As filed with the Securities and Exchange Commission on December 18, 1998
Registration No. 333-40943
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------
POST-EFFECTIVE
AMENDMENT NO. 3
TO
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
----------------------------
LASER MORTGAGE MANAGEMENT, INC.
(Exact Name of Registrant as Specified in its Governing Instruments)
51 John F. Kennedy Parkway
Short Hills, New Jersey 07078
(973) 912-8770
(Address of Principal Executive Offices)
----------------------------
Frederick N. Khedouri
245 Park Avenue
New York, New York 10167
(212) 272-8005
(Name and Address of Agent for Service)
----------------------------
Copies to:
James R. Tanenbaum, Esq.
Stroock & Stroock & Lavan LLP
180 Maiden Lane
New York, New York 10038-4982
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: From
time to time after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_| If this Form is a
post-effective amendment filed pursuant to Rule 462(c) under the Securities Act,
check the following box and list the Securities Act registration statement
number of the earlier effective registration statement for the same offering.
|_| If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. |_|
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
<PAGE>
PROSPECTUS
4,087,099 SHARES
LASER MORTGAGE MANAGEMENT, INC.
COMMON STOCK
This Prospectus is being used in connection with the offering (the
"Offering") from time to time of up to 4,087,099 shares (the "Shares") of common
stock, $.001 par value (the "Common Stock"), of LASER Mortgage Management, Inc.,
a Maryland corporation (the "Company"), by certain stockholders of the Company
identified herein (the "Selling Stockholders"). See "Selling Stockholders." The
Company is not selling any of the Shares offered hereby and will not receive any
of the proceeds from sales of Common Stock by the Selling Stockholders.
FOR A DISCUSSION OF CERTAIN RECENT DEVELOPMENTS, INCLUDING CHANGES IN THE
MANAGEMENT OF THE COMPANY AND LASER ADVISERS, INC., A REGISTERED INVESTMENT
ADVISER WHICH MANAGES THE DAY-TO-DAY OPERATIONS OF THE COMPANY (THE "MANAGER"),
SEE "PROSPECTUS SUMMARY--RECENT DEVELOPMENTS" BEGINNING ON PAGE 7.
The sale or distribution of any of the Shares may be effected by the
Selling Stockholders from time to time on terms to be determined at the time of
sale, in transactions in the over-the-counter market, in negotiated
transactions, or by a combination of these methods, at fixed prices that may be
changed, at market prices prevailing at the time of the sale, at prices related
to such market prices or at negotiated prices. The Selling Stockholders may
effect such transactions by selling the Shares to or through securities
broker-dealers or other agents, and such broker-dealers or other agents may
receive compensation in the form of discounts, concessions or commissions from
the Selling Stockholders and/or the purchasers of the Shares for whom such
broker-dealers may act as agent or to whom they sell as principal, or both
(which compensation as to a particular broker-dealer might be in excess of
customary commissions). Additionally, agents or dealers may acquire Shares or
interests therein as a pledgee and may, from time to time, effect distributions
of the Shares or interests in such capacity. See "Selling Stockholders" and
"Plan of Distribution." The Selling Stockholders and any brokers, dealers or
agents through whom sales of the Shares are made may be deemed "underwriters"
within the meaning of the Securities Act, and any profits realized by them on
the sale of the Shares may be considered to be underwriting compensation.
The Company has agreed to bear all of the expenses in connection with the
registration and sale of the Shares offered hereby by the Selling Stockholders
(other than underwriting discounts and selling commissions). The Common Stock is
traded on the New York Stock Exchange (the "NYSE") under the symbol "LMM." The
closing sale price per share of the Common Stock on the NYSE on December 14,
1998 was $5.38.
-------------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 15 FOR A DISCUSSION OF MATERIAL RISKS
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 a limited operating
history.
- - The Board of Directors has directed the Manager to delever the Company's
portfolio by selling certain Mortgage Securities in an attempt to reduce
the portfolio's susceptibility to basis and interest rate risk and to
create additional liquidity.
- - Lehman Brothers Inc., as financial adviser to the Company, has attempted
unsuccessfully to sell the Company. Lehman Brothers Inc. is continuing to
solicit bids on behalf of the Company.
- - The Company has experienced significant operating losses, after giving
effect to certain impairment charges relating to IOs, and may incur future
losses. The Company may suffer additional losses on investments in IOs, Sub
IOs, Inverse IOs and other Mortgage Derivatives, especially during periods
of declining interest rates.
- - The Company has treated its portfolio of adjustable rate IOs as impaired
assets and taken an impairment charge against operating earnings in the
second and third quarters. For the nine months ended September 30, 1998,
the impairment charges of $(51.0 million), or $(2.60) per share, reduced
reporting earnings to a net loss of $(52.6 million), or $(2.68) per share.
- - On November 29, 1993, Mr. Smirlock consented to the entry of a
cease-and-desist order issued against him by the Commission arising out of
trading activities in Mortgage Securities.
- - During the summer of 1998, pricing irregularities detected in one of the
Affiliated Funds managed by the Manager resulted in the termination of
Michael L. Smirlock as the Company's Chief Executive Officer and President
and the removal of Mr. Smirlock from his post as Chairman of the Board; Mr.
Smirlock remains a director of the Company, although the Board of Directors
has asked for his resignation.
- - On July 29, 1998, the Company announced that it had been informed by the
Manager of certain administrative changes, including the resignation of
Michael L. Smirlock as Chief Executive Officer of the Manager; Mr. Smirlock
continues as Chairman of the Board and a majority stockholder of the
Manager.
- - 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 is entitled to receive an incentive fee that may encourage
speculative investments.
- - The Company is totally reliant on the Manager, which has significant
operating discretion, including as to the Company's operating policies and
strategies. Neither the Manager nor the Manager's investment professionals
responsible for day-to-day portfolio management decisions have operated, or
have been officers or directors of, another REIT.
- - Interest rate fluctuations may decrease or eliminate net income from the
Company's investments.
- - The Company's investments are leveraged; there are no limitations on the
Company's borrowings.
(CONTINUED ON NEXT PAGE)
<PAGE>
(CONTINUED FROM COVER)
- - The Company engages in complex hedging strategies which have resulted, and
may continue to result, in losses.
- - 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.
------------------------------
The date of this Prospectus is__________, 1998
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information may be inspected and copied at the public
reference facilities maintained by the Commission at Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the following Regional Offices of
the Commission: Northeast Regional Office, 7 World Trade Center, Suite 1300, New
York, New York 10048; and Midwest Regional Office, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661. Copies of such reports and other
information may be obtained from the Public Reference Section of the Commission,
450 Fifth Street, N.W., Washington, D.C. 20549, on payment of prescribed
charges. In addition, such reports, proxy statements and other information may
be electronically accessed at the Commission's site on the World Wide Web
located at http://www.sec.gov. Such reports, proxy statements and other
information concerning the Company may also be inspected at the offices of the
New York Stock Exchange, 20 Broad Street, New York, New York 10005.
The Company has filed with the Commission a Registration Statement on Form
S-11, of which this Prospectus forms a part (together with any amendments and
exhibits thereto, the "Registration Statement"), under the Securities Act in
respect of the Shares offered hereby. This Prospectus does not contain all of
the information set forth in the Registration Statement, certain parts of which
are omitted in accordance with the rules and regulations of the Commission. Such
additional information may be obtained from the public reference room of the
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Statements contained
in this Prospectus or in any document incorporated by reference in this
Prospectus as to the contents of any contract or other document referred to
herein or therein are not necessarily complete, and in each instance reference
is made to the copy of such contract or other document filed as an exhibit to
the Registration Statement or such other document, each such statement being
qualified in all respects by such reference.
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
PAGE
Prospectus
Summary......................................................................7
The Company..................................................................7
General......................................................................7
Recent Developments..........................................................7
Investment Strategy..........................................................8
Risk Factors.................................................................9
Capital and Leverage Policies...............................................10
Hedging and Risk Management.................................................10
The Manager..................................................................11
Management Agreement........................................................11
Conflicts of Interest of the Manager........................................11
Certain Benefits to Existing Stockholder, Directors and Officers............12
Tax Status of the Company...................................................13
Distribution Policy.........................................................13
Risk Factors................................................................14
Recently-Organized Corporation; Recent Losses And Expectations Of Future
Losses....................................................................14
Pricing Irregularities Detected in One of the Affiliated Funds Resulted in
Termination of Company's Chief Executive Officer..........................14
Change in Management of the Manager Results in Changes to Business Strategy.14
Total Reliance on the Manager; Inexperienced New Management.................15
Management Agreement Places Few Restrictions on the Manager's Allocation of
Time........................................................................15
Management Agreement Places Few Restrictions on Manager's Allocation of
Investment Opportunities....................................................15
Incentive Fee Payable to Manager May Encourage Speculative Investments......16
Limitations on Termination of Management Agreement..........................16
Conflicts of Interest of the Manager........................................16
Cease and Desist Order Against Mr. Smirlock.................................16
Results of Operations Adversely Affected by Factors Beyond
Company's Control.........................................................17
Illiquidity of Mortgage Loans, Subordinate Interests and Mortgage Derivatives
Could Cause Losses........................................................17
Leverage Can Result in Net Interest and Operating Losses...................17
No Restriction on the Incurrence of Additional Indebtedness................19
Interest Rate Fluctuations Will Affect Value of Mortgage Assets
and Net Income.............................................................19
Consequences and Costs Of Hedging Transactions..............................21
Lack of Operating Policies; Board of Directors May Change Policies Without
Stockholder Consent........................................................22
Lack of Policy Regarding Hedging or Credit Risk, Future Revisions in
Policies and Strategies....................................................22
Value of CMOs May Be Adversely Affected By Prepayments on Underlying
Collateral................................................................22
Value of Mortgage Derivatives May Be Reduced or Eliminated Due to Interest Rate
Fluctuations, No Limit on Mortgage Derivatives............................22
Value of Subordinate Interests May Be Adversely Affected By Losses On
Underlying Mortgage Loans.................................................23
Investment In Non-Real Estate Assets Subject To Liquidity And Credit Risks;
Limit On Such Assets May Change Without Stockholder Approval.................23
Losses Incurred Related to Emerging Market Sovereign Debt Securities........ 24
The Company Invests In Certain High-Risk Assets.............................24
Failure To Maintain Reit Status Would Subject Company To Corporate Tax And
Penalty Tax...............................................................24
Failure To Maintain Investment Company Act Exemption Would Adversely Affect
Results Of Operations.......................................................25
Taxable Mortgage Pool Risk; Increased Taxation To Tax Exempt Entities And Other
Investors..................................................................25
Phantom Income May Result In Additional Tax Liability........................26
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
Failure To Utilize Accounting Controls And Testing Systems...................27
Limitation On Liability Of Directors And Officers And Manager
Indemnification.......................................................... 28
Use Of Proceeds.............................................................29
Price Range Of Common Stock And Dividend Policy.............................29
Distribution Policy.........................................................29
Selected Financial Data.....................................................31
Management's Discussion And Analysis Of Financial Condition
And Results Of Operations..................................................32
General.....................................................................32
Results Of Operations For The Period Ended December 31, 1997.................32
Results Of Operations For The Nine Months Ended September 30, 1998......... 32
Net Loss Summary............................................................32
Taxable Income and GAAP Income (Loss).......................................33
Interest Income and Average Earning Asset Yield.............................34
Interest Expense and the Cost of Funds......................................34
Interest Rate Swaps.........................................................35
Net Interest Income.........................................................35
Losses on Sales of Securities...............................................36
Credit Considerations.......................................................36
General and Administrative Expenses.........................................36
Net Loss and Return on Average Equity.......................................36
Distributions and Taxable Income............................................37
Financial Condition.........................................................37
Borrowings..................................................................39
Liquidity...................................................................39
Stockholders' Equity........................................................40
Capital and Leverage Policies...............................................41
Inflation...................................................................41
Year 2000 Compliance........................................................41
Recent Accounting Pronouncements............................................42
Business....................................................................43
General.....................................................................43
Investment Strategy.........................................................43
Operating Policies And Strategies...........................................44
Employees...................................................................47
Facilities..................................................................47
Legal Proceedings...........................................................47
Description Of Assets.......................................................47
Mortgage Loans..............................................................47
Pass-Through Certificates...................................................47
CMOs .......................................................................49
Mortgage Derivatives........................................................49
Subordinate Interests.......................................................50
Other Fixed-Income Assets...................................................51
The Manager.................................................................52
Cease-And-Desist Order Against Mr. Smirlock.................................53
The Management Agreement....................................................54
Management Fees.............................................................55
Stock Options And Deferred Common Stock Awards..............................56
Limits Of Responsibility....................................................56
The Company.................................................................57
Directors And Executive Officers............................................57
Committees Of The Board Of Directors........................................58
Compensation Of Directors...................................................58
Executive Compensation......................................................58
Stock Incentive Plan........................................................58
Grants Of Awards............................................................60
Compensation Committee Interlocks...........................................61
Certain Relationships And Related Party Transactions
And Conflicts Of Interest.................................................62
Principal Stockholders......................................................63
Federal Income Tax Considerations...........................................65
General.....................................................................65
Requirements For Qualification..............................................66
Distribution Requirement....................................................68
Taxation Of The Company.....................................................69
Taxation Of Stockholders....................................................70
Taxation Of Stockholders On The Disposition Of The Common Stock.............71
Capital Gains And Losses....................................................71
Information Reporting Requirements And Backup Withholding...................72
Taxation Of Tax-Exempt Stockholders.........................................72
Taxation Of Non-U.S. Stockholders...........................................72
State And Local Taxes.......................................................73
Erisa Considerations........................................................74
Employee Benefit Plans, Tax-Qualified Retirement Plans And IRAs.............74
Status Of The Company Under Erisa...........................................74
Certain Provisions Of Maryland Law And The Company's Charter And Bylaws.....76
Certain Anti-Takeover Provisions............................................76
Staggered Board Of Directors................................................76
Number Of Directors, Removal, Filling Vacancies.............................76
Advance Notice Provisions For Stockholder Nominations
And Stockholder Proposals..................................................76
Rights To Purchase Securities And Other Property............................77
Indemnification.............................................................77
Limitation Of Liability.....................................................77
Business Combinations.......................................................78
Control Share Acquisitions..................................................78
Description Of Capital Stock................................................79
General.....................................................................79
Common Stock................................................................79
Preferred Stock.............................................................79
Repurchase Of Shares And Restrictions On Transfer...........................79
Transfer Agent And Registrar................................................81
Selling Stockholders........................................................82
Plan Of Distribution........................................................83
Public Offering.............................................................85
Private Placement...........................................................85
Legal Matters...............................................................85
Experts.....................................................................85
Glossary....................................................................86
Index To Financial Statements...............................................F-1
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION INCLUDED ELSEWHERE IN THIS PROSPECTUS. 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
INFORMATION SET FORTH BELOW IN "RECENT DEVELOPMENTS" AND THE RISK FACTORS SET
FORTH IN THIS SUMMARY AND "RISK FACTORS" BEGINNING ON PAGE 14.
THE COMPANY
GENERAL
LASER Mortgage Management, Inc. (the "Company"), a Maryland corporation, is
a specialty finance company, organized in September 1997, that invests primarily
in mortgage-backed securities and mortgage loans. The mortgage-backed securities
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
are 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 ASSETS."
The Board of Directors has directed the Manager to delever the Company's
portfolio by selling certain securities in an attempt to reduce the portfolio's
susceptibility to basis and interest rate risk and to create additional
liquidity. From September 30, 1998 through November 30, 1998, the Company sold
approximately $1.1 billion of Mortgage Assets. The Manager has determined the
Company's net asset value as of November 30, 1998 to be between $7.50 and $8.00
per share. The net asset value as of such date reflects sales of Mortgage Assets
completed through November 30, 1998. Lehman Brothers Inc. ("Lehman Brothers"),
as financial adviser to the Company, has attempted unsuccessfully to sell the
Company. Lehman Brothers is continuing to solicit bids on behalf of the Company.
The Company has elected to be taxed and intends to continue to qualify as a
real estate investment trust (a "REIT") under the Internal Revenue Code of 1986,
as amended (the "Code") commencing with its short taxable year ended December
31, 1997, and such election has not been revoked. The Company has qualified as a
REIT for the taxable year ended December 31, 1997, and 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, manages the Company's day-to-day operations. The
Manager, organized in October 1997, is a registered investment adviser under the
Investment Advisers Act of 1940, as amended (the "Advisers Act").
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.
RECENT DEVELOPMENTS
In June 1998, the Company's Board of Directors was advised by the Manager
of certain pricing irregularities in connection with Shetland Fund Ltd., one of
the five private investment funds (the "Affiliated Funds") advised and managed
by the Manager, which invests in Mortgage Securities. On July 29, 1998, the
Company's Board of Directors was informed by the Manager that the pricing
irregularities detected in the Affiliated Fund did not affect the portfolio of
securities held by the Company, that certain procedural deficiencies existed at
the Manager which allowed for the pricing irregularities and that new procedures
had been implemented to rectify the deficiencies. The Manager also announced
certain administrative changes, including the resignation of Michael L. Smirlock
as Chief Executive Officer of the Manager. Mr. Smirlock continues as Chairman of
the Board and a majority stockholder of the Manager.
On July 30, 1998, the Company's Board of Directors terminated the
employment of Michael L. Smirlock as Chief Executive Officer and President and
removed Mr. Smirlock as Chairman of the Board of the Company. Mr. Smirlock
remains a director of the Company, although the Board of Directors has asked for
his resignation. The day-to-day portfolio management decisions for the Manager
on behalf of the Company are being made by Peter T. Zimmermann and Robert J.
Gartner. Messrs. Zimmermann and Gartner are Senior Vice President and Vice
President of Operations of the Manager, respectively. The Company also accepted
the resignation of two of its directors, David A. Tepper and William Marshall,
effective July 30, 1998. Both Mr. Tepper and Mr. Marshall resigned due to other
commitments. Mr. Tepper remains a director and minority stockholder of the
Manager. The Board elected Jonathan Ilany as a member of the Company's Board of
Directors.
On October 2, 1998, the Company's Board of Directors authorized its
financial advisor, Lehman Brothers, to promptly solicit offers to acquire the
Company or all, or substantially all, of its assets. To date, Lehman Brothers,
after soliciting offers to acquire the Company, has not received any firm bids.
Lehman Brothers continues to solicit bids on behalf of the Company. Also on
October 2, 1998, the Company's Board of Directors engaged BlackRock Financial
Management, Inc. ("BlackRock") as its consultant to review the Company's
portfolio and to make recommendations designed to reduce the portfolio's
susceptibility to basis and interest rate risk and to create additional
liquidity. BlackRock has recommended that the Manager delever the Company's
portfolio by selling certain Mortgage Assets. See "Risk Factors--Change in
Management of the Manager Results in Changes to Business Strategy."
The Board of Directors of the Company has declared a special fourth quarter
distribution in cash of $1.00 per share of common stock. The special
distribution is payable on December 30, 1998 to stockholders of record as of
December 23, 1998. Depending upon the Company's final reported taxable income
for 1998, this distribution may in whole or in part be characterized as a return
of capital for tax purposes. As of November 30, 1998, the Company's portfolio
was comprised of approximately $700 million of agency mortgage pass-through
certificates; $95 million of subordinated interests; $16 million of CMOs; $25
million of interest-only certificates and $9 million of mortgage loans.
On December 15, 1998, the Company was informed by the Manager of its
resignation as investment adviser to four of the Affiliated Funds, Steed Finance
LDC, Quarter Horse Finance Ltd., Shetland Fund Ltd. and Trakehner Fund L.P. The
Manager continues to manage investments for the Company and Mustang Investment
Limited Partnership. All references to the Affiliated Funds herein relate to
Mustang Investment Limited Partnership and the other four Affiliated Funds
previously managed by the Manager.
INVESTMENT STRATEGY
The Company was organized to create and manage an investment portfolio,
principally of Mortgage Assets, that, in combination with financing and hedging
activities, would generate income for distribution to its stockholders while
preserving the Company's capital base. During 1998, the Company maintained a
portfolio at its peak of approximately $3.8 billion of Mortgage Assets. However,
over recent months, the Manager has been directed to delever the Company's
portfolio of Mortgage Assets and to dispose of its illiquid securities.
The Company generally is authorized 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 ("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. At October 31, 1998, the Company's portfolio
consisted of 80.5% Agency Certificates, 3.3% CMOs, 0.9% Mortgage Loans, 4.1%
Mortgage Derivatives, all of which were IOs, 11.2% Subordinate Interests and 0%
other fixed-income securities. See "DESCRIPTION OF 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)(5)(B) of the Code ("Qualified
Real Estate Assets").
The Company is required to 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. At October 31, 1998, 89% of the
Company's total assets were in the 70% Asset Group.
The remainder of the Company's assets, not to exceed 30% of its total
assets (the "30% Asset Group"), may 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 has
attempted to limit its investments in, and diversify its portfolio of,
securities in the 30% Asset Group. At October 31, 1998, 11% of the Company's
total assets were in the 30% Asset Group.
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 a limited operating
history.
- - The Board of Directors has directed the Manager to delever the Company's
portfolio by selling certain securities in an attempt to reduce the
portfolio's susceptibility to basis and interest rate risk and to create
additional liquidity.
- - Lehman Brothers, as financial adviser to the Company, has attempted
unsuccessfully to sell the Company. Lehman Brothers is continuing to
solicit bids on behalf of the Company.
- - The Company has experienced significant operating losses, after giving
effect to certain impairment charges relating to IOs, and may incur future
losses. The Company may suffer additional losses on investments in IOs, Sub
IOs, Inverse IOs and other Mortgage Derivatives, especially during periods
of declining interest rates.
- - The Company has treated its portfolio of adjustable rate IOs as impaired
assets and taken an impairment charge against operating earnings in the
second and third quarters. For the nine months ended September 30, 1998,
the impairment charges of $(51.0 million), or $(2.60) per share, reduced
reporting earnings to a net loss of $(52.6 million), or $(2.68) per share.
- - On November 29, 1993, Mr. Smirlock consented to the entry of a
cease-and-desist order issued against him by the Commission arising out of
trading activities in Mortgage Securities.
- - During the summer of 1998, pricing irregularities detected in one of the
Affiliated Funds managed by the Manager resulted in the termination of
Michael L. Smirlock as the Company's Chief Executive Officer and President
and the removal of Mr. Smirlock from his post as Chairman of the Board; Mr.
Smirlock remains a director of the Company, although the Board of Directors
has asked for his resignation.
- - On July 29, 1998, the Company announced that it had been informed by the
Manager of certain administrative changes, including the resignation of
Michael L. Smirlock as Chief Executive Officer of the Manager; Mr. Smirlock
continues as Chairman of the Board and a majority stockholder of the
Manager.
- - 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 is entitled to receive an incentive fee that may encourage
speculative investments.
- - The Company is totally reliant on the Manager, which has significant
operating discretion, including as to the Company's operating policies and
strategies. Neither the Manager nor the Manager's investment professionals
responsible for day-to-day portfolio management decisions have operated, or
have been officers or directors of, another REIT.
- - Interest rate fluctuations may decrease or eliminate net income from the
Company's investments.
- - The Company's investments are leveraged; there are no limitations on the
Company's borrowings.
- - The Company engages in complex hedging strategies which have resulted and
may continue to result in losses.
- - 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.
CAPITAL AND LEVERAGE POLICIES
The Company's operations are leveraged approximately 8 to 1 as of October
31, 1998. Currently, the Company has been delevering, thereby increasing its
equity-to-assets ratio. At October 31, 1998, the Company's equity-to-assets
ratio was 12.0%, and has ranged from a high of 12.0% to a low of 5.9% during
1998. Initially, the Company financed its acquisition of Mortgage Assets through
the proceeds of its initial public offering (the "Public Offering") and several
concurrent private placements (collectively, the "Private Placement") and
currently finances any acquisitions primarily by borrowing against or
"leveraging" its existing portfolio and using the proceeds to acquire additional
Mortgage Assets. See "RISK FACTORS--Leverage Can Result in Net Interest and
Operating Losses." The Company's target for its equity-to-assets ratio depends
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 endeavors 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. 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.
In fact, from inception through September 30, 1998, the Company used
interest rate swaps to hedge two different interest rate risks: changes in asset
values and interest expense due to fluctuations in interest rates. As interest
rates increased, the Company believed that interest rate swaps (i) would
increase in value to offset a decrease in value of its fixed-rate assets and
(ii) would create increased cash flow to offset any increased funding expense
from the Company's borrowings. During the first three quarters of 1998, the
value of the Company's interest rate swaps did not correlate as expected to the
value of its fixed-rate assets. As a result, the Company's hedges did not
perform as expected. The Company closed out all of its interest rate swaps in
the second through fourth quarters of 1998 at a loss of $(62.5) million.
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."
The Company manages 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 are managed
by the Manager, subject to the supervision of the Company's Board of Directors.
The Manager, organized in October 1997 and a registered investment adviser under
the Advisers Act, specializes in managing investments in Mortgage Securities for
institutions and other sophisticated investors. The Manager employs
professionals who have experience in mortgage finance and in the purchase and
administration of Mortgage Securities; however, neither the Manager nor its
investment professionals have previously managed another REIT.
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. In 1998, Mr. Smirlock resigned as Chief
Executive Officer of the Manager and was terminated as Chief Executive Officer
and President of the Company as a result of the pricing irregularities detected
in one of the Affiliated Funds managed by the Manager. See "RISK FACTORS--
Pricing Irregularities Detected in One of the Affiliated Funds Resulted in
Termination of the Company's Chief Executive Officer" and "-- Cease-and-Desist
Order Against Mr. Smirlock" and "THE MANAGEr-- Cease-and-Desist Order Against
Mr. Smirlock." The Board of Directors engaged BlackRock as its consultant to
review the Company's portfolio and to make recommendations designed to reduce
the portfolio's susceptibility to interest rate risk and to create liquidity.
BlackRock has recommended that the Manager delever the Company's portfolio by
selling certain Mortgage Assets. See "RISK FACTORS--Change in Management of the
Manager Results in Changes to Business Strategy."
The Manager's principal executive offices are located at 51 John F. Kennedy
Parkway, Short Hills, New Jersey 07078.
MANAGEMENT AGREEMENT
The Company has entered into a management agreement (the "Management
Agreement") with the Manager pursuant to which the Manager, for an initial term
expiring on December 31, 2002, subject to the supervision of the Company's Board
of Directors, formulates operating strategies for the Company, oversees the
acquisition of assets by the Company, arranges for various types of financing
for the Company, monitors the performance of the Company's assets and provides
certain administrative and managerial services in connection with the Company's
operations. The Management Agreement continues automatically for successive
three-year periods, provided such continuance is specifically approved by the
Board of Directors who are unaffiliated with the Manager. For its performance of
these services, the Manager receives a quarterly base management fee of
$225,000, payable monthly.
The Manager also receives 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.
The Manager will be reimbursed for certain out-of-pocket expenses incurred on
behalf of the Company. For the nine months ended September 30, 1998, management
fees amounted to $2.0 million and incentive fees were $1.4 million. 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 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.
The structure and relationships of the Company, the Manager and the
Affiliated Funds are as follows:
CHART IS HERE
- -----------------
(1) The executive officers of the Company, except the Company's President, are
officers and employees of the Manager. See "--Certain Benefits to Existing
Stockholders, Directors and Officers" and "Principal Stockholders."
(2) A majority of the equity of the Manager is owned by Mr. Smirlock, a
director of the Company. The remaining equity of the Manager is owned by
Mr. Tepper, a former director of the Company and a director of the Manager.
(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.
CERTAIN BENEFITS TO EXISTING STOCKHOLDERS, DIRECTORS AND OFFICERS
Through the date hereof, Michael L. Smirlock, a director of the Company,
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 purchased 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 public offering price of $15.00 per share.
The Company also has sold a total of 5,013,999 shares in the Private
Placement. The purchasers in the Private Placement purchased 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 purchased
67,000 shares, (ii) David A. Tepper, a former director of the Company and a
director of the Manager, purchased 103,000 shares and (iii) Frederick N.
Khedouri, the President and a director of the Company and a Senior Managing
Director of Bear, Stearns & Co. Inc. ("Bear, Stearns"), one of the
Representatives of the several Underwriters in the Public Offering, purchased
10,000 shares. In addition, a total of 714,235 shares of Common Stock were
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 include 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 has entered into the Management Agreement with the Manager
pursuant to which the Manager is entitled to receive an annual base management
fee, a quarterly incentive fee and a non-competition payment in the event of
termination without cause or nonrenewal. Mr. Smirlock, the Chairman of the Board
and a majority stockholder of the Manager, is also a director of the Company.
David A. Tepper, a director and minority stockholder of the Manager, is a former
director of the Company. See "The Manager--The Management Agreement."
An Affiliated Fund, Mustang Investment Limited Partnership, 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 has elected to be taxed and intends to continue to qualify as a
REIT under the REIT Provisions of the Code commencing with its short taxable
year ended December 31, 1997. The Company has qualified as a REIT for the
taxable year ended December 31, 1997 and, if the Company continues to qualify 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."
<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.
RECENTLY-ORGANIZED CORPORATION; RECENT LOSSES AND EXPECTATIONS OF FUTURE
LOSSES
The Company was organized in September 1997, commenced operations only upon
receipt of the proceeds of the Public Offering and the Private Placement and,
therefore, has a limited operating history. The Company has experienced
significant operating losses, after giving effect to certain impairment charges
relating to IOs, and may incur future losses. The Company has suffered, and can
continue to suffer, significant losses on investments in IOs, Sub IOs, Inverse
IOs and other Mortgage Derivatives as a result of rapid prepayments during
periods of declining interest rates. The Company has treated its portfolio of
adjustable rate IOs as impaired assets and taken an impairment charge against
operating earnings in the second and third quarters. For the nine months ended
September 30, 1998, the impairment charges of $(51.0 million), or $(2.60) per
share, reduced reporting earnings to a net loss of $(52.6 million), or $(2.68)
per share. There is no assurance that these losses will not continue or that the
Company will be profitable in the future.
PRICING IRREGULARITIES DETECTED IN ONE OF THE AFFILIATED FUNDS RESULTED IN
TERMINATION OF COMPANY'S CHIEF EXECUTIVE OFFICER
In June 1998, the Company's Board of Directors was advised by the Manager
of certain pricing irregularities in connection with Shetland Fund Ltd., one of
the Affiliated Funds. On July 29, 1998, the Company's Board of Directors was
informed by the Manager that the pricing irregularities detected in the
Affiliated Fund did not affect the portfolio of securities held by the Company,
that certain procedural deficiencies existed at the Manager which allowed for
the pricing irregularities and that new procedures had been implemented to
rectify the deficiencies. In addition, as of the date of this Prospectus, no
securities held by any of the Affiliated Funds were transferred to the Company,
and no securities held by the Company were transferred to any of the Affiliated
Funds. The Manager also announced certain administrative changes, including the
resignation of Michael L. Smirlock as Chief Executive Officer of the Manager.
Mr. Smirlock continues as Chairman of the Board and a majority stockholder of
the Manager.
On July 30, 1998, the Company's Board of Directors terminated the
employment of Michael L. Smirlock as Chief Executive Officer and President and
removed Mr. Smirlock as Chairman of the Board of the Company. Mr. Smirlock
remains a director of the Company, although the Board of Directors has asked for
his resignation. The Company has been advised that day-to-day portfolio
management decisions for the Manager on behalf the Company are being made by
Peter T. Zimmermann and Robert J. Gartner. Messrs. Zimmermann and Gartner are
Senior Vice President and Vice President of Operations of the Manager,
respectively. The Company also accepted the resignation of two of its directors,
David A. Tepper and William Marshall, effective July 30, 1998. Both Mr. Tepper
and Mr. Marshall resigned due to other commitments. Mr. Tepper remains a
director and minority stockholder of the Manager.
CHANGE IN MANAGEMENT OF THE MANAGER RESULTS IN CHANGES TO BUSINESS STRATEGY
The Board of Directors of the Company, after considering executive,
management and operational changes and alternatives, engaged Lehman Brothers as
financial advisor to assist the Company in the exploration and evaluation of
strategic alternatives designed to maximize stockholder value. On October 2,
1998, the Company's Board of Directors authorized its financial adviser, Lehman
Brothers, to promptly solicit offers to acquire the Company or all, or
substantially all, of its assets. To date, Lehman Brothers, after soliciting
offers to acquire the Company, has not received any firm bids. Lehman Brothers
continues to solicit bids on behalf of the Company. Concurrently, the Board
engaged BlackRock as its consultant to review the Company's portfolio and to
make recommendations designed to reduce the portfolio's susceptibility to basis
and interest rate risk and to create additional liquidity. BlackRock has
recommended that the Manager delever the Company's portfolio by selling certain
Mortgage Assets. The Board of Directors has directed the Manager to delever the
Company's portfolio by selling certain Mortgage Assets. If a suitable
acquisition candidate is not found, or the Company is unable to sell Mortgage
Assets, the Company's financial condition, results of operations and business
might be materially adversely affected.
TOTAL RELIANCE ON THE MANAGER; INEXPERIENCED NEW MANAGEMENT
The Company's day-to-day operations are 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 Company and the
Manager may terminate the Management Agreement at any time upon 60 days' written
notice to the other party. If the Company lost the services of the Manager and a
suitable replacement was not available, the Company's financial condition,
results of operations and business might be materially adversely affected. See
"The Manager."
Neither the Manager nor the Manager's investment professionals responsible
for day-to-day portfolio management decisions have operated, nor have been an
executive officer or director of, another REIT. All of the employees and
officers of the Company, except Mr. Khedouri, are also employees of the Manager.
While the investment professionals have experience in trading Mortgage
Securities, there can be no assurance that they will be able to supervise,
manage and operate the business of the Manager and the Company effectively, and
the Company's financial condition, results of operations and business might be
materially adversely affected by such lack of experience.
MANAGEMENT AGREEMENT PLACES FEW RESTRICTIONS ON THE MANAGER'S ALLOCATION OF TIME
The Management Agreement does not limit or restrict the right of the
Manager or any of its officers, directors, employees or Affiliates to engage in
any business or render 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
invests primarily in Mortgage Assets and follows 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. 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. 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 Manager's employees currently spend
approximately 85% of their business time managing the Company. All of the
Manager's resources, including each of the employees, are devoted to all of its
clients. 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.
MANAGEMENT AGREEMENT PLACES FEW RESTRICTIONS ON MANAGER'S ALLOCATION OF
INVESTMENT OPPORTUNITIES
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.
INCENTIVE FEE PAYABLE TO MANAGER MAY ENCOURAGE SPECULATIVE INVESTMENTS
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.
LIMITATIONS ON TERMINATION OF MANAGEMENT AGREEMENT
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.
CONFLICTS OF INTEREST OF THE MANAGER
The Company is subject to conflicts of interest involving the Manager. The
executive officers of the Company are officers and employees of the Manager. A
majority of the Company's directors have no business affiliations with the
Manager, but Mr. Khedouri was initially selected by the Manager. Michael L.
Smirlock, a director of the Company, is the owner of a majority of the capital
stock and a director of the Manager. See "CERTAIN RELATIONSHIPS AND RELATED
PARTY TRANSACTIONS AND CONFLICTS OF INTEREST."
CEASE-AND-DESIST ORDER AGAINST MR. SMIRLOCK
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. As a result of circumstances
described under "PROSPECTUS SUMMARY-Recent Developments" and "-Pricing
Irregularities Detected in One of the Affiliated Funds Resulted in Termination
of the Company's Chief Executive Officer," Mr. Smirlock resigned from his
position as Chief Executive Officer of the Manager, and the Company's Board of
Directors terminated Mr. Smirlock's employment as Chief Executive Officer and
President and removed Mr. Smirlock as Chairman of the Board of the Company. Mr.
Smirlock remains a director of the Company, although the Board of Directors has
asked for his resignation. See "The Manager -- Cease-and-Desist Order Against
Mr. Smirlock."
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 current trends in the
financial markets (including the continued flat yield curve, the dislocation in
the market for fixed-income securities, the tightening of credit available for
investment in securities and the increased risk of interest rate sensitive
prepayment on mortgages) have had an adverse effect upon the Company's earnings.
The continued flat yield curve has caused financing costs to be relatively high
compared to the income earned on the Company's Mortgage Assets. The dislocation
in the fixed-income securities market and the increased risk of prepayments,
which primarily affect the value of the Company's portfolio, together with the
tightening of credit available for investment in securities, has adversely
affected the Company's ability to employ leverage profitably. 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." Generally, 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 Securities and
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.
ILLIQUIDITY OF MORTGAGE LOANS, SUBORDINATE INTERESTS AND MORTGAGE DERIVATIVES
COULD CAUSE LOSSES
At October 31, 1998, approximately 16% of the Company's portfolio was
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. While there is no limit on the percentage of the Company's
investments that may be invested in illiquid assets, the Company's Board of
Directors has directed the Manager to dispose of the illiquid assets.
LEVERAGE CAN RESULT IN NET INTEREST AND OPERATING LOSSES
LEVERAGING STRATEGY
The Company borrows against, or "leverages," its Mortgage Assets in order
to acquire additional Mortgage Assets, generally through the use of reverse
repurchase agreements. The Company's target for its equity-to-assets ratio
depends on market conditions and other factors deemed relevant by the Manager,
subject to the review of the Company's Board of Directors. Currently, the
Company has been delevering, thereby increasing its equity-to-assets ratio. At
October 31, 1998, the Company's equity-to-assets ratio was 12.0%, and has ranged
from a high of 12.0% to a low of 5.9% during 1998. 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 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 income available for distributions to
stockholders. For the nine months ended September 30, 1998, the Company's net
interest expense in connection with its repurchase agreements was $139.7
million. 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 Company has recently been delevering which has had the effect of lowering
the Company's interest expense. The intended effect of the lower interest
expense on net income has been offset by the impact of a smaller asset base. The
net effect of reducing leverage has been to decrease the Company's net interest
income.
From time to time, 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.
Current trends in the financial markets (including dislocation in the
market for fixed-income securities, the tightening of credit available for
investment in securities and the decrease in value of Mortgage Securities due to
higher prepayment rates) have had an adverse effect on the Company's ability to
borrow funds and may continue to have such an effect. To address liquidity
concerns, the Company has begun to delever its portfolio.
BORROWING RISKS
To date, the Company's debt has consisted entirely of repurchase agreements
or borrowings collateralized by a pledge of the Company's investments.
Substantially all of the Company's investments are currently accepted as
collateral for such borrowings. The Company has not established, and currently
does not intend to establish, committed lines of credit. Such borrowings are
generally short-term (7-day or 30-day terms) and are terminable at the lenders'
discretion. At November 30, 1998, the Company had established uncommitted
borrowing facilities with twenty lenders. At November 30, 1998, the Company had
borrowings outstanding from eight lenders reduced from a high of thirteen
lenders as of April 13, 1998. Certain lenders have reduced the funds available
to the Company for certain less liquid securities.
POTENTIAL INABILITY OF COMPANY TO MEET ITS MARGIN CALLS
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 declines, and
lenders initiate margin calls (i.e., the Company is 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 recently has been
forced to sell Mortgage Assets to meet margin calls and reduce the amount
borrowed, which has resulted in losses to the Company. In the third quarter of
1998, the Company realized a loss of $(22.0) million, or $(1.17) per weighted
average share on sales of Mortgage Securities and terminations of interests rate
swaps as the Company raised cash to meet increased margin requirements.
As of the date of this Prospectus, the Company has met every margin call
initiated by its lenders despite the devaluation of the Company's portfolio,
which has substantially reduced the Company's liquidity. As of September 30,
1998, the Company's cash and cash equivalent balance was $24.7 million compared
to $82.6 million as of December 31, 1997. If the current depressed state of the
fixed income market persists, there can be no assurance that the Company will
continue to meet its margin calls. A default by the Company under its
collateralized borrowings 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." Any failure by the Company to
meet margin calls would have a material adverse effect on the Company's
financial condition, results of operations and business.
RISK OF BANKRUPTCY IN REVERSE REPURCHASE AGREEMENTS
Substantially all of the Mortgage Assets are pledged to secure reverse
repurchase agreements. Therefore, such Mortgage Assets are not 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
enters 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."
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's target for its
equity-to-assets ratio depends on market conditions and other factors deemed
relevant by the Manager, subject to the review of the Company's Board of
Directors. Currently, the Company has been delevering, thereby increasing its
equity-to-assets ratio. At October 31, 1998, the Company's equity-to-assets
ratio was 12.0%, and has ranged from a high of 12.0% to a low of 5.9% during
1998. See "- -Leverage Can Result in Net Interest and Operating
Losses--Leveraging Strategy."
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. See "--Consequences and Costs of Hedging
Transactions." During the first three quarters of 1998, the Mortgage Securities
market has changed significantly because of (i) declining interest rates and
accelerated prepayment rates for Mortgage Securities associated therewith and
(ii) a "flight to quality" in the fixed-income market generally. As a result,
the relative value of the Company's Mortgage Assets declined substantially more
than anticipated relative to U.S. Treasury securities.
FAILURE TO MANAGE MISMATCH BETWEEN LONG-TERM ASSETS AND SHORT-TERM FUNDING
The Company's operating results depend in large part on differences between
the income from its Mortgage Assets and its borrowing costs. At least 65% of the
Company's Mortgage Assets have interest payment rates (i.e., coupon rates) which
remain fixed for periods of 30 years or more until their maturity. The Company
funds 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 invests primarily in fixed-rate Mortgage Assets, the
Company also owns adjustable rate Mortgage Assets. The coupon rates of
adjustable rate Mortgage Assets normally fluctuate with reference to a specific
rate index. The Company funds 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 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 the Company's Mortgage Assets has been 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 modeled 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 acquires 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. During the third
quarter of 1998, the Company's net income declined as a result of losses
incurred in sales of securities and a reduction in the income from its Mortgage
Securities due to a reduced investment portfolio and increasing prepayments. In
the third quarter of 1998, the Company realized a loss of $(22.0 million) or
$(1.17) per weighted average share on sales of securities and terminations of
interest rate swaps. These sales were made in response to a difficult credit
environment, as the Company raised cash in order to meet increased margin
requirements.
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 invests 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 enters 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
From inception through September 30, 1998, the Company used interest rate
swaps to hedge two different interest rate risks: changes in asset values and
interest expense due to fluctuations in interest rates. As interest rates
increased, the Company believed that interest rate swaps (i) would increase in
value to offset a decrease in value of its fixed-rate assets and (ii) would
create increased cash flow to offset any increased funding expense from the
Company's borrowings. During the first three quarters of 1998, the value of the
Company's interest rate swaps did not correlate as expected to the value of its
fixed-rate assets. As a result, the Company's hedges did not perform as
expected. The Company closed out all of its interest rate swaps in the second
through fourth quarters of 1998 at a loss of $(62.5) million.
There can be no assurance that the Company's future 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.
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 generally hedges 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 amount of income the Company may earn from its
hedging instruments is subject to substantial limitations under the REIT
Provisions of the Code.
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 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.
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 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 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, as have recently been experienced, the Company's ability to
utilize Inverse IOs and Sub IOs as capital for collateralized borrowings is
impaired. To the extent that Inverse IOs and Sub IOs decrease in value, the
Company is 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 is forced
to liquidate securities into illiquid markets and incur losses. Additionally, in
such environments, lenders require additional capital as a percentage of the
market value of the Inverse IOs or Sub IOs (a higher capital "haircut") or do
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 reduces the Company's
liquidity and requires 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 invests 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 invests 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 invests 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 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
overcollateralization 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 invests 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 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
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 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 Assets."
LOSSES INCURRED RELATED TO EMERGING MARKET SOVEREIGN DEBT SECURITIES
The Company has invested previously in debt securities issued or guaranteed
by foreign governments, including debt securities rated below investment grade.
As of October 31, 1998, the Company sold all of its investments in emerging
market sovereign debt securities for a net loss of $15.1 million. The Board of
Directors has determined that the Company will no longer invest in such
securities.
THE COMPANY INVESTS IN CERTAIN HIGH-RISK ASSETS
The Company invests 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 seeks 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 does not perform independent
credit reviews.
FAILURE TO MAINTAIN REIT STATUS WOULD SUBJECT COMPANY TO CORPORATE TAX AND
PENALTY TAX
The Company operates in such a manner as to qualify as a REIT for federal
income tax purposes. Although the Company did not request a ruling from the
Service as to its REIT status, the Company received an opinion of its Special
Tax Counsel that, based on certain assumptions and representations, it did so
qualify for the short taxable year ended December 31, 1997 and will continue to
so qualify by following its proposed method of operation. 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.
The Company makes 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.
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, 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 enters 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
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 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-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. The Company's Board
of Directors has waived the Ownership Limitation for the several mutual funds
advised by Franklin Mutual Advisers Inc. (each a "Fund" and, together, the
"Funds") who have participated in the Private Placement. The Company's Board of
Directors also has waived the Ownership Limitation For the President and Fellows
of Harvard College ("Harvard"). See "Description of Capital 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.
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
also may have the effect of delaying, deterring or 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."
FAILURE TO UTILIZE ACCOUNTING CONTROLS AND TESTING SYSTEMS
The Company has the following internal accounting controls and testing
systems in place: (i) monthly pricing of the value of the Company's investment
portfolio using dealer price information; (ii) an annual test reviewed by the
Company's independent accountants to ensure that the Company satisfies the REIT
Gross Income Tests; (iii) a quarterly test to ensure that the Company meets the
55% Requirement; and (iv) a quarterly test reviewed by the Company's independent
accountants to ensure that the Company satisfies the REIT Asset Tests. In
addition, the Company uses the MFact(C) portfolio accounting software system
which has certain built-in control features, including without limitation, daily
cash reconciliation, price variation warning flags and calculation of interest
accruals. The failure to utilize successfully 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.
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."
USE OF PROCEEDS
This Prospectus relates to Shares being offered and sold for the accounts
of the Selling Stockholders. The Company will not receive any of the proceeds
from the sale of the Shares offered by the Selling Stockholders. The Company
will pay for all expenses related to the registration of the Shares. See
"Selling Stockholders" and "Plan of Distribution."
PRICE RANGE OF COMMON STOCK AND DISTRIBUTION POLICY
The Common Stock began trading on the NYSE on November 27, 1997 under the
symbol "LMM." Prior to such date, no public market for the Company's Common
Stock existed. The following table sets forth, for the periods indicated, the
high and low bid prices and closing sales prices per share of Common Stock as
reported on the NYSE composite tape and the cash distributions declared per
share of Common Stock.
<TABLE>
<CAPTION>
STOCK PRICES
HIGH LOW CLOSE
1997
<S> <C> <C> <C>
Fourth Quarter (commencing November 27, 1997) $14.94 $13.56 $14.50
1998
First Quarter $17.63 $14.13 $15.13
Second Quarter $16.44 $ 9.44 $10.88
Third Quarter $11.25 $ 6.25 $ 7.50
Fourth Quarter (through December 14, 1998) $ 7.38 $ 3.50 $ 5.38
Cash Dividends/
Distributions
DECLARED PER SHARE
1997
Fourth Quarter $0.13
1998
First Quarter $0.43
Second Quarter $0.38
Third Quarter $0.38
Fourth Quarter $1.00
</TABLE>
On December 14, 1998, the closing sales price for the Common Stock on the
NYSE was $5.38 per share. As of November 12, 1998, the Company had 18,466,199
shares of Common Stock issued and outstanding, which were held by 77 holders of
record. The Company believes it has more than 2,000 beneficial holders of Common
Stock.
DISTRIBUTION POLICY
The Company distributes substantially all of its taxable income (which
generally does not ordinarily 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 Plan that allows
stockholders to reinvest their dividends automatically in additional shares of
Common Stock.
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following selected statement of operations data for the year ended
December 31, 1997 and the balance sheet data as of December 31, 1997 are derived
from the Company's audited financial statements and notes thereto included
elsewhere herein audited by Deloitte & Touche LLP, independent public
accountants, as of and for the year ended December 31, 1997, as set forth in
their report also included elsewhere herein. The unaudited selected statement of
operations data for the nine months ended September 30, 1998 and the unaudited
balance sheet data as of September 30, 1998 are derived from the unaudited
financial statements of the Company and, in the opinion of the Company, reflect
all adjustments consisting of normal recurring adjustments, necessary for a fair
presentation of the financial position and results of operations of the Company
for these periods. Operating results for the nine months ended September 30,
1998 are not necessarily indicative of the results that may be expected for the
full year. The information set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and all of the financial statements and the notes thereto and other
financial information included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
Year Ended NINE MONTHS
ENDED DECEMBER 31, 1997 SEPTEMBER 30, 1998
----------------------- ------------------
Statements of Operations Data: (UNAUDITED)
Interest income:
<S> <C> <C>
Mortgage loans and securities $ 10,078 $ 161,335
Cash and cash equivalents..................... 811 3,458
--------- ----------
Total...................................... 10,889 164,792
- ------ ---------- ---------
Interest expense:
Repurchase agreements...................... 8,489 139,692
--------- -----------
Net interest income........................... 2,400 25,101
Gain (loss) on sale of securities 558 (20,725)
Impairment loss on interest-only securities -- (51,030)
General and administrative expenses 415 5,995
--------- -----------
Net income (loss)................................... $ 2,572 $ (52,649)
========= =============
Unrealized gain (loss) on securities:
Unrealized holding gain (loss) arising
during period.................................. $ (38,150)
Add: reclassification adjustment for losses
included in net income (loss)............... 20,725
------------
Other comprehensive income (loss)................... 17,435
------------
Comprehensive loss.................................. $(70,084)
============
Net income (loss) per share:
Basic......................................... $ 0.13 $ (2.68)
========= ============
Diluted....................................... $ 0.13 $ (2.68)
========= ============
Weighted average number of shares outstanding:
Basic......................................... 20,019,999 19,623,221
========== ==========
Diluted....................................... 20,019,999 19,623,221
========== ==========
As of AS OF
DECEMBER 31, 1997 SEPTEMBER 30, 1998
----------------- ------------------
BALANCE SHEET DATA: (UNAUDITED)
Cash and cash equivalents........................... $ 82,627 $ 24,675
Total assets........................................ 3,793,239 2,327,943
Total liabilities................................... 3,510,805 2,153,460
Stockholders' equity................................ 282,433 174,483
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Board of Directors has directed the Manager to delever the Company's
portfolio by selling certain securities in an attempt to reduce the portfolio's
susceptibility to basis and interest rate risk and to create additional
liquidity. Lehman Brothers, as financial adviser to the Company, has attempted
unsuccessfully to sell the Company. Lehman Brothers is continuing to solicit
bids on behalf of the Company. From September 30, 1998 through November 30,
1998, the Company sold approximately $1.1 billion of Mortgage Assets. The
Manager has determined the Company's net asset value as of November 30, 1998 to
be between $7.50 and $8.00 per share. The net asset value as of such date
reflects sales of Mortgage Assets completed through November 30, 1998.
RESULTS OF OPERATIONS FOR THE PERIOD ENDED DECEMBER 31, 1997
The Company's 1997 fiscal year commenced with the beginning of its
operations on November 26, 1997. The 36-day period from November 26, 1997 to
December 31, 1997 is referred to as the "period ended December 31, 1997."
NET INCOME. For the period ended December 31, 1997, the Company's net
income was $2,572,404, or $0.13 per share, based on 20,019,999 shares
outstanding.
NET INTEREST INCOME. Net interest income for the period ended December 31,
1997 totaled $2,399,546. Net interest income is comprised of the interest income
earned on the Company's Mortgage Assets less interest expense from borrowings.
GAIN ON SALE OF SECURITIES. The Company recorded a gain on sale of
securities of $588,289.
GENERAL AND ADMINISTRATIVE EXPENSES. The Company incurred general and
administrative expenses of $415,431, consisting of management fees paid to the
Manager of $232,858, incentive fees paid to the Manager of $94,992 and
professional and other miscellaneous fees.
The unannualized return on end of period equity for the period ended
December 31, 1997 was 0.91%.
For the period ended December 31, 1997, the Company's taxable income was
$2,602,600, or $0.13 per average share outstanding. As a REIT, the Company is
required to declare dividends amounting to 85% of each year's taxable income by
the end of each calendar year and to have declared dividends amounting to 95% of
its taxable income for each year by the time it files its applicable tax return
and, therefore, generally passes through substantially all of its earnings to
stockholders without paying federal income tax at the corporate level. The
Company declared and paid a dividend of $0.13 per share for its first quarter of
operations.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
NET LOSS SUMMARY
For the nine months ended September 30, 1998, the Company had a net loss
before giving effect to charges relating to the impairment of certain IOs of
$(1.6 million), or $(0.08) per weighted average share. After giving effect to
the impairment charges of $(51.0 million), or $(2.60) per weighted average
share, for the nine-month period ended September 30, 1998, the Company had a net
loss of $(52.6 million), or $(2.68) per weighted average share. The weighted
average number of shares of common stock outstanding for the nine-month period
was 19,623,221. Distributions were $1.18 per weighted average share, $23.2
million in total. Return on average equity was (20.60)% on an unannualized basis
(after giving effect to the impairment charges), for the nine-month period ended
September 30, 1998.
During the third quarter of 1998, the Company's net income declined as a
result of losses incurred in sales of securities and a reduction in the income
from its Mortgage Securities due to a reduced investment portfolio and
increasing prepayments. In the third quarter of 1998, the Company realized a
loss of $(22.0 million) or $(1.17) per weighted average share on sales of
securities and terminations of interest rate swaps. These sales were made in
response to a difficult credit environment, as the Company raised cash in order
to meet increased margin requirements.
Most of the IOs were LIBOR floating rate IOs and were purchased in December
1997. They were acquired to balance duration in the Company's portfolio. This
investment was made based on the Company's evaluation of the then-current
prepayments and shape of the yield curve, and the relative values of similar
investments.
In evaluating the impairment charge on the IOs, the Company employs current
estimates of future prepayments that are obtained from independent sources. For
IOs collateralized by fixed-rate pass-through mortgage securities issued by
FNMA, GNMA and FHLMC (collectively, "Agency Fixed Rate Pass-Throughs"), the
Company utilized the median lifetime projection prepayment speeds compiled and
reported by Bloomberg L.P. from a survey of leading dealers in the mortgage
market. For "private label" IOs (collateralized by non-government agency
mortgage securities), the Company employs prepayment estimates from at least one
independent dealer. The prepayment estimates typically take into consideration
the current level and shape of the yield curve.
As a result of the substantial decline in interest rates since the purchase
of the IOs, current estimates of prepayment speeds significantly exceed the
original prepayment speed estimates.
At the end of the first quarter of 1998, the majority of the Company's IOs
were floating rate IOs. Floating rate IOs are unique securities in that the
interest payments on these securities increase as one-month LIBOR increases. Due
to this characteristic of option value, floating rate IOs trade at much lower
yields than fixed rate IOs. At the end of the second and third quarter of 1998,
in light of the continued flat yield curve, low levels of LIBOR and faster than
expected prepayment rates actually occurring for an extended period of time, the
Company decided that the impairment in market value was other than temporary.
TAXABLE INCOME AND GAAP INCOME (LOSS)
For the nine-month period ended September 30, 1998, income as calculated
for tax purposes ("taxable income") is estimated at approximately $18.0 million,
or $0.92 per weighted average share, and capital losses in excess of capital
gains are estimated at approximately $21.1 million or $1.08 per weighted average
share. Capital losses in excess of capital gains are eligible to be carried
forward to future tax years to offset capital gains. Taxable income was
different from income (loss) as calculated according to generally accepted
accounting principles ("GAAP income (loss)") as a result of, among other things,
differing treatment of losses on securities transactions and interest rate
swaps, permanent impairment writedowns on IOs and a differing treatment of
premium and discount amortization.
Taxable income and GAAP income (loss) could also differ for other reasons.
For example, the Company may take credit provisions which would affect GAAP
income whereas only actual credit losses are deducted in calculating taxable
income. In addition, G&A Expenses may differ due to differing treatment of
leasehold amortization, certain stock option expenses and other items. As of
September 30, 1998, the Company had not taken credit provisions because 91% of
Investments held by the Company at September 30, 1998 are Mortgage Securities
issued by government agencies.
The distinction between taxable income and GAAP income (loss) is important
to the Company's stockholders because dividends or distributions are declared on
the basis of taxable income. While the Company does not pay taxes so long as it
satisfies the requirements for exemption from taxation pursuant to the REIT
Provisions of the Code, each year the Company completes a corporate tax form
wherein taxable income is calculated as if the Company were to be taxed. This
taxable income level helps to determine the amount of dividends the Company
intends to pay out over time.
The Manager's incentive fee is calculated based on taxable income not GAAP
income.
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
The Company had average earning assets of $3,478 million for the nine-month
period ended September 30, 1998. The table below shows, for the nine-month
period ended September 30, 1998, the Company's average balance of cash
equivalents, loans and securities, the yields earned on each type of earning
assets, the yield on average earning assets and interest income.
<TABLE>
<CAPTION>
AVERAGE EARNING ASSET YIELD
(dollars in thousands)
Yield on Yield on
Average Yield on Average Average
Average Amortized Average Average Amortized Interest
Cash Cost of Earning Cash Cost of Earning Interest
Equivalents Securities Assets Equivalents Securities Assets Income
For the Nine Months Ended
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 52,599 $3,478,359 $ 3,425,760 5.78% 6.68% 6.67% $ 164,792
</TABLE>
INTEREST EXPENSE AND THE COST OF FUNDS
For the nine-month period ended September 30, 1998, the Company had average
borrowed funds of $3,240 million and total interest expense of $140 million with
an average cost of funds of 5.69%. The Company believes that its largest expense
will usually be the cost of borrowed funds. Interest expense is calculated in
the same manner for tax and GAAP purposes. With the Company's current
asset/liability management strategy, changes in the Company's cost of funds are
expected to be closely correlated with changes in one-month LIBOR, although the
Company may choose to extend the maturity of its liabilities at any time,
subject to the lender's consent. The Company's average cost of funds was 0.05%
above one-month LIBOR for the nine months ended September 30, 1998. The Company
generally has structured its borrowings to adjust with one-month LIBOR. During
the quarter ended September 30, 1998, average one-month LIBOR, which was 5.62%,
was 0.01% lower than average six-month LIBOR, which was 5.63%.
The table below shows, for the nine-month period ended September 30, 1998,
the Company's average borrowed funds and average cost of funds as compared to
average one and six-month LIBOR.
AVERAGE COST OF FUNDS
(dollars in thousands)
<TABLE>
<CAPTION>
Average Average Average
One-Month Cost of Cost of
LIBOR Funds Funds
Relative to Relative to Relative to
Average Average Average Average Average Average Average
Borrowed Interest Cost of One-Month Six-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
For the Nine Months Ended
<S> <C> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $ 3,240,11 $ 139,692 5.69% 5.64% 5.68% -0.04% 0.05% 0.01%
</TABLE>
The current trends in the financial markets (including the continued flat
yield curve, the dislocation in the market for fixed-income securities, the
tightening of credit available for investment in securities and the increased
risk of interest rate sensitive prepayment on mortgages) have had an adverse
effect upon the Company's earnings. The continued flat yield curve has caused
financing costs to be relatively high compared to the income earned on the
Company's Mortgage Assets. The dislocation in the fixed-income securities market
and the increased risk of prepayments, which primarily affect the value of the
Company's portfolio, together with the tightening of credit available for
investment in securities, has adversely affect the Company's ability to employ
leverage profitably.
INTEREST RATE SWAPS
At September 30, 1998, the Company had outstanding interest rate swaps with
the original notional amounts stated below. Under these swap agreements, the
Company receives a floating rate from its swap counterparty and pays a fixed
rate to its swap counterparty. As part of its asset/liability management
process, the Company may enter into interest rate agreements such as interest
rate caps, floors and swaps. These agreements are entered into to reduce
interest rate risk and would be designed to provide income and capital
appreciation to the Company in the event of certain changes in interest rates.
INTEREST RATE SWAP TERMS
(dollars in thousands)
<TABLE>
<CAPTION>
Average
Notional Fixed Floating Unrealized
Amount Rate Rate Net Income Loss
<S> <C> <C> <C> <C> <C>
At September 30, 1998 $ 550,000 7.41% 5.65% $ (12,312) $(42.1)
</TABLE>
During the three months ended September 30, 1998, the Company terminated
interest rate swaps with notional amounts totaling $485 million and incurred a
realized loss of $25.8 million which is included in loss on sale of securities
in the statement of operations. Since the appreciation on the hedged mortgage
securities was insufficient to offset the hedging loss and the overall position
in mortgage securities was reduced, the Company has taken the loss in the
current period rather than amortizing such loss over the life of the contract.
Interest rate swaps are carried on the balance sheet at fair value. At September
30, 1998, there were $42.1 million in unrealized losses on interest rate swaps.
At October 31, 1998, the Company did not have any interest rate swaps
outstanding. In October 1998, the Company realized a $34.8 million loss on the
termination of its interest rate swaps which will be recognized in the fourth
quarter of 1998.
The Company entered into approximately $1,035.0 million of interest rate
swaps for hedging purposes. The interest rate swaps were used to hedge two
interest rate risks for the Company. As interest rates increase, the value of
the interest rate swaps should increase to hedge the decline in asset values.
The swaps also serve to fix interest expense by increasing cash flow as LIBOR
increases which offsets the Company's increased interest expense. By using
interest rate swaps to fix liability expense, the Company attempted to preserve
both value and income as interest rates fluctuate. The interest rate swaps also
serve an additional hedging purpose. Since swap spreads and mortgage spreads
tend to be highly correlated, a decrease in the value of the Company's mortgage
securities due to a widening in mortgage spreads should be offset by the
increased value of the interest rate swaps if the change in mortgage spreads is
due to a change in swap spreads.
NET INTEREST INCOME
Net interest income, which equals interest income less interest expense,
totaled $25.1 million for the nine-month period ended September 30, 1998. Net
interest rate spread, which equals the yield on the Company's interest earning
assets (excluding cash) less the average cost of funds for the period was 0.99%
for the nine-month period ended September 30, 1998.
The table below shows interest income by earning asset type, average
earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
nine-month period ended September 30, 1998.
NET INTEREST INCOME
(dollars in thousands)
<TABLE>
<CAPTION>
Yield on
Average Interest Net Income Average Average
Amortized Interest Average Income on on Total Interest Balance of Average Net
Cost of Income on Cash Cash Contractual Interest Earning Repurchase Interest Cost of Interest
Investment Investments Equivalents Equivalent Commitments Income Assets Agreements Expense Funds Income
For the Nine Months
Ended September 30,
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998 $3,425,760 $173,647 $52,599 $3,458 (12,312) $164,793 6.67% $3,240,113 $139,692 5.69% $25,101
</TABLE>
LOSSES ON SALES OF SECURITIES
For the nine-month period ended September 30, 1998, the Company sold
Mortgage Assets with an aggregate historical amortized cost of $3.4 billion for
a net loss of $20.7 million. The difference between the sale price and the
historical amortized cost of the securities is a realized loss and reduced net
income accordingly.
CREDIT CONSIDERATIONS
The Company has not experienced credit losses on its investment portfolio
to date, but losses may be experienced in the future. At September 30, 1998, the
Company had limited its exposure to credit losses on its portfolio by holding
91% of its Investments in Mortgage Securities issued by FNMA, GNMA and FHLMC
(including IOs, fixed/floating rate mortgage securities, fixed rate pass-through
mortgage securities and principal-only mortgage securities).
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses ("operating expense" or "G&A expense")
were $6.0 million for the nine-month period ended September 30, 1998, consisting
of management fees paid to the Manager of $2.0 million, incentive fees payable
to the Manager of $1.4 million and professional and other miscellaneous fees.
There were no differences in the calculation of G&A expense for taxable and GAAP
income purposes. The "Efficiency Ratio" is the G&A expense divided by the net
interest income.
G&A EXPENSE RATIOS
(dollars in thousands)
<TABLE>
<CAPTION>
Total G&A Total G&A
Expense/ Expense/
Deferred Other Total Average Average Efficiency
Management Incentive Stock G&A G&A Assets Equity Ratio
Fee Fee Expense Expense Expense (Annualized) (Annualized) (Annualized)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the Nine Months Ended $ 1$991 $ 1,414 1,047 $ 1,542 5,994 0.21% 3.14% 23.88%
September 30, 1998
</TABLE>
NET LOSS AND RETURN ON AVERAGE EQUITY
Net losses were $(52.6) million for the nine-month period ended September
30, 1998. Return on average equity for the nine-month period ended September 30,
1998 was (20.60)% on an unannualized basis. The table below shows, on an
unannualized basis, for the nine-month period ended September 30, 1998, the
Company's net interest income, gain on sale of securities and G&A expense each
as a percentage of average equity, and the return on average equity.
COMPONENTS OF RETURN ON AVERAGE EQUITY
<TABLE>
<CAPTION>
Net Interest Loss on Sale Impairment
Income/ of Securities Loss on
Average Average Interest-Only G&A Expense/ Return on
Equity Equity Securities Equity Average Equity
<S> <C> <C> <C> <C> <C>
For the Nine Months Ended September 30, 1998 9.82% (8.11)% (19.97)% 2.34% (20.60)%
</TABLE>
DISTRIBUTIONS AND TAXABLE INCOME
The Company has elected to be taxed as a REIT under the Code. Accordingly,
the Company intends to distribute substantially all of its taxable income for
each year to stockholders, including income resulting from gains on sales of
securities. For the nine months ended September 30, 1998, distribution
declarations exceeded estimated taxable income by approximately $5.1 million or
$0.26 per share, based on the weighted average number of shares of common stock
outstanding during the period.
DISTRIBUTION SUMMARY
(dollars in thousands)
<TABLE>
<CAPTION>
Estimated Distributions
Estimated Weighted Taxable Distribution in Excess of
Taxable Average Net Per Weighted Distribution Estimated
Net Common Income Average Total Pay-Out Taxable
Income Shares Per Share Share Distribution Ratio Income
For the Nine Months Ended
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $18,046 19,623,221 $ 0.92 $ 1.18 $ 23,194 128.5% $ (5,148)
</TABLE>
FINANCIAL CONDITION
Investments
At September 30, 1998, the Company's investments consisted of: $121.3
million fixed/floating rate mortgage securities issued by government agencies
("Agency Fixed/Floating Rate Mortgage Securities"); $1,813.3 million fixed rate
pass-through mortgage securities issued by government agencies ("Agency Fixed
Rate Pass- Throughs"); $20.2 million emerging market sovereign debt securities
("Emerging Market Bonds"); $102.1 million subordinate mortgage securities
("Mortgage Subordinates"); $23.5 million other rated and unrated debt
securities, including collateralized bond obligations, bank loans and
collateralized loan obligations ("Non-Mortgage Subordinates"); $52.4 million
principal-only mortgage securities ("Principal-Only Securities"); $34.9 million
fixed/floating rate mortgage securities issued by non-governmental entities
("Non-Agency Fixed/Floating Rate Mortgage Securities"); $47.4 million IOs; and
$9.2 million Mortgage Loans.
At December 31, 1997, the Company's investments consisted of: $3,312.9
million Fixed Rate Agency Pass- Throughs; $48.5 million Emerging Market Bonds;
$48.0 million Mortgage Subordinates; $10.0 million Non-Mortgage Subordinates;
$36.2 million Principal-Only Securities; $151.5 million IOs; and $9.7 million
Non-Agency Fixed/Floating Rate Mortgage Securities.
The Company's investment portfolio has been reduced since December 31, 1997
through amortization, prepayments and selected sales.
Discount balances are accreted as an increase in interest income over the
life of discount investments and premium balances are amortized as a decrease in
interest income over the life of premium investments. At September 30, 1998, the
Company had on its balance sheet (excluding IOs) $48.9 million total unamortized
discount (which is the difference between the remaining principal value and the
current historical amortized cost of investments acquired at a price below
principal value) and $12.7 million unamortized premium (which is the difference
between the remaining principal amount and the current historical amortized cost
of investments acquired at a price above principal value). The Company also had
$50.0 million unamortized premium on IOs.
Mortgage principal repayments received were $240.3 million for the period
ended September 30, 1998. Given the Company's current portfolio composition, if
mortgage principal repayment rates increase over the life of the Mortgage
Securities comprising the current portfolio, all other factors being equal, the
Company's net interest income should decrease during the life of such Mortgage
Securities as the Company will be required to amortize its net premium balance
into income over a shorter time period. Similarly, if mortgage principal
prepayment rates decrease over the life of such Mortgage Securities, all other
factors being equal, the Company's net interest income should increase during
the life of such Mortgage Securities as the Company will amortize its net
premium balance over a longer time.
The table below summarizes the Company's investments at September 30, 1998.
SECURITIES (EXCLUDING IOs)
(dollars in thousands)
<TABLE>
<CAPTION>
Amortized Estimated Weighted
Cost to Fair Value Average
Principal Net Amortized Principal Estimated to Principal Life
Amount Discount Cost Amount Fair Value Amount (Years)
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $ 2,176,456 $ (36,547) $ 2,139,909 98.32% $ 2,167,774 99.60% 6.0
</TABLE>
MORTGAGE LOANS
(dollars in thousands)
<TABLE>
<CAPTION>
Amortized Estimated Weighted
Cost to Fair Value Average
Principal Net Amortized Principal Estimated to Principal Life
Amount Premium Cost Amount Fair Value Amount (Years)
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $ 8,899 $ 347 $ 9,246 103.90% $ 9,246 103.90% 2.6
</TABLE>
At September 30, 1998, the Company had borrowing outstanding from eight
lenders. Such borrowings are generally short-term (7-day or 30-day terms) and
may not be renewed by the lender at is discretion.
IO SECURITIES
(dollars in thousands)
<TABLE>
<CAPTION>
Amortized Estimated Weighted
Cost to Fair Value Average
Notional Net Amortized Notional Estimated to Notional Life
Amount Premium Cost (1) Amount Fair Value Amount (Years)
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $ 1,040,105 $ 50,039 $ 50,039 4.81% $ 47,419 4.56% 7.6
</TABLE>
---------------------
(1) After provision for impairment.
The table below shows unrealized gains and losses on the securities in the
Company's portfolio at September 30, 1998.
UNREALIZED GAINS AND LOSSES
<TABLE>
<CAPTION>
At September 30,
1998
(dollars in thousands)
<S> <C>
Unrealized Gain $ 48,997
Unrealized Loss (65,828)
Net Unrealized Loss (16,831)
Net Unrealized Loss as % of Investments Principal/Notional
Amount -0.52%
Net Unrealized Loss as % of Investments Amortized Cost -0.77%
</TABLE>
BORROWINGS
To date, the Company's debt has consisted entirely of borrowings
collateralized by a pledge of the Company's investments. These borrowings appear
on the balance sheet as repurchase agreements. At September 30, 1998, the
Company had established uncommitted borrowing facilities in this market with
twenty lenders. Substantially all of the Company's investments are currently
accepted as collateral for such borrowings. The Company has not established, and
currently does not intend to establish, permanent lines of credit. The Company
has obtained, and believes it will be able to continue to obtain, short-term
financing in amounts and at interest rates consistent with the Company's
financing objectives. At September 30, 1998, the Company had borrowings
outstanding from eight lenders. Such borrowings are generally short-term (7-day
or 30-day terms) and may not be renewed by the lender at its discretion. At
November 30, 1998, the Company had borrowings outstanding from eight lenders.
Certain lenders have reduced the funds available to the Company for certain less
liquid securities.
For the quarter ended September 30, 1998, the term to maturity of the
Company's borrowings has ranged from one day to five years, with a weighted
average remaining maturity of 411 days at September 30, 1998. At September 30,
1998, the Company had outstanding $2,029.8 million of repurchase agreements.
Approximately $600 million of the Company's borrowings have a cost of funds
which adjusts monthly based on a fixed spread over or under one-month LIBOR. At
September 30, 1998, the weighted average cost of funds for all of the Company's
borrowings was 5.79%. At September 30, 1998, Investments actually pledged had an
estimated fair value of $2,129.1 million.
At September 30, 1998, $500.0 million of the Company's Agency Fixed Rate
Pass-Throughs were subject to a repurchase agreement with a broker-dealer,
Merrill Lynch Government Securities, Inc., with a term of five years ending
March 10, 2003. The borrowing rate of this repurchase agreement is three-month
LIBOR plus 61.5 basis points and is capped at 6.365%.
LIQUIDITY
Liquidity, which is the Company's ability to turn non-cash assets into
cash, allows the Company to purchase additional securities and to pledge
additional assets to secure existing borrowings should the value of pledged
assets decline. Potential immediate sources of liquidity for the Company include
cash balances and unused borrowing capacity. Unused borrowing capacity will vary
over time as the market value of the Company's securities varies. The Company's
balance sheet also generates liquidity on an on-going basis through mortgage
principal repayments and net earnings held prior to payment as dividends. Should
the Company's needs ever exceed these on-going sources of liquidity plus the
immediate sources of liquidity discussed above, management believes that the
Company's securities could in most circumstances be sold to raise cash; however,
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 its REIT status.
Current trends in the financial markets (including the dislocation in the
market for fixed-income securities, the tightening of credit available for
investment in securities and the decrease in value of mortgage securities due to
prepayment risk) have had an adverse effect on the Company's ability to borrow
funds and may continue to have such an effect. To address concerns with respect
to possible decreased liquidity, the Company has begun to delever its portfolio
and sell securities. From September 30, 1998 through October 31, 1998, the
Company has sold approximately $1.1 billion of securities (agency fixed/floating
rate mortgage securities, agency fixed rate pass-through certificates, emerging
market securities, interest-only securities, principal-only securities and
interest rate swaps).
In June 1998, the Board of Directors increased the amount of Common Stock
authorized to be repurchased under the Company's stock repurchase program to $30
million. Pursuant to the repurchase program, to date the Company has repurchased
1,633,800 shares of Common Stock for $15.7 million in open market transactions.
Such purchases were made at a weighted average price per share of $9.63
(excluding commission costs). The repurchased shares have been returned to the
Company's authorized but unissued shares of common stock as treasury shares.
STOCKHOLDERS' EQUITY
The Company uses "available-for-sale" treatment for its securities; these
assets are carried on the balance sheet at estimated market value rather than
historical amortized cost. Based upon such "available-for-sale" treatment, the
Company's equity base at September 30, 1998 was $174.5 million, or $9.44 per
share. If the Company had used historical amortized cost accounting, the
Company's equity base at September 30, 1998 would have been $191.3 million, or
$10.35 per share.
With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact GAAP net income or taxable
income but rather are reflected on the balance sheet by changing the carrying
value of the assets and reflecting the change in stockholders' equity under
"Accumulated Other Comprehensive Income (Loss)" and in the statement of
operations under "Other Comprehensive Loss." By accounting for its assets in
this manner, the Company hopes to provide useful information to stockholders and
creditors and to preserve flexibility to sell assets in the future without
having to change accounting methods.
As a result of this mark-to-market accounting treatment, the book value and
book value per share of the Company are likely to fluctuate far more than if the
Company used historical amortized cost accounting. As a result, comparison with
companies that use historical cost accounting for some or all of their balance
sheet may be misleading.
Unrealized changes in the estimated net market value of securities have one
direct effect on the Company's potential earnings and dividends: positive
market-to-market changes will increase the Company's equity base and allow the
Company to increase its borrowing capacity while negative changes in the net
market value of the Company's securities might impair the Company's liquidity
position, requiring the Company to sell assets with the likely result of
realized losses upon sale. "Accumulated Other Comprehensive Income (Loss)" was
$(16.8) million, or (0.77)% of the amortized cost of securities at September 30,
1998.
The table below shows the Company's equity capital base as reported and on
a historical amortized cost basis at September 30, 1998. The historical cost
equity basis is influenced by issuances of Common Stock, the level of GAAP
earnings as compared to dividends declared, and other factors. The GAAP reported
equity base is influenced by these factors plus changes in the "Accumulated
Other Comprehensive Income" account.
STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Net Unrealized GAAP Historical GAAP
Historical Losses on Reported Amortized Reported
Amortized Assets Equity Cost Equity
Cost Equity Available Base Equity (Book Value
Base for Sale (Book Value) Per Share Per Share)
<S> <C> <C> <C> <C> <C>
At September 30, 1998 $ 191,314 $ (16,831) $ 174,483 $ 10.35 $ 9.44
</TABLE>
CAPITAL AND LEVERAGE POLICIES
The Company's operations are leveraged. Initially, the Company financed its
acquisition of Investments through proceeds of its initial public offering and
several private placements, and currently finances acquisitions primarily by
borrowing against or "leveraging" its existing portfolio and using the proceeds
to acquire additional Investments. The Company's target for its equity-to-assets
ratio depends on market conditions and other factors deemed relevant by the
Manager, subject to the review of the Company's Board of Directors. Currently,
the Company has been delevering, thereby increasing its equity-to-assets ratio.
At September 30, 1998, the Company's equity-to-assets ratio was 7.50%. At
October 31, 1998, the Company's equity-to-assets ratio was approximately 12.0%.
The equity-to-assets ratio is total stockholders' equity 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 Investments, the Company obtains
market quotes for its Investments from independent broker-dealers that make
markets in securities similar to those in the Company's portfolio. 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 Investments. These conditions could occur, for example, when, due to
interest rate fluctuations, interest income on the Company's Investments (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 enters into
hedging transactions in an effort to protect its assets and liabilities, such
hedging transactions include interest rate swaps, IOs, the purchase or sale of
interest rate collars, caps or floors and options.
INFLATION
Virtually all of the Company's assets and liabilities are 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 or results of operations will be influenced by inflation to
the extent interest rates are affected by inflation.
YEAR 2000 COMPLIANCE
The Company is substantially dependent upon the Manager's information
technology infrastructure. The Manager uses a significant number of computer
software programs and operating systems in its internal operations relating to
the management of the Company and its portfolio. The year 2000 issue is the
result of computer programs being written using two digits rather than four to
define the applicable year and impacts both information technology ("IT") and
non-IT systems. Any of the Company's or the Manager's computer programs that
have time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could cause the Company to incur expenses and
the risk and potential expense of any disruptions that may be caused by the
software's impaired functioning as the year 2000 approaches and by the
modification or replacement of such software. The Manager will bear the costs
associated with determining whether its systems are year 2000 compliant and the
costs of any necessary modifications or replacements.
The Manager has advised the Company that the Manager has reviewed its
computer systems in order to evaluate necessary modifications for year 2000
compliance. The Manager does not anticipate any material difficulties in
achieving year 2000 compliance with respect to the Manager's computer systems.
The Company has completed the process of identifying its IT systems that
are not year 2000 compliant. As the Company does not use any proprietary
software in its operations, the Company does not foresee any material issues or
costs associated with year 2000 compliance. The Company is currently in the
process of assessing its non- IT systems for year 2000 compliance.
The ability of third parties with whom the Company transacts business to
address adequately their year 2000 compliance is beyond the Company's control.
The Company has not started the process of contacting vendors and others with
whom the Company does significant business to determine their year 2000
compliance status and the extent to which the Company could be affected by any
third party year 2000 compliance issues. There can be no assurance that the
systems of other companies with whom the Company does business or on which the
Manager's systems rely will be timely converted, or that a failure to convert by
another company, or a conversion that is incompatible with the Manager's
systems, would not have a material adverse effect on the Company.
The costs incurred by the Company to address year 2000 compliance have not
had, and are not anticipated to have, a material adverse effect on the Company's
business, financial condition, results of operations or ability to sustain
growth. The costs are based on management's best estimates, which were derived
using numerous assumptions of future events including the continued availability
of certain resources, third party modification plans and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ from those plans.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133")
was issued and is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. SFAS No. 133 generally requires that entities recognize all
derivative financial instruments as assets or liabilities, measured at fair
value, and include in earnings the changes in the fair value of such assets and
liabilities. SFAS No. 133 also provides that changes in the fair value of assets
or liabilities being hedged with recognized derivative instruments be recognized
and included in earnings. The Company has not yet completed its evaluation of
SFAS No. 133, and therefore, at this time, cannot predict what, if any, effect
its adoption will have on the Company's financial condition or results of
operations.
BUSINESS
GENERAL
The Company is a specialty finance company, organized in September 1997,
that invests primarily in Mortgage Securities and Mortgage Loans. The Mortgage
Securities include Pass-Through Certificates, CMOs and other securities
representing interests in, or obligations backed by, pools of Mortgage Loans.
The Mortgage Loans are secured by first or second liens on single-family
residential, multi-family residential, commercial or other real property. See
"DESCRIPTION OF ASSETS."
The Board of Directors has directed the Manager to delever the Company's
portfolio by selling certain Securities in an attempt to reduce the portfolio's
susceptibility to basis and interest rate risk and to create additional
liquidity. From September 30, 1998 through November 30, 1998, the Company sold
approximately $1.1 billion of Mortgage Assets. The Manager has determined the
Company's net asset value as of November 30, 1998 to be between $7.50 and $8.00
per share. The net asset value as of such date reflects sales of Mortgage Assets
completed through November 30, 1998. Lehman Brothers, as financial adviser to
the Company, has attempted unsuccessfully to sell the Company. Lehman Brothers
is continuing to solicit bids on behalf of the Company.
The Company has elected to be taxed and intends to continue to qualify as a
REIT under the REIT Provisions of Code commencing with its short taxable year
ended December 31, 1997. The Company has qualified as a REIT for the taxable
year ended December 31, 1997 and, if the Company continues to qualify 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."
INVESTMENT STRATEGY
The Company was organized to create and manage an investment portfolio,
principally of Mortgage Assets, that, in combination with financing and hedging
activities, would generate income for distribution to its stockholders while
preserving the Company's capital base. During 1998, the Company maintained a
portfolio at its peak of approximately $3.8 billion of Mortgage Assets. However,
over recent months, the Manager has been directed to delever the Company's
portfolio of Mortgage Assets and to dispose of its illiquid securities.
The Company generally is authorized 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. At October 31, 1998, the Company's portfolio
consisted of 80.5% Agency Certificates, 3.3% CMOs, 0.9% Mortgage Loans, 4.1%
Mortgage Derivatives, all of which were IOs, 11.2% Subordinate Interests and 0%
other fixed-income securities.
As of December 31, 1997 and September 30, 1998, the asset balances of the
Company's portfolio consisted of: (i) $40.4 million and $60.3 million,
respectively, of securities which are rated within one of the two highest rating
categories by one of the Rating Agencies; (ii) $3,469.9 million and $2,009.1
million, respectively, of securities which are unrated but are guaranteed by the
US government or an agency or instrumentality thereof; (iii) $0 and $0,
respectively, of Mortgage Loans to borrowers who would otherwise meet FHLMC,
FNMA, or GNMA guidelines, except with respect to the size of the loans; (iv) $0
and $9.2 million, respectively, of Mortgage Loans (other than those included in
the 70% Asset Group); (v) $57.9 million and $125.6 million, respectively, of
retained Subordinate Interests; (vi) $48.5 million and $20.2 million,
respectively, of fixed-income securities (other than those included in the 70%
Asset Group) that are primarily Qualified Real Estate Assets; and (vii) $0 and
$0, respectively, of non-investment grade high yield corporate debt. See
"DESCRIPTION OF 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 consist of Qualified Real Estate Assets.
The Company is required to 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. At October 31, 1998, 89% of the Company's
total assets were in the 70% Asset Group.
The remainder of the Company's total assets, not to exceed 30%, may 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
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 has attempted to limit its investments in, and diversify its
portfolio of, securities in the 30% Asset Group. At October 31, 1998 11% of the
Company's total assets were in the 30% Asset Group.
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 Manager will determine which
rating it believes most accurately reflects the Mortgage Asset's quality and
risk at that time taking into account numerous factors, including the price of
the security, available public information regarding the issuer and liquidity
concerns. A rating is not a recommendation to buy, sell or hold a security,
inasmuch as such rating does not comment as to the market price of the security
or the suitability of the security for a particular investor. There is no
assurance that a rating will continue for any given period of time or that a
rating will not be lowered or withdrawn entirely by a Rating Agency if, in its
judgment, circumstances so warrant.
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 selects 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, for any other reasons, 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.
OPERATING POLICIES AND STRATEGIES
The Company adopted 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 determines 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 regularly monitors 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
Currently, the Company has been delevering, thereby increasing its
equity-to-assets ratio. At October 31, 1998, the Company's equity-to-assets
ratio was 12.0%, and has ranged from a high of 12.0% to a low of 5.9% during
1998.
Initially, the Company financed its acquisition of Mortgage Assets through
proceeds of its initial public offering and several private placements, and
currently finances any acquisitions primarily by borrowing against or
"leveraging" its existing portfolio and using the proceeds to acquire additional
Mortgage Assets. The Company's target for its equity-to-assets ratio depends 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 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 which were 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 endeavors 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, like first three quarters of 1998, 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.
SHORT-TERM BORROWING
Mortgage Assets, other than securitized Mortgage Loans, are financed
primarily at short-term borrowing rates through reverse repurchase agreements.
Reverse repurchase 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 that 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.
Reverse repurchase agreements are expected to continue to be the principal
means of leveraging the Company's Mortgage Assets. The Company enters into
reverse repurchase agreements with financially sound institutions, including
broker-dealers, commercial banks and other lenders.
Reverse repurchase agreements also 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 recently has been subject to numerous margin calls under its
collateralized borrowings and has been forced to sell Mortgage Assets to reduce
the amount borrowed which, at times, has resulted in losses to the Company. In
the third quarter of 1998, the Company realized a loss of $(22.0) million, or
$(1.17) per weighted average share on sales of Mortgage Securities and
terminations of interests rate swaps as the Company raised cash to meet
increased margin requirements.
As of the date of this Prospectus, the Company has met every margin call
initiated by its lenders despite the devaluation of the Company's portfolio,
which has substantially reduced the Company's liquidity. As of September 30,
1998, the Company's cash and cash equivalent balance was $24.7 million compared
to $82.6 million as of December 31, 1997. If the current depressed state of the
fixed income market persists, there can be no assurance that the Company will
continue to meet its margin calls. 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." The Company has been
liquidating, and will continue to liquidate, Mortgage Assets in such a manner to
maintain compliance with the REIT Provisions of the Code regarding asset and
source of income. Any failure by the Company to meet margin calls would have a
material adverse effect on the Company's financial condition, results of
operations and business.
INTEREST RATE RISK MANAGEMENT STRATEGY AND HEDGING ACTIVITIES
The Company follows 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. The Company enters into hedging transactions which include interest rate
swaps, the purchase or sale of interest rate collars, caps or floors, options
and IOs. These instruments are 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 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 seeks 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 seeks 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.
From inception through September 30, 1998, the Company used interest rate
swaps to hedge two different interest rate risks: changes in asset values and
interest expense due to fluctuations in interest rates. As interest rates
increased, the Company believed that interest rate swaps (i) would increase in
value to offset a decrease in value of its fixed-rate assets and (ii) would
create increased cash flow to offset any increased funding expense from the
Company's borrowings. During the first three quarters of 1998, the value of the
Company's interest rate swaps did not correlate as expected to the value of its
fixed-rate assets. As a result, the Company's hedges did not perform as
expected. The Company closed out all of its interest rate swaps in the second
through fourth quarters of 1998 at a loss of $62.5 million.
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.
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.
EMPLOYEES
The Company currently has six employees. The employees of the Company
provide various services relating to accounting and clearing and trading the
Company's portfolio of assets. The Manager employs five of the executive
officers of the Company and seven additional employees.
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.
DESCRIPTION OF ASSETS
The Company has acquired and intends to continue to acquire the following
types of investments subject to the operating restrictions described in
"BUSINESS--Operating Policies and Strategies."
MORTGAGE LOANS
The Company acquires and accumulates 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.
PASS-THROUGH CERTIFICATES
The Company's investments in Mortgage Securities are concentrated in
Pass-Through Certificates. The Pass-Through Certificates the Company acquires
consist primarily of fixed and adjustable rate Agency Certificates and
Privately-Issued Certificates and 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. 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 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.
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 11th 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.
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 invests, 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 acquires 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 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 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 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 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. In connection with the Company's investment in such securities,
particularly collateralized loan obligations and collateralized bond
obligations, the Company may pay fees to unrelated third-party managers in
addition to fees payable by the Company to the Manager. 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 has invested previously 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 has suffered significant
losses on its investments in emerging market sovereign debt securities, and the
Board of Directors has determined that the Company will no longer invest in such
securities.
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.
THE MANAGER
The day-to-day business and investment affairs of the Company is 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. Mr. Smirlock, the Chairman of the Board, a director and
majority stockholder of the Manager, is a director of the Company, and Mr.
Tepper, a director and minority stockholder of the Manager, is a former director
of the Company. The Manager employs investment professionals who have experience
in mortgage finance; however, neither the Manager nor its investment
professionals have previously managed another REIT.
On December 15, 1998, the Company was informed by the Manager of its
resignation as investment adviser to four of the Affiliated Funds, Steed Finance
LDC, Quarter Horse Finance Ltd., Shetland Fund Ltd. and Trakehner Fund L.P. The
Manager continues to manage investments for the Company and Mustang Investment
Limited Partnership. The Manager's employees currently spend approximately 85%
of their business time managing the Company. All of the Manager's resources,
including each of the employees, are devoted to all of its clients.
The directors and executive officers of the Manager are as follows:
NAME Age Position with the Manager
Michael L. Smirlock, Ph.D.* 41 Chairman of the Board and Director
Thomas G. Jonovich* 34 Chief Financial Officer
Peter T. Zimmermann* 31 Vice President and Director
Robert J. Gartner* 35 Vice President and Secretary
Jonathan Green* 35 General Counsel
David A. Tepper 40 Director
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* These persons also serve as directors or officers of the Company.
MICHAEL L. SMIRLOCK, Ph.D. has been the Chairman of the Board and a
director of the Manager since its inception and is one of its founders, and was
the Chief Executive Officer and President of the Manager until he resigned in
July 1998. Mr. Smirlock is also a director of the Company and was Chairman of
the Board, Chief Executive Officer and President of the Company until his
termination in July 1998. 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. 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 Vice President and a director of the Manager
since its inception. Mr. Zimmermann is also 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 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.
JONATHAN GREEN has been the General Counsel to the Manager since February
1998. He is also the General Counsel of the Company. From April 1996 until he
joined the Manager, Mr. Green was the General Counsel of Appaloosa Management
L.P. Previously, Mr. Green had worked as an associate at the law firm Coudert
Brothers from September 1990.
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 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 a minority stockholder of the Manager.
The address of the Manager is 51 John F. Kennedy Parkway, Short Hills, New
Jersey 07078.
CEASE-AND-DESIST ORDER AGAINST MR. SMIRLOCK
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. As a result of circumstances described under
"PROSPECTUS SUMMARY-Recent Developments" and "RISK FACTORS-Pricing
Irregularities Detected in One of the Affiliated Funds Resulted in Termination
of the Company's Chief Executive Officer," Mr. Smirlock resigned from his
position as Chief Executive Officer of the Manager, and the Company's Board of
Directors terminated Mr. Smirlock's employment as Chief Executive Officer and
President of the Company and removed Mr. Smirlock as Chairman of the Board of
the Company. Mr. Smirlock remains a director of the Company, although the Board
of Directors has asked for his resignation.
THE MANAGEMENT AGREEMENT
The Company entered into the Management Agreement with the Manager for an
initial term expiring on December 31, 2002. The Management Agreement continues
automatically for successive three-year periods, provided such continuance is
specifically approved by the Board of Directors, including 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 delegates to it. The Manager is 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 is
responsible for the day-to-day operations of the Company and performs (or causes
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;
(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
For its performance of these services, the Manager receives a quarterly
base management fee of $225,000, payable monthly. 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 Company and the Manager have agreed that the provision for
impairment charge on the IOs in the Company's portfolio is not a mark-to-market
adjustment for purposes of these calculations.
The Manager also is 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 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 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 values 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 are 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 are 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. For the nine months ended
September 30, 1998, management fees amounted to $2.0 million and incentive fees
were $1.4 million.
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. In 1997, options were 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) were granted to directors, officers, employees and
consultants of the Company. The Company also granted 400,000 shares of deferred
Common Stock to certain of its directors and officers in 1997. See "THE
COMPANY--Stock Incentive Plan."
LIMITS OF RESPONSIBILITY
Pursuant to the Management Agreement, the Manager shall 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.
THE COMPANY
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information regarding the current
directors and executive officers of the Company:
NAME Age Position with the Company
Frederick N. Khedouri 47 President and Director
Thomas G. Jonovich 34 Chief Financial Officer and Treasurer
Peter T. Zimmermann 31 Vice President and Chief Operating Officer
Robert J. Gartner 35 Vice President and Secretary
Jonathan Green 35 General Counsel
Thomas H. Luehs 36 Controller
Stuart H. Coleman 44 Director
Jonathan Ilany 46 Director
Michael L. Smirlock, Ph.D. 41 Director
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For biographical information regarding the business background and
experience of the Company's directors and officers other than Messrs. Khedouri,
Luehs, Coleman and Ilany, see "THE MANAGER."
FREDERICK N. KHEDOURI has been President of the Company since August 1998.
Mr. Khedouri is a Senior Managing Director of Bear, Stearns 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.
THOMAS H. LUEHS has been the Controller of the Company since April 1998.
From November 1993 until he joined the Company in November 1997, Mr. Luehs was
employed by Lexington Management Corporation, a registered investment adviser,
where he was Assistant Treasurer for fourteen of the funds managed by Lexington
Management Corporation. From 1986 until he joined Lexington Management
Corporation, Mr. Luehs was a Supervisor in investment accounting with Alliance
Capital Management L.P., a registered investment adviser.
STUART H. COLEMAN has been a partner in the law firm of Stroock & Stroock &
Lavan LLP in New York, New York for more than five years. Such firm and Mr.
Coleman have performed legal services for the Company. The aggregate amount of
fees paid by the Company to Stroock & Stroock & Lavan LLP was less than 5% of
the law firm's gross revenues for the last fiscal year.
JONATHAN ILANY is the Chief Executive Officer and a director of
Angiosonics, Inc., a private medical device company with operations in the
United States and Israel. Prior to joining Angiosonics, Inc. in 1996, Mr. Ilany
was, since 1987, a Senior Managing Director of Bear, Stearns, and served on the
Board of Directors of The Bear Stearns Companies Inc. until 1995. Mr. Ilany
holds a B.A. and an M.B.A. from the University of San Francisco.
The Company's Board of Directors consists of four 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. Coleman, Class II--Mr.
Khedouri, and Class III--Messrs. Ilany and Smirlock. 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 has two standing committees: the Compensation
Committee and the Audit Committee. The Independent Directors, Messrs. Coleman,
Ilany and Khedouri, serve on the Compensation Committee and the Audit Committee.
The Compensation Committee is 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." 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 is administered by the
Compensation Committee. 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. 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 have been 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 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.
GRANTS OF AWARDS
In connection with the Public 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:
NAME OR GROUP Deferred Stock
COMMON STOCK(1) OPTIONS(2)
Types of Awards and Number of
Shares of Common Stock
SUBJECT TO AWARDS
Michael L. Smirlock (3) 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
- -----------
(1) The deferral period expires 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 are 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 are exercisable
in full upon the earlier occurrence of an Acceleration Event.
(3) Prior to Mr. Smirlock's termination in July 1998, 60,000 shares of
deferred Common Stock and 120,000 stock options had vested.
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.
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
AND CONFLICTS OF INTEREST
The Company is subject to conflicts of interest involving the Manager. The
executive officers of the Company are officers and employees of the Manager. A
majority of the Company's directors have no business affiliations with the
Manager, but two were initially selected by the Manager. Michael L. Smirlock, a
director of the Company, is the owner of a majority of the capital stock and a
director 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 to engage in
any business or render 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
invests primarily in Mortgage Assets and follows 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
invested in the Company's securities. See "THE OFFERING AND 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
earned 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."
For the nine months ended September 30, 1998, management fees amounted to
$2.0 million and incentive fees were $1.4 million.
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.
The Manager, its Affiliates and the funds managed by Appaloosa have
purchased an aggregate of 714,235 shares of Common Stock as part of the Private
Placement. See "THE OFFERING AND PRIVATE PLACEMENT." This purchase resulted in
ownership by all such persons of approximately 3.6% of the total shares
outstanding after the Public Offering, exclusive of 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 of which this
Prospectus forms a part. 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.
The market in which the Company purchases 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
President and a director of the Company and has purchased 10,000 shares at the
initial public offering price in the Private Placement and an additional 25,000
shares in the public market. Bear, Stearns provides financial advisory services
to the Company and its Affiliates.
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company's Common Stock as of October
31, 1998, by (i) each director and executive officer, (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.
Shares
BENEFICIALLY OWNED
NAME AND ADDRESS OF BENEFICIAL OWNER (1) Number
- ---------------------------------------- OF SHARES PERCENT
--------- -------
Frederick N. Khedouri (2) 32,500 *
Thomas G. Jonovich (3) 8,000 *
Peter T. Zimmermann (4) 63,750 *
Robert Gartner (5) 31,750 *
Jonathan Green 1,032 *
Thomas H. Luehs (2) 2,500 *
Stuart H. Coleman 0 *
Jonathan Ilany 0 *
Michael L. Smirlock, Ph.D. (6) 253,000 1.4%
Franklin Mutual Advisers Inc. (7) 2,525,933 13.7%
President and Fellows of Harvard College (8) 3,011,800 16.3%
Kingdon Capital Management, LLC (9) 1,627,100 8.8%
Legg Mason, Inc. (10) 1,528,700 8.3%
Perry Corp. (11) 1,160,000 6.3%
All directors and executive officers
as a group (9 persons) 392,532 2.1%
----------------
* 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. Coleman's address is c/o Stroock & Stroock & Lavan
LLP, 180 Maiden Lane, New York, New York 10038. Mr. Ilany's address is c/o
Angiosonics Inc., 2200 Gateway Centre Blvd., Suite 207, Morrisville, North
Carolina 27560. Mr. Khedouri's address is c/o Bear, Stearns & Co. Inc., 245
Park Avenue, New York, New York 10167. The address of Franklin Mutual
Advisers Inc. is 51 John F. Kennedy Parkway, Short Hills, New Jersey 07078.
The address of President and Fellows of Harvard College is c/o Harvard
Management Company Inc., 600 Atlantic Avenue, Boston, Massachusetts 02210.
The address of Legg Mason, Inc. is 100 Light Street, Baltimore, Maryland
21202. The address of Perry Corp. is 599 Lexington Avenue, New York, New
York 10022.
(2) Includes 2,500 options which are currently exercisable.
(3) Includes 7,000 options which are currently exercisable.
(4) Includes 11,250 shares of deferred common stock which have vested and
27,500 options which are currently exercisable.
(5) Includes 3,750 shares of deferred common
stock which have vested and 18,000 options which are currently exercisable.
(6) Includes 60,000 shares of deferred Common Stock and 120,000 options which
vested prior to his termination in July 1998.
(7) Based on information provided by Franklin Mutual Advisers Inc. on May 20,
1998. Includes all of the shares of common stock owned beneficially by a
series of mutual funds advised by Franklin Mutual Advisers Inc.
(8) Based on Schedule 13(G/A) filed on August 10, 1998.
(9) Based on Schedule 13(G) filed on October 1, 1998.
(10) Based on Schedule 13(G) filed on February 12, 1998. Includes all of the
shares of common stock owned beneficially by a series of mutual funds
advised by Legg Mason, Inc.
(11) Based on Schedule 13(G) filed on February 18, 1998.
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 elected 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 ended December 31, 1997, and such election has not been revoked.
The Company has qualified as a REIT for the taxable year ended December 31,
1997, and currently expects that it will continue to operate in a manner that
will permit the Company to maintain its qualification as a REIT for the taxable
year ending December 31, 1998, 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 has
qualified as a REIT for the taxable year ended December 31, 1997, and the
Company's 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 for the taxable year ending December 31, 1998 and
thereafter. 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 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. If the Company did not know, or have reason to know,
that its capital stock was owned directly or indirectly by five or fewer
individuals, it will be treated as having more than five owners as long as it
complied with Treasury regulations that provide rules on ascertaining actual
ownership. 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), 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 and 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), 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 President's budget proposal would require that no more
than 50% of the vote or value of all classes of the Company's capital
stock be owned by five or fewer individuals. This proposal would be
effective for entities electing REIT status for taxable years beginning
on or after the date of the first Committee action.
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 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,
future contracts, 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.
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
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 also may 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.
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 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.
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 treated as such 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. U.S. stockholders that are corporations may, however, be required to
treat up to 20% of certain capital gain dividends as ordinary income.
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
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.
The Company does not 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 enters 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.
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. 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 20%.
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 reports 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, 1999,
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 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, 1999, 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 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.
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 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 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.
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 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 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 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 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 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 shares
acquisition" statute. No assurance can be given, however, that such Bylaw
provision may not removed at any time by amendment of the Bylaws.
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"). As of the date of the filing of this Registration Statement, 18,466,199
shares of Common Stock are issued and outstanding and no Preferred Stock will be
issued and outstanding.
COMMON STOCK
All outstanding shares of Common Stock are duly authorized, fully paid and
nonassessable. 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.
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 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 or
partnership, 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, 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.
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 December 2, 1997 (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.
The Funds purchased 3,333,333 shares of Common Stock from the Company in
the Private Placement. See "Public Offering" and "Private Placement." The Board
of Directors waived the Ownership Limit for the Funds and their Affiliates and
the Funds 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. 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.
Harvard beneficially owns 3,011,800 shares of Common Stock of the Company.
The Board of Directors waived the Ownership Limit for Harvard. Any subsequent
transfer of the Shares held by Harvard and its Affiliates will be subject to the
Ownership Limt, unless specifically exempted by the Company's Board of
Directors.
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.
SELLING STOCKHOLDERS
This Prospectus relates to the offer and sale from time to time of
4,087,099 shares of Common Stock. The Shares are offered by the Selling
Stockholders identified in the table below. It is unknown if, when, or in what
amounts a Selling Stockholder may offer the Shares for sale. There is no
assurance that the Selling Stockholders will sell any or all of the Shares
offered hereby.
In addition, in the Purchase Agreements (the "Purchase Agreement"), the
Company has agreed to indemnify the Selling Stockholders against certain civil
liabilities, including liabilities under the Securities Act, or to contribute to
payments the Selling Stockholders may be required to make in respect thereof.
Insofar as indemnification of the Selling Stockholders for liabilities arising
under the Securities Act may be permitted pursuant to such agreements, the
Company has been informed that, in the opinion of the Commission, such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
Because the Selling Stockholders may offer all or some of the Shares
pursuant to the Offering, and because there are currently no agreements,
arrangements or understandings with respect to the sale of any of the Shares
that will be held by the Selling Stockholders after completion of the Offering,
no estimate can be given as to the amount of the Shares that will be held by the
Selling Stockholders after completion of the Offering.
The Selling Stockholders and any broker or dealer to or through whom any of
the Shares are sold may be deemed to be underwriters within the meaning of the
Securities Act with respect to the Shares offered hereby, and any profits
realized by the Selling Stockholders are not expected to exceed normal selling
expenses for sales. The registration of the Shares under the Securities Act
shall not be deemed an admission by the Selling Stockholders or the Company that
the Selling Stockholders are underwriters for purposes of the Securities Act of
any Shares offered under this Prospectus.
The Selling Stockholders purchased the Shares in connection with private
placement transactions. In connection with the purchase of such Shares, each
Selling Stockholder entered into a purchase agreement pursuant to which such
Selling Stockholder represented that he, she or it was acquiring the Shares for
investment and with no present intention of distributing the Shares. In
accordance with the Purchase Agreements, which contain customary representations
and warranties relating to the Company, this Prospectus (and the registration
statement of which it is a part) relates to sales of the Shares by the Selling
Stockholders, subject to the terms and conditions set forth in the Purchase
Agreements. The Company agreed, in the Purchase Agreements, to bear all expenses
other than fees and expenses of counsel for a Selling Stockholder and
underwriting discounts and commissions and brokerage commissions and fees. The
Company has agreed to prepare and file such amendments and supplements to the
Registration Statement as may be necessary to keep the Registration Statement
effective until all Shares offered hereby have been sold pursuant hereto or
until such Shares are no longer, by reason of Rule 144 under the Securities Act
or any other rule of similar effect, required to be registered for the sale
thereof by the Selling Stockholders.
The following table sets forth the name of each Selling Stockholder and the
number of shares and percentage of Common Stock owned beneficially by each
Selling Stockholder as of September 30, 1998. The Company will not receive any
of the proceeds from the sale of Shares by the Selling Stockholders.
Shares of Common Stock
Beneficially Owned
PRIOR TO OFFERING(1)
NAME OF SELLING STOCKHOLDER NUMBER Percent
Robert J. Gartner (2) 10,000 *
Ahkil A. Vasvani 1,000 *
Peter T. Zimmermann (3) 25,000 *
Ronald M. Goldstein 10,000 *
James E. Bolin 4,500 *
John Jakubowski 300 *
Devra E. Karlebach 333 *
Michael L. Smirlock (4) 73,000 *
Jonathan Green (5) 1,032 *
Thomas G. Jonovich (6) 1,000 *
The Tepper Family Irrevocable Trust 14,600 *
Abigail Fournier 1,200 *
Elizabeth Fournier 1,200 *
Alan P. Fournier 17,600 *
David A. Tepper (7) 103,000 *
Appaloosa Investment
Limited Partnership I (8) 586,235 3.2%
Lawrence P. O'Friel 2,000 *
John C. Walton 10,000 *
The Walton Family Irrevocable Trust 5,000 *
Frederick N. Khedouri (9) 30,000 *
Mutual Beacon Fund (10) 255,000 1.4%
Mutual Discovery Fund (10) 1,141,933 6.2%
Mutual Finance Services Fund (10) 212,300 1.2%
Mutual Qualified Fund (10) 220,000 1.2%
Mutual Shares Fund (10) 332,200 1.8%
Mutual Discovery Securities Fund (11) 94,000 *
Mutual Shares Securities Fund (11) 215,000 1.2%
Mutual Beacon Fund (12) 53,000 *
Merrill Lynch Pierce Fenner & Smith 666,666 3.6%
- ----------------------------
* Less than one percent
(1) Unless otherwise indicated, the Selling Stockholders named in the table
have sole voting and sole investment power with respect to all shares
beneficially owned.
(2) Mr. Gartner is Vice President and Secretary of the Company.
(3) Mr. Zimmermann is Vice President and Chief Operating Officer of the
Company.
(4) Mr. Smirlock is a director of the Company.
(5) Mr. Green is General Counsel of the Company.
(6) Mr. Jonovich is the Chief Financial Officer and Treasurer of the Company.
(7) Mr. Tepper is a former director of the Company.
(8) Mr. Tepper, a former director of the Company, exercises sole voting and
investment power over the shares held by Appaloosa Investment Limited
Partnership I.
(9) Of the 30,000 shares of Common Stock beneficially owned by Mr. Khedouri,
only 10,000 shares are being offered hereby. Mr. Khedouri is the President
and a director of the Company.
(10) Each, a series of Franklin Mutual Series Fund Inc. and one of the Funds.
(11) Each, a series of Franklin Valuemark Funds and one of the Funds.
(12) One of the Funds.
PLAN OF DISTRIBUTION
The Company will not receive any of the proceeds from the sale of the
Shares offered hereby. The Selling Stockholders may sell all or a portion of the
Shares from time to time while the registration statement of which this
Prospectus is a part remains effective. The Company has agreed to maintain the
effectiveness of such registration statement until the date all of the Shares
offered hereby have been sold or withdrawn from registration by them. To the
extent required, the number of Shares to be sold, the names of the Selling
Stockholders, the purchase price, the name of any agent or dealer and any
applicable commissions with respect to a particular offer will be set forth in
an accompanying supplement to this Prospectus. The aggregate proceeds to the
Selling Stockholders from the sale of the Shares offered hereby will be the
prices at which such securities are sold, less any commissions.
The Shares may be sold by the Selling Stockholders in transactions on the
over-the-counter market, in negotiated transactions, or by a combination of
these methods, at fixed prices that may be changed, at market prices prevailing
at the time of sale, at prices related to such market prices or at negotiated
prices. A Selling Stockholder may elect to engage a broker or dealer to effect
sales in one or more of the following transactions: (a) block trades in which
the broker or dealer so engaged will attempt to sell the converted shares as
agent but may position and resell a portion of the block as principal to
facilitate the transaction, (b) purchases by a broker or dealer as principal and
resale by such broker or dealer for its account pursuant to this Prospectus, and
(c) ordinary brokerage transactions and transactions in which the broker
solicits purchasers, (d) pro rata distributions as part of the liquidation and
winding up of the affairs of the Selling Stockholders, (e) privately negotiated
transactions and (f) exchange distributions and/or secondary distributions in
accordance with the rules of the NYSE. In effecting sales, brokers and dealers
engaged by Selling Stockholders may arrange for other brokers or dealers to
participate. Brokers or dealers may receive commissions or discounts from
Selling Stockholders in amounts to be negotiated (and, if such broker-dealer
acts as agent for the purchaser of such shares, from such purchaser).
Broker-dealers may agree with the Selling Stockholders to sell a specified
number of such shares at a stipulated price per share, and, to the extent such
broker-dealer is unable to do so acting as agent for a Selling Stockholder, to
purchase as principal any unsold shares at the price required to fulfill the
broker-dealer commitment to such Selling Stockholder.
Broker-dealers who acquire shares as principal may thereafter resell such
shares from time to time in transactions (which may involve crosses and block
transactions and sales to and through other broker-dealers, including
transactions of the nature described above) in the over-the-counter market or
otherwise at prices and on terms then prevailing at the time of sale, at prices
then related to the then-current market price or in negotiated transactions and,
in connection with such resales, may pay to or receive from the purchasers of
such shares commissions as described above. The Selling Stockholders may also
pledge such shares to banks, brokers or other financial institutions as security
for margin loans or other financial accommodations that may be extended to such
Selling Stockholders, and any such bank, broker or other institution may
similarly offer, sell and effect transactions in such shares.
The Selling Stockholders may from time to time deliver all or a portion of
the Shares to cover a short sale or sales upon the exercise, settlement, or
closing of a call equivalent position or a put equivalent position.
The Selling Stockholders may sell all or any portion of the Shares in
reliance upon Rule 144 under the Securities Act. Shares not sold pursuant to the
Registration Statement of which this Prospectus is a part may be subject to
certain restrictions under the Securities Act and could be sold, if at all, only
pursuant to Rule 144 or another exemption from the registration requirements of
the Securities Act. In general, under Rule 144, a person (or persons whose
Shares are aggregated) who has satisfied a one-year holding period may, under
certain circumstances, sell within any three-month period a number of Shares
which does not exceed the greater of one percent of the Company's outstanding
shares of Common Sock or the average weekly reported trading volume of the
Company's Common Stock during the four calendar weeks prior to such sale. Rule
144 also permits, under certain circumstances, the sale of Shares by a person
who is not an affiliate of the Company and who has satisfied a two-year holding
period without any volume limitation. Therefore, both during and after the
effectiveness of the Registration Statement, sales of the Shares may be made by
the Selling Stockholders pursuant to Rule 144.
The Selling Stockholders and any broker-dealers or agents that participate
with the Selling Stockholders in sales of the Shares may be deemed to be
"underwriters" within the meaning of the Securities Act in connection with such
sales. In such event, any commissions received by such broker-dealers or agents
and any profit on the resale of the Shares purchased by them may be deemed to be
underwriting commissions or discounts under the Securities Act.
The Company will pay all expenses incident to the offering and sale of the
Shares to the public other than underwriting discounts and selling commissions.
The Company and the Selling Stockholders may agree to indemnify certain
persons, including broker-dealers or others, against certain liabilities in
connection with the offering of the Shares, including liabilities under the
Securities Act.
PUBLIC OFFERING
The Underwriters of the Public Offering purchased from the Company an
aggregate of 15,000,000 shares of Common Stock. Consummation of the Private
Placement was contingent upon and occurred simultaneous with the closing of the
Public Offering on December 2, 1997.
PRIVATE PLACEMENT
On December 2, 1997, the Company sold, in a private placement, 1,014,000
shares of Common Stock at the initial public offering price to certain officers,
directors, proposed directors, employees and Affiliates of the Company and the
Manager. On December 2, 1997, the Company sold, in a private placement,
3,333,333 shares of Common Stock at the initial public offering price to the
Funds. 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, Mustang Investment Limited Partnership, 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 a
private placement.
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.
LEGAL MATTERS
Certain legal matters with respect to the shares of Common Stock offered
hereby have been passed upon for the Company by Stroock & Stroock & Lavan LLP,
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 financial statements of the Company as of December 31, 1997, included
in this Prospectus are 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.
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 of 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.
"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 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.
"Board of Directors" means the Board of Directors of the Company.
"Bylaws" means the Bylaws, as amended, of the Company.
"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."
"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.
"DOL" means the U.S. Department of Labor.
"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.
"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.
"Funds" means the several mutual funds advised by Franklin Mutual Advisers
Inc. purchasing in the Private Placement.
"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.
"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.
"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.
"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 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.
"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.
"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, futures contracts, 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 offering from time to time of up to 4,087,099 shares
of Common Stock of the Company by the Selling Stockholders.
"One Hundred Stockholder Date" means December 2, 1997.
"Order" means the order of the Commission issued on November 29, 1993
pursuant to Sections 203(f) and 203(k) 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 Goldman Sachs Asset
Management.
"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 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.
"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.
"Public Offering" means the initial public offering of the Company's Common
Stock described herein under the caption "Public Offering" completed on December
2, 1997.
"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)(5)(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.
"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.
"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 or
regular interests in a FASIT (except that, if less than 95% of the assets of a
REMIC or FASIT 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 or FASIT), shares 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.
"Shares" means up to 4,087,099 shares of Common Stock of the Company to be
offered from time to time by the Selling Stockholders.
"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, her 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.
"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.
"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.
"Underwriters" means the underwriters acting as underwriters of the Public
Offering.
"Yield Curve" means the relationship between short-term and long-term
interest rates.
<PAGE>
INDEX TO FINANCIAL STATEMENTS
PAGE
INDEPENDENT AUDITORS' REPORT F-2
AUDITED FINANCIAL STATEMENTS:
Balance Sheet - December 31, 1997 F-3
Statement of Operations for the period November 26, 1997
(Commencement of Operations) through December 31, 1997 F-4
Statement of Stockholders' Equity for the period November 26, 1997
(Commencement of Operations) through December 31, 1997 F-5
Statement of Cash Flows for the period November 26, 1997
(Commencement of Operations) through December 31, 1997 F-6
Notes to Financial Statements F-7
UNAUDITED FINANCIAL STATEMENTS:
Balance Sheet at September 30, 1998 F-13
Statement of Operations for the
nine months ended September 30, 1998 F-14
Statement of Stockholders' Equity for the
nine months ended September 30, 1998 F-15
Statement of Cash Flows for the nine
months ended September 30, 1998 F-16
Notes to Unaudited Financial Statements
for the nine months ended September 30, 1998 F-18
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders of
LASER Mortgage Management, Inc.
We have audited the accompanying balance sheet of LASER Mortgage Management,
Inc. (the "Company") as of December 31, 1997, and the related statements of
operations, stockholders' equity and cash flows for the period November 26, 1997
(commencement of operations) through December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion. In our
opinion, such financial statements present fairly, in all material respects, the
financial position of the Company at December 31, 1997 and the results of its
operations and its cash flows for the period November 26, 1997 (commencement of
operations) through December 31, 1997 in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
March 6, 1998
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
BALANCE SHEET
DECEMBER 31, 1997
- ----------------------------------------------------------------------------------
ASSETS
<S> <C>
CASH AND CASH EQUIVALENTS $ 82,626,526
RECEIVABLE FOR SECURITIES SOLD 67,208,943
INVESTMENT IN SECURITIES AT FAIR VALUE 3,616,733,170
ACCRUED INTEREST RECEIVABLE 21,170,369
VARIATION MARGIN ON INTEREST RATE SWAPS 5,500,000
--------------------
TOTAL ASSETS $ 3,793,239,008
==================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements $ 2,747,060,588
Payable for securities purchased 747,594,232
Accrued interest payable 8,348,831
Contractual commitments at fair value 3,114,900
Dividends payable 2,602,600
Accounts payable 2,084,037
------------------
Total liabilities 3,510,805,188
STOCKHOLDERS' EQUITY:
Common stock: par value $.001 per share;
100,000,000 authorized, 20,019,999
shares issued and outstanding 20,020
Additional paid-in capital 281,840,175
Net unrealized gain on investment in securities 603,821
Accumulated deficit (30,196)
----------------------
Total stockholders' equity 282,433,820
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,793,239,008
==================
See notes to financial statements.
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS
FOR THE PERIOD NOVEMBER 26, 1997 (COMMENCEMENT OF OPERATIONS)
THROUGH DECEMBER 31, 1997
- --------------------------------------------------------------------------------------
INTEREST INCOME:
<S> <C>
Long-term securities $ 10,078,047
Cash and cash equivalents 810,880
--------
Total interest income 10,888,927
INTEREST EXPENSE:
Repurchase agreements 8,489,381
NET INTEREST INCOME 2,399,546
GAIN ON SALE OF SECURITIES 588,289
GENERAL AND ADMINISTRATIVE EXPENSES 415,431
NET INCOME $ 2,572,404
=================
NET INCOME PER SHARE:
Basic $0.13
Diluted $0.13
AVERAGE NUMBER OF SHARES OUTSTANDING 20,019,999
See notes to financial statements.
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 26, 1997 (C0MMENCEMENT OF OPERATIONS)
THROUGH DECEMBER 31, 1997
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
Common Additional Net
Stock Paid-in Unrealized Retained
Par Value Capital Gain Earnings Total
BALANCE,
<S> <C> <C> <C> <C> <C>
NOVEMBER 26, 1997 $ 6 $ 14,999 $ - $ - $ 15,005
Issuance of common stock 20,014 281,825,176 - - 281,845,190
Available for sale securities -
fair value adjustment - - 603,821 - 603,821
Net income - - - 2,572,404 2,572,404
Dividends declared -
$0.13 per share - - - (2,602,600) (2,602,600)
-------- ------------- ---------- ------------- --------------
BALANCE,
DECEMBER 31, 1997 $ 20,020 $ 281,840,175 $ 603,821 $ (30,196) $ 282,433,820
======== ============= ========== ============ ============
See notes to financial statements.
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
STATEMENT OF CASH FLOWS
FOR THE PERIOD NOVEMBER 26, 1997 (C0MMENCEMENT OF OPERATIONS)
THROUGH DECEMBER 31, 1997
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C>
Net income $ 2,572,404
------------
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of mortgage premiums and discounts, net 899,182
Gain on sale of securities (588,289)
Increase in accrued interest receivable (21,170,369)
Increase in variation margin on securities (5,500,000)
Increase in accrued interest payable 8,348,831
Increase in accrued expenses and other liabilities 2,084,037
Net cash used in operating activities (13,354,204)
----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities (4,098,377,223)
Payable for securities purchased 747,594,232
Proceeds from sale of securities 483,980,452
Receivable for securities sold (67,208,943)
Principal payments on securities 1,071,429
----------------------
Net cash used in investing activities (2,932,940,053)
---------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements 2,854,535,588
Principal payments on repurchase agreements (107,475,000)
Net proceeds from issuance of common stock 281,860,195
---------------------
Net cash provided by financing activities 3,028,920,783
--------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 82,626,526
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD -
----------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 82,626,526
=====================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 140,550
======================
Noncash financing activities:
Net unrealized gain on available-for-sale securities $ 603,821
======================
Dividends declared, not yet paid $ 2,602,600
=====================
See notes to financial statements.
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD NOVEMBER 26, 1997 (COMMENCEMENT OF OPERATIONS)
THROUGH DECEMBER 31, 1997
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
LASER Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on September 3, 1997. The Company commenced its operations on
November 26, 1997 (see Note 5).
A summary of the Company's significant accounting policies follows:
CASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on hand
and overnight repurchase agreements. The carrying amounts of cash
equivalents approximates their value.
MORTGAGE ASSETS - The Company invests primarily in mortgage backed
securities and mortgage loans. The mortgage backed securities 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 are 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").
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the
Company to classify its investments as either trading investments,
available-for-sale investments or held-to-maturity investments. Although
the Company generally intends to hold most of its Mortgage Assets until
maturity, it may, from time to time, sell any of its Mortgage Assets as
part of its overall management of its balance sheet. Accordingly, this
flexibility requires the Company to classify all of its Mortgage Assets as
available-for-sale. All assets classified as available-for-sale are
reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of stockholders' equity.
Unrealized losses on Mortgage Assets that are considered other than
temporary, as measured by the amount of decline in fair value attributable
to factors other than temporary, are recognized in income and the cost
basis of the Mortgage Assets is adjusted. At December 31, 1997, no such
adjustments were needed.
Interest income is accrued based on the outstanding principal amount of the
Mortgage Assets and their contractual terms. For available-for-sale
securities, premiums and discounts associated with the purchase of the
Mortgage Assets are amortized into interest income over the lives of the
securities using the effective yield method.
Mortgage Asset transactions are recorded on the date the securities are
purchased or sold. Purchases of newly-issued securities are recorded when
all significant uncertainties regarding the characteristics of the
securities are removed, generally shortly before settlement date. Realized
gains and losses on Mortgage Asset transactions are determined on the
specific identification basis.
INTEREST RATE SWAPS - In a simple interest rate swap, one investor pays a
floating rate of interest on a notional principal amount and receives a
fixed rate of interest on the same notional principal amount for a
specified period of time. Alternatively, an investor may pay a fixed rate
and receive a floating rate. Interest rate swaps were conceived as
asset/liability management tools and are used for various hedging
activities. In more complex interest rate swaps, the notional principal
amount may decline (or amortize) over time.
During the term of the interest rate swap, changes in value are recognized
on the balance sheet as contractual commitments receivable/payable with the
corresponding amount included as an unrealized gain/loss on investments in
securities included in stockholders' equity. When the interest rate swap is
terminated, the Company will record a realized gain or loss equal to the
difference between the proceeds from (or cost of) the closing transaction
and the Company's basis in the contract, if any.
The Company is exposed to credit loss in the event of nonperformance by the
other party to the interest rate swap. However, the Company does not
anticipate nonperformance by any counterparty.
CREDIT RISK - The Company intends to invest primarily in Mortgage Assets
which would be classified in the 70% Asset Group. The "70% Asset Group" is
comprised of (i) securities which are rated within one of the two highest
rating categories by one of the nationally-recognized 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. The "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, as well as Mortgage Loans and Mortgage
Securities that constitute the 30% Asset Group.
INCOME TAXES - The Company will elect to be taxed as a Real Estate
Investment Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code") with respect
thereto. Accordingly, the Company should not be subjected to Federal income
tax to the extent of its distributions to stockholders and as long as
certain asset, income and stock ownership tests are met.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
2. AVAILABLE-FOR-SALE INVESTMENTS
The following table pertains to the Company's securities classified as
available-for-sale investments as of December 31, 1997 which are carried at
their fair value:
<TABLE>
<CAPTION>
FEDERAL FEDERAL GOVERNMENT
EMERGING HOME LOAN NATIONAL NATIONAL TOTAL
MARKETS MORTGAGE MORTGAGE MORTGAGE PRIVATE AVAILABLE
BONDS CORPORATION ASSOCIATION ASSOCIATION ISSUES FOR SALE
<S> <C> <C> <C> <C> <C> <C>
Securities, gross $52,221,550 $618,386,967 $3,121,690,958 $255,090,965 $402,265,526 $4,449,655,966
Unamortized discount (3,915,578) (13,122,493) (543,928,304) (2,349,479) (302,114,463) (865,430,317)
Unamortized premium 415,210 6,233,721 20,872,533 969,464 297,872 28,788,800
----------- ------------ -------------- ------------ ------------ ---------------
Amortized cost 48,721,182 611,498,195 2,598,635,187 253,710,950 100,448,935 3,613,014,449
Gross unrealized gains 54,033 2,440,679 11,245,732 767,922 252,415 14,760,781
Gross unrealized losses (274,504) (257,441) (8,156,846) - (2,353,269) (11,042,060)
----------- ------------ -------------- ------------ ------------ ---------------
Estimated fair value $48,500,711 $613,681,433 $2,601,724,073 $254,478,872 $ 98,348,081 $3,616,733,170
=========== ============ ============== ============ ============ ==============
</TABLE>
FASB Statement No. 107, Disclosures About Fair Value of Financial
Instruments, defines the fair value of a financial instrument as the amount
at which the instrument could be exchanged in a current transaction between
willing parties, other than in a forced or liquidation sale.
The fair values of the Company's Mortgage Assets are based on market prices
provided by certain dealers who make markets in these financial
instruments. The fair values reported reflect estimates and may not
necessarily be indicative of the amounts the Company could realize in a
current market exchange. Cash and cash equivalents, interest receivable,
repurchase agreements and other liabilities are reflected in the financial
statements at their fair value because of the short-term nature of these
instruments.
3. REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements to finance most of its
Mortgage Assets. The repurchase agreements are collateralized by the market
value of the Company's Mortgage Assets and bear interest rates that have
historically moved in close relationship to LIBOR.
As of December 31, 1997, the Company had outstanding $2,747,060,588 of
repurchase agreements with a weighted average borrowing rate of 5.95% and a
weighted average remaining maturity of 14 days. At December 31, 1997,
Mortgage Assets actually pledged had an estimated fair value of
$2,839,467,729.
At December 31, 1997, the repurchase agreements had the following remaining
maturities:
At December 31, 1997, the repurchase agreements had the following remaining
maturities:
Within 30 days $2,742,501,588
30 to 90 days 4,559,000
--------------
$2,747,060,588
4. COMMON STOCK
The Company's common stock was sold through several transactions as
follows:
The Company was initially capitalized with the sale of 6,000 shares of
common stock on September 2, 1997, for a total of $15,005.
The Company received commitments on September 15, 1997 for the purchase, in
a private placement, of 1,014,000 shares of common stock for a total of
$15,210,000, at $15.00 per share from certain officers, directors, proposed
directors, employees and affiliates of the Company and the Manager. The
sale of these shares was consummated at the time of the closing of the
public offering.
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 for a total of $49,999,995. 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 sale of these shares was
consummated at the time of the closing of the public offering.
The Company has been informed by LASER Advisers Inc. (the "Manager") that a
fund affiliated with the Manager 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 for a total of $9,999,990. Such shares of common
stock were sold by the Company to such broker-dealer in a private placement
without registration under the Securities Act.
The remaining 15,000,000 shares were sold through a public offering for
$225,000,000.
Syndication costs of $18,364,795 were deducted from the gross proceeds of
the offerings.
During the Company's period ending December 31, 1997, the Company declared
dividends to stockholders totaling $.13 per share, which will be paid on
January 31, 1998. For Federal income tax purposes, all dividends paid for
the period are ordinary income to the Company's stockholders.
5. TRANSACTIONS WITH AFFILIATES
The Company has 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, formulates operating strategies for the
Company, oversees the acquisition of assets by the Company, arranges for
various types of financing for the Company (including the issuance of
CMOs), monitors the performance of the Company's assets and provides
certain administrative and managerial services in connection with the
Company's operations. For its performance of these services, the Manager
receives an annual base management fee, payable monthly as set forth below:
AVERAGE STOCKHOLDERS' EQUITY ANNUAL BASE MANAGEMENT FEE AS A
PERCENTAGE OF AVERAGE STOCKHOLDERS' EQUITY
$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
The Manager also receives 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%. Average Stockholders' Equity means, for any period,
stockholders' equity, calculated in accordance with GAAP, excluding any
mark-to-market adjustments of the investment portfolio. For the period
ended December 31, 1997 management fees amounted to $232,858 and incentive
fees were $94,992 and are included in General and Administrative Expenses.
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 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.
6. EARNINGS PER SHARE (EPS)
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting No. 128, Earnings Per Share (SFAS No.
128) which requires dual presentation of Basic EPS and Diluted EPS on the
face of the income statement for all entities with complex capital
structures. SFAS No. 128 also will require a reconciliation of the
numerator and denominator of the Basic EPS to the numerator and denominator
of Basic EPS and Diluted EPS computation. The reconciliation is as follows:
<TABLE>
<CAPTION>
FOR THE PERIOD ENDED
DECEMBER 31, 1997
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
<S> <C> <C> <C>
Basic EPS $2,572,404 20,019,999 $0.13
=====
Effect of Dilutive Securities:
Deferred Common Stock - 400,000
---------- ----------
Diluted EPS $2,572,404 20,419,999 $0.13
========== ========== =====
</TABLE>
Deferred common stock totaling 400,000 shares was included in Diluted EPS.
The receipt of the stock is contingent upon the holder's continued
employment or service. The Deferred common stock has been awarded and does
not have an exercise or strike price.
Options to purchase 778,000 shares were outstanding during the period (Note
7) and were anti-dilutive, because the exercise price ($15.00) was greater
than the year-end stock price for the Company ($14.50). Therefore, these
options were excluded from Dilutive EPS.
7. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a Long-Term Stock Incentive Plan for directors,
executive officers, and key employees (the "Incentive Plan"). The Incentive
Plan authorizes the Compensation Committee of the Board of Directors to
grant awards, including deferred stock, incentive stock options as defined
under Section 422 of the Code ("ISOs") and options not so qualified
("NQSOs"). The Incentive Plan authorizes the granting of options or other
awards for an aggregate of 778,000 shares and 400,000 deferred shares of
the Company's common stock.
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" for the options. Accordingly, no compensation cost for the
Incentive Plan has been determined based on the fair value at the grant
date for awards consistent with the provisions of SFAS No. 123. For the
Company's pro forma net earnings, the compensation cost will be amortized
over the four-year vesting period of the options.
The following table summarizes information about stock options outstanding:
OPTIONS OUTSTANDING
WEIGHTED
AVERAGE WEIGHTED
RANGE OF REMAINING AVERAGE
EXERCISE OPTIONS CONTRACTUAL EXERCISE
PRICES OUTSTANDING LIFE (YRS. PRICE
$15.00 778,000 10 $ 15.00
====== ======= == =======
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.
The compensation expense for the 400,000 shares of deferred stock will be
amortized over a four-year period.
8. CONTRACTUAL COMMITMENTS
During the year ended December 31, 1997 the Company entered into
contractual commitments with original notional amounts as stated below.
Under these agreements, the Company receives a floating rate and pays a
fixed rate.
<TABLE>
<CAPTION>
CURRENT
NOTIONAL UNREALIZED
AMOUNT FIXED TERMINATION APPRECIATION/
(000) TYPE RATE FLOATING RATE DATE DEPRECIATION
<S> <C> <C> <C> <C> <C>
$350,000 Interest Rate Swap 7.4075% LIBOR 1/10/13 $(1,382,500)
550,000 Interest Rate Swap 7.4100% LIBOR 1/10/13 (2,172,500)
135,000 Interest Rate Swap 7.3025% LIBOR 1/10/13 440,100
-----------
$(3,114,900)
============
</TABLE>
******
<PAGE>
<TABLE>
<CAPTION>
LASER MORTGAGE MANAGEMENT, INC.
BALANCE SHEET AT SEPTEMBER 30, 1998 DECEMBER 31, 1997
(UNAUDITED)
- -------------------------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 24,674,797 $ 82,626,526
Receivable for securities sold -- 67,208,943
Investment in securities at fair value 2,215,192,770 3,616,733,170
Investment in mortgage loans at amortized cost 9,246,381 --
Accrued interest receivable 16,431,875 21,170,369
Margin deposits 62,396,863 5,500,000
----------------- ---------------
Total assets $ 2,327,942,686 $ 3,793,239,008
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements $ 2,029,801,000 $ 2,747,060,588
Payable for securities purchased 68,465,077 747,594,232
Accrued interest payable 5,566,582 8,348,831
Interest rate swaps at fair value 42,075,000 3,114,900
Dividends payable 7,022,096 2,602,600
Accounts payable 386,334 1,756,187
Payable to Manager 143,556 327,850
----------------- -----------------
Total liabilities 2,153,459,645 3,510,805,188
----------------- -----------------
STOCKHOLDERS' EQUITY:
Common stock: par value $.001 per share;
100,000,000 shares authorized, 20,094,999 and 20,019,999
shares issued, respectively 20,095 20,020
Additional paid-in capital 282,886,975 281,840,175
Accumulated other comprehensive (loss) income (16,830,704) 603,821
Distributions in excess of net loss (75,873,276) (30,196)
Treasury stock at cost (1,615,800 shares) (15,720,049) --
---------------- ---------------
Total stockholders' equity 174,483,041 282,433,820
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,327,942,686 $ 3,793,239,008
================= =================
</TABLE>
See notes to financial statements.
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS
FOR THE
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
(UNAUDITED) (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
<S> <C> <C>
Mortgage loans and securities $ 48,934,346 $ 161,334,678
Cash and cash equivalents 1,035,186 3,457,713
-------------- --------------
Total interest income 49,969,532 164,792,391
-------------- --------------
INTEREST EXPENSE:
Repurchase agreements 43,412,378 139,691,623
-------------- --------------
NET INTEREST INCOME 6,557,154 25,100,768
LOSS ON SALE OF SECURITIES (21,990,909) (20,725,108)
IMPAIRMENT LOSS ON INTEREST-ONLY
SECURITIES (22,412,673) (51,030,419)
GENERAL AND ADMINISTRATIVE EXPENSES 1,662,319 5,994,629
--------------- ---------------
NET LOSS $ (39,508,747) $ (52,649,388)
================= ===============
Unrealized loss on securities:
Unrealized holding loss arising during period (27,199,052) (38,159,633)
Add: reclassification adjustment for losses included in
net loss 21,990,909 20,725,108
----------------- ----------------
Other comprehensive loss (5,208,143) (17,434,525)
----------------- ----------------
Comprehensive loss $ 44,716,890) $ (70,083,913)
================= ================
NET LOSS PER SHARE:
Basic $ ( 2.10) $ ( 2.68)
================= ================
Diluted $ ( 2.10) $ ( 2.68)
================= ================
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING:
Basic 18,788,275 19,623,221
================== ================
Diluted 18,788,275 19,623,221
================== ================
</TABLE>
See notes to financial statements.
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)
- -----------------------------------------------------------------------------------------------------------------------------------
Accumulated Dividends
Common Additional Comprehensive Other In Treasury
Stock Paid-in Income Comprehensive Excess Stock
Par Capital (Loss) Income of Net Income at Cost Total
Value (Loss) (Loss)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
DECEMBER 31, 1997 $ 20,020 $ 281,840,175 - $ 603,821 $ (30,196) - $282,433,820
Comprehensive income (loss)
Net income - - 8,529,653 - 8,529,653 - 8,529,653
Other comprehensive loss
Unrealized loss on
securities, net of
reclassification adjustment - - (14,190,050) (14,190,050) - - (14,190,050)
------------
Comprehensive loss - - $(5,660,397) - - -
Common stock issued 25 365,600 - - - 365,625
Dividends declared -
$0.43 per share - - - (8,619,350) - (8,619,350)
--------- ------------ ------------ ------------ ---------- ------------
BALANCE, MARCH 31, 1998 $20,045 $282,205,775 $(13,586,229) $ (119,893) $ - $268,519,698
========= ============ ============= ============== ========== ============
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------
Accumulated Dividends
Common Additional Comprehensive Other In Treasury
Stock Paid-in Income Comprehensive Excess Stock
Par Capital (Loss) Income of Net Income at Cost Total
Value (Loss) (Loss)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
MARCH 31, 1998 $ 20,045 $ 282,205,775 $ - $(13,586,229) $ (119,893) $ - $ 268,519,698
Comprehensive income (loss)
Net loss - - (21,670,294) - (21,670,294) - (21,670,294)
Other comprehensive income (loss)
Unrealized gains on
securities, net of
reclassification adjustment - - 1,963,668 1,963,668 - - 1,963,668
-------------
Comprehensive loss - - $(19,706,626) - - - -
=============
Repurchase of common stock - - - - (6,395,134) (6,395,134)
Common stock issued 25 406,225 - - - 406,250
Dividends declared -
$0.38 per share - - - (7,626,600) - (7,626,600)
------- -------------- ---------------- ----------- -------- -----------
BALANCE,
JUNE 30, 1998 $20,070 $282,612,000 $(11,622,561) $(29,416,787)$(6,395,134) $235,197,588
========= ================ ============== ============= ============ =============
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) (CONCLUDED)
- -----------------------------------------------------------------------------------------------------------------------------------
Accumulated Dividends
Common Additional Comprehensive Other In Treasury
Stock Paid-in Income Comprehensive Excess Stock
Par Capital (Loss) Income of Net at Cost Total
Value (Loss) Income
(Loss)
BALANCE,
<S> <C> <C> <C> <C> <C> <C>
JUNE 30, 1998 $20,070 $282,612,000 $(11,622,561) $(29,416,787) $ (6,395,134) $235,197,588
Comprehensive loss
Net loss - - (39,508,747) - (39,508,747) - (39,508,747)
Other comprehensive loss
Unrealized losses on
securities, net of
reclassification adjustment - - (5,208,143) (5,208,143) - - (5,208,143)
-------------
Comprehensive loss - - $(44,716,890) - - - -
Repurchase of common stock - - - - (9,324,915) (9,324,915)
Common stock issued 25 274,975 - - - 275,000
Dividends declared
- $0.38 per share - - - (6,947,742) - (6,947,742)
----------- -------------- ----------- ----------- ------------ -----------
BALANCE,
SEPTEMBER 30, 1998 $20,095 $282,886,975 $(16,830,704) $(75,873,276) $(15,720,049) $174,483,041
=========== =============== ============= ============= ============= ============
Unrealized holding losses
arising during period $ (38,159,633)
Add: reclassification
adjustment for losses
included in net loss 20,725,108
-------------
Net unrealized losses on $ (17,434,525)
securities ================
</TABLE>
See notes to financial statements.
<PAGE>
<TABLE>
<CAPTION>
LASER MORTGAGE MANAGEMENT, INC.
STATEMENT OF CASH FLOWS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1998 (UNAUDITED)
- -----------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C>
Net loss $ (52,649,388)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of mortgage premiums and discounts, net 14,318,262
Impairment loss on interest-only securities 51,030,419
Loss on sale of securities 20,725,108
Decrease in accrued interest receivable 4,738,494
Increase in margin deposits (56,896,863)
Decrease in accrued interest payable (2,782,249)
Decrease in accounts payable (1,554,147)
----------------
Net cash used in operating activities (23,070,364)
----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities (2,989,589,332)
Purchase of mortgage loans (11,912,075)
Proceeds from sale of securities 3,477,020,779
Principal payments on securities 240,306,221
----------------
Net cash provided by investing activities 715,825,593
----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements 33,414,807,277
Principal payments on repurchase agreements (34,132,066,865)
Net payments from issuance (repurchase) of common stock (14,673,174)
Dividends paid (18,774,196)
----------------
Net cash used in financing activities (750,706,958)
----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (57,951,729)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 82,626,526
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 24,674,797
================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid $ 142,473,872
Noncash financing activities:
Net change in unrealized loss on available-for-sale securities $ (17,434,525)
=================
Dividends declared, not yet paid $ 7,022,096
=================
</TABLE>
See notes to financial statements.
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
LASER Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on September 3, 1997. The Company commenced its operations on November
26, 1997 (see Note 5).
BASIS OF PRESENTATION - The accompanying unaudited financial
statements have been prepared in conformity with the instructions to Form 10-Q
and Article 10, Rule 10-01 of Regulation S-X for interim financial statements.
The interim financial statements for the three- and nine-month periods are
unaudited; however, in the opinion of the Company's management, all adjustments,
consisting only of normal recurring accruals, necessary for a fair statement of
the results of operations have been included. These unaudited financial
statements should be read in conjunction with the audited financial statements
included in the Company's Annual Report on Form 10-K for the period ended
December 31, 1997. The nature of the Company's business is such that the results
of any interim period are not necessarily indicative of results for a full year.
Prior period financial statements have been reclassified, where appropriate, to
conform to the 1998 presentation.
A summary of the Company's significant accounting policies follows:
CASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on
hand and overnight repurchase agreements. The carrying amounts of cash
equivalents approximates their value.
INVESTMENTS - The Company invests primarily in mortgage-backed
securities and mortgage loans. The mortgage-backed securities include mortgage
pass-through certificates, collateralized mortgage obligations and other
securities representing interests in, or obligations backed by, pools of
mortgage loans (collectively, "Mortgage Securities"). The Company also invests
in other debt and equity securities ("Other Securities" and, together with
Mortgage Securities, "Securities"). The mortgage loans are secured by first or
second liens on single-family residential, multi-family residential, commercial
or other real property ("Mortgage Loans" and, together with Securities,
"Investments").
Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities (SFAS 115), requires the
Company to classify its securities as either trading investments,
available-for-sale investments or held-to-maturity investments. Although the
Company generally intends to hold most of its Securities until maturity, it may,
from time to time, sell any of its Securities as part of its overall management
of its balance sheet. Accordingly, this flexibility requires the Company to
classify all of its Securities as available-for-sale. All Securities classified
as available-for-sale are reported at fair value, with unrealized gains and
losses reported as a separate component of stockholders' equity within
accumulated other comprehensive income (loss).
Unrealized losses on Securities that are considered
other-than-temporary, as measured by the amount of decline in fair value
attributable to factors other than temporary factors, are recognized in income
and the cost basis of the Securities is adjusted. Other-than-temporary
unrealized losses are based on management's assessment of various factors
affecting the expected cash flow from the Securities, including the level of
interest rates, an other-than-temporary deterioration of the credit quality of
the underlying mortgages and/or the credit protection available to the related
mortgage pool and a significant change in the prepayment characteristics of the
underlying collateral.
The Company's Mortgage Loans are held as long-term investments and are
carried at their unpaid principal balance, net of unamortized discount or
premium.
Interest income is accrued based on the outstanding principal or
notional amount of the Investments and their contractual terms. Premiums and
discounts associated with the purchase of the Investments are amortized into
interest income over the lives of the Investments using the effective yield
method.
Investment transactions are recorded on the date the Investments are
purchased or sold. Purchases of newly-issued securities are recorded when all
significant uncertainties regarding the characteristics of the securities are
removed, generally shortly before settlement date. Realized gains and losses on
Investment transactions are determined on the specific identification basis.
INTEREST RATE SWAPS - In a simple interest rate swap, one investor
pays a floating rate of interest on a notional principal amount and receives a
fixed rate of interest on the same notional principal amount for a specified
period of time. Alternatively, an investor may pay a fixed rate and receive a
floating rate. Interest rate swaps were conceived as asset/liability management
tools and are used for various hedging activities. In more complex interest rate
swaps, the notional principal amount may decline (or amortize) over time.
During the term of the interest rate swap, changes in value are recognized
on the balance sheet as interest rate swaps at fair value and included among
assets (if there is a net unrealized gain) or among liabilities (if there is a
net unrealized loss). A corresponding amount is included in accumulated other
comprehensive income (loss) as a component of stockholders' equity. When the
interest rate swap is terminated, the Company intends to defer the gain or loss
equal to the difference between the proceeds from (or cost of) the closing
transaction and the Company's basis in the contract, if any. However, since the
appreciation on the hedged mortgage securities was insufficient to offset the
hedging loss and Mortgage Securities have been sold in response to current
market conditions, the Company has taken the loss in the current period rather
than amortizing such loss over the life of the contract. During the term of an
interest rate swap, the Company is generally required to provide collateral to
the counterparty in an amount equal to the sum of an agreed-upon percentage of
the notional principal amount and the Company's unrealized loss in value (if
any) of the interest rate swap. The amount of such collateral appears on the
balance sheet as margin deposits.
The Company is exposed to credit loss in the event of nonperformance
by the other party to the interest rate swap. However, the Company does not
anticipate nonperformance by any counterparty.
INCOME TAXES - The Company has elected to be taxed as a Real Estate
Investment Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code") with respect thereto.
Accordingly, the Company should not be subjected to Federal income tax to the
extent of its distributions to stockholders and as long as certain asset, income
and stock ownership tests are met.
USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires the Company to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
COMPREHENSIVE INCOME - The Company has adopted SFAS No. 130, Reporting
Comprehensive Income. This statement requires the reporting of comprehensive
income in addition to net income from operations. Comprehensive income is a more
inclusive financial reporting methodology that includes disclosure of certain
financial information (such as unrealized gains or losses on securities) that
historically has not been recognized in the calculation of net income.
2. AVAILABLE-FOR-SALE INVESTMENTS
The following table sets forth the fair value of the Company's
Securities, excluding interest-only securities ("IOs"), as of September 30, 1998
and December 31, 1997:
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Non-Agency
Agency Fixed/
Fixed/ Agency Floating
Floating Fixed Emerging Non- Principal Rate
Rate Rate Market Mortgage Mortgage Only Mortgage
Mortgage Pass- Bonds Subordinates Subordinates Securities Securities Total
Securities Throughs
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities, $118,294,078 $1,767,936,92 $27,310,000 $142,165,277 $27,055,388 $57,015,501 $36,678,475 $2,176,455,645
principal amount
Unamortized discount (292,532) (5,783,876) (1,869,028) (28,995,997) (1,151,221) (10,243,302) (540,386) (48,876,342)
Unamortized premium 923,816 10,372,219 430,193 253,230 217,404 - 132,994 12,329,856
---------- ---------- ---------- ------------ ----------- ------------ ----------- -------------
Amortized cost 118,925,362 1,772,525,269 25,871,165 113,422,510 26,121,571 46,772,199 36,271,083 2,139,909,159
Gross unrealized gains 2,399,954 40,856,867 - - - 5,626,158 113,709 48,996,688
Gross unrealized losses - (49,783) (5,660,401) (11,369,832) (2,600,586) - (1,451,391) (21,131,993)
Estimated fair value $121,325,316 $1,813,332,35 $20,210,764 $102,052,678 $23,520,985 $52,398,357 $34,933,401 $2,167,773,854
============ ============= =========== ============= =========== =========== =========== ==============
</TABLE>
DECEMBER 31, 1997
<TABLE>
<CAPTION>
Non-Agency
Fixed/
Agency Floating
Fixed Emerging Non- Principal Rate
Rate Market Mortgage Mortgage Only Mortgage
Pass-Throughs Bonds Subordinates Subordinates Securities Securities Total
<S> <C> <C> <C> <C> <C> <C> <C>
Securities, $ 3,286,896,621 $ 52,221,550 $ 58,399,966 $ 10,000,000 57,788,134 $ 9,754,000 $3,475,060,271
principal amount
Unamortized discount (14,104,395) (3,915,578) (10,416,934) (44,194) (23,718,298) (6,150) (52,205,549)
Unamortized premium 28,075,718 415,210 297,872 - - - 28,788,800
-------------- ------------ -------------- ------------ ------------- ------------ ---------------
Amortized cost 3,300,867,944 48,721,182 48,280,904 9,955,806 34,069,836 9,747,850 3,451,643,522
Gross unrealized gains 12,208,264 54,033 240,088 3,569 2,217,185 56 14,723,195
Gross unrealized losses (182,202) (274,504) (532,520) - (115,961) - (1,105,187)
-------------- ------------ -------------- ------------- ------------- -------------- --------------
Estimated fair value $3,312,894,006 48,500,711 $47,988,472 $9,959,375 $36,171,060 $ 9,747,906 $3,465,261,530
============== ============ =============== ============= ============= ================ ==============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
The fair value of the Company's IOs as of September 30, 1998 and
December 31, 1997 are summarized as follows:
SEPTEMBER 30, 1998
Residential Commercial Floating Total
Rate
<S> <C> <C> <C> <C>
Securities, notional amount $235,258,731 $545,742,208 $259,104,251 $1,040,105,190
Amortized cost, after 4,925,730 34,344,476 10,769,108 50,039,314
provision for impairment
Gross unrealized gains - - - -
Gross unrealized losses - (2,620,398) - (2,620,398)
----------------- --------------- --------------- ---------------
Estimated fair value $4,925,730 $31,724,078 $10,769,108 $ 47,418,916
================= =============== =============== ===============
DECEMBER 31, 1997
Residential Commercial Floating Total
Rate
<S> <C> <C> <C> <C>
Securities, notional amount $201,685,139 $373,650,000 $399,260,556 $ 974,595,695
Amortized cost 57,545,769 22,965,348 80,859,810 161,370,927
Gross unrealized gains - 32,494 5,093 37,587
Gross unrealized losses (3,153,808) (51,639) (6,731,427) (9,936,874)
------------ -------------- --------------- ---------------
Estimated fair value $54,391,961 $22,946,203 $74,133,476 $151,471,640
============== =============== =============== ===============
</TABLE>
The following table sets forth a historical reconciliation of the Company's
activities with respect to IOs:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
March 31, June 30, September 30,
1998 1998 1998
<S> <C> <C> <C>
Securities, beginning notional amount 974,595,695 943,163,085 1,185,413,736
Acquisitions, notional amount 126,210,955 334,600,020 -
Disposals, notional amount (129,442,016) (62,336,949) (111,874,185)
Paydowns, notional amount (28,201,549) (30,012,420) (33,434,361)
-------------- --------------- ---------------
Securities, ending notional amount 943,163,085 1,185,413,736 1,040,105,190
============= =============== ===============
Amortized cost, beginning 161,370,927 128,526,212 90,853,884
Acquisitions, at cost 9,311,100 15,048,458 -
Dispositions, at cost (37,282,413) (18,142,073) (16,181,945)
Amortization of premium (4,873,402) (5,960,967) (2,219,952)
Permanent impairment - (28,617,746) (22,412,673)
Amortized cost, ending 128,526,212 90,853,884 50,039,314
============= =============== ================
</TABLE>
FASB Statement No. 107, Disclosures About Fair Value of Financial
Instruments, defines the fair value of a financial instrument as the amount at
which the instrument could be exchanged in a current transaction between willing
parties, other than in a forced or liquidation sale.
The fair values of the Company's Investments are based on prices
provided by dealers who make markets in these financial instruments. The fair
values reported reflect estimates and may not necessarily be indicative of the
amounts the Company could realize in a current market exchange. Cash and cash
equivalents, interest receivable, repurchase agreements and other liabilities
are reflected in the financial statements at their fair value because of the
short-term nature of these instruments.
During the nine months ended September 30, 1998, the Company wrote
down (took a permanent impairment charge of $51,030,419) its floating-rate and
residential IOs which had an amortized cost greater than their market value. All
of the Company's floating-rate and residential IOs were written down to their
estimated fair market value, and such writedown is reflected in the Company's
statement of operations.
Most of the IOs were LIBOR floating rate IOs and were purchased in the
fourth quarter of 1997. They were acquired to balance duration in the Company's
portfolio. This investment was made based on the Company's evaluation of the
then-current prepayments and shape of the yield curve, and the relative values
of similar investments.
In evaluating the impairment charge on the IOs, the Company employs
current estimates of future prepayments that are obtained from independent
sources. For IOs collateralized by fixed-rate pass-through mortgage securities
issued by FNMA, GNMA and FHLMC (collectively, "Agency Fixed Rate
Pass-Throughs"), the Company utilized the median lifetime projection prepayment
speeds compiled and reported by Bloomberg L.P. from a survey of leading dealers
in the mortgage market. For "private label" IOs (collateralized by
non-government agency mortgage securities), the Company employs prepayment
estimates from at least one independent dealer. The prepayment estimates
typically take into consideration the current level and shape of the yield
curve.
As a result of the substantial decline in interest rates since the
purchase of the IOs, current estimates of prepayment speeds significantly exceed
the original prepayment speed estimates.
At the end of the first quarter of 1998, the majority of the Company's
IOs were floating rate IOs. Floating rate IOs are unique securities in that the
interest payments on these securities increase as one-month LIBOR increases. Due
to this characteristic of option value, floating rate IOs trade at much lower
yields than fixed rate IOs. At the end of the second and third quarters of 1998,
in light of the continued flat yield curve, low levels of LIBOR and faster than
expected prepayment rates actually occurring for an extended period of time, the
Company decided that the impairment in market value was other than temporary.
3. MORTGAGE LOANS
The following table pertains to the Company's Mortgage Loans as of
September 30, 1998 which are carried at their amortized cost:
Total
Mortgage Loans, principal amount $ 8,899,132
Unamortized discount -
Unamortized premium 347,249
---------------
Amortized cost $ 9,246,381
================
As of September 30, 1998, the amortized cost of the Mortgage Loans approximated
their fair value.
4. REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements to finance most of
its Investments. The repurchase agreements are collateralized by the market
value of the Company's Investments and bear interest rates that generally move
in close relation to one-month LIBOR.
As of September 30, 1998, the Company had outstanding $2,029,801,000
of repurchase agreements with a weighted average borrowing rate of 5.79% and a
weighted average remaining maturity of 411 days. At September 30, 1998,
Investments actually pledged had an estimated fair value of $2,129,104,195.
At September 30, 1998, the repurchase agreements had the following
remaining maturities:
Within 30 days $ 1,508,002,656
30 to 90 days 21,798,344
Greater than 90 days 500,000,000
--------------------
$ 2,029,801,000
=====================
At September 30, 1998, $500,000,000 of the Company's Securities were
subject to a repurchase agreement with a broker-dealer with a term of five years
ending March 10, 2003. The borrowing rate of this repurchase agreement is
three-month LIBOR plus 61.5 basis points and is capped at 6.365%.
5. COMMON STOCK
SALES OF COMMON STOCK - The Company's common stock was sold through
several transactions as follows:
The Company was initially capitalized with the sale of 6,000 shares of
common stock on September 2, 1997, for a total of $15,005.
The Company received commitments on September 15, 1997 for the
purchase, in a private placement, of 1,014,000 shares of common stock, at $15.00
per share, for a total of $15,210,000 from certain officers, directors, proposed
directors, employees and affiliates of the Company and LASER Advisers Inc. (the
"Manager"). The sale of these shares was consummated at the time of the closing
of the public offering.
The Company received commitments on November 7, 1997 from several
mutual funds under common management (the "Funds") for the purchase, in a
private placement, of 3,333,333 shares of common stock, at $15.00 per share, for
a total of $49,999,995. The sale of these shares was consummated at the time of
the closing of the public offering.
The Company has been informed by the Manager that a fund affiliated
with the Manager 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 for a total of
$9,999,990. Such shares of common stock were sold by the Company to such
broker-dealer in a private placement without registration under Section 4(2) of
the Securities Act of 1933.
15,000,000 shares of common stock were sold through a public offering
for $225,000,000. Syndication costs of $18,364,795 were deducted from the gross
proceeds of the offerings.
On each of January 2, 1998, April 1, 1998 and July 1, 1998, 25,000
shares (75,000 shares in the aggregate) of common stock were issued as deferred
stock awards to certain employees of the Company.
DIVIDENDS - During the three months ended September 30, 1998, the
Company declared distributions to stockholders totaling $0.38 per share, which
were paid on October 30, 1998. During the three months ended June 30, 1998, the
Company declared distributions to stockholders totaling $0.38 per share, which
were paid on July 31, 1998. During the three months ended March 31, 1998, the
Company declared dividends to stockholders totaling $0.43 per share, which were
paid on April 30, 1998.
STOCK REPURCHASES - In March 1998, the Board of Directors of the
Company approved the repurchase of up to $20 million of the Company's common
stock. In June 1998, the Board of Directors increased the amount of common stock
authorized to be repurchased to $30 million. Pursuant to this repurchase
program, the Company repurchased 979,100 shares of its common stock for $9.3
million in open market transactions at their prevailing market prices during the
three months ended September 30, 1998. Such purchases were made at a weighted
average price per share of $9.484 (excluding commissions). The total number of
shares repurchased by the Company as of September 30, 1998 was 1,615,800. The
repurchased shares have been returned to the Company's authorized but unissued
shares of common stock as treasury shares.
6. TRANSACTIONS WITH AFFILIATES
The Company has 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, formulates operating strategies for the
Company, oversees the acquisition of Investments by the Company, arranges for
various types of financing for the Company, monitors the performance of the
Company's Investments and provides certain administrative and managerial
services in connection with the Company's operations. For its performance of
these services, the Manager receives a quarterly base management fee of
$225,000, payable monthly. As of October 1, 1998, the Board of Directors
decreased the base management fee from 1% of Average Stockholders' Equity.
The Manager also receives 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%. 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 fee and before deduction of dividends paid.
For purposes of both the management and incentive fee calculations,
Average Stockholders' Equity means, for any period, stockholders' equity,
calculated in accordance with GAAP, excluding any mark-to-market adjustments of
the investment portfolio. The Company and the Manager have agreed that the
provision for impairment charge on the IOs in the Company's portfolio is not a
mark-to-market adjustment for purposes of these calculations. For the three
months ended September 30, 1998 management fees amounted to $590,984 and
incentive fees were $(34,757) and are included in General and Administrative
Expenses. The Manager will be reimbursed for certain out-of-pocket expenses
incurred on behalf of the Company.
7. EARNINGS PER SHARE (EPS)
In February 1997, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting No. 128, Earnings Per Share (SFAS No.
128) which requires dual presentation of Basic EPS and Diluted EPS on the face
of the income statement for all entities with complex capital structures. SFAS
No. 128 also requires a reconciliation of the numerator and denominator of the
Basic EPS to the numerator and denominator of Basic EPS and Diluted EPS
computation. There are no differences between Basic EPS and Diluted EPS.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
Loss Shares Per-Share Loss Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $ (39,508,747) 18,788,275 $ (2.10) $ (52,649,388) 19,623,221 $ (2.68)
============== ============= ========= ============= ============ =======
Diluted EPS $ (39,508,747) 18,788,275 $ (2.10) $(52,649,388) 19,623,221 $ (2.68)
=============== ============= ======== ============== ============== ========
</TABLE>
The Company has deferred common stock totaling 65,000 shares reserved
for issuance. The receipt of the stock is contingent upon the holder's continued
employment or service. The deferred common stock has been awarded and does not
have an exercise or strike price. Such shares were not included in Diluted EPS
as the Company has a loss from operations and including such amounts would be
anti-dilutive.
For the three months ended September 30, 1998, options to purchase
298,000 shares were outstanding during the period and were anti-dilutive because
the strike price ($15.00) was greater than the average daily market price of the
Company's common stock for the quarter ($8.594). Therefore, these options were
excluded from Diluted EPS.
For the nine months ended September 30, 1998, options to purchase
298,000 shares were outstanding during the period and were anti-dilutive because
the strike price ($15.00) was greater than the average daily market price of the
Company's common stock for the period ($12.959). Therefore, these options were
excluded from Diluted EPS.
8. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a Long-Term Stock Incentive Plan for
directors, executive officers, and key employees (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the Board of Directors
to grant awards, including deferred stock, incentive stock options as defined
under Section 422 of the Code ("ISOs") and options not so qualified ("NQSOs").
The Incentive Plan authorizes the granting of options or other awards for an
aggregate of 778,000 shares and 400,000 deferred shares of the Company's common
stock.
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" for the options. Accordingly, no compensation cost for the
Incentive Plan has been determined based on the fair value at the grant date for
awards consistent with the provisions of SFAS No. 123. For the Company's pro
forma net earnings, the compensation cost will be amortized over the four-year
vesting period of the options. The Company's net loss per share would have been
increased to the pro forma amounts indicated below:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
Net loss - as reported $(39,508,747) $(52,649,388)
Net loss - pro forma $(39,514,521) $(52,666,709)
Loss per share - as reported $(2.10) $(2.68)
Loss per share - pro forma $(2.10) $(2.68)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in the three months and nine months ended September
30, 1998: dividend yield of 11.47%; expected volatility of 18%; risk-free
interest rate of 5.82%; and expected lives of ten years.
The following table summarizes information about stock options
outstanding:
Weighted
Average Weighted
Range of Remaining Average
Exercise Options Contractual Exercise
Prices Outstanding Life Price
(Yrs.)
$ 15.00 298,000 9.2 $ 15.00
====== ============= =========== ==========
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. During the third quarter of 1998,
480,000 stock options have terminated.
The compensation expense for the 140,000 shares of deferred stock will
be amortized over a four-year period.
9. INTEREST RATE SWAPS
As of September 30, 1998, the Company is a party to interest rate
swaps with original notional amounts as stated below. Under these agreements,
the Company receives a floating rate and pays a fixed rate. These swaps are
cancelable at the option of the Company on the fifth anniversary of their
respective effective dates.
<PAGE>
Non-Amortizing
Notional
Amount Fixed Floating Termination Unrealized
(in Rate Rate Date Loss in
thousands) Value
$550,000 7.4100% 1-month LIBOR 1/10/13 $(42,075,000)
============
During the three-months ended September 30, 1998, the Company
terminated interest rate swaps with notional amounts totaling $485,000,000 and
incurred a realized loss of $25,782,250, which is included in loss on sale of
securities in the statement of operations.
10. TAXABLE INCOME AND CAPITAL LOSSES IN EXCESS OF CAPITAL GAINS
For the quarter ended September 30, 1998, income as calculated for tax
purposes ("taxable income") is estimated at approximately $5.3 million, or $0.28
per weighted average share, and capital losses in excess of capital gains are
estimated at approximately $22.7 million, or $1.21 per weighted average share.
For the nine-month period ended September 30, 1998, taxable income is estimated
at approximately $18.0 million, or $0.92 per weighted average share, and capital
losses in excess of capital gains are estimated at approximately $21.1 million
or $1.08 per weighted average share. Capital losses in excess of capital gains
are eligible to be carried forward to future tax years to offset capital gains.
Taxable income was different from income (loss) as calculated according to
generally accepted accounting principles ("GAAP income (loss)") as a result of,
among other things, differing treatment of losses on securities transactions and
interest rate swaps, permanent impairment writedowns on IOs and a differing
treatment of premium and discount amortization.
11. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133")
was issued and is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. SFAS No. 133 generally requires that entities recognize all
derivative financial instruments as assets or liabilities, measured at fair
value, and include in earnings the changes in the fair value of such assets and
liabilities. SFAS No. 133 also provides that changes in the fair value of assets
or liabilities being hedged with recognized derivative instruments be recognized
and included in earnings. The Company has not yet completed its evaluation of
SFAS No. 133, and therefore, at this time, cannot predict what, if any, effect
its adoption will have on the Company's financial condition or results of
operations.
12. SUBSEQUENT EVENTS
On October 2, 1998, the Company's Board of Directors authorized its
financial advisor, Lehman Brothers Inc., to promptly solicit offers to acquire
the Company or all, or substantially all, of its assets. To date, Lehman
Brothers Inc., after soliciting offers to acquire the Company, has not received
any firm bids. Lehman Brothers Inc. is continuing to solicit bids on behalf of
the Company.
Also on October 2, 1998, the Company's Board of Directors engaged
BlackRock Financial Management, Inc. ("BlackRock") as its consultant to review
the Company's portfolio and to make recommendations designed to reduce the
portfolio's susceptibility to basis and interest rate risk and to create
additional liquidity.
BlackRock has recommended that the Manager delever the Company's
portfolio by selling certain Securities. From September 30, 1998 through October
31, 1998, the Company sold approximately $1.1 billion of Securities (agency
fixed/floating rate mortgage securities, agency fixed rate pass-through
certificates, emerging market securities, interest-only securities,
principal-only securities and interest rate swaps).
The Manager has determined the Company's net asset value as of October
31, 1998 to be between $7.50 and $8.00 per share. The net asset value as of such
date reflects sales of Securities completed through October 31, 1998.
*****
<PAGE>
=============================================================
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 SELLING STOCKHOLDER. 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.
------------
SUMMARY TABLE OF CONTENTS
PAGE
Prospectus Summary..................................7
Risk Factors.......................................13
Use of Proceeds....................................28
Price Range of Common Stock and Dividend Policy....28
Distribution Policy................................29
Management's Discussion and Analysis of Financial
Condition and Results of Operations 30
Business...........................................38
Description of Assets..............................44
The Manager........................................49
The Company........................................53
Certain Relationships and Related Party
Transactions and Conflicts of Interest 57
Principal Stockholders.............................59
Federal Income Tax Considerations 60
ERISA Considerations...............................68
Certain Provisions of Maryland Law and the
Company's Charter and Bylaws....................70
Description of Capital Stock.......................73
Selling Stockholders...............................76
Plan of Distribution...............................78
Public Offering....................................79
Private Placement..................................79
Legal Matters......................................80
Experts............................................80
Glossary...........................................80
Index to Financial Statements.....................F-1
=============================================================
4,087,099 Shares
LASER MORTGAGE
MANAGEMENT, INC.
Common Stock
------------------------------
PROSPECTUS
------------------------------
_______________, 1998
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The expenses estimated to be incurred in connection with the issuance
and distribution of the securities being registered are as set forth below:
SEC registration fee $22,650.00
Legal fees and expenses $50,000.00
Accounting fees and expenses $10,000.00
Blue Sky qualification fees and
expenses (including counsel fees) $ 1,000.00
Miscellaneous $ 1,350.00
-------------
Total $85,000.00
===========
ITEM 32. SALES TO SPECIAL PARTIES.
On December 2, 1997, the Registrant sold 1,014,000 shares of Common Stock
at the initial public offering price to certain directors, officers, employees
and Affiliates of the Company and the Manager. The foregoing shares were sold
without registration under the Securities Act, in reliance on the exemption
provided by Section 4(2) thereof.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
On December 2, 1997, the Registrant sold 1,014,000 shares of Common Stock
to certain directors, officers, employees and Affiliates of the Company and the
Manager. On December 2, 1997, the Registrant sold 3,333,333 shares of Common
Stock at the initial public offering price to several mutual funds under common
management. The foregoing shares were sold without registration under the
Securities Act, in reliance on the exemption provided by Section 4(2) thereof.
An Affiliated Fund, Mustang Investment Limited Partnership, has entered
into the Total Return Swap with a broker-dealer which provides that the
Affiliated Fund will bear the economic benefit and risk of directly holding
666,666 shares of the Company's Common Stock. Such shares were sold by the
Company to such broker-dealer in a private placement without registration under
the Securities Act.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 2-418 of the Maryland General Corporation Law provides that a
Maryland corporation may indemnify any director (and any person who, while a
director of the corporation, is or was serving at the request of the corporation
as director, officer, partner, trustee, employee, or agent of another foreign or
domestic corporation, partnership, joint venture, trust, or other enterprise or
employee benefit plan), is made a party to any proceeding by reason of service
in that capacity unless it is established that (i) the act or omission of the
director was material to the matter giving rise to the proceeding and was
committed in bad faith or was the result of active and deliberate dishonesty; or
(ii) the director actually received an improper personal benefit in money,
property or services; or, (iii) in the case of any criminal proceeding, the
director had reasonable cause to believe that the act or omission was unlawful.
Indemnification may be against judgments, penalties, fines, settlements, and
reasonable expenses actually incurred by the director in connection with the
proceeding. If the proceeding was one by or in the right of the corporation,
indemnification may not be made in respect of any proceedings in which the
director shall have been adjudged to be liable to the corporation. Such
indemnification may not be made unless authorized for a specific proceeding
after a determination has been made, in the manner prescribed by the law, that
indemnification is permissible in the circumstances because the director has met
the applicable standard of conduct. On the other hand, the director must be
indemnified for expenses if he has been successful in the defense of such
proceeding or as otherwise ordered by a court. The law also permits the
circumstances under which the corporation may advance expenses to, or obtain
insurance or similar protection for, directors.
The law also permits for comparable indemnification for corporate officers
and agents.
The Registrant's Charter provides that its directors and officers shall,
and its agents in the discretion of the Board of Directors may, be indemnified
to the fullest extent required or permitted from time to time by the laws of
Maryland.
The Maryland General Corporation Law permits the charter of a Maryland
corporation to include a provision limiting the liability of its directors and
officers to the corporation and its stockholders for money damages except to the
extent that (i) it is proved that the person actually received an improper
benefit or profit in money, property or services for the amount of the benefit
or profit in money, property or services actually received, or (ii) a judgment
or other final adjudication is entered in a proceeding based on a finding that
the person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's 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
from time to time.
Policies of insurance may be obtained and maintained by the Company under
which its directors and officers, will be insured, within the limits and subject
to the limitations of the policies, against certain expenses in connection with
the defense of, and certain liabilities which might be imposed as a result of,
actions, suits or proceedings to which they are parties by reason of being or
having been such directors or officers.
The Company has entered into agreements with each of its executive officers
and directors of the Company whereby the Company agrees to indemnify such
officer or director with respect to certain liabilities such officer or director
may incur in such capacity.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements:
AUDITED FINANCIAL STATEMENTS:
Balance Sheet - December 31, 1997
Statementof Operations for the period November 26, 1997 (Commencement
of Operations) through December 31, 1997
Statementof Stockholders' Equity for the period November 26, 1997
(Commencement of Operations) through December 31, 1997
Statementof Cash Flows for the period November 26, 1997 (Commencement
of Operations) through December 31, 1997
Notes to Financial Statements
UNAUDITED FINANCIAL STATEMENTS:
Balance Sheet at September 30, 1998
Statement of Operations for the nine months ended September 30, 1998
Statement of Stockholder's Equity for the nine months ended September
30, 1998 Statement of Cash Flows for the nine months ended September
30, 1998
Statement of Cash Flows for the nine months ended September 30, 1998
Notes to Unaudited Financial Statements
(b) Exhibits:
EXHIBIT
NUMBER EXHIBIT
3.1 Charter of the Registrant (Incorporated by reference to Exhibit
3.1 to the Registration Statement on Form S-11 (File No.
333-35673))
3.2 By-Laws of the Registrant (Incorporated by reference to Exhibit
3.2 to the Registration Statement on Form S-11 (File No.
333-35673)
4.1 Specimen Common Stock Certificate (Incorporated by reference to
Exhibit 4.1 to the Registration Statement on Form S-11 (File No.
333-35673))
+5.1 Opinion of Miles & Stockbridge, a Professional Corporation
(including consent)
*8.1 Opinion of Stroock & Stroock & Lavan LLP (including consent)
10.1 Form of Stock Incentive Plan (Incorporated by reference to
Exhibit 10.1 to the Registration Statement on Form S-11 (File No.
333-35673))
10.2 Form of Management Agreement (Incorporated by reference to
Exhibit 10.2 to the Registration Statement on Form S-11 (File No.
333-35673))
10.3 Form of Dividend Reinvestment Plan (Incorporated by reference to
Exhibit 10.3 to the Registration Statement on Form S-11 (File No.
333-35673))
10.4 Consulting Agreement dated as of October 2, 1998 between Black
Rock Financial Management, Inc. and the Registrant (Incorporated
by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998)
*23.1 Consent of Stroock & Stroock & Lavan LLP (included in Exhibit
8.1)
*23.2 Consent of Independent Auditors
+23.3 Consent of Miles & Stockbridge, a Professional Corporation
(included in Exhibit 5.1)
+24.1 Power of Attorney
*27.1 Financial Data Schedule
- ------------------------
* Filed herewith.
+ Previously filed.
ITEM 37. UNDERTAKINGS.
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are
being made, a post-effective amendment to this registration statement.
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-effective
amendment thereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in the registration statement.
Notwithstanding the foregoing, any increase or decrease in volume of securities
offered (if the total dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of prospectus
filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20 percent change in the
maximum aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement;
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial BONA
FIDE offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Commission, such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes that: (i) for purposes of
determining any liability under the Securities Act, the information omitted from
the form of Prospectus filed as a part of this Registration Statement in
reliance upon Rule 430A and contained in a form of Prospectus filed by the
Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act
shall be deemed to be part of this Registration Statement as of the time it was
declared effective; and (ii) for the purpose of determining liability under the
Securities Act, each post-effective amendment that contains a form of Prospectus
shall be deemed to be a new Registration Statement, relating to the securities
offered therein and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-11 and has duly caused this Post- Effective
Amendment No. 3 to the registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Short Hills, State of New
Jersey on the 18th day of December, 1998.
LASER MORTGAGE MANAGEMENT, INC.
By: /S/ PETER T. ZIMMERMANN
Peter T. Zimmermann
CHIEF OPERATING OFFICER
(authorized officer of Registrant)
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment No. 3 to the registration statement has been signed by
the following persons in the capacities and on the dates indicated.
SIGNATURE Title Date
/s/ Frederick N. Khedouri President and Director December 18, 1998
Frederick N. Khedouri
/s/ Thomas G. Jonovich Chief Financial Officer December 18, 1998
Thomas G. Jonovich and Treasurer (principal
financial and accounting officer)
/s/ Peter T. Zimmermann Chief Operating Officer December 18, 1998
Peter T. Zimmermann (authorized officer of Registrant)
/s/ Stuart H. Coleman Director December 18, 1998
Stuart H. Coleman
/s/ Jonathan Ilany Director December 18, 1998
Jonathan Ilany
Director December 18, 1998
Michael L. Smirlock
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF DOCUMENT
3.1 Charter of the Registrant (Incorporated by reference to Exhibit 3.1
to the Registration Statement on Form S-11 (File No. 333-35673)
3.2 By-Laws of the Registrant (Incorporated by reference to Exhibit 3.2
to the Registration Statement on Form S-11 (File No. 333-35673)
4.1 Specimen Common Stock Certificate (Incorporated by reference to
Exhibit 4.1 to the Registration Statement on Form S-11
(File No. 333-35673)
+5.1 Opinion of Miles & Stockbridge, a Professional Corporation
(including consent)
*8.1 Opinion of Stroock & Stroock & Lavan LLP (including consent)
10.1 Form of Stock Incentive Plan (Incorporated by reference to
Exhibit 10.1 to the Registration Statement on Form S-11
(File No. 333-35673))
10.2 Form of Management Agreement (Incorporated by reference to
Exhibit 10.2 to the Registration Statement on Form S-11
(File No. 333-35673))
10.3 Form of Dividend Reinvestment Plan (Incorporated by reference to
Exhibit 10.3 to the Registration Statement on Form S-11
(File No. 333-35673))
10.4 Consulting Agreement dated as of October 2, 1998 between BlackRock
Financial Management, Inc. and the Registrant (Incorporated by
reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for
the quarter ended September 30, 1998)
*23.1 Consent of Stroock & Stroock & Lavan LLP (included in Exhibit 8.1)
*23.2 Consent of Independent Auditors
+23.3 Consent of Miles & Stockbridge, a Professional Corporation
(included in Exhibit 5.1)
+24.1 Power of Attorney (included in the signature page)
*27.1 Financial Data Schedule
- ---------------------
* Filed herewith.
+ Previously filed.
Laser Mortgage Management, Inc.
51 John F. Kennedy Parkway
Shorthills, New Jersey 07078
Ladies and Gentlemen:
We have acted as counsel to Laser Mortgage Management Inc., a Maryland
corporation (the "Company"), in connection with the preparation of
Post-Effective Amendment No. 3 to a Form S-11 registration statement (the
"Registration Statement") filed with the Securities and Exchange Commission on
December 18, 1998 (No. 333-40943), as amended through the date hereof, with
respect to the offering and sale (the "Offering") of up to 4,087,099 shares of
common stock, par value $0.001 per share, of the Company (the "Common Stock").
You have requested our opinion regarding certain U.S. federal income tax matters
in connection with the Offering.
In giving this opinion letter, we have examined (i) the Company's Articles of
Incorporation, as duly filed with the Secretary of State of the Commonwealth of
Maryland in September 1997; (ii) the Company's Restated and Amended Articles of
Incorporation, a form of which is filed as an exhibit to the Registration
Statement; (iii) the Company's Bylaws; (iv) the Registration Statement,
including the prospectus contained as part of the Registration Statement (the
"Prospectus"); and such other documents as we have deemed necessary or
appropriate for purposes of this opinion.
In connection with the opinions rendered below, we have assumed (i) the
genuineness of all signatures on documents we have examined, (ii) the
authenticity of all documents submitted to us as originals, (iii) the conformity
to the original documents of all documents submitted to us as copies, (iv) the
authority and capacity of the individual or individuals who executed any such
documents on behalf of any person, (v) the accuracy and completeness of all
documents made available to us, (vi) the accuracy of all representations,
warranties and written statements made by all parties, (vii) that all documents,
certificates, representations, warranties and covenants on which we have relied
in rendering the opinion set forth below and that were given or dated earlier
than the date of this letter continue to remain accurate, insofar as relevant to
the opinion set forth herein, from such earlier date through and including the
date of this letter, (viii) that during its short taxable year ended December
31, 1997 the Company operated and in taxable years ending after December 31,
1997 the Company will continue to operate in a manner consistent with the
representations contained in the certificate, dated December 17, 1998 and
executed by a duly appointed officer of the Company (the "Officer's
Certificate"), (ix) the Company will not make any amendments to its
organizational documents after the date of this opinion that would affect its
qualification as a real estate investment trust (a "REIT") for any taxable year,
and (x) that no action will be taken by the Company, after the date hereof, that
would have the effect of altering the facts upon which we have based the
opinions set forth below.
Based on the documents and assumptions set forth above, the representations
set forth in the Officer's Certificate, and the discussion in the Prospectus
under the caption "Federal Income Tax Considerations" (which is incorporated
herein by reference), we are of the opinion that:
(a) the Company has qualified as a REIT for the taxable year ended
December 31, 1997, and the Company is organized and operates in a manner
that will enable it to qualify to be taxed as a REIT pursuant to sections
856 through 860 of the Internal Revenue Code of 1986, as amended (the
"Code") for the taxable year ending December 31, 1998 and thereafter,
provided the Company continues to meet the asset composition, source of
income, shareholder diversification, distributions, record keeping, and
other requirements of the Code which are necessary for the Company to
qualify as a REIT;
(b) the descriptions of the law and the legal conclusions contained in
the Prospectus under the caption "Federal Income Tax Considerations" are
correct in all material respects.
We will not review on a continuing basis the Company's compliance with the
documents or assumptions set forth above, or the representations set forth in
the Officer's Certificate. Accordingly, no assurance can be given that the
actual results of the Company's operations for any given taxable year will
satisfy the requirements for qualification and taxation as a REIT.
We note that our opinion expressed herein is based on our examination of
the law, our review of the documents described above, the statements and
representations referred to above, the provisions of the Code, the regulations,
published rulings and announcements thereunder, and the judicial interpretations
thereof currently in effect. This opinion will not be binding on the Internal
Revenue Service (the "Service"), and there can be no assurance that the Service
will not challenge the conclusion stated herein or that, if the issue were
decided in court, such a challenge would not ultimately succeed. Further, there
can be no assurance that future legislative or administrative changes or future
court decisions or the inaccuracy of any statements or representations on which
we have relied may not significantly affect the continuing validity of this
opinion.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement. We also consent to the references to Stroock & Stroock &
Lavan LLP under the caption "Federal Income Tax Considerations" in the
Prospectus. In giving this consent, we do not admit that we are in the category
of persons whose consent is required by Section 7 of the Securities Act of 1933,
as amended, or the rules and regulations promulgated thereunder by the
Securities and Exchange Commission.
The foregoing opinions are limited to the U.S. federal income tax matters
addressed herein, and no other opinions are rendered with respect to other
federal tax matters or to any issues arising under the tax laws of any other
country, or any state or locality. We undertake no obligation to update the
opinions expressed herein after the date of this letter.
Very truly yours,
/s/ STROOCK & STROOCK & LAVAN LLP
Stroock & Stroock & Lavan LLP
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement No. 333-40943 of LASER
Mortgage Management, Inc. on Form S-11 of our report dated March 6, 1998
appearing in the Prospectus, which is part of this Registration Statement.
We also consent to the reference to us under the heading "Experts" in the
Prospectus.
/S/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
New York, New York
December 15, 1998
<TABLE> <S> <C>
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
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REFERENCE TO SUCH
</LEGEND>
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
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