and investment strategy may change over time
in response to changing market conditions.
OPERATING POLICIES AND STRATEGIES
The Company's operating strategy is to acquire those Mortgage Assets which
it believes are likely to generate the highest returns on capital invested,
consistent with the Company's policies and strategies, after considering (i) the
amount and nature of anticipated cash flows from the Mortgage Asset, (ii) the
Company's ability to pledge the Mortgage Asset to secure collateralized
borrowings, (iii) the capital requirements resulting from the purchase and
financing of the Mortgage Assets, and (iv) the costs of financing, hedging and
managing the Mortgage Asset. Prior to acquisition, potential returns on capital
employed will be assessed over the life of the Mortgage Asset and in a variety
of interest rate, yield spread, financing cost, credit loss and prepayment
scenarios. Except as specifically prohibited by the Company's Charter or Bylaws,
the Board of Directors may, in its discretion, establish specific operating
policies and financing strategies and revise such policies and strategies, from
time to time, in response to changes in market conditions without stockholder
approval. Any such revisions to operating policies and financing strategies are
subject to approval of the Independent Directors.
The Company will adopt compliance guidelines, including restrictions on
acquiring, holding and selling assets, to ensure that the Company continues to
qualify as a REIT. Before acquiring any asset, the Manager will determine
whether such asset would constitute a Qualified Real Estate Asset. Substantially
all of the assets that the Company intends to acquire are expected to be
Qualified Real Estate Assets. The Company will regularly monitor purchases of
Mortgage Assets and the income generated from such assets, including income from
its hedging activities, in an effort to ensure that at all times the Company
maintains its qualification as a REIT and its exemption under the Investment
Company Act. The Company has engaged a nationally recognized independent public
accounting firm to assist it in developing internal accounting and testing
procedures and to assist in monitoring and conducting quarterly compliance
reviews to determine compliance with the REIT Provisions of the Code.
CAPITAL AND LEVERAGE POLICIES
The Company's operations are expected to be highly leveraged. Initially, the
Company intends to finance its acquisition of Mortgage Assets through the
proceeds of the Offering and, thereafter, primarily by borrowing against or
"leveraging" its existing portfolio and using the proceeds to acquire additional
Mortgage Assets. The Company expects to incur debt such that it will maintain an
equity-to-assets ratio of
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between 6% to 10%, although the actual ratio may be higher or lower from time to
time depending on market conditions and other factors deemed relevant by the
Manager, subject to the review of the Company's Board of Directors. The
equity-to-assets ratio is total stockholders' equity, calculated in accordance
with GAAP, as a percentage of total assets. For purposes of calculating the
equity-to-assets ratio, the Company's total assets include the value of the
Company's investment portfolio on a marked-to-market basis. For purchased
Mortgage Assets, the Company obtains market quotes for its Mortgage Assets from
independent broker-dealers that make markets in securities similar to those in
the Company's portfolio or from pricing services approved by the Company's
Independent Directors. The Company's total stockholders' equity, for purposes of
this calculation, equals the Company's stockholders' equity determined in
accordance with GAAP. The Board of Directors has discretion to deviate from or
change the Company's indebtedness policy at any time. However, the Company
intends to maintain an adequate capital base to protect against interest rate
environments in which the Company's financing and hedging costs might exceed
interest income from its Mortgage Assets. These conditions could occur, for
example, when, due to interest rate fluctuations, interest income on the
Company's Mortgage Assets (which occur during periods of rapidly rising interest
rates or during periods when the Mortgage Loans in the portfolio are prepaying
rapidly) lags behind interest rate increases in the Company's variable rate
borrowings. The Company intends to enter into hedging transactions in an effort
to protect its portfolio of Mortgage Assets and related debt from interest rate
fluctuations. These transactions may include interest rate swaps, the purchase
or sale of interest rate collars, caps or floors, options and IOs. See
"--Securitization."
SHORT-TERM BORROWING
Mortgage Assets, other than securitized Mortgage Loans, will be financed
primarily at short-term borrowing rates through reverse repurchase agreements,
dollar roll agreements, loan agreements, lines of credit, commercial paper
borrowings and other credit facilities with institutional lenders. Reverse
repurchase agreements and dollar roll agreements are sales of pledged securities
to a lender at discounted prices in return for an agreement by the lender to
resell the same or substantially similar securities to the borrower on some
future date at an agreed price.
Reverse repurchase agreements are structured as sale and repurchase
obligations which allow a borrower to pledge purchased Mortgage Assets as
collateral securing short-term loans to finance the purchase of such Mortgage
Assets. Typically, the lender in a reverse repurchase arrangement makes a loan
in an amount equal to a percentage of the market value of the pledged
collateral. At maturity, the borrower is required to repay the loan and the
pledged collateral is released. Pledged Mortgage Assets continue to pay
principal and interest to the borrower.
A dollar roll agreement provides for the sale and delayed delivery of
Mortgage Securities and a simultaneous forward repurchase commitment by the
borrower to repurchase the same or a substantially similar security on a future
date. During the roll period, the borrower foregoes principal and interest
payments on the Mortgage Securities, but is compensated by the interest earned
on the cash proceeds of the initial sale of the Mortgage Securities and the
spread on the forward repurchase price. Because the dollar roll provides a
borrower with funds for the roll period, its value may be expressed as an
"implied financing rate." Dollar rolls are a favorable means of financing when
the forward repurchase price is low compared to the initial sale price, making
the implied financing rate lower than alternative short-term borrowing rates.
The Company's ability to enter into dollar roll agreements may be limited in
order to maintain the Company's status as a REIT or to avoid the imposition of
tax on the Company. See "FEDERAL INCOME TAX CONSIDERATIONS."
The Company expects that reverse repurchase agreements and, to the extent
consistent with the REIT Provisions of the Code, dollar roll agreements will be,
together with Mortgage Loan securitizations, the principal means of leveraging
its Mortgage Assets. To the extent that reverse repurchase agreements or dollar
roll agreements are not available to finance certain assets, the Company intends
to finance such assets with loan agreements, lines of credit and other credit
facilities with institutional lenders. The Company intends to enter into reverse
repurchase agreements with financially sound institutions, including
broker-dealers, commercial banks and other lenders, which meet credit standards
established by the Board
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of Directors. Upon repayment of a reverse repurchase agreement, or a repurchase
pursuant to a dollar roll agreement, the Company intends to pledge the same
collateral promptly to secure a new reverse repurchase agreement or will sell
similar collateral pursuant to a new dollar roll agreement. Since the Company is
newly-formed and has not commenced operations, it has not yet established any
lines of credit or collateralized financing facilities. The Company has
conducted preliminary discussions with potential lenders and believes, on the
basis of these discussions, that it will be able to obtain financing in amounts
and at interest rates consistent with the Company's financing objectives.
The reverse repurchase and dollar roll agreements also would require the
Company to deposit additional collateral (a "margin call") or reduce its
borrowings thereunder, if the market value of the pledged collateral declines.
This may require the Company to sell Mortgage Assets to provide such additional
collateral or to reduce the amount borrowed. If these sales were made at prices
lower than the carrying value of the Mortgage Assets, the Company would
experience losses. The Company intends to maintain an equity cushion sufficient
to provide liquidity in the event of interest rate movements and other market
conditions affecting the market value of the pledged Mortgage Assets. However,
there can be no assurance that the Company will be able to safeguard against
being required to sell Mortgage Assets in the event of a change in market
conditions. If the Company were forced to liquidate Mortgage Assets, there can
be no assurance that it would be able to maintain compliance with the REIT
Provisions of the Code regarding asset and source of income. See "FEDERAL INCOME
TAX CONSIDERATIONS--Requirements for Qualification."
SECURITIZATION
The Company intends to acquire and accumulate Mortgage Loans for
securitization as part of its investment strategy. The Manager, in its
discretion, will determine the quantity of Mortgage Loans sufficient for
securitization (which will generally be at least $100 million), after
discussions with potential underwriters, rating agencies and monoline insurers,
if any are to be used, and an evaluation of the costs of securitization.
Securitization is the process of pooling Mortgage Loans in a trust or other
special purpose vehicle and issuing securities, such as CMOs, from the special
purpose vehicle. The Company intends to securitize Mortgage Loans by issuing
structured debt. Under this approach, for accounting purposes, the securitized
Mortgage Loans will remain on the Company's balance sheet as assets and the debt
obligations (I.E., the CMOs) will appear as liabilities, in contrast with
off-balance sheet sale treatment. The proceeds of securitizations by the Company
will be applied against preexisting borrowings (I.E., borrowings under reverse
repurchase or dollar roll agreements). Issuing structured debt in this manner
locks in less expensive, long-term, non-recourse financing that better matches
the terms of the Mortgage Loans serving as collateral for such debt. Each series
of Mortgage Securities created by securitization is expected to be fully payable
from the collateral pledged to secure the series. Except upon a breach of the
standard representations and warranties made by the Company when loans are
securitized, the debt obligations created in the securitization will be
non-recourse to the Company.
The Company anticipates that the proceeds from its securitizations will be
available to acquire additional Mortgage Loans and other investments.
Securitizations provide long-term financing and are not subject to margin calls
if an increase in interest rates reduces the value of the underlying Mortgage
Loans.
The Company expects that its retained interests in the securitizations will
be subordinated with respect to payments of principal and interest on the
underlying Mortgage Loans to the classes of securities issued to investors in
such securitizations. Accordingly, any losses incurred on the underlying
Mortgage Loans will be applied first to reduce the remaining amount of the
Company's retained interest, until reduced to zero. Thereafter, any further
losses would be borne by investors or, if used, by the monoline insurers in such
securitizations rather than the Company.
Typically, in connection with the creation of a new Mortgage Loan
securitization, the issuer generally will be required to enter into a master
servicing agreement with respect to such series of Mortgage Securities with an
entity acceptable to the Rating Agencies, that regularly engages in the business
of servicing Mortgage Loans (the "Master Servicer"). If, in the future, the
Company decides to service its
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own securitized Mortgage Loans, it will do so only in structures designed not to
endanger the Company's REIT status.
The Company intends to structure its securitizations so as to avoid the
attribution of any "excess inclusion" income to the Company's stockholders. See
"FEDERAL INCOME TAX CONSIDERATIONS-- Taxation of Stockholders."
HEDGING ACTIVITIES
The Company intends to enter into hedging transactions to protect its
investment portfolio from interest rate fluctuations and other changes in market
conditions. These transactions may include interest rate swaps, the purchase or
sale of interest rate collars, caps or floors, options and IOs. These
instruments may be used to hedge as much of the interest rate risk as the
Manager determines is in the best interest of the Company's stockholders, given
the cost of such hedges and the need to maintain the Company's status as a REIT.
The Company has not established specific policies as to the extent of the
hedging transactions in which it will engage; however, the Independent Directors
will be responsible for reviewing the extent and effect of hedging activities at
their regular meetings. The Manager may elect to have the Company bear a level
of interest rate risk that could otherwise be hedged when the Manager believes,
based on all relevant facts, that bearing such risk is advisable.
Hedging instruments often are not traded on regulated exchanges, guaranteed
by an exchange or its clearing house, or regulated by any U.S. or foreign
governmental authorities. Consequently, there are no requirements with respect
to record keeping, financial responsibility or segregation of customer funds and
positions. The business failure of a counterparty with which the Company has
entered into a hedging transaction will most likely result in a default. The
default of a counterparty with which the Company has entered into a hedging
transaction may result in the loss of unrealized profits and force the Company
to cover its resale commitments, if any, at the then current market price.
Although generally the Company will seek to reserve for itself the right to
terminate its hedging positions, it may not always be possible to dispose of or
close out a hedging position without the consent of the counterparty, and the
Company may not be able to enter into an offsetting contract in order to cover
its risk. There can be no assurance that a liquid secondary market will exist
for hedging instruments purchased or sold, and the Company may be required to
maintain a position until exercise or expiration, which could result in losses.
The Company intends to seek to protect its investment portfolio against the
effects of significant interest rate fluctuations and to preserve the net income
flows and capital value of the Company. Specifically, the Company's asset
acquisition and borrowing strategies are intended to offset the potential
adverse effects resulting from the differences between fixed-rates or other
limitations on coupon rate adjustment, such as interest rate caps, associated
with its Mortgage Assets and the shorter term variable nature of the Company's
related borrowings.
The Company's hedging activities are intended to address both income and
capital preservation. Income preservation refers to maintaining a stable spread
between yields from Mortgage Assets and the Company's borrowing costs across a
reasonable range of adverse interest rate environments. Capital preservation
refers to maintaining a relatively steady level in the market value of the
Company's capital across a reasonable range of adverse interest rate scenarios.
To monitor and manage capital preservation risk, the Company will measure the
"duration" of its capital. The duration of capital is the expected change in the
market value of the Company's capital caused by a 1% change in interest rate. To
monitor duration and the related risks of fluctuations in the liquidation value
of the Company's equity, the Company will model the impact of various economic
scenarios on the market value of the Company's Mortgage Assets, liabilities and
hedging instruments.
The Company believes its hedging activities will provide a level of income
and capital protection against reasonable interest rate risks. However, no
strategy can insulate the Company completely from such risks, and certain of the
federal income tax requirements that the Company must satisfy to qualify as a
REIT limit the Company's ability to hedge. The Company intends to monitor its
hedging activity carefully and may have to limit its hedging strategies so that
it does not realize excessive income from hedging activities or hold hedging
instruments having excess value in relation to total assets, which would result
in
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the Company's disqualification as a REIT or, in the case of excess hedging
income, the payment of a penalty tax for failure to satisfy certain REIT income
tests under the Code, provided such failure was for reasonable cause. See
"FEDERAL INCOME TAX CONSIDERATIONS--Requirements for Qualification."
Hedging activity involves transaction costs, and such costs can increase
significantly as the period covered by such activity increases. Therefore, the
Company may be prevented from effectively hedging all of its interest rate risk.
Certain losses incurred in connection with hedging activities may be capital
losses that would not be deductible to offset ordinary REIT income. In such a
situation, the Company would have incurred an economic loss of capital that
would not be deductible to offset the ordinary income from which dividends must
be paid.
INTEREST RATE RISK MANAGEMENT STRATEGY
The Company intends to follow an interest rate risk management strategy to
protect against the adverse effects of major interest rate changes. The
Company's interest rate risk management strategy is formulated with the intent
to offset the potential adverse effects resulting from the fixed rate nature or
other rate adjustment limitations of its assets and changes in the short-term
borrowing costs. This encompasses a number of procedures including: (i)
purchasing interest rate caps and swaps to attempt to mitigate the risk of the
cost of variable rate liabilities increasing at a faster rate than the earnings
on the assets, (ii) purchasing IOs to attempt to offset the adverse effects of
rising interest rates, and (iii) monitoring the effect of changes in interest
rates on the earnings and the value of the Company.
The Company may purchase interest rate caps, interest swaps and similar
securities to attempt to mitigate the risk of the cost of its variable rate
liabilities increasing at a faster rate than the earnings on its assets. The
Company intends generally to hedge as much of the interest rate risk as the
Manager determines is in the best interest 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 Manager having the Company bear a
level of interest rate risk that could otherwise be hedged when the Manager
believes, based on all relevant facts, that bearing such risk is advisable. The
Company also may, to the extent consistent with its compliance with the REIT
gross income tests and applicable law, utilize options and forward contracts as
a hedge against future interest rate changes.
Interest rate caps are legal contracts between the Company and a third party
firm (the "counterparty") in which, in exchange for an initial premium, the
counterparty agrees to make payments to the Company if interest rates rise above
the rate specified in the contract.
Interest rate swaps are legal contracts between the Company and a
counterparty in which the Company pays a fixed rate of interest to the
counterparty and the counterparty pays a variable rate of interest to the
Company. These and other similar securities have the effect of offsetting the
increasing cost of variable rate liabilities during periods of rising interest
rates.
The Company intends to purchase IOs to endeavor to offset the effects of
rising interest rates. These securities can be effective in hedging the
investment portfolio as the values and yields of these securities tend to
increase as interest rates rise and to decrease as interest rates fall. However,
IOs may decline in value during periods of declining interest rates.
EMPLOYEES
The Company initially expects to have seven employees. The Manager will
employ the four executive officers of the Company and four additional employees.
Each of the investment professionals of the Manager has at least ten years'
experience in mortgage research, mortgage finance and investment management.
FACILITIES
The Company's executive offices are located at 51 John F. Kennedy Parkway,
Short Hills, New Jersey 07078.
LEGAL PROCEEDINGS
There are no pending legal proceedings to which the Company is a party or to
which any property of the Company is subject.
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DESCRIPTION OF PROPOSED ASSETS
The Company intends to acquire the following types of investments subject to
the operating restrictions described in "BUSINESS--Operating Policies and
Strategies."
MORTGAGE LOANS
The Company intends to acquire and accumulate fixed and adjustable-rate
Mortgage Loans secured by first or second liens on single-family (one-to-four
unit) residential, multi-family residential, commercial or other real property
as part of its investment strategy.
The Company may acquire Mortgage Loans directly from Mortgage Sellers which
include originators, and entities holding Mortgage Loans originated by others
throughout the United States, such as savings and loans associations, banks,
mortgage bankers, home builders, insurance companies and other mortgage lenders.
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 the Mortgage Sellers.
The Company may issue commitments ("Commitments") to purchase Mortgage Loans
to Mortgage Sellers that follow policies and procedures that generally comply
with FHLMC, FNMA and GNMA regulations and guidelines and with all applicable
federal and state laws and regulations for loans secured by single-family
residential properties. In addition, Commitments may be issued for Agency
Certificates, Privately-Issued Certificates and Mortgage Loans. These
Commitments will obligate the Company to purchase Mortgage Assets from the
holders of the Commitment for a specific period of time, in a specific aggregate
principal amount and at a specified price and margin over an index. Although the
Company may commit to acquire Mortgage Loans prior to funding, all loans are
expected 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 the Company's Mortgage Assets.
The Mortgage Loans will be acquired by the Company and held until a quantity
sufficient for securitization has been accumulated. During the accumulation
period, the Company will be subject to risks of borrower defaults, bankruptcies,
fraud losses and special hazard losses that are not covered by standard hazard
insurance. 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 and hedging the Mortgage Loans could exceed the interest income on the
Mortgage Loans. No assurance can be given that any mortgage, fraud or hazard
insurance will adequately cover a loss suffered by the Company. See "CERTAIN
CHARACTERISTICS OF MORTGAGE LOANS AND REAL PROPERTY INVESTMENTS."
It is anticipated that each Mortgage Loan purchased will have a commitment
for mortgage pool insurance from a monoline insurance company with a claims
paying ability in one of the two highest rating categories of a Rating Agency.
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 guarantees, 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, and the Company intends to rely primarily
upon this credit evaluation rather than making its own independent credit review
in determining whether to purchase a Mortgage Loan. Credit losses covered by the
mortgage 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 Loans. The mortgage pool insurance or
credit enhancement will be issued when the Mortgage Loan is subsequently
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securitized, and the Company will be at risk for credit losses on that Mortgage
Loan prior to its securitization.
In addition to credit enhancement, the Company may obtain a commitment for
special hazard insurance on the Mortgage Loans, if available at reasonable cost,
to protect against casualty losses not usually covered by standard hazard
insurance. This special hazard insurance does not cover losses during the
accumulation period, but coverage commences at the time the Mortgage Loans are
pledged as collateral for a securitization. Accordingly, the risks associated
with such special hazard losses exist only between the time the Company
purchases a Mortgage Loan and the subsequent securitization.
In connection with the Company's acquisition of Mortgage Loans, Mortgage
Sellers generally make representations and warranties customary in the industry
relating to, among other things, compliance with laws, regulations and program
standards, lack of encumbrances, enforceability, validity of the lien,
recordation of the Mortgage Loans and as to the accuracy of information. In the
event of a breach of these representations and warranties, the Mortgage Sellers
may become liable for certain damages or be required to repurchase such loans.
The Company will provide similar representations and warranties when the Company
sells or pledges the Mortgage Loans as collateral for Mortgage Securities.
Although the Company will have recourse to the Mortgage Sellers based on the its
representations and warranties, the Company will be at risk for loss to the
extent the Mortgage Seller does not perform its repurchase obligations. If a
Mortgage Loan becomes delinquent and the mortgage pool insurer is able to prove
that there was fraud or misrepresentation in connection with the origination of
the Mortgage Loan, the mortgage pool insurer will not be liable for the portion
of the loss attributable to such fraud or misrepresentation.
PASS-THROUGH CERTIFICATES
The Company's investments in Mortgage Securities are expected to be
concentrated in Pass-Through Certificates. The Pass-Through Certificates to be
acquired by the Company will consist primarily of High Quality fixed and
adjustable rate Agency Certificates and Privately-Issued Certificates and will
represent interests in Mortgage Loans primarily secured by liens on
single-family residential, multi-family residential and commercial real
properties, but also may be secured by liens on other types of real property.
FHLMC CERTIFICATES
FHLMC is a privately-owned, government-sponsored enterprise created pursuant
to an act of Congress. FHLMC purchases conventional conforming Mortgage Loans or
participation interests therein and resells the loans and participations so
purchased in the form of guaranteed, mortgage-backed securities. FHLMC
guarantees to each holder of FHLMC certificates the timely payment of interest
at the applicable pass-through rate and ultimate collection of all principal on
the holder's PRO RATA share of the unpaid principal balance of the related
Mortgage Loans, but does not guarantee the timely payment of scheduled principal
of the underlying Mortgage Loans. Under FHLMC's Gold PC Program, FHLMC
guarantees the timely payment of principal based on the difference between the
pool factor published in the month preceding the month of distribution and the
pool factor published in such month of distribution. The obligations of FHLMC
under its guarantees are solely those of FHLMC and are not backed by the full
faith and credit of the U.S. government. If FHLMC were unable to satisfy such
obligations, distributions to holders of FHLMC certificates would consist solely
of payments and other recoveries on the underlying Mortgage Loans and,
accordingly, monthly distributions to holders of FHLMC certificates would be
affected by delinquent payments and defaults on such Mortgage Loans.
FHLMC certificates may be backed by pools of Mortgage Loans secured by
single-family or multi-family residential properties. Such underlying Mortgage
Loans may have original terms to maturity of up to 40 years. FHLMC certificates
may be issued under Cash Programs (composed of Mortgage Loans purchased from a
number of sellers) or Guarantor Programs (composed of Mortgage Loans purchased
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from one seller in exchange for participation certificates representing an
interest in the Mortgage Loans purchased). FHLMC certificates may pay interest
at a fixed or adjustable rate. The interest rate paid on FHLMC adjustable rate
mortgage ("ARM") certificates adjusts periodically within 60 days prior to the
month in which the interest rates on the underlying Mortgage Loans adjust. The
interest rates paid on FHLMC ARM certificates issued under FHLMC's standard ARM
programs adjust in relation to the Treasury Index. Other specified indices used
in FHLMC ARM programs include the 11th District Cost of Funds Index published by
the Federal Home Loan Bank of San Francisco (the "11th District Index") and
LIBOR. Interest rates paid on fully-indexed FHLMC ARM certificates equal the
applicable index rate plus a specified number of basis points ranging typically
from 125 to 250 basis points. In addition, the majority of series of FHLMC ARM
certificates issued to date have evidenced pools of Mortgage Loans with monthly,
semi-annual or annual interest adjustments. Adjustments in the interest rates
paid are generally limited to an annual increase or decrease of either 100 or
200 basis points and to a lifetime cap of 500 or 600 basis points over the
initial interest rate. Certain FHLMC programs include Mortgage Loans which allow
the borrower to convert the adjustable mortgage interest rate of its ARMs to a
fixed rate. ARMs which are converted into fixed rate Mortgage Loans are
repurchased by FHLMC, or by the seller of such loan to FHLMC, at the unpaid
principal balance thereof plus accrued interest to the due date of the last
adjustable rate interest payment.
FNMA CERTIFICATES
FNMA is a privately-owned, federally chartered corporation that provides
funds to the mortgage market primarily by purchasing Mortgage Loans (with
respect to residential properties) from local lenders, thereby replenishing
their funds for additional lending. FNMA guarantees to each registered holder of
a FNMA certificate that it will distribute amounts representing scheduled
principal and interest at the rate provided by the FNMA certificate on the
Mortgage Loans in the pool underlying the FNMA certificate whether or not
received, and the full principal amount of any such Mortgage Loan foreclosed or
otherwise finally liquidated, whether or not the principal amount is actually
received. The obligations of FNMA under its guarantees are solely those of FNMA
and are not backed by the full faith and credit of the U.S. government. If FNMA
were unable to satisfy such obligations, distributions to holders of FNMA
certificates would consist solely of payments and other recoveries on the
underlying Mortgage Loans and, accordingly, monthly distributions to holders of
FNMA certificates would be affected by delinquent payments and defaults on such
Mortgage Loans.
FNMA certificates may be backed by pools of Mortgage Loans secured by
single-family or multi-family residential properties. The original terms to
maturities of the Mortgage Loans generally do not exceed 40 years. FNMA
certificates may pay interest at a fixed rate or adjustable rate. Each series of
FNMA ARM certificates bears an initial interest rate and margin tied to an index
based on all loans in the related pool, less a fixed percentage representing
servicing compensation and FNMA's guarantee fee. The specified index used in
each such series has included the Treasury Index, the 11(th) District Index and
LIBOR. Interest rates paid on fully-indexed FNMA ARM certificates equal the
applicable index rate plus a specified number of basis points ranging typically
from 125 to 250 basis points. In addition, the majority of series of FNMA ARM
certificates issued to date have evidenced pools of Mortgage Loans with monthly,
semi-annual or annual interest rate adjustments. Adjustments in the interest
rates paid are generally limited to an annual increase or decrease of either 100
or 200 basis points and to a lifetime cap of 500 or 600 basis points over the
initial interest rate. Certain FNMA programs include Mortgage Loans which allow
the borrower to convert the adjustable mortgage interest rate of its ARM to a
fixed rate. ARMs which are converted into fixed rate Mortgage Loans are
repurchased by FNMA, or by the seller of such loans to FNMA, at the unpaid
principal balance thereof plus accrued interest to the due date of the last
adjustable rate interest payment. Adjustments to the interest rates on FNMA ARM
certificates are typically subject to lifetime caps and periodic rate or payment
caps.
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GNMA CERTIFICATES
GNMA is a wholly-owned corporate instrumentality of the United States within
the Department of Housing and Urban Development ("HUD"). GNMA guarantees the
timely payment of the principal of and interest on certificates which represent
an interest in a pool of mortgages insured by the United States Federal Housing
Authority (the "FHA") and other loans eligible for inclusion in mortgage pools
underlying GNMA certificates. GNMA certificates are general obligations of the
U.S. government.
GNMA certificates may pay a fixed or adjustable coupon rate. At present,
most GNMA certificates issued under GNMA's standard ARM program adjust annually
in relation to the Treasury Index. Interest rates paid on GNMA ARM certificates
typically equal the index rate plus 150 basis points. Adjustments in the
interest rate are generally limited to an annual increase or decrease of 100
basis points and to a lifetime cap of 500 basis points over the initial coupon
rate.
PRIVATELY-ISSUED CERTIFICATES
Privately-Issued Certificates are structured similarly to Agency
Certificates 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 Certificates are usually backed by a pool of
fixed or adjustable rate Mortgage Loans and are generally structured with one or
more types of credit enhancement, including mortgage pool insurance or
subordination. However, Privately-Issued Certificates are typically not
guaranteed by an entity having the credit status of FHLMC, FNMA or GNMA.
CMOS
The Company may invest, from time to time, in adjustable rate and fixed rate
CMOs issued by private issuers or FHLMC, FNMA or GNMA. CMOs are a series of
bonds or certificates ordinarily issued in multiple classes, each of which
consists of several classes with different maturities and often complex
priorities of payment, secured by a single pool of Mortgage Loans, Pass-Through
Certificates, other CMOs or other Mortgage Assets. Principal prepayments on
collateral underlying a CMO may cause it to be retired substantially earlier
than the stated maturities or final distribution dates. Interest is paid or
accrues on all interest bearing classes of a CMO on a monthly, quarterly or
semi-annual basis. The principal and interest on underlying Mortgages Loans may
be allocated among the several classes of a series of a CMO in many ways,
including pursuant to complex internally leveraged formulas that make the CMO
class especially sensitive to interest rate or prepayment risk.
CMOs may be subject to certain rights of issuers thereof to redeem such CMOs
prior to their stated maturity dates, which may have the effect of diminishing
the Company's anticipated return on its investment. Privately-issued
single-family, multi-family and commercial CMOs are supported by private credit
enhancements similar to those used for Privately-Issued Certificates and are
often issued as senior-subordinated Mortgage Securities. The Company intends to
only acquire CMOs or multi-class Pass-Through certificates that constitute debt
obligations or beneficial ownership in grantor trusts holding Mortgage Loans, or
regular interests in real estate mortgage investment conduits ("REMICs"), or
that otherwise constitute Qualified Real Estate Assets (provided that the
Company has obtained a favorable opinion of the Company's Special Tax Counsel or
a ruling from the Service to that effect).
MORTGAGE DERIVATIVES
The Company may acquire Mortgage Derivatives, including IOs, Inverse IOs,
Sub IOs and floating rate derivatives, as market conditions warrant. Mortgage
Derivatives 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 Derivatives are highly
sensitive to the rate of prepayments on the underlying Mortgage Loans. In the
event of more rapid than anticipated prepayments
44
<PAGE>
on such Mortgage Loans, the rates of return on Mortgage Derivatives representing
the right to receive interest only or a disproportionately large amount of
interest, I.E., IOs, would be likely to decline. Conversely, the rates of return
on Mortgage Derivatives representing the right to receive principal only or a
disproportionate amount of principal, I.E., POs, would be likely to increase in
the event of rapid prepayments.
Some IOs in which the Company may invest, such as Inverse IOs, bear interest
at a floating rate that varies inversely with (and often at a multiple of)
changes in a specific index. The yield to maturity of an Inverse IO is extremely
sensitive to changes in the related index. The Company also may invest in
inverse floating rate Mortgage Derivatives which are similar in structure and
risk to Inverse IOs, except they generally are issued with a greater stated
principal amount than Inverse IOs.
Other IOs in which the Company may invest, such as Sub IOs, have the
characteristics of a Subordinate Interest. A Sub IO is entitled to no payments
of principal; moreover, interest on a Sub IO often is withheld in a reserve fund
or spread account to fund required payments of principal and interest on more
senior tranches of Mortgage Securities. Once the balance in the spread account
reaches a certain level, excess funds are paid to the holders of the Sub IO.
These Sub IOs provide credit support to the senior classes and thus bear
substantial credit risks. In addition, because a Sub IO receives only interest
payments, its yield is extremely sensitive to the rate of prepayments (including
prepayments as a result of defaults) on the underlying Mortgage Loans.
IOs can be an effective hedging device because they generally increase in
value as fixed rate Mortgage Securities decrease in value. The Company also may
invest in other types of derivatives currently available in the market and other
Mortgage Derivatives that may be developed in the future if the Manager
determines that such investments would be advantageous to the Company. The
Company does not intend to purchase REMIC residuals or other CMO residuals.
SUBORDINATE INTERESTS
The Company intends to retain a Subordinate Interest in the pools of
Mortgage Loans it securitizes and to acquire Subordinate Interests in pools of
Mortgage Loans securitized by others. The credit quality of Mortgage Loans and
the Mortgage Securities utilizing Mortgage Loans as the underlying collateral,
depends on a number of factors, including their loan-to-value ratio, their terms
and the geographic diversification of the location of the properties securing
the Mortgage Loans and, in the case of multi-family and commercial properties,
the creditworthiness of tenants.
In a securitization, the principal of and interest on the underlying
Mortgage Loans may be allocated among several classes of Mortgage Securities in
many ways and the credit quality of a particular class depends primarily on its
payment priority. In a typical securitization, the Subordinate Interests absorb
losses from defaults or foreclosures on the Mortgage Loan collateral before such
losses are allocated to senior classes, providing credit protection to more
senior classes. As a result, Subordinate Interests carry significant credit
risks. Subordinate Interests in a typical securitization are subject to a
substantially greater risk of non-payment than more senior classes. Accordingly,
Subordinate Interests are assigned lower credit ratings, or no rating at all.
Neither the Subordinate Interests nor the underlying mortgages are guaranteed by
agencies, or instrumentalities of the U.S. government.
As a result of the typical "senior-subordinated" structure, Subordinate
Interests will be extremely sensitive to losses on the underlying Mortgage
Loans. For example, if the Company owns a $10 million Subordinate Interest in an
issuance of Mortgage Securities consisting of $100 million of Mortgage Loan
collateral, a 7% loss on the underlying Mortgage Loans will result in a 70% loss
on the Subordinate Interest. Accordingly, the holder of the Subordinate Interest
is particularly interested in minimizing the loss frequency (the percentage of
the Mortgage Loan balances that default over the life of the Mortgage Loan
collateral) and the loss severity (the amount of loss on a defaulted Mortgage
Loan, I.E., the principal amount of the Mortgage Loan unrecovered after applying
any recovery to the expenses of foreclosure and
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<PAGE>
accrued interest) on the underlying Mortgage Loans. The loss frequency on a pool
of Mortgage Loans will depend upon a number of factors, most of which will be
beyond the control of the Company or the applicable Master Servicer.
Many of the Subordinate Interests to be acquired by the Company will not
have been registered under the Securities Act, but instead, will have initially
been sold in private placements. Such unregistered Subordinate Interests will be
subject to certain restrictions on resale and, accordingly, will have more
limited marketability and illiquidity. Although there are some exceptions, most
issuers of multi-class Mortgage Securities elect to be treated, for federal
income tax purposes, as REMICs. The Company intends to acquire only Subordinate
Interests that are treated as regular interests in REMICs. Although the
Company's strategy is to purchase Subordinate Interests at a price designed to
return the Company's investment and generate a profit thereon, there can be no
assurance that such goal will be met or that the Company's investment in a
Subordinate Interest will be returned in full or at all.
OTHER FIXED-INCOME ASSETS
The Company may invest in fixed-income securities that are not Mortgage
Assets, including securities issued by corporations or issued or guaranteed by
the U.S. government or its agencies or instrumentalities, loan participations,
emerging market debt, non-investment grade high yield corporate debt and
collateralized bond obligations, denominated in U.S. dollars and foreign
currencies. A portion of these assets will be securities which are included in
the 30% Asset Group. The Company will invest no more than 5% of its assets in
such fixed-income securities. However, the Board of Directors, with the approval
of the Independent Directors, may determine to invest a larger percentage of the
Company's assets in such fixed-income securities.
The Company may invest in debt securities issued or guaranteed by foreign
governments, including debt securities rated below investment grade. Obligations
of governments of emerging market countries are often subject to, or may be
adversely affected by, risks associated with political and economic uncertainty,
fluctuations of currency exchange rates, lower levels of disclosure and
regulation in foreign securities markets than in the United States, risks of
nationalization, expropriation and confiscatory taxation, taxation of income
earned in foreign nations or other taxes imposed with respect to investments in
foreign nations, foreign exchange controls and uncertainties as to the status,
interpretation and application of laws.
The Company also may invest in non-investment grade high yield corporate
debt rated below investment grade, commonly known as junk bonds. Junk bonds are
generally unsecured, may be subordinated to other obligations of the issuer and
generally have greater credit and liquidity risk than is typically associated
with investment grade corporate obligations.
The Company also may acquire interests in non-real estate loans. Such loan
interests may be purchased either directly (by way of assignment from the
selling institution) or indirectly (by way of the purchase of a participation
interest from the selling institution). The purchaser of an assignment of an
interest in a loan typically succeeds to all rights and obligations of the
assigning selling institution and becomes a lender under the loan agreement.
Participations typically result in a contractual relationship only with the
selling institution, not with the borrower.
In addition, the Company may invest in asset-backed securities which have
structural characteristics similar to Mortgage Securities but relate to assets
other than Mortgage Assets, including credit card, automobile and other
receivables. Asset-backed securities may be rated or unrated and, if rated, may
be above or below investment grade. They may bear coupons at a fixed or floating
interest rate and also may be subject to prepayment risk.
46
<PAGE>
THE MANAGER
The day-to-day business and investment affairs of the Company will be
managed by the Manager subject to the supervision of the Company's Board of
Directors (the "Board of Directors"). The Manager, a Delaware corporation and a
registered investment adviser under the Advisers Act, specializes in managing
investments in Mortgage Securities. The stockholders of the Manager are
directors of the Company. The Manager employs investment professionals each of
whom has at least ten years' experience in mortgage research, mortgage finance
and investment management; however, neither the Manager nor its investment
professionals have previously managed a REIT. The Manager's investment
professionals currently manage over $300 million of capital invested primarily
in $3.9 billion of Mortgage Securities. See "APPENDIX A--Past Performance
Results" for information relating to the prior performance of the Manager's
investment professionals using an investment strategy similar to the strategy to
be employed by the Manager in managing the Company's investments.
The directors and executive officers of the Manager are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE MANAGER
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Michael L. Smirlock, Ph.D.*.......................... 41 Chief Executive Officer, President and Director
Thomas G. Jonovich*.................................. 33 Chief Financial Officer
Peter T. Zimmermann*................................. 31 Vice President and Director
Robert J. Gartner*................................... 35 Vice President and Secretary
David A. Tepper*..................................... 40 Director
</TABLE>
- ------------------------
* These persons also serve as directors or officers of the Company.
MICHAEL L. SMIRLOCK, Ph.D. has been the Chief Executive Officer, President
and a Director of the Manager since its inception and is one of its founders.
Mr. Smirlock is also the Chairman of the Board, Chief Executive Officer,
President and a Director of the Company. Mr. Smirlock currently directs the
investment of over $300 million in capital invested primarily in $3.9 billion of
Mortgage Securities for institutions and other sophisticated investors. Prior to
forming the Manager, Mr. Smirlock was a principal of Appaloosa Management L.P.
("Appaloosa"), where he managed investment vehicles and accounts investing
primarily in Mortgage Securities since 1994. See "APPENDIX A--Past Performance
Results." From 1990 until he resigned in 1993, Mr. Smirlock was Domestic Fixed
Income Chief Investment Officer for GSAM, a division of Goldman, Sachs & Co.,
and in 1992, became a partner of Goldman, Sachs & Co. From 1988 to 1990, Mr.
Smirlock served as the head of the Asset Acquisition Group at Franklin Savings
Association. Mr. Smirlock was an Associate Professor of Finance at the Wharton
School of Business of the University of Pennsylvania from 1982 to 1990.
THOMAS G. JONOVICH has been the Chief Financial Officer of the Manager since
its inception. Mr. Jonovich is also the Chief Financial Officer and Treasurer of
the Company. Before joining the Manager, Mr. Jonovich was employed by Appaloosa,
since April 1997, where he was chief accountant for funds investing in Mortgage
Securities. From May 1996 until April 1997, Mr. Jonovich was a Fund Accounting
Manager with Individual Investor Group, Inc., a private investment adviser. He
was a Senior Accountant at Steinhardt Management Company Inc., an investment
advisory firm, from September 1993 to April 1996 and was employed as a certified
public accountant at Gershon, Pierce and Company, a public accounting firm, from
November 1991 to September 1993.
PETER T. ZIMMERMANN has been a Vice President and a Director of the Manager
since its inception. Mr. Zimmermann is also a Vice President and Chief Operating
Officer of the Company. Before joining the Manager, Mr. Zimmermann was employed
by Appaloosa, since October 1994, where he assisted Mr. Smirlock in the
management of investments, primarily in Mortgage Securities. Before joining
Appaloosa, Mr. Zimmermann was a Vice President and Mortgage Portfolio Manager
for GSAM, where he was employed since 1990. While at GSAM, he specialized in
adjustable rate mortgages and was responsible
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for the management of over $6 billion in fixed-income mortgage assets. Mr.
Zimmermann was an associate at Franklin Savings Association prior to joining
GSAM.
ROBERT J. GARTNER has been a Vice President and Secretary of the Manager
since its inception. Mr. Gartner is also a Vice President and Secretary of the
Company. Before joining the Manager, Mr. Gartner was employed by Appaloosa,
since January 1997, where he assisted Mr. Smirlock in the management of
investments, primarily in Mortgage Securities. Before joining Appaloosa, Mr.
Gartner held various positions at Donaldson, Lufkin & Jenrette Securities
Corporation from 1987, including Vice President and trader in the
mortgage-backed securities department.
DAVID A. TEPPER has been a Director of the Manager since its inception. Mr.
Tepper is the chief principal and founder of Appaloosa which specializes in
investments in high-yield securities, Mortgage Securities and bank loans. Before
forming Appaloosa in 1993, Mr. Tepper was head trader in the High-Yield
Department of Goldman, Sachs & Co. Mr. Tepper was a director of the Stone Street
Funds, a private investment fund, from 1987 to 1992, and managed the high-yield
portion of those funds during that period. Mr. Tepper is an indirect minority
stockholder of the Manager.
The address of the Manager is 51 John F. Kennedy Parkway, Short Hills, New
Jersey 07078.
A majority of the equity of the Manager is owned by Mr. Smirlock. The
remaining equity of the Manager is owned by Appaloosa Partners Inc. Mr. Tepper
owns all of the equity of Appaloosa Partners Inc.
CEASE-AND-DESIST ORDER AGAINST CHIEF EXECUTIVE OFFICER
Except as described below, there have been no material administrative, civil
or criminal actions against the Manager or its principals during the preceding
five years. On November 29, 1993, Mr. Smirlock consented to the entry of the
Order issued pursuant to Sections 203(f), 203(k) and 206(2) (the anti-fraud
provisions) of the Advisers Act against him by the Commission in connection with
certain securities transactions executed between December 1992 and February 1993
while Mr. Smirlock was Chief Investment Officer for GSAM. The Commission found
that Mr. Smirlock caused and aided and abetted violations of the Advisers Act by
(i) causing to be executed a series of purchase transactions in Mortgage
Securities for which he failed to prepare promptly order tickets allocating the
securities to specific client accounts and (ii) causing to be executed two
Mortgage Securities transactions between client accounts without obtaining
independent evaluations of the prices at which he instructed the transactions to
be executed in order to ensure that the best price and execution were obtained
for the clients. The Commission found that Mr. Smirlock caused and aided and
abetted violations of these recordkeeping provisions by failing to write tickets
allocating trades on the days the trades were executed. The Commission (i)
ordered Mr. Smirlock to cease and desist from committing or causing any
violation of the provisions of the Advisers Act set forth in the Order, (ii)
suspended him from association with any broker, dealer, investment adviser,
investment company or municipal securities dealer for a three-month period and
(iii) required him to pay a penalty of $50,000. Contemporaneously with the entry
of the Order, Mr. Smirlock submitted an Offer of Settlement to the Commission,
which the Commission accepted, in which he consented to the Commission's entry
of the Order, without admitting or denying the findings set forth therein. GSAM
had become aware of serious violations of its internal compliance policies and
reported these violations to the Commission. In March 1993, following its report
to the Commission, GSAM suspended Mr. Smirlock's trading activities. Mr.
Smirlock resigned from GSAM and Goldman, Sachs & Co. effective November 30,
1993. No limitations will be imposed on Mr. Smirlock's activities in his roles
at the Manager and the Company in light of this proceeding and the Order.
THE MANAGEMENT AGREEMENT
The Company will enter into the Management Agreement with the Manager for an
initial term expiring on December 31, 2002. The Management Agreement shall
continue automatically for successive three-year periods, provided such
continuance is specifically approved by the Board of Directors, including
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<PAGE>
a majority of the Independent Directors. The Management Agreement is terminable
by either the Company, pursuant to a majority vote of the Independent Directors
or a vote of the holders of 66 2/3% of the outstanding shares of Common Stock,
or the Manager, without cause at any time upon 60 days' written notice to the
other party. In addition, the Company has the right to terminate the Management
Agreement upon the occurrence of certain specified events, including a breach by
the Manager of any material provision contained in the Management Agreement. The
Management Agreement also will terminate automatically in the event of its
assignment (as defined in the Advisers Act), unless the assignment is consented
to by the non-assigning party. The Manager has agreed that, during the term of
the Management Agreement, it shall not to serve as an investment adviser to any
other publicly-traded mortgage REIT or any additional private investment fund
that invests primarily in Mortgage Assets and follows investment strategies and
policies similar to those employed by the Company without the prior written
approval of the Independent Directors. In connection with such forbearance on
the Manager's part, the Company has agreed that if the Company terminates the
Management Agreement without cause or the Board of Directors fails to approve a
continuation of the Management Agreement, or the Company engages another person
to manage a portion of its assets or to manage assets internally with personnel
other than those previously employed by the Manager, the Manager will extend the
period of such forebearance and be entitled to receive a "Non-Competition
Payment" in an amount equal to the fair market value of the Management Agreement
(without giving effect to any termination and assuming it is renewed in
accordance with its terms), to be determined in accordance with the provisions
of the Management Agreement.
The Management Agreement does not impose a minimum time commitment that the
Manager and its personnel must make in providing services to the Company. The
ability of the Manager and its employees to engage in other business activities
could reduce the time and effort spent by the Manager and its employees on the
management of the Company.
The Manager at all times will be subject to the supervision 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 authorized to invest the assets
of the Company according to the strategy set forth in this Prospectus and with
the written instructions of the Company's Board of Directors. The Manager will
be responsible for the day-to-day operations of the Company and will perform (or
cause to be performed) such services and activities relating to the assets and
operations of the Company as may be appropriate, including, among other things:
(i) serving as the Company's consultant with respect to formulation of
investment criteria by the Board of Directors;
(ii) advising the Company in connection with the purchase and commitment
to purchase Mortgage Assets, the sale and commitment to sell Mortgage
Assets, and the maintenance and administration of its portfolio of Mortgage
Assets;
(iii) arranging for the securitization of Mortgage Loans;
(iv) 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;
(v) monitoring and providing to the Board of Directors on an ongoing
basis price information and other data obtained from certain nationally
recognized dealers that maintain markets in 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;
(vi) providing executive and administrative personnel, office space and
office services required in rendering services to the Company;
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<PAGE>
(vii) administering the day-to-day operations of the Company and
performing and supervising the performance of such other administrative
functions necessary to the management of the Company as may be agreed upon
by the Manager and the Board of Directors, including the collection of
revenues and the payment of the Company's debts and obligations and
maintenance of appropriate computer systems to perform such administrative
functions;
(viii) communicating on behalf of the Company with the holders of any
equity or debt securities of the Company as required to satisfy the
reporting and other requirements of any governmental bodies or agencies or
trading markets and to maintain effective relations with such holders;
(ix) to the extent not otherwise subject to an agreement executed by the
Company, designating a servicer for Mortgage Loans purchased by the Company
and arranging for the monitoring and administering of such servicer,
including negotiating servicing agreements, collecting information and
submitting reports pertaining to the Mortgage Loans and to monies remitted
to the Manager or the Company;
(x) counseling the Board of Directors in connection with policy
decisions;
(xi) engaging in hedging activities on behalf of the Company, consistent
with the Company's status as a REIT;
(xii) arranging financing of the type described under
"BUSINESS--Operating Policies and Strategies--Capital and Leverage
Policies;"
(xiii) supervising compliance with the REIT Provisions of the Code and
Investment Company Act requirements;
(xiv) upon request by, and in accordance with the directions of, the
Board of Directors, investing or reinvesting any monies of the Company;
(xv) qualifying and causing the Company to qualify to do business in all
applicable jurisdictions; and
(xvi) causing the Company to retain qualified accountants and tax experts
for at least a two-year period to assist in developing appropriate
accounting procedures and testing systems and to conduct quarterly
compliance reviews.
MANAGEMENT FEES
The Manager will receive an annual base management fee, payably monthly, as
set forth below:
<TABLE>
<CAPTION>
ANNUAL BASE MANAGEMENT FEE AS A
PERCENTAGE OF AVERAGE STOCKHOLDERS'
AVERAGE STOCKHOLDERS' EQUITY EQUITY
- ---------------------------------------- ----------------------------------------
<S> <C>
$0 to $500 million...................... 1.0%
$500 million to $1 billion.............. $5 million plus 0.8% of amounts in
excess of $500 million
$1 billion or more...................... $9 million plus 0.6% of amounts in
excess of $1 billion
</TABLE>
The term "Average Stockholders' Equity" for any period means stockholders'
equity, calculated in accordance with GAAP, excluding any mark-to-market
adjustments of the investment portfolio. The Manager will not receive any
management fee for the period prior to the sale of the shares of Common Stock
offered hereby.
The Manager also will be entitled to receive a quarterly incentive fee in an
amount equal to 20% of the Net Income of the Company for the preceding fiscal
quarter, in excess of the amount that would produce an annualized Return on
Average Stockholders' Equity for such fiscal quarter equal to the Ten-Year U.S.
Treasury Rate plus 1%. The term "Return on Average Stockholders' Equity" is
calculated for
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<PAGE>
any quarter by dividing the Company's Net Income for the quarter by its Average
Stockholders' Equity for the quarter. For such calculations, the "Net Income" of
the Company means the taxable income of the Company within the meaning of the
Code, less capital gains and capital appreciation included in taxable income,
but before the Manager's incentive fees and before deduction of dividends paid.
The incentive fee payments to the Manager will be computed before any income
distributions are made to stockholders. As used in calculating the Manager's
fee, the term "Ten-Year U.S. Treasury Rate" means the arithmetic average of the
weekly yield to maturity for actively traded current coupon U.S. Treasury fixed
interest rate securities (adjusted to constant maturities of ten years)
published by the Federal Reserve Board during a quarter, or, if such rate is not
published by the Federal Reserve Board, published by any Federal Reserve Bank or
agency or department of the federal government selected by the Company. The
Ten-Year U.S. Treasury Rate is a commonly used index for calculating management
fees of REITs similar to the Company and is the benchmark interest rate
typically used in pricing Mortgage Securities.
The incentive fee payable to the Manager may create an incentive for the
Manager to recommend investments with greater income potential, which generally
are riskier or more speculative than would otherwise be the case if such fees
did not include a "performance" component. Because the incentive fee is
calculated and payable quarterly, the failure to achieve income over the
Ten-Year U.S. Treasury Rate plus 1% in one quarter will not offset income in a
subsequent quarter, and the Manager is not required to repay any portion of the
management fee as a result of losses in any quarter. Losses or gains in the
value of the Company's portfolio will not affect the calculation of the
incentive compensation, which is based on income. The Company will value its
portfolio on a mark-to-market basis in accordance with GAAP. The Manager
regularly will obtain third-party valuations of its portfolio securities from
brokers-dealers making a market in the securities or from pricing services.
These valuations will be made available to the Board of Directors. The Board of
Directors, with the approval of a majority of Independent Directors, is
authorized to change the rate at which fees are payable to the Manager from time
to time. The Manager will be reimbursed for out-of-pocket expenses paid to third
parties on behalf of the Company.
The management fees are payable in arrears. The Manager's base fee will be
calculated by the Manager as promptly as practicable after the month-end. The
Manager's incentive fee and expenses will be calculated by the Manager within 45
days after the end of each quarter. Such calculations shall be promptly
delivered to the Company. The Company is obligated to pay such fees and expenses
within 15 days after delivery of such calculation.
STOCK OPTIONS AND DEFERRED COMMON STOCK AWARDS
The Company has adopted the Stock Incentive Plan under which awards may be
granted to the directors, officers and employees of the Company and the Manager
from time to time. Upon consummation of the Offering, options will be granted at
the initial public offering price in the amounts indicated to the following
executive officers and directors: Michael L. Smirlock (480,000 shares); Peter T.
Zimmermann (110,000 shares); Robert J. Gartner (72,000 shares); and Thomas G.
Jonovich (28,000 shares). Options to acquire 778,000 shares of Common Stock
(which includes options to purchase 748,000 shares of Common Stock granted to
directors and officers of the Manager) have been granted to directors, officers,
employees and consultants of the Company. The Company has also granted 400,000
shares of deferred Common Stock to certain of its directors and officers. See
"THE COMPANY--Stock Incentive Plan."
LIMITS OF RESPONSIBILITY
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Board of Directors in following or
declining to follow its advice or recommendations. The Manager and its directors
and officers will not be liable to the Company, any subsidiary of the Company,
the Independent Directors, the Company's stockholders or any subsidiary's
stockholders for acts performed in accordance with and
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<PAGE>
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 Company has agreed to indemnify the
Manager and its directors and officers with respect to all expenses, losses,
damages, liabilities, demands, charges and claims arising from acts of the
Manager not constituting bad faith, willful misconduct, gross negligence or
reckless disregard of duties, performed in good faith in accordance with and
pursuant to the Management Agreement.
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THE COMPANY
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information regarding the current
directors and executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Michael L. Smirlock, Ph.D............................ 41 Chairman of the Board, President, Chief Executive
Officer and Director
Thomas G. Jonovich................................... 33 Chief Financial Officer and Treasurer
Peter T. Zimmermann.................................. 31 Vice President and Chief Operating Officer
Robert J. Gartner.................................... 35 Vice President and Secretary
Martin Bernstein..................................... 60 Director(1)
Frederick N. Khedouri................................ 47 Director(1)
William Marshall, Ph.D............................... 51 Director(1)
David A. Tepper...................................... 40 Director
</TABLE>
- ------------------------
(1) To become a Director upon and subject to the closing of the Offering.
For biographical information regarding the business background and
experience of the Company's directors and officers other than Messrs. Bernstein,
Khedouri and Marshall, see "THE MANAGER."
MARTIN BERNSTEIN is a private investor who has been managing family funds
since 1988. Mr. Bernstein also currently serves on the Board of Directors of
Astro Communications, Inc., a public company specializing in strobe lighting,
and MBO Properties, Inc., a real estate mortgage investment trust, and on the
Board of Trustees of Value Property Trust, a real estate investment trust.
FREDERICK N. KHEDOURI is a Senior Managing Director of Bear Stearns, one of
the Representatives, and head of the firm's Financial Institutions Group, which
provides investment banking services to the banking, thrift, insurance,
investment management and specialty finance industries. Prior to joining Bear
Stearns at the end of 1986, Mr. Khedouri was Associate Director of the White
House Office of Management and Budget from 1981 to 1985 and Deputy Chief of
Staff for Vice President George Bush in 1985 and 1986. After joining Bear
Stearns, he was appointed by President Ronald Reagan to the Board of Directors
of the Securities Investor Protection Corporation in 1987.
WILLIAM MARSHALL, PH.D. has been the Chief Operating Officer of NISA
Investment Advisors since 1994. From 1991 to 1994 Mr. Marshall was the Senior
Vice President of National Investment Services of America, Inc., a registered
investment adviser.
The Company's Board of Directors will, upon closing of the Offering, consist
of five directors, and at all times, a majority will be Independent Directors.
The directors will be divided as evenly as possible into three classes,
denominated Class I, Class II and Class III, with the terms of office of each
class expiring at the 1998, 1999 and 2000 annual meeting of stockholders,
respectively. At each annual meeting following such initial classification and
election, directors elected to succeed those directors whose terms expire will
be elected for a term to expire at the third succeeding annual meeting of
stockholders after their election. The directors in each class are as follows:
Class I--Mr. Bernstein, Class II--Messrs. Tepper and Khedouri, and Class
III--Messrs. Smirlock and Marshall. All officers are appointed by and serve at
the discretion of the Board of Directors.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors will have three standing committees: the Executive
Committee, the Compensation Committee and the Audit Committee. Messrs. Smirlock
and Tepper will serve on the Executive
53
<PAGE>
Committee which will be authorized to exercise the powers of the Board of
Directors between meetings. However, the Executive Committee may not (i) amend
the Charter or the Bylaws of the Company, (ii) adopt an agreement of merger or
consolidation, (iii) recommend to the stockholders the sale, lease, or exchange
of all or substantially all of the Company's property and assets, (iv) recommend
to the stockholders a dissolution of the Company or revoke a dissolution, (v)
elect a director, (vi) make a distribution or authorize the issuance of stock or
(vii) agree to an amendment, modification, renewal or termination of the
Management Agreement. The Independent Directors will serve on the Compensation
Committee and the Audit Committee. Messrs. Khedouri and Marshall will serve on
the Compensation Committee. The Compensation Committee will be responsible for
recommending to the Board of Directors the Company's executive compensation
policies for the Chief Executive Officer and other senior officers and for
administering the Stock Incentive Plan. See "--Stock Incentive Plan." Messrs.
Bernstein and Khedouri will serve on the Audit Committee. The Audit Committee is
responsible for recommending independent auditors, reviewing the audit plan, the
adequacy of internal controls, the audit report and the management letter, and
performing such other duties as the Board of Directors may from time to time
prescribe.
COMPENSATION OF DIRECTORS
The Company will pay each non-employee director compensation of $10,000 per
annum and a fee of $500 for each meeting of the Board of Directors that he
attends. However, the directors may be granted awards from time to time pursuant
to the Stock Incentive Plan. See "--Stock Incentive Plan." The Company will
reimburse each director for ordinary and necessary expenses related to such
director's attendance at Board of Directors and committee meetings.
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 executive officers and directors may be granted awards
from time to time pursuant to the Stock Incentive Plan. See "--Stock Incentive
Plan."
STOCK INCENTIVE PLAN
The Company adopted the 1997 Stock Incentive Plan (the "Stock Incentive
Plan") in October 1997. The Stock Incentive Plan will be administered by the
Compensation Committee. Prior to the Offering, the Stock Incentive Plan was
administered by the Board of Directors. All employees and directors of, and
consultants to, the Company (including employees and directors of the Manager),
as may be determined from time to time by the Compensation Committee, are
eligible to receive awards under the Stock Incentive Plan (each, a "SIP
Participant").
Awards under the Stock Incentive Plan may include: (i) options to purchase
shares of Common Stock, including incentive stock options, non-qualified stock
options or both, which options may contain automatic reload features; (ii) stock
appreciation rights, whether in connection with the grant of stock options or
independent of such grant, or stock appreciation rights that are only
exercisable in the event of a Change of Control of the Company (as defined in
the Stock Incentive Plan) or upon other events; (iii) restricted stock, in which
Common Stock is granted to or purchased by SIP Participants for a purchase price
determined by the Compensation Committee, subject to restrictions on
transferability and other restrictions, which lapse over time; (iv) deferred
stock, in which delivery of Common Stock occurs upon expiration of a deferral
period; (v) bonus stock, consisting of a right to receive Common Stock in an
amount determined with reference to a fixed bonus amount; or (vi) other awards
not otherwise provided for, the value of which are based in whole or in part
upon the value of the Common Stock.
A total of 2,066,666 shares of Common Stock were authorized for issuance
under the Stock Incentive Plan; PROVIDED, HOWEVER, that such number shall be
increased on a pro rata basis, to the extent the
54
<PAGE>
Underwriters exercise their over-allotment option. Not more than 1,300,000
shares of Common Stock may be the subject of options and stock appreciation
rights (including stock appreciation rights that are exercisable only for cash)
granted to any individual during any calendar year. Prior to the Offering, the
Board of Directors granted awards which are expected to be ratified by the
Compensation Committee with respect to the issuance of an aggregate of 1,200,000
shares of its Common Stock. See "--Grants of Awards."
At the time a stock option is granted, the Compensation Committee, in its
sole discretion, may designate whether the stock option is to be considered an
incentive stock option or non-qualified stock option. Stock options with no such
designation shall be deemed incentive stock options.
The exercise price of an incentive stock option or a non-qualified stock
option is fixed by the Compensation Committee at the date of grant; however, the
exercise price under an incentive stock option must be at least equal to the
fair market value of the Common Stock at the date of grant. The base value of a
stock appreciation right granted in connection with a stock option is equal to
the exercise price of the related option. The base value of a stock appreciation
right granted independently of an option is equal to the fair market value of a
share of Common Stock on the date of grant. Upon any exercise of a stock
appreciation right, the holder is entitled to receive an amount equal to the
spread (or a portion of such spread, as determined by the Compensation
Committee) between the fair market value of the Common Stock on the date of
exercise and the base value of the stock appreciation right. Such amount is
payable by the Company in the form of cash or shares of Common Stock, as
determined by the Compensation Committee.
Stock options and stock appreciation rights are exercisable for a duration
determined by the Compensation Committee, but in no event more than ten years
after the date of grant. Options and rights shall be exercisable at such rate
and times as may be fixed by the Compensation Committee on the date of grant.
The aggregate fair market value (determined at the time the option is granted)
of the Common Stock with respect to which incentive stock options are
exercisable for the first time by a SIP Participant during any calendar year
(under all stock incentive plans of the Company) shall not exceed $100,000; to
the extent this limitation is exceeded, such excess options shall be treated as
non-qualified stock options for purposes of the Stock Incentive Plan and the
Code.
The Company shall obtain such consideration for granting awards under the
Stock Incentive Plan as the Compensation Committee in its discretion may
request. Each award may be subject to provisions to assure that the grant, or
any exercise or disposition of Common Stock, will not violate federal and state
securities laws.
No award may be granted under the Stock Incentive Plan after the day
preceding the tenth anniversary of the adoption of the Stock Incentive Plan. No
awards may be granted under the Stock Incentive Plan to any person who, assuming
exercise or settlement of all options and rights held by such person, would own
or be deemed to own more than 9.8%, in number of shares or value, of any class
of capital stock of the Company.
Payment of the purchase price for shares acquired upon the exercise of
options may be made by any one or more of the following methods: in cash, by
check, by delivery to the Company of shares of Common Stock already owned by the
option holder, or by such other method as the Compensation Committee may permit
from time to time. However, a holder may not use previously owned shares of
Common Stock to pay the purchase price under an option, unless the holder has
beneficially owned such shares for at least six months. Payment of the purchase
price to purchase restricted shares pursuant to a restricted stock award shall
be made in cash or by check payable to the order of the Corporation.
Stock options and stock appreciation rights terminate at the end of the 30th
business day following the SIP Participant's termination of employment or
service. This period is extended to one year in the case of the disability or
death of the SIP Participant and, in the case of death, the stock option is
exercisable by the
55
<PAGE>
SIP Participant's estate. The post-termination exercise period for any
individual may be extended by the Board of Directors, but not beyond the
expiration of the original term of the option.
The awards granted under the Stock Incentive Plan generally become
immediately vested and exercisable in full in the following circumstances (each,
an "Acceleration Event"): (i) upon the occurrence of special circumstances
determined in the opinion of the Board of Directors of the Company to merit
special consideration, (ii) upon a termination by the Company of the holder's
employment or service without cause (as defined in the Stock Incentive Plan),
(iii) in the case of an employee or director of the Manager, if the Management
Agreement terminates without the occurrence of a Termination Event (as defined
in the Stock Incentive Plan), or (iv) upon a Change of Control (as defined in
the Stock Incentive Plan) of the Company, except that vesting and exercisability
in the event of such a Change of Control shall be limited to the extent
necessary, and shall occur as soon as permissible under GAAP, to permit pooling
of interests accounting treatment if such treatment is desired.
The awards granted under the Stock Incentive Plan are not transferable,
except that the Compensation Committee may authorize a transfer of an award
(other than an incentive stock option) by the holder to certain family members
or trusts or other entities specified in the Plan or permitted by the
Compensation Committee, subject to such terms and conditions as the Compensation
Committee approves.
The awards granted under the Stock Incentive Plan contain anti-dilution
provisions which will automatically adjust the number of shares subject to the
awards in the event of a stock dividend, split-up, conversion, exchange,
reclassification or substitution. In the event of any other change in the
corporate structure or outstanding shares of Common Stock, the Compensation
Committee may make such equitable adjustments to the number of shares and the
class of shares available under the Stock Incentive Plan or any outstanding
awards as it shall deem appropriate to prevent dilution or enlargement of
rights.
The Board of Directors or the Compensation Committee may at any time
withdraw or amend the Stock Incentive Plan and may, with the consent of the
affected holder of an outstanding award at any time withdraw or amend the terms
and conditions of outstanding awards. Any amendment which would increase the
number of shares issuable pursuant to the Stock Incentive Plan or to any
individual thereunder or change the class of individuals to whom awards may be
granted shall be subject to the approval of the stockholders of the Company.
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<PAGE>
GRANTS OF AWARDS
In connection with the Offering, options to acquire 778,000 shares of Common
Stock and a grant of 400,000 shares of deferred Common Stock were awarded under
the Stock Incentive Plan, to certain individuals and groups of individuals, as
follows:
<TABLE>
<CAPTION>
TYPES OF AWARDS AND NUMBER OF
SHARES OF COMMON STOCK
SUBJECT TO AWARDS
-----------------------------
DEFERRED STOCK
NAME OR GROUP COMMON STOCK(1) OPTIONS(2)
- ----------------------------------------------------------------------------------- ---------------- -----------
<S> <C> <C>
Michael L. Smirlock................................................................ 320,000 480,000
Thomas G. Jonovich................................................................. -- 28,000
Peter T. Zimmermann................................................................ 60,000 110,000
Robert J. Gartner.................................................................. 20,000 72,000
Martin Bernstein................................................................... -- 10,000
Frederick N. Khedouri.............................................................. -- 10,000
William Marshall................................................................... -- 10,000
David A. Tepper.................................................................... -- 20,000
All other employees of, or consultants to, the Company or the Manager, as a
group............................................................................ -- 38,000
</TABLE>
- ------------------------
(1) The deferral period will expire at the rate of 6.25% per quarter commencing
on January 2, 1998, subject to the holder's continued employment or service,
or upon the earlier occurrence of an Acceleration Event.
(2) The options will be non-qualified options with a per share exercise price
under each option equal to the initial public offering price. The options
become exercisable at the rate of 25% on each of January 2, 1998, January 2,
1999, January 2, 2000, and January 2, 2001, subject to the holder's
continued employment or service, and will become exercisable in full upon
the earlier occurrence of an Acceleration Event.
If the Underwriters' over-allotment option to purchase an additional
2,250,000 shares is exercised, the number of options issued will increase on a
PRO RATA basis to each of the above-named individuals.
COMPENSATION COMMITTEE INTERLOCKS
No interlocking relationship exists between members of the Company's Board
of Directors or the Compensation Committee or officers responsible for
compensation decisions and the board of directors or compensation committee of
any other company, nor has such interlocking relationship existed in the past.
57
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
AND CONFLICTS OF INTEREST
The Company will be subject to conflicts of interest involving the Manager.
The executive officers of the Company will be officers and employees of the
Manager. A majority of the Company's directors have no business affiliations
with the Manager, but were initially selected by the Manager. Michael L.
Smirlock, the Chief Executive Officer, President and a Director of the Company,
is the owner of a majority of the capital stock of the Manager. David A. Tepper,
a Director of the Company, is the indirect owner of a minority of the capital
stock of the Manager.
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, except that,
during the term of the Management Agreement, the Manager may not manage another
publicly-traded mortgage REIT or any additional private investment fund that
invest primarily in Mortgage Assets and follow investment strategies and
policies similar to those employed by the Company without the prior approval of
the Independent Directors. The Manager and its officers and employees advise and
manage the Affiliated Funds, which invest in Mortgage Securities and have
committed to invest in the Company's securities. See "PRIVATE PLACEMENT." The
ability of the Manager and its officers and employees to engage in other
business activities could reduce the time and effort the Manager spends on
managing the Company's investment portfolio. The Manager and its officers and
employees also may receive fees in connection with any investment by the
Affiliated Funds in the Company. In addition, the incentive fee payable to the
Manager by the Affiliated Funds or other clients may be higher than the fee paid
by the Company, creating additional potential conflicts of interest.
Many investments appropriate for the Company also will be appropriate for
accounts of other clients the Manager advises, including the Affiliated Funds.
The Manager will act in a manner which it considers fair and equitable in
allocating investment opportunities among the Company and the other accounts it
manages. Situations may arise in which the investment activities of the Manager
or the other accounts may disadvantage the Company, such as the inability of the
market to fully absorb orders for the purchase or sale of particular securities
placed by the Manager for the Company and its other accounts at prices and in
quantities which would be obtained if the orders were being placed only for the
Company. The Manager may aggregate orders of the Company with orders for its
other accounts. Such aggregation of orders may not always be to the benefit of
the Company with regard to the price or quantity executed.
The Manager, however, will not permit the Affiliated Funds or its other
clients to sell securities or other assets to, or purchase securities or other
assets from, the Company, nor will any such Affiliates be permitted to enter
into derivative transactions with the Company. The Manager will not reallocate
assets among the Company and the Affiliated Funds.
The incentive fee payable to the Manager is based upon the net income
received by the Company. This may create an incentive for the Manager to
recommend investments with greater income potential, which generally are riskier
or more speculative than would be the case if such fees did not include a
"performance" component. Such incentives may result in increased risk to the
value of the Company's investment portfolio. See "THE MANAGER--Management Fees."
The Company has agreed that if it terminates the Management Agreement
without cause or the Board of Directors fails to approve a continuation of the
Management Agreement, or the Company engages another person to manage a portion
of its assets or to manage assets internally with personnel other than those
previously employed by the Manager, the Manager will be entitled to receive a
"Non-Competition Payment" in an amount equal to the fair market value of the
Management Agreement (without giving effect to any termination and assuming it
is renewed in accordance with its terms), to be determined in accordance with
the provisions of the Management Agreement.
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<PAGE>
The Manager, its Affiliates and the funds managed by Appaloosa have
committed to purchase an aggregate of 714,235 shares of Common Stock as part of
the Private Placement. See "PRIVATE PLACEMENT." This purchase will result in
ownership by all such persons of approximately 3.6% of the total shares
outstanding after the Offering, exclusive of the Underwriters' over-allotment
option and any options granted under the Stock Incentive Plan. The sale of the
shares purchased in the Private Placement will be subject to a resale
registration statement expected to be declared effective shortly following the
closing of the Offering. The Manager and its directors, officers and employees
will receive stock options pursuant to the Company's Stock Incentive Plan. See
"THE COMPANY--Stock Incentive Plan."
The Manager, its Affiliates and funds managed by Appaloosa may dispose of
their shares any time after the lock-up period pursuant to the resale
registration statement and otherwise in compliance with all applicable
restrictions. See "SHARES ELIGIBLE FOR FUTURE SALE" and "UNDERWRITING."
The market in which the Company expects to purchase Mortgage Assets is
characterized by the rapid evolution of products and services, and thus, there
may in the future be relationships among the Company, the Manager, and
Affiliates of the Manager in addition to those described herein.
Frederick N. Khedouri, a Senior Managing Director of Bear Stearns, is a
proposed Director of the Company and has committed to purchase 10,000 shares at
the initial public offering price in the Private Placement. Bear Stearns
provides financial advisory services to the Company and its Affiliates.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to the Company with
respect to beneficial ownership of the Company's Common Stock on the date
hereof, including the commitments to purchase shares of Common Stock which have
been received in connection with the Private Placement, and as adjusted to
reflect the sale of Common Stock being offered hereby and assuming the sale of
all of the shares of Common Stock for which commitments to purchase have been
received in connection with the Private Placement, by (i) each director and
nominee for director, (ii) any person known to the Company to be the beneficial
owner of five percent or more of the Common Stock and (iii) all directors and
executive officers as a group. Unless otherwise indicated in the footnotes to
the table, the beneficial owners named have, to the knowledge of the Company,
sole voting and investment power with respect to the shares beneficially owned,
subject to community property laws where applicable.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OWNED AFTER
THE OFFERING(2) THE OFFERING
---------------------- ----------------------
NUMBER NUMBER
NAME AND ADDRESS OF BENEFICIAL OWNER(1) OF SHARES PERCENT OF SHARES PERCENT
- ------------------------------------------------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Michael L. Smirlock, Ph.D........................ 73,000 1.45% 213,000(3) 1.06%
Thomas G. Jonovich............................... 1,000 * 8,000(4) *
Peter T. Zimmermann.............................. 25,000 * 56,250(5) *
Robert J. Gartner................................ 10,000 * 29,250(6) *
Martin Bernstein (7)(8).......................... 14,600 * 17,100(9) *
Frederick N. Khedouri (7)........................ 10,000 * 12,500(9) *
William Marshall, Ph.D. (7)...................... -- -- 2,500(9) *
David A. Tepper(10).............................. 831,835 16.57% 836,835 11) 4.18%
Franklin Mutual Advisers Inc. (12)............... 3,333,333 66.40% 3,333,333 16.65%
All directors and executive officers as a group
(8 persons).................................... 950,835 18.94% 1,160,835 5.74%
</TABLE>
- ------------------------------
* Less than one percent
(1) Unless otherwise indicated, the address of each beneficial owner is c/o
LASER Mortgage Management, Inc., 51 John F. Kennedy Parkway, Short Hills,
New Jersey 07078. Mr. Bernstein's address is 85 Shrewsbury Drive,
Livingston, New Jersey 07039. Mr. Khedouri's address is c/o Bear, Stearns &
Co. Inc., 245 Park Avenue, New York, New York 10167. Mr. Marshall's address
is c/o NISA Investment Advisors, L.L.C., 150 N. Meramec, Suite 640, St.
Louis, Missouri 63105.
(2) Includes shares for which commitments have been received in the Private
Placement, although the Private Placement is contingent upon the
consummation of the Offering. See "PRIVATE PLACEMENT."
(3) Includes 20,000 shares of deferred Common Stock which will vest and 120,000
options which will become exercisable within the next 60 days.
(4) Includes 7,000 options which will become exercisable within the next 60
days.
(5) Includes 3,750 shares of deferred Common Stock which will vest and 27,500
options which will become exercisable within the next 60 days.
(6) Includes 1,250 shares of deferred Common Stock which will vest and 18,000
options which will become exercisable with in the next 60 days.
(7) To become a director upon, and subject to, the Closing.
(8) Includes 14,600 shares of Common Stock as to which Mr. Bernstein exercises
voting control as trustee for the Tepper Family Irrevocable Trust, as to
which Mr. Bernstein disclaims beneficial ownership.
(9) Includes 2,500 options which will become exercisable within the next 60
days.
(10) Includes 714,235 shares of Common Stock beneficially held by private
investment funds over which Mr. Tepper exercises dispositive control and
14,600 shares held by the Tepper Family Irrevocable Trust for the benefit of
Mr. Tepper's minor children, as to which Mr. Tepper disclaims beneficial
ownership.
(11) Includes 5,000 options which will become exercisable within the next 60
days.
(12) Includes all of the shares of Common Stock owned beneficially by the Funds,
which are advised by Franklin Mutual Advisers Inc., 51 John F. Kennedy
Parkway, Short Hills, New Jersey 07078. See "PRIVATE PLACEMENT."
60
<PAGE>
DIVIDEND REINVESTMENT AND DIRECT PURCHASE PLAN
The Company has adopted a Dividend Reinvestment and Direct Purchase Plan
(the "DRP") to provide stockholders of the Company and interested investors who
are not stockholders with a convenient and economical method to automatically
reinvest all or a portion of their cash distributions in, and, subject to the
Board of Directors' determination, make periodic cash subscriptions for, shares
of the Company's Common Stock.
The Plan will be administered by The Chase Manhattan Bank (the "Plan
Administrator"). The Plan Administrator will keep records, send statements of
account to each person who participates in the DRP and provide safekeeping for
the shares and perform other duties relating to the DRP. The Plan Administrator
also will act as the distribution disbursing agent, transfer agent and registrar
for the Company's Common Stock.
All stockholders or interested investors making a minimum optional
subscription of $250 are eligible to participate in the DRP. A stockholder who
owns shares of the Company's Common Stock in his or its own name (a "Stockholder
of Record") may participate directly in the DRP by delivering a completed
authorization form (the "Authorization Form") to the Plan Administrator. A
stockholder who beneficially owns shares of the Company's Common Stock that are
registered in a name other than such stockholder's name (a "Beneficial Owner")
may participate in the plan by instructing its broker, bank or other nominee to
complete and sign the Authorization Form and forward it to its securities
depository, which will provide the Plan Administrator with the information
necessary to allow the Beneficial Owner to participate in the DRP. In addition
to the reinvestment of dividends, the DRP provides current stockholders and non-
stockholders with the opportunity to make monthly investments in the Company's
Common Stock through optional cash purchases ("Cash Purchases"), subject to a
minimum of $250 and a maximum of $5,000 per month (or such larger amount as to
which the Company may consent), after receipt of a prospectus forming part of a
Registration Statement on Form S-11 which has been filed with the Commission
prior to the date of this Prospectus and relates solely to the shares to be sold
pursuant to the DRP.
Shares purchased directly from the Company through distribution reinvestment
under the DRP will be issued without a sales commission and may be issued at a
discount, ranging from 0% to 5%. If the Company should elect that the shares of
the Company's Common Stock to be purchased under the DRP are to be purchased in
the open market instead of directly from the Company, the Company will pay any
brokerage fees or commissions on such purchases. No discount will apply to open
market purchases or to privately negotiated purchases of the Company's Common
Stock. A DRP participant will be subject to a minimal fee in the event the DRP
participant asks the Plan Administrator to sell all or a portion of such DRP
participant's shares.
The Authorization Form provides for the purchase of shares of the Company's
Common Stock through the following participation options: (i) Full Distribution
Reinvestment--the Plan Administrator will apply all cash distributions on all
shares of the Company's Common Stock then or subsequently registered in the DRP
participant's name, including all whole and fractional shares of the Company's
Common Stock, together with any voluntary cash contributions for Cash Purchases
towards the purchase of additional shares of the Company's Common Stock; (ii)
Partial Distribution Reinvestment--the Plan Administrator will apply all cash
distributions on the number of shares of the Company's Common Stock then
registered in the DRP participant's name and designated in the appropriate space
on the Authorization Form and all cash dividends on shares of the Company's
Common Stock purchased by the DRP participant pursuant to the DRP, together with
any voluntary cash contributions towards the purchase of additional shares of
the Company's Common Stock; or (iii) Cash Purchases Only--the Plan Administrator
will only apply the voluntary cash contributions received from the DRP
participant towards the purchase of shares of the Company's Common Stock.
Distributions shall be reinvested (the date of such reinvestment, the
"Distribution Reinvestment Date") as soon as practicable after the date on which
the Company makes a distribution (the "Distribution
61
<PAGE>
Record Date"), except where reinvestment of such funds at a later date is
necessary under applicable securities laws. Under normal market conditions, the
funds are expected to be reinvested on the Distribution Record Date. The
"Average Market Price for Distribution Reinvestments" per share of the Company's
Common Stock acquired directly from the Company under the DRP shall be the
average of the daily high and low sales prices, computed to seven decimal
places, of the shares of the Company's Common Stock as reported on the NYSE on
the Distribution Reinvestment Date, or if no trading occurs in the Company's
Common Stock on the Distribution Reinvestment Date, the average of the high and
low sales prices for the first trading day immediately preceding the
Distribution Reinvestment Date for which trades are reported. If the Company
elects to purchase the shares on the open market or in privately negotiated
transactions, the price per share of the Company's Common Stock acquired through
such open market or privately negotiated transactions will be the weighted
average purchase price for all the Company's Common Stock purchased by the Plan
Administrator in connection with such open market purchases, without application
of a discount.
The "Average Market Price for Cash Purchases" per share shall be the average
of the daily high and low sales prices, computed to seven decimal places, of the
shares of the Company's Common Stock as reported on the NYSE during the twelve
trading days prior to the date scheduled for investment of Cash Purchases for
that month. No commission shall be paid with respect to purchases of authorized
but unissued shares of the Company's Common Stock directly from the Company. If
the Company elects to purchase the shares on the open market or in privately
negotiated transactions, the price per share of the Company's Common Stock
acquired through such open market or privately negotiated transactions will be
the weighted average of the actual prices paid, computed to seven decimal
places, for all the Company's Common Stock purchased by the Plan Administrator
in connection with such open market purchases, without application of a
discount. Cash Purchases in excess of $5,000 may be made only upon acceptance in
writing by the Company of a completed written request for waiver form from the
Plan participant. It is solely within the Company's discretion as to whether any
such approval for cash investments in excess of $5,000 will be granted.
As soon as practical after the purchase of the shares has been completed,
the Plan Administrator will send each DRP participant a statement of account
confirming the transaction and itemizing the previous reinvestment activity for
the calendar year. DRP participants will receive tax information annually for
their personal records and to assist in the preparation of their federal income
tax returns. DRP participants generally will be treated as having received a
distribution equal to the fair market value of the shares of the Company's
Common Stock that are purchased with the DRP participant's reinvested
distributions generally on the date that the Company credits such shares to the
DRP participant's account, plus the brokerage commissions, if any, allocable to
the purchase of such shares, and DRP Participants will have a tax basis in the
shares equal to such value. See "FEDERAL INCOME TAX CONSIDERATIONS."
62
<PAGE>
FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of Common Stock in the Company.
Stroock & Stroock & Lavan LLP has acted as Special Tax Counsel to the Company
and has reviewed this summary and has rendered an opinion that the descriptions
of the law and the legal conclusions contained herein are correct in all
material respects, and the discussions hereunder fairly summarize the federal
income tax considerations that are likely to be material to the Company and to
holders of the Common Stock. The discussion contained herein does not address
all aspects of taxation that may be relevant to particular stockholders in light
of their personal investment or tax circumstances, or to certain types of
stockholders (including insurance companies, tax-exempt organizations, financial
institutions or broker-dealers, foreign corporations, and persons who are not
citizens or residents of the U.S.) subject to special treatment under the
federal income tax laws.
The statements in this discussion, including the opinions of Stroock &
Stroock & Lavan LLP referred to herein, are based on current provisions of the
Code, existing, temporary and currently proposed Treasury Regulations
promulgated under the Code, the legislative history of the Code, existing
administrative rulings and practices of the Service and judicial decisions. No
assurance can be given that future legislative, judicial, or administrative
actions or decisions, which may be retroactive in effect, will not affect the
accuracy of any statements in this Prospectus.
EACH PROSPECTIVE PURCHASER IS ADVISED TO CONSULT HIS OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSIDERATIONS TO HIM OF THE PURCHASE, OWNERSHIP, AND
SALE OF THE COMMON STOCK AND OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT,
INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER TAX CONSIDERATIONS OF
SUCH PURCHASE, OWNERSHIP, SALE, AND ELECTION, AND OF POTENTIAL CHANGES IN
APPLICABLE TAX LAWS.
GENERAL
The Company will elect to become subject to tax as a REIT under the REIT
Provisions of the Code for federal income tax purposes, commencing with the
taxable year ending December 31, 1997. The Company currently expects that it
will operate in a manner that will permit the Company to maintain its
qualification as a REIT for the taxable year ending December 31, 1997, and in
each taxable year thereafter. This treatment will permit the Company to deduct
dividend distributions to its stockholders for Federal income tax purposes, thus
effectively eliminating the "double taxation" that generally results when a
corporation earns income and distributes that income to its stockholders in the
form of dividends.
In the opinion of Special Tax Counsel to the Company, the Company's
contemplated method of operation described in this Prospectus and as represented
by the Company will enable it to satisfy the requirements for qualification as a
REIT under the Code commencing with the taxable year ending December 31, 1997.
This opinion is based on various assumptions relating to the organization and
operation of the Company and is conditioned upon certain representations made by
the Company as to certain factual matters. The continued qualification and
taxation of the Company as a REIT will depend upon the Company's ability to
meet, on a continuing basis, distribution levels and diversity of stock
ownership, and the various qualification tests imposed by the Code as discussed
below.
There can be no assurance, however, that the Company will qualify as a REIT
in any particular taxable year, given the highly complex nature of the rules
governing REITs, the ongoing importance of factual determinations and the
possibility of future changes in the circumstances of the Company. If the
Company were not to qualify as a REIT in any particular year, it would be
subject to federal income tax as a regular, domestic corporation, and its
stockholders would be subject to tax in the same manner as stockholders of such
corporation. In this event, the Company could be subject to potentially
substantial income tax liability in respect of each taxable year that it fails
to qualify as a REIT, and the amount of
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earnings and cash available for distribution to its stockholders could be
significantly reduced or eliminated. In addition, the Company may be subject to
a 4% federal excise tax to the extent the Company does not distribute 85% of its
REIT ordinary income for such year and 95% of its REIT capital gain net income
for such year.
REQUIREMENTS FOR QUALIFICATION
The following is a brief summary of certain technical requirements that the
Company must meet on an ongoing basis in order to qualify, and remain qualified,
as a REIT under the Code:
STOCK OWNERSHIP TESTS
The capital stock of the Company must be transferable stock held, beginning
with its January 1, 1998 taxable year, by at least 100 persons during at least
335 days of a taxable year of 12 months (or during a proportionate part of a
taxable year of less than 12 months), and no more than 50% of the value of such
capital stock may be owned, directly or indirectly, by five or fewer individuals
(as defined in the Code to include certain entities) at any time during the last
half of the taxable year. Tax-exempt entities, other than private foundations,
certain unemployment compensation trusts and certain charitable trusts generally
are not treated as individuals for these purposes. The Company expects that it
will satisfy the capital stock ownership requirements immediately following the
Offering. In addition, the Charter provides restrictions regarding the transfer
of the Company's shares to assist in meeting the stock ownership requirements.
See "DESCRIPTION OF CAPITAL STOCK."
ASSET TESTS
The Company must generally meet the following asset tests (the "REIT Asset
Tests") at the close of each quarter of each taxable year:
(a) at least 75% of the value of the Company's total assets must consist
of Interests in Real Property (as defined below), including interests in
mortgages on real property (to the extent the principal balance of a
mortgage does not exceed the fair market value of the associated real
property), regular or residual interests in a REMIC (except that, if less
than 95% of the assets of a REMIC consists of real estate assets (determined
as if the Company held such assets), the Company will be treated as holding
directly its proportionate share of the assets of such REMIC), shares of
other REITs, government securities, temporary investments in stock or debt
instruments during the one year period following the Company's receipt of
certain new capital cash, and cash items (the "75% Asset Test"). For
purposes of the 75% Asset Test, the term "Interest in Real Property"
includes an interest in Mortgage Loans (to the extent the principal balance
of a mortgage does not exceed the fair market value of the associated real
property) or land and improvements thereon, such as buildings or other
inherently permanent structures (including items that are structural
components of such buildings or structures), a leasehold of real property,
and an option to acquire real property (or a leasehold of real property);
and
(b) the value of securities held by the Company but not taken into
account for purposes of the 75% Asset Test must not exceed (i) 5% of the
value of the Company's total assets in the case of securities of any one
issuer, or (ii) 10% of the outstanding voting securities of any such issuer.
The Company expects that any Subordinate Interests, IOs, Inverse IOs, and
temporary investments that it acquires generally will be treated as qualifying
assets for purposes of the 75% Asset Test, except to the extent that less than
95% of the assets of a REMIC in which the Company owns an interest consists of
real estate assets and the Company's proportionate share of those assets
includes assets that are nonqualifying assets for purposes of the 75% Asset
Test. In addition, the Company does not expect that the value of any security of
any one entity would exceed 5% of the Company's total assets, and the Company
does not expect to own more than 10% of any one issuer's voting securities. The
Company also may
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purchase regular interests in a Financial Asset Securitization Investment Trust
(a "FASIT") which will be treated as qualifying assets for purposes of the 75%
Asset Test, except to the extent that less than 95% of the assets of a FASIT
consists of real estate assets in which case the Company's proportionate share
of the FASIT's nonqualifying assets will be treated as nonqualifying assets for
purposes of the 75% Asset Test.
The Company will monitor the status of the assets that it acquires to assure
compliance with the REIT Asset Tests and has represented that it will manage its
portfolio to comply with such tests.
If the Company should fail to satisfy the REIT Asset Tests at the end of a
calendar quarter, such a failure would not cause it to lose its REIT status if
(i) it satisfied the REIT Asset Tests at the close of the preceding calendar
quarter and (ii) the discrepancy between the value of the Company's assets and
the REIT Asset Test requirements arose from changes in the market values of its
assets and was not wholly or partly caused by the acquisition of one or more
nonqualifying assets. If the condition described in clause (ii) of the preceding
sentence was not satisfied, the Company still could avoid disqualification by
eliminating any discrepancy within 30 days after the close of the calendar
quarter in which it arose.
GROSS INCOME TESTS
The Company must generally meet the following gross income tests (the "REIT
Gross Income Tests") for each taxable year:
(a) at least 75% of the Company's gross income must be derived from
certain specified real estate sources including interest income on Mortgage
Loans and gain from the disposition of Qualified Real Estate Assets or
"qualified temporary investment income," (I.E., income derived from "new
capital" within one year of the receipt of such capital) (the "75% Gross
Income Test"); and
(b) at least 95% of the Company's gross income must consist of the
income which qualifies for the 75% Gross Income Test, as well as other
interest and gains from the sale of stock or other securities (including
certain interest rate swap or cap agreements, options, forward rate
agreements, and similar financial instruments entered into to reduce the
interest rate risk with respect to debt incurred to acquire Qualified Real
Estate Assets) not held for sale in the ordinary course of business (the
"95% Gross Income Test").
For purposes of determining whether the Company complies with the 75% and
95% Gross Income Tests, 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. If the Company sells Mortgage Securities
that it created through Mortgage Loan securitizations, the Company may recognize
income that, if sufficient to cause the Company to be treated as a dealer in
Mortgage Securities for federal income tax purposes, could constitute
"prohibited transaction" income. See "--Taxation of the Company."
Interest on obligations secured by mortgages on real property or on
Interests in Real Property is qualifying income for purposes of the 75% Gross
Income Test. Any amount includible in gross income with respect to a regular or
residual interest in a REMIC or a regular interest in a FASIT generally is
treated as interest on an obligation secured by a mortgage on real property. If,
however, less than 95% of the assets of a REMIC or a FASIT consists of real
estate assets (determined as if the Company held such assets), the Company will
be treated as receiving directly its proportionate share of the income of the
REMIC or the FASIT. In addition, if the Company receives interest income with
respect to a mortgage loan that is secured by both real property and other
property and the highest principal amount of the loan outstanding during a
taxable year exceeds the fair market value of the real property on the date the
Company purchased the mortgage loan, the interest income will be apportioned
between the real property and the other property, which apportionment may cause
the Company to recognize income that is not qualifying income for purposes of
the 75% Gross Income Test.
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Most of the income that the Company recognizes with respect to its
investments in Mortgage Loans will be qualifying income for purposes of both the
75% and 95% Gross Income Tests. This generally will include interest, original
issue discount, and market discount income that the Company derives from its
investments in Subordinate Interests, IOs and Inverse IOs.
The Company may originate or acquire Mortgage Loans and securitize such
loans through the issuance of non-REMIC CMOs. As a result of such transactions,
the Company will retain an equity ownership interest in the Mortgage Loans that
has economic characteristics similar to those of a Subordinate Interest. In
addition, the Company may resecuritize Mortgage Securities (or non-REMIC CMOs)
through the issuance of non-REMIC CMOs, retaining an equity interest in the
Mortgage Securities used as collateral in the resecuritization transaction. Such
transactions will not cause the Company to fail to satisfy the Gross Income
Tests. Further, the Company intends to structure such securitizations in a
manner which does not result in treatment of the REIT or issuing entity as a
"taxable mortgage pool."
The Company may receive income that is nonqualifying income for either the
75% Gross Income Test or both the 75% and 95% Gross Income Tests. For example,
(i) the loan amount of a Mortgage Loan may exceed the value of the real property
securing the loan, which will result in a portion of the income from the loan
being classified as qualifying income for purposes of the 95% Gross Income Test,
but not for purposes of the 75% Gross Income Test, (ii) the Company may hold an
interest in a REMIC or in a FASIT less than 95% of the assets of which consists
of real estate assets (determined as if the Company held such assets), in which
case the Company's proportionate share of the income of the REMIC or FASIT may
include income that is not qualifying income for purposes of the 75% or 95%
Gross Income Tests and (iii) the Company may recognize foreign currency gain
from non-dollar denominated loans which will not be qualifying income for
purposes of the 75% and 95% Gross Income Tests.
It is possible that, from time to time, the Company will enter into hedging
transactions with respect to one or more of its assets or liabilities. Any such
hedging transactions could take a variety of forms, including interest rate swap
contracts, interest rate cap or floor contracts, forward contracts, and options.
To the extent that the Company enters into a contract to hedge indebtedness
incurred to acquire or carry real estate assets, any periodic income or gain
from the disposition of such contract should be qualifying income for purposes
of the 95% Gross Income Test, but not the 75% Gross Income Test. To the extent
that the Company hedges its capital assets, it is not clear how the income from
those transactions will be treated for purposes of the Gross Income Tests.
To ensure that the Company does not violate the REIT Gross Income Tests,
certain hedging activities, the creation of Mortgage Securities through
securitizations, and certain financing techniques may be conducted through one
or more taxable subsidiaries of the Company. To avoid a violation of the REIT
Asset Tests, the Company would own only nonvoting preferred and common stock of
the taxable subsidiary (other entities and/or individuals would own all of the
voting common stock) and the value of the Company's investment in such a
subsidiary would be limited to less than 5% of the value of the Company's total
assets at the end of each calendar quarter. The taxable subsidiary would not
elect REIT status and would distribute only net after-tax profits to its
stockholders, including the Company.
DISTRIBUTION REQUIREMENT
In order to avoid subjecting its income to tax at regular corporate rates
(without a deduction for dividends paid), the Company generally must distribute
to its stockholders an amount equal to at least 95% of the Company's REIT
taxable income before deductions of dividends paid, excluding net capital gain
and certain non-cash income including original issue discount and cancellation
of indebtedness income.
The Company intends to make distributions to its stockholders to comply with
the 95% Distribution Requirement. However, differences in timing between the
recognition of taxable income and the actual receipt of cash could require the
Company to borrow funds or sell assets on a short-term basis to satisfy the
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95% Distribution Requirement. The requirement to distribute a substantial
portion of the Company's net taxable income could cause the Company to (i) sell
assets in adverse market conditions, (ii) distribute amounts that represent a
return of capital, or (iii) distribute amounts that would otherwise be spent on
future investments or repayment of debt.
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, the Company will
generally not be subject to federal income tax on the portion of its REIT
taxable income or capital gain which is distributed to its stockholders. The
Company will, however, be subject to federal income tax at normal corporate
income tax rates upon any undistributed taxable income or capital gain.
Beginning with the Company's 1998 taxable year, stockholders will be entitled to
a credit against their federal income tax for their allocable share of tax paid
by the Company on undistributed long-term capital gains so designated in a
notice by the Company (which are treated as having been distributed to and
subject to tax in the hands of the stockholders).
Notwithstanding its qualification as a REIT, the Company may also be subject
to tax in certain other circumstances. If the Company fails to satisfy either
the 75% or the 95% Gross Income Test, but nonetheless maintains its
qualification as a REIT because certain other requirements are met, it generally
will be subject to a 100% tax on the greater of the amount by which the Company
fails either the 75% or the 95% Gross Income Test. The Company also will be
subject to a tax of 100% on net income derived from a "prohibited transaction,"
and if the Company has (i) net income from the sale or other disposition of
"foreclosure property" which is held primarily for sale to customers in the
ordinary course of business or (ii) other non-qualifying income from foreclosure
property, it will be subject to Federal income tax on such income at the highest
corporate income tax rate. In addition, if the Company fails to distribute
during each calendar year at least the sum of (i) 85% of its REIT ordinary
income for such year and (ii) 95% of its REIT capital gain net income for such
year, the Company would be subject to a 4% Federal excise tax on the excess of
such required distribution over the amounts actually distributed during the
taxable year, plus any undistributed amount of ordinary and capital gain net
income from the preceding taxable year. The Company also may be subject to the
corporate alternative minimum tax, as well as other taxes in certain situations
not presently contemplated.
Further, if the Company were to sell Mortgage Securities that it created
through securitization of Mortgage Loans or to sell to customers Mortgage Assets
or hedging instruments on a regular basis, there is a substantial risk that such
assets 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. Although the Company does not presently intend to make regular
sales to customers of such Mortgage Securities or other assets, if this
intention changes in the future, the Company intends that any such sales would
be made through a taxable subsidiary formed for such purpose. Any such
subsidiary would not be subject to this 100% tax, which is only applicable to
REITs or Qualified REIT Subsidiaries. The Company (either directly or through
Qualified REIT Subsidiaries or a taxable subsidiary) intends to enter into
dollar roll transactions which will be structured such that income or gain from
such transactions will not be subject to the 100% tax.
A "dealer" (as specifically defined in Section 475 of the Code) generally is
required to mark-to-market for tax purposes, I.E. treat as sold in a taxable
transaction, securities which it holds at the end of each year, unless it
identifies the securities as held for investment. Pursuant to proposed Treasury
Regulations such a dealer is required to mark-to-market securities that are
transferred in a securitization transaction unless the transferor expects to
hold for investment each of the interests received. The Company intends to
structure its activities in a manner which avoids (or, with respect to
securities used in dollar roll financings, which substantially reduces or
eliminates any potential negative impact of) the application to it of the
mark-to-market rule. It should be noted that final Treasury Regulations may
require a different treatment of Mortgage Loans or Mortgage Securities acquired
for securitizations than provided in the proposed regulations, possibly with
retroactive effect.
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If the Company fails to qualify as a REIT in any taxable year and certain
relief provisions of the Code do not apply, the Company would be subject to
Federal income tax (including any applicable alternative minimum tax) on its
taxable income at the regular corporate income tax rates and may be subject to a
4% federal excise tax. Distributions to stockholders in any year in which the
Company fails to qualify as a REIT would not be deductible by the Company, nor
would they generally be required to be made under the Code. Further, unless
entitled to relief under certain other provisions of the Code, the Company also
would be disqualified from re-electing REIT status for the four taxable years
following the year during which it became disqualified.
The Company intends to monitor on an ongoing basis its compliance with the
REIT requirements described above. To maintain its REIT status, the Company will
be required to limit the types of assets that the Company might otherwise
acquire, or hold certain assets at times when the Company otherwise might have
determined that the sale or other disposition of such assets would have been
more prudent.
TAXATION OF STOCKHOLDERS
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable U.S. stockholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such U.S. stockholders as ordinary income and will not be eligible
for the dividends received deduction generally available to corporations. As
used herein, the term "U.S. stockholder" means a holder of Common Stock that for
U.S. federal income tax purposes is (i) a citizen or resident of the U.S., (ii)
a corporation, partnership, or other entity created or organized in or under the
laws of the U.S. or of any political subdivision thereof, (iii) an estate whose
income from sources without the United States is includible in gross income for
U.S. federal income tax purposes regardless of its connection with the conduct
of a trade or business within the United States, or (iv) any trust with respect
to which (A) a U.S. court is able to exercise primary supervision over the
administration of such trust and (B) one or more U.S. persons have the authority
to control all substantial decisions of the trust. Distributions that are
designated as capital gain dividends will be taxed as gain from the sale of a
capital asset held for more than one year (to the extent they do not exceed the
Company's actual net capital gain for the taxable year) without regard to the
period for which the U.S. stockholder has held his Common Stock. Stockholders'
bases in their shares will be increased by undistributed long-term capital gains
so designated by the Company less the taxes thereon paid by the Company and
credited to stockholders. Distributions in excess of current and accumulated
earnings and profits will not be taxable to a U.S. stockholder to the extent
that they do not exceed the adjusted basis of the U.S. stockholder's Common
Stock, but rather will reduce the adjusted basis of such stock. To the extent
that such distributions in excess of current and accumulated earnings and
profits exceed the adjusted basis of a stockholder's Common Stock, such
distributions will be included in income as long-term capital gain (or
short-term capital gain if the Common Stock had been held for one year or less),
assuming the Common Stock is a capital asset in the hands of the U.S.
stockholder. In addition, any distribution declared by the Company in October,
November or December of any year and payable to a U.S. stockholder of record on
a specified date in any such month shall be treated as both paid by the Company
and received by the U.S. stockholder on December 31 of such year, provided that
the distribution is actually paid by the Company during January of the following
calendar year.
U.S. stockholders may not include in their individual income tax returns any
net operating losses or capital losses of the Company. Instead, such losses
would be carried over by the Company for potential offset against its future
income (subject to certain limitations). Taxable distributions from the Company
and gain from the disposition of the Common Stock will not be treated as passive
activity income and, therefore, stockholders generally will not be able to apply
any "passive activity losses" (such as losses from certain types of limited
partnerships in which a U.S. stockholder is a limited partner) against such
income. In addition, taxable distributions from the Company generally will be
treated as investment income for purposes of the investment interest
limitations. Capital gains from the disposition of Common Stock (or
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distributions treated as such), however, will be treated as investment income
only if the U.S. stockholder so elects, in which case such capital gains will be
taxed at ordinary income rates. The Company will notify U.S. stockholders after
the close of the Company's taxable year as to the portions of the distributions
attributable to that year that constitute ordinary income or capital gain
dividends. In addition, pursuant to Notice 97-64, recently issued by the
Service, the Company will notify its U.S. stockholders of the portions of the
capital gain dividends, if any, which are designated as "20% rate gain
distributions," "unrecaptured Section 1250 gain distributions," and "28% rate
gain distributions," which generally will be subject to tax at rates of 20%, 25%
and 28%, respectively. To the extent that the Company does not make such a
specific designation, a capital gain dividend will be treated as a "28% rate
gain distribution."
The Company does not expect to acquire or retain (other than through taxable
subsidiaries) residual interests issued by REMICs. Such residual interests, if
acquired by a REIT, would generate excess inclusion income. Excess inclusion
income cannot be offset by net operating losses of a stockholder. If the
stockholder is a Tax-Exempt Entity, the excess inclusion income is fully taxable
as UBTI. If allocated to a foreign stockholder, the excess inclusion income is
subject to Federal income tax withholding without reduction pursuant to any
otherwise applicable tax treaty.
The Company intends to enter into master reverse repurchase agreements with
secured lenders known as "counterparties." Typically, such master reverse
repurchase agreements have cross-collateralization provisions that afford the
counterparty the right to foreclose on the Mortgage Assets pledged as
collateral. If the cross-collateralization provisions of the master reverse
repurchase agreements result in the Company being treated as if it issued debt
instruments with differing maturity dates secured by a pool of Mortgage Assets
the Company would be subject to the "taxable mortgage pool" rules and a portion
of its income would be characterized as "excess inclusion income." Special Tax
Counsel has advised the Company that the master repurchase agreements may be
structured, and the Company intends to structure such agreements, in a manner
which should not cause the Mortgage Assets to be treated as a taxable mortgage
pool. No assurance can be given, however, that the Company will be able to
structure the master reverse repurchase agreements in this manner, or that the
Service might not successfully maintain that the Mortgage Assets collateralizing
such master reverse repurchase agreements constitute a taxable mortgage pool.
The Company's investment in Subordinate Interests and certain types of
Mortgage Securities may cause it under certain circumstances to recognize
taxable income in excess of its economic income and to experience an offsetting
excess of economic income over its taxable income (or losses) in later years. As
a result, stockholders, from time to time, may be required to pay federal income
tax on distributions that economically represent a return of capital, rather
than a "dividend." Such distributions would be offset in later years by
distributions representing economic income that would be treated as returns of
capital for federal income tax purposes (or less income). Accordingly, if the
Company receives phantom income, its stockholders may be required to pay federal
income tax with respect to such income on an accelerated basis, I.E., before
such income is realized by the stockholders in an economic sense. Taking into
account the time value of money, such an acceleration of federal income tax
liabilities would cause stockholders to receive an after-tax rate of return on
an investment in the Company that would be less than the after-tax rate of
return on an investment with an identical before-tax rate of return that did not
generate phantom income. For example, if an investor subject to an effective
income tax rate of 30% purchased a bond (other than a tax-exempt bond) with an
annual interest rate of 10% for its face value, his before-tax return on his
investment would be 10%, and his after-tax return would be 7%. However, if the
same investor purchased stock of the Company at a time when the before-tax rate
of return was 10%, his after-tax compounded rate of return on his stock might be
somewhat less than 7% as a result of the Company's phantom income. In general,
as the ratio of the Company's phantom income to its total income increases, the
after-tax rate of return received by a taxable stockholder of the Company will
decrease. The Company will consider the potential effects of phantom income on
its taxable stockholders in managing its investments.
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TAXATION OF STOCKHOLDERS ON THE DISPOSITION OF THE COMMON STOCK
In general, any gain or loss realized upon a taxable disposition of the
Common Stock by a stockholder who is not a dealer in securities will be treated
as long-term capital gain or loss if the Common Stock has been held for more
than one year and otherwise as short-term capital gain or loss. Lower capital
gains rates will apply to individuals who have held such stock for more than
eighteen months. However, any loss upon a sale or exchange of Common Stock by a
stockholder who has held such shares for six months or less (after applying
certain holding period rules) will be treated as a long-term capital loss to the
extent of distributions from the Company required to be treated by such
stockholder as long-term capital gain. All or a portion of any loss realized
upon a taxable disposition of the Common Stock may be disallowed if other shares
of Common Stock are purchased within 30 days before or after the disposition.
CAPITAL GAINS AND LOSSES
A capital asset generally must be held for more than one year in order for
gain or loss derived from its sale or exchange to be treated as long-term
capital gain or loss. The highest marginal individual income tax rate is 39.6%,
and the tax rate on long-term capital gains applicable to individuals is 28%
with respect to a capital asset held more than 12 months and not more than 18
months, and, generally, 20% for capital assets held for more than 18 months.
Thus, the tax rate differential between capital gain and ordinary income for
individuals may be significant. In addition, the characterization of income as
capital gain or ordinary income may affect the deductibility of capital losses.
Capital losses not offset by capital gains may be deducted against an
individual's ordinary income only up to a maximum annual amount of $3,000.
Unused capital losses may be carried forward indefinitely by individuals. All
net capital gain of a corporate taxpayer is subject to tax at ordinary corporate
rates. A corporate taxpayer can deduct capital losses only to the extent of
capital gains, with unused losses being carried back three years and forward
five years.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
The Company will report to its U.S. stockholders and to the Service the
amount of distributions paid during each calendar year, and the amount of tax
withheld, if any. Under the backup withholding rules, a stockholder may be
subject to backup withholding at the rate of 31% with respect to distributions
paid unless such holder (i) is a corporation or comes within certain other
exempt categories and when required, demonstrates this fact or (ii) provides a
taxpayer identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with the applicable requirements of the
backup withholding rules. A stockholder who does not provide the Company with
his correct taxpayer identification number also may be subject to penalties
imposed by the Service. Any amount paid as backup withholding will be creditable
against the stockholder's income tax liability. The Treasury Department has
issued regulations regarding the backup withholding rules as applied to non-U.S.
stockholders that unify and tighten current certification procedures and forms
and clarify reliance standards but generally do not substantially alter the
current system of backup withholding compliance. These regulations will be
generally effective with respect to distributions made after December 31, 1998,
subject to certain transition rules.
TAXATION OF TAX-EXEMPT STOCKHOLDERS
Tax-exempt entities, including qualified employee pension and profit sharing
trusts and individual retirement accounts ("Exempt Organizations"), generally
are exempt from federal income taxation. However, they are subject to taxation
on their UBTI. While many investments in real estate generate UBTI, the Service
has issued a published ruling that dividend distributions from a REIT to an
exempt employee pension trust do not constitute UBTI, provided that the shares
of the REIT are not otherwise used in an unrelated trade or business of the
exempt employee pension trust. Based on that ruling, amounts distributed by the
Company to Exempt Organizations generally should not constitute UBTI. However,
if an Exempt Organization finances its acquisition of the Common Stock with
debt, a portion of
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its income from the Company will constitute UBTI pursuant to the "debt-financed
property" rules. Furthermore, social clubs, voluntary employee benefit
associations, supplemental unemployment benefit trusts, and qualified group
legal services plans that are exempt from taxation under paragraphs (7), (9),
(17), and (20), respectively, of Section 501(c) of the Code are subject to
different UBTI rules, which generally will require them to characterize
distributions from the Company as UBTI. In addition, in certain circumstances, a
pension trust that was to own more than 10% of the Company's stock would be
required to treat a percentage of the dividends from the Company as UBTI (the
"UBTI Percentage"). The UBTI Percentage is the gross income derived by the
Company from an unrelated trade or business (determined as if the Company were a
pension trust) divided by the gross income of the Company for the year in which
the dividends are paid. The UBTI rule applies to a pension trust holding more
than 10% of the Company's stock only if (i) the UBTI Percentage is at least 5%,
(ii) the Company qualifies as a REIT by reason of the modification of the rule
that allows the beneficiaries of the pension trust to be treated as holding
shares of the Company in proportion to their actuarial interests in the pension
trust for purposes of certain stock ownership tests, and (iii) either (A) one
pension trust owns more than 25% of the value of the Company's stock or (B) a
group of pension trusts individually holding more than 10% of the value of the
Company's stock collectively owns more than 50% of the value of the Company's
stock.
TAXATION OF NON-U.S. STOCKHOLDERS
The rules governing U.S. federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships, and other foreign
stockholders (collectively, "Non-U.S. stockholders") are complex and no attempt
will be made herein to provide more than a summary of such rules. PROSPECTIVE
NON-U.S. STOCKHOLDERS ARE ADVISED TO CONSULT WITH THEIR OWN TAX ADVISORS TO
DETERMINE THE IMPACT OF FEDERAL, STATE, FOREIGN AND LOCAL INCOME TAX LAWS WITH
REGARD TO AN INVESTMENT IN THE COMMON STOCK, INCLUDING ANY REPORTING
REQUIREMENTS.
Distributions to Non-U.S. stockholders that are not designated by the
Company as capital gains dividends will be treated as dividends of ordinary
income to the extent that they are made out of current or accumulated earnings
and profits of the Company. Such distributions ordinarily will be subject to a
withholding tax equal to 30% of the gross amount of the distribution unless an
applicable tax treaty reduces or eliminates that tax. However, if income from
the investment in the Common Stock is treated as effectively connected with the
Non-U.S. stockholder's conduct of a U.S. trade or business, the Non-U.S.
stockholder generally will be subject to federal income tax at graduated rates,
in the same manner as U.S. stockholders are taxed with respect to such
distributions (and also may be subject to a 30% branch profits tax in the case
of a Non-U.S. stockholder that is a corporation). The Company expects to
withhold U.S. income tax at the rate of 30% on the gross amount of any such
distributions made to a Non-U.S. stockholder unless (i) a lower treaty rate
applies and any required form evidencing eligibility for that reduced rate is
filed with the Company or (ii) the Non-U.S. stockholder files an IRS Form 4224
with the Company claiming that the distribution is effectively connected income.
The Treasury Department has issued regulations regarding the backup withholding
rules as applied to non-U.S. stockholders that unify and tighten current
certification procedures and forms and clarify reliance standards but generally
do not substantially alter the current system of backup withholding compliance.
These regulations will be generally effective with respect to distributions made
after December 31, 1998, subject to certain transition rules.
Distributions in excess of current and accumulated earnings and profits of
the Company will not be taxable to a stockholder to the extent that such
distributions do not exceed the adjusted basis of the stockholder's Common
Stock, but rather will reduce the adjusted basis of such shares. To the extent
that distributions in excess of current and accumulated earnings and profits
exceed the adjusted basis of a Non-U.S. stockholder's Common Stock, such
distributions will give rise to tax liability if the Non-U.S. stockholder would
otherwise be subject to tax on any gain from the sale or disposition of his
Common
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Stock. Because it generally cannot be determined at the time a distribution is
made whether or not such distribution will be in excess of current and
accumulated earnings and profits, the entire amount of any distribution normally
will be subject to withholding at the same rate as a "dividend." However,
amounts so withheld are refundable to the extent it is determined subsequently
that such distribution was, in fact, in excess of current and accumulated
earnings and profits of the Company.
A Non-U.S. stockholder 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 Non-U.S. stockholder, or (ii)
in the case of a Non-U.S. stockholder who is a nonresident alien individual and
holds the Common Stock as a capital asset, such holder is present in the United
States for 183 or more days in the taxable year and certain other requirements
are met. Gain of a Non-U.S. stockholder that is effectively connected with the
conduct of a U.S. trade or business by the Non-U.S. stockholder will be subject
to the U.S. federal income tax on net income that applies to U.S. persons
generally (and, with respect to corporate stockholders and under certain
circumstances, the branch profits tax) but will not be subject to withholding.
Non-U.S. stockholders should consult applicable treaties, which may provide for
different rules.
STATE AND LOCAL TAXES
The Company and its stockholders may be subject to state and local tax in
various states and localities, including those states and localities in which it
or they transact business, own property, or reside. The state and local tax
treatment of the Company and its stockholders in such jurisdictions may differ
from the federal income tax treatment described above. Consequently, prospective
stockholders should consult their own tax advisors regarding the effect of state
and local tax laws upon an investment in the Common Stock.
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ERISA CONSIDERATIONS
The following is a summary of material considerations arising under ERISA,
and the prohibited transaction provisions of Section 4975 of the Code that may
be relevant to a prospective purchaser subject to ERISA. The discussion does not
purport to deal with all aspects of ERISA or Section 4975 of the Code that may
be relevant to particular stockholders in light of their particular
circumstances.
The discussion is based on current provisions of ERISA and the Code,
existing and currently proposed regulations under ERISA and the Code, the
legislative history of ERISA and the Code, existing administrative rulings of
the Department of Labor ("DOL") and reported judicial decisions. No assurance
can be given that legislative, judicial, or administrative changes will not
affect the accuracy of any statements herein with respect to transactions
entered into or contemplated prior to the effective date of such changes.
EMPLOYEE BENEFIT PLANS, TAX-QUALIFIED RETIREMENT PLANS AND IRAS
Each fiduciary of a pension, profit-sharing, or other employee benefit plan
subject to Title I of ERISA (a "Plan") should consider carefully whether an
investment in the Common Stock is consistent with his fiduciary responsibilities
under ERISA. In particular, the fiduciary requirements of Part 4 of Title I of
ERISA require a Plan's investment to be (i) prudent and in the best interests of
the plan, its participants, and its beneficiaries, (ii) diversified in order to
minimize the risk of large losses, unless it is clearly prudent not to do so,
and (iii) authorized under the terms of the Plan's governing documents (provided
the documents are consistent with ERISA). In determining whether an investment
in the Common Stock is prudent for purposes of ERISA, the appropriate fiduciary
of a Plan should consider all of the facts and circumstances, including whether
the investment is reasonably designed, as a part of the plan's portfolio for
which the fiduciary has investment responsibility, to meet the objectives of the
Plan, taking into consideration the risk of loss and opportunity for gain (or
other return) from the investment, the diversification, cash flow, and funding
requirements of the plan's portfolio. A fiduciary also should take into account
the nature of the Company's business, the management of the Company, the length
of the Company's operating history, the fact that certain investment assets may
not have been identified yet, and the possibility of the recognition of UBTI.
The fiduciary of an IRA or of a qualified retirement plan not subject to
Title I of ERISA because it is a governmental or church plan or because it does
not cover common law employees (a "Non-ERISA Plan") should consider that such an
IRA or Non-ERISA Plan may only make investments that are authorized by the
appropriate governing documents and under applicable state law.
STATUS OF THE COMPANY UNDER ERISA
The following section discusses certain principles that apply in determining
whether the fiduciary requirements of ERISA and the prohibited transaction
provisions of ERISA and the Code apply to an entity because one or more
investors in the equity interests in the entity is a Plan. A Plan fiduciary also
should consider the relevance of those principles to ERISA's prohibition on
improper delegation of control over or responsibility for "plan assets" and
ERISA's imposition of co-fiduciary liability on a fiduciary who participates in,
permits (by action or inaction) the occurrence of, or fails to remedy a known
breach by another fiduciary.
If the assets of the Company are deemed to be "plan assets" under ERISA, (i)
the prudence standards and other provisions of Part 4 of Title I of ERISA would
be applicable to any transactions involving the Company's assets, (ii) persons
who exercise any authority over the Company's assets, or who provide investment
advice to the Company, would (for purposes of the fiduciary responsibility
provisions of ERISA) be fiduciaries of each Plan that acquires Common Stock, and
transactions involving the Company's assets undertaken at their direction or
pursuant to their advice might violate their fiduciary responsibilities under
ERISA, especially with regard to conflicts of interest, (iii) a fiduciary
exercising his
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investment discretion over the assets of a Plan to cause it to acquire or hold
the Common Stock could be liable under Part 4 of Title I of ERISA for
transactions entered into by the Company that do not conform to ERISA standards
of prudence and fiduciary responsibility, and (iv) certain transactions that the
Company might enter into in the ordinary course of its business and operations
might constitute "prohibited transactions" under ERISA and the Code.
The "Plan Asset Regulations" generally provide that when a Plan acquires a
security that is an equity interest in an entity and the security is neither a
"publicly-offered security" nor a security issued by an investment company
registered under the Investment Company Act, the Plan's assets include both the
equity interest and an undivided interest in each of the underlying assets of
the issuer of such equity interest, unless one or more exceptions specified in
the Plan Asset Regulations are satisfied.
The Plan Asset Regulations define a publicly-offered security as a security
that is "widely-held," "freely transferable," and either part of a class of
securities registered under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), or sold pursuant to an effective registration statement under
the Securities Act (provided the securities are registered under the Exchange
Act within 120 days after the end of the fiscal year of the issuer during which
the Offering occurred). The Common Stock is being sold in an offering registered
under the Securities Act and will be registered under the Exchange Act. The Plan
Asset Regulations provide that a security is "widely held" only if it is part of
a class of securities that is owned by 100 or more investors independent of the
issuer and of one another. A security will not fail to be widely held because
the number of independent investors falls below 100 subsequent to the initial
public offering as a result of events beyond the issuer's control. The Company
anticipates that upon completion of the Offering, the Common Stock will be
"widely held."
The Plan Asset Regulations provide that whether a security is "freely
transferable" is a factual question to be determined on the basis of all
relevant facts and circumstances. The Plan Asset Regulations further provide
that where a security is part of an offering in which the minimum investment is
$10,000 or less (as is the case with the Offering), certain restrictions
ordinarily will not, alone or in combination, affect a finding that such
securities are freely transferable. The restrictions on transfer enumerated in
the Plan Asset Regulations as not affecting that finding include: (i) any
restriction on or prohibition against any transfer or assignment that would
result in the termination or reclassification of an entity for federal or state
tax purposes, or that otherwise would violate any federal or state law or court
order, (ii) any requirement that advance notice of a transfer or assignment be
given to the issuer, (iii) any administrative procedure that establishes an
effective date, or an event (such as completion of an offering), prior to which
a transfer or assignment will not be effective, and (iv) any limitation or
restriction on transfer or assignment that is not imposed by the issuer or a
person acting on behalf of the issuer. The Company believes that the
restrictions imposed under the Charter on the transfer of the Company's stock
will not result in the failure of the Common Stock to be "freely transferable."
The Company also is not aware of any other facts or circumstances limiting the
transferability of the Common Stock that are not enumerated in the Plan Asset
Regulations as those not affecting free transferability, and no assurance can be
given that the DOL or the Treasury Department will not reach a contrary
conclusion.
Assuming that the Common Stock will be "widely held" and that no other facts
and circumstances other than those referred to in the preceding paragraph exist
that restrict transferability of the Common Stock, the shares of Common Stock
should be publicly offered securities and the assets of the Company should not
be deemed to be "plan assets" of any Plan, IRA or non-ERISA Plan that invests in
the Common Stock.
Without regard to whether the assets of the Company are considered plan
assets, fiduciaries of Plans should consider the application of the prohibited
transaction provisions of ERISA and the Code in making their decision to
purchase the Common Stock, as such acquisition may be a sale or exchange of
property between a Plan and a party in interest or disqualified person. A "party
in interest" or "disqualified person" with respect to an Plan or with respect to
a Plan subject to Section 4975 of the Code is subject to (i) an
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initial 15% excise tax on the amount involved in any prohibited transaction
involving the assets of the Plan and (ii) an excise tax equal to 100% of the
amount involved if any prohibited transaction is not corrected. If the
disqualified person who engages in the transaction is the individual on behalf
of whom an IRA is maintained (or his beneficiary), the IRA will lose its
tax-exempt status and its assets will be deemed to have been distributed to such
individual in a taxable distribution (and no excise tax will be imposed) on
account of the prohibited transaction. In addition, a fiduciary who permits a
Plan to engage in a transaction that the fiduciary knows or should know is a
prohibited transaction may be liable to the Plan for any loss the Plan incurs as
a result of the transaction or for any profits earned by the fiduciary in the
transaction. In this regard Prohibited Transaction Class Exemption 75-1 may be
applicable.
A FIDUCIARY MAKING THE DECISION TO INVEST IN THE COMMON STOCK ON BEHALF OF A
PROSPECTIVE PURCHASER THAT IS AN EMPLOYEE BENEFIT PLAN, A TAX-QUALIFIED
RETIREMENT PLAN, OR AN IRA IS ADVISED TO CONSULT ITS OWN LEGAL ADVISOR REGARDING
THE SPECIFIC CONSIDERATIONS ARISING UNDER ERISA, SECTION 4975 OF THE CODE, AND
STATE LAW WITH RESPECT TO THE PURCHASE, OWNERSHIP, OR SALE OF THE COMMON STOCK
BY SUCH PLAN OR IRA.
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CERTAIN CHARACTERISTICS OF MORTGAGE LOANS
AND REAL PROPERTY INVESTMENTS
As summarized in "DESCRIPTION OF PROPOSED ASSETS," Mortgage Assets will
include Mortgage Loans and Mortgage Securities which are backed by or represent
an interest in Mortgage Loans. The following discussion describes a number of
considerations involved in the acquisition of Mortgage Loans or the foreclosure
and sale of defaulted Mortgage Loans (whether individually or as part of a
series of Mortgage Securities). It generally summarizes certain characteristics
of Mortgage Loans and real property. Because certain of such characteristics are
governed by applicable state law (which laws vary from state to state), the
summaries do not purport to be complete, to reflect the laws of any particular
state, or to encompass the laws of all states, nor are such summaries based on
an opinion of counsel. Accordingly, the summaries are qualified in their
entirety by reference to the applicable laws of the states where the property is
located.
GENERAL
Each Mortgage Loan will be evidenced by a note or bond and secured by an
instrument granting a security interest in real property, which may be a
mortgage, deed of trust or a deed to secure debt, depending upon the prevailing
practice and law in the state in which the related mortgaged property is
located. Mortgages, deeds of trust and deeds to secure debt are herein
collectively referred to as "mortgages." A mortgage creates a lien upon, or
grants a title interest in, the real property covered thereby, and represents
the security for the repayment of the indebtedness customarily evidenced by a
promissory note. The priority of the lien created or interest granted will
depend on the terms of the mortgage and, in some cases, on the terms of separate
subordination agreements or intercreditor agreements with others that hold
interests in the real property, the knowledge of the parties to the mortgage
and, generally, the order of recordation of the mortgage in the appropriate
public recording office. However, the lien of a recorded mortgage will generally
be subordinate to later-arising liens for real estate taxes and assessments and
other charges imposed under governmental police powers.
TYPES OF MORTGAGE INSTRUMENTS
There are two parties to a mortgage: a mortgagor (the borrower and usually
the owner of the subject property) and a mortgagee (the lender). In contrast, a
deed of trust is a three-party instrument, among a trustor (the equivalent of a
borrower), a trustee to whom the real property is conveyed, and a beneficiary
(the lender) for whose benefit the conveyance is made. Under a deed of trust,
the trustor grants the property, irrevocably until the debt is paid, in trust
and generally with a power of sale, to the trustee, to secure repayment of the
indebtedness evidenced by the related note. A deed to secure debt typically has
two parties. The grantor (the borrower) conveys title to the real property to
the grantee (the lender), generally with a power of sale, until such time as the
debt is repaid. The mortgagee's authority under a mortgage, the trustee's
authority under a deed of trust and the grantee's authority under a deed to
secure debt are governed by the express provisions of the related instrument,
the law of the state in which the real property is located, certain federal laws
and, in some deed of trust transactions, the directions of the beneficiary.
LEASES AND RENTS
Mortgages that encumber income-producing property often contain an
assignment of rents and leases, pursuant to which the borrower assigns to the
lender the borrower's right, title and interest as landlord under each lease and
the income derived therefrom, while (unless rents are to be paid directly to the
lender) retaining a revocable license to collect the rents for so long as there
is no default. If the borrower defaults, the license terminates and the lender
is entitled to collect the rents. Local law may require that the lender take
possession of the property and/or obtain a court-appointed receiver before
becoming entitled to collect the rents.
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The potential payments from a property may be less than the periodic
payments due under the mortgage. For example, the net income that would
otherwise be generated from the property may be less than the amount that would
be needed to service the debt if the leases on the property are at below-market
rents, the market rents have fallen since the original financing, vacancies have
increased, or as a result of excessive or increased maintenance, repair or other
obligations to which a lender succeeds as landlord.
SECONDARY FINANCING: DUE-ON-ENCUMBRANCE PROVISIONS
Some Mortgage Loans may have no restrictions on secondary financing, thereby
permitting the borrower to use the mortgaged property as security for one or
more additional loans. Some Mortgage Loans may preclude secondary financing
(often by permitting the first lender to accelerate the maturity of its loan if
the borrower further encumbers the mortgaged property) or may require the
consent of the senior lender to any junior or substitute financing, however,
such provisions may be unenforceable in certain jurisdictions under certain
circumstances.
Where the borrower encumbers the mortgaged property with one or more junior
items, the senior lender is subjected to additional risk. First, the borrower
may have difficulty servicing and repaying multiple loans. Second, acts of the
senior lender which prejudice the junior lender or impair the junior lender's
security may create a superior equity in favor of the junior lender. Third, if
the borrower defaults on the senior loan and/or any junior loan or loans, the
existence of junior loans and actions taken by junior lenders can impair the
security available to the senior lender and can interfere with, delay and in
certain circumstances even prevent the taking of action by the senior lender.
Fourth, the bankruptcy of a junior lender may operate to stay foreclosure or
similar proceeding by the senior lender.
DUE-ON-SALE PROVISIONS
The enforceability of due-on-sale clauses has been the subject of
legislation or litigation in many states, and in some cases, typically involving
single family residential mortgage transactions, the enforceability has been
limited or denied. The Garn-St. Germain Depository Institutions Act of 1982 (the
"Garn-St. Germain Act") preempts state constitutional, statutory and case law
that prohibits the enforcement of due-on-sale clauses and permits leaders to
enforce those clauses in accordance with their terms, subject to certain
exceptions. As a result, due-on-sale clauses have become generally enforceable
except in those states whose legislatures exercised their authority to regulate
the enforceability of such clauses with respect to certain Mortgage Loans. The
Garn-St. Germain Act does "encourage" lenders to permit assumption of loans at
the original rate of interest or at some other rate less than the average of the
original rate and the market rates.
Under federal bankruptcy law, due-on-sale clauses may not be enforceable in
bankruptcy proceedings and, under certain circumstances, may be eliminated in
any modified mortgage resulting from such bankruptcy proceeding.
CONDEMNATION AND INSURANCE
The form of the mortgage or deed of trust used by many lenders confers on
the mortgagee or beneficiary the right both to receive all proceeds collected
under any hazard insurance policy and all awards made in connection with any
condemnation proceedings, and to apply such proceeds and awards to any
indebtedness secured by the mortgage or deed of trust, in such order as the
mortgage or beneficiary may determine. Thus, in the event improvements on the
property are damaged or destroyed by fire or other casualty, or if the property
is taken by condemnation, the mortgagee or beneficiary under the senior mortgage
or deed of trust will have the prior right to collect any insurance proceeds
payable under a hazard insurance policy and any award of damages in connection
with the condemnation and to apply the same to the indebtedness secured by the
senior mortgage or deed of trust. Proceeds in excess of the amount of senior
mortgage indebtedness will, in most cases, be applied to the indebtedness of a
junior mortgage or trust deed to the extent the junior mortgage or deed of trust
so provides. The laws of certain
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states may limit the ability of mortgagees or beneficiaries to apply the
proceeds of hazard insurance and partial condemnation awards to the secured
indebtedness. In such states, the mortgagor or trustor must be allowed to use
the proceeds of hazard insurance to repair the damage unless the security of the
mortgagee or beneficiary has been impaired. Similarly, in certain states, the
mortgagee or beneficiary is entitled to the award for a partial condemnation of
the real property security only to the extent that its security is impaired.
FORECLOSURE
GENERAL
Foreclosure is a legal procedure that allows the lender to recover its
mortgage debt by enforcing its rights and available legal remedies under the
mortgage. If the borrower defaults in payment or performance of its obligations
under the note or mortgage, the lender has the right to institute foreclosure
proceedings to sell the real property at a public auction to satisfy the
indebtedness.
Foreclosure procedures vary from state to state. Two primary methods of
foreclosing a mortgage are judicial foreclosure, involving court proceedings,
and non-judicial foreclosure pursuant to a power of sale granted in the mortgage
instrument. Other foreclosure procedures are available in some states, such as
strict foreclosure, but they are either infrequently used or available only in
limited circumstances.
JUDICIAL FORECLOSURE
A judicial foreclosure proceeding is conducted in a court having
jurisdiction over the mortgaged property. Generally, the action is initiated by
the service of legal pleadings upon all parties having a subordinate interest of
record in the real property and all parties in possession of the property, under
leases or otherwise, whose interests are subordinate to the mortgage. A
foreclosure action is subject to most of the delays and expenses of other
lawsuits if defenses are raised or counterclaims are interposed, and sometimes
requires several years to complete. When the lender's right to foreclose is
contested, the legal proceedings can be time-consuming. Upon successful
completion of a judicial foreclosure proceeding, the court generally issues a
judgment of foreclosure and appoints a referee or other officer to conduct a
public sale of the mortgaged property, the proceeds of which are used to satisfy
the judgment. Such sales are made in accordance with procedures that vary from
state to state.
NON-JUDICIAL FORECLOSURE/POWER OF SALE
Foreclosure of a deed of trust is generally accomplished by a non-judicial
trustee's sale pursuant to a power of sale typically granted in the deed of
trust. A power of sale also may be contained in any other type of mortgage
instrument if applicable law so permits. A power of sale under a deed of trust
allows a non-judicial public sale to be conducted generally following a request
from the beneficiary/lender to the trustee to sell the property upon default by
the borrower and after notice of sale is given in accordance with the terms of
the mortgage and applicable state law. The borrower or junior lienholder may
then have the right, during a reinstatement period required in some states, to
cure the default by paying the entire actual amount in arrears (without regard
to the acceleration of the indebtedness), plus the lender's expenses incurred in
enforcing the obligation. In other states, the borrower or the junior lienholder
is not provided a period to reinstate the loan, but has only the right to pay
off the entire debt to prevent the foreclosure sale. Generally, state law
governs the procedure for public sale, the parties entitled to notice, the
method of giving notice and the applicable time periods.
EQUITABLE LIMITATIONS ON ENFORCEABILITY OF CERTAIN PROVISIONS
Relying on equitable principles, a court may alter the specific terms of a
loan to the extent it considers necessary to prevent or remedy an injustice,
undue oppression or overreaching, or may require the lender to undertake
affirmative actions to determine the cause of the borrower's default and the
likelihood that the borrower will be able to reinstate the loan. In some cases,
courts have required that lenders reinstate
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loans or recast payment schedules in order to accommodate borrowers who are
suffering from a temporary financial disability. In other cases, courts have
limited the right of the lender to foreclose in the case of a non-monetary
default, such as a failure to adequately maintain the mortgaged property or an
impermissible further encumbrance of the mortgaged property.
Even if the lender is successful in the foreclosure action and is able to
take possession of the property, the costs of operating and maintaining a
property may be significant and may be greater than the income derived from that
property, especially for commercial and multifamily property. The costs of
management and operation of those mortgaged properties which are hotels, motels,
restaurants, nursing homes, convalescent homes or hospitals may be particularly
significant because of the expertise, knowledge and with respect to nursing or
convalescent homes, regulatory compliance, required to run such operations and
the effect which foreclosure and a change in ownership may have with respect to
consent requirements and on the public's and the industry's (including
franchisers) perception of the quality of such operations. The lender also
commonly will obtain the services of a real estate broker and pay the broker's
commission in connection with the sale or lease of the property. Depending upon
market conditions, the ultimate proceeds of the sale of the property may not
equal the lender's investment in the property. Moreover, because of the expenses
associated with acquiring, owning and selling a mortgaged property, a lender
could realize an overall loss on a mortgage loan even if the mortgaged property
is sold at foreclosure, or resold after it is acquired through foreclosure, for
an amount equal to the full outstanding principal amount of the loan plus
accrued interest.
The holder of a junior mortgage that forecloses on a mortgaged property does
so subject to senior mortgages and any other prior liens, and may be obliged to
keep senior Mortgage Loans current in order to avoid foreclosure of its interest
in the property. In addition, if the foreclosure of a junior mortgage triggers
the enforcement of a "due-on-sale" clause contained in a senior mortgage, the
junior mortgagee could be required to pay the full amount of the senior mortgage
indebtedness or face foreclosure.
POST-SALE REDEMPTION
In a majority of states, after sale pursuant to a deed of trust or
foreclosure of a mortgage, the borrower and foreclosed junior lienors are given
a statutory period in which to redeem the property. In some states, statutory
redemption may occur only upon payment of the foreclosure sale price. In other
states, redemption may be permitted if the former borrower pays only a portion
of the sums due. In some states, the borrower retains possession of the property
during the statutory redemption period. The effect of a statutory right of
redemption is to diminish the ability of the lender to sell the foreclosed
property because the exercise of a right of redemption would defeat the title of
any purchaser through a foreclosure. Consequently, the practical effect of the
redemption right is to force the lender to maintain the property and pay the
expenses of ownership until the redemption period has expired. In some states, a
post-sale statutory right of redemption may exist following a judicial
foreclosure, but not following a trustee's sale under a deed of trust.
ANTI-DEFICIENCY LEGISLATION
Any commercial or multi-family residential Mortgage Loans acquired by the
Company are likely to be nonrecourse loans, as to which recourse in the case of
default will be limited to the property and such other assets, if any, that were
pledged to secure the Mortgage Loan. However, even if a Mortgage Loan by its
terms provides for recourse to the borrower's other assets, a lender's ability
to realize upon those assets may be limited by state law. For example, in some
states a lender cannot obtain a deficiency judgment against the borrower
following foreclosure or sale under a deed of trust or by non-judicial means.
Other statutes may require the lender to exhaust the security afforded under a
mortgage before bringing a personal action against the borrower. In certain
other states, the lender has the option of bringing a personal action against
the borrower on the debt without first exhausting such security; however, in
some of those states, the lender, following judgment on such personal action,
may be deemed to have elected a
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remedy and thus may be precluded from foreclosing upon the security.
Consequently, lenders in those states where such an election of remedy provision
exists may choose to proceed first against the security. Finally, other
statutory provisions limit any deficiency judgment to the excess of the
outstanding debt over the fair market value of the property at the time of the
sale.
BANKRUPTCY LAWS
Operation of the Bankruptcy Code and related state laws may interfere with
or affect the ability of a lender to realize upon collateral and/or to enforce a
deficiency judgment. For example, under the Bankruptcy Code, virtually all
actions (including foreclosure actions and deficiency judgment proceedings) to
collect a debt are automatically stayed upon the filing of the bankruptcy
petition and, often, no interest or principal payments are made during the
course of the bankruptcy case. The delay and the consequences thereof caused by
such automatic stay can be significant. Also, under the Bankruptcy Code, the
filing of a petition in bankruptcy by or on behalf of a junior lienor may stay
the senior lender from taking action to foreclose out such junior lien. Under
the Bankruptcy Code, provided certain substantive and procedural safeguards
protective of the lender are met, the amount and terms of a mortgage loan
secured by a lien on property of the debtor may be modified under certain
circumstances. For example, the outstanding amount of the loan may be reduced to
the then-current value of the property (with a corresponding partial reduction
of the amount of lender's security interest) pursuant to a confirmed plan or
lien avoidance proceeding, thus leaving the lender a general unsecured creditor
for the difference between such value and the outstanding balance of the loan.
Other modifications may include the reduction in the amount of each scheduled
payment, by means of a reduction in the rate of interest and/or an alteration of
the repayment schedule (with or without affecting the unpaid principal balance
of the loan), and/or by an extension (or shortening) of the term to maturity.
Federal bankruptcy law also may have the effect of interfering with or
affecting the ability of the secured lender to enforce the borrower's assignment
of rents and leases related to the mortgaged property. Under Section 362 of the
Bankruptcy Code, the lender will be stayed from enforcing the assignment, and
the legal proceedings necessary to resolve the issue could be time-consuming,
with resulting delays in the lender's receipt of the rents. In addition, the
Bankruptcy Code has been amended to provide that a lender's perfected
pre-petition security interest in leases, rents and hotel revenues continues in
the post-petition leases, rents and hotel revenues, unless a bankruptcy court
orders to the contrary "based on the equities of the case."
In a bankruptcy or similar proceeding, action may be taken seeking the
recovery as a preferential transfer of any payments made by the mortgagor under
the related mortgage loan to the owner of such mortgage loan. Payments on
long-term debt may be protected from recovery as preferences if they are
payments in the ordinary course of business made on debts incurred in the
ordinary course of business. Whether any particular payment would be protected
depends upon the facts specific to a particular transaction.
A trustee in bankruptcy, in some cases, may be entitled to collect its costs
and expenses in preserving or selling the mortgaged property ahead of payment to
the lender. In certain circumstances, a debtor in bankruptcy may have the power
to grant liens senior to the lien of a mortgage, and analogous state statutes
and general principles of equity may also provide a mortgagor with means to halt
a foreclosure proceeding or sale and to force a restructuring of a mortgage loan
on terms a lender would not otherwise accept.
Moreover, the laws of certain states also give priority to certain tax liens
over the lien of a mortgage or deed of trust. Under the Bankruptcy Code, if the
court finds that actions of the mortgagee have been unreasonable, the lien of
the related mortgage may be subordinated to the claims of unsecured creditors.
The Company's acquisition of real property, particularly real estate owned
("REO") property, may be affected by many of the considerations applicable to
mortgage loan lending. For example, the Company's acquisition of certain
property at foreclosure sales could be affected by a borrower's post-sale right
of redemption. In addition, the Company's ability to derive income from real
property will generally be
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dependent on its receipt of rent payments under leases of the related property.
The ability to collect rents may be impaired by the commencement of a bankruptcy
proceeding relating to a lessee under such lease. Under the Bankruptcy Code, the
filing of a petition in bankruptcy by or on behalf of a lessee results in a stay
in bankruptcy against the commencement or continuation of any state court
proceeding for past due rent, for accelerated rent, for damages or for a summary
eviction order with respect to a default under the lease that occurred prior to
the filing of the lessee's petition. In addition, the Bankruptcy Code generally
provides that a trustee or debtor-in-possession may, subject to approval of the
court, (i) assume the lease and retain it or assign it to a third party or (ii)
reject the lease. If the lease is assumed, the trustee or debtor-in-possession
(or assignee, if applicable) must cure any defaults under the lease, compensate
the lessor for its losses and provide the lessor with "adequate assurance" of
future performance. Such remedies may be insufficient, and any assurances
provided to the lessor may, in fact, be inadequate. If the lease is rejected,
the lessor will be treated as an unsecured creditor with respect to its claim
for damages for termination of the lease. The Bankruptcy Code also limits a
lessor's damages for lease rejection to the rent reserved by the lease (without
regard to acceleration) for the greater of one year, or 15%, not to exceed three
years, of the remaining term of the lease.
DEFAULT INTEREST AND LIMITATIONS ON PREPAYMENTS
Notes and mortgages may contain provisions that obligate the borrower to pay
a late charge or additional interest if payments are not timely made, and in
some circumstances, may prohibit prepayments for a specified period and/or
condition prepayments upon the borrower's payment of prepayment fees or yield
maintenance penalties. In certain states, there are or may be specific
limitations upon the late charges that a lender may collect from a borrower for
delinquent payments. Certain states also limit the amounts that a lender may
collect from a borrower as an additional charge if the loan is prepaid. In
addition, the enforceability of provisions that provide for prepayment fees or
penalties upon an involuntary prepayment is unclear under the laws of many
states.
The Company may invest in Mortgage Loans which contain a "debt-acceleration"
clause, which permits the lender to accelerate the full debt upon a monetary or
non-monetary default of the borrower. The courts of most states will enforce
clauses providing for acceleration in the event of a material payment default
after giving effect to any appropriate notices. The equity courts of any state,
however, may refuse to foreclose a mortgage or deed of trust when an
acceleration of the indebtedness would be inequitable or unjust or the
circumstances would render the acceleration unconscionable. Furthermore, in some
states, the borrower may avoid foreclosure and reinstate an accelerated loan by
paying only the defaulted amounts and the costs and attorneys' fees incurred by
the lender in collecting such defaulted payments.
State courts also are known to apply various legal and equitable principles
to avoid enforcement of the forfeiture provisions of installment contracts. For
example, a lender's practice of accepting late payments from the borrower may be
deemed a waiver of the forfeiture clause. State courts also may impose equitable
grace periods for payment of arrearage or otherwise permit reinstatement of the
contract following a default. Not infrequently, if a borrower under an
installment contract has significant equity in the property, equitable
principles will be applied to reform or reinstate the contract or to permit the
borrower to share the proceeds upon a foreclosure sale of the property if the
sale price exceeds the debt.
ENVIRONMENTAL RISKS
GENERAL
The Company will be subject to environmental risks when taking a security
interest in real property, as well as when it acquires any real property. Of
particular concern may be properties that are or have been used for industrial,
manufacturing, military or disposal activity. Such environmental risks include
the risk of the diminution of the value of a contaminated property or as
discussed below, liability for the costs of compliance with environmental
regulatory requirements or the costs of clean-up or other remedial actions.
These compliance or clean-up costs could exceed the value of the property or the
amount of the lender's
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loan. In certain circumstances, a lender could determine to abandon a
contaminated mortgaged property as collateral for its loan rather than foreclose
and risk liability for compliance or clean-up costs.
CERCLA
The Federal Comprehensive Environmental Response, Compensation and Liability
Act of 1980, as amended ("CERCLA"), imposes strict liability on present and past
"owners" and "operators" of contaminated real property for the costs of
clean-up. A secured lender may be liable as an "owner" or "operator" of a
contaminated mortgaged property if agents or employees of the lender have become
sufficiently involved in the management of such mortgaged property or the
operations of the borrower. Such liability may exist even if the lender did not
cause or contribute to the contamination and regardless of whether the lender
has actually taken possession of a mortgaged property through foreclosure, deed
in lieu of foreclosure or otherwise. The magnitude of the CERCLA liability at
any given contaminated site is a function of the actions required to address
adequately the risks to human health and the environment posed by the particular
conditions at the site. As a result, such liability is not constrained by the
value of the property or the amount of the original or unamortized principal
balance of any loans secured by the property. Moreover, under certain
circumstances, liability under CERCLA may be joint and several--I.E., any liable
party may be obligated to pay the entire cleanup costs regardless of its
relative contribution to the contamination.
The Asset Conservation, Lender Liability and Deposit Insurance Act of 1996
(the "1996 Lender Liability Act") provides for a safe harbor for secured lenders
from CERCLA liability even though the lender forecloses and sells the real
estate securing the loan, provided the secured lender sells "at the earliest
practicable, commercially reasonable time, at commercially reasonable terms,
taking into account market conditions and legal and regulatory requirements."
Although the 1996 Lender Liability Act provides significant protection to
secured lenders, it has not been construed by the courts and there are
circumstances in which actions taken could expose a secured lender to CERCLA
liability. And, the transferee from the secured lender is not entitled to the
protections enjoyed by a secured lender. Hence, the marketability of any
contaminated real estate continues to be suspect.
CERTAIN OTHER FEDERAL AND STATE LAWS
Many states have environmental clean-up statutes similar to CERCLA, and not
all those statutes provide for a secured creditor exemption. In addition,
underground storage tanks are commonly found on a wide variety of commercial and
industrial properties. Federal and state laws impose liability on the owners and
operators of underground storage tanks for any cleanup that may be required as a
result of releases from such tanks. These laws also impose certain compliance
obligations on the tank owners and operators, such as regular monitoring for
leaks and upgrading of older tanks. The Company may become a tank owner or
operator and subject to compliance obligations and potential cleanup
liabilities, either as a result of becoming involved in the management of a site
at which a tank is located or, more commonly, by taking title to such a
property. Federal and state laws also obligate property owners and operators to
maintain and, under some circumstances, to remove asbestos-containing building
materials and lead-based paint. As a result, the presence of these materials can
increase the cost of operating a property and thus diminish its value. In a few
states, transfers of some types of properties are conditioned upon cleanup of
contamination prior to transfer. In these cases, a lender that becomes the owner
of a property through foreclosure, deed in lieu of foreclosure or otherwise, may
be required to clean up the contamination before selling or otherwise
transferring the property.
Beyond statute-based environmental liability, there exist common law causes
of action (for example, actions based on nuisance or on toxic tort resulting in
death, personal injury or damage to property) related to hazardous environmental
conditions on a property.
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SUPERLIEN LAWS
Under the laws of many states, contamination of a property may give rise to
a lien on the property for clean-up costs. In several states, such a lien has
priority over all existing liens, including those of existing mortgages. In
these states, the lien of a mortgage may lose its priority to such a
"superlien."
ADDITIONAL CONSIDERATIONS
The cost of remediating environmental contamination at a property can be
substantial. To reduce the likelihood of exposure to such losses, the Company
will not acquire title to a mortgaged property or take over its operation
unless, based on an environmental site assessment prepared by a qualified
environmental consultant, it has made the determination that it is appropriate
to do so. The Company expects that it will organize a special purpose subsidiary
to acquire any environmentally contaminated real property.
ENVIRONMENTAL SITE ASSESSMENTS
In addition to possibly allowing a lender to qualify for the innocent
landowner defense (see "--Environmental Risks--CERCLA" above), environmental
site assessments can be a valuable tool in anticipating, managing and minimizing
environmental risk. They are commonly performed in many commercial real estate
transactions.
Environmental site assessments vary considerably in their content and
quality. Even when adhering to good professional practices, environmental
consultants will sometimes not detect significant environmental problems because
an exhaustive environmental assessment would be far too costly and
time-consuming to be practical. Nevertheless, it is generally helpful in
assessing and addressing environmental risks in connection with commercial real
estate (including multi-family properties) to have an environmental site
assessment of a property because it enables anticipation of environmental
problems and, if agreements are structured appropriately, can allow a party to
decline to go forward with a transaction.
APPLICABILITY OF USURY LAWS
Title V of the Depository Institutions Deregulation and Monetary Control Act
of 1980 ("Title V") provides that state usury limitations shall not apply to
certain types of residential (including multi-family) first Mortgage Loans
originated by certain lenders after March 31, 1980. Title V authorized any state
to reimpose interest rate limits by adopting, before April 1, 1983, a law or
constitutional provision that expressly rejects application of the federal law.
In addition, even where Title V is not so rejected, any state is authorized by
the law to adopt a provision limiting discount points or other charges on
Mortgage Loans covered by Title V. Certain states have taken action to reimpose
interest rate limits and/or to limit discount points or other charges.
AMERICANS WITH DISABILITIES ACT
Under Title 111 of the Americans with Disabilities Act of 1990 and rules
promulgated thereunder (collectively, the "ADA"), in order to protect
individuals with disabilities, public accommodations (such as hotels,
restaurants, shopping centers, hospitals, schools and social service center
establishments) must remove architectural and communication barriers that are
structural in nature from existing places of public accommodation to the extent
"readily achievable." In addition, under the ADA, alterations to a place of
public accommodation or a commercial facility are to be made so that, to the
maximum extent feasible, such altered portions are readily accessible to and
usable by disabled individuals. The "readily achievable" standard takes into
account, among other factors, the financial resources of the affected site,
owner, landlord or other applicable person. In addition to imposing a possible
financial burden on the borrower in its capacity as owner or landlord, the ADA
may also impose such requirements on a foreclosing lender who succeeds to the
interest of the borrower as owner or landlord. Furthermore, since the "readily
achievable" standard may vary depending on the financial condition of the owner
or landlord, a foreclosing lender who is financially more capable than the
borrower of complying with the requirements of the ADA may be subject to more
stringent requirements than those to which the borrower is subject.
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CERTAIN PROVISIONS OF MARYLAND LAW
AND THE COMPANY'S CHARTER AND BYLAWS
The following summary of certain provisions of 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.
CERTAIN ANTI-TAKEOVER PROVISIONS
The Charter and the Bylaws of the Company contain certain provisions that
could discourage, impede or impair acquisition of control of the Company by
means of a tender offer, a proxy contest or otherwise. These provisions are
expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
the Company to negotiate first with the Board of Directors. The Company believes
that these provisions increase the likelihood that proposals initially will be
on more attractive terms than would be the case in their absence and increases
the likelihood of negotiations, which might outweigh the potential disadvantages
of discouraging such proposals because, among other things, negotiation of such
proposals might result in improvement of terms. See "DESCRIPTION OF CAPITAL
STOCK--Repurchase of Shares and Restrictions on Transfer."
STAGGERED BOARD OF DIRECTORS
The Charter and the Bylaws divide the Board of Directors into three classes
of directors, each class constituting approximately one-third of the total
number of directors, with the classes serving staggered three-year terms. The
classification of the Board of Directors will make it more difficult for
stockholders to change the composition of the Board of Directors because only a
minority of the directors can be elected at once. The Company believes, however,
that the staggered Board of Directors will help to ensure continuity and
stability of the Company's management and policies. The classification
provisions could also discourage a third party from accumulating the Company's
stock or attempting to obtain control of the Company, even though this attempt
might be beneficial to the Company and some, or a majority, of its stockholders.
Accordingly, under certain circumstances stockholders could be deprived of
opportunities to sell their shares of Common Stock at a higher price than might
otherwise be available.
NUMBER OF DIRECTORS, REMOVAL, FILLING VACANCIES
The Charter and Bylaws provide that the number of directors will be five, a
majority of whom will at all times be Independent Directors, and may be changed
by a majority of the entire Board of Directors. In addition, the Bylaws provide
that, unless the Board of Directors otherwise determines, any vacancies may be
filled by a majority of the remaining directors, though less than a quorum,
except vacancies created by the increase in the number of directors, which only
may be filled by a majority of the entire Board of Directors. Accordingly, the
Board of Directors could temporarily prevent any stockholder from enlarging the
Board of Directors and filling the new directorship with such stockholder's own
nominees. The Charter provides that, subject to the rights of any class or
series separately to elect one or more directors, directors may be removed only
for cause upon the affirmative vote of a majority of holders of all the then
outstanding shares of stock entitled to vote generally in the election of
directors, voting together as a single class.
ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER NOMINATIONS AND STOCKHOLDER PROPOSALS
The Bylaws establish an advance notice procedure for stockholders to make
nominations of candidates for director or bring other business before an annual
meeting of stockholders of the Company (the "Stockholders Notice Procedure").
The Bylaws provide that (i) only persons who are nominated by, or at the
direction of, the Board of Directors, or by a stockholder who has given timely
written notice containing specified information to the Secretary of the Company
prior to the meeting, at which directors are to be
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elected, will be eligible for election as directors of the Company, and (ii) at
an annual meeting, only such business may be conducted as has been brought
before the meeting by or at the direction of, the Chairman or the Board of
Directors or by a stockholder who has given timely written notice to the
Secretary of the Company of such stockholder's intention to bring such business
before such meeting. In general, for notice of stockholder nominations or
proposed business (other than business to be included in the Company's Proxy
Statement under the Commission's Rule 14a-8) to be conducted at an annual
meeting to be timely, such notice must be received by the Company not less than
60 days nor more than 90 days prior to the first anniversary of the previous
year's annual meeting. The purpose of requiring stockholders to give the Company
advance notice of nominations and other business is to afford the Board of
Directors a meaningful opportunity to consider the qualifications of the
proposed nominees or the advisability of the other proposed business and, to the
extent deemed necessary or desirable by the Board of Directors, to inform
stockholders and make recommendations about such nominees or business, as well
as to ensure an orderly procedure for conducting meetings of stockholders.
Although the Charter and the Bylaws do not give the Board of Directors power to
block stockholder nominations for the election of directors or proposals for
action, they may have the effect of discouraging stockholders from proposing
nominees or business, precluding a contest for the election of directors or the
consideration of stockholder proposals if procedural requirements are not met
and deterring third parties from soliciting proxies for a non-management slate
of directors or proposals, without regard to the merits of such slate or
proposals.
RIGHTS TO PURCHASE SECURITIES AND OTHER PROPERTY
The Charter provides that the Board of Directors may create and authorize
the Company to issue rights entitling the holders thereof to purchase from the
Company shares of capital stock or other securities or property. The times at
which and terms upon which such rights are to be issued are within the
discretion of the Board of Directors. The provision is intended to confirm the
Board of Directors' authority to issue share purchase rights which could have
terms that would impede a merger, tender offer or other takeover attempt, or
other rights to purchase securities of the Company or any other entity.
INDEMNIFICATION
The Company's Charter obligates the Company to indemnify its directors and
officers and to pay or reimburse expenses for such individuals in advance of the
final disposition of a proceeding to the maximum extent permitted from time to
time by Maryland law. The 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 the proceeding and (i) was committed in bad faith, or (ii) was a 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. 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.
LIMITATION OF LIABILITY
The MGCL permits the Charter of a Maryland corporation to include a
provision limiting the liability of its directors and officers to the
corporation and to its stockholders for money damages, except to the extent that
(i) it is proved that the person actually received an improper benefit or profit
in money, property or services, or (ii) a judgment or other final adjudication
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
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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 and officers to the Company or its stockholders for money damages to
the maximum extent permitted by Maryland law as amended or interpreted.
BUSINESS COMBINATIONS
Under Section 3-603(c) of 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 or
associate of the corporation which, at any time within the two-year period prior
to the date in question, beneficially owned 10% or more of the voting power of
the corporation's shares (an "Interested Stockholder") or an affiliate thereof,
are prohibited for five years after the most recent date on which the Interested
Stockholder became an Interested Stockholder. Thereafter, any such business
combination must be recommended by the board of directors of such corporation
and approved by the affirmative vote of at least (a) 80% of the votes entitled
to be cast by holders of outstanding voting shares of the corporation and (b)
two-thirds of the votes entitled to be cast by holders of outstanding voting
shares of the corporation other than shares held by the Interested Stockholder
with whom (or with whose affiliate) the business combination is to be effected,
or by an affiliate or associate of the Interested Stockholder, unless, among
other things, the corporation's stockholders receive a minimum price (as defined
in the MGCL) for their shares and the consideration is received in cash or in
the same form as previously paid by the Interested Stockholder for its shares.
These provisions of Maryland law do not apply, however, to business combinations
that are approved or exempted by the board of directors of the corporation prior
to the time that the Interested Stockholder becomes an Interested Stockholder.
By resolution of the Board of Directors, dated November 7, 1997, the several
mutual funds advised by Franklin Mutual Advisers Inc. (each, a "Fund" and,
together, the "Funds") who have participated in the Private Placement and their
Affiliates have been irrevocably exempted from Section 3-603(c) of the MGCL.
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 or by officers or directors who
are employees of the corporation. "Control shares" are voting shares of stock
which, if aggregated with all other shares of stock owned by such a person,
would entitle the acquiror to exercise voting power in electing directors within
one of the following ranges of voting power: (i) one-fifth or more but less than
one-third, (ii) one-third or more but less than a majority, or (iii) a majority
or more of all voting power. "Control shares" do not include shares of stock the
acquiring person is then entitled to vote as a result of having previously
obtained stockholder approval. A "control share acquisition" means, subject to
certain exceptions, the acquisition of, ownership of, or the power to direct the
exercise of voting power with respect to "control shares."
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an acquiring
person statement as permitted by the statute, then, subject to certain
conditions and limitations, the corporation may redeem any or all of the
"control shares" (except those for which voting rights have previously been
approved) for fair value determined, without regard to absence of voting rights,
as of the date of the last "control share acquisition" or of any meeting of
stockholders at which the voting rights of such shares are considered and not
approved. If voting rights for "control shares" are approved at a
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stockholders' meeting and the acquiror becomes entitled to vote a majority of
the shares entitled to vote, all other stockholders may exercise appraisal
rights. The fair value of the stock, as determined for purposes of such
appraisal rights may not be less than the highest price per share paid in the
"control share acquisition," and certain limitations and restrictions otherwise
applicable to the exercise of appraisal rights do not apply in the context of
"control share acquisitions."
The "control share acquisition" statute does not apply to stock acquired in
a merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by a provision of the
charter or bylaws of the corporation adopted prior to the acquisition of the
shares. The Company has adopted a provision in its Bylaws that exempts the
Company's shares of Common Stock from application of the "control share
acquisition" statute. No assurance can be given, however, that such Bylaw
provision may not removed at any time by amendment of the Bylaws.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The Charter provides that the Company may issue up to 100,000,000 shares of
capital stock, consisting of 75,000,000 shares of Common Stock, par value $.001,
and 25,000,000 shares of Preferred Stock, par value $.01 (the "Preferred
Stock"). Upon completion of the Offering, 20,019,999 shares of Common Stock will
be issued and outstanding (or 22,269,999 shares if the Underwriters'
over-allotment option is exercised in full), and 2,066,666 shares of Common
Stock will be reserved pursuant to the Stock Incentive Plan for issuance upon
exercise of options and grants of deferred Common Stock, and no Preferred Stock
will be issued and outstanding.
COMMON STOCK
All outstanding shares of Common Stock will be duly authorized, fully paid
and nonassessable upon the Closing. Subject to the preferential rights of any
other shares or series of shares of capital stock, holders of Common Stock are
entitled to receive distributions if and when authorized and declared by the
Board of Directors of the Company out of assets legally available therefor and
to share ratably in the assets of the Company legally available for distribution
to its stockholders in the event of its liquidation, dissolution or winding-up
after payment of, or adequate provision for, all known debts and liabilities of
the Company. The Company intends to make quarterly distributions.
Each outstanding share of Common Stock entitles the holder to one vote on
all matters submitted to a vote of stockholders, including the election of
directors, and, except as otherwise required by law or except as provided with
respect to any other class or series of shares of capital stock, the holders of
Common Stock will possess the exclusive voting power. There is no cumulative
voting in the election of directors, which means in all elections of directors,
each holder of Common Stock has the right to cast one vote for each share of
stock for a candidate.
PREFERRED STOCK
Preferred Stock may be issued from time to time, in one or more series, as
authorized by the Board of Directors. Because the Board of Directors has the
power to establish the preferences and rights of each class or series of
Preferred Stock, the Board of Directors may afford the holders of any series or
class of Preferred Stock preferences, powers and rights, voting or otherwise,
senior to the rights of the holders of Common Stock. The Board could authorize
the issuance of Preferred Stock with terms and conditions which could have the
effect of discouraging a takeover or transaction which holders of some, or a
majority, of the shares of Common Stock might believe to be in their best
interests or in which holders of some, or a majority, of the shares of Common
Stock might receive a premium for their shares of Common Stock over the then
market price of such shares of Common Stock. As of the date hereof, no shares of
Preferred Stock are outstanding. The Charter provides that the Board of
Directors may classify or reclassify any unissued capital stock from time to
time. Thus, the Company may in the future increase the number of authorized
shares of Preferred Stock.
REGISTRATION RIGHTS
The Company has agreed that it will file and use its best efforts to have
declared a resale registration statement covering the sale of the shares sold in
the Private Placement. The Company has agreed with certain officers and
directors and certain other stockholders holding an aggregate of 5,013,999
shares of Common Stock that it shall keep the resale registration statement
effective until such time as sales may be made in reliance on Rule 144(k) under
the Securities Act. See "PRIVATE PLACEMENT."
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STANDSTILL AGREEMENT
Each of the Funds has agreed with respect to any shares of Common Stock
owned or purchased by any of the Funds aggregating in excess of 9.8% of the
outstanding voting stock of the Company (the "Excess Shares"), for so long as
such shares shall be deemed Excess Shares (the "Standstill Period"): (a) not to
solicit proxies from stockholders of the Company, the power to vote, become a
"participant" in any "election contest" (as such terms are used in Rule 14a-11
of the Exchange Act), with respect to the Company, or make a communication
referred to in Rule 14a-1(l)(2)(iv) of the Exchange Act in connection with any
election contest or other vote by stockholders of the Company that is contrary
to or is opposed to the position of the Board of Directors or management of the
Company, subject to certain restrictions; (b) not to seek or vote for the
removal of any member of or the election of any person to the Board of Directors
of the Company, except removal "for cause," within the contemplation of the
MGCL; (c) not to seek or vote for the replacement of the Manager or any change
in the terms of the Management Agreement, unless such proposed change or removal
is "for cause," as defined in the Management Agreement; (d) not to call or seek
to have called any meeting of the stockholders of the Company; (e) not to
otherwise act, alone or in concert with others to (i) solicit, propose, seek to
effect or negotiate with any other person with respect to (A) any business
combination with the Company or (B) any restructuring, recapitalization or
similar transaction of the Company, (ii) solicit, propose, seek to effect or
negotiate with any other person with respect to, or announce an intent to make,
any tender offer or exchange offer for any voting securities of the Company,
(iii) disclose an intent, purpose, plan or proposal with respect to the Company
or any voting securities of the Company otherwise prohibited by these
provisions, or (iv) assist, participate in, facilitate or solicit any effort or
attempt by any person to do or seek any of the foregoing; and (f) not to form,
join or participate in a "group" (within the meaning of Section 13(d)(3) of the
Exchange Act) with respect to the matters described in clauses (a) through (e)
above.
The Standstill Period shall terminate upon a change of control of the
Company (as defined in the purchase agreement among the Company and the Funds)
or if Michael L. Smirlock shall no longer serve as Chief Executive Officer and a
Director of the Company and the Manager.
REPURCHASE OF SHARES AND RESTRICTIONS ON TRANSFER
Two of the requirements of qualification for the tax benefits afforded by
the REIT Provisions of the Code are that (i) 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 "5/50 Rule") and (ii)
there must be at least 100 stockholders during 335 days of each taxable year of
12 months.
So 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 of the aggregate of the outstanding
shares of Common Stock or in excess of 9.8% (in value or in number of shares,
whichever is more restrictive) of the aggregate of the outstanding shares of
Common Stock of the Company. For this purpose, the term "ownership" is defined
in accordance with the REIT Provisions of the Code and the constructive
ownership provisions of Section 544 of the Code, as modified by Section
856(h)(1)(B) of the Code. The Board of Directors has waived the Ownership Limit
for the Funds and their Affiliates.
For purposes of the 5/50 Rule, the constructive ownership provisions
applicable under Section 544 of the Code attribute ownership of securities owned
by a corporation, partnership, estate or trust proportionately to its
stockholders, partners or beneficiaries, attribute ownership of securities owned
by family members and partners to other members of the same family, treat
securities with respect to which a person has an option to purchase as actually
owned by that person, and set forth rules as to when securities constructively
owned by a person are considered to be actually owned for the application of
such attribution provisions (I.E., "reattribution"). Thus, for purposes of
determining whether a person holds shares of Common Stock in violation of the
ownership limitation set forth in the Charter, many types of
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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 nevertheless may be in violation of the ownership
limitations set forth in the Charter. Ownership of shares of the Company's
Common Stock through such attribution is generally referred to as constructive
ownership. The 100 stockholder test is determined by actual, and not
constructive, ownership. It is contemplated that, following the Offering, the
Company will have greater than 100 stockholders of record.
The Charter further provides that any transfer of shares of Common Stock
that would result in disqualification of the Company as a REIT or that would (a)
create a direct or constructive ownership of shares of stock in excess of the
Ownership Limit, or (b) from and after the earlier of January 1, 1998 and the
date of closing of the sale of Common Stock pursuant to the Offering (the "One
Hundred Stockholder Date"), result in the shares of stock being beneficially
owned (within the meaning Section 856(a) of the Code) by fewer than 100 persons
(determined without reference to any rules of attribution), or (c) result in the
Company being "closely held" within the meaning of Section 856(h) of the Code,
will be null and void, and the intended transferee (the "purported transferee")
will acquire no rights to such shares. Any purported transfer of shares that
would result in a person owning (directly or constructively) shares in excess of
the Ownership Limit (except as otherwise waived by the Board of Directors) due
to the unenforceability of the transfer restrictions set forth above will
constitute "Excess Securities." Excess Securities will automatically be deemed
to have been transferred by operation of law to a trust to be established by the
Company for the exclusive benefit of a charitable organization, until such time
as the trustee of the trust, which shall be a banking institution designated as
trustee by the Company, which is unaffiliated with either the Company or the
purported transferee, retransfers the Excess Securities. Subject to the
Ownership Limit, Excess Securities may be transferred by the trust to any person
(if such transfer would not result in Excess Securities) at a price not to
exceed the price paid by the purported transferee, the fair market value of the
Excess Securities on the date of the purported transfer), at which point the
Excess Securities will automatically cease to be Excess Securities. See "FEDERAL
INCOME TAX CONSIDERATIONS--Requirements for Qualification."
Subject to certain limitations, the Board of Directors may increase or
decrease the Ownership Limit. In addition, to the extent consistent with the
REIT Provisions of the Code, the Board of Directors has the right, in its sole
discretion, pursuant to the Company's Charter to waive the Ownership Limit for,
and at the request of, a purchaser of the Common Stock. In connection with any
such waiver, the Company may require that the stockholder requesting such a
waiver enter into an agreement with the Company providing for the repurchase by
the Company of shares from the stockholder under certain circumstances to ensure
compliance with the REIT Provisions of the Code. Such repurchase would be at
fair market value as set forth in the agreement between the Company and such
stockholder. The consideration received by the stockholder in such repurchase
might be characterized as the receipt by the stockholder of a dividend from the
Company, and any stockholder entering into such an agreement with the Company
should consult its tax advisor in connection with its entering into such an
agreement.
Prior to the Offering, as part of the Private Placement, the Company
received commitments to purchase 3,333,333 shares of Common Stock from the
Funds. See "PRIVATE PLACEMENT." The Board of Directors has waived the Ownership
Limit for the Funds and their Affiliates and the Funds have entered into an
agreement with the Company which imposes certain restrictions on the sale and
transfer of the shares held, beneficially or constructively, by the Funds. The
Funds have agreed not to acquire more than 17.5% of the Company's outstanding
shares of Common Stock. This waiver of the Ownership Limit applies only to the
Funds and their Affiliates. Any subsequent transferee of the shares held by the
Funds and their Affiliates will be subject to the Ownership Limit, unless
specifically exempted by the Company's Board of Directors.
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Every owner of more than five percent (or such lower percentage as required
by the Code or the regulations promulgated thereunder) of all classes or series
of the Company's stock, within 30 days after the end of each taxable year, is
required by the Company's Charter to give written notice to the Company stating
the name and address of such owner, the number of shares of each class and
series of stock of the Company beneficially owned and a description of the
manner in which such shares are held. Each such owner shall provide to the
Company such additional information as the Company may request in order to
determine the effect, if any, of such beneficial ownership on the Company's
status as a REIT and to ensure compliance with the ownership limitations.
The provisions described above may inhibit market activity and the resulting
opportunity for the holders of the Company's Common Stock to receive a premium
for their shares or warrants 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 Common Stock.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services LLC.
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SHARES ELIGIBLE FOR FUTURE SALE
Prior to this Offering, there has been no public market for the Common Stock
of the Company. Sales of a substantial number of shares of Common Stock in the
public market following the Offering, or the perception that such sales could
occur, could adversely affect the market price of the Common Stock prevailing
from time to time and could impair the Company's future ability to raise capital
through an offering of equity securities.
Upon the closing of the Offering, the Company will have reserved for
issuance upon exercise of options 2,066,666 shares of Common Stock. The
15,000,000 shares of Common Stock issued in the Offering will be freely tradable
by persons other than "affiliates" of the Company, as that term is defined under
the Securities Act ("Affiliates"), of the Company without restriction under the
Securities Act, subject to certain limitations on ownership set forth in the
Charter. See "DESCRIPTION OF CAPITAL STOCK--Repurchase of Shares and
Restrictions on Transfer."
In general, pursuant to Rule 144 under the Securities Act as currently in
effect, if one year has elapsed since the later of the date of acquisition of
restricted shares from the Company or any "Affiliate" of the Company, as that
term is defined under the Securities Act, the acquiror or subsequent holder
thereof is entitled to sell within any three-month period a number of shares
that does not exceed the greater of 1% of the then outstanding Common Stock or
the average weekly trading volume of the Common Stock during the four calendar
weeks preceding the date on which notice of the sale is filed with the
Commission. Sales pursuant to Rule 144 under the Securities Act also are subject
to certain manner of sale provisions, notice requirements and the availability
of current public information about the Company. If two years have elapsed since
the date of acquisition of restricted shares from the Company or from any
Affiliate of the Company, and the acquiror or subsequent holder thereof is
deemed not to have been an Affiliate of the Company at any time during the three
months preceding a sale, such person would be entitled to sell such shares in
the public market pursuant to Rule 144(k) under the Securities Act without
regard to the volume limitations, manner of sale provisions, public information
requirements or notice requirements.
The 5,013,999 shares of Common Stock sold in the Private Placement are
"restricted securities" for purposes of Rule 144 under the Securities Act.
However, the Company will file and seek to have declared effective a resale
registration statement covering the sale of such shares in the public market.
See "DESCRIPTION OF CAPITAL STOCK--Registration Rights." Following expiration of
the applicable lock-up restrictions discussed in "UNDERWRITING," these shares
will be available for sale in the public market, subject to Rule 144 manner of
sale and volume limitations in the case of Affiliates. See "PRIVATE PLACEMENT."
At the closing of the Offering, options to purchase 778,000 shares of Common
Stock will be outstanding (866,000 shares of Common Stock if the over-allotment
option is exercised). Shortly after the Offering, the Company intends to file a
Registration Statement on Form S-8 under the Securities Act covering shares of
Common Stock reserved for issuance under the Company's Stock Incentive Plan.
Shares of Common Stock issued upon exercise of options under the Registration
Statement on Form S-8 will be available for sale in the public market, subject
to Rule 144 manner of sale and volume limitations in the case of Affiliates and
subject to any lock-up restrictions discussed in "UNDERWRITING." The Company has
also granted 400,000 shares of deferred Common Stock to certain of its directors
and officers.
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UNDERWRITING
The underwriters of the Offering of the Common Stock (the "Underwriters"),
for whom Bear, Stearns & Co. Inc., Friedman, Billings, Ramsey & Co., Inc.,
EVEREN Securities, Inc. and Stifel, Nicolaus & Company, Incorporated are acting
as representatives (the "Representatives"), have severally agreed, subject to
the terms and conditions of the Underwriting Agreement (the "Underwriting
Agreement") (the form of which is filed as an exhibit to the Registration
Statement of which this Prospectus is a part), to purchase from the Company the
aggregate number of shares of Common Stock set forth opposite their name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- -------------------------------------------------------------------------------- ------------
<S> <C>
Bear, Stearns & Co. Inc......................................................... 4,657,500
Friedman, Billings, Ramsey & Co., Inc........................................... 2,587,500
EVEREN Securities, Inc.......................................................... 1,552,500
Stifel, Nicolaus & Company, Incorporated........................................ 1,552,500
ABN AMRO Chicago Corporation.................................................... 300,000
Allen & Company Incorporated.................................................... 150,000
Blaylock & Partners, L.P........................................................ 150,000
Brean Murray & Co., Inc......................................................... 150,000
BT Alex. Brown Incorporated..................................................... 300,000
CIBC Oppenheimer Corp........................................................... 300,000
Crowell, Weedon & Co............................................................ 150,000
Donaldson, Lufkin & Jenrette Securities Corporation............................. 300,000
Equitable Securities Corporation................................................ 150,000
First Southwest Company......................................................... 150,000
Furman Selz LLC................................................................. 300,000
Gaines, Berland Inc............................................................. 150,000
Gerard Klauer Mattison & Co., Inc............................................... 150,000
Janney Montgomery Scott Inc..................................................... 150,000
Keefe, Bruyette & Woods, Inc.................................................... 150,000
Ladenburg Thalmann & Co. Inc.................................................... 150,000
Lehman Brothers Inc............................................................. 300,000
McDonald & Company Securities, Inc.............................................. 150,000
Neuberger & Berman, LLC......................................................... 150,000
Prudential Securities Incorporated.............................................. 300,000
Raymond James & Associates, Inc................................................. 150,000
Sutro & Co. Incorporated........................................................ 150,000
Tucker Anthony Incorporated..................................................... 150,000
Wheat, First Securities, Inc.................................................... 150,000
------------
Total........................................................................... 15,000,000
------------
------------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that, if any of the foregoing
shares of Common Stock are purchased by the Underwriters pursuant to the
Underwriting Agreement, all such shares must be so purchased. The Company has
agreed to indemnify the Underwriters against certain liabilities, including
liabilities under the Securities Act, or to contribute to payments that the
Underwriters may be required to make in respect thereof.
The Company has been advised that the Underwriters propose to offer the
shares of Common Stock to the public initially at the public offering price set
forth on the cover of this Prospectus and to certain selected dealers (who may
include the Underwriters) at such public offering price less a concession not to
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exceed $0.60 per share. The selected dealers may reallow a concession to certain
other dealers not to exceed $0.10 per share. After the initial offering to the
public, the public offering price, the concession to selected dealers and the
reallowance to other dealers may be changed by the Representatives.
In order to facilitate the Offering, certain persons participating in the
Offering may engage in transactions that stabilize, maintain or otherwise affect
the price of the Common Stock during and after the Offering. Specifically, the
Underwriters may over-allot or otherwise create a short position in the Common
Stock for their own account by selling more shares of Common Stock than have
been sold to them by the Company. The Underwriters may elect to cover any such
short position by purchasing shares of Common Stock in the open market or by
exercising the over-allotment option granted to the Underwriters. In addition,
such persons may stabilize or maintain the price of the Common Stock by bidding
for or purchasing shares of Common Stock in the open market and may impose
penalty bids, under which selling concessions allowed to syndicate members or
other broker-dealers participating in the Offering are reclaimed if shares of
Common Stock previously distributed in the Offering are repurchased in
connection with stabilization transactions or otherwise. The effect of these
transactions may be to stabilize or maintain the market price of the Common
Stock at a level above that which might otherwise prevail in the open market.
The imposition of a penalty bid may also affect the price of the Common Stock to
the extent that it discourages resales thereof. No representation is made as to
the magnitude or effect of any such stabilization or other transactions. Such
transactions may be effected on the NYSE or otherwise and, if commenced, may be
discontinued at any time.
The Company has granted the Underwriters options to purchase up to 2,250,000
additional shares of Common Stock at the public offering price less underwriting
discounts and commissions set forth on the cover page of this Prospectus, solely
to cover over-allotments, if any. Such options may be exercised at any time
until 30 days after the date of this Prospectus. To the extent the Underwriters
exercise such options, each of the Underwriters will be committed, subject to
certain conditions, to purchase a number of additional shares of Common Stock
proportionate to such Underwriter's initial commitment as indicated in the
preceding table.
Prior to the Offering, there has been no public market for the Common Stock.
Consequently, the public offering price was determined by negotiation between
the Company and the Underwriters. Among the factors considered in such
negotiations were the nature of the Company's business, its prospects and
management, and the general conditions of the securities markets at the time of
the Offering. There can be no assurance, however, that the prices at which the
shares will sell in the public market after the Offering will not be lower than
the price at which they are sold by the Underwriters. The Company's Common Stock
has been approved for listing on the NYSE, subject to official notice of
issuance.
The Representatives have informed the Company that the Underwriters do not
intend to confirm sales to any accounts over which they exercise discretionary
authority.
In connection with the Offering, the Company, its officers and directors and
certain other stockholders who have purchased an aggregate of 1,014,000 shares
of Common Stock in the Private Placement have agreed that they will not,
directly or indirectly, offer, pledge, sell, offer to sell, contract to sell or
grant any option to purchase or otherwise sell or dispose (or announce any
offer, pledge, sale, offer of sale, contract of sale, grant of any option to
purchase or other sale or disposition) of any shares of Common Stock or other
capital stock or securities exchangeable or exercisable for, or convertible
into, shares of Common Stock or other capital stock for a period of 180 (or such
shorter period as expressly agreed to by Bear Stearns) days after the date of
this Prospectus, except (i) with the prior written consent of Bear Stearns, on
behalf of the Underwriters, and (ii) in the case of the Company, for issuances
under the terms of the Stock Incentive Plan or the Dividend Reinvestment Plan.
The Funds have agreed to the same restrictions as to their 3,333,333 shares of
Common Stock for a period of 90 days. Each of the parties to the Total Return
Swap has agreed to the same restrictions with respect to the 666,666 shares of
Common Stock which are the subject of the Total Return Swap for a period of 180
days.
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Frederick N. Khedouri, a proposed Director of the Company and a Senior
Managing Director of Bear Stearns, one of the Representatives, has committed to
purchase 10,000 shares at the initial public offering price in the Private
Placement.
PRIVATE PLACEMENT
The Company received commitments on September 15, 1997 for the purchase, in
a private placement, of 1,014,000 shares of Common Stock at the initial public
offering price from certain officers, directors, proposed directors, employees
and Affiliates of the Company and the Manager. On November 7, 1997, the Company
received commitments from the Funds for the purchase, in a private placement, of
3,333,333 shares of Common Stock at the initial public offering price. In
connection with their purchase, the Funds entered into an agreement with the
Company providing for, among other things, certain restrictions on the sale and
transfer of the shares held, beneficially or constructively, by the Funds. See
"DESCRIPTION OF CAPITAL STOCK."
An Affiliated Fund has entered into a Total Return Swap with a broker-dealer
which provides that the Affiliated Fund will bear the economic benefit and risk
of directly holding the 666,666 shares of the Company's Common Stock purchased
by such broker-dealer in the Private Placement.
Consummation of such transactions (the "Private Placement") is contingent
only upon and will occur simultaneous with the closing of the Offering. The
shares sold in the Private Placement were sold without registration under the
Securities Act, in reliance on the exemption provided by Section 4(2) thereof.
The Company has agreed that it will file and use its best efforts to have
declared effective a resale registration statement covering the sale of the
shares purchased in the Private Placement. These shares will be subject to
certain lock-up restrictions as described in "UNDERWRITING" but will be
available for public sale following expiration of such restrictions.
LEGAL MATTERS
Certain legal matters will be passed upon for the Company by Stroock &
Stroock & Lavan LLP, New York, New York, and for the Underwriters by Cadwalader,
Wickersham & Taft, New York, New York. Certain matters relating to Maryland law
have been passed upon for the Company by Miles & Stockbridge, a Professional
Corporation, Baltimore, Maryland. Certain tax matters have been passed upon by
Stroock & Stroock & Lavan LLP, New York, New York, as Special Tax Counsel.
EXPERTS
The statement of financial condition of the Company as of September 25,
1997, included in this Prospectus is included in reliance on the report of
Deloitte & Touche LLP, independent certified public accountants, given on the
authority of said firm as experts in auditing and accounting.
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ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement (of which
this Prospectus forms a part) under the Securities Act with respect to the
Common Stock offered pursuant to the Prospectus. This Prospectus contains
summaries of the material terms of the documents referred to herein and therein,
but does not contain all of the information set forth in the Registration
Statement pursuant to the rules and regulations of the Commission. For further
information, reference is made to such Registration Statement and the exhibits
thereto. Such Registration Statement and exhibits as well as reports and other
information filed by the Company can be inspected without charge and copied at
prescribed rates at the public reference facilities maintained by the Commission
at the Public Reference Section of the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at its Regional Offices located as follows: Chicago
Regional Office, Citicorp Center, Suite 1400, 500 West Madison Street, Chicago,
Illinois 60661-2511; and New York Regional Office, Seven World Trade Center,
Suite 1300, New York, New York 10048. The Commission maintains a Web site that
contains reports, proxy, and information statements and other information
regarding registrants that file electronically with the Commission. The Web site
is located at http://www.sec.gov. Application has been made to list the
Company's Common Stock on the NYSE. Reports and other information concerning the
Company can also be inspected at the offices of the NYSE, 20 Broad Street, New
York, New York 10005.
Statements contained in this Prospectus as to the contents of any contract
or other document that is filed as an exhibit to the Registration Statement are
not necessarily complete, and each such statement is qualified in its entirety
by reference to the full text of such contract or document.
The Company will be required to file reports and other information with the
Commission pursuant to the Exchange Act. In addition to applicable legal
requirements, if any, holders of Common Stock will receive annual reports
containing audited financial statements with a report thereon by the Company's
independent certified public accounts, and quarterly reports containing
unaudited financial information for each of the first three quarters of each
fiscal year.
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GLOSSARY
As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.
"Acceleration Event" means any of the following circumstances in which the
awards granted under the Stock Incentive Plan generally become immediately
vested and exercisable: (i) upon the occurrence of special circumstances
determined in the opinion of the Board of Directors of the Company to merit
special consideration, (ii) upon a termination by the Company of the holder's
employment or service without cause (as defined in the Stock Incentive Plan),
(iii) in the case of an employee or director of the Manager, if the Management
Agreement terminates without the occurrence of a Termination Event (as defined
in the Stock Incentive Plan), or (iv) upon a Change of Control (as defined in
the Stock Incentive Plan) of the Company, except that vesting and exercisability
in the event of such a Change of Control shall be limited to the extent
necessary, and shall occur as soon as permissible under GAAP, to permit pooling
of interests accounting treatment if such treatment is desired.
"ADA" means the Americans with Disabilities Act of 1990.
"Advisers Act" means the Investment Advisers Act of 1940, as amended.
"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.
"Affiliated Funds" means the private investment funds advised by the Manager
which invest in Mortgage Assets.
"Agency Certificates" means FHLMC Certificates, FNMA Certificates and GNMA
Certificates.
"Appaloosa" means Appaloosa Management L.P.
"ARM" means a Mortgage Loan or any mortgage loan underlying a Mortgage
Security that features adjustments of the underlying interest rate at
predetermined times based on an agreed margin to an established index. An ARM is
usually subject to periodic and lifetime interest rate and/or payment caps.
"Average Market Price" means the average of the daily high and low sales
prices, computed to seven decimal places, of the Company's Common Stock on the
NYSE, as reported in THE WALL STREET JOURNAL, during the pricing period (the ten
days on which the NYSE is open and for which trades in the Company's Common
Stock are reported immediately preceding the relevant investment date).
"Average Market Price for Cash Purchases" means the average of the daily
high and low sale prices, computed to seven decimal places, of the Company's
Common Stock as reported on the NYSE during the twelve trading days prior to the
date scheduled for investment of Cash Purchases for that month.
"Average Market Price for Distribution Reinvestments" means the average of
the daily high and low sale prices, computed to seven decimal places, of the
shares of the Company's Common Stock as reported on the NYSE on the Distribution
Reinvestment Date.
"Average Stockholders' Equity" means, for any period, stockholders' equity,
calculated in accordance with GAAP, excluding any mark-to-market adjustments of
the investment portfolio.
"Bear Stearns" means Bear, Stearns & Co. Inc., one of the Representatives.
"Beneficial Owner" means a stockholder who beneficially owns shares of the
Company's Common Stock that are registered in a name other than such
stockholder's name.
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"Board of Directors" means the Board of Directors of the Company.
"Bylaws" means the Bylaws, as amended, of the Company.
"Cash Purchases" means the opportunity to make monthly investments in the
Company's Common Stock through optional cash purchases subject to a $250 minimum
and a $5,000 maximum per month.
"CERCLA" means the Federal Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended.
"Charter" means the Articles of Incorporation, as amended, of the Company.
"CMOs" means fixed- or adjustable-rate debt obligations (bonds) that are
collateralized by Mortgage Loans or other Mortgage Assets. Such bonds may be
issued by U.S. government agencies or private issuers in one or more classes
with fixed or variable interest rates, maturities and degrees of subordination
which are characteristics designed for the investment objectives of different
bond purchasers.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commission" means the Securities and Exchange Commission.
"Commitments" means commitments issued by the Company which 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 shares of the Company's common stock, $.001 par value
per share.
"Company" means LASER Mortgage Management, Inc., a Maryland corporation.
"control shares" means voting shares of stock which, if aggregated with all
other shares of stock owned by such person, would entitle the acquiror to
exercise voting power in electing directors within one of the following ranges
of voting power: (i) one-fifth or more but less than one-third; (ii) one-third
or more but less than a majority or (iii) a majority or more of all voting
power.
"control share acquisition" means, subject to certain exceptions, the
acquisition of, ownership of, or the power to direct the exercise of voting
power with respect to "control shares."
"Crime Control Act" means the Comprehensive Crime Control Act of 1984.
"dealer property" means assets such as Mortgage Securities that the Company
creates through securitization of Mortgage Loans or Mortgage Assets or hedging
instruments in which any of the profits made from selling such assets would be
subject to tax at the rate of 100% as income from prohibited transactions.
"Distribution Record Date" means the date on which the Company makes a
distribution.
"Distribution Reinvestment Date" means the date that distributions shall be
reinvested as soon as practicable after the Distribution Record Date.
"DOL" means the U.S. Department of Labor.
"DRP" means the Dividend Reinvestment and Direct Purchase Plan adopted by
the Company.
"11th District Index" means the 11th District Cost of Funds Index published
by the Federal Home Loan Bank of San Francisco.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"excess inclusion" means taxable income that is generated by the Mortgage
Assets constituting a "taxable mortgage pool" under regulations to be issued by
the Treasury Department.
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"Excess Securities" means shares of the Company owned by a person (directly
or indirectly) in excess of the Ownership Limit due to the unenforceability of
transfer restrictions.
"Excess Shares" means any shares of Common Stock owned or purchased by any
of the Funds aggregating in excess of 9.8% of the outstanding voting stock of
the Company.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Exempt Organizations" means tax-exempt entities, including qualified
employee pension and profit sharing trusts and individual retirement accounts.
"FASIT" means a Financial Asset Securitization Investment Trust.
"FHA" means the U.S. Federal Housing Administration.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FHLMC Certificates" means mortgage participation certificates issued by
FHLMC, either in certificated or book-entry form. An FHLMC ARM Certificate is an
FHLMC Certificate collateralized by adjustable-rate FHLMC Certificates.
"55% Requirement" means the requirement under the Investment Company Act
that the Company must, among other things, maintain at least 55% of its assets
in Qualifying Interests in order to qualify for the Investment Company Act
exemption.
"5/50 Rule" means that, for the Company to maintain its qualification as a
REIT, during the last half of each taxable year, not more than 50% in value of
its outstanding shares may be owned directly or indirectly by five or fewer
individuals.
"Funds" means the several mutual funds advised by Franklin Mutual Advisers
Inc. purchasing in the Private Placement.
"FNMA" means the Federal National Mortgage Association.
"FNMA Certificates" means guaranteed mortgage-pass-through certificates
issued by FNMA either in certified or book-entry form. An FNMA ARM Certificate
is an FNMA Certificate collateralized by adjustable-rate FNMA Certificates.
"GAAP" means generally accepted accounting principles.
"GAAP income" means income calculated according to GAAP.
"Garn-St. Germain Act" means the Garn-St. Germain Depository Institutions
Act of 1982.
"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. A GNMA ARM Certificate is a GNMA Certificate collateralized by
adjustable-rate GNMA Certificates.
"GSAM" means Goldman Sachs Asset Management.
"haircut" means the over-collateralization amount required by a lender in
connection with a collateralized borrowing.
"HUD" means the Department of Housing and Urban Development.
"Independent Directors" means those directors that are not affiliated,
directly, or indirectly, with the Company or the Manager, 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 Company or the
Manager or an affiliated business entity of the Company or the Manager.
99
<PAGE>
"Interest in Real Property" means an interest in Mortgage Loans or land and
improvements thereon, such as buildings or other inherently permanent
structures, a leasehold of real property, and an option to acquire real
property.
"Interested Stockholder" means any person who beneficially owns 10% or more
of the voting power of the Company's shares or an affiliate or associate of the
Company which, at any time within the two-year period prior to the date in
question, beneficially owned 10% or more of the voting power of the Company's
shares.
"Inverse IOs" means IOs that bear interest at a floating rate that varies
inversely with (and often at a multiple of ) changes in a specified index.
"Investment Company Act" means the Investment Company Act of 1940, as
amended.
"IRAs" means Individual Retirement Accounts.
"Interest-only security" or "IO" means a type of Mortgage Security which
receives a portion of the interest payments from an underlying pool of Mortgage
Loans but will receive little or no principal payments and hence will have
little or no face value.
"junk bonds" means non-investment grade high yield corporate debt.
"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 fees.
"Manager" means Laser Advisers Inc., a Delaware corporation.
"margin call" means additional collateral that the Company would be required
to deposit due to potential reverse repurchase and dollar roll agreements.
"Master Servicer" means an entity that will administer and supervise the
performance by servicers of the duties and responsibilities under Servicing
Agreements in respect of the collateral for a series of Mortgage Securities.
"MGCL" means the Maryland General Corporation Law.
"Mortgage Assets" means (i) Mortgage Securities and (ii) Mortgage Loans.
"Mortgage Derivatives" means Mortgage Securities which 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.
"Mortgage Loans" means mortgage loans secured by first or second liens on
single-family residential, multi-family residential, commercial or other real
property.
"Mortgage Securities" means (i) Pass-Through Certificates, (ii) CMOs, and
(iii) other securities representing interests in, or obligations backed by,
pools of Mortgage Loans.
"Mortgage Seller" means entities such as savings and loan associations,
banks, mortgage bankers, home builders, insurance companies and other mortgage
lenders which sell Mortgage Loans.
"Net Income" means the taxable income of the Company within the meaning of
the Code, less capital gains and capital appreciation included in taxable
income, but before the Manager's fees and before deduction of dividends paid.
"1996 Lender Liability Act" means the Lender Liability and Deposit Insurance
Act of 1996.
"95% Distribution Requirement" means the requirement of the Company to
distribute 95% of its net taxable income annually (excluding any net capital
gain and certain non-cash income) in order to avoid corporate income taxation of
the earnings that it distributes.
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"95% Gross Income Test" means the requirement for each taxable year that at
least 95% of the Company's gross income for each taxable year must be derived
from certain specified real estate sources including interest income and gain
from the disposition of Qualified Real Estate Assets or "qualified temporary
investment income" (I.E., income derived from "new capital" within one year of
the receipt of such capital), dividends, interest, and gains from the sale of
stock or other securities (including certain interest rate swap or cap
agreements, options, forward rate agreements, and similar financial instruments
entered into to reduce the interest rate risk with respect to debt incurred to
acquire Qualified Real Estate Assets) not held for sale in the ordinary course
of business.
"Non-ERISA Plan" means an IRA or a qualified retirement plan not subject to
Title I of ERISA because it is a governmental or church plan or because it does
not cover common law employees.
"Non-U.S. stockholders" means nonresident alien individuals, foreign
corporations, foreign partnerships, and other foreign stockholders
"NYSE" means the New York Stock Exchange.
"Offering" means the initial public offering of the Company's Common Stock
pursuant to this Prospectus.
"OID" means, with respect to a debt instrument, the excess of its stated
redemption price at maturity over its issue price; provided that such excess is
more than a defined DE MINIMIS amount.
"One Hundred Stockholder Date" means the earlier of (i) January 1, 1998 and
(ii) the date of closing of the sale of Common Stock pursuant to the Offering.
"Order" means the order of the Commission issued on November 29, 1993
pursuant to Sections 203(f) , 203(k) and 206(2) of the Advisers Act in
connection with certain securities transactions executed between December 1992
and February 1993 while Mr. Smirlock was Chief Investment Officer for GSAM.
"Ownership Limit" means the limit set forth by the Charter of the Company
which prohibits direct or indirect ownership by any person of more than 9.8% of
the number of outstanding shares of Common Stock.
"Pass-Through Certificates" means securities (or interests therein) other
than Mortgage Derivative Securities and Subordinate 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 residential, multi-family residential, commercial
and/or other real property.
"passive activity losses" means losses like those from certain types of
limited partnerships in which a U.S. stockholder is a limited partner.
"phantom income" means that the Company's investment in Subordinate
Interests and certain types of Mortgage Securities may cause it under certain
circumstances to recognize taxable income in excess of its economic income.
"Plan Administrator" means The Chase Manhattan Bank.
"Plan Asset Regulations" means regulations of the DOL defining "plan
assets."
"Plan" means any pension, profit-sharing or other employee benefit plan
subject to Title I of ERISA.
"Preferred Stock" means the Company's preferred stock, par value $0.01.
"Principal-only Derivative," or "PO"' means a type of Mortgage Security
which receives only principal payments.
101
<PAGE>
"Private Placement" means the consummation of the transactions described
herein under the caption "PRIVATE PLACEMENT."
"Privately-Issued Certificates" means privately-issued Pass-Through
Certificates issued by a third party issuer which is not an Agency Certificate.
"prohibited transaction" means a transaction involving a sale of dealer
property, other than foreclosure property.
"Prospectus" means this Prospectus.
"purported transfer" means any transfer of shares of capital stock that
would result in disqualification of the Company as a REIT or that would (a)
create a direct or constructive ownership of shares of stock in excess of the
Ownership Limit, (b) result in the shares of stock being beneficially owned by
fewer than 100 persons or (c) result in the Company being "closely held" within
the meaning of Section 856(h) of the Code.
"purported transferee" means any intended transferee of a purported
transfer.
"Qualified Real Estate Assets" means real estate assets of the type
described in Section 856(c)(6)(B) of the Code.
"Qualified REIT Subsidiaries" means subsidiaries that meet the requirements
under the REIT Provisions of the Code.
"Qualifying Interests" means "mortgages and other liens on and interests in
real estate," as defined in Section 3(c)(5)(C) under the Investment Company Act.
"Rating Agencies" means the nationally recognized rating agencies.
"REIT" means Real Estate Investment Trust.
"REIT Provisions of the Code" means Sections 856 through 860 of the Code.
"REMIC" means real estate mortgage investment conduit.
"REO" means real estate owned property.
"Representatives" means Bear, Stearns & Co. Inc., Friedman, Billings, Ramsey
& Co., Inc., EVEREN Securities, Inc. and Stifel, Nicolaus & Company,
Incorporated.
"Return on Average Stockholders' Equity" means an amount calculated for any
quarter by dividing the Company's Net Income for the quarter by its Average
Stockholders' Equity for the quarter.
"Securities Act" means the Securities Act of 1933, as amended.
"Service" means the Internal Revenue Service.
"70% Asset Group" is comprised of (i) securities which are rated within one
of the two highest rating categories by one of the Rating Agencies or (ii)
securities which are unrated but are guaranteed by the U.S. government or any
agency or instrumentality thereof and (iii) Mortgage Loans to borrowers who
would otherwise meet FHLMC, FNMA or GNMA guidelines, except with respect to the
size of the loans.
"75% Asset Test" means at the close of each quarter of each taxable year
that at least 75% of the value of the Company's total assets must consist of
Interests in Real Property, interests in mortgages on real property to the
extent the principal balance of a mortgage does not exceed the fair market value
of the associated real property, regular or residual interests in a REMIC
(except that, if less than 95% of the assets of a REMIC consists of real estate
assets (determined as if the Company held such assets), the Company will be
treated as holding directly its proportionate share of the assets of such
REMIC), shares
102
<PAGE>
of other REITs, government securities, temporary investments in stock or debt
instruments closing the one year period following the Company's receipt of
certain new capital cash and cash items.
"75% Gross Income Test" means for each taxable year that at least 75% of the
Company's gross income must be derived from certain specified real estate
sources including interest income on Mortgage Loans and gain from the
disposition of Qualified Real Estate Assets or "qualified temporary investment
income," I.E., income derived from "new capital" within one year of the receipt
of such capital.
"SIP Participant" means all employees and directors of, and consultants to,
the Company, as well as all employees and directors of the Manager, eligible to
receive awards under the Stock Incentive Plan.
"Special Tax Counsel" means the law firm of Stroock & Stroock & Lavan LLP.
"Standstill Period" means the period so long as any shares of Common Stock
owned or purchased by any of the Funds shall be deemed Excess Shares.
"Stock Incentive Plan" means the stock incentive plan adopted by the
Company.
"Stockholder of Record" means a stockholder who owns shares of the Company's
Common Stock in his or its own name.
"Stockholders Notice Procedure" means the advance notice procedure for
stockholders to make nominations of candidates for director or bring other
business before an annual meeting of stockholders of the Company established in
the Bylaws.
"Sub IO" means a subordinated interest-only security.
"Subordinate Interests" means a class of Mortgage Securities that is junior
to other classes of Mortgage Securities in the right to receive payments from
the underlying Mortgage Loans.
"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.
"taxable mortgage pool" means a REIT that incurs debt obligations with two
or more maturities and which are secured by assets such as the Mortgage Assets.
"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.
"30% Asset Group" is comprised of the remainder of the Company's total
assets, which are expected to consist of Mortgage Loans not included in the 70%
Asset Group, retained Subordinate Interests and fixed-income securities that are
primarily Qualified Real Estate Assets but also will include non-investment
grade high yield corporate debt.
"Title V" means Title V of the Depository Institutions Deregulation and
Monetary Control Act of 1980.
"Total Return Swap" means the total rate of return swap entered into between
an Affiliated Fund and a broker-dealer which provides that the Affiliated Fund
will bear the economic benefit and risk of directly holding the 666,666 shares
of the Company's Common Stock purchased by such broker-dealer in the Private
Placement.
"UBTI" means "unrelated business taxable income" as defined in Section 512
of the Code.
103
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"UBTI Percentage" means that, in certain circumstances, a pension trust that
owns more than 10% of the Company's stock is required to treat a percentage of
the dividends from the Company as UBTI.
"UCC" means the Uniform Commercial Code.
"Underwriters" means the underwriters named in this Prospectus acting as
underwriters of the Offering.
"Underwriting Agreement" means the underwriting agreement by and among the
Company and the Representatives on behalf of the Underwriters.
"U.S. stockholder" means a holder of Common Stock that for U.S. federal
income tax purposes is (i) a citizen or resident of the U.S., (ii) a
corporation, partnership, or other entity created or organized in or under the
laws of the U.S. or of any political subdivision thereof, (iii) an estate whose
income from sources without the United States is includible in gross income for
U.S. federal income tax purposes regardless of its connection with the conduct
of a trade or business within the United States, or (iv) any trust with respect
to which (A) a U.S. court is able to exercise primary supervision over the
administration of such trust and (B) one or more U.S. persons have the authority
to control all substantial decisions of the trust.
"yield curve" means the relationship between short-term and long-term
interest rates.
104
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INDEPENDENT AUDITORS' REPORT
To the Stockholders of
LASER Mortgage Management, Inc.
We have audited the accompanying statement of financial condition of LASER
Mortgage Management, Inc. (the "Company") as of September 25, 1997. This
statement of financial condition is the responsibility of the Company's
management. Our responsibility is to express an opinion on the statement of
financial condition based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opionion.
In our opinion, the statement of financial condition presents fairly, in all
material respects, the financial position of LASER Mortgage Management, Inc. as
of September 25, 1997 in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
New York, New York
September 26, 1997, except for Note 5, dated November 7, 1997 and Note 6, dated
November 25, 1997.
F-1
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
STATEMENT OF FINANCIAL CONDITION
SEPTEMBER 25, 1997
<TABLE>
<S> <C>
Asset
Cash............................................................................... $ 15,005
---------
---------
Stockholders' equity
Common Stock, par value $.001 per share, authorized 75,000,000 shares; 6,000
shares issued and outstanding; Preferred Stock, par value $.01 per share,
authorized 25,000,000 shares; no shares issued and outstanding................. $ 6
Additional paid-in capital......................................................... 14,999
---------
Total stockholders' equity......................................................... $ 15,005
---------
---------
</TABLE>
See accompanying Notes to Statement of Financial Condition
F-2
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
NOTES TO STATEMENT OF FINANCIAL CONDITION
NOTE 1. ORGANIZATION
LASER Mortgage Management, Inc. (the "Company") was incorporated in Maryland
on September 3, 1997 but has had no operations to date other than matters
relating to its organization and the issuance of 6,000 shares of Common Stock,
par value $.001 per share ("Common Stock"), to its initial stockholder.
The Company is a newly organized specialty finance company that will invest
primarily in mortgage-backed securities and mortgage loans. The mortgage-backed
securities will include mortgage pass-through certificates, collateralized
mortgage obligations and other securities representing interests in, or
obligations backed by, pools of mortgage loans. The mortgage loans will be
secured by first or second liens on single-family residential, multi-family
residential, commercial or other real property.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING
The books and records of the Company are maintained on an accrual basis, in
accordance with generally accepted accounting principles.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts in the financial statements. Actual
results may differ from those estimates.
INCOME TAXES
The Company intends to elect to be taxed as a real estate investment trust
(a "REIT") and to comply with the provisions of the Internal Revenue Code of
1986, as amended, with respect thereto. Accordingly, the Company will not be
subject to Federal income tax to the extent of its distributions to
stockholders.
PROFIT AND LOSS ALLOCATIONS AND DISTRIBUTIONS
As a REIT, the Company intends to distribute substantially all its taxable
income to stockholders each year. The Company intends to make regular quarterly
distributions.
NOTE 3. FEES
ORGANIZATIONAL, OFFERING, GENERAL AND ADMINISTRATIVE COSTS
The Company will be required to pay all of its organizational and offering
expenses.
NOTE 4. RELATED PARTIES
The day-to-day business and investment affairs of the Company will be
managed by LASER Advisers Inc. ("LASER Advisers"), an investment adviser
registered under the Investment Advisers Act of 1940, as amended, subject to the
supervision of the Company's Board of Directors and pursuant to a management
agreement between the Company and LASER Advisers (the "Management Agreement").
Under the Management Agreement, the Company will pay LASER Advisers: (i) an
annual base management fee equal to 1.0% of the first $500 million of average
stockholders' equity, plus 0.8% of the next $500 million of average
stockholders' equity, plus 0.6% of average stockholders' equity exceeding $1
billion and (ii) a quarterly incentive fee in an amount equal to 20% of the net
income of the Company for
F-3
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
NOTES TO STATEMENT OF FINANCIAL CONDITION (CONTINUED)
NOTE 4. RELATED PARTIES (CONTINUED)
the preceding fiscal quarter (less capital gains and capital appreciation
included in taxable income, but before LASER Advisers' incentive fee and before
deduction of dividends paid) in excess of the amount that would produce an
annualized return on average stockholders' equity for such fiscal quarter equal
to the Ten-Year Treasury Rate plus 1%.
The Company and LASER Advisers will share office space. The officers of the
Company are also officers of LASER Advisers. Messrs. Michael L. Smirlock and
David A. Tepper, directors of the Company, together own all of the equity of
LASER Advisers.
The Company received commitments on September 15, 1997 for the purchase, in
a private placement, of 1,014,000 shares of Common Stock at the inital public
offering price from certain officers, directors, proposed directors, employees
and Affiliates of the Company and the Manager.
NOTE 5. SUBSEQUENT EVENT
The Company received commitments on November 7, 1997 from several mutual
funds under common management (each, a "Fund" and together, the "Funds") for the
purchase, in a private placement, of 3,333,333 shares of Common Stock. In
connection with their purchase, the Funds entered into an agreement with the
Company providing for, among other things, certain restrictions on the sale and
transfer of the shares held, beneficially or constructively, by the Funds.
The Company has been informed by an affiliated fund that it has entered into
a total rate of return swap with a broker-dealer which provides that the
affiliated fund bear the economic benefit and risk of directly holding 666,666
shares of the Company's Common Stock. Such shares of Common Stock have been sold
by the Company to such broker-dealer in a private placement without registration
under the Securities Act.
F-4
<PAGE>
APPENDIX A
PAST PERFORMANCE RESULTS
The Manager acts as (i) the general partner of one fund ("Fund A"), and (ii)
the investment adviser to three funds ("Fund B," "Fund C" and "Fund D") and a
master fund (the "Master Fund" and, together with Funds A, B, C and D,
collectively, the "Affiliated Funds"). Prior to the formation of the Manager,
the investment management professionals of the Manager managed the investment
accounts of the Affiliated Funds at Appaloosa, which was then the general
partner of Fund A and the investment adviser to Funds B, C and D and the Master
Fund.
Substantially all of the assets of Funds A, B, C and D are invested,
directly or indirectly, in the Master Fund whose sole purpose is to serve as a
"master" trading vehicle for the other Affiliated Funds. As a result, the
investment objective and activities of Funds A, B, C and D are, and have been
since the formation of the Master Fund, substantially identical.
The Master Fund currently has, and the Manager currently manages, in the
Affiliated Funds over $300 million of capital invested primarily in $3.9 billion
of Mortgage Securities, similar to those in which the Company will be investing.
The Affiliated Funds have approximately 114 investors of record, some of whom,
for pooled investment vehicles sold offshore, act as nominees for multiple
eligible investors. This Appendix sets forth composite past performance results
for these funds.
The Manager's investment strategy with respect to the Affiliated Funds has
been to create a portfolio principally of Mortgage Assets similar to those
included in the 70% Asset Group that generates income while minimizing interest
rate exposure. However, consistent with maintaining the Company's status as a
REIT for federal income tax purposes and its exemption from registration under
the Investment Company Act, certain differences will exist between the operating
and investment strategy employed for these funds and the strategy which will be
employed for the Company. For example, the Company's ability to actively trade
and dynamically hedge will be limited by the REIT Provisions of the Code. In
addition, requirements to hold Mortgage Assets to meet the 55% Requirement and
the 75% Asset and Gross Income Tests will limit the Company's investment
options. The costs associated with hedging in the Company are expected to be
higher, which may affect gross returns.
The Affiliated Funds have invested primarily in Pass-Through Certificates,
CMOs, Mortgage Derivatives, Subordinate Interests and U.S. government
fixed-income securities. See "DESCRIPTION OF PROPOSED ASSETS." The Affiliated
Funds have also invested in asset-backed securities, derivative securities and
other fixed-income and equity securities.
The total returns for the Affiliated Funds and certain other information,
(i) without deduction of fees, (ii) net of fees and (iii) as adjusted to give
effect to the Company's fee structure are shown below. Performance figures for a
variety of relevant indices are also provided for comparative purposes.
A-1
<PAGE>
The following information sets forth the composite performance record of
these funds for the periods indicated. The tables should be read in conjunction
with the notes thereto. PAST PERFORMANCE DOES NOT GUARANTEE, AND IS NOT
NECESSARILY INDICATIVE OF, FUTURE RESULTS. Prospective investors should
recognize that there are certain differences between the investment policies
applicable to these funds and those of the Company and that their fees and
expenses also differ. Future performance of client accounts and that of the
Company will differ.
The first column presents the composite gross returns produced by the
Manager since inception for the Affiliated Funds. The second column presents the
actual net returns received by investors, after deduction of the fees paid to
the Manager. The third column presents, on a pro forma basis, the net returns
calculated with the Company's base management and incentive fees, which are less
in aggregate than the fees actually paid. The next three columns present the
monthly returns for three fixed-income indices. The last column is the aggregate
capital under management for the Affiliated Funds.
<TABLE>
<CAPTION>
COMPOSITE RETURNS
---------------------------------------------------
ADJUSTED FOR
ESTIMATED MERRILL LEHMAN LIPPER
MANAGEMENT 1-2.99 YR. MBS ARM
MONTH GROSS(A) NET(B) FEES(C) INDEX(D) INDEX(E) INDEX(F)
- ------------------------ ----------- ----------- ------------------------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Jul-94 (inception)...... 0.04% (0.03%) (0.04%) 0.86% 2.00% 0.32%
Aug-94.................. 1.75% 1.34% 1.47% 0.35% 0.32% 0.00%
Sep-94.................. 1.86% 1.42% 1.57% (0.23%) (1.42%) (0.19%)
Oct-94.................. (0.61%) (0.56%) (0.70%) 0.23% (0.06%) (0.15%)
Nov-94.................. 1.02% 0.75% 0.90% (0.45%) (0.31%) (0.48%)
Dec-94.................. 0.06% (0.02%) (0.03%) 0.23% 0.80% (0.41%)
Jan-95.................. (0.34) (0.34%) (0.42%) 1.39% 2.14% 0.54%
Feb-95.................. 1.70% 1.21% 1.44% 1.37% 2.55% 1.01%
Mar-95.................. 1.59% 1.20% 1.34% 0.56% 0.47% 0.60%
Apr-95.................. 1.70% 1.29% 1.43% 0.89% 1.42% 0.65%
May-95.................. 1.16% 0.86% 0.99% 1.75% 3.15% 1.04%
Jun-95.................. 2.13% 1.63% 1.75% 0.54% 0.56% 0.08%
Jul-95.................. 2.25% 1.59% 1.85% 0.41% 0.17% 0.23%
Aug-95.................. 1.52% 1.05% 1.28% 0.60% 1.04% 0.57%
Sep-95.................. 1.52% 1.05% 1.27% 0.49% 0.88% 0.26%
Oct-95.................. 2.25% 1.59% 1.85% 0.84% 0.89% 0.06%
Nov-95.................. 0.80% 0.51% 0.69% 0.88% 1.14% 0.65%
Dec-95.................. 1.29% 0.88% 1.08% 0.77% 1.25% 0.44%
Jan-96.................. 2.16% 1.53% 1.78% 0.85% 0.75% 0.65%
Feb-96.................. 1.56% 1.07% 1.29% (0.42%) (0.83%) 0.08%
Mar-96.................. 1.14% 0.76% 0.97% (0.09%) (0.36%) 0.17%
Apr-96.................. 1.78% 1.24% 1.48% 0.08% (0.28%) 0.28%
May-96.................. 2.06% 1.45% 1.71% 0.21% (0.29%) 0.34%
Jun-96.................. 1.53% 1.06% 1.29% 0.72% 1.38% 0.57%
Jul-96.................. 1.70% 1.18% 1.42% 0.39% 0.37% 0.42%
Aug-96.................. 1.87% 1.31% 1.56% 0.34% 0.00% 0.37%
Sep-96.................. 1.73% 1.20% 1.45% 0.91% 1.67% 0.68%
Oct-96.................. 2.02% 1.42% 1.67% 1.13% 1.96% 0.75%
Nov-96.................. 0.76% 0.47% 0.66% 0.77% 1.43% 0.57%
Dec-96.................. 1.31% 0.89% 1.10% 0.00% (0.52%) 0.39%
Jan-97.................. 1.84% 1.29% 1.53% 0.47% 0.74% 0.44%
Feb-97.................. 1.51% 1.04% 1.27% 0.23% 0.33% 0.48%
Mar-97.................. 1.67% 1.16% 1.40% (0.04%) (0.94%) 0.31%
Apr-97.................. 1.72% 1.20% 1.44% 0.82% 1.59% 0.70%
May-97.................. 1.55% 1.07% 1.30% 0.68% 0.98% 0.57%
Jun-97.................. 1.69% 1.17% 1.41% 0.69% 1.17% 0.58%
Jul-97.................. 1.51% 1.04% 1.26% 1.10% 1.88% 0.68%
Aug-97.................. 1.58% 1.09% 1.32% 0.09% (0.24%) 0.23%
Sep-97.................. 1.21% 0.81% 1.02% 0.76% 1.27% 0.55%
Oct-97.................. 0.58% 0.34% 0.51% 0.74% 1.11% 0.50%
<CAPTION>
CAPITAL UNDER
MONTH MANAGEMENT
- ------------------------ ---------------
<S> <C>
(IN MILLIONS)
Jul-94 (inception)...... $ 39.8
Aug-94.................. $ 39.8
Sep-94.................. $ 40.5
Oct-94.................. $ 43.1
Nov-94.................. $ 42.8
Dec-94.................. $ 50.5
Jan-95.................. $ 43.6
Feb-95.................. $ 43.4
Mar-95.................. $ 43.6
Apr-95.................. $ 43.2
May-95.................. $ 43.9
Jun-95.................. $ 49.4
Jul-95.................. $ 50.6
Aug-95.................. $ 56.7
Sep-95.................. $ 57.6
Oct-95.................. $ 56.9
Nov-95.................. $ 58.0
Dec-95.................. $ 53.4
Jan-96.................. $ 41.9
Feb-96.................. $ 47.7
Mar-96.................. $ 54.5
Apr-96.................. $ 56.9
May-96.................. $ 59.4
Jun-96.................. $ 64.9
Jul-96.................. $ 80.2
Aug-96.................. $ 98.5
Sep-96.................. $ 105.7
Oct-96.................. $ 122.3
Nov-96.................. $ 154.8
Dec-96.................. $ 161.4
Jan-97.................. $ 199.2
Feb-97.................. $ 217.9
Mar-97.................. $ 244.3
Apr-97.................. $ 249.0
May-97.................. $ 266.2
Jun-97.................. $ 276.8
Jul-97.................. $ 293.0
Aug-97.................. $ 310.8
Sep-97.................. $ 315.7
Oct-97.................. $ 320.6
</TABLE>
- ------------------------
A-2
<PAGE>
COMPOSITE HISTORICAL PERFORMANCE RECORD
<TABLE>
<CAPTION>
COMPOSITE RETURNS
---------------------------------------
ADJUSTED FOR
ESTIMATED MERRILL LEHMAN
MANAGEMENT 1-2.99 YR. MBS
GROSS(A) NET(B) FEES(C) INDEX(D) INDEX(E)
----------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
ANNUAL RETURNS
1994 Return (6 mo.)..................................... 4.17% 2.92% 3.19% 0.99% 1.30%
1995 Return............................................. 19.03% 13.35% 15.53% 11.00% 16.79%
1996 Return............................................. 21.47% 14.46% 17.56% 4.98% 5.35%
1997 Return Through Oct................................. 15.89% 10.69% 13.19% 5.67% 8.15%
LIFE OF FUNDS RETURNS (JUL-94--OCT-97)
Total................................................... 74.55% 47.81% 58.78% 24.36% 34.79%
Annualized.............................................. 18.19% 12.44% 14.88% 6.76% 9.37%
Risk-Adjusted Return Ratio (g).......................... 5.52x 4.01x 4.69x 0.85x 1.17x
<CAPTION>
LIPPER
ARM
INDEX(F)
-----------
<S> <C>
ANNUAL RETURNS
1994 Return (6 mo.)..................................... (0.91%)
1995 Return............................................. 6.30%
1996 Return............................................. 5.39%
1997 Return Through Oct................................. 5.15%
LIFE OF FUNDS RETURNS (JUL-94--OCT-97)
Total................................................... 16.73%
Annualized.............................................. 4.75%
Risk-Adjusted Return Ratio (g).......................... (0.52x)
</TABLE>
- ------------------------
(a) Composite Gross Return is calculated without reduction of any fees charged
by the Manager. These figures must be read in conjunction with the column
setting forth Composite Net Return.
(b) Composite Net Return is calculated by reducing Composite Gross Return (the
aggregate return, including mark-to-market gains or losses for the period,
divided by the beginning net capital of the period) by the highest fee
charged by the Manager during the relevant period. The Manager's actual fee
formulas ranged from a 1% base management fee plus a 20% incentive fee based
on total returns after the base fee to a 1.5% base management fee plus a 25%
incentive fee based on total returns after the base fee.
(c) Composite Return Adjusted for Estimated Management Fees is calculated by
reducing Composite Gross Return by the estimated fees payable under the
Manager's proposed fee schedule for the Company. These returns are not
necessarily indicative of the actual returns which might have been achieved
by the Company.
(d) The Merrill 1-2.99 Year Index is a market capitalization weighted index
including all U.S. Treasury Notes and Bonds with maturities greater than or
equal to one year and less than three years, but excluding U.S. Treasury
Bills, stripped U.S. Treasury securities and index-linked bonds. The index
is equally weighted and adjusted for distributions and capital gains. The
index is unmanaged and is calculated without reduction of any fees.
(e) The Lehman Mortgage-Backed Securities Index is a market value-weighted index
that tracks the daily price, coupon paydown and total return performance of
publicly traded, fixed rate Agency Certificates. The index is unmanaged and
is calculated without reduction of any fees.
(f) The Lipper ARM Index is comprised of the ten largest ARM mutual funds as of
December 31 of the prior year. The index is equally weighted and adjusted
for distributions and capital gains. An ARM mutual fund is an investment
company which invests more than 65% of its assets in ARMs.
(g) The Risk-Adjusted Return Ratio is the Sharpe Ratio which takes a portfolio's
volatility, as measured by its standard deviation of return, into account.
The higher the ratio, the better the portfolio's risk-adjusted return. The
ratio is calculated by subtracting the risk-free Treasury bill return from
the portfolio's return and then dividing the difference by the portfolio's
overall standard deviation of return.
A-3
<PAGE>
TABLE I. EXPERIENCE IN RAISING AND INVESTING FUNDS (ON A PERCENTAGE BASIS).
Table I shows the costs of raising funds for investment by the Affiliated
Funds. All information is shown from inception through October 1, 1997 (the most
recent period for which this information is available).
<TABLE>
<CAPTION>
FUND B FUND D
-------------------------- ------------
FUND A A SHARES (1) B SHARES (1) FUND C A SHARES (2)
---------- ------------ ------------ ---------- ------------
<S> <C> <C> <C> <C> <C>
Dollar amount offered (3)..................... n/a n/a n/a n/a n/a
Dollar amount raised
(100 percent)............................... $78,736,201 2$29,939,836 $22,756,452 $12,685,104 $15,807,543
Less offering expenses:
Selling commissions and discounts retained
by affiliates............................. 0.00% 0.00% 0.00% 0.00% 0.00%
Organizational expenses..................... 0.04% 0.50% 0.12% 0.50% 0.00%
Other (explain) (4)......................... n/a n/a n/a n/a n/a
Reserves (5).................................. n/a n/a n/a n/a n/a
Percent available for investment (5).......... 99.96% 99.50% 99.80% 99.50% 100%
Acquisition costs:
Prepaid items and fees related to purchase
of property (6)........................... n/a n/a n/a n/a n/a
Cash down payment (6)....................... n/a n/a n/a n/a n/a
Acquisition fees (6)........................ n/a n/a n/a n/a n/a
Other (explain) (7)......................... 99.96% 99.50% 99.88% 99.50% 100.00%
Total acquisition cost (8).................... 99.96% 99.50% 99.88% 99.50% 100.00%
Percent leverage (asset financing divided by
total acquisition cost) (8)............... 1000.00% 1000.00% 1000.00% 1000.00% 1000.00%
Date offering began........................... 6/22/94 7/1/95 6/22/94 10/1/95 2/1/96
Length of offering (in months) (3)............ 40 28 40 25 21
Month(s) to invest 90% of amount available for
investment (measured from beginning of
offering)................................... 1 1 1 1 1
</TABLE>
- ------------------------
(1) Fund B has two classes of shares. Although both classes participate on a pro
rata basis in Fund B's investments, these classes have different fee
structures pursuant to an agreement with Fund B's sponsor, which is
unaffiliated with the Manager.
(2) Fund D has two classes of shares, Class A and Class B Shares. Holders of
Class B Shares are not charged a performance fee. Class B Shares are held
only by Affiliates of the Manager.
(3) The Affiliated Funds are open-ended, and the offering continues through the
date hereof. There is no limit on the amount offered.
(4) Other than organizational expenses (which include an upfront organizational
charge paid to the sponsor of Funds B and C), there are no material offering
expenses.
(5) The Affiliated Funds do not currently have any reserves and are fully
invested.
(6) The Affiliated Funds do not purchase real property, but purchase securities
which trade at bid/ask spreads which incorporate dealers' fees.
(7) The Affiliated Funds do not purchase real property, but purchase securities;
therefore, this item represents the acquisition cost of such securities.
(8) The acquisition of investment assets of the Affiliated Funds is financed.
The leverage of the Affiliated Funds is approximately 10 times net capital,
although there is no leverage limit.
A-4
<PAGE>
TABLE II. COMPENSATION TO THE MANAGER.
Table II shows the compensation of the Manager, with respect to the
operations of the Affiliated Funds. The Manager receives a management fee based
upon the net assets of the particular Affiliated Fund and an incentive fee based
on the net returns of an investment in such fund. All amounts are shown from
inception through October 1, 1997 (the most recent period for which this
information is available).
<TABLE>
<CAPTION>
FUND B FUND D
----------------------- ----------
FUND A A SHARES B SHARES FUND C A SHARES
---------- ----------- ---------- ---------- ----------
Date offering commenced......................... 6/22/94 7/1/95 6/22/94 10/1/95 2/1/96
<S> <C> <C> <C> <C> <C>
Dollar amount raised............................ $78,736,201 $239,231,766 $22,756,452 $12,685,104 $15,807,543
Amount paid to the Manager from proceeds of
offering (1):
Underwriting fees........................... n/a n/a n/a n/a n/a
Acquisition fees:
Real estate commissions................... n/a n/a n/a n/a n/a
Advisory fees............................. n/a n/a n/a n/a n/a
Other (identify and quantify)............. n/a n/a n/a n/a n/a
Other....................................... n/a n/a n/a n/a n/a
Dollar amount of cash generated from operations
before deducting payments to the Manager
(2)........................................... $16,333,015 $32,710,320 $5,772,625 $1,874,872 $1,250,864
Amount paid to the Manager from operations:
Property management fees (3).............. n/a n/a n/a n/a n/a
Fund management fees (4).................. $ 908,879 $ 1,677,645 $ 191,765 $ 90,861 $ 58,554
Reimbursements (3)........................ n/a n/a n/a n/a n/a
Leasing commissions(3).................... n/a n/a n/a n/a n/a
Fund incentive fees (5)................... $2,794,615 $ 5,164,253 $1,209,083 $ 297,705 $ 198,718
Dollar amount of property sales and refinancing
before deducting payments to the Manager (2)
Cash...................................... n/a n/a n/a n/a n/a
Notes..................................... n/a n/a n/a n/a n/a
Amount paid to the Manager from
property sales and refinancing: (3)
Real estate commissions................... n/a n/a n/a n/a n/a
Incentive fees............................ n/a n/a n/a n/a n/a
Other (identify and quantify)............. n/a n/a n/a n/a n/a
</TABLE>
- ------------------------
(1) The Manager does not receive any fees or commissions with respect to
offerings by the Affiliated Funds.
(2) "Dollar amount of cash generated from operations before deducting payments
to the Manager" represents the cumulative net income of the Affiliated Funds
(including realized and unrealized investment income) generated from
investment activities (the "operations" of the Affiliated Funds) since
inception. The Affiliated Funds have not purchased, sold or refinanced real
property.
(3) Other than the management fee and the incentive fee, described in notes 4
and 5 below, the Manager does not receive any other fees, commissions or
payments from the Affiliated Funds.
(4) The Manager receives a management fee equal to (a) 1% of the net assets of
Fund A and the Class B Shares of Fund B and (b) 0.75% of the net assets of
Fund C and the Class A Shares of Funds B and D.
(5) The Manager receives an incentive fee equal to (a) 20% of the net return on
the partnership interests of Fund A and the Class B Shares of Fund B and (b)
15% of the net return on the partnership interests of Fund C and the Class A
Shares of Funds B and D.
A-5
<PAGE>
TABLE III. OPERATING RESULTS OF PRIOR PROGRAMS.
<TABLE>
<CAPTION>
FUND A
------------------------------------
1994 (9) 1995 1996
----------- ---------- -----------
<S> <C> <C> <C>
Gross revenues (1)........................................................ $ 4,435,727 $10,998,673 $ 4,393,292
Profit on sales of properties (1)......................................... n/a n/a n/a
Less:Operating expenses (2)............................................... 303,104 1,181,749 987,471
Interest expense........................................................ 3,160,563 6,566,400 --
Depreciation (3)........................................................ n/a n/a n/a
Net income--GAAP basis.................................................... 972,060 3,250,524 3,405,821
Taxable income
from operations (1)................................................... 2,183,954 3,612,251 4,365,631
from gain on sale (1)................................................. n/a n/a n/a
Cash generated from operations (4)........................................ 1,058,065 2,646,958 (183,815)
Cash generated from sales (4)(5).......................................... n/a n/a n/a
Cash generated from refinancing (4)(5).................................... n/a n/a n/a
Cash generated from operations, sales and refinancing (4)(5).............. 1,058,065 2,646,958 (183,815)
Less: Cash distributions to investors
from operating cash flow (6).......................................... n/a n/a n/a
from sales and financing (6).......................................... n/a n/a n/a
from other (6)........................................................ (24,282,305) 1,211,808 (4,957,035)
Cash generated (deficiency) after cash distributions...................... 25,340,370 1,435,150 4,773,220
Less: Special items (not including sales and refinancing)
Cash used in investing activities..................................... 20,214,976 6,488,411 4,693,158
Cash generated (deficiency) after cash distributions and special items.... 5,125,394 (5,053,261) 80,062
TAX AND DISTRIBUTION DATE PER $1000 INVESTED
Federal Income Tax Results:
Ordinary income (loss).................................................. 44 188 216
from operations (7)................................................... 44 188 216
from recapture (3).................................................... n/a n/a n/a
Capital gain (loss)..................................................... 9 (101) (44)
Source (on GAAP Basis)
Investment income..................................................... 29 113 163
Return of capital (8)................................................. n/a n/a n/a
Source (on cash basis) (8)
Sales................................................................. n/a n/a n/a
Refinancing........................................................... n/a n/a n/a
Operations............................................................ n/a n/a n/a
Other................................................................. n/a n/a n/a
Amount (in percentage terms) remaining invested in program properties
at the end of the last year reported in the Table (original total
acquisition cost of properties retained divided by original total
acquisition cost of all properties in program) (8).................. n/a n/a n/a
</TABLE>
- ------------------------
(1) "Gross Revenues" represent the gross income of Fund A (including realized
and unrealized investment income) for the year indicated generated from
investment activities (the "operations" of Fund A). Fund A has not purchased
or sold real property.
(2) Includes management and incentive fees paid to the Manager.
(3) None of the assets of Fund A is depreciable for tax or accounting purposes
(I.E., Fund A does not hold real property).
(4) Cash generated from investment activities, which are the "operations" of
Fund A.
(5) Fund A has not sold or refinanced real property.
(6) Net cash distributed (received) from investors through redemptions
(subscriptions). Cash distributed to investors represents cash from
operations and return of capital.
(7) Includes ordinary income (loss) from trade or business activities and
investment expense on investment debts.
(8) Fund A does not make distributions to investors other than in connection
with a redemption by an investor of its interest in Fund A. As a result, an
investor remains fully invested in Fund A (and, in turn, in the assets held
by Fund A), until its investment is redeemed.
(9) Fund A commenced operations June 22, 1994.
A-6
<PAGE>
TABLE III. OPERATING RESULTS OF PRIOR PROGRAMS (CONTINUED).
<TABLE>
<CAPTION>
FUND B
------------------------------------
1994 (9) 1995 1996
----------- ---------- -----------
<S> <C> <C> <C>
Gross revenues (1)........................................................ $ 1,441,960 $9,160,186 $10,493,882
Profit on sales of properties (1)......................................... n/a n/a n/a
Less: Operating expenses (2).............................................. 159,276 1,267,404 3,403,932
Interest expense........................................................ 1,030,055 4,660,585 --
Depreciation (3)........................................................ n/a n/a n/a
Net income--GAAP Basis.................................................... 252,630 3,262,197 7,089,950
Taxable income (4)
from operations......................................................... n/a n/a n/a
from gain on sale....................................................... n/a n/a n/a
Cash generated from operations (5)........................................ 118,458 10,530,526 1,584,015
Cash generated from sales (6)............................................. n/a n/a n/a
Cash generated from refinancing (6)....................................... n/a n/a n/a
Cash generated from operations, sales and refinancing..................... 118,458 10,530,526 1,584,015
Less: Cash distributions to investors
from operating cash flow (7)............................................ n/a n/a n/a
from sales and financing (7)............................................ n/a n/a n/a
from other (7).......................................................... (17,756,452) (1,444,923) (84,471,734)
Cash generated (deficiency) after cash distributions...................... 17,874,910 11,975,449 86,055,749
Less: Special items (not including sales and refinancing)
Cash used in investing activities....................................... 6,362,987 21,558,541 84,000,000
Cash generated (deficiency) after cash distributions and special Items.... 11,511,923 (9,610,092) 2,055,749
TAX AND DISTRIBUTION DATE PER $1000 INVESTED
Federal Income Tax Results: (4)
Ordinary income (loss).................................................. n/a n/a n/a
from operations....................................................... n/a n/a n/a
from recapture........................................................ n/a n/a n/a
Capital gain (loss)..................................................... n/a n/a n/a
Source (on GAAP Basis)
Investment income..................................................... n/a n/a n/a
Return of capital..................................................... n/a n/a n/a
Source (on cash basis)
Sales................................................................. n/a n/a n/a
Refinancing........................................................... n/a n/a n/a
Operations............................................................ n/a n/a n/a
Other................................................................. n/a n/a n/a
Amount (in percentage terms) remaining invested in program properties at
the
end of the last year reported in the Table (original total acquisition
cost of
properties retained divided by original total acquisition cost of all
properties
in program) (8)......................................................... n/a n/a n/a
</TABLE>
- ------------------------
(1) "Gross Revenues" represent the gross income of Fund B (including realized
and unrealized investment income) for the year indicated generated from
investment activities (the "operations" of Fund B). Fund B has not purchased
or sold real property.
(2) Includes management and incentive fees paid to the Manager.
(3) None of the assets of Fund B is depreciable for tax or accounting purposes
(I.E., Fund B does not hold real property).
(4) Fund B is a British Virgin Islands company and is not subject to taxation in
any jurisdiction.
(5) Cash generated from investment activities, which are the "operations" of
Fund B.
(6) Fund B has not sold or refinanced real property.
(7) Net cash distributed (received) from investors through redemptions
(subscriptions). Cash distributed to investors represents cash from
operations and return of capital.
(8) Fund B does not make distributions to investors other than in connection
with a redemption by an investor of its interest in Fund B. As a result, an
investor remains fully invested in Fund B (and, in turn, in the assets held
by Fund B), until its investment is redeemed.
(9) Fund B commenced operations June 22, 1994.
A-7
<PAGE>
TABLE III. OPERATING RESULTS OF PRIOR PROGRAMS (CONTINUED).
<TABLE>
<CAPTION>
FUND C
--------------------
1995 (9) 1996
--------- ---------
<S> <C> <C>
Gross revenues (1)......................................................................... $ 59,649 $ 782,170
Profit on sales of properties (1).......................................................... n/a n/a
Less: Operating expenses (2)............................................................... 24,234 254,143
Interest expense......................................................................... -- --
Depreciation (3)......................................................................... n/a n/a
Net income--GAAP Basis..................................................................... 35,415 528,027
Taxable income
from operations (1)...................................................................... 41,780 528,027
from gain on sale (1).................................................................... n/a n/a
Cash generated from operations (4)......................................................... (18,738) (43,934)
Cash generated from sales (4)(5)........................................................... n/a n/a
Cash generated from refinancing (4)(5)..................................................... n/a n/a
Cash generated from operations, sales and refinancing (4)(5)............................... (18,738) (43,934)
Less: Cash distributions to investors
from operating cash flow (6)............................................................. n/a n/a
from sales and financing (6)............................................................. n/a n/a
from other (6)........................................................................... (2,197,129) (1,808,149)
Cash generated (deficiency) after cash distributions....................................... 2,178,391 1,764,215
Less: Special items (not including sales and refinancing)
Cash used in investing activities........................................................ 2,125,000 1,700,000
Cash generated (deficiency) after cash distributions and special Items..................... 53,391 64,215
TAX AND DISTRIBUTION DATE PER $1000 INVESTED
Federal Income Tax Results:
Ordinary income (loss)................................................................... 6 141
from operations (7).................................................................... 6 141
from recapture (3)..................................................................... n/a n/a
Capital gain (loss)...................................................................... n/a n/a
Source (on GAAP Basis)
Investment income...................................................................... 8 141
Return of capital (8).................................................................. n/a n/a
Source (on cash basis) (8)
Sales.................................................................................. n/a n/a
Refinancing............................................................................ n/a n/a
Operations............................................................................. n/a n/a
Other.................................................................................. n/a n/a
Amount (in percentage terms) remaining invested in program properties at the
end of the last year reported in the Table (original total acquisition cost of
properties retained divided by original total acquisition cost of all properties
in program) (8).......................................................................... n/a n/a
</TABLE>
- ------------------------
(1) "Gross Revenues" represent the gross income of Fund C (including realized
and unrealized investment income) for the year indicated generated from
investment activities (the "operations" of Fund C). Fund C has not purchased
or sold real property.
(2) Includes management and incentive fees paid to the Manager.
(3) None of the assets of Fund C is depreciable for tax or accounting purposes
(I.E., Fund C does not hold real property).
(4) Cash generated from investment activities, which are the "operations" of
Fund C.
(5) Fund C has not sold or refinanced real property.
(6) Net cash distributed (received) from investors through redemptions
(subscriptions). Cash distributed to investors represents cash from
operations and return of capital.
(7) Includes ordinary income (loss) from trade or business activities, interest
and dividends.
(8) Fund C does not make distributions to investors other than in connection
with a redemption by an investor of its interest in Fund C. As a result, an
investor remains fully invested in Fund C (and, in turn, in the assets held
by Fund C), until its investment is redeemed.
(9) Fund C commenced operations October 1, 1995.
A-8
<PAGE>
TABLE III. OPERATING RESULTS OF PRIOR PROGRAMS (CONTINUED).
<TABLE>
<CAPTION>
FUND D
1996 (9)
---------
<S> <C>
Gross revenues (1)..................................................................................... $ 507,407
Profit on sales of properties (1)...................................................................... n/a
Less: operating expenses (2)........................................................................... 158,746
Interest expense..................................................................................... --
Depreciation (3)....................................................................................... n/a
Net income--GAAP Basis............................................................................... 348,661
Taxable income (4)
from operations...................................................................................... n/a
from gain on sale.................................................................................... n/a
Cash generated from operations (5)..................................................................... --
Cash generated from sales (6).......................................................................... n/a
Cash generated from refinancing (6).................................................................... n/a
Cash generated from operations, sales and refinancing.................................................. --
Less: cash distributions to investors
from operating cash flow (7)......................................................................... n/a
from sales and financing (7)......................................................................... n/a
from other (7)....................................................................................... (3,104,477)
Cash generated (deficiency) after cash distributions................................................... 3,104,477
Less: special items (not including sales and refinancing)
cash used in investing activities.................................................................... 3,000,000
Cash generated (deficiency) after cash distributions and special items................................. 104,477
TAX AND DISTRIBUTION DATE PER $1000 INVESTED
Federal Income Tax Results: (4)
Ordinary income (loss)............................................................................... n/a
from operations.................................................................................. n/a
from recapture................................................................................... n/a
Capital gain (loss).................................................................................. n/a
Source (on GAAP Basis)
Investment income................................................................................ n/a
Return of capital................................................................................ n/a
Source (on cash basis)
Sales............................................................................................ n/a
Refinancing...................................................................................... n/a
Operations....................................................................................... n/a
Other............................................................................................ n/a
Amount (in percentage terms) remaining invested in program properties at the
end of the last year reported in the Table (original total acquisition cost of
properties retained divided by original total acquisition cost of all properties
in program) (8)...................................................................................... n/a
</TABLE>
- ------------------------
(1) "Gross Revenues" represent the gross income of Fund D (including realized
and unrealized interest income) for the year indicated generated from
investment activities (the "operations" of Fund D). Fund D has not purchased
or sold real property.
(2) Includes management and incentive fees paid to the Manager.
(3) None of the assets of Fund D is depreciable for tax or accounting purposes
(I.E., Fund D does not hold real property).
(4) Fund D is a British Virgin Islands company and is not subject to taxation in
any jurisdiction.
(5) Cash generated from investment activities, which are the "operations" of
Fund D.
(6) Fund D has not sold or refinanced real property.
(7) Net cash distributed (received) from investors through redemptions
(subscriptions). Cash distributed to investors represents cash from
operations and return of capital.
(8) Fund D does not make distributions to investors other than in connection
with a redemption by an investor of its interest in Fund D. As a result, an
investor remains fully invested in Fund D (and, in turn, in the assets held
by Fund D), until its investment is redeemed.
(9) Fund D--Class A Shares commenced operations February 1, 1996.
A-9
<PAGE>
- --------------------------------------------------------------------------------
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NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFERING
OTHER THAN THOSE CONTAINED IN 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 UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A
SOLICITATION OF ANY OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH
SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, 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 THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF
ANY TIME SUBSEQUENT TO THE DATE HEREOF.
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SUMMARY TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary.............................. 5
Risk Factors.................................... 13
Use of Proceeds................................. 30
Capitalization.................................. 31
Distribution Policy............................. 32
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 33
Business........................................ 35
Description of Proposed Assets.................. 41
The Manager..................................... 47
The Company..................................... 53
Certain Relationships and Related Party
Transactions and Conflicts of Interest........ 58
Principal Stockholders.......................... 60
Dividend Reinvestment and Direct Purchase Plan.. 61
Federal Income Tax Considerations............... 63
ERISA Considerations............................ 73
Certain Characteristics of Mortgage Loans and
Real Property Investments..................... 76
Certain Provisions of Maryland Law and the
Company's Charter and Bylaws.................. 84
Description of Capital Stock.................... 88
Shares Eligible for Future Sale................. 92
Underwriting.................................... 93
Private Placement............................... 95
Legal Matters................................... 95
Experts......................................... 95
Additional Information.......................... 96
Glossary........................................ 97
Statement of Financial Condition................ F-1
Appendix A--Past Performance Results............ A-1
</TABLE>
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UNTIL DECEMBER 22, 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, 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.
15,000,000 SHARES
LASER MORTGAGE
MANAGEMENT, INC.
COMMON STOCK
---------------------
PROSPECTUS
---------------------
BEAR, STEARNS & CO. INC.
FRIEDMAN, BILLINGS, RAMSEY
& CO., INC.
EVEREN SECURITIES, INC.
STIFEL, NICOLAUS & COMPANY
INCORPORATED
NOVEMBER 26, 1997
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