<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 7, 1997
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
PRIME CAPITAL INVESTMENT CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN GOVERNING INSTRUMENTS)
77 WEST WACKER DRIVE
SUITE 3900
CHICAGO, ILLINOIS 60601
TELEPHONE: (312) 917-1500
FACSIMILE: (312) 782-5867
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
----------------
JAMES W. ROITER
CHIEF EXECUTIVE OFFICER
PRIME CAPITAL INVESTMENT CORP.
77 WEST WACKER DRIVE
SUITE 3900
CHICAGO, ILLINOIS 60601
(NAME AND ADDRESS OF AGENT FOR SERVICE)
----------------
COPIES TO:
WAYNE D. BOBERG, ESQ. GEORGE C. HOWELL, III, ESQ.
WINSTON & STRAWN DAVID C.WRIGHT, ESQ.
35 WEST WACKER DRIVE HUNTON & WILLIAMS
CHICAGO, ILLINOIS 60601 RIVERFRONT PLAZA
TELEPHONE: (312) 558-5600 951 EAST BYRD STREET
FACSIMILE: (312) 558-5700 RICHMOND, VIRGINIA 23219
TELEPHONE: (804) 788-8200
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
FACSIMILE: (804) 788-8218
----------------
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 number of the earliest 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, please 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. [_]
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED
PROPOSED MAXIMUM
AMOUNT MAXIMUM AGGREGATE AMOUNT OF
TITLE OF SECURITIES TO BE OFFERING PRICE OFFERING REGISTRATION
BEING REGISTERED REGISTERED(1) PER SHARE(2) PRICE(2) FEE(3)
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<S> <C> <C> <C> <C>
Common Stock, par value
$.01 per share........ 22,101,563 $16.00 $353,625,008 $107,159
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</TABLE>
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(1) Includes 2,812,500 shares which the Underwriter have the option to
purchase to lower over-allotments, if any, and up to 539,063 shares
issuable upon exercise of warrants granted to the Underwriter
(2) Estimated solely for the purpose of calculating the registration fee.
(3) The registration fee has been computed in accordance with Rule 457(a)
under the Securities Act of 1933.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION,
ACTING PURSUANT TO SUCH SECTION 8(A), MAY DETERMINE.
----------------
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, PRELIMINARY PROSPECTUS DATED OCTOBER 7, 1997
PROSPECTUS
, 1997
18,750,000 SHARES [LOGO]
PRIME CAPITAL INVESTMENT CORP.
COMMON STOCK
Prime Capital Investment Corp. ("PCI" and, together with its subsidiaries,
the "Company") was organized as a Maryland corporation on September 19, 1997.
PCI will elect to be taxed as a real estate investment trust ("REIT") under the
Internal Revenue Code of 1986, as amended (the "Code"). Prime Capital
Management, L.L.C. (the "Manager"), a wholly owned subsidiary of Prime Capital
Holding, LLC ("PCH") which is an Affiliate of The Prime Group, Inc. ("Prime"),
will manage the day-to-day operations of the Company, subject to the
supervision of PCI's Board of Directors.
All of the 18,750,000 shares of Common Stock offered pursuant to this
Prospectus are being offered by the Company. Of the shares offered hereby,
1,875,000 shares of Common Stock will be sold by the Company to Prime and
certain senior executives of the Manager at the initial price. After such sale
Prime, together with such senior executives of the Manager, will own 10.0% of
the common stock of the Company, par value $0.01 per share (the "Common
Stock"), assuming that the Underwriter does not exercise its over-allotment
option. The Underwriter will receive no discounts or commissions on the Common
Stock offered to Prime and such senior executives of the Manager.
The initial public offering price for the shares of Common Stock currently is
expected to be $16.00 per share. Prior to the offering of Common Stock hereby
(the "Offering"), there has been no market for the shares of Common Stock. The
initial public offering price has been determined by negotiation between the
Company and the Underwriter. See "Underwriting." The Company will apply for
inclusion of the Common Stock in The Nasdaq Stock Market under the symbol
"PRCI."
SEE "RISK FACTORS" BEGINNING ON PAGE 14 FOR CERTAIN FACTORS RELEVANT TO AN
INVESTMENT IN THE COMMON STOCK INCLUDING, AMONG OTHERS:
. The Company and the Manager have common officers and directors, which may
present conflicts of interest in the Company's dealings with the Manager
and its Affiliates, including the Company's purchase of assets from the
Manager's Affiliates;
. The Company, which has no operating history prior to the completion of the
Offering, will engage in highly competitive businesses;
. The yield on and the value of the Company's investments (particularly
those in mortgage loans and mortgage-backed securities) may be affected
adversely by changes in prevailing interest rates, rates of prepayment and
credit losses;
. The Company intends to leverage its investments, in amounts to be
determined by the Manager and, ultimately, PCI's Board of Directors, which
could lead to reduced or negative cash flow and reduced liquidity;
. The Company has identified specific investments for only approximately
$33.5 million of the net proceeds of the Offering, and the Company will
face significant competition in acquiring additional investments, which
may inhibit the Company's ability to achieve its investment objectives;
. The Company intends to invest in sub-investment grade and unrated
mortgage-backed securities, which may be affected adversely by events of
loss, such as credit losses due to borrower default, hazard losses and
state law enforceability issues;
. The Company intends to invest in non-performing and sub-performing
mortgage loans and mortgage loans that are subordinate to prior liens
against the collateral, each of which may be affected adversely by events
of loss, such as credit losses due to borrower default, hazard losses and
state law enforceability issues;
. Ownership of Common Stock by each stockholder is limited to 9.9% of the
outstanding Common Stock, which may deter third parties from seeking to
control or acquire the Company;
. To avoid being taxed as a regular corporation, the Company must satisfy
certain requirements relating to its assets and income, which may restrict
the Company's investment opportunities, and the Company must distribute at
least 95% of its taxable income each year, which could require the Company
to sell assets or borrow money in order to satisfy this requirement; and
. The Company may invest in REMIC Residual Interests, Non-REMIC Residual
Interests, non-performing and sub-performing loans, each of which may
generate taxable income in excess of cash receipts.
----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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<CAPTION>
PRICE TO PRIME
AND CERTAIN
SENIOR UNDERWRITING
PRICE TO EXECUTIVES OF DISCOUNTS AND PROCEEDS TO
PUBLIC THE MANAGER COMMISSIONS(1) COMPANY(2)
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<S> <C> <C> <C> <C>
Per Share Purchased by the Public............... $ $ $
Per Share Purchased by Prime and certain senior
executives of the Manager (3).................. $ $ $
Total (4)....................................... $ $ $
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</TABLE>
(1) The Company has agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses in connection with the Offering, estimated at
$800,000, which will be payable by the Company.
(3) Prime and certain senior executives of the Manager have agreed to purchase
1,875,000 of the 18,750,000 shares of Common Stock offered hereby at the
Price to Public, net of underwriting discounts.
(4) The Company has granted the Underwriter a 30-day option to purchase up to
2,812,500 additional shares of Common Stock to cover over-allotments, if
any. If the Underwriter exercises such option in full, the total Price to
Public (not including the 1,875,000 shares purchased by Prime and certain
senior executives of the Manager), Underwriting Discounts and Commissions
and Proceeds to Company (including the 1,875,000 shares purchased by Prime
and certain senior executives of the Manager), before expenses of the
Offering, will be $ , $ and $ ,
respectively. The Underwriter has agreed to reserve up to 200,000 shares of
Common Stock for sale to certain individuals at the Price to the Public net
of any Underwriting Discounts and Commissions. To the extent such reserved
shares are sold to such individuals, total Underwriting Discounts and
Commissions will be reduced to the extent of such discounts. See
"Underwriting."
The shares of Common Stock are offered by the Underwriter subject to receipt
and acceptance by the Underwriter, approval of certain legal matters by counsel
for the Underwriter and certain other conditions. The Underwriter reserves the
right to withdraw, cancel or modify such offers and to reject orders in whole
or in part. It is expected that delivery of the shares of Common Stock will be
made in New York, New York on or about , 1997.
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
<PAGE>
--------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING STABILIZATION, THE PURCHASE OF COMMON STOCK TO COVER SYNDICATE SHORT
POSITIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER (AND SELLING GROUP
MEMBERS) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK
ON NASDAQ IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."
--------------
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement (the "Registration Statement") (of
which this Prospectus forms a part) under the Securities Act of 1933, as
amended (the "Securities Act"), with respect to the Common Stock offered
pursuant to this Prospectus. This Prospectus contains summaries of the
material terms of the documents referred to herein and therein, but does not
contain all of the information set forth in the Registration Statement
pursuant to the rules and regulations of the Commission. For further
information, reference is made to such Registration Statement and the exhibits
thereto. Such Registration Statement and exhibits as well as reports and other
information filed by PCI can be inspected without charge and copied at
prescribed rates at the public reference facilities maintained by the
Commission at the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at its Regional Offices located as
follows: Chicago Regional Office, Citicorp Center, Suite 1400, 500 West
Madison Street, Chicago, Illinois 60661-2511; and New York Regional Office,
Seven World Trade Center, Suite 1300, New York, New York 10048. The Commission
maintains a Web site that contains reports, proxy, and information statements
and other information regarding registrants that file electronically with the
Commission. The Web site is located at http://www.sec.gov.
Statements contained in this Prospectus as to the contents of any contract
or other document that is filed as an exhibit to the Registration Statement
are not necessarily complete, and each such statement is qualified in its
entirety by reference to the full text of such contract or document.
The Company will be required to file reports and other information with the
Commission pursuant to the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). In addition to applicable legal requirements, if any, holders
of Common Stock will receive annual reports containing information regarding
the business and performance of the Company, including audited financial
statements with a report thereon by the Company's independent certified public
accountants, and quarterly reports containing unaudited financial information
for each of the first three quarters of each fiscal year.
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
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PAGE
<S> <C>
PROSPECTUS SUMMARY........................................................ 3
THE COMPANY............................................................... 3
Primary Investments..................................................... 3
Other Assets............................................................ 5
Leverage................................................................ 5
Initial Investments..................................................... 5
RISK FACTORS.............................................................. 6
The Manager............................................................. 8
Management Agreement.................................................... 9
Conflicts of Interest................................................... 10
Operating Policies and Objectives....................................... 11
THE OFFERING.............................................................. 11
Use of Proceeds......................................................... 11
Distribution Policy..................................................... 11
Tax Status of the Company............................................... 12
ORGANIZATION AND RELATIONSHIPS............................................ 13
RISK FACTORS.............................................................. 14
Conflicts of Interest in the Business of the Company May Result in
Decisions of the Company That Do Not Fully Reflect the Interests of the
Stockholders of the Company............................................ 14
Benefits to Insiders; Common Officers and Directors.................... 14
Manager May Engage in Other Business................................... 14
Independent Directors Will Not Participate in Day-to-Day Operations.... 15
Purchase of Assets from Prime and its Affiliates....................... 15
Newly-Organized Corporation; Absence of Identifiable Assets............. 15
Newly-Organized Corporation............................................ 15
Appropriate Investments May Not Be Available and Full Investment of Net
Proceeds Will Be Delayed.............................................. 16
Limited Availability of Investments May Inhibit Company's Objectives... 16
Risks Related to Investments in MBS Interests........................... 16
Subordinated Interests are Subject to Greater Credit Risks Than More
Senior Classes........................................................ 16
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Yields on Subordinated Interests, IOs and POs May Be Affected Adversely
By Interest Rate Changes.............................................. 17
REMIC Residual Interests May Generate Taxable Income Exceeding Cash
Flow.................................................................. 18
Risk Related to Investments in Mortgage Loans........................... 18
Multifamily and Commercial Loans Involve a Greater Risk of Loss than
Single Family Loans................................................... 18
Volatility of Values of Mortgaged Properties May Affect Adversely the
Company's Mortgage Loans.............................................. 18
Construction and Mezzanine Loans Involve Greater Risks of Loss than
Loans Secured by Income Producing Properties.......................... 18
Distressed Mortgage Loans May Have Greater Default Risks Than
Performing Loans...................................................... 19
Delinquency and Loss Ratios May Be Affected by Performance of Third-
Party Servicers....................................................... 19
Limited Recourse Loans May Limit the Company's Recovery to the Value of
the Mortgaged Property................................................ 19
One Action Rules May Limit the Company's Rights Following Defaults..... 19
Default Risks Associated with Distressed Mortgage Loans................ 20
Risks Related to Investments in Real Property............................. 20
Conditions Beyond Company's Control May Affect Adversely the Value of
Real Property......................................................... 20
Real Estate is Illiquid and its Value May Decrease..................... 20
The Company's Insurance Will Not Cover All Losses...................... 20
Property Taxes Decrease Returns on Real Estate......................... 20
Compliance with Americans with Disabilities Act and Other Changes in
Governmental Rules and Regulations May Be Costly...................... 21
</TABLE>
i
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PAGE
<S> <C>
Real Properties with Hidden Environmental Problems Will Increase Costs
and May Create Liability for the Company.............................. 21
Real Properties with Known Environmental Problems May Create Liability
for the Company....................................................... 21
Foreign Real Properties are Subject to Currency Conversion Risks and
Uncertainty of Foreign Laws........................................... 21
Economic and Business Risks............................................. 21
Interest Rate Changes May Adversely Affect the Company's Investments... 21
The Company's Performance May Be Affected Adversely If Its Hedging
Strategy Is Not Successful............................................ 22
Leverage Can Reduce Income Available for Distribution.................. 23
Maturity Mismatch Between Asset Maturities and Borrowing Maturities May
Affect Adversely the Company's Net Income............................. 23
Interest Rate Mismatch Between Asset Yields and Borrowing Rates May
Affect Adversely the Company's Net Income............................. 23
The Company May Not Be Able to Borrow Money on Favorable Terms......... 24
Adverse Changes in General Economic Conditions Can Adversely Affect
Company's Business.................................................... 24
Competition in the Acquisition of Appropriate Investments May Inhibit
Company's Ability to Achieve Objectives............................... 24
Appropriate Investments May Not Be Available and Full Investment of Net
Proceeds May Be Delayed............................................... 24
Investments May Be Illiquid and Their Value May Decrease............... 25
Legal and Tax Risks..................................................... 25
Tax Risks.............................................................. 25
Ownership Limit May Restrict Business Combination Opportunities........ 26
Plans Should Consider ERISA Risks of Investing in Common Stock......... 26
</TABLE>
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Certain Anti-Takeover Provisions May Inhibit a Change in Control of the
Company............................................................... 26
General................................................................ 26
Ownership Limit........................................................ 26
Preferred Stock........................................................ 27
Staggered Board........................................................ 27
Exemption from Maryland Business Combination Statute................... 27
Maryland Control Shares Acquisition.................................... 27
Board of Directors May Change Certain Policies Without Shareholder
Consent............................................................... 28
Loss of Investment Company Act Exemption Would Adversely Affect the
Company............................................................... 28
Limitation on Liability of Manager and Officers and Directors of the
Company............................................................... 28
Other Risks............................................................. 29
Uncertainty as to the Company's Ability Successfully to Implement Its
Operating Policies and Strategies Resulting From Its Lack of Operating
History............................................................... 29
Risk that Market for Common Stock Will Not Develop..................... 29
External Management of the Company..................................... 29
Increases in Interest Rates May Affect Adversely the Yield of the
Common Stock.......................................................... 29
Future Offerings of Capital Stock May Result in Dilution of the Book
Value or Earnings per Share of the Outstanding Common Stock........... 29
OPERATING POLICIES AND OBJECTIVES......................................... 30
Strategy................................................................ 30
Relationship with Prime................................................. 31
The Company's Guidelines................................................ 31
General................................................................ 31
Purchase From Prime and Its Affiliates................................. 32
The Company's Assets.................................................... 33
MBS Interests.......................................................... 33
Mortgage Loans......................................................... 37
Preferred Equity....................................................... 38
Net Leased Real Estate................................................. 38
Other Assets........................................................... 39
</TABLE>
ii
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<TABLE>
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PAGE
<S> <C>
Portfolio Management..................................................... 39
Leverage and Borrowing.................................................. 39
Reverse Repurchase Agreements........................................... 39
Bank Credit Facilities.................................................. 39
Mortgage Loans on Real Estate Owned by the Company...................... 40
CMOs and Warehouse Lines of Credit...................................... 40
Interest Rate Management Techniques..................................... 40
Hedging................................................................. 40
MANAGEMENT OF OPERATIONS................................................... 41
The Manager.............................................................. 41
Directors of the Manager................................................. 41
The Management Agreement................................................. 42
Management Fees.......................................................... 43
Costs and Expenses....................................................... 44
Stock Options............................................................ 44
Limits of Responsibility................................................. 45
Certain Relationships; Conflicts of Interest............................. 45
THE COMPANY................................................................ 48
Directors and Executive Officers......................................... 48
Insider Directors........................................................ 48
Election of Board of Directors; Compensation............................. 48
Indemnification of Directors and Officers................................ 48
DISTRIBUTION POLICY........................................................ 49
YIELD CONSIDERATIONS RELATED TO THE COMPANY'S INVESTMENTS.................. 50
Subordinated Interests................................................... 50
Mortgage Loans........................................................... 51
Preferred Equity......................................................... 52
Net Leased Real Estate................................................... 52
IOs, Inverse IOs and Sub IOs............................................. 52
INITIAL INVESTMENTS........................................................ 53
Brookdale Net Leased Real Estate Transaction............................. 53
The Brookdale Properties................................................ 53
Description of Lease.................................................... 54
Description of Indebtedness on the Properties........................... 54
YIELD CONSIDERATIONS RELATED TO THE INITIAL INVESTMENTS.................... 55
General.................................................................. 55
CAPITALIZATION............................................................. 56
USE OF PROCEEDS............................................................ 56
</TABLE>
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PAGE
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF LIQUIDITY AND CAPITAL RESOURCES... 56
PRINCIPAL SHAREHOLDERS OF THE COMPANY..................................... 57
DESCRIPTION OF CAPITAL STOCK.............................................. 57
General................................................................. 57
Common Stock............................................................ 58
Preferred Stock......................................................... 58
Restrictions on Transfer................................................ 58
Dividend Reinvestment Plan.............................................. 61
Reports to Stockholders................................................. 61
Transfer Agent and Registrar............................................ 61
List of Common Stock.................................................... 61
CERTAIN PROVISIONS OF MARYLAND LAW AND OF PCI'S ARTICLES OF INCORPORATION
AND BYLAWS............................................................... 61
Classification of the Board of Directors................................ 61
Removal of Directors.................................................... 62
Business Combinations................................................... 62
Control Shares Acquisitions............................................. 62
Amendment to the Articles of Incorporation and Bylaws................... 63
Advance Notice of Director Nominations and New Business................. 64
Meetings of Stockholders................................................ 64
Possible Anti-Takeover Effect of Certain Provisions of Maryland Law and
of the Articles of Incorporation and Bylaws............................ 64
COMMON STOCK AVAILABLE FOR FUTURE SALE.................................... 64
OPERATING PARTNERSHIP AGREEMENT........................................... 65
General................................................................. 65
General Partner Not to Withdraw......................................... 65
Capital Contribution.................................................... 66
Redemption Rights....................................................... 66
Operations.............................................................. 67
Distributions........................................................... 67
Allocations............................................................. 67
Term.................................................................... 67
Tax Matters............................................................. 68
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS................................. 68
General................................................................. 68
Taxation of PCI......................................................... 69
Requirements for Qualification.......................................... 70
</TABLE>
iii
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PAGE
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Organizational Requirements.............................................. 70
Qualified REIT Subsidiary................................................ 71
Ownership of a Partnership Interest...................................... 71
Income Tests............................................................. 72
Asset Tests.............................................................. 75
Annual Distribution Requirements......................................... 76
Penalty Tax on Prohibited Transactions................................... 77
Failure to Qualify....................................................... 77
Taxation of Taxable U.S. Stockholders.................................... 77
Taxation of Tax-Exempt Stockholders...................................... 79
Taxation of Non-U.S. Stockholders........................................ 80
Information Reporting Requirements and Backup Withholding Tax............ 82
Other Tax Considerations................................................. 82
ERISA CONSIDERATIONS....................................................... 83
Employee Benefit Plans, Tax-Qualified Retirement Plans, and IRAs......... 83
Status of PCI under ERISA................................................ 84
CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS AND REAL PROPERTY INVESTMENTS...... 85
General.................................................................. 85
Types of Mortgage Instruments............................................ 86
Interests in Real Property............................................... 86
Leases and Rents......................................................... 86
</TABLE>
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PAGE
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Condemnation and Insurance............................................... 86
Foreclosure.............................................................. 87
Ground Lease Risks....................................................... 89
Bankruptcy Laws.......................................................... 89
Default Interest and Limitations on Prepayments.......................... 90
Due on Sale and Due on Encumbrance....................................... 91
Subordinate Financing.................................................... 91
Acceleration on Default.................................................. 91
Certain Laws and Regulations; Types of Mortgaged Property................ 91
Forfeitures in Drug and RICO Proceedings................................. 91
Environmental Risks...................................................... 92
Applicability of Usury Laws.............................................. 93
Americans With Disabilities Act.......................................... 93
Soldiers' and Sailors' Civil Relief Act of 1940.......................... 94
UNDERWRITING............................................................... 94
LEGAL MATTERS.............................................................. 96
EXPERTS.................................................................... 96
GLOSSARY OF TERMS.......................................................... G-1
INDEX OF FINANCIAL STATEMENTS.............................................. F-1
</TABLE>
iv
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information included elsewhere in this Prospectus. Unless otherwise indicated,
the information contained in this Prospectus assumes that (i) the transactions
relating to the formation of the Company are consummated, (ii) the
Underwriter's over-allotment option is not exercised and (iii) the offering
price (the "Offering Price") of the Common Stock offered hereby is $16 per
share. Unless the context otherwise requires, all references in this Prospectus
to the (i) "Company" shall mean Prime Capital Investment Corp. ("PCI") and its
subsidiaries and Affiliates, including (a) Prime Capital Investment
Partnership, L.P. (the "Operating Partnership"), (b) Prime Capital Partner,
Inc. (the "General Partner"), the general partner of the Operating Partnership
and a wholly-owned subsidiary of PCI, and (c) PCLP, Inc. (the "Initial Limited
Partner"), the initial limited partner of the Operating Partnership and a
wholly-owned subsidiary of PCI; and (ii) "Common Stock" shall mean PCI's common
stock, par value $.01 per share. Capitalized terms used but not defined herein
shall have the meanings set forth in the Glossary beginning on page G-1.
THE COMPANY
PCI is a newly organized Maryland corporation that will elect to be taxed as
a REIT under the Code. The Company will be externally managed and advised by
Prime Capital Management, L.L.C. (the "Manager"), a wholly-owned subsidiary of
Prime Capital Holdings, L.L.C. ("PCH") which is an affiliate of The Prime
Group, Inc. ("Prime"). See "Management of Operations." The Company intends to
enhance the value of its Common Stock by pursuing advantageous investments that
capitalize on inefficiencies in the real estate and mortgage markets. The
Company's investments will include several categories of real estate related
assets.
PRIMARY INVESTMENTS
The Company intends to invest primarily in the following four categories of
real estate related assets (hereinafter collectively referred to as "Targeted
Portfolio Investments"):
Mortgage-Backed Securities. The Company intends to invest in interests in
commercial and multifamily mortgage-backed securities ("CMBS"). The Company
also may invest in interests in residential mortgage-backed securities
("RMBS" and, together with CMBS, "MBS"). The Company intends to invest in
various classes of MBS ("MBS Interests"), primarily sub-investment grade
and unrated classes. The acquisition of sub-investment grade and unrated
classes offers the potential of a higher yield than relatively more senior
classes which customarily are rated investment grade, but carry greater
credit risk, including a substantially greater risk of loss of principal
and non-payment of interest than investment grade rated classes. In
connection with its acquisition of sub-investment grade and unrated MBS,
the Company will attempt to mitigate these risks through underwriting
analysis of the real estate collateral, the borrowers, and the related
REMIC structure and, where appropriate, by obtaining rights to service the
underlying mortgage loans with respect to the Company's MBS Interests
("Special Servicing"), although the Company likely will not obtain Special
Servicing rights unless the underlying mortgage loan is in default. See
"Operating Policies and Objectives--The Company's Assets" and "Risk
Factors--Risks Related to Investments in MBS Interests--Subordinated
Interests are Subject to Greater Credit Risks Than More Senior Classes."
The Company intends to invest in various classes of collateralized mortgage
obligations ("CMO") and pass-through certificates ("Pass-Through
Certificates"), consisting primarily of non-investment grade classes. The
Company also may invest in various other classes of MBS, including interest
only ("IO"), principal only ("PO"), subordinated interest only ("Sub IO")
and inverse floating rate interest only ("Inverse IO") classes, as a short
term liquidity tool or as a longer term investment strategy. Although these
investments can present increased risks, the Company believes that a
managed portfolio of IOs, POs, Sub IOs and Inverse IOs can produce
attractive returns in a variety of interest rate environments. See "Risk
Factors--Risks Related to Investments in MBS Interests--Yields on
Subordinated Interests, IOs and POs May Be Affected Adversely By Interest
Rate Changes."
Mortgage Loans. The Company intends to invest, by way of purchase or
origination, in commercial and multifamily senior, mezzanine and
subordinate mortgage loans and interests therein (hereinafter
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collectively referred to as "Mortgage Loans"), including (i) first Mortgage
Loans that are current as to payments of principal and interest, including
construction and rehabilitation loans and interim and bridge loans
("Performing Mortgage Loans"), (ii) first Mortgage Loans that are in
default ("Nonperforming Mortgage Loans"), or for which default is likely or
imminent or for which the borrower is currently making monthly payments in
accordance with a forbearance plan ("Subperforming Mortgage Loans" and,
together with Nonperforming Mortgage Loans, "Distressed Mortgage Loans"),
(iii) Mortgage Loans that are subject to a prior lien, such as second
mortgages and mezzanine loans ("Subordinated Mortgage Loans"), (iv)
Mortgage Loans that entitle the mortgagee to the receipt of contingent
interest, in addition to the stated rate of interest, based on a percentage
of the property's gross revenues, and/or gain on sale of the property
("Participating Mortgage Loans"), and (v) senior, pari passu, and
subordinate interests in the Mortgage Loans described in clauses (i) thru
(iv) above ("Mortgage Loan Interests"). Generally, the Company does not
expect to invest in performing first Mortgage Loans other than the
potential purchase of a subordinate participation interest in a Mortgage
Loan. Investments in Mortgage Loan Interests offer the potential of a
higher yield than an investment in performing first Mortgage Loans, but
carry a greater risk of loss of principal and the nonpayment of interest
than performing first Mortgage Loans. The Company will attempt to mitigate
these risks through underwriting analysis of both the real estate
collateral and the borrower. See "Risk Factors--Risks Related to
Investments in MBS Interests--Subordinated Interests are Subject to Greater
Credit Risks Than More Senior Classes."
Preferred Equity. The Company intends to make preferred equity
investments in specific real estate assets (or pools of assets) or in real
estate operating companies. Generally, the preferred equity (the "Preferred
Equity") will have a preferred claim against both the operating cash flow
and liquidation proceeds from the specific real estate assets (or pool of
assets) or from the operating company. The Company expects that the
Preferred Equity will earn a stated cumulative return and, in some
instances, may participate in future growth in both the net operating
income and the value of the assets of the issuer (or equity of the issuer).
Generally, a Preferred Equity investment is made when the existing owner,
borrower, or real estate company requires additional equity to fund an
acquisition, development, refinancing or expansion of the assets (or the
company) and either (i) such equity is not generally available to the
borrower/owner on a pari passu or common equity basis, or (ii) the
owner/borrower desires to further leverage its assets and is willing to
grant the provider of such leverage a preferred interest in such assets in
exchange for retaining a greater percentage of common ownership. Regardless
of the underlying rationale of the investment, the Company's Preferred
Equity investments are expected to offer the potential for a higher yield
than is generally available from the direct purchase of assets or the
funding of senior mortgage loans, although such investments also carry
greater risk of loss of principal and the nonpayment of the preferred
return. The Company will attempt to mitigate these risks through
underwriting analysis of both the real estate collateral and the
borrower/owner. See "Risk Factors--Risks Related to Investments in Real
Property."
Net Leased Real Estate. The Company intends to invest in net leased real
estate on a leveraged basis. Net leased real estate is generally defined as
real estate that is net leased on a long-term basis (ten years or more) to
tenants who are customarily responsible for paying all costs of owning,
operating, and maintaining the leased property during the term of the
lease, in addition to the payment of a monthly net rent to the landlord for
the use and occupancy of the premises ("Net Leased Real Estate"). The
Company expects to acquire Net Leased Real Estate on a leveraged basis with
triple-net rents that will provide sufficient cash flow to provide an
attractive cash return on its investment therein after debt service.
Although the time during which the Company will hold Net Leased Real Estate
will vary, the Company anticipates holding most Net Leased Real Estate for
more than ten years. The Company will focus on Net Leased Real Estate that
is either leased to credit tenants or is real estate that can be leased to
other tenants in the event of a default of the initial tenant.
The Company believes that the above-described investment activities will
complement each other from both a cash flow and a tax planning perspective. The
Company expects to invest in a balanced amount of Preferred Equity and Net
Leased Real Estate in order to have the tax depreciation associated with such
investments to offset the non-cash accrual of interest on certain MBS Interests
and Mortgage Loans, including the original issue discount ("OID") generally
associated with either MBS Interests that are issued at a discount from par or
participating Mortgage Loans and the "phantom" taxable income associated with
interests in REMIC Residual
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Interests and Non-REMIC Residual Interests. No assurances can be made, however,
that the Company's investment strategy will be successful.
OTHER ASSETS
The Company will take an opportunistic approach to its investments and,
accordingly, the Company may invest in assets other than Targeted Portfolio
Investments. The Company may invest in multifamily, commercial and other real
property ("Real Property"), including properties acquired at foreclosure or by
deed-in-lieu of foreclosure ("REO Property") and other underperforming or
otherwise distressed Real Property (all of such underperforming and distressed
Real Property, together with REO Property, is referred to collectively as
"Distressed Real Property"). In addition, the Company may invest in Real
Property (or interests therein) located outside the United States. Targeted
Portfolio Investments and Real Property are referred to collectively as "Real
Estate Related Assets." The Company also may acquire securities with imbedded
leverage characteristics, such as mortgage derivatives and subordinate
interests.
LEVERAGE
To create yields commensurate with its investment objectives, the Company
intends to leverage its assets primarily through the issuance of CMOs, reverse
repurchase agreements, warehouse lines of credit and other secured borrowing
arrangements. The Company intends to use the proceeds from securitizations and
other borrowings to invest in additional MBS Interests, Mortgage Loans,
Preferred Equity and other assets and, in turn, to borrow against such assets
and to repeat this process of borrowing and investing until it has
significantly leveraged its portfolio of assets. A substantial portion of the
Company's borrowings is expected to be in the form of reverse repurchase
agreements that are based on the market value of the MBS Interests pledged to
secure the specific borrowings. A decline in the market value of those MBS
Interests could limit the Company's ability to borrow or result in lenders
initiating margin calls, requiring the Company to sell assets under adverse
market conditions in order to maintain liquidity. If these sales were made at
prices lower than the carrying value of the assets, the Company would
experience losses. A substantial portion of the Company's cash flow is expected
to consist of the difference between the interest income generated by its
Mortgage Loans, MBS Interests and the interest expense incurred with respect to
such borrowings, net of hedging and other costs. To the extent that the
Company's borrowings bear interest at a short-term floating rate, the Company
may hedge all or a portion of the interest rate risk associated with such
borrowings through the use of interest rate caps and swaps, forward contracts
and other similar hedging techniques. The Company also may engage in a variety
of interest rate risk management techniques for the purpose of managing the
effective maturity or interest rate of its assets. These techniques also may be
used to attempt to protect against declines in the market value of the
Company's assets resulting from general economic and market trends. Any such
hedging and other interest rate risk management techniques are subject to risks
and may affect adversely the Company's earnings. See "Risk Factors--Economic
and Business Risks--Leverage Can Reduce Income Available for Distribution." No
assurances can be made that the Company's investment and leverage strategy can
be implemented or will be successful.
INITIAL INVESTMENTS
The Company and Brookdale Living Communities, Inc. ("Brookdale"), an
Affiliate of Prime, have agreed to a non-binding term sheet pursuant to which
the Company will purchase four senior housing and assisted living facilities
from Brookdale for a purchase price of approximately $126.5 million, consisting
of the assumption of approximately $93.0 million of tax-exempt bond obligations
and the payment of approximately $33.5 million of cash. The term sheet provides
that the Company will lease these properties back to Brookdale on a long-term
triple-net basis as further described herein. The Brookdale transaction is
subject to various conditions and contingencies, including the approval by a
majority of the Independent Directors (as defined in the Glossary of Terms) of
the Company, approval of the Brookdale board of directors, consent of the U.S.
Department of Housing and Urban Development ("HUD") and consent of certain
lenders. Therefore, there can be no assurance that the Initial Investments will
be consummated. If the Initial Investments are consummated, the equity
investment will represent approximately 12.0% of the net proceeds of the
Offering. See "Initial Investments" and "Use of Proceeds."
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RISK FACTORS
An investment in the Common Stock involves various risks, and prospective
investors should consider carefully the matters discussed under "Risk Factors"
beginning on page 14 prior to an investment in the Company. Such risks include,
among others, the following:
. The Company and the Manager have common officers and directors, which may
present conflicts of interest in the Company's dealings with the Manager
and its Affiliates, including the Company's purchase of assets from the
Manager's Affiliates.
. The Company, which has no operating history prior to the completion of
the Offering, will engage in highly competitive businesses.
. The yield on and the value of the Company's investments (particularly
those in mortgage loans and MBS) may be affected adversely by changes in
prevailing interest rates, rates of prepayment and credit losses;
. The Company intends to leverage its investments in an amount to be
determined by the Manager and, ultimately, PCI's Board of Directors,
which could lead to reduced or negative cash flow and reduced liquidity.
. The Company has identified specific investments for only approximately
$33.5 million of the net proceeds of the Offering and the Company will
face significant competition in acquiring additional investments, which
may inhibit the Company's ability to achieve its investment objectives.
. The Company intends to invest in sub-investment grade and unrated
mortgage-backed securities, which may be affected adversely by events of
loss, such as credit losses due to borrower default, hazard losses and
state law enforceability issues.
. The Company intends to invest in non-performing and sub-performing
mortgage loans and mortgage loans that are subordinated to prior liens
against the collateral, each of which may be affected adversely by events
of loss, such as credit losses due to borrower default, hazard losses and
state law enforceability issues.
. Ownership of Common Stock by each stockholder is limited to 9.9% of the
outstanding Common Stock, which may deter third parties from seeking to
control or acquire the Company.
. In order to maintain REIT status, the Company must distribute at least
95% of its taxable REIT income each year, which could require the Company
to sell assets or borrow money to satisfy this requirement.
. The Company's proposed investment in MBS Interests and Distressed
Mortgage Loans could result in the Company recognizing interest income
(including, but not limited to, OID) for tax purposes without any
corresponding cash receipts, which could require the Company to sell
assets, borrow money or raise capital in order to have the cash needed to
distribute all of its taxable income and thereby avoid corporate income
tax on its retained earnings. Specifically, the Company may invest in
REMIC Residual Interests and Non-REMIC Residual Interests (each as
defined herein), which may generate taxable income in excess of cash
receipts.
. The Company's acquisition of the Initial Investments is subject to the
approval of HUD and certain lenders and there can be no assurance that
such consents will be forthcoming.
. The Company will contract with the Manager to advise the Board of
Directors of PCI (the "Board of Directors") and direct the day-to-day
business affairs of the Company. Thus, the Company's success may depend
on the skill and experience of the Manager's employees. In particular,
the Independent Directors will rely on information provided by the
Manager to review transactions of the Company with Prime and its
Affiliates.
. The directors and officers of the Company will not devote their full time
to the business of the Company.
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. Investing in commercial and multifamily loans, especially loans that are
junior or subordinate to the first mortgage loan, is generally riskier
than investing in single family residential loans, due to generally
larger loan balances, dependency on the successful completion or
operation of the project for repayment, and loan terms that require
little or no amortization of the loan over its term, but instead provide
for a balloon payment at stated maturity and, in the case of junior or
subordinate loans, are subject to subordination to a senior mortgage
loan.
. The yield on the Company's IOs, Sub IOs and Inverse IOs will be adversely
affected by faster than anticipated prepayment rates, which are generally
associated with a declining interest rate environment, and the Company's
Inverse IOs, which bear interest at rates that vary inversely with
changes to a specified index, will be adversely affected by higher than
anticipated levels of such index. Particularly high rates of prepayment
could result in a failure of the Company to recover fully its initial
investment in its IOs, Sub IOs and Inverse IOs.
. The Company's POs will be adversely affected by slower than anticipated
prepayment rates, which generally are associated with a rising interest
rate environment.
. Certain of the Company's real estate investments may require significant
management resources, may be illiquid, and may decrease in value because
of changes in economic conditions.
. The Company's borrowings are likely to include reverse repurchase
agreements with respect to its MBS Interests. A decline in the market
value of such MBS Interests could limit the Company's ability to borrow
or result in lenders initiating margin calls, requiring the Company to
sell assets under adverse market conditions in order to maintain
liquidity. If such sales are made at prices lower than the carrying value
of the assets, the Company will experience losses.
. Distressed Real Properties (which may have significant amounts of
unleased space) may not generate sufficient revenues to provide a return
on investment after meeting operating expenses and debt service
obligations. In addition, declining real estate values may result in
losses on the Company's Real Properties.
. Certain of the Company's Real Estate Related Assets may require
significant management resources, may be illiquid and may decrease in
value because of changes in economic conditions.
. The Company may be taxed as a regular corporation if it fails to qualify
as a REIT.
. In order to qualify as a REIT, the Company must satisfy certain
requirements concerning the nature of its assets and income, which may
restrict the Company's ability to invest in various types of assets.
. To maintain its exemption from regulation under the Investment Company
Act of 1940 (the "Investment Company Act"), the Company, among other
things, must maintain certain percentages of its investments in assets
that qualify for exemption from such regulation, which requirement may
restrict the Company's ability to invest in various types of assets.
. The Company may invest in Real Property, or Mortgage Loans secured by
Real Property, with known environmental problems that may materially
impair the value of the Real Property, which may expose the Company to
liability in excess of the Company's investment therein.
. The Company must rely on the experience of the Manager's employees
generally, and in particular the Independent Directors must rely on
information provided by the Manager to review transactions of the Company
with Prime and its Affiliates.
. Delinquency and loss ratios on the Company's Mortgage Loans will be
affected by the performance of third-party servicers and special
servicers.
. In periods of declining interest rates, prepayments on Mortgage Loans and
MBS Interests generally increase and the Company likely will have to
reinvest such funds in lower-yielding investments. Conversely, in periods
of rising interest rates, prepayments on Mortgage Loans and MBS Interests
generally decrease and the value of the Company's fixed-rate investments
generally will decline.
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. Investing in mezzanine loans generally is riskier than investing in more
senior mortgage loans because a foreclosure by a senior lienholder may
result in the mezzanine loan becoming unsecured, and the Company may not
recover the full amount, or indeed any, of its investment in such
mezzanine loan.
. The underlying real estate assets in which the Company may invest (which
may have significant amounts of unleased space) may not generate
sufficient revenues to provide a return on investment after meeting
operating expenses and debt service obligations. In addition, declining
real estate values may result in losses being charged to earnings.
. The Company intends to issue CMOs collateralized by its Mortgage Loans,
retaining the Mortgage Loans subject to the CMO debt. Any losses on such
Mortgage Loans would be borne by the Company.
. The Company's performance may be affected adversely if the Company fails
to hedge effectively against interest rate and other risks.
THE MANAGER
In managing the business and investment affairs of the Company, the Board of
Directors will be advised by Prime Capital Management, L.L.C. (the "Manager"),
a wholly owned subsidiary of PCH which is an Affiliate of Prime. Since 1982,
and until recent corporate spin-offs, Prime, together with its affiliates, was
a diversified real estate company engaged in the ownership, development,
acquisition, operation, leasing, marketing and finance of institutional-quality
commercial and multifamily real estate across the nation. Starting in 1994,
Prime began contributing its various operating divisions to separate self-
managed and self-administered publicly-traded REITs and operating companies. In
March, 1994, Prime Retail, Inc. (NYSE: PRT) became the successor-in-interest to
Prime's retail division. In August, 1994, Ambassador Apartments, Inc. (NYSE:
AAH) became the successor-in-interest to Prime's multifamily division. In May,
1997, Brookdale (NASD: BLCI) became the successor-in-interest to Prime's senior
independent and assisted living division.
As a result of the foregoing corporate spin-offs, Prime has become a holding
company for its various ownership interests in Prime Retail, Inc., Ambassador
Apartments, Inc., and Brookdale. As of August 31, 1997, these three public
companies had a combined market capitalization in excess of $2.7 billion and
Prime's equity interest in these companies had a combined market value in
excess of $280.0 million. In addition, Prime owns a majority interest in PCH.
PCH was recently formed to engage in the origination and securitization of
first mortgage loans relating to all forms of income-producing real estate. In
addition to the Manager, PCH has formed two wholly-owned subsidiaries: Prime
Capital Funding, LLC ("PCF") which will originate and securitize mortgage loans
in excess of $1.0 million and Prime Commercial Credit, LLC ("PCC") which
originate and securitize mortgage loans under $1.0 million. Both PCF and PCC
plan to originate these loans through regional offices located throughout the
country and finance such loans through long-term warehouse lines of credit and
by issuing MBS.
In an effort to address potential conflicts of interest, Prime, Prime Group
Limited Partnership ("PGLP") and certain other affiliates of Prime
(collectively, the "TPG Group"), and Michael W. Reschke ("Reschke") have
entered into certain non-compete agreements with Prime Retail, Inc., Brookdale
and Ambassador Apartments, Inc., respectively. PGLP is affiliated, under common
ownership, with Prime. Subject to certain conditions and exceptions, these non-
compete agreements prohibit the TPG Group, Reschke or any of their Affiliates
from making investments in areas that are considered the primary businesses of
such publicly-traded companies for certain periods. See "Management of
Operations--Relationship with Prime."
In September, 1997, PCH organized the Manager as an investment vehicle to
take advantage of the many attractive real estate investment opportunities
which are not otherwise suitable for investment by Prime, PCH, or the various
affiliated publicly-traded REITs and operating companies. The senior executives
of the Manager are experienced in the origination and underwriting of the
investments intended for the Company, including MBS, Mortgage Loans (non-
performing and subordinate), Preferred Equity and Net Leased Real Estate. The
senior officers and directors of the Manager have an average of fifteen years
of experience in commercial and multifamily real estate and mortgage finance.
The Company intends to enter into non-compete agreements with Prime and certain
senior executives of the Manager.
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The Manager believes that the Company will be in a unique position to
capitalize on investment opportunities originated by the senior executives of
the Manager, as well as on the relationship of the Manager to Prime and PCH.
Although many of the Company's prospective competitors may have access to
greater capital than the Company and other advantages, the Company believes
that the experience of the senior executives of the Manager in acquiring and
managing MBS, in acquiring and managing Mortgage Loans and, generally, in
developing, acquiring, operating, leasing and financing all forms of commercial
and multifamily real estate, will provide the Company with the means to compete
effectively. There can be no assurance, however, that the resources and
relationships developed by the Manager will enable the Company to be
successful.
MANAGEMENT AGREEMENT
The Company will enter into an agreement (the "Management Agreement") with
the Manager pursuant to which the Manager, subject to the supervision of PCI's
Board of Directors, will assist the Board of Directors in the formulation of
operating strategies for the Company, advise the Company concerning the
acquisition of assets by the Company, advise the Company concerning various
types of financing for the Company, including reverse repurchase agreements,
secured lines of credit, mortgage loans and the issuance of CMOs, monitor the
performance of the Company's assets and provide certain administrative and
managerial services in connection with the operation of the Company. For
performing these services, the Manager will receive (i) a base management fee
in an amount equal to 1% per annum on the first $500.0 million of the Average
Invested Assets of the Company (calculated quarterly), and 0.75% per annum on
the balance of the Average Invested Assets of the Company, payable in quarterly
installments, which base management fee is intended to cover the Manager's
costs of providing management services to the Company, and (ii) an incentive
fee, paid quarterly, in an amount equal to the product of (A) 25% of the dollar
amount by which (1)(a) Funds From Operations (before the incentive fee) of the
Company per share of Common Stock (based on the weighted average number of
shares outstanding) plus (b) gains (or minus losses) from debt restructuring or
sales of property per share of Common Stock for each quarter (based on the
weighted average number of shares outstanding), exceed (2) an amount equal to
(a) the weighted average of the price per share in the Offering and the prices
per share at any secondary offerings by the Company multiplied by (b) the Ten-
Year U.S. Treasury Rate plus five percent per annum multiplied by (B) the
weighted average number of shares of Common Stock outstanding during such
period. The Board of Directors of PCI may adjust the base management fee in the
future if necessary to align the fee more closely with the actual costs of such
services. The term "Average Invested Assets" for any period means the average
of the aggregate book value of the assets of the Company, including a
proportionate amount of the assets of all of PCI's direct and indirect
subsidiaries, before reserves for depreciation or bad debts or other similar
noncash reserves, computed by taking the daily average of such values during
such period. "Funds From Operations" as defined by the National Association of
Real Estate Investment Trusts ("NAREIT") means net income (computed in
accordance with GAAP) excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation and amortization on real estate assets,
and after adjustments for unconsolidated partnerships and joint ventures. Funds
From Operations does not represent cash generated from operating activities in
accordance with GAAP and should not be considered as an alternative to net
income as an indication of the Company's performance or to cash flows as a
measure of liquidity or ability to make distributions. As used in calculating
the Manager's compensation, the term "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
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, any
Federal Reserve Bank or agency or department of the federal government selected
by the Company. In addition, the Manager will be reimbursed for all out-of-
pocket expenses incurred on behalf of the Company. See "Management of
Operations."
Prime, along with certain senior executives of the Manager, will purchase
1,875,000 shares of Common Stock on the Closing Date at the initial public
offering price (the "Offering Price"), net of underwriting discounts, after
which Prime and such senior executives will own 10.0% of the Common Stock of
the Company assuming that the Underwriter does not exercise its over-allotment
option. To provide an incentive for the
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Manager to enhance the value of the Common Stock, the Company will grant the
Manager options to purchase 1,875,000 shares of Common Stock (2,156,250 shares
if the Underwriter exercises its over-allotment option) or, at the option of
the Company, units of limited partnership interest in the Operating Partnership
("Units"), at an exercise price per share (or Unit) equal to the Offering
Price. The Manager may cause the Company or the Operating Partnership to redeem
any Units for cash, or, at the election of the General Partner, shares of
Common Stock, on a one-for-one basis. One quarter of the Manager's warrants
will be exercisable on each of the first four anniversaries of the Closing
Date. Unexercised options will terminate on the tenth anniversary of the
Closing Date. See "Management of Operations--Stock Options."
CONFLICTS OF INTEREST
The Company will be managed by the Manager, a wholly owned subsidiary of PCH
which is an Affiliate of Prime. The Manager also is expected to provide
mortgage servicing and certain asset management services for the Company. Prime
along with certain senior executives of the Manager will purchase directly from
the Company, at the Offering Price, 1,875,000 shares of Common Stock
representing 10.0% of the outstanding shares of the Company's Common Stock
immediately after the Closing. Because of the Company's relationship with the
Manager and Prime, the Company will be subject to various potential conflicts
of interest. First, although the Company's Board of Directors will include a
majority of Independent Directors, the remaining directors and each of the
executive officers of the Company also serve as directors or executive officers
of the Manager, and one of the directors is an employee of and devotes
substantial time to Prime. Second, although the Manager and Prime have agreed
that the Company will have an exclusive right to invest in sub-investment grade
and unrated MBS and Net Leased Real Estate so long as the Management Agreement
has not been terminated, nothing restricts the Manager or Prime from providing
advice to other REITs that may compete in certain respects with the Company for
other types of assets. Third, Prime and PCH will continue to have the right to
originate and purchase Mortgage Loans that are suitable for securitization and
to make Preferred Equity investments associated with the origination of such
Mortgage Loans. Fourth, the Manager will receive a management fee for services
rendered to the Company. The Management Agreement may be terminated without
cause only if the Manager is paid a termination fee in an amount to be
determined by independent appraisal, which may affect adversely the Company's
ability to terminate the Manager without cause. Fifth, the Company will acquire
the Initial Investments from Brookdale, an Affiliate of Prime, and anticipates
that it may acquire substantial additional assets from Prime and its Affiliates
following completion of the Offering. Sixth, 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.
Although PCH's activities may result in a conflict of interest from time to
time, the Manager and the Company believe that such conflicts will be minimal
because PCH's primary business is the origination and purchase of first
Mortgage Loans that are suitable for securitization, and the funding of
Preferred Equity investments to facilitate the origination of such Mortgage
Loans; whereas, the Company's primary investment focus will be to purchase
distressed and non-performing first Mortgage Loans and to originate and
purchase second, mezzanine, and subordinate Mortgage Loans, or interim or
bridge first Mortgage Loans that are not suitable for securitization. In
addition, PCH will agree to fund Preferred Equity investments only if such
Preferred Equity investments are associated with its origination or purchase of
first Mortgage Loans which are suitable for securitization.
To protect the Company's stockholders from risks related to these potential
conflicts, prior to or upon the effectiveness of the Registration Statement
that contains this Prospectus, a majority of the Company's Board of Directors
will be unaffiliated with the Manager or Prime ("Independent Directors"). The
Independent Directors are expected to approve the Company's acquisition of the
Initial Investments and the execution of the Management Agreement and will
establish general guidelines for the Company's investments, borrowings and
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operations (the "Guidelines"). Although the Manager will perform the day to day
operations of the Company, the Independent Directors will review all
transactions on a quarterly basis to ensure compliance with the Guidelines. In
such a review, the Independent Directors are expected to rely primarily on
information provided by the Manager. See "Operating Policies and Objectives--
The Guidelines".
OPERATING POLICIES AND OBJECTIVES
The Company intends to invest in the Targeted Portfolio Investments when
opportunities that the Company considers advantageous become available. Until
appropriate real estate related acquisitions are made, however, the net
proceeds of the Offering may be invested in readily marketable securities,
consistent with maintaining the Company's REIT qualification, or in interest
bearing deposit accounts. Investors should be aware that it may take
considerable time for the Company to find appropriate investments, during which
time the Company's assets will be invested in relatively low yield instruments.
The Company believes that its long-term strategy of investing primarily in a
combination of MBS Interests, Mortgage Loans, Preferred Equity and Net Leased
Real Estate will be beneficial to the Company from a tax planning perspective.
Sub-investment grade and unrated MBS are typically issued with OID. The Company
will be required to recognize a portion of the OID as taxable income each year,
which may cause the Company to incur a corporate-level tax in such year unless
it sells assets or borrows money in a sufficient amount to distribute all of
its taxable income, although there may be no contemporaneous corresponding
receipt of cash by the Company. Certain participating Mortgage Loans also may
be deemed to have OID and Distressed Mortgage Loans may produce taxable
interest income prior to the receipt of cash payments by the Company.
Depreciation deductions associated with the Company's investments in Preferred
Equity and Net Leased Real Estate, however, will reduce the adverse tax effects
of the OID generated by the Company's investments in MBS Interests and
participating Mortgage Loans. See "Risk Factors--Legal and Tax Risks--Tax
Risks."
THE OFFERING
<TABLE>
<S> <C>
Shares offered to the public (1)............................... 16,875,000
Shares to be outstanding after the Offering (1)(2)............. 18,750,000
Proposed Nasdaq Stock Market Symbol............................ PRCI
</TABLE>
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(1) Assumes that the Underwriter's option to purchase up to an additional
2,812,500 shares to cover over-allotments is not exercised.
(2) Includes 1,875,000 shares to be sold by the Company directly to Prime and
certain senior executives of the Manager. Does not include 5,000,000 shares
reserved for issuance under the Option Plan or up to 539,063 shares
issuable pursuant to warrants granted to the Underwriter. See "Description
of Capital Stock" and "Capitalization."
USE OF PROCEEDS
The Company and Brookdale have agreed to a non-binding term sheet pursuant to
which the Company will purchase from Brookdale four properties consisting of
senior housing and assisted living facilities shortly after the completion of
the Offering for a purchase price of approximately $126.5 million, consisting
of the assumption of approximately $93.0 million of tax-exempt bond obligations
and the payment of approximately $33.5 million of cash, which is equal to
approximately 12.0% of the expected net proceeds of the Offering. The term
sheet contemplates that the Company will lease these properties back to
Brookdale on a long-term triple-net basis as further described herein. The
Brookdale transaction is subject to various conditions and contingencies,
including approval by a majority of the Independent Directors of the Company,
approval of the Brookdale board of directors, consent of HUD and consent of
certain lenders. The Company intends temporarily to invest the balance of the
net proceeds of the Offering in readily marketable, interest-bearing
securities, consistent with maintaining its status as a REIT, until the Company
finds appropriate Targeted Portfolio Investment in which to invest. See
"Operating Policies and Objectives."
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DISTRIBUTION POLICY
PCI intends to make distributions to its stockholders of all or substantially
all of its net taxable income each year (subject to certain adjustments) so as
to qualify for the tax benefits accorded to REITs under the Code. PCI intends
to make distributions at least quarterly. It is anticipated that the first
distribution to stockholders will be in January 1998.
TAX STATUS OF THE COMPANY
PCI intends to qualify and will elect to be taxed as a REIT under sections
856 through 860 of the Code, commencing with its short taxable year ending
December 31, 1997. If PCI qualifies for taxation as a REIT, PCI generally will
not be subject to federal corporate income tax on its taxable income that is
distributed to its stockholders. A REIT is subject to a number of
organizational and operational requirements. Although PCI does not intend to
request a ruling from the Internal Revenue Service ("IRS") as to its REIT
status, PCI has received an opinion of its legal counsel that PCI qualifies as
a REIT, which opinion is based on certain assumptions and representations about
PCI's ongoing businesses and investment activities and other matters. No
complete assurance can be given that PCI will be able to comply with such
assumptions and representations in the future. Furthermore, such opinion is not
binding on the Service or on any court. Failure to qualify as a REIT would
render PCI subject to federal income tax (including any applicable alternative
minimum tax) on its taxable income at regular corporate rates and distributions
to PCI's stockholders would not be deductible. Even if PCI qualifies for
taxation as a REIT, the Company may be subject to certain federal, state and
local taxes on its income and property. PCI will adopt the calendar year as its
taxable year. In connection with PCI's election to be taxed as a REIT, PCI's
Articles of Incorporation impose restrictions on the ownership and transfer of
the Common Stock. See "Risk Factors--Legal Risks--Tax Risks" and "Certain
Federal Income Tax Considerations--Taxation of the Company."
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ORGANIZATION AND RELATIONSHIPS
The Company intends to invest primarily in the Targeted Portfolio
Investments. The Manager will manage the day-to-day operations of the Company,
subject to the supervision of PCI's Board of Directors. The relationship among
PCI, its Affiliates and the Manager is depicted in the picture shown below.
LOGO
(1) PCI, a Maryland corporation which will elect to be taxed as a REIT, will
issue 10.0% of its Common Stock to Prime and certain senior executives of
the Manager and approximately 90.0% of its Common Stock to public investors
in the Offering.
(2) PCI will incorporate and capitalize two qualified REIT subsidiaries, the
General Partner and the Initial Limited Partner.
(3) The Initial Limited Partner and the General Partner will organize and
capitalize the Operating Partnership, with the Initial Limited Partner to
hold a 99% limited partnership interest in the Operating Partnership, and
the General Partner to hold a 1% general partnership interest in the
Operating Partnership.
(4) The Operating Partnership expects to acquire the Initial Investments for
cash and the assumption of debt.
(5) The Operating Partnership will undertake the business of PCI, including the
acquisition of sub-investment grade and unrated MBS Interests, Mortgage
Loans, Preferred Equity and Net Leased Real Estate.
(6) Prime Capital Holding, LLC, an Affiliate of Prime, will incorporate and
capitalize the Manager.
(7) The Manager will enter into the Management Agreement with PCI and the
Operating Partnership, pursuant to which the Manager will formulate
operating strategies and provide certain managerial and administrative
functions for the Company, subject to the supervision of PCI's Board of
Directors.
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This Prospectus contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, which can be identified
by the use of forward-looking terminology such as "may," "will," "should,"
"expect," "anticipate," "estimate" or "continue" or the negatives thereof or
other comparable terminology. The Company's actual results could differ
materially from those described in such forward-looking statements as a result
of certain factors, including those set forth in the following risk factors
and the other factors described elsewhere in this Prospectus.
RISK FACTORS
An investment in the Common Stock involves various risks. Before purchasing
shares of Common Stock offered hereby, prospective investors should give
special consideration to the information set forth below, in addition to the
information set forth elsewhere in this Prospectus.
CONFLICTS OF INTEREST IN THE BUSINESS OF THE COMPANY MAY RESULT IN DECISIONS
OF THE COMPANY THAT DO NOT FULLY REFLECT THE INTERESTS OF THE STOCKHOLDERS OF
THE COMPANY
Benefits to Insiders; Common Officers and Directors. The Company is subject
to various potential conflicts of interests arising from its relationship with
Prime, the Manager and their Affiliates. First, after the Closing, Prime and
certain senior executives of the Manager will own 1,875,000 shares,
representing 10.0% of the Common Stock, which will be purchased for cash at
the Offering Price net of underwriting discounts. Second, the Manager will
render management services to the Company for a management fee, which benefits
PCH, the Manager's parent company. Prime, which holds a majority position in
PCH, will also benefit.
The Management Agreement will require the approval of a majority of the
Independent Directors (as defined in the "Glossary of Terms"). The renewal of
the Management Agreement after the initial two-year term will require the
affirmative vote of a majority of the Independent Directors, and a majority of
the Independent Directors may terminate the Management Agreement at any time
after two years upon ninety days written notice. However, the Company will be
required to pay a termination fee to the Manager upon any termination (or non-
renewal) of the Management Agreement without cause. The amount of the
termination fee will be determined by independent appraisal. See "Management
of Operations--The Management Agreement." This requirement may affect
adversely the Company's ability to terminate the Manager without cause.
Two of the Company's directors and each of its executive officers serve as
directors or officers of the Manager. Moreover, Michael W. Reschke, Chairman
of the Board of the Company, is also Chairman of the Board of Prime and of
Prime Retail, Inc. and of Brookdale, publicly traded companies in which Prime
holds a substantial interest, and will continue to serve in those capacities
in the future. As such, he is expected to provide services not only to the
Company but also to Prime and its Affiliates and to Prime Retail, Inc. and
Brookdale. Although the Company expects that he will devote adequate time to
the Company's operations, if the operations of Prime or its Affiliates or
Prime Retail, Inc. or Brookdale need immediate attention, there can be no
assurance that he will have adequate time for the Company.
Manager May Engage in Other Business. The Management Agreement does not
limit or restrict the right of the Manager or any of its officers, directors,
employees or Affiliates from engaging in any business or rendering services of
any kind to any other person, including the purchase of or rendering advice to
others purchasing real estate assets that meet the Company's policies and
criteria. As a result, certain of the Manager's activities may compete with
the Company.
Manager and its Affiliates expect to continue to purchase real estate and to
purchase and originate first Mortgage Loans suitable for securitization in the
future, and will have no obligation to make investment opportunities available
to the Company except with respect to Subordinated Interests, Preferred Equity
and Net Leased Real Estate. See "Management of Operations--Certain
Relationships; Conflicts of Interest." Moreover, the Manager and its
Affiliates have no obligation to offer Subordinated Interests to the Company
if the mortgage loans collateralizing such Subordinated Interests were owned
by the Manager or one of its Affiliates. The Manager and its Affiliates will
not invest in a Subordinated Interest (other than one collateralized by loans
owned by the Manager or its Affiliates), Preferred Equity (other than
Preferred Equity funded to facilitate the origination
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or purchase of a first Mortgage Loan suitable for securitization), or Net
Leased Real Estate unless a majority of the Independent Directors have decided
that the Company should not invest in such asset. In deciding whether to invest
in such an asset, the Independent Directors may consider, among other factors,
whether the asset is well-suited for the Company and whether the Company is
financially able to take advantage of the investment opportunity.
Independent Directors Will Not Participate in Day-to-Day Operations. Although
the Independent Directors will approve the Management Agreement, daily
operations between the Company and the Manager and its Affiliates will not be
required to be approved by a majority of the Company's Independent Directors.
Instead, the majority of the Independent Directors will establish general
guidelines ("Guidelines") for the Company's investments, borrowings and
operations. On a quarterly basis, the Independent Directors will review
transactions engaged in by the Company to monitor compliance with the
Guidelines. Moreover, the Independent Directors will review the Guidelines, and
the Company's investment policies, annually. Investors should be aware that, in
conducting this review, the Independent Directors will rely primarily on
information provided to them by the Manager. See "Operating Policies and
Objectives--The Company's Guidelines."
Purchase of Assets from Prime and its Affiliates. The Company is subject to
conflicts of interest with the Manager because the Company intends to purchase
assets from the Manager's Affiliates, including Brookdale. The Company and
Brookdale, an Affiliate of Prime, have agreed to a non-binding term sheet
pursuant to which the Company will purchase from Brookdale four senior housing
and assisted living facilities soon after the Closing for an aggregate purchase
price of approximately $126.5 million, consisting of $33.5 million in cash and
the assumption of approximately $93.0 million of tax-exempt bond obligations,
and to lease back such properties to Brookdale pursuant to a triple net lease
with a projected initial term of twenty-four years, with two twenty-five year
options to renew at the then current fair market value. The Company also will
receive a 10.0% participation in future increases in gross revenues from such
properties over the gross revenues for the base year (defined as calendar year
1998). The Brookdale Transaction is subject to various conditions and
contingencies, including the approval by a majority of the Independent
Directors of the Company, the approval by the Brookdale board of directors, the
consent of HUD and the consent of certain lenders.
In the future, the Company may acquire Subordinated Interests, Mortgage
Loans, Preferred Equity or Net Leased Real Estate from the Manager or one of
its Affiliates only if a majority of the Independent Directors approve the
transaction in advance. In making each decision, the Independent Directors will
consider information provided by the Manager and such other information as they
deem appropriate to determine whether the investment is consistent with the
Guidelines, whether the price is fair and whether the investment is otherwise
in the best interest of the Company. To determine whether the price is fair,
the Independent Directors may consider a number of factors, including an
appraisal of an appraiser who is certified or licensed in the applicable state
and whose compensation is not dependent on the transaction. In approving the
acquisition of a Subordinated Interest or other class of MBS, the Independent
Directors may consider all relevant data, including price quotes from
investment bankers (such as the placement agents or underwriters of such MBS).
Nevertheless, the Independent Directors are likely to rely substantially on
information and analysis provided by the Manager to evaluate the Company's
Guidelines, compliance therewith and other matters relating to the Company's
investments.
The Company may participate in Mortgage Loans and Preferred Equity
investments together as a co-participant with the Manager or its Affiliates.
Any such co-participating transactions with the Manager or its Affiliates will
be reviewed by the Independent Directors as part of their quarterly review to
ensure compliance with the Guidelines. As to risks related to investments of
these kinds see "Risk Factors--Risks Related to Investments in Mortgage Loans."
NEWLY-ORGANIZED CORPORATION; ABSENCE OF IDENTIFIABLE ASSETS
Newly-Organized Corporation. The Company has no operating history and its
operating policies and strategies are untried. The Company will be dependent
upon the experience and expertise of the Manager in administering its day-to-
day operations. There can be no assurance, however, that the Manager will be
able to implement successfully the strategies that the Company intends to
pursue.
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Appropriate Investments May Not Be Available and Full Investment of Net
Proceeds Will Be Delayed. Not all of the Company's investments have been
identified. The Company intends temporarily to invest the net proceeds of the
Offering (other than those used to purchase the Initial Investments) in
readily marketable, interest-bearing securities until the Company finds
appropriate Targeted Portfolio Investments. There can be no assurance,
however, that the Company will identify Targeted Portfolio Investments or
other appropriate assets that meet its investment criteria or that any such
assets will produce a return on the Company's investment. Moreover, the
Company has identified only a relatively small amount of Initial Investments
in relation to the Company's initial capitalization, and the Company will have
broad authority to invest the remaining proceeds in whatever investments the
Company deems appropriate at the time of their acquisition. In making these
investment decisions, the Company will rely on the Manager's recommendations
and on the Guidelines. The Independent Directors will approve and monitor
compliance with the Guidelines. See "Operating Policies and Objectives--The
Company's Guidelines." Subject to the Guidelines, the Manager will have great
latitude in the types of real estate and related assets it may decide are
proper investments for the Company. No assurance can be made that the
Manager's decisions in this regard will result in a profit for the Company.
Limited Availability of Investments May Inhibit Company's Objectives. The
results of the Company's operations are dependent upon the availability of
opportunities for the acquisition of Targeted Portfolio Investments. The
Initial Investments of the Company will be small relative to the Common Stock
outstanding, and it may take considerable time for the Company to find
appropriate additional investments. In general, the results of the Company's
operations will be affected by the level and volatility of interest rates, by
conditions in the real estate and financial markets, and general economic
conditions. No assurances can be given that the Company will be successful in
acquiring economically desirable assets or that the assets, once acquired,
will maintain their economic desirability. To the extent that the Company
acquires assets other than those detailed herein, such other acquisitions may
pose risks to the Company and to the Company's stockholders that are different
from or in addition to the risks enumerated herein.
RISKS RELATED TO INVESTMENTS IN MBS INTERESTS
Subordinated Interests are Subject to Greater Credit Risks Than More Senior
Classes. The Company intends to acquire a significant amount of various
classes of MBS Interests, including "first loss" classes of subordinated MBS
Interests (hereinafter referred to as "Subordinated Interests"). A first loss
class is the most subordinated class of a multi-class issuance of pass-through
or debt securities and is the first to bear the loss upon a default on the
underlying Mortgage Collateral. Subordinated Interests are subject to special
risks, including a substantially greater risk of loss of principal and non-
payment of interest than more senior classes. While the market values of most
Subordinated Interest classes tend to react less to fluctuations in interest
rate levels than more senior classes, the market values of Subordinated
Interests classes tend to be more sensitive to changes in economic conditions
than more senior classes. As a result of these and other factors, Subordinated
Interests generally are not actively traded and may not provide holders
thereof with liquidity of investment.
The yield to maturity on Subordinated Interests of the type the Company
intends to acquire will be extremely sensitive to the default and loss
experience of the underlying mortgage pass-through securities or pools of
whole loans securing or backing a series of MBS ("Mortgage Collateral") and
the timing of any such defaults or losses. Because the Subordinated Interests
of the type the Company intends to acquire generally have no credit support,
to the extent there are realized losses on the Mortgage Collateral for such
classes, the Company may not recover the full amount, or any, of its initial
investment in such Subordinated Interests.
When the Company acquires a Subordinated Interest, it typically will be
unable to obtain the right to service the underlying performing Mortgage
Collateral. To minimize its losses, if the underlying Mortgage Collateral is
in default, the Company will seek to obtain the rights to service such
underlying Mortgage Collateral (the servicing of defaulted mortgage loans is
referred to as "Special Servicing"), although in many cases it will not be
able to obtain Special Servicing rights on acceptable terms. If the Company
does acquire Special Servicing rights, then it will contract with a third-
party special servicer to perform the Special Servicing functions, and
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thus the performance of the Company's investments will be dependent upon such
third party's performance. To the extent the Company does not obtain Special
Servicing rights with respect to the Mortgage Collateral underlying its MBS
Interests, the servicer of the Mortgage Collateral generally would be
responsible to holders of the senior classes of MBS, whose interests may not be
the same as those of the holders of the subordinated classes. Accordingly, the
Mortgage Collateral may not be serviced in a manner that is most advantageous
to the Company as the holder of a subordinated class.
The subordination of Subordinated Interests to more senior classes may affect
adversely the yield on the Subordinated Interests even if realized losses are
not ultimately allocated to such classes. On any payment date, interest and
principal are paid on the more senior classes before interest and principal are
paid with respect to the unrated or non-investment grade credit support
classes. Typically, interest deferred on these credit support classes is
payable on subsequent payment dates to the extent funds are available, but such
deferral may not itself bear interest. Such deferral of interest will affect
adversely the yield on the Subordinated Interests.
Yields on Subordinated Interests, IOs and POs May Be Affected Adversely By
Interest Rate Changes. The yield of the Subordinated Interests also will be
affected by the rate and timing of payments of principal (including
prepayments, repurchase, defaults and liquidations) on the mortgage loans
underlying a series of MBS. The rate of principal payments may vary
significantly over time depending on a variety of factors such as the level of
prevailing mortgage loan interest rates and economic, demographic, tax, legal
and other factors. Prepayments on the mortgage loans underlying a series of MBS
are generally allocated to the more senior classes of MBS until those classes
are paid in full or until the end of a lock-out period, typically of five years
or more. Generally, prepayments of principal from the mortgage loans are not
received by the Subordinated Interests holders for a period of at least five
years. As a result, the weighted average lives of the Subordinated Interests
may be longer than would be the case if, for example, prepayments were
allocated pro rata to all classes of MBS. To the extent that the holder of
Subordinated Interests is not paid compensating interest on interest shortfalls
due to prepayments, liquidations or otherwise, the yield on the Subordinated
Interests may be affected adversely. The Company may acquire classes of MBS
that are entitled to no (or only nominal) payments of principal, but only to
payments of interest ("IOs"). The yield to maturity of IOs is very sensitive to
changes in the weighted average life of such securities, which in turn is
dictated by the rate of prepayments on the underlying mortgage loans. In
periods of declining interest rates, rates of prepayments on mortgage loans
generally increase, and if the rate of prepayments is faster than anticipated,
then the yield on IOs will be negatively affected. Some IOs bear interest at a
floating rate that varies inversely with (and often at a multiple of) changes
in a specified index ("Inverse IOs"). The Company may invest in Inverse IOs for
the purpose of, among other things, hedging its portfolio of IOs. The yield to
maturity of an Inverse IO is extremely sensitive to changes in the related
index. The Company also expects to invest in Sub IOs, a class 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 until 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 all IO classes only
receive interest payments, their yields are extremely sensitive not only to
default losses but also to changes in the weighted average life of the relevant
classes, which in turn will be dictated by the rate of prepayments on the
underlying Mortgage Collateral. In addition, Sub IOs often generate taxable
income in excess of cash received. See "Operating Policies and Objectives--
Yield Considerations Related to the Company's Investments--IOs, Inverse IOs and
Sub IOs."
The Company may acquire POs, which are classes of MBS that are entitled to no
payments of interest, but only to payments of principal. The yield to maturity
of POs is very sensitive to changes in the weighted average life of such
securities, which in turn is dictated by the rate of prepayments on the
underlying Mortgage Collateral. In periods of declining interest rates, rates
of prepayment on mortgage loans generally increase, and if the rate of
prepayments is faster than anticipated, the yield on POs will be positively
affected. Conversely, the yield on POs will be affected adversely by slower
than anticipated prepayment rates, which generally are associated with a rising
interest rate environment. In addition, POs typically generate original issue
discount ("OID").
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Certain Investments May Generate Taxable Income Exceeding Cash Flow. The
Company also may invest in certain classes of MBS that are designated as the
residual interest in the related REMIC (a "REMIC Residual Interest") or that
represents the residual interest in a non-REMIC securitization ("Non-REMIC
Residual Interest"), which receive principal and interest payments in excess
of amounts needed to make payments on other classes of securities or to fund a
reserve account. Like interest otherwise allocable to Sub IOs, principal and
interest amounts otherwise allocable to such residual interests are used to
protect the senior classes of securities from credit losses on the underlying
Mortgage Loans. Moreover, in any given year, the taxable income produced by a
residual interest may exceed its cash flow. The Company may also invest in
Distressed Mortgage Loans and such loans may produce taxable interest income
for the Company prior to the Company's receipt of loan payments by the
borrowers. See "--Legal and Tax Risks."
RISK RELATED TO INVESTMENTS IN MORTGAGE LOANS
Multifamily and Commercial Loans Involve a Greater Risk of Loss than Single
Family Loans. The Mortgage Loans that the Company expects to acquire generally
will be secured by existing multifamily or commercial real estate, including
apartments, shopping centers, office buildings, hotels, industrial properties,
theme parks, hospitals and nursing homes. Property pledged as security for
Mortgage Loans is referred to as "Mortgaged Property." Multifamily and
commercial real estate lending is considered to involve a higher degree of
risk than single family residential lending because of a variety of factors,
including generally larger loan balances, dependency on successful operation
of the Mortgaged Property and the operating businesses of tenants therein for
repayment, and loan terms that often require little or no amortization and,
instead, provide for balloon payments at stated maturity. In addition, the
value of multifamily and commercial real estate can be affected significantly
by the supply and demand in the market for that type of property. Market
values may vary as a result of economic events, governmental regulations or
other factors outside the control of the borrower or the Company, such as rent
control laws in the case of multifamily Mortgage Loans, which may impact the
future cash flow of the underlying Mortgaged Property.
The successful operation of a multifamily or commercial real estate project
also generally is dependent on the performance and viability of the property
manager of that project. The property manager would be responsible for
responding to changes in the local market, planning and implementing the
rental structure, including establishing appropriate rental rates, and
advising the owner so that maintenance and capital improvements can be carried
out in a timely fashion and at an appropriate cost. There can be no assurance
regarding the performance of any operators and/or managers or persons who may
become operators and/or managers upon the expiration or termination of leases
or management agreements or following any default or foreclosure under a
Mortgage Loan.
Volatility of Values of Mortgaged Properties May Affect Adversely the
Company's Mortgage Loans. Commercial and multifamily property values and net
operating income derived therefrom are subject to volatility and may be
affected adversely by a number of factors, including, but not limited to,
national, regional and local economic conditions (which may be impacted
adversely by plant closings, industry slowdowns and other factors); local real
estate conditions (such as an oversupply of housing, retail, industrial,
office or other commercial space); changes or continued weakness in specific
industry segments; perceptions by prospective tenants and, in the case of
retail properties, retailers and shoppers, of the safety, convenience,
services and attractiveness of the property; the willingness and ability of
the property's owner to provide capable management and adequate maintenance;
construction quality, age and design; demographic factors; retroactive changes
to building or similar codes; and increases in operating expenses (such as
energy costs). The historical operating results of the Mortgaged Properties
may not be comparable to future operating results. In addition, other factors
may affect adversely the Mortgaged Properties' value without affecting the net
operating income, including changes in governmental regulations, zoning or tax
laws, potential environmental or other legal liabilities, the availability of
refinancing, and changes in interest rate levels.
Construction and Mezzanine Loans Involve Greater Risks of Loss than Loans
Secured by Income Producing Properties. The Company may acquire loans used to
finance the costs of construction or rehabilitation of Real Property
("Construction Loans") and, in some cases, loans ("Mezzanine Loans") secured
by a lien on Real
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Property that is subordinate to a lien on such Real Property securing another
loan. Construction Loans and Mezzanine Loans are considered to involve a
higher degree of risk than term mortgage lending secured by income-producing
Real Property. This is because of a variety of factors, including, in the case
of Construction Loans, dependency on successful completion and operation of
the project for repayment, difficulties in estimating construction or
rehabilitation costs and loan terms that often require little or no
amortization, providing instead for additional advances to be made and for a
balloon payment at a stated maturity date. In the case of Mezzanine Loans, the
factors would include, among other things, that a foreclosure by the holder of
the senior loan could result in a Mezzanine Loan becoming unsecured.
Accordingly, the Company may not recover the full amount, or any, of its
investment in such Mezzanine Loan. In addition, Construction Loans and
Mezzanine Loans may have higher loan to value ratios than conventional term
first mortgage loans because of shared appreciation provisions. Although the
borrower may have an initial equity investment of 10% to 15% of total project
costs, such initial equity may not be sufficient to protect the Company's
investment in Construction Loans and Mezzanine Loans.
Distressed Mortgage Loans May Have Greater Default Risks Than Performing
Loans. The Company may acquire Nonperforming and Subperforming Mortgage Loans,
as well as Mortgage Loans that have had a history of delinquencies. These
Mortgage Loans presently may be in default or may have a greater than normal
risk of future defaults and delinquencies, as compared to newly originated,
high quality loans. Returns on an investment of this type depend on the
borrower's ability to make required payments (or, with respect to
Subperforming Loans, the modified monthly payments required under the
applicable forbearance plan) or, in the event of default, the ability of the
loan's servicer to foreclose and liquidate the Mortgaged Property underlying
the Mortgage Loan. There can be no assurance that the servicer can liquidate a
defaulted Mortgage Loan successfully or in a timely fashion. See "Certain
Legal Aspects of Mortgage Loans and Real Property Investments."
Delinquency and Loss Ratios May Be Affected by Performance of Third-Party
Servicers. The Company intends to contract for the servicing of its Mortgage
Loans with servicers (including the Manager) and will be subject to risks
associated with potentially inadequate servicing. Many borrowers require
notices and reminders to keep Mortgage Loans current and to prevent
delinquencies and foreclosures. A substantial increase in the delinquency or
foreclosure rate resulting from inadequate servicing could affect adversely
the Company's performance and ability to access profitability the capital
markets for its financing needs, including future securitizations.
The Company's servicing agreements with its servicers often will provide
that if the Company terminates the servicing agreement without cause (as
defined in the agreement), the Company may be required to pay the third-party
servicer a termination fee. Depending upon the size of the particular Mortgage
Loan portfolio then being serviced, the termination fee that the Company would
be obligated to pay upon termination of a servicing agreement without cause
could be substantial and could deter a termination without cause that
otherwise would be advantageous to the Company.
Limited Recourse Loans May Limit the Company's Recovery to the Value of the
Mortgaged Property. The Company anticipates that a substantial portion of the
Mortgage Loans that it will acquire and of the mortgage loans underlying MBS
Interests that it will acquire may contain limitations on the mortgagee's
recourse against the borrower. In other cases, the mortgagee's recourse
against the borrower may be limited by applicable provisions of the laws of
the jurisdictions in which the Mortgaged Properties are located or by the
mortgagee's selection of remedies and the impact of those laws on that
selection. In those cases, in the event of a borrower default, recourse may be
limited to only the specific Mortgaged Property and other assets, if any,
pledged to secure the relevant Mortgage Loan. Even as to those Mortgage Loans
that provide for recourse against the borrower and its assets generally, there
can be no assurance that such recourse will provide a recovery in respect of a
defaulted Mortgage Loan greater than the liquidation value of the Mortgaged
Property securing that Mortgage Loan.
One Action Rules May Limit the Company's Rights Following Defaults. Several
states have laws that prohibit more than one "judicial action" to enforce a
mortgage obligation, and some courts have construed the term "judicial action"
broadly. The servicer of the mortgage obligation may be required to foreclose
first on properties located in states where such "one action" rules apply (and
when non-judicial foreclosure is permitted) before foreclosing on properties
located in states where judicial foreclosure is the only permitted method of
foreclosure. See "Certain Legal Aspects of Mortgage Loans and Real Property
Investments--Foreclosure."
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RISKS RELATED TO INVESTMENTS IN REAL PROPERTY
Conditions Beyond Company's Control May Affect Adversely the Value of Real
Property. The Company expects to invest directly and indirectly in real estate
through the funding of Preferred Equity investments in real estate and real
estate operating companies, as well as the direct investment in Net Leased
Real Estate. These investments are subject to varying degrees of risk
generally incident to the ownership of real estate. The underlying value of
these investments and the Company's income and ability to make distributions
to its stockholders are dependent upon the ability of the owner to operate the
underlying real estate properties in a manner sufficient to maintain or
increase revenues in excess of operating expenses and debt service or, in the
case of real estate leased to a single lessee, the ability of the lessee to
make rent payments. Revenues may be adversely affected by adverse changes in
national or local economic conditions, competition from other properties
offering the same or similar services, changes in interest rates and in the
availability, cost and terms of mortgage funds, the impact of present or
future environmental legislation and compliance with environmental laws, the
ongoing need for capital improvements (particularly in older structures),
changes in real estate tax rates and other operating expenses, adverse changes
in governmental rules and fiscal policies, civil unrest, acts of God,
including earthquakes, hurricanes and other natural disasters (which may
result in uninsured losses), acts of war, adverse changes in zoning laws, and
other factors which are beyond the control of the Company. Additionally, it
may become necessary for the Company to foreclose on certain of the Mortgage
Loans by which the Company would receive an equity interest in the borrower.
The receipt of such equity interest could cause the Company to fail certain of
the requirements which are necessary for it to be taxed as a REIT. See
"Certain Federal Income Tax Considerations--". For instance, such an
acquisition could potentially cause PCI to: (1) own securities of a particular
issuer the value of which exceeds 5% of the value of PCI's total assets or (2)
own more than 10% of a particular issuer's voting securities. Additionally, to
the extent the Company acquires an equity interest in a real estate operating
company, the Company potentially could receive income which would not qualify
for purposes of the gross income tests because of the furnishing of non-
customary services to the tenants at the property. See "Certain Federal Income
Tax Considerations--Income Tests."
Real Estate is Illiquid and its Value May Decrease. Real estate investments
are relatively illiquid. The ability of the Company to vary its portfolio in
response to changes in economic and other conditions will be limited. No
assurances can be given that the fair market value of any of the Company's
real estate assets will not decrease in the future.
The Company's Insurance Will Not Cover All Losses. The Company intends to
maintain, or cause the owner to maintain, comprehensive insurance on each of
the underlying real estate properties, including liability and fire and
extended coverage, in amounts sufficient to permit the replacement of the
properties in the event of a total loss, subject to applicable deductibles.
The Company will endeavor to obtain coverage of the type and in the amount
customarily obtained by owners of properties similar in nature. There are
certain types of losses, however, generally of a catastrophic nature, such as
earthquakes, floods and hurricanes, that may be uninsurable or not
economically insurable. Inflation, changes in building codes and ordinances,
environmental considerations, and other factors also might make it infeasible
to use insurance proceeds to replace a property if it is damaged or destroyed.
Under such circumstances, the insurance proceeds received by the Company, if
any, might not be adequate to restore the Company's investment with respect to
the affected property.
Property Taxes Decrease Returns on Real Estate. All Real Property owned by
the Company will be subject to real property taxes and, in some instances,
personal property taxes. Such real and personal property taxes may increase or
decrease as property tax rates change and as the properties are assessed or
reassessed by taxing authorities. An increase in property taxes on the
Company's Real Property could affect adversely the Company's income and
ability to make distributions to its stockholders and could decrease the value
of that Real Property.
Compliance with Americans with Disabilities Act and Other Changes in
Governmental Rules and Regulations May Be Costly. Under the Americans with
Disabilities Act of 1990 (the "ADA"), all public properties are required to
meet certain federal requirements related to access and use by disabled
persons. Certain underlying real estate properties acquired directly or
indirectly by the Company may not be in compliance with
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the ADA. If a property is not in compliance, the owner of the property will be
required to make modifications to such property to bring it in compliance, or
face the possibility of an imposition of fines or an award of damages to
private litigants. In addition, changes in governmental rules and regulations
or enforcement policies affecting the use and operation of the real estate,
including changes to building codes and fire and life-safety codes, may occur.
If the owner of the property is required to make substantial modifications to
the property to comply with the ADA or other changes in governmental rules and
regulations, the owner's ability to make payments to the Company or the
tenant's ability to make rent payments to the Company and, accordingly, the
Company's ability to make expected distributions to its stockholders could be
adversely affected.
Real Properties with Hidden Environmental Problems Will Increase Costs and
May Create Liability for the Company. Operating costs and the value of the
underlying real estate property acquired by the Company may be affected by the
obligation to pay for the cost of competing with existing environmental laws,
ordinances and regulations, as well as the cost of future legislation. Under
various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic substances
on, under or in such property. Such laws often impose liability whether or not
the owner or operator knew of, or was responsible for, the presence of such
hazardous or toxic substances. Therefore, an environmental liability could have
a material adverse effect on the value of the underlying real estate property
acquired by the Company, the Company's income and cash available for
distribution to its stockholders. The Company intends to obtain Phase I
environmental assessments on all underlying real estate property acquired by
the Company prior to the acquisition by the Company of such properties. The
purpose of Phase I environmental assessments is to identify potential
environmental contamination that is made apparent from historical reviews of
the properties, reviews of certain public records, preliminary investigations
of the sites and surrounding properties, and screening for the presence of
hazardous substances, toxic substances and underground storage tanks. Further,
even if a Phase I environmental assessment is obtained, there is no assurance
it will reveal all existing and potential environmental risks and liabilities,
and there is no assurance that there will be no unknown or material
environmental obligations or liabilities.
Real Properties with Known Environmental Problems May Create Liability for
the Company. The Company may invest in real estate, or mortgage loans secured
by real estate, with known environmental problems that materially impair the
value of the real estate. In such cases, the Company will take certain steps to
limit its environmental liability, including, the creation of a special purpose
entity which will own such real estate. Despite these precautionary measures,
there are risks associated with such an investment.
Foreign Real Properties are Subject to Currency Conversion Risks and
Uncertainty of Foreign Laws. The Company may invest in real estate, or mortgage
loans secured by real estate, located outside the United States. Investing in
real estate located in foreign countries creates risks associated with the
uncertainty of foreign laws and markets. Moreover, investments in foreign
assets are subject to currency conversion risks. In addition, income from
investment in foreign Real Property and, in some instances, foreign Mortgage
Loans may be subject to tax by foreign jurisdictions, which would reduce the
economic benefit of such investments. The Manager has no experience in
investing in foreign real estate. The Company intends to limit its investments
in foreign real estate to no more than 10% of the Company's portfolio.
ECONOMIC AND BUSINESS RISKS
Interest Rate Changes May Adversely Affect the Company's Investments. The
value of MBS is affected substantially by prepayment rates on the mortgage
loans comprising the mortgage collateral for such securities. Prepayment rates
on MBS are influenced by changes in current interest rates and a variety of
economic, geographic and other factors and cannot be predicted with certainty.
In periods of declining mortgage interest rates, prepayments on MBS generally
increase. If general interest rates also decline, the amounts available for
reinvestment by the Company during such periods are likely to be reinvested at
lower interest rates than the Company was earning on the MBS that were prepaid.
MBS may decrease in value as a result of increases in interest rates and may
benefit less than other fixed-income securities from declining interest rates
because of the risk of prepayment. In general, changes in both prepayment rates
and interest rates will change the total return
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on MBS, which in turn will affect the amount available for distribution to
stockholders. This volatility may be greater with certain MBS, such as IOs and
Inverse IOs, that the Company intends to acquire. The value of adjustable rate
mortgage loans and MBS paying adjustable coupon rates, which the Company may
acquire in the future, generally will vary inversely with changes in prevailing
interest rates. Under certain interest rate or prepayment rate scenarios, the
Company may fail to recoup fully its cost of acquisition of such investments.
The Company's operating results depend in part on the difference between the
interest income earned on interest-earning assets and the interest expense
incurred in connection with its interest-bearing liabilities. Changes in the
general level of interest rates can affect the Company's income by affecting
the spread between the Company's interest-earning assets and interest-bearing
liabilities, as well as, among other things, the value of the Company's
interest-earning assets and its ability to realize gains from the sale of
assets and the average life of the Company's interest-earning assets.
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. The
profitability of the Company may be adversely affected during any period as a
result of changing interest rates.
The Company's Performance May Be Affected Adversely If Its Hedging Strategy
Is Not Successful. The Company's performance may be affected adversely if the
Company fails to limit the effects of changes in interest rates on its
operations by employing an effective hedging strategy, including engaging in
interest rate swaps, caps, floors and other interest rate exchange contracts,
and buying and selling interest rate futures and options on such futures. The
use of these instruments to hedge a portfolio carries certain risks, including
the risk that losses on a hedge position will reduce the funds available for
distribution to shareholders and, indeed, that such losses may exceed the
amount invested in such instruments. There is no perfect hedge for any
investment and a hedge may not perform its intended purpose of offsetting
losses on an investment. For example, the Company will attempt to match the
interest rate indexes and repricing terms of its Mortgage Loans with those of
its borrowings, but it may not be able to achieve a perfect match. During
periods of volatile interest rates, such interest rate mismatches could affect
adversely the Company's ability to hedge effectively its interest rate risk.
The Company may enter into over-the-counter hedging transactions in which the
protections afforded to participants in an organized exchange and in a
regulated environment may not be available, which will expose the Company to
counterparty risk. Although the Company intends to enter into such contract
only with counterparties the Company believes to be financially sound and to
monitor the financial soundness of such parties on a periodic basis, the
Company may be exposed to the risk that the counterparties with which the
Company trades may become financially unsound or insolvent. If a counterparty
ceases making markets and quoting prices in such instruments, which may render
the Company unable to enter into an offsetting transaction with respect to an
open position, the Company may be forced to unwind its position, which may
result in a loss on the hedge position and could cause the Company to suffer
the adverse consequence against which the hedging transaction was designed to
protect. Certain of the hedging instruments acquired by the Company are traded
on exchanges, which may subject the Company to the risk of trading halts,
suspensions, exchange or clearing house equipment failure, insolvency of a
brokerage firm or other disruptions of normal trading activities. If the
Company anticipates that the income from any hedging transaction will not be
qualifying income for REIT income test purposes, the Company may form a
corporate subsidiary that is subject fully to federal corporate income taxation
through which the Company could conduct part or all of its hedging activities.
See "Certain Federal Income Tax Considerations--Requirements for
Qualification--Income Tests."
Leverage Can Reduce Income Available for Distribution. After the initial
"start-up" period, the Company intends to leverage its portfolio through
borrowings, generally through the use of reverse repurchase agreements, bank
credit facilities, warehouse lines of credit on pools of real estate and
mortgage loans, mortgage loans on real estate and other borrowings. The
percentage of leverage used will vary depending on the Company's estimate of
the stability of the portfolio's cash flow. To the extent that changes in
market conditions cause the cost of such financing to increase relative to the
income that can be derived from the assets acquired, the Company may reduce the
amount of leverage it utilizes.
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Although there is no specified limitation on the Company's indebtedness, in
general the Company expects the ratio of the Company's overall indebtedness to
not exceed 60% of the Company's total market capitalization defined as total
debt outstanding, on a consolidated basis, divided by the sum of (a) total debt
outstanding, plus (b) total equity market value of the Company's outstanding
equity securities, from time to time. However, the Company's Articles of
Incorporation and Bylaws do not limit the amount of indebtedness the Company
can incur, and the Board of Directors has the discretion to deviate from or
change this indebtedness policy at any time, without consent from or notice to
the Company's shareholders.
Leverage creates an opportunity for increased net income, but at the same
time creates risks. For example, leverage can reduce the net income available
for distributions to stockholders. The Company will leverage assets only when
there is an expectation that it will enhance returns, although there can be no
assurance that the Company's use of leverage will prove to be beneficial.
Moreover, there can be no assurance that the Company will be able to meet its
debt service obligations and, to the extent that it cannot, the Company risks
the loss of some or all of its assets to foreclosure.
Maturity Mismatch Between Asset Maturities and Borrowing Maturities May
Affect Adversely the Company's Net Income. The Company's use of short-term
floating rate borrowings to acquire long term assets, including Mortgage Loans
and MBS Interests, some of which will bear a fixed rate of interest may expose
the Company to a maturity mismatch. As a consequence, the Company's borrowing
costs could exceed the income earned on the Company's assets acquired with the
borrowed funds, thereby reducing the Company's income and ability to make
distributions to its stockholders. Further, MBS Interests subject to reverse
repurchase agreements periodically are marked to market by the repurchase
lender, and a decline in the value of MBS Interests pledged to secure reverse
repurchase agreements may result in margin calls. In addition, if renewals of
or substitutes for maturing or called short term borrowings are unavailable to
the Company for any reason, the Company may be required to sell assets quickly
to repay those borrowings. Certain of the Company's MBS Interests may be
illiquid and a sale associated with a short marketing period generally would
result in the Company receiving a lower price than otherwise would be
available. There can be no assurance that the Company will not incur losses
associated with forced sales of illiquid collateral to repay borrowings.
Furthermore, the use of leverage will magnify the Company's exposure to losses.
For example, a loss equal to 20% on an asset that is 80% leveraged would
eliminate the Company's equity in that asset completely, while the same loss
would leave the Company with 80% of its equity in an asset if no leverage had
been applied to that asset.
Interest Rate Mismatch Between Asset Yields and Borrowing Rates May Affect
Adversely the Company's Net Income. The Company's borrowings may be at interest
rates based on indexes and repricing terms similar to, but of somewhat shorter
maturities than, the interest rate indexes and repricing terms of various of
the Company's variable rate assets. While the historical spread between
relevant short-term interest rate indexes has been relatively stable, there
have been periods, such as the 1979 through 1982 high interest rate
environment, when the spread between those indexes was volatile. Further,
certain of the Company's assets will bear fixed rates of interest and have long
term maturities. There can be no assurance that such fixed rates of interest
will exceed the variable rates of interest on related borrowings. Interest rate
mismatches could impact the Company's financial condition in a material way,
and affect adversely the Company's income and ability to make distributions to
its stockholders, dividend yield and the market price of the Common Stock. See
"--Leverage Can Reduce Income Available for Distribution" and "--The Company
May Not Be Able to Borrow Money on Favorable Terms."
The Company May Not Be Able to Borrow Money on Favorable Terms. The ability
of the Company to achieve its investment objectives through leverage will
depend on the Company's ability to borrow money on favorable terms. The Company
has not entered into any borrowing arrangements at the present time, and there
can be no assurance that the Company will be able to enter into arrangements
enabling it to borrow money on favorable terms.
Adverse Changes in General Economic Conditions Can Adversely Affect Company's
Business. The Company's success is dependent upon the general economic
conditions in the geographic areas in which a
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substantial number of its investments are located. Adverse changes in national
economic conditions or in the economic conditions of the regions in which the
Company conducts substantial business likely would have an adverse affect on
real estate values, interest rates and, accordingly, the Company's business.
Competition in the Acquisition of Appropriate Investments May Inhibit
Company's Ability to Achieve Objectives. The Company intends to engage in
highly competitive businesses. The acquisition of MBS, Mortgage Loans,
Preferred Equity and Net Leased Real Estate is often based on competitive
bidding. In addition, the Company's competitors may seek to establish
relationships with the financial institutions and other firms from whom the
Company intends to purchase such assets. Many of the Company's anticipated
competitors, including Goldman Sachs' Whitehall Street Real Estate Fund, Black
Rock Capital Finance, AMRESCO, General Electric Capital Corporation, First
Chicago Commercial Assets, LaSalle National Bank, Ocwen Financial Corporation,
Blackstone Real Estate Advisors, Bank of America Securities Corporation and
CRIIMI MAE Inc., are significantly larger than the Company at the present time,
have established operating histories and procedures, may have access to greater
capital and other resources, and may have other advantages over the Company in
conducting certain businesses and providing certain services. There are several
REITs similar to the Company and others may be organized in the future. The
effect of the existence of additional REITs may be to increase competition for
the available supply of Real Estate Related Assets contemplated to be acquired
by the Company. The Company's net income will depend, in large part, on the
Company's ability to acquire and originate Mortgage Loans and MBS having yields
that produce favorable spreads over the Company's borrowing costs. Increased
competition for the acquisition of Mortgage Loans and MBS or a reduction in the
available supply could result in higher prices and thus lower yields on such
Mortgage Loans and MBS, which could narrow (or make negative) the yield spread
relative to the Company's borrowing costs. In addition, the Company's
competitors may seek to establish relationships with the financial institutions
and other firms from whom the Company intends to acquire such assets. There can
be no assurance that the Company will be able to acquire sufficient Real Estate
Related Assets at favorable spreads relative to the Company's borrowing costs
to achieve the Company's objectives. In addition, there can be no assurance
that a supply of Real Estate Related Assets suitable for acquisition by the
Company will continue to be available, or that changes in market conditions or
applicable laws will not affect the availability of suitable Real Estate
Related Assets.
Appropriate Investments May Not Be Available and Full Investment of Net
Proceeds May Be Delayed. Only approximately $33.5 million of the Company's
assets have been identified. The Company intends to invest the remaining net
proceeds of the Offering (after purchase of the Initial Investments) in readily
marketable, interest-bearing securities on a temporary basis until the Company
finds appropriate MBS, Mortgaged Loans and Real Property in which to invest.
There can be no assurance, however, that the Company will identify MBS,
Mortgage Loans or Real Property that meet its investment criteria or that any
such assets will produce a return on the Company's investments. Moreover, the
Company and the Manager have broad discretion in determining how to invest the
remaining net proceeds of the Offering and may change the current investment
and operating policies of the Company without a vote of the stockholders. Such
deviations from current policies might expose the Company to increased risks of
loss or liability, which could affect adversely the Company or the market price
of the Common Stock.
Investments May Be Illiquid and Their Value May Decrease. Many of the
Company's assets are and will be relatively illiquid. In addition, certain of
the MBS Interests that the Company will acquire will include interests that
have not been registered under the Securities act of 1933, as amended (the
"Securities Act"), or other applicable securities laws, resulting in a
prohibition against transfer, sale, pledge or other disposition of those MBS
Interests except in a transaction that is exempt from the registration
requirements of, or is otherwise in accordance with, those laws. The ability of
the Company to vary its portfolio in response to changes in economic and other
conditions will be relatively limited. No assurances can be given that the fair
market value of any of the Company's assets will not decrease in the future.
LEGAL AND TAX RISKS
Tax Risks. PCI intends to operate in a manner so as to qualify as a REIT for
federal income tax purposes. Although PCI does not intend to request a ruling
from the Service as to its REIT status, PCI has received an
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opinion from Winston & Strawn that, based on certain assumptions and
representations, it so qualifies. 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 counsel to PCI 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 PCI as a REIT will depend on PCI's satisfaction of certain
asset, income, organizational, distribution and stockholder ownership
requirements on a continuing basis. If PCI were to fail to qualify as a REIT in
any taxable year, PCI 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 PCI in
computing its taxable income. 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, PCI also would be disqualified from taxation as a REIT for the
four taxable years following the year during which PCI ceased to qualify as a
REIT.
PCI must distribute annually at least 95% of its net taxable income
(excluding any net capital gain) in order to avoid corporate income taxation of
the earnings that it distributes. In addition, PCI will be subject to a 4%
nondeductible 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. However, to the extent PCI elects to retain and pay income tax on net
long-term capital gains it received during the year such amounts will be
treated as having been distributed for purposes of the 4% excise tax.
PCI intends to make distributions to its stockholders to comply with the 95%
distribution requirement and to avoid the nondeductible excise tax. However,
differences in timing between the recognition of taxable income and the actual
receipt of cash could require the Company to borrow funds or sell assets on a
short-term basis to meet the 95% distribution requirement and to avoid the
nondeductible excise tax. The requirement to distribute a substantial portion
of PCI's net taxable income could cause PCI (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
acquisitions, unanticipated capital expenditures, 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.
The Company expects to acquire Subordinated Interests and participating
Mortgage Loans that are deemed to have OID for federal income tax purposes,
which is generally equal to the difference between an obligation's issue price
and its redemption price. The income generated by such instruments for federal
income tax purposes will consist of amortization of the OID and the coupon
interest associated with the instruments. PCI will be required to recognize as
income each year the portion of the OID that accrues during that year, which
will increase its taxable income for that year and subject PCI to a corporate-
level tax, notwithstanding the fact that there may be no corresponding
contemporaneous receipt of cash by PCI. REMIC Residual Interests and Non-REMIC
Residual Interests also may generate taxable income in excess of cash flow or
economic income in any year. In addition, certain taxable income produced by a
REMIC Residual Interest ("Excess Inclusion") (and, to the extent provided by
future Treasury Regulations, by Non-REMIC Residual Interests) may cause PCI's
stockholders to suffer certain adverse tax consequences. Additionally, because
PCI is an accrual basis taxpayer, it may be required to recognize interest
income from Distressed Mortgage Loans even though the borrowers fail to pay the
full amounts due. See "Certain Federal Income Tax Considerations."
Consequently, the acquisition by PCI of Subordinated Interests, Mortgage Loans
that are deemed to have OID, REMIC Residual Interests, or Non-REMIC Residual
Interests could have the effect of requiring PCI to incur borrowings or to
liquidate a portion of its portfolio at rates or times that PCI regards as
unfavorable to meet the REIT distribution requirement or to pay a corporate-
level tax.
Ownership Limit May Restrict Business Combination Opportunities. In order 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) during the
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last half of any taxable year (other than its first REIT taxable year). For
the purpose of preserving the Company's REIT qualification, the Articles of
Incorporation generally prohibit direct or indirect ownership of more than (i)
9.9% of the number of outstanding shares of Common Stock, or (ii) 9.9% of the
number of outstanding shares of any series of Preferred Stock (the "Ownership
Limit"). The Ownership Limit could have the effect of discouraging a takeover
or other transaction 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 prevailing market price or which such holders might believe to be
otherwise in their best interests. See "Description of Capital Stock--
Restrictions on Transfer" and "Certain Federal Income Tax Considerations--
Requirements for Qualification."
Plans Should Consider ERISA Risks of Investing in Common Stock. The Employee
Retirement Income Security Act of 1974, as amended ("ERISA"), and section 4975
of the Code prohibit certain transactions that involve (i) certain pension,
profit-sharing, employee benefit, or retirement plans or individual retirement
accounts (each a "Plan") and (ii) the assets of a Plan. A "party in interest"
or "disqualified person" with respect to a Plan will be subject to (x) an
initial 15% excise tax on the amount involved in any prohibited transaction
involving the assets of the Plan and (y) an excise tax equal to 100% of the
amount involved if any prohibited transaction is not corrected. Consequently,
the fiduciary of a Plan contemplating an investment in the Common Stock should
consider whether the Company, any other person associated with the issuance of
the Common Stock, or any Affiliate of the foregoing is or might become a
"party in interest" or "disqualified person" with respect to the Plan. In such
a case, the acquisition or holding of Common Stock by or on behalf of the Plan
could be considered to give rise to a prohibited transaction under ERISA and
the Code. See "ERISA Considerations--Employee Benefit Plans, Tax Qualified
Retirement Plans, and IRAs."
CERTAIN ANTI-TAKEOVER PROVISIONS MAY INHIBIT A CHANGE IN CONTROL OF THE
COMPANY.
General. Certain provisions contained in the Articles of Incorporation and
Bylaws and the Maryland General Corporation Law (the "MGCL") and certain
provisions of the Operating Partnership Agreement may have the effect of
discouraging a third party from making an acquisition proposal for the Company
and may thereby delay, deter or prevent a change in control of the Company or
the removal of existing management and, as a result, could prevent the
stockholders of the Company from being paid a premium for their shares of
Common Stock over then-prevailing market prices. See "Description of Capital
Stock--Common Stock" and "Certain Provisions of Maryland Law and of the
Articles of Incorporation and Bylaws."
Ownership Limit. In order to protect the Company against the risk of losing
REIT status due to a concentration of ownership among its stockholders, the
Ownership Limit set forth in the Articles of Incorporation provides that,
subject to certain specified exceptions, no person or entity (which does not
include certain pension plans and mutual funds) may own, or be deemed to own
by virtue of the applicable constructive ownership provisions of the Code,
more than 9.9% (by number or value, whichever is more restrictive) of the
outstanding shares of Common Stock. In addition, the Articles of Incorporation
provide that, in general, pension plans and mutual funds may actually and
beneficially own up to 9.9% of the outstanding shares of Common Stock (the
"Look-Through Ownership Limit"). The Board of Directors may, but in no event
will be required to, waive the Ownership Limit, the Look-Through Ownership
Limit or such other limitation as provided in the Articles of Incorporation,
as applicable, with respect to a particular stockholder if it determines that
such ownership will not jeopardize the Company's status as a REIT and the
Board of Directors otherwise decides such action would be in the best interest
of the Company. As a condition of such waiver, the Board of Directors may
require a ruling from the Internal Revenue Service ("IRS") or an opinion of
counsel satisfactory to it and/or undertakings or representations from the
applicant with respect to preserving the REIT status of the Company. The
foregoing ownership limitations may have the effect of precluding acquisition
of control of the Company without the consent of the Board of Directors and,
consequently, stockholders may be unable to realize a premium for their shares
over the then prevailing market price which is customarily associated with
such acquisitions.
Preferred Stock. The Articles of Incorporation permit the Board of Directors
to issue up to 30,000,000 shares of preferred stock, par value $.01 per share
("Preferred Stock"), and to establish the preferences and rights (including
the right to vote, participate in earnings, and to convert into Common Stock)
of any such
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Preferred Stock issued. Thus, the Board of Directors could authorize the
issuance of Preferred Stock with terms and conditions which could have the
effect of discouraging a takeover or other transaction in which holders of some
or a majority of shares of Common Stock might receive a premium for their
shares of Common Stock over the then-prevailing market price of such Common
Stock. See "Description of Capital Stock--Preferred Stock."
Staggered Board. The Board of Directors has three classes of directors. The
initial terms of the first, second and third classes will expire in 1999, 2000
and 2001, respectively. Directors for each class will be elected for a three-
year term upon the expiration of that class, term, beginning in 1999. Subject
to the right of the holders of any Preferred Stock to elect and remove
directors in certain circumstances, the affirmative vote of two-thirds of the
outstanding Common Stock is required to remove a director.
Exemption from Maryland Business Combination Statute. Under the MGCL, certain
"business combinations" (including certain issuance of equity securities)
between a Maryland corporation such as the Company and any person who owns 10%
or more of the voting power of the corporation's shares or an Affiliate of the
corporation which, at any time within the two-year period prior to the date in
question, was the beneficial owner of 10% of more of the voting stock of then-
outstanding voting stock of the corporation (an "Interested Stockholder") 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 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
Company's voting stock and (b) two-thirds of the votes entitled to be cast by
holders of outstanding voting shares of the Company's voting stock other than
shares held by the Interested Stockholder with whom the business combination is
to be effected, unless, among other things, the holders of shares of voting
stock 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. See "Certain Provisions of Maryland Law
and of the Articles of Incorporation and Bylaws--Business Combinations."
Maryland Control Shares Acquisition. Maryland law provides that "control
shares" of a corporation acquired in a "control share acquisition" have no
voting rights except to the extent approved by a vote of two-thirds of the
votes eligible under the statute to be cast on the matter. Control shares are
voting shares of stock which, if aggregated with all other such shares of stock
previously acquired by the acquiror, 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 of all voting power ("Control
Shares"). Control Shares do not include shares that the acquiring person is
then entitled to vote as a result of having previously obtained stockholder
approval. A "Control Share Acquisition" means the acquisition of Control
Shares, subject to certain exceptions.
If voting rights are not approved at a meeting of stockholders then, subject
to certain conditions and limitations, the issuer may redeem any or all of the
Control Shares (except those for which voting rights have previously been
approved) for fair value. If voting rights for Control Shares are approved at a
stockholders' meeting and the acquiror becomes entitled to vote a majority of
the shares of beneficial interest entitled to vote, all other stockholders may
exercise appraisal rights.
The Articles of Incorporation currently contain a provision exempting from
the control share acquisition statute any and all acquisitions by any person of
the Company's shares of capital stock. There can be no assurance that such
provision will not be amended or eliminated at any point in the future. If the
foregoing provisions in the Articles of Incorporation are rescinded, the
control shares acquisition statute or the business combination statute, as the
case may be, could have the effect of discouraging offers to acquire the
Company and of increasing the difficulty of consummating any such offer.
Board of Directors May Change Certain Policies Without Shareholder Consent.
The major policies of the Company, including its investment policy, the
Guidelines and other policies with respect to acquisitions, financing, growth,
operations, debt and distributions, are 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,
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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. See "Operating Policies and Objectives" and "Certain
Provisions of Maryland Law and of the Company's Articles of Incorporation and
Bylaws."
Loss of Investment Company Act Exemption Would Adversely Affect the Company.
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. 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 Securities and Exchange Commission (the "Commission"), in order to
qualify for this exemption, the Company, among other things, must maintain at
least 55% of its assets in Qualifying Interests 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, by obtaining the Special Servicing 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. 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 this
position. If the Commission or its staff were to take a different position with
respect to whether such Subordinated Interests constitute Qualified 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 an adverse effect on the Company and the market price for the
Common Stock.
Limitation on Liability of Manager and Officers and Directors of the Company.
The Articles of Incorporation of the Company contain 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 engaged in willful
misconduct or a knowing violation of criminal law or of any federal or state
securities law. 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 "Management of Operations--Limits of Responsibility."
OTHER RISKS
Risk that Market for Common Stock Will Not Develop. Prior to the Offering,
there has not been a public market for the shares of Common Stock offered
hereby. The Offering Price will be determined by the Company and the
Underwriter. See "Underwriting." There can be no assurance that the price at
which the shares of Common Stock will sell in the public market after the
Offering will not be lower than the price at which they are sold by the
Underwriter. The Common Stock has been approved for listing on The Nasdaq Stock
Market. Quotation through The Nasdaq Stock Market does not ensure, however,
that an active market will develop for the Company's Common Stock.
External Management of the Company. The Company will be managed by the
Manager, subject to the supervision of the Board of Directors. Thus, the
Company will depend on the services of the Manager and its officers and
employees for the success of the Company. Certain officers, directors and
employees of the Company and the Manager and its affiliates have experience in
creating, evaluating, acquiring and managing
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Mortgage Loans and MBS interests. Moreover, the Manager, a newly organized
company, will need to subcontract with third parties or with employees of Prime
and its Affiliates to provide certain services on behalf of the Company. For
example, the Manager recently acquired, and the Company is training personnel
to become proficient in the use of, certain internal computer analytic programs
designed, among other things, for use in analyzing MBS Interests. Until those
programs are fully integrated into the Company's operations, the Manager
intends to contract with third party experts to perform such analytics. Third
parties and Prime employees who provide services to the Company through
subcontracts with the Manager may provide similar services to other mortgage
REITs and other competitors of the Company. There can be no assurance that the
Company and the Manager will be able to implement successfully the strategies
that the Company intends to pursue. Subject to the Guidelines, the Manager is
expected to have significant latitude as to the types of assets it may
determine to be proper investments for the Company. No assurance can be made
that the Manager's decisions in this regard will result in a profit for the
Company. Moreover, certain of the Manager's personnel are employees of Prime or
its Affiliates, and accordingly the Company's success may depend in part on the
continuing ability of Prime and its Affiliates, including the Manager, to hire
and retain knowledgeable personnel and the Manager's ability to cause such
personnel to focus their attention to the affairs of the Company rather than
the affairs of Prime and its Affiliates. The ability of Prime and its
Affiliates to attract and retain such personnel may be affected, in turn, by
Prime's continued financial strength. Finally, the Company is subject to the
risk that the Manager will terminate the Management Agreement and that no
suitable replacement can be found to manage the Company.
Increases in Interest Rates May Affect Adversely the Yield of the Common
Stock. The Company's earnings will be derived primarily from the expected
positive spread between the yield on the Company's Real Estate Related Assets
and the costs to the Company of its borrowings. This expected positive spread
will not necessarily be larger in high interest rate environments than in low
interest rate environments. In periods of high interest rates, however, the net
income of the Company, and therefore the dividend yield on the Common Stock,
may be less attractive compared to alternative investments of equal or lower
risk, which could impact adversely the market price of the Common Stock.
Future Offerings of Capital Stock May Result in Dilution of the Book Value or
Earnings per Share of the Outstanding Common Stock. The Company may increase
its capital resources in the future by making additional offerings of its
Common Stock, securities convertible into its Common Stock or Preferred Stock.
The actual or perceived effect of such offerings may be the dilution of the
book value or earnings per share of the Common Stock outstanding, which may
result in the reduction of the market price of the Common Stock.
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OPERATING POLICIES AND OBJECTIVES
STRATEGY
The Company intends to invest primarily in (i) sub-investment grade and
unrated MBS; (ii) Performing Mortgage Loans; (iii) Distressed Mortgage Loans;
(iv) Subordinated Mortgage Loans; (v) Participating Mortgage Loans; (vi)
Mortgage Loan Interests; (vii) Preferred Equity and (viii) Net Leased Real
Estate. There can be no assurances that the Company will be able to acquire
such assets, that the terms or results of such acquisitions will be beneficial
to the Company, or that the Company will achieve its objectives. See "Risk
Factors."
To create yields commensurate with its investment objectives, the Company
intends to borrow funds through the issuance of CMOs in debt securitizations
or other borrowings arrangements. The Company also, in certain cases, may
securitize Mortgage Loans by transferring them to a special purpose trust or
corporation which elects to be treated as a REMIC or a financial asset
securitization investment trust ("FASIT"). The special purpose entity would
issue MBS pass-through certificates ("Pass-Through Certificates") to the
Company, which would sell certain classes of certificates and retain certain
non-investment grade and IO classes of certificates. The Company intends to
use the proceeds from securitizations and borrowings to invest in additional
Mortgage Loans, MBS Interests and other assets and, in turn, to borrow against
those newly acquired assets, primarily through additional securitizations. The
Company's strategy is to repeat this process to the extent opportunities to
use leverage are available and the Manager determines and advises that using
leverage is prudent and consistent with maintaining acceptable levels of risk
until the Company has significantly leveraged its portfolio of Mortgage Loans
and MBS Interests. There can be no assurances that the Company will be able to
acquire appropriate assets other than the Initial Investments, that the terms
or results of the Company's acquisitions will be beneficial to the Company, or
that the Company will achieve its objectives. See "Risk Factors."
In addition, the Company may decide to pursue other strategies and other
available acquisition opportunities it deems suitable for the Company's
portfolio. The Company also may acquire Real Property, including Distressed
Real Property.
The Company cannot anticipate with any certainty the percentage of the
proceeds of the Offering that will be invested in each category of Target
Portfolio Investments. Subject to the Guidelines, the Company has significant
discretion in the manner in which to invest the proceeds of the Offering.
There can be no assurance that the Company will be successful in its
investment strategy.
The Company will have no predetermined limitations or targets for
concentration of property type or geographic location. Instead, the Company
plans to make acquisition decisions through asset, borrower, and collateral
analysis, evaluating investment risks on a case-by-case basis. To the extent
that the Company's assets become concentrated in a few states or a particular
region, the return on an investment in the Common Stock will become more
dependent on the economy of such states or region.
The Company intends to acquire or finance investments through the use of
leverage, consistent with maintaining an acceptable level of risk.
The Company will acquire the Initial Investments from Brookdale and in the
future may acquire additional assets from Prime, the Manager or their
Affiliates. The Company intends to acquire assets, other than the Initial
Investments, from various sources unaffiliated with Prime located throughout
the United States, such as savings and loan associations, banks, mortgage
bankers, home builders, insurance companies and other mortgage lenders.
The Company currently does not intend to invest in the securities of other
issuers for the purpose of exercising control, to issue any series of senior
securities, to underwrite securities of other issuers, to offer securities in
exchange for property or to repurchase or otherwise reacquire the Common
Stock.
The Company may change its policies in connection with any of the foregoing
without the approval of the stockholders.
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RELATIONSHIP WITH PRIME
Since 1982, and until recent corporate spin-offs, Prime was a diversified
real estate company engaged in the ownership, development, acquisition,
operation, leasing, marketing and finance of institutional-quality commercial
and multifamily real estate across the nation. Starting in 1994, Prime began
contributing its various operating divisions to separate self-managed and
self-administered publicly-traded real estate investment trusts and operating
companies. In March, 1994, Prime Retail, Inc. became the successor-in-interest
to Prime's retail division. In August, 1994, Ambassador Apartments, Inc.
became the successor-in-interest to Prime's multifamily division. In May,
1997, Brookdale became the successor-in-interest to Prime's senior independent
and assisted living division.
As a result of the above-described corporate spin-off, Prime has become a
holding company for its various ownership interests in Prime Retail, Inc.,
Ambassador Apartments, Inc., and Brookdale. As of August 31, 1997, these three
public companies had a combined market capitalization in excess of $2.7
billion and Prime's equity interest in these companies had a combined market
value in excess of $280.0 million. In addition, Prime owns a majority interest
in PCH which was recently formed to engage in the origination and
securitization of first mortgage loans on all forms of income-producing real
estate. PCH's two subsidiaries are PCF which will originate and securitize
mortgage loans in excess of $1.0 million and PCC which will originate and
securitize mortgage loans under $1.0 million. Both PCF and PCC plan to
originate these loans through regional offices located throughout the country
and finance such loans through long-term warehouse lines of credit and by
issuing MBS.
In an effort to eliminate potential conflicts of interest, the TPG Group and
Reschke have entered into certain non-compete agreements with Prime Retail,
Inc., Brookdale and Ambassador Apartments, Inc., respectively. Subject to
certain conditions and exceptions, these non-compete agreements restrict the
TPG Group, Reschke or any of their Affiliates from making investments in areas
that are considered the primary businesses of such publicly-traded companies
for certain periods.
In September, 1997, PCH organized the Manager as an investment vehicle to
take advantage of the many attractive real estate investment opportunities
which are not otherwise suitable for investment by Prime, PCH, or the various
affiliated publicly-traded REITs and operating companies. The senior
executives of the Manager are experienced in the origination and underwriting
of the investments intended for the Company, including MBS, Mortgage Loans
(non-performing and subordinate), Preferred Equity and Net Leased Real Estate.
The senior executives of the Manager have substantial experience in the
acquisition, management, finance, and disposition of Targeted Portfolio
Investments and the management of diverse real estate assets. Moreover, Prime
and its Affiliates have substantial experience in the development,
acquisition, operation, management, leasing, finance, and disposition of most
types of institutional-quality, income-producing real estate over the past
sixteen years.
THE COMPANY'S GUIDELINES
General. The following is a summary of the guidelines setting forth the
general parameters for the Company's investments, borrowings and operations
(the "Guidelines"). See also "--The Company's Assets." The Guidelines are
expected to be approved by the Board of Directors (including a majority of the
Independent Directors) and may be changed by the Board of Directors without a
vote of the stockholders. The Manager is empowered to make the day-to-day
investment decisions of the Company based on the Guidelines. Such investment
decisions will include decisions to issue commitments on behalf of the Company
to purchase Mortgage Loans, MBS Interests and other assets meeting the
investment criteria of the Company. The Independent Directors will review all
transactions of the Company on a quarterly basis to insure compliance with the
Guidelines.
The Company intends to invest primarily in Real Estate Related Assets with a
view to maximizing income for distribution to stockholders, consistent with
levels of risk that are perceived by the Company to be acceptable.
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Pending investment of its funds in longer term investments as provided for in
the Guidelines, the Company intends to invest those funds in readily
marketable securities or interest-bearing deposit accounts, consistent in each
case with maintaining the Company's status as a REIT. The Company is permitted
to take an opportunistic approach to its investments, and may acquire any of
the types of assets described in the Guidelines if the Company and the Manager
determine that to do so would be in the Company's best interests.
The Company, in consultation with the Manager, may establish underwriting
criteria for evaluating potential investments and, if such underwriting
criteria are established, the Company, in consultation with the Manager, may
modify such underwriting criteria at any time and from time to time. The
Company's policy generally is to offer a price for each asset that it
contemplates acquiring not greater than the price that the Manager estimates
to be sufficient to generate an acceptable risk-adjusted return to the Company
from the acquisition of that asset.
Purchase From Prime and Its Affiliates. The price at which the Company will
purchase Mortgage Loans and other assets from Prime and its Affiliates,
including PCH, will be determined in accordance with the Guidelines, as
amended from time to time. A majority of the Independent Directors are
expected to approve the purchase of the Initial Investments and are expected
to authorize the officers of the Company to negotiate the final terms of the
purchase. In the future, the Manager will determine the transfer price for the
Company's acquisitions of assets from Prime and its Affiliates based on
pricing guidelines approved by the Independent Directors. The Independent
Directors will review those transactions on a quarterly basis to insure
compliance with the Company's pricing guidelines.
In deciding whether to approve an acquisition of any assets, including
acquisitions of Mortgage Loans and other assets from Prime or its Affiliates,
the Manager may consider such information as it deems appropriate to determine
whether the acquisition is consistent with the Guidelines, such as whether the
price is fair and the investment otherwise is suitable and in the best
interests of the Company. In addition, the Manager may consider, among other
factors, whether the acquisition of that asset will enhance the Company's
ability to achieve or exceed the Company's risk adjusted target rate of
return, if any, established for the relevant time period by the Board of
Directors, whether the asset otherwise is well-suited for the Company and
whether the Company financially is able to take advantage of the investment
opportunity presented thereby. There is no geographic limitation or
requirement of geographic diversification (either as to size, jurisdictional
boundary, zip code or other geographic measure) as to the properties that
secure repayment of the Mortgage Loans or underlying the MBS Interests
contemplated to be acquired by the Company; the only limitations as to the
type of assets that the Company may acquire and the characteristics thereof
being limitations either (i) imposed by law, (ii) set forth in the Guidelines
or (iii) with which the Company must comply as a condition of maintaining both
its status as a REIT and its exemption from regulation under the Investment
Company Act. In approving the acquisition of a Mortgage Loan or MBS Interest
in the future, the Manager may consider all data deemed necessary to determine
the proper value of such Mortgage Loan or MBS Interest. To determine whether
the price of a Distressed Real Property is fair, the Manager may consider a
number of other factors, which may include an appraisal by an appraiser who is
certified or licensed in the applicable state and whose compensation is not
dependent on the transaction. The Independent Directors are likely to rely
substantially on information and analysis provided by the Manager to evaluate
the Company's Guidelines, compliance therewith and other matters relating to
the Company's investments.
Where possible, the price that the Company will pay for Mortgage Loans, MBS
Interests and other assets acquired from Prime or its Affiliates will be
determined by reference to the prices most recently paid to Prime or its
Affiliates for similar assets, adjusted for differences in the terms of such
transactions and for changes in market conditions between the dates of the
relevant transactions. If no previous sales of similar assets have occurred,
the Company will attempt to determine a market price for the asset by an
alternative method, such as obtaining a broker's price opinion or an
appraisal, if it can do so at a reasonable cost. Investors should understand,
however, that such determinations are estimates and are not bona fide third
party offers to buy or sell. Investors should give special consideration to
the information set forth under "Initial Investments."
It is the intention of the Company that the agreements and transactions,
including the sale of Mortgage Loans, MBS Interests and Real Property, taken
as a whole, between the Company on the one hand and Prime,
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PCH and their Affiliates on the other hand are fair to both parties. However,
there can be no assurance that each of such agreements and transactions will be
on terms at least as favorable to the Company as it could have obtained from
unaffiliated third parties.
The Company anticipates that the price it pays for assets acquired from Prime
or its Affiliates, in certain cases, should be lower than the price that a
third party would pay for those assets if economic benefits would inure to
Prime and its Affiliates by selling to the Company, rather than a third party.
For example, Prime and its Affiliates generally would not incur any broker's
fees in connection with a sale of Mortgage Loans and MBS Interests to the
Company. In addition, if Prime and its Affiliates engage in repetitive sales of
assets to the Company, the purchase and sale agreement used in the successive
transactions is likely to contain standard terms and conditions that previously
will have been negotiated by the parties, resulting in reduced legal costs.
Prime and its Affiliates, including the Manager, expect to continue to
originate and purchase real estate related assets in the future and have no
obligation to make investment opportunities available to the Company except
with respect to Subordinated Interests, Preferred Equity and Net Leased Real
Estate. The Manager and its Affiliates have no obligation to offer Subordinated
Interests to the Company if the mortgage loans collateralizing such
Subordinated Interests were owned by the Manager or one of its Affiliates. In
addition, the Manager and its Affiliates have no obligation to offer Preferred
Equity to the Company if the Preferred Equity investment is related to the
funding of a first Mortgage Loan by the Manager or one of its Affiliates that
is suitable for securitization. As a consequence, the opportunity for the
Company to invest in Targeted Portfolio Investments may be limited if such
investment opportunities would be attractive to the Manager or one of its
Affiliates. The Manager and its Affiliates will not invest in a Subordinated
Interest (other than one collateralized by loans owned by the Manager or its
Affiliates), Preferred Equity (other than Preferred Equity funded to facilitate
the origination of a first Mortgage Loan suitable for securitization), or Net
Leased Real Estate unless a majority of the Independent Directors have decided
that the Company should not invest in such asset. In deciding whether to invest
in such an asset, the Independent Directors may consider, among other factors,
whether the asset is well-suited for the Company and whether the Company is
financially able to take advantage of the investment opportunity.
The Company expects to maintain a relationship with Prime and PCH in which
the Company will be a ready, willing and able purchaser of not only Mortgage
Loans, but other assets, that may be sold from time to time by PCH. The Company
expects that Prime and PCH will offer to sell any such assets to the Company on
terms and at prices that, in the aggregate, will be fair to both parties. See
"Management of Operations--Certain Relationships; Conflicts of Interests." In
deciding whether to acquire any such asset, the Manager may consider, among
other factors, whether acquisition of the asset will enhance the Company's
ability to achieve or exceed the Company's risk adjusted target rate of return,
if any, established for that period by the Board of Directors, whether the
asset otherwise is well-suited for the Company and whether the Company is
financially able to take advantage of the investment opportunity. If an asset
that otherwise meets all of the Company's criteria for asset acquisition is
being offered to the Company at a price that is greater, or on terms that are
less favorable, than would be required by third parties for similar assets in
bona fide arms' length transactions, the Manger would be expected to recommend
that the Company decline to acquire that asset at the quoted price and terms,
notwithstanding the relationship among the Company, Prime and PCH.
THE COMPANY'S ASSETS
The discussion below describes the principal categories of assets that the
Company intends to acquire.
MBS Interests. The Company intends to acquire sub-investment grade and
unrated MBS (hereinafter referred to as "Subordinated Interests"). MBS
typically are divided into two or more classes, sometimes called "tranches."
The senior classes are higher "rated" securities, which would be rated from low
investment grade "BBB" to higher investment grade "AA" or "AAA." The junior,
subordinated classes typically would include one or more lower rated, non-
investment grade classes, and an unrated, higher-yielding, credit support class
(which generally is required to absorb the first losses on the underlying
mortgage loans).
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MBS generally are issued either as collateralized mortgage obligations
("CMOs" or "CMO Bonds") or pass-through certificates ("Pass-Through
Certificates"). CMO Bonds are debt obligations of special purpose
corporations, owner trusts or other special purpose entities secured by
commercial mortgage loans or MBS. Pass-Through Certificates evidence interests
in trusts, the primary assets of which are mortgage loans. CMO Bonds and Pass-
Through Certificates may be issued or sponsored by private originators of, or
investors in, mortgage loans, including savings and loan associations,
mortgage bankers, commercial banks, investment banks and other entities. MBS
are not guaranteed by an entity having the credit status of a governmental
agency or instrumentality and generally are structured with one or more of the
types of credit enhancement described below. In addition, MBS may be illiquid.
See "Risk Factors--Risks Related to Investments in MBS Interests--Subordinated
Interests are Subject to Greater Credit Risks Than More Senior Classes."
In most mortgage loan securitizations, a series of MBS is issued in multiple
classes in order to obtain investment-grade ratings for the senior classes and
thus increase their marketability. Each class of MBS may be issued with a
specific fixed or variable coupon rate and has a stated maturity or final
scheduled distribution date. Principal prepayments on the mortgage loans
comprising the Mortgage Collateral may cause the MBS to be retired
substantially earlier than their stated maturities or final scheduled
distribution dates, although, with respect to commercial mortgage loans, there
generally are penalties for or limitations on the ability of the borrower to
prepay the loan. Interest is paid or accrued on MBS on a periodic basis,
typically monthly.
The credit quality of MBS depends on the credit quality of the underlying
Mortgage Collateral. Among the factors determining the credit quality of the
underlying mortgage loans will be the ratio of the mortgage loan balances to
the value of the properties securing the mortgage loans, the purpose of the
mortgage loans (e.g., refinancing or new purchase), the amount of the mortgage
loans, their terms and the geographic diversification of the location of the
properties, and the credit-worthiness of tenants. Moreover, the principal of
and interest on the underlying mortgage loans may be allocated among the
several classes of a MBS in many ways, and the credit quality of a particular
class of a MBS results primarily from the order and timing of the receipt of
cash flow generated from the underlying mortgage loans.
Subordinated Interests carry significant credit risks. Typically, in a
"senior-subordinated" structure, the Subordinated Interests provide credit
protection to the senior classes by absorbing losses from loan defaults or
foreclosures before such losses are allocated to senior classes. Moreover,
typically, as long as the more senior tranches of securities are outstanding,
all prepayments on the mortgage loans generally are paid to those senior
tranches, at least until the end of a lock-out period, which typically is five
years or more. In some instances, the holders of Subordinated Interests are
not entitled to receive scheduled payments of principal until the more senior
tranches are paid in full or until the end of a lock-out period. Because of
this structuring of the cash flows from the underlying mortgage loans,
Subordinated Interests in a typical securitization are subject to a
substantially greater risk of non-payment than are those more senior tranches.
Accordingly, the Subordinated Interests are assigned lower credit ratings, or
no ratings at all. Neither the Subordinated Interests nor the underlying
mortgage loans are guaranteed by agencies or instrumentalities of the U.S.
government or by other governmental entities and accordingly are subject to,
among other things, credit risks. See "Risk Factors--Risks Related to
Investments in MBS Interests--Subordinated Interests are Subject to Greater
Credit Risks Than More Senior Classes."
As a result of the typical "senior-subordinated" structure, the Subordinated
Interest will be extremely sensitive to losses on the underlying mortgage
loans. For example, if the Company owns a $10 million Subordinated Interest in
a securitization consisting of $100 million of underlying mortgage loans, a 7%
loss on the underlying mortgage loans (i.e. $7 million) will result in a 70%
loss on the Subordinated Interest. Accordingly, the holder of the Subordinated
Interest is particularly interested in minimizing the loss frequency (the
percentage of the loan balances that default over the life of the Mortgage
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 commercial mortgage loans will depend upon a
number of factors, most of which will be beyond the control of the Company or
the applicable servicer. Among other things, the default
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frequency will reflect broad conditions in the economy generally and real
estate particularly, economic conditions in the local area in which the
underlying Mortgage Collateral is located, the loan-to-value ratio of the
mortgage loan, the purpose of the loan, and the debt service coverage ratio.
The loss severity will depend upon many of the same factors described above,
and will also be influenced by the servicer's ability to foreclose on the
defaulted mortgage loan and sell the underlying Mortgage Collateral. For a
discussion of certain legal issues affecting the servicer's ability to
foreclose on a mortgage loan, and the legal impediments to the sale of the
underlying Mortgage Collateral, see "Certain Legal Aspects of Mortgage Loans
and Real Property Investments." These legal issues may extend the time of
foreclosure proceedings or may require the expenditure of additional sums to
sell the underlying Mortgage Collateral, in either case increasing the amount
of loss with respect to the loan.
Before acquiring a Subordinated Interest, the Company will perform a number
of due diligence tasks to evaluate the investment and to verify the
information and material provided by the seller. The Company will determine on
a loan-by-loan basis which loans will undergo a full-scope review and which
loans will undergo a more streamlined "desktop analysis." Although the choice
is a subjective one, considerations that influence the choice for scope of
review often include loan size, debt service coverage ratio, loan to value
ratio, loan maturity, lease rollover, property type and geographic location. A
full-scope review may include, among other factors, a property site
inspection, tenant-by-tenant rent roll analysis, review of historical income
and expenses for each property securing the loan, a review of major leases for
each property (if available), recent appraisals (if available), and a review
of engineering and environmental reports (if available). For those loans that
are selected for the more streamlined desktop analysis, the Manager's
evaluation may include a review of the property operating statements, summary
loan level data, and third party reports, each as available. If the Manager's
review of such information does not reveal any unusual or unexpected
characteristics or factors, no further due diligence is performed. After
completing the review of the documentation and the property inspection, the
information compiled will be analyzed to determine collateral value for each
property securing the loans. Based on these factors, the Manager will
determine a resolution value for each loan for purposes of projecting future
cash flows after adjustments for estimated future losses.
Determining a resolution value is a subjective process, requiring,
ultimately, a business judgment. In making this determination, the Manager
often evaluates some of the following characteristics: (i) the type of
collateral (multifamily, office, hotel, industrial or retail Mortgage
Collateral); (ii) the payment status of the underlying mortgage (performing,
non-performing or sub-performing); (iii) the actual mortgage prepayment and
default history; (iv) the ratio of the unpaid mortgage balance to the current
property value; (v) the current income and cash flows generated by the
Mortgage Collateral as compared to the debt service requirements and (vi) the
region of the country in which the Mortgage Collateral is located. However,
which of these characteristics (if any) are important and how important each
characteristic may be to the evaluation of a particular MBS depends on the
individual circumstances. Because there are so many characteristics to
consider, each Subordinated Interest must be analyzed individually, taking
into consideration both objective data as well as subjective analysis.
After completing the foregoing evaluations, the Manager will model the
structure of the MBS securitization based on the disclosure documents that
reveal the payment structure of the MBS and the characteristics of the
underlying Mortgage Collateral. This modeling is done in order to estimate
future cash flows to be received by the Subordinated Interests, after
adjustments for estimated future losses. Using that information, the Manager
will determine the price at which it would effect the purchase of the
Subordinated Interest on behalf of the Company. Although the Manager uses
objective data to make this decision, the decision is in essence a subjective
one.
The Company also intends in many instances to acquire Special Servicing
rights with respect to the mortgage loans underlying the securitization in
which the Company owns a Subordinated Interest. Such Special Servicing rights
will give the Company, among other things, some control over the timing of
foreclosures on such mortgage loans and, thus, may enable the Company to
reduce losses on such mortgage loans. No assurances can be made, however, that
the Company will be able to acquire such Special Servicing rights or that
losses on
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the mortgage loans will not exceed the Company's expectations. Although the
Company's strategy is to purchase Subordinated 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, indeed, that the Company's
investment in a Subordinated Interest will be returned in full or at all. See
"Risk Factors--Related to Investments in MBS Interests" and
"--Economic and Business Risks."
The terms of Special Servicing agreements vary considerably, and the Company
cannot predict with certainty the precise terms of the Special Servicing
agreements into which it will enter. In general, however, the Company will
attempt to negotiate Special Servicing agreements that will permit the Company
to service, or direct the servicing of, mortgage loans that are more than
ninety days delinquent. At that point, the Company would have the right (and
the obligation) to decide whether to begin foreclosure proceedings or to seek
alternatives to foreclosure, such as forbearance agreements, partial payment
forgiveness, repayment plans, loan modification plans, loan sales and loan
assumption plans. Thus, the Company will have within its control, subject to
obligations to the related senior classes, some ability to minimize losses on
mortgage loans underlying Subordinated Interests owned by the Company.
Because the Operating Partnership generally will be the entity that acquires
the Subordinated Interests, it also will acquire the related Special Servicing
rights. The Operating Partnership intends to assign all of its Special
Servicing rights and obligations (other than the right to direct foreclosure)
to a rated special servicer that it will select. In some instances, and with
the approval of a majority of the Independent Directors, the Company may
select PCH as the special servicer. It is expected that most or all of the
Special Servicing compensation will be paid to the third-party special
servicer, and thus the Company may benefit from the ability to direct certain
of the Special Servicing activities but not from receipt of material amounts
of Special Servicing fees.
Many of the Subordinated Interests to be acquired by the Company will not
have been registered under the Securities Act, but instead initially were sold
in private placements. Because Subordinated Interests acquired in private
placements have not been registered under the Securities Act, they will be
subject to certain restrictions on resale and, accordingly, will have more
limited marketability and liquidity.
Although there are some exceptions, most issuers of multi-class MBS elect to
be treated, for federal income tax purposes, as REMICs. The Company intends to
acquire not only Subordinated Interests that are treated as regular interests
in REMICs, but also those that are designated as REMIC Residual Interests.
Unlike regular interests in REMICs, REMIC Residual Interests typically
generate excess inclusion as specified in section 860E(c) of the Code ("Excess
Inclusion") or other forms of "phantom income" that bear no relationship to
the actual economic income that is generated by a REMIC. Consequently, if a
Subordinated Interest that is designated as a REMIC Residual Interest
generates a significant amount of phantom income in any taxable year, the
Company could be required to borrow funds or to liquidate assets in order to
meet the REIT distribution requirement for such taxable year and to avoid
being taxed at regular corporate rates on undistributed taxable income.
Subordinated Interests (other than REMIC Residual Interests and Non-REMIC
Residual Interests) generally are issued at a significant discount to their
outstanding principal balance, which gives rise to OID for federal income tax
purposes. The Company will be required to accrue the OID as taxable income
over the life of the related Subordinated Interest on a level-yield method in
advance of the receipt of the related cash flow. The OID income attributable
to a Subordinated Interest generally will increase the Company's taxable
income and cause it to be subject to a corporate-level tax in the early years
of the Company's ownership of the Subordinated Interest even though the
Company may not receive the related cash flow from the Subordinated Interest
until a later taxable year. As a result, the Company could be required to
borrow funds or to liquidate assets in order to pay such corporate-level tax
for any taxable year. See "Risk Factors--Legal Risks--Tax Risks."
The legal aspects of the mortgage loans that underlie the Subordinated
Interests owned and to be acquired by the Company affect the value of those
assets. For a discussion of certain legal aspects of mortgage loans, see
"Certain Legal Aspects of Mortgage Loans and Real Property Investments."
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The Company may invest not only in classes of Subordinated Interests but
also in other classes of MBS. For example, the Company may invest in IOs,
which are entitled to no (or only nominal) payments of principal, but only to
payments of interest. The holder of an IO may be entitled to receive a stated
rate of interest on a notional principal balance equal to the principal
balance of the Mortgage Collateral, that portion that bears interest in excess
of a certain rate, or one more classes of that MBS (such as where the Mortgage
Collateral (or portion thereof) carries an 8.5% interest rate after servicing
costs, and the holders of the other classes are entitled to receive 8.0%
interest, leaving 0.5% for the holder of the IO). Alternatively, the holder of
an IO may be entitled to a variable rate of interest on a nominal principal
balance that adjusts based upon adjustment in the interest rate of the
underlying Mortgage Collateral.
Because IOs often pay at a relatively small rate of interest on a large
notional principal balance, an accelerated reduction of that principal balance
will have an adverse effect on the anticipated yield to maturity of such IO.
Accordingly, if the underlying Mortgage Collateral prepays (including
prepayments as a result of default and repurchases by the seller) at a rate
faster than anticipated, the weighted average life of the IO will be reduced,
and the yield to maturity adversely affected. Conversely, if the underlying
Mortgage Collateral prepays at a rate slower than anticipated, the weighted
average life of the IO will be extended, with the consequent positive effect
on the anticipated yield to maturity.
The Company also may invest in Inverse IOs, which bear interest at a
floating rate that varies inversely with (and often at a multiple of) changes
in a specified index. The yield to maturity of a class of Inverse IOs is not
only very sensitive to the rate of prepayments on the underlying Mortgage
Collateral, but also to changes in the related index. See "Yield
Considerations Related to the Company's Investments--IOs, Inverse IOs and Sub-
IOs" and "Risk Factors--Risks Related to Investments in MBS Interests--Yields
on Subordinated Interests, IOs and POs May Be Affected Adversely by Interest
Rate Changes."
The Company may invest in POs, which do not provide for payment of periodic
interest, but only provide for payment of the stated principal amount at
maturity or earlier prepayment of the underlying loans. The Company believes
that its POs will be affected adversely by slower than anticipated prepayment
rates. Generally, a rising interest rate environment will result in the
interest rate to be paid by the borrower pursuant to the terms of a fixed rate
loan becoming relatively more favorable to that borrower, decreasing the
likelihood of that borrower making a prepayment on that loan. Slower than
anticipated prepayment rates can result in a significant decrease in the yield
realized by the Company on its investments in POs.
Mortgage Loans. The Company expects to invest in Nonperforming Mortgage
Loans and Subperforming Mortgage Loans and other types of first Mortgage Loans
that are otherwise not suitable for securitization. The Company also expects
to invest in Mortgage Loans that are subject to a prior lien, such as second
mortgages, subordinated loan participations, and mezzanine loans. All of the
foregoing investments require a detailed underwriting analysis of the
underlying real estate collateral and the real estate market in which property
is located, including the property's historical and projected operating cash
flows, physical condition, appraised value, rent roll, and competitive
position in the market.
The Company's due diligence generally will include a review of market
studies for each market where a property is located. The market studies
typically will include area economic data, employment trends, absorption rates
and market rental rates. Due diligence also will include site inspections by
the Manager's employees or agents of most properties in a portfolio and a
review of all available asset files and documentation. To the extent possible,
the review will include examinations of available legal documents, litigation
files, correspondence, title reports, operating statements, appraisals and
engineering and environmental reports. The information compiled is then
analyzed to determine a valuation for each property.
The property valuation process relies upon a variety of sources of
information to prepare a discounted cash flow model of the projected net cash
flows from each property. Sources of information examined to determine future
net cash flows and, accordingly, the value of the property, may include: (a)
current and historical operating statements; (b) existing appraisals; (c) rent
and sales comparables; (d) industry statistics and reports regarding operating
expenses such as those compiled by the Institute of Real Estate Management;
(e) rent roll, tenant credit history, and material lease terms; and (f)
deferred maintenance observed during site inspections or described in
structural reports, engineering reports and correspondence found in the loan
files.
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The Manager develops projections of future net operating income and cash
flows taking into account lease rollovers, tenant improvement costs and leasing
commissions. The Manager will compare its estimates of revenue and expenses to
historical operating statements, appraisals and general industry and regional
statistics. Market capitalization rates and discount rates are then applied to
the cash flow projections to estimate values based on a discounted cash flow
model. These values are then compared to available appraisals and market sale
comparables to determine the final value of a property.
The Company intends to purchase Nonperforming Mortgage Loans or Subperforming
Mortgage Loans. The Company generally will foreclose on such Mortgage Loans in
order to acquire title to the underlying real estate. See "Certain Legal
Aspects of Mortgage Loans and Real Property Investments."
The Company intends to invest in Subordinated Mortgage Loans. For example, on
a commercial property subject to a first lien mortgage loan with a principal
balance equal to 70% of the value of the property, the Company could lend the
owner of the property an additional 15% to 20% of the value of the property.
Typically the loan would be secured, either by the property subject to the
first lien (giving the Company a second lien position) or by a controlling
equity interest in the owner. If the equity interest is pledged, then the
Company would be in a position to make decisions with respect to the operation
of the property in the event of a default by the owner. These Subordinated
Mortgage Loans generally would provide the Company with the right to receive a
stated interest rate on the loan balance plus a percentage of net operating
income or gross revenues from the property, payable to the Company on an
ongoing basis, and a percentage of any increase in value of the property,
payable upon maturity or refinancing of the loan, or otherwise would allow the
Company to charge an interest rate that would provide an attractive risk-
adjusted return. In the alternative, the Company may structure its investment
as a junior or subordinate loan participation in either a Performing Mortgage
Loan or a Distressed Mortgage Loan.
Preferred Equity. The Company intends to make Preferred Equity investments in
specific real estate assets (or pools of assets) or in real estate operating
companies. Generally, the Preferred Equity investments will have a preferred
claim against both the operating cash flow and liquidation proceeds from the
specific real estate assets (or pool of assets) or the real estate operating
company. The Preferred Equity will earn a stated preferred and cumulative
return and, in certain instances, will participate in the future growth in both
the value of the assets (or the company) and the operating cash flow from the
assets (or the company). Generally, a Preferred Equity investment is made when
the existing owner, borrower, or real estate company requires additional equity
to fund an acquisition, development, refinancing or expansion of the assets (or
the company) and either (i) such equity is not generally available to the
borrower/owner on a pari passu or common basis, or (ii) the owner/borrower
desires to further leverage its assets and is willing to grant the provider of
such leverage a preferred interest in such assets in exchange for retaining a
greater percentage of ownership. Regardless of the underlying rationale of the
investment, the Company's Preferred Equity investments are expected to offer
the potential for a higher yield than is generally available from the direct
purchase of assets or the funding of senior mortgage loans, although such
investments also carry greater risk of loss of principal and the nonpayment of
the preferred return. The Company will attempt to mitigate these risks with
thorough and rigorous underwriting analysis of both the real estate collateral
and the borrower/owner. See "Risk Factors--Risks Related to Investments in Real
Property."
Net Leased Real Estate. The Company intends to participate in sale leaseback
transactions, in which the Company would purchase improved or unimproved real
estate and then lease such real estate back to the seller under a long-term
triple net lease. The Company also may provide financing necessary to build
commercial improvements on the land, to refinance existing debt on the property
or to provide additional funds to operate the business. The Company and
Brookdale have agreed to a non-binding term sheet pursuant to which the Company
will purchase shortly after the closing of the Offering four senior housing and
assisted living facilities from Brookdale, an Affiliate of Prime, for
approximately $126.5 million ($33.5 million of cash plus the assumption of
$93.0 million of tax-exempt bond obligations) and to triple-net lease such
properties to Brookdale for an initial term of twenty-four years, with two
twenty-five year options to renew at the then current fair market value. The
Brookdale transaction is subject to various conditions and contingencies,
including approval by a
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majority of the Independent Directors of the Company, approved by the
Brookdale board of directors, consent by HUD and certain lenders. Therefore,
there can be no assurance that the Initial Investments will be consummated.
See "Initial Investments."
Other Assets. The Company will take an opportunistic approach to its
investments and, accordingly, the Company may invest in assets other than
Targeted Portfolio Investments. The Company may invest in Distressed Real
Property.
The Company may acquire or originate Mortgage Loans secured by real estate
located outside the United States or purchase such real estate, but the
Company currently does not intend to invest more than 10% of the portfolio in
foreign real estate. Investing in real estate located in foreign countries
creates risks associated with the uncertainty of foreign laws and markets and
risks related to currency conversion. The Company may be subject to foreign
income tax with respect to its investments in foreign real estate. However,
any foreign tax credit that otherwise would be available to the Company for
U.S. federal income tax purposes will not flow through to the Company's
stockholders.
PORTFOLIO MANAGEMENT
The following describes some of the investment management practices that the
Company may employ from time to time to earn income, facilitate portfolio
management (including managing the effect of maturity or interest rate
sensitivity) and mitigate risk (such as the risk of changes in interest
rates). There can be no assurance that the Company will not amend or deviate
from these policies or adopt other policies in the future.
Leverage and Borrowing. The Company intends to leverage its assets through
the use of reverse repurchase agreements, bank credit facilities, secured and
unsecured corporate debt, mortgage loans on real estate and other borrowings,
when there is an expectation that such leverage will benefit the Company.
However, the Company does not intend to borrow funds from the Manager or its
Affiliates. If changes in market conditions cause the cost of such financing
to increase relative to the income that can be derived from securities
purchased with the proceeds thereof, the Company may reduce the amount of its
borrowings.
Leverage creates an opportunity for increased income but, at the same time,
creates special risks. For example, leveraging magnifies changes in the net
worth of the Company and affects the amounts available for distribution to the
Company's stockholders. Although the amount owed will be fixed, the Company's
assets may change in value during the time the debt is outstanding. Leverage
will create interest expenses for the Company which can exceed the revenues
from the assets retained.
To the extent the revenues derived from assets acquired with borrowed funds
exceed the interest expense the Company will have to pay, the Company's net
income will be greater than if borrowing had not been used. Conversely, if the
revenues from the assets acquired with borrowed funds are not sufficient to
cover the cost of borrowing, the net income of the Company will be less than
if borrowing had not been used and, therefore, the amount available for
distribution to the Company's stockholders will be reduced. See "Risk
Factors--Economic and Business Risks--Leverage Can Reduce Income Available for
Distribution."
Under certain circumstances, and notwithstanding adverse interest rate or
market conditions, the Company may use leverage to obtain sufficient cash to
make required distributions of dividends or to fund share repurchases and
tender offers when such leveraging is deemed to be in the best interests of
the Company's stockholders. Such situations may arise if the Company's status
as a REIT or its ability to maintain minimum liquidity levels is endangered.
Reverse Repurchase Agreements. The Company intends to enter into reverse
repurchase agreements, which are agreements under which the Company would sell
assets to a third party with the commitment that the Company repurchase such
assets from the purchaser at a fixed price on an agreed date. Reverse
repurchase agreements will be characterized as loans to the Company from the
other party that are secured by the underlying assets. The repurchase price
reflects the purchase price plus an agreed market rate of interest.
Bank Credit Facilities. The Company intends to borrow money through various
bank credit facilities, which will have varying interest rates, which may be
fixed or adjustable, and varying maturities.
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Mortgage Loans on Real Estate Owned by the Company. The Company expects to
borrow funds secured by mortgages on the Company's real estate, including any
Net Leased Real Estate owned by the Company.
CMOs and Warehouse Lines of Credit. The Company intends to acquire Mortgage
Loans and to issue non-REMIC CMOs collateralized by such loans. Moreover, the
Company may issue non-REMIC CMOs collateralized by previously issued CMOs or
MBS in transactions known as "resecuritizations." The Company will structure a
resecuritization in the same manner as a securitization. The collateral
(whether whole mortgage loans or MBS) will be transferred into a qualified
REIT subsidiary, and that entity (or a special purpose trust or corporation
formed by that entity) will issue non-REMIC CMOs. The transaction will be
structured as debt, with the issuer retaining an equity interest in the
collateral. In a debt transaction, the principal balance of the collateral
(whether whole loans or MBS) will exceed the principal balance of the CMOs.
Thus, once the CMOs are paid in full, the issuer will own the collateral free
of the lien of the CMO debt. During the period in which the Company is
acquiring mortgage loans for securitization, the Company is likely to borrow
funds secured by such loans pursuant to warehouse lines of credit.
Interest Rate Management Techniques. The Company may engage in a variety of
interest rate management techniques for the purpose of managing the effective
maturity or interest rate of its assets. These techniques also may be used to
attempt to protect against declines in the market value of the Company's
assets resulting from general trends in debt markets. Any such transaction is
subject to risks, and may limit the potential earnings on the Company's
investment in real estate related assets. Such techniques may include puts and
calls on securities or indices of securities, Eurodollar futures contracts and
options on such contracts, interest rate swaps (the exchange of fixed-rate
payments for floating-rate payments), or other such transactions. Applicable
REIT qualification rules may limit the Company's ability to use these
techniques, except through a corporate subsidiary that is fully subject to
corporate income taxation. See "Certain Federal Income Tax Considerations--
Requirements for Qualification--Income Tests."
Hedging. The Company may enter into hedging transactions and may at times be
hedged against indebtedness incurred by the Company to finance its acquisition
and origination of Mortgage Loans and MBS Interests to attempt to provide
protection from interest rate fluctuations or other market movements. With
respect to indebtedness, hedging can be used to limit, fix or cap the interest
rate on any indebtedness.
The Company's hedging activities may include interest rate swaps, interest
rate caps, options, futures contracts, forward rate agreements, and the
purchase of excess servicing rights constituting "real estate assets" for
purposes of the REIT qualification tests under the Code. See "Federal Income
Tax Considerations--Requirements for Qualification--Asset Tests." The Company
may hedge against interest rate increases by purchasing Qualified Hedges. A
"Qualified Hedge" for this purpose is limited to a bona fide interest rate
swap or cap agreement, option, futures contract, forward rate agreement, or
any similar financial instrument entered into by the Company to hedge against
the interest rate risks with respect to any indebtedness that the Company may
incur to acquire or carry real estate assets. See "Federal Income Tax
Considerations--Requirements for Qualification--Income Tests." In certain
circumstances, the provisions of the Code regarding the qualification of an
entity as a REIT may restrict the Company's ability to enter into hedging
transactions, except through a fully taxable corporate subsidiary. See
"Federal Income Tax Considerations--Requirements for Qualification--Asset
Tests" and "--Income Tests."
The Manager intends to appoint, at an appropriate time, a hedging specialist
who, among other things, will be expected to monitor and manage risks
associated with derivative financial investments. The Company does not intend
to acquire derivative financial instruments for speculative purposes.
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MANAGEMENT OF OPERATIONS
THE MANAGER
The business and investment affairs of the Company will be managed by the
Manager, a wholly-owned subsidiary of PCH which is an Affiliate of Prime. The
following tables set forth certain information about the directors and
executive officers of the Manager. Each of the directors of the Manager is
also a director of the Company. The executive offices of the Manager are
located at 77 West Wacker Drive, Suite 3900, Chicago, Illinois 60601, and the
telephone number of its executive offices is (312) 917-1500.
DIRECTORS AND EXECUTIVE OFFICERS OF THE MANAGER
<TABLE>
<CAPTION>
NAME AGE POSITION(S) HELD
---- --- ----------------
<S> <C> <C>
Michael W. Reschke...... 41 Chairman of the Board of Directors
James W. Roiter......... 44 President and Chief Executive Officer and Director
</TABLE>
The principal occupation for the last ten years of each director of the
Manager, as well as additional biographical information, is set forth below.
MR. MICHAEL W. RESCHKE. Michael W. Reschke, age 41, is the Chairman of the
Board of Directors of the Company. Mr. Reschke founded Prime in 1981 and,
since that time, has acted as Prime's Chairman and Chief Executive Officer.
Mr. Reschke is also Chairman of the Board of Prime Retail, Inc., Brookdale
Living Communities, Inc. and PCH, and is a member of the Board of Directors of
Ambassador Apartments, Inc. For the last sixteen years, Mr. Reschke has
directed and managed the acquisition, development, finance, construction,
leasing, marketing, renovation and property management activities of Prime.
Mr. Reschke is licensed to practice law in the State of Illinois and is a
certified public accountant. Mr. Reschke is a member of the Chairman's
Roundtable and the Executive Committee of the National Realty Committee and is
a full member of the Urban Land Institute. Mr. Reschke also serves on the
Board of Visitors of the University of Illinois Law School.
MR. JAMES W. ROITER. James W. Roiter, age 44, is President and Chief
Executive Officer of PCH, where he is responsible for the day to day
activities of PCF and PCC. Prior to joining PCH in July of 1997, Mr. Roiter
was a Managing Director of Donaldson, Lufkin & Jenrette ("DLJ") where he was
responsible for all commercial and residential real estate finance activities
where DLJ or one of its subsidiaries, acted as principal. Under Mr. Roiter's
leadership, DLJ became one of the largest providers of debt capital to the
commercial and residential market, lending over $8.0 billion in debt
financings during his tenure at DLJ (1988-1996) and was consistently one of
the largest issuers of CMBS. In addition to the debt origination business, Mr.
Roiter was also responsible for new issue and secondary trading, structured
finance, and contract finance activities relating to commercial and
residential real estate business while at DLJ. In addition to his role as head
of the Real Estate Finance Group, Mr. Roiter served on the Investment
Committee of Donaldson, Lufkin & Jenrette Real Estate Capital Partners, L.P.,
a $600.0 million fund established to make opportunistic real estate
investments, and on the Board of Directors of Column Financial Corporation
("Column"). Column, which Mr. Roiter founded, is one of the country's largest
commercial mortgage originators and issuers of CMBS. Prior to joining DLJ in
1988, he was a First Vice President at Shearson Lehman Hutton ("Shearson").
Before joining Shearson, he was a First Vice President and Manager of the
Whole Loan Trading Desk at E.F. Hutton, which he joined in 1985 after serving
as Director of Negotiated Transactions with the Federal National Mortgage
Association. Mr. Roiter is a graduate of the University of Rhode Island and
holds a J.D. from George Mason University.
The officers and directors of the Manager have an average of fifteen years
experience in commercial and multifamily real estate and mortgage finance.
THE MANAGEMENT AGREEMENT
The Company will enter into the Management Agreement with the Manager for an
initial term expiring on the second anniversary of the Closing Date.
Thereafter, successive extensions, each for a period not to exceed one year,
may be made by agreement between the Company and the Manager, subject to the
affirmative vote of a majority of the Independent Directors. The Company may
terminate, or decline to extend the term of, the
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Management Agreement without cause at any time after the first two years upon
ninety days written notice by a majority vote of the Independent Directors or
by a vote of the holders of a majority of the outstanding shares of Common
Stock; provided, that the Company shall pay the Manager a termination fee, the
amount of which will be determined by independent appraisal. Such appraisal is
to be conducted by a nationally-recognized appraisal firm mutually agreed upon
by the Company and the Manager. If the Company and the Manager are unable to
agree upon an appraisal firm, then each of the Company and the Manager is to
choose an independent appraisal firm to conduct an appraisal. In such event,
(i) if the appraisals prepared by the two appraisers so selected are the same
or differ by an amount that does not exceed 20% of the higher of the two
appraisals, the termination fee is to be deemed to be the average of the
appraisals as prepared by each party's chosen appraiser, and (ii) if these two
appraisals differ by more than 20% of such higher amount, the two appraisals
together are to select a third appraisal firm to conduct an appraisal. If two
appraisers are unable to agree as to the identity of such third appraiser,
either of the Manager and the Company may request that the American Arbitration
Association ("AAA") select the third appraiser. The termination fee then is to
be the amount determined by such third appraiser, but in no event less than the
lower of the two initial appraisals or more than the higher of such two initial
appraisals.
In addition, the Company has the right to terminate the Management Agreement
upon the occurrence of certain specified events, including a material breach by
the Manager of any provision contained in the Management Agreement, without the
payment of any termination fee. If the Management Agreement is terminated for
any reason, the Manager will have certain registration rights with respect to
the Common Stock which it holds.
Pursuant to the provisions of the Management Agreement, the Manager will at
all times be subject to the supervision of the Company's Board of Directors and
will have only such functions and authority as delegated by the Company. The
Manager will be responsible for the day-to-day operations of the Company and
will perform (or cause to be performed) such services and activities relating
to the assets and operations of the Company as may be directed by the Board of
Directors or as the Manager otherwise considers appropriate, including:
(i) serving as the Company's consultant with respect to formulation of
investment criteria and preparation of policy Guidelines by the Board of
Directors;
(ii) representing the Company in connection with the purchase and
commitment to purchase assets, the sale and commitment to sell assets, and
the maintenance and administration of its portfolio of assets;
(iii) 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;
(iv) 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;
(v) providing executive and administrative personnel, administering
office space and office services required in rendering services to the
Company;
(vi) administering the day-to-day operations of the Company and
performing and supervising the performance of such other administrative
functions necessary in the management of the Company as may be agreed upon
by the Manager and the Board of Directors, including the collection of
revenues and the payment of the Company's debts and obligations and
maintenance of appropriate computer services to perform such administrative
functions;
(vii) 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;
(viii) to the extent not otherwise subject to an agreement executed by
the Company, designating a servicer for mortgage loans acquired by the
Company and arranging for the monitoring and administering of such
servicers;
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(ix) counseling the Company in connection with policy decisions to be
made by the Board of Directors;
(x) engaging in hedging activities on behalf of the Company, consistent
with the Company's status as a REIT and with the Guidelines;
(xi) upon request by and in accordance with the directions of the Board
of Directors, investing or reinvesting any money of the Company; and
(xii) counseling the Company regarding the maintenance of its status as a
REIT and monitoring compliance with the various REIT qualification tests
and other rules set out in the Code and the income tax regulations
promulgated thereto (the "Treasury Regulations").
The Manager will perform portfolio management services on behalf of the
Company pursuant to the Management Agreement with respect to the Company's
investments. Such services will include, but not be limited to, consulting
with the Company on purchase and sale opportunities, collection of information
and submission of reports pertaining to the Company's assets, interest rates,
and general economic conditions, periodic review and evaluation of the
performance of the Company's portfolio of assets, acting as liaison between
the Company and banking, mortgage banking, investment banking and other
parties with respect to the purchase, financing and disposition of assets, and
other customary functions related to portfolio management. The Manager may
enter into subcontracts with other parties, including its Affiliates, to
provide any such services to the Company.
The Manager will perform monitoring services on behalf of the Company
pursuant to the Management Agreement with respect to the Company's portfolio
of Special Servicing rights. Such monitoring services will include, but not be
limited to, the following activities: negotiating Special Servicing
agreements; serving as the Company's consultant with respect to the Special
Servicing of mortgage loans; collection of information and submission of
reports pertaining to the mortgage loans and to moneys remitted to the Manager
or the Company; acting as a liaison between the servicers of the mortgage
loans and the Company and working with servicers to the extent necessary to
improve their servicing performance; with respect to mortgage loans for which
the Company is special servicer, periodic review and evaluation of the
performance of each servicer to determine its compliance with the terms and
conditions of the related servicing agreement; review of and recommendations
as to fire losses, easement problems and condemnation, delinquency and
foreclosure procedures with regard to mortgage loans; review of servicers'
delinquency, foreclosures and other reports on mortgage loans; supervising
claims filed under any mortgage insurance policies; and enforcing the
obligation of any servicer to repurchase mortgage loans. The Manager may enter
into subcontracts with other parties, including its Affiliates, to provide any
such services for the Manager.
MANAGEMENT FEES
The Manager will receive (i) a base management fee in an amount equal to 1%
per annum on the first $500.0 million of the Average Invested Assets of the
Company (calculated quarterly), and 0.75% per annum on the balance of the
Average Invested Assets of the Company, payable in quarterly installments,
which base management fee is intended to cover the Manager's costs of
providing management services to the Company, and (ii) an incentive fee, paid
quarterly, in an amount equal to the product of (A) 25% of the dollar amount
by which (1)(a) Funds From Operations (before the incentive fee) of the
Company per share of Common Stock (based on the weighted average number of
shares outstanding) plus (b) gains (or minus losses) from debt restructuring
or sales of property per share of Common Stock for each quarter (based on the
weighted average number of shares outstanding), exceed (2) an amount equal to
(a) the weighted average of the price per share in the Offering and the prices
per share at any secondary offerings by the Company multiplied by (b) the Ten-
Year U.S. Treasury Rate plus five percent per annum multiplied by (B) the
weighted average number of shares of Common Stock outstanding during such
period. The Board of Directors of PCI may adjust the base management fee in
the future if necessary to align the fee more closely with the actual costs of
such services. The term "Average Invested Assets" for any period means the
average of the aggregate book value of the assets of the Company, including
the assets of all of PCI's direct and indirect subsidiaries, before reserves
for depreciation or bad debts or other similar noncash reserves, computed by
taking the daily average of such values during such period. The Manager will
not receive any management fee for the period prior to the sale of the shares
of
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Common Stock offered hereby. The base management fee is intended to compensate
the Manager, among other things, for its costs in providing management services
to the Company. "Funds From Operations" as defined by the National Association
of Real Estate Investment Trusts ("NAREIT") means net income (computed in
accordance with GAAP) excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation and amortization on real estate assets,
and after adjustments for unconsolidated partnerships and joint ventures. Funds
From Operations does not represent cash generated from operating activities in
accordance with GAAP and should not be considered as an alternative to net
income as an indication of the Company's performance or to cash flows as a
measure of liquidity or ability to make distributions. As used in calculating
the Manager's compensation, the term "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
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, any
Federal Reserve Bank or agency or department of the federal government selected
by the Company. If the Company determines in good faith that the Ten Year U.S.
Treasury Rate cannot be calculated as provided above, then the rate shall be
the arithmetic average of the per annum average yields to maturities, based
upon closing asked prices on each business day during a quarter, for each
actively traded marketable U.S. Treasury fixed interest rate security with a
final maturity date not less than eight nor more than twelve years from the
date of the closing asked prices as chosen and quoted for each business day in
each such quarter in New York City by at least three recognized dealers in U.S.
government securities selected by the Company.
The ability of the Company to generate Funds From Operations in excess of the
Ten Year U.S. Treasury Rate, and of the Manager to earn the incentive
compensation described in the preceding paragraph, is dependent upon the level
and volatility of interest rates, the Company's ability to react to changes in
interest rates and to implement successfully the operating strategies described
herein, and other factors, many of which are not within the Company's control.
COSTS AND EXPENSES
The Company does not expect to maintain an office or to employ full-time
personnel. Instead it expects to rely on the facilities and resources of the
Manager to conduct its operations, and it will be required to pay out-of-pocket
expenses of the Manager attributable to the operations of the Company. Expense
reimbursement will be made quarterly. Because the Manager's employees will
perform certain due diligence tasks that purchasers of real estate (including
managers of REITs) typically hire outside consultants to perform, the Manager
will be reimbursed for (or charge the Company directly for) the Manager's out-
of-pocket costs in performing such due diligence on assets purchased or
considered for purchase by the Company.
The management fees are payable in arrears. The Manager's base and incentive
fees and due diligence and other expenses shall be calculated by the Manager
within 45 days after the end of each quarter, and such calculation shall be
promptly delivered to the Company. The Company is obligated to pay such fees
and expenses within 60 days after the end of each quarter.
STOCK OPTIONS
The Company intends to adopt a non-qualified stock option plan (the "Option
Plan"), which provides for options to purchase shares of Common Stock (or, at
the election of the Company, limited partnership interests ("Units") in the
Operating Partnership that may be redeemed for cash, or, at the election of the
General Partner, shares of Common Stock on a one-for-one basis). See "Operating
Partnership Agreement--Redemption Rights." The maximum aggregate number of
shares of Common Stock that may be issued pursuant to options granted under the
Option Plan is 5,000,000. The purpose of the Option Plan is to provide a means
of performance-based compensation in order to provide incentive for the Manager
to enhance the value of PCI's stock.
Before Closing, the Company will grant to the Manager options under the
Option Plan, representing the right to acquire 1,875,000 shares of Common Stock
(2,156,250 assuming the Underwriter exercises its over-allotment option) or, at
the option of the Company, Units, at an exercise price per share (or Unit)
equal to the Offering Price. If the options could be exercised immediately and
converted into Common Stock, they would
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represent 10% of the number of shares of Common Stock outstanding after
completion of the Offering. However, the options cannot be exercised
immediately. One fourth of the Manager's options become exercisable on each of
the first four anniversaries of the Closing Date. Any unexercised options
terminate on the tenth anniversary of the Closing Date.
The Board of Directors may amend the Option Plan any time, except that
approval by PCI's stockholders is required for any amendment that increases the
aggregate number of shares of Common Stock that may be issued pursuant to the
Option Plan, increases the maximum number of shares of Common Stock that may be
issued to any person, changes the class of persons eligible to receive such
options, modifies the period within which the options may be granted, modifies
the period within which the options may be exercised or the terms upon which
options may be exercised, or increases the material benefits accruing to the
participants under the plan. Unless previously terminated by the Board of
Directors, the Option Plan will terminate ten years from the Closing Date.
LIMITS OF RESPONSIBILITY
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Company's Board of Directors in
following or declining to follow its advice or recommendations. The Manager,
its directors and its officers will not be liable to the Company, any
subsidiary of the Company, the Independent Directors, PCI'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, its directors and its 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 Management Agreement does not limit or restrict the right of the Manager
or any of its officers, directors, employees or Affiliates from engaging in any
business or rendering services of any kind to any other person, including the
purchase of, or rendering advice to others purchasing, assets that meet the
Company's policies and criteria. The Manager has agreed, however, to give the
Company an exclusive right to invest in Subordinated Interests, Preferred
Equity and Net Leased Real Estate, subject to certain exceptions. See "Risk
Factors--Conflicts of Interest in the Business of the Company May Result in
Decisions of the Company That Do Not Fully Reflect the Interests of the
Stockholders of the Company" and "--Certain Relationships; Conflicts of
Interest."
CERTAIN RELATIONSHIPS; CONFLICTS OF INTEREST
It is contemplated that the Company, on the one hand, and the Manager and its
Affiliates, on the other, will enter into a number of relationships other than
those governed by the Management Agreement, some of which may give rise to
conflicts of interest. Moreover, two of the members of the Board of Directors
of the Company and all of its officers are also employed by the Manager or its
Affiliates.
The relationships between the Company, on the one hand, and the Manager and
its Affiliates, on the other, will be governed by policy Guidelines to be
approved by a majority of the Independent Directors. The Guidelines establish
certain parameters for the operations of the Company, including quantitative
and qualitative limitations on the Company's assets that may be acquired. The
Guidelines are to assist and instruct the Manager and to establish restrictions
applicable to transactions with Affiliates of the Manager. Transactions with
Affiliates of the Manager that fall within the provisions of the Guidelines
need not be specifically approved by a majority of the Independent Directors.
The Independent Directors will, however, review the Company's transactions on a
quarterly basis to ensure compliance with the Guidelines.
Although the Independent Directors will review the Guidelines periodically
and will monitor compliance with those Guidelines, investors should be aware
that, in conducting this review, the Independent Directors will rely primarily
on information provided to them by the Manager. The Manager will obtain
appraisals with respect
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to the value of Subordinated Interests, Mortgage Loans, Preferred Equity and
Net Leased Real Estate from the Manager or its Affiliates, but the Independent
Directors are likely to rely substantially on information and analysis
provided by the Manager to evaluate the Company's Guidelines, compliance
therewith and other matters relating to the Company's investments. Moreover,
appraisals are not always reliable indicators of the value of assets. With
respect to the value of Subordinated Interests, for example, estimates of
value generally are obtained from the underwriter or placement agent of the
MBS, who may have an incentive to overstate the value of the MBS. Moreover,
the market for unregistered MBS is illiquid, and therefore accurate prices are
difficult to estimate. See "Risk Factors--Conflicts of Interest in the
Business of the Company May Result in Decisions of the Company That Do Not
Fully Reflect the Interests of the Stockholders of the Company."
If the Independent Directors determine in their periodic review of
transactions that a particular transaction does not comply with the
Guidelines, then the Independent Directors will consider what corrective
action, if any, can be taken. If the transaction is one with the Manager or an
Affiliate of the Manager, then the Manager will be required to repurchase the
asset at the purchase price to the Company.
The Management Agreement does not limit or restrict the right of the Manager
or any of its officers, directors, employees or Affiliates from engaging in
any business or rendering services of any kind to any other person, including
the purchase of or rendering advice to others purchasing real estate related
assets that meet the Company's policies and criteria.
Prime and its Affiliates, including the Manager, expect to continue to
originate and purchase real estate related assets in the future and have no
obligation to make investment opportunities available to the Company except
with respect to Subordinated Interests, Preferred Equity and Net Leased Real
Estate. The Manager and its Affiliates have no obligation to offer
Subordinated Interests to the Company if the mortgage loans collateralizing
such Subordinated Interests are owned by the Manager or one of its Affiliates.
In addition, the Manager and its Affiliates have no obligation to offer
Preferred Equity to the Company if the Preferred Equity investment is related
to the funding of a first Mortgage Loan by the Manager or one of its
Affiliates that is suitable for securitization. As a consequence, the
opportunity for the Company to invest in Targeted Portfolio Investments may be
limited if such investment opportunities would be attractive to the Manager or
one of its Affiliates. The Manager and its Affiliates will not invest in a
Subordinated Interest (other than one collateralized by loans owned by the
Manager or its Affiliates), Preferred Equity (other than Preferred Equity
funded to facilitate the origination of a first Mortgage Loan suitable for
securitization), or Net Leased Real Estate unless a majority of the
Independent Directors have decided that the Company should not invest in such
asset. In deciding whether to invest in such an asset, the Independent
Directors may consider, among other factors, whether the asset is well-suited
for the Company and whether the Company is financially able to take advantage
of the investment opportunity.
The Company and Brookdale have agreed to a non-binding term sheet pursuant
to which the Company will purchase four senior housing and assisted living
facilities from Brookdale, an Affiliate of Prime, for an aggregate purchase
price of approximately $126.5 million, consisting of $33.5 million in cash
plus the assumption of $93.0 million of tax-exempt bond obligations. The term
sheet provides that the Company will lease these properties back to Brookdale
on a long-term triple-net basis as further described herein. The Brookdale
transaction is subject to various conditions and contingencies, including the
approval by a majority of the Independent Directors of the Company, approval
by the Brookdale board of directors, consent of HUD and consent of certain
lenders. Therefore, there can be no assurance that the Initial Investments
will be consummated. See "Initial Investments."
The Company may purchase additional assets from the Manager and its
Affiliates in the future and may participate on a joint basis with the Manager
and its Affiliates in investments. See "Risk Factors--Conflicts of Interest in
the Business of the Company May Result in Decisions of the Company That Do Not
Fully Reflect the Interests of the Stockholders of the Company." Any such
purchases will be in accordance with the Guidelines to be approved by a
majority of the Company's Independent Directors. The terms of a particular
transaction, however, will not be approved in advance by the Company's Board
of Directors. The Independent Directors will review any such transactions
quarterly to ensure compliance with the Guidelines, but in doing so they, by
necessity, will rely primarily on information and analysis provided to them by
the Manager.
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Prime, along with certain senior executives of the Manager, will purchase
1,875,000 shares of Common Stock from the Company on the Closing Date at a
price equal to the Offering Price, net of any underwriting discounts or
commissions, and such shares will represent 10.0% of the total shares offered
hereby, exclusive of the Underwriter's over-allotment option. The Manager also
has received stock options pursuant to the Company's Option Plan. See
"Management of Operations--Stock Options."
Prime and such senior executives of the Manager will retain their shares of
the Company for at least two years after the Offering, but may dispose of their
shares any time thereafter in accordance with the provisions of Rule 144 of the
Securities Act. See "Common Stock Available for Future Sale." Notwithstanding
the foregoing, if the Company terminates the Management Agreement, Prime and
such senior executives of the Manager may require the Company to register their
shares of Common Stock with the Commission (and under applicable state law).
The market in which the Company expects to purchase assets is characterized
by rapid evolution of products and services and, thus, there may in the future
be relationships between the Company, the Manager, and Affiliates of the
Manager in addition to those described herein.
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THE COMPANY
PCI was incorporated in the State of Maryland in September 1997 and will
elect to be taxed as a REIT under the Code. The principal executive offices of
the Company are located at 77 West Wacker Drive, Suite 3900, Chicago, Illinois
60601. The Company's telephone number is (312) 917-1500.
DIRECTORS AND EXECUTIVE OFFICERS
The following tables set forth certain information about the directors and
executive officers of PCI.
INSIDER DIRECTORS
<TABLE>
<CAPTION>
NAME AGE POSITION(S) HELD
---- --- ----------------
<S> <C> <C>
Michael W. Reschke...... 41 Chairman of the Board of Directors
James W. Roiter......... 44 President and Chief Executive Officer and Director
</TABLE>
For biographical information on Messrs. Michael W. Reschke and James W.
Roiter, see "Management of Operations--The Manager."
ELECTION OF BOARD OF DIRECTORS; COMPENSATION
The Board of Directors has three classes of directors. The initial terms of
the first, second and third classes will expire in 1999, 2000 and 2001,
respectively. Directors for each class will be elected for a three-year term
upon the expiration of that class, term, beginning in 1999. Subject to the
right of the holders of any Preferred Stock to elect and remove directors in
certain circumstances, the affirmative vote of two-thirds of the outstanding
Common Stock is required to remove a director. All officers serve at the
discretion of the Board of Directors. Although the Company may have salaried
employees, it currently does not have employees and does not expect to employ
anyone as long as the Management Agreement is in force. The Company will pay
an annual director's fee to each Independent Director equal to $25,000, with
no additional fee to be paid for the first four meetings of the Board of
Directors. Each Independent Director will be paid a fee of $2,000 for each
additional meeting of the Board of Directors attended in person by such
Independent Director and a fee of $500 for each committee meeting of the Board
of Directors if such meeting is held on the same day as the full board meeting
and a fee of $1,000 if the committee meeting is held on a separate day. All
Directors will be reimbursed for their costs and expenses in attending all
meetings of the Board of Directors.
Directors and executive officers of PCI will be required to devote only so
much of their time to the Company's affairs as is necessary or required for
the effective conduct and operation of the Company's business. Because the
Management Agreement provides that the Manager will assume principal
responsibility for managing the affairs of the Company, the officers of the
Company, in their capacities as such, are not expected to devote substantial
portions of their time to the affairs of the Company. However, in their
capacities as officers or employees of the Manager, or its Affiliates, they
will devote such portion of their time to the affairs of the Manager as is
required for the performance of the duties of the Manager under the Management
Agreement.
The Bylaws of PCI will provide that, except in the case of a vacancy, the
majority of the members of the Board of Directors will at all times after the
issuance of the shares offered hereby be Independent Directors. Vacancies
occurring on the Board of Directors among the Independent Directors will be
filled by the vote of a majority of the directors, including a majority of the
Independent Directors.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Articles of Incorporation limits the liability of its directors and
officers to PCI and its stockholders to the fullest extent permitted from time
to time by Maryland law. Maryland law presently permits the liability of
directors and officers to a corporation or its stockholders for money damages
to be limited, except (i) to the extent that it is proved that the director or
officer 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) if a judgment or other final adjudication
is entered in a proceeding based on a finding that the director's or officer'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. This
provision does not limit the ability of PCI or its stockholders to obtain
other relief, such as an injunction or rescission.
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The Articles of Incorporation and Bylaws require PCI to indemnity and hold
harmless and, without requiring a determination of the ultimate entitlement to
indemnification, pay reasonable expenses in advance of the final disposition
of any proceeding to its present and former directors and officers and certain
other parties to the fullest extent permitted from time to time by Maryland
law. The MGCL permits a corporation to indemnity its directors, officers and
certain other parties against judgments, penalties, fines, settlements and
reasonable expenses incurred by them in connection with any proceeding to
which they may be made a party by reason of their service to or at the request
of the corporation, unless it is established that (i) the act or omission of
the indemnified party was material to the matter giving rise to the proceeding
and (x) was committed in bad faith or (y) was the result of active and
deliberate dishonesty, (ii) the indemnified party actually received an
improper personal benefit in money, property or services or (iii) in the case
of any criminal proceeding, the indemnified party had reasonable cause to
believe that the act or omission was unlawful. Indemnification may be made
against judgments, penalties, fines, settlements and reasonable expenses
actually incurred by the director or officer in connection with the
proceeding. Indemnification is limited to court ordered reimbursement for
expenses; however, if the proceeding is one by or in the right of the
corporation, and the director or officer was adjudged to be liable to the
corporation or if the proceeding is one charging improper personal benefit to
the director or officer and the director or officer was adjudged to be liable
on the basis that personal benefit was improperly received. The termination of
any proceeding by conviction, or upon a plea of nolo contendere or its
equivalent, or an entry of any order of probation prior to judgment, creates a
rebuttal presumption that the director or officer did not meet the requisite
standard of conduct required for indemnification to be permitted. Maryland law
requires a corporation (unless its Articles of Incorporation provides
otherwise, which PCI's Articles of Incorporation does not) to indemnity a
director or officer who has been successful, on the merits or otherwise, in
the defense of any proceeding to which he is made a party by reason of his
service in that capacity. It is the position of the Commission that
indemnification of directors and officers for liabilities arising under the
Securities Act is against public policy and is unenforceable pursuant to
Section 14 of the Securities Act.
DISTRIBUTION POLICY
In order to avoid corporate income taxation of the earnings that it
distributes, PCI must distribute to its stockholders an amount at least equal
to (i) 95% of its REIT taxable income (determined before the deduction for
dividends paid and excluding any net capital gain) plus (ii) 95% of the excess
of its net income from foreclosure property over the tax imposed on such
income by the Code less (iii) any excess noncash income (as determined under
the Code). See "Certain Federal Income Tax Considerations." The actual amount
and timing of distributions, however, will be at the discretion of the Board
of Directors and will depend upon the financial condition of PCI in addition
to the requirements of the Code. It is anticipated that the first distribution
will be made in January 1998.
Subject to the distribution requirements referred to in the immediately
preceding paragraph, PCI intends, to the extent practicable, to invest
substantially all of the principal from repayments, sales and refinancings of
the Company's Targeted Portfolio Investments in additional Targeted Portfolio
Investments. PCI may, however, under certain circumstances, make a
distribution of principal. Such distributions, if any, will be made at the
discretion of the Board of Directors.
It is anticipated that distributions generally will be taxable as ordinary
income to non-exempt stockholders of PCI, although a portion of such
distributions may be designated by PCI as long-term capital gain or may
constitute a return of capital. PCI will furnish annually to each of its
stockholders a statement setting forth distributions paid during the preceding
year and their federal income tax status. For a discussion of the federal
income tax treatment of distributions by PCI and certain adverse tax
consequences for stockholders associated with Non-REMIC and REMIC Residual
Interests, OID investments and Distressed Mortgage Loans held by the Company,
see "Certain Federal Income Tax Considerations--Taxation of the Company" and
"--Taxation of Taxable U.S. Stockholders."
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YIELD CONSIDERATIONS RELATED TO THE COMPANY'S INVESTMENTS
Before purchasing any Targeted Portfolio Investments, the Company, with the
assistance of the Manager, will consider the expected yield of the investment.
The Company considers the expected yield of an investment to be a benchmark for
evaluating profitability of all types of assets over time. "Yield" or "yield to
maturity" is the interest rate that will make the present value of the future
cash flow from an investment equal to its price. Despite the Manager's
substantial experience in evaluating potential yields on Targeted Portfolio
Investments, no assurances can be given that the Company can make an accurate
assessment of the actual yield to be produced by an asset. Many factors beyond
the control of the Company are likely to influence the yield on the Company's
investments, as described in more detail below, such that the actual yield on
an investment may vary substantially from its expected yield.
SUBORDINATED INTERESTS
The yield to maturity on any class of Subordinated Interests will depend upon
and be sensitive to, among other things, the price at which such class is
purchased, the interest rate for such class and the timing and aggregate amount
of distributions on the securities of such class, which in turn will depend
primarily on (i) whether there are any defaults or losses on the underlying
loans allocated to such class and (ii) whether and when there are any
prepayments of the related Mortgage Loans (which include both voluntary
prepayments by the obligors on the Mortgage Loans and prepayments resulting
from liquidations due to defaults and foreclosures).
The yield on the Subordinated Interests acquired by the Company will be
extremely sensitive to defaults on the mortgage loans comprising the Mortgage
Collateral for such securities and the severity of losses resulting from such
defaults, as well as the timing of such defaults and actual losses. The
Company's right as a holder of Subordinated Interests to distributions of
principal and interest will be subordinated to all of the more senior classes
of securities. Actual losses on the Mortgage Collateral (after default, where
the proceeds from the foreclosure sale of the real estate securing the loan are
less than the unpaid balance of the mortgage loan plus interest thereon and
disposition costs) will be allocated first to the Subordinated Interests prior
to being allocated to the more senior securities. The Subordinated Interests
the Company intends to acquire with the proceeds from the Offering are subject
to special risks, including a substantially greater risk of loss of principal
and non-payment of interest than the more senior securities of such series.
If the Company acquires Subordinated Interests with an anticipated yield as
of the acquisition date based on an assumed rate of default and severity of
loss on the mortgage loans comprising the Mortgage Collateral that is lower
than the actual default rate and severity of loss, its yield will be lower than
the Company initially anticipated. In the event of substantial losses, the
Company may not recover the full amount (or, indeed, any) of its acquisition
cost. The timing of actual losses also will affect the Company's yield, even if
the number of defaults and severity of loss are consistent with the Company's
anticipation. In general, the earlier a loss occurs, the greater the adverse
effect on the Company's yield. Additionally, the yield on MBS collateralized by
adjustable rate mortgage loans will vary depending on the amount of and caps on
the adjustments to the interest rates of such mortgage loans. There can be no
assurance as to the rate of delinquency, severity of loss or the timing of any
such losses on mortgage loans underlying Subordinated Interests and thus as to
the actual yield received by the Company.
The aggregate amount of distributions on the Company's Subordinated Interests
and their yield also will be affected by the amount and timing of principal
prepayments on the mortgage loans comprising the Mortgage Collateral. To the
extent that more senior tranches of Subordinated Interests are outstanding, all
prepayments of principal on the underlying mortgage loans typically will be
paid to the holders of more senior classes, and typically none (or very little)
will be paid to the Company during the first five years, and in some cases a
longer period, after the original issue date of the related Subordinated
Interests. This subordination of the Subordinated Interests to more senior
classes may affect adversely the yield on the Subordinated Interests acquired
by the
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<PAGE>
Company. Even if there are no actual losses on the mortgage loans, interest and
principal payments are made on the more senior classes before interest and
principal are paid with respect to the Subordinated Interests. Typically,
interest deferred on Subordinated Interests is payable on subsequent payment
dates to the extent funds are available, but such deferral does not itself bear
interest. Such deferral of interest will reduce the actual yield on the
Company's Subordinated Interests.
Because the Company will acquire Subordinated Interests at a significant
discount from their outstanding principal balance, if the Company estimates the
yield on a security based on a faster rate of payment of principal than
actually occurs, the Company's yield on that security will be lower than the
Company anticipated. Whether and when there are any principal prepayments on
the Mortgage Loans will be affected by a variety of factors, including, without
limitation, the terms of the Mortgage Loans, the level of prevailing interest
rates, the availability of mortgage credit and economic, tax, legal and other
factors. Principal prepayments on Mortgage Loans secured by multifamily
residential and commercial properties are likely to be affected by lock-out
periods and prepayment premium provisions applicable to each of the Mortgage
Loans, and by the extent to which the servicer of such Mortgage Loans is able
to enforce such prepayment premium provisions. Moreover, the yield to maturity
on such Subordinated Interests may also be affected by any extension of the
scheduled maturity dates of the Mortgage Loans as a result of modifications of
the Mortgage Loans by the servicer of such Mortgage Loans, if permitted.
The timing of any prepayments on the mortgage loans underlying MBS owned by
the Company may significantly affect the Company's yield to maturity, even if
the average rate of principal payments is consistent with the Company's
expectation. In general, the earlier a prepayment of principal of the mortgage
loans, the greater the effect on an investor's yield. The effect on the
Company's yield of principal payments occurring at a rate higher (or lower)
than the rate anticipated by the Company during any particular period may not
be fully offset by a subsequent like decrease (or increase) in the rate of
principal payments.
Because the rate and timing of principal payments on the underlying mortgage
loans will depend on future events and on a variety of factors, no assurances
can be given as to such rate or the timing of principal payments on the
Subordinated Interests the Company owns or acquires.
MORTGAGE LOANS
The yield to maturity on the Company's investment in Mortgage Loans will
depend upon and be sensitive to, among other things, upon (i) whether there are
any defaults or losses on such Mortgage Loans, (ii) whether and when there are
any prepayments of such Mortgage Loans, (iii) the interest rates on such
Mortgage Loans, and (iv) the purchase price of such Mortgage Loans.
The yield to maturity on all Mortgage Loans will be sensitive to defaults by
the borrower and the severity of the losses that might result from such
defaults. The borrower generally will have an equity investment of 10% to 15%
of total project costs, but if the borrower defaults there can be no assurance
that losses will not exceed such amount. Because the borrower's equity may be
insufficient to protect the Company's investment, the Company's yield on such
loans may be directly and adversely affected by defaults.
If the Company acquires a Mortgage Loan at a significant discount from its
outstanding principal balance and the Company estimates the yield on the
Mortgage Loan based on a faster rate of payment of principal than actually
occurs, the Company's yield on that Mortgage Loan will be lower than the
Company anticipated. Conversely, if the Company acquires a Mortgage Loan at a
significant premium to its outstanding principal balance, estimating the yield
on such Mortgage Loan based on a slower rate of payment of principal than
actually occurs, the Company's yield on that Mortgage Loan will be lower than
anticipated.
Whether and when there are any principal prepayments on the Mortgage Loans
will be affected by a variety of factors, including, without limitation, the
credit, liquidity and other attributes of the borrower, the terms of the
Mortgage Loans, the level of prevailing interest rates, the availability of
mortgage credit and economic, tax, legal
51
<PAGE>
and other factors. Principal prepayments on Mortgage Loans secured by
multifamily residential and commercial properties are likely to be affected by
lock-out periods and prepayment premium provisions applicable to each of the
Mortgage Loans, and by the extent to which the Servicer is able to enforce
such prepayment premium provisions. Moreover, the yield to maturity on
Mortgage Loans may also be affected by any extension of the scheduled maturity
dates of the Mortgage Loans as a result of modifications of the Mortgage Loans
by the servicer, if permitted.
PREFERRED EQUITY
The yield to maturity on the Company's investment in Preferred Equity will
depend upon and be sensitive to, among other things, the price at which such
Preferred Equity is purchased and the timing and aggregate amount of
distributions on such Preferred Equity, which in turn will depend primarily on
(i) whether there are any default or losses on the underlying assets subject
to such preferred claim, and (ii) the solvency of the real estate operating
company in which the Company holds Preferred Equity, as applicable.
The yield on Preferred Equity acquired by the Company will be extremely
sensitive to defaults on the assets in which the Company has a preferred claim
and the severity of losses resulting from such defaults, as well as the timing
of such defaults and actual losses. The Company's right as a holder of
Preferred Equity to distributions of preferred dividends and the return of its
principal investment will be subordinated to the rights of all creditors with
claims against the underlying assets whether secured or unsecured. Actual
losses on the underlying assets (after default, where the proceeds from the
foreclosure sale of the underlying assets are less than the creditors' claims
(secured or unsecured) thereon and disposition costs) will be allocated to the
Preferred Equity prior to being allocated to the creditors with claims
(whether secured or unsecured) against such assets. The Company's investments
in Preferred Equity carry a greater risk of loss of principal and the
nonpayment of the preferred dividend than an investment in debt which is
either secured or unsecured.
NET LEASED REAL ESTATE
The yield on the Company's investments in Net Leased Real Estate will depend
upon the price that the Company pays for such investments, the costs of
capital improvements and other costs of managing the properties, the level of
rents and other income generated by the properties, the length of time between
acquisition and disposition and the price at which the Company ultimately
disposes of such properties. The party leasing the property from the Company
will be responsible for all operating expenses, real estate taxes, repairs and
maintenance, and all capital expenditures required to maintain the leased
properties in good working condition, reasonable wear and tear accepted. The
yield on the investment will depend upon the lessee's ability to generate
sufficient cash flow to cover such costs. In addition, the Company's
investment in Net Leased Real Estate will also depend on the lessee's ability
to increase revenues over the lease period. In the event actual revenue
increases on leased property are not consistent with the Company's projected
growth in revenues, the yield on such investment may be adversely affected.
The yield on such investments may be adversely affected by factors beyond the
Company's control, such as adverse changes in economic conditions,
neighborhood characteristics and competition from other properties offering
the same or similar services.
IOS, INVERSE IOS AND SUB IOS
The Company's earnings resulting from its investments in IOs, Inverse IOs
and Sub IOs will be extremely sensitive to changes in the prepayment rates on
the underlying mortgage loans, and investments in Inverse IOs will be very
sensitive to changes in the index used to calculate the interest on such
classes.
The yield on IOs declines as prepayments on the underlying mortgage loans
increase. As market interest rates decline, prepayments on the underlying
loans typically increase as borrowers refinance their mortgage loans, although
commercial and multifamily loans typically have provisions that prohibit or
provide disincentives for prepayments for specified periods. Prepayment rates
on mortgage loans on which there is no prepayment penalty or prepayment "lock
out" period (as is typical for single-family residential loans) may be
particularly sensitive to changes in interest rates and, therefore, quite
volatile. Faster than anticipated prepayment rates can result in a loss of
part or all of the purchase price for the IO.
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<PAGE>
The Company intends to invest in Inverse IOs, interest on which is payable
at a floating rate that varies inversely with (and often at a multiple of) a
specified index, such as the prime rate, one-month, three-month or six-month
LIBOR, or a U.S. Treasury rate. Generally, if the index exceeds a certain
level, the Inverse IO receives no payments. Moreover, Inverse IOs generally
have a cap on the interest rate payable on such class.
Investors in Inverse IOs are subject to the risk that higher than
anticipated levels of the index could result in actual yields to investors
that are significantly lower than the anticipated yields, and that the
interest rate on the class will be 0% at or above specified levels of the
index. In addition, the interest rate on an Inverse IO cannot exceed its
specified maximum rate, regardless of the level of the index. Further, high
levels of the index (especially in combination with fast prepayment rates on
the Mortgage Loans) may result in the failure of the Company to recover fully
its investments in Inverse IOs. For example, the holder of an Inverse IO with
a per annum interest rate equal to 8.5% minus one-month LIBOR, subject to a
maximum rate of 8.5%, would receive no interest if one-month LIBOR were to
equal or exceed 8.5%. Moreover, under no circumstance will such Inverse IO
accrue interest at a rate greater than 8.5% per annum.
Changes in the index may not correlate with changes in mortgage interest
rates. It is possible that lower prevailing mortgage interest rates (which
would be expected to result in faster prepayments) could occur concurrently
with a higher level of the index, thereby compounding the negative effects of
each separate factor on the yields to investors in the Inverse IOs.
Conversely, higher prevailing mortgage interest rates (which would be expected
to result in slower prepayments) could occur concurrently with a lower level
of the index.
It is highly unlikely that the index will remain constant at any level. The
timing of changes in the level of the index may affect the actual yield to the
Company, even if the average level is consistent with the Company's
expectation. In general, the earlier a change in the level of the index, the
greater the effect on the Company's yield. As a result, the effect on the
Company's yield of the index level that is higher (or lower) than the rate
anticipated by the Company during earlier periods is not likely to be offset
by a later equivalent reduction (or increase).
The Company intends to invest in Sub IOs. Interest otherwise allocable to
Sub IOs generally is withheld and used to make payments on more senior classes
or to fund a reserve account for the protection of senior classes until over
collateralization or the balance in the reserve account reaches a specified
level. In those cases, interest on the Sub IO generally will be paid to the
holders of the Sub IO only after the balance in the reserve account reaches
the specified level. Sub IOs of this nature provide credit support to the
senior classes, and thus bear substantial credit risk. Moreover, because a Sub
IO receives only interest payments, its yield is extremely sensitive not only
to default losses but also to changes in the weighted average life of the
class, which in turn is dictated by the rate of prepayments (including as a
result of defaults) on the underlying loans. See "Risk Factors--Risks Related
to Investments in MBS Interests--Yields on Subordinated Interests, IOs and POs
May Be Affected Adversely by Interest Rate Changes."
INITIAL INVESTMENTS
BROOKDALE NET LEASED REAL ESTATE TRANSACTION
The Brookdale Properties. The Company and Brookdale have agreed to a non-
binding term sheet pursuant to which the Company will purchase shortly after
the Closing four senior housing and assisted living facilities from Brookdale
for approximately $126.5 million, consisting of $33.5 million in cash plus the
assumption of $93.0 million of tax exempt bond obligations and will lease-back
such facilities to Brookdale on a triple-net basis. The transaction is subject
to various conditions and contingencies, including the approval by a majority
of the Independent Directors of the Company, approval by the Brookdale board
of directors, the consent of HUD and the consent of certain lenders. There can
be no assurance that such transaction will be consummated. Brookdale is a
provider of senior and assisted living services to the elderly, currently with
ten facilities in six states, containing an aggregate of approximately 2,200
units. The purchase of these facilities is subject to the approval of the
majority of the Independent Directors.
The four subject facilities are (1) The Devonshire, in Lisle, Illinois, a
323 unit senior and assisted living facility, opened in 1990; (2) The
Heritage, in Des Plaines, Illinois, a 254 unit senior and assisted living
facility,
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<PAGE>
opened in 1993; (3) Hawthorn Lakes, in Vernon Hills, Illinois, a 202 unit
senior and assisted living facility opened in 1987; and (4) Edina Park Plaza,
in Edina, Minnesota, a 201 unit senior and assisted living facility opened in
1987 (collectively, the "Brookdale Facilities"). The following table sets forth
certain information regarding each facility:
<TABLE>
<CAPTION>
YEAR CURRENT
PROPERTY UNITS OPENED OCCUPANCY(1) NOI(2)
- -------- ----- ------ ------------ -----------
<S> <C> <C> <C> <C>
The Devonshire............................ 323 1990 100% $ 4,249,416
The Heritage.............................. 254 1993 99% 3,126,024
Hawthorn Lakes............................ 202 1987 100% 2,651,928
Edina Park Plaza.......................... 201 1987 99% 1,984,836
-----------
$12,012,204
===========
</TABLE>
- ---------------------
1. Percent of available units occupied as of September 7, 1997.
2. Annualized Brookdale Facilities net operating income based on the month of
June, 1997 results (unaudited).
Description of Brookdale Operations. Brookdale provides senior and assisted
living services to the elderly. Brookdale had unaudited revenues and net income
for the six months ended June 30, 1997 of $11.6 million and $.4 million,
respectively. All of Brookdale's revenues are derived from private pay sources.
Brookdale derives most of its operating revenue from resident fees, which are
paid monthly by residents, their families or other responsible parties.
The Brookdale Facilities are designed for middle to upper income residents.
In addition to studio, one-bedroom and two-bedroom units, the Brookdale
facilities provide residents with basic services, such as meal service, 24-hour
emergency response, housekeeping, concierge services, transportation and
recreational activities. For residents who require additional supplemental care
services, Brookdale provides assistance with certain activities of daily
living, including check-in services and shopping, escort and companion
services. Residents with cognitive or physical frailties and higher level
service needs are either accommodated with supplemental services in their own
units or, in certain facilities, are cared for in a more structured and
supervised environment on a separate wing or floor of the facility with a
dedicated staff and with separate dining rooms and activity areas. Residents
with such frailties typically receive personal care and assistance and personal
care with activities of daily living. The average age of Brookdale's residents
is approximately 82 years old, and many of these residents require some level
of assistance with activities of daily living. Supplemental care services are
provided either by the Company or by outside services or agencies.
In addition to the living units, the Brookdale Facilities typically contain
common areas for residents, including a living room, library, billiards room,
multi-purpose room, arts and crafts room, exercise room, convenience store,
beauty/barber shop, mail room, dining room and private dining room.
Competition. The senior and assisted living services and health care
industries are highly competitive and the Company expects that the senior and
assisted living business in particular will become more competitive in the
future. Brookdale will continue to face competition from numerous local,
regional and national providers of senior and assisted living services.
Brookdale will also compete with companies providing home based health care.
Governmental Regulation. Senior and assisted living facilities are subject to
varying degrees of regulation and licensing by local and state health and
social service agencies and other regulatory authorities. While regulations and
licensing requirements often vary significantly from state to state, they
typically address, among other things: personal education; training and
records; facility services; physical plant specifications; furnishing of
resident units; food and housekeeping services; emergency evacuation plans; and
resident rights and responsibilities. In most states, senior and assisted
living facilities also are subject to state or local building codes, fire codes
and food service licensure or certification requirements. Assisted living
facilities may be subject to periodic survey or inspection by governmental
authorities. In certain states in which Brookdale operates, it may
54
<PAGE>
be unable to provide certain higher levels of assisted living services without
obtaining the appropriate licenses, if applicable. Brookdale's success will
depend in part on its ability to satisfy such regulations and requirements and
to acquire and maintain required licenses. In certain instances, the Company,
as owner of the Brookdale Facilities, will be subject to certain of such
regulatory requirements. Brookdale's operations could also be adversely
affected by, among other things, regulatory developments such as revisions in
licensing and certification standards.
Although the Brookdale Facilities currently do not participate in the
Medicare or Medicaid programs, the hospitals with which it has affiliations do
participate in those programs. Also, all of Brookdale's residents are eligible
for Medicare benefits. Therefore, certain aspects of Brookdale's business are
and will be subject to federal and state laws and regulations which govern
financial and other arrangements between and among healthcare providers,
suppliers and vendors. These laws prohibit certain direct and indirect payments
and fee-splitting arrangements designed to induce or encourage the referral of
patients to, or the recommendation of, a particular provider or other entity or
person for medical products and services. These laws incude, but are not
limited to, the federal "anti-kickback law" which prohibits, among other
things, the offer, payment, solicitation or receipt of any form of remuneration
in return for the referral of Medicare and Medicaid patients. The Office of the
Inspector General of the Department of Health and Human Services, the
Department of Justice and other federal agencies interpret these statutes
liberally and enforce them aggressively. Members of Congress have proposed
legislation that would significantly expand the federal government's
involvement in curtailing fraud and abuse and increase the monetary penalties
for violation of these provisions. Violation of these laws can result in, among
other things, loss of licensure, civil and criminal penalties for individuals
and entities, and exclusion of health care providers or suppliers from
participation in the Medicare and/or Medicaid programs.
In addition, although Brookdale is not a Medicare or Medicaid provider or
supplier, it is subject to these laws because (i) the state laws typically
apply regardless of whether Medicare or Medicaid payments are at issue, and may
establish licensed home health agencies which are intended to participate in
Medicare, and (ii) as required under some state licensure laws, and for the
convenience of its residents, some of the Brookdale senior and assisted living
facilities maintain contracts with hospitals, who in turn maintain contracts
with certain health care providers and practitioners, including pharmacies,
home health agencies and hospices, through which the health care providers make
their health care items or services (some of which may be covered by Medicare
or Medicaid) available to facility residents. There can be no assurance that
such laws will be interpreted in a manner consistent with the practices of
Brookdale.
Under the Americans with Disabilities Act of 1990, all places of public
accommodation are required to meet certain federal requirements related to
access and use by disabled persons. A number of additional federal, state and
local laws exist which also may require modifications to existing and planned
properties to create access to the properties by disabled persons. While the
Company believes the Brookdale Facilities are substantially in compliance with
present requirements or are exempt therefrom, if required changes involve a
greater expenditure than anticipated or must be made on a more accelerated
basis than anticipated, additional costs would be incurred by the Company.
Further legislation may impose additional burdens or restrictions with respect
to access by disabled persons, the cost of compliance with which could be
substantial. Brookdale and its activities also are subject to zoning and other
state and local government regulations.
Description of Lease. The term sheet provides that Brookdale will enter into
a long-term triple-net lease with PCI with an initial term of twenty-four
years, with two twenty-five year options to renew at the then current fair
market value. The lease rate will be structured such that Brookdale will pay a
base rent of approximately $4.5 million plus the debt service on the Brookdale
Facilities indebtedness being assumed by PCI. The expected debt service amount
in the base rent is approximately $5.4 million, which implies an aggregate base
rent payment
55
<PAGE>
of approximately $9.9 million. The lease will provide for additional rent of
10% of the increase in gross revenue over the base year (defined as the
calendar year 1998). Brookdale will covenant to maintain specified minimum net
operating income ("NOI") coverage ratios over the term of the lease (as
defined in the lease). PCI will grant an option to Brookdale to refinance, or
repay, any of the indebtedness on the Brookdale Facilities at any time,
provided that Brookdale pay the cost of such refinancing and that Brookdale
may not reduce the maturity or increase the principal amount of the
indebtedness without the consent of PCI. If PCI consents to an increased
principal amount, which consent may be withheld in PCI's sole and absolute
discretion, PCI may, at its option either, (i) remit such additional proceeds
to Brookdale with a corresponding increase in base rent (reflecting higher
debt service) or (ii) retain such additional proceeds with a corresponding
decrease in base rent (based on a formula defined in the lease). The lease is
triple-net which means that Brookdale will be responsible for all operating
expenses, real estate taxes, repairs and maintenance, and all capital
expenditures required to maintain the Brookdale Facilities in good working
condition, reasonable wear and tear accepted.
Description of Indebtedness on the Properties. The Brookdale Facilities are
currently encumbered by approximately $93.0 million of tax-exempt bond
indebtedness. Approximately $65 million of such indebtedness, with maturities
of December 2019 with respect to $32 million of such indebtedness and December
2025 with respect to $33 million of such indebtedness, is structured as "low-
floater" tax-exempt bonds which have an "all-in" rate of approximately 5.25%
per annum, including on-going fees related to the credit enhancement and
periodic remarketing of such indebtedness. Approximately $15 million of such
indebtedness is tax-exempt fixed rate debt at 8.0% and is insured by HUD. Such
$15 million of indebtedness is fully amortizing with maturities of October
2007 with respect to $1 million of such indebtedness and September 2027 with
respect to $14 million of such indebtedness. Approximately $13 million of such
indebtedness is currently tax-exempt fixed rate at 8.525% and is insured by
HUD. Such $13 million of indebtedness is fully amortizing with a maturity of
December 2027. It is currently anticipated that such $13 million of
indebtedness will be restructured as a "low-floater" bond prior to the
Closing. $65 million of the tax-exempt bond indebtedness is credit enhanced by
two banks via letters of credit. Brookdale has represented that it expects to
replace such credit enhancement with an alternative, lower cost, "AAA" rated
enhancement source prior to, and as a condition to, the closing of the sale
and leaseback of the Brookdale Facilities. Such enhancement source is also
expected by Brookdale to enhance the $13 million of indebtedness which is
being restructured as described above.
YIELD CONSIDERATIONS RELATED TO THE INITIAL INVESTMENTS
GENERAL
The actual yield to maturity on the Initial Investments will depend upon,
among other things, the level of rents and other income generated by the
Brookdale Facilities, the costs of capital improvements and other costs of
managing such properties, the growth of rental revenues from such properties
over the term of the lease and the price at which the Company ultimately
disposes of the Brookdale Facilities. See "Yield Considerations Related to the
Company's Investments."
56
<PAGE>
CAPITALIZATION
The capitalization of the Company, as of September 30, 1997, and as adjusted
to reflect the sale of the shares of Common Stock offered hereby, is as
follows:
<TABLE>
<CAPTION>
AS ADJUSTED
ACTUAL (1)
------ ------------
<S> <C> <C>
Common Stock, par value $.01........................ $ 1 $ 187,500
Authorized--200,000,000 shares
Outstanding--100 shares, 18,750,000 shares, as
adjusted(1)
Additional Paid-in Capital.......................... 999 278,012,500
------ ------------
Total........................................... $1,000 $278,200,000
====== ============
</TABLE>
- ---------------------
(1) Assumes an Offering Price of $16 per share. Includes 1,875,000 shares of
Common Stock to be purchased by Prime and certain senior executives of the
Manager, less underwriting discounts and commissions, after deducting
offering expenses estimated to be $800,000 payable by the Company, and
assuming no exercise of the Underwriter's over-allotment option to
purchase up to an additional 2,812,500 shares of Common Stock. Excludes up
to 539,063 shares issuable pursuant to warrants granted to the
Underwriter.
PRO FORMA CONDENSED CONSOLIDATED INFORMATION
A Pro Forma Condensed Consolidated Balance Sheet of the Company, presented
as if, at June 30, 1997, (1) the Company had sold 18,750,000 shares of its
Common Stock at a sales price of $16 per share and contributed the net
proceeds of $278.2 million to the Operating Partnership and (2) the Operating
Partnership acquired the Initial Investments for $33.5 million in cash and the
assumption of $93.0 million of tax exempt bond obligations, consists of total
assets of $371.2 million comprised of $126.5 million of real estate and $244.7
million in cash. Pro forma liabilities and stockholders' equity at June 30,
1997 consist of tax exempt bond obligations of $93.0 million and stockholders'
equity of $278.2 million.
The Pro Forma Condensed Consolidated Statements of Operations for the six
months ended June 30, 1997 and for the year ended December 31, 1996 are
discussed below as if the above transactions occurred as of January 1, 1996.
The condensed consolidated results of operations do not assume any earnings
from the cash balances of the Company.
SIX MONTHS ENDED JUNE 30, 1997
The Pro Forma Condensed Consolidated Statement of Operations for the six
months ended June 30, 1997 consists of rental income of $5.0 million earned
from the net leased Initial Investments, interest expense and financing fees
of $2.7 million relating to the assumed tax exempt bond obligations,
depreciation expense relating to the Initial Investments of $1.3 million,
general and administrative expenses which include management's estimate of
expenses to be incurred as a public company of $.2 million, and management fee
expense of $1.9 million. Pro forma net loss and net loss per share (based upon
net loss divided by 18,750,000 shares of common stock) for the six months
ended June 30, 1997 equal $1.1 million and $.06 per share, respectively.
YEAR ENDED DECEMBER 31, 1996
The Pro Forma Condensed Consolidated Statement of Operations for the year
ended December 31, 1996 consists of rental income of $9.9 million earned from
the Initial Investments, interest expense and financing fees of $5.2 million
relating to the assumed tax exempt bond obligations, depreciation expense
relating to the Initial Investments of $2.5 million, general and
administrative expenses which include management's estimate of expenses to be
incurred as a public company of $.4 million, and management fee expense of
$3.7 million. Pro forma net loss and net loss per share (based upon net loss
divided by 18,750,000 shares of Common Stock) for the year ended December 31,
1996 would equal $1.9 million and $.10, respectively.
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<PAGE>
This Pro Forma Condensed Consolidated Information should be read in
conjunction with the financial statements contained elsewhere in this
Prospectus. In management's opinion, all adjustments necessary to reflect the
effects of the Offering and purchase of the Initial Investments have been
made. The Pro Forma Condensed Consolidated Information described above for the
Company is not necessarily indicative of what the actual financial position or
results operations would have been assuming the Offering and purchase of the
Initial Investments had occurred at the dates indicated above, nor do they
purport to represent the future financial position or results of operations of
the Company.
USE OF PROCEEDS
All of the expected net proceeds of the Offering will be contributed by the
Company to the Operating Partnership in exchange for Units. Thereupon, the
Operating Partnership will use approximately $33.5 million of the net proceeds
of the Offering to purchase the Initial Investments (assuming all approvals
for such purchase are received and all other conditions to such purchase are
satisfied). The purchase price for the Initial Investments was based on
certain assumptions made with respect to the potential net cash flows to be
generated by the Initial Investments. See "Initial Investments," "Yield
Considerations Regarding the Initial Investments" and "Risk Factor--Conflicts
of Interest in the Business of the Company May Result in Decisions of the
Company That Do Not Fully Reflect the Interests of the Stockholders of the
Company." Pending investment, the balance of the net proceeds will be invested
in short-term, interest-bearing securities consistent with maintaining the
Company's status as a REIT and held by the Operating Partnership until such
proceeds are used to originate or acquire MBS, Mortgage Loans, Preferred
Equity and Net Leased Real Estate as provided herein. See "Operating Policies
and Objectives."
The Company intends to supplement the proceeds of the Offering through bank
borrowings, commercial paper borrowings and the issuance of debt securities
and additional equity securities.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF LIQUIDITY AND CAPITAL RESOURCES
PCI has been organized and will elect to qualify as a REIT under the Code
and, as such, anticipates distributing annually at least 95% of its taxable
income, subject to certain adjustments. Cash for such distributions is
expected to be generated from the Company's operations, although the Company
also may borrow funds to make distributions. The Company's revenues will be
derived from (i) ownership of sub-investment grade and unrated MBS; (ii)
ownership of Performing Mortgage Loans; (iii) ownership of Distressed Mortgage
Loans; (iv) ownership of Subordinated Mortgage Loans; (v) ownership of
Participating Mortgage Loans; (vi) ownership of Mortgage Loan Interests; (vii)
ownership of Preferred Equity; and (viii) ownership of Net Leased Real Estate.
See "Distribution Policy" and "Certain Federal Income Tax Considerations."
The principal sources of the Company's funds in the near term will be the
net proceeds of the Offering made by this Prospectus, borrowings under lines
of credit to be arranged on behalf of the Company, additional bank borrowings,
commercial paper borrowings, mortgage loans on the Company's real estate and
future equity offerings. From the net proceeds of the Offering, approximately
$33.5 million will be used to purchase the Initial Investments.
The Initial Investments comprise a relatively small portion of the assets to
be purchased with the net proceeds of the Offering and most of the net
proceeds of the Offering initially will be invested in readily marketable
securities. Accordingly, the Company would not anticipate a need to sell the
Initial Investments for liquidity purposes. Moreover, the Company has no
capital commitments with respect to the Initial Investments. Management
believes that the net proceeds of the Offering, combined with the cash flow
from operations and borrowings, will be sufficient to enable the Company to
meet its anticipated liquidity and capital requirements. See "Operating
Policies and Objectives" and "Use of Proceeds."
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PRINCIPAL SHAREHOLDERS OF THE COMPANY
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock and Units as of October 3, 1997, and as adjusted
to reflect the sale of the Common Stock offered hereby, by (a) each person
known by the Company to be the beneficial owner of more than 5.0% of the
Common Stock, (b) each director of the Company, (c) each executive officer of
the Company and (d) all directors and executive officers of the Company as a
group. Unless otherwise indicated in the footnotes, all of such interests are
owned directly, and the indicated person or entity has sole voting and
investment power. The number of shares represents the number of shares of
Common Stock the person holds or the number of shares of Common Stock into
which Units held by the person are redeemable, at the option of the holder (if
the Company elects to issue shares rather than pay cash upon such exchange).
The extent to which a person holds Units as opposed to Common Stock is set
forth in the notes to the following table. The Operating Partnership Agreement
provides that holders of Units may cause the Units to be redeemed, subject to
certain limitations and only after the first year following completion of the
Offering, for cash equal to the fair market value of a share of Common Stock
at the time of exchange or, at the option of Company, Common Stock on a one-
for-one basis.
<TABLE>
<CAPTION>
NUMBER OF COMMON PERCENTAGE OF PERCENTAGE OF ALL
STOCK/UNITS ALL COMMON STOCK/
NAME BENEFICIALLY OWNED COMMON STOCK (1) UNITS (2)
- ---- ------------------ ---------------- -----------------
<S> <C> <C> <C>
The Prime Group, Inc. and
certain senior
executives of the
Manager................. 1,875,000 9.1% 9.1%
The Manager (3).......... 1,875,000 9.1% 9.1%
</TABLE>
- ---------------------
(1) Assumes redemption only of Units owned by such beneficial owner for Common
Stock and includes options granted under the Option Plan.
(2) Assumes redemption of all outstanding Units for Common Stock and includes
options granted under the Option Plan.
(3) Represents options granted to the Manager under the Option Plan.
DESCRIPTION OF CAPITAL STOCK
The Company is incorporated in the State of Maryland. Rights of stockholders
are governed by the MGCL and by the Company's Articles of Incorporation and
Bylaws.
GENERAL
The Articles of Incorporation provide that PCI may issue up to 230,000,000
shares of capital stock, consisting of 200,000,000 shares of Common Stock,
$0.01 par value per share, and 30,000,000 shares of Preferred Stock. Upon
completion of the Offering, 18,750,000 shares of Common Stock will be issued
and outstanding, and 1,875,000 shares of Common Stock will be reserved for
issuance upon exercise of options granted under the Option Plan, and no
Preferred Stock will be issued and outstanding.
COMMON STOCK
All outstanding shares of Common Stock will be duly authorized, fully paid
and nonassessable upon the Closing. Subject to the preferential rights of any
other shares or series of shares of capital stock, holders of Common Stock are
entitled to receive non-cumulative dividends if and when authorized and
declared by the Board of Directors of PCI out of assets legally available
therefor and to share ratably in the assets of PCI 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 PCI. PCI intends to pay quarterly dividends.
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
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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
each candidate. For a discussion of the voting rights of holders of the Common
Stock, including the provisions specifying the vote required by security
holders to take action, see "Certain Provisions of Maryland Law and of PCI's
Articles of Incorporation and Bylaws."
No holder of any Common Stock shall have any preemptive right to subscribe
for a purchase of any stock or other securities of PCI other than such, if
any, as the Board of Directors, in its sole discretion, may determine.
Certain provisions of PCI's Articles of Incorporation and Bylaws and certain
provisions of Maryland law could have the effect of delaying, deferring or
preventing a change in control of PCI. See "Certain Provisions of Maryland Law
and of PCI's Articles of Incorporation and Bylaws."
PREFERRED STOCK
Preferred Stock may be issued from time to time, in one or more series, as
authorized by the Board of Directors without the approval of the stockholders.
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 of Directors could authorize the issuance of Preferred
Stock with terms and conditions which could have the effect of discouraging a
takeover or other 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.
RESTRICTIONS ON TRANSFER
For PCI to qualify as a REIT under the Code, it must meet certain
requirements concerning the ownership of its outstanding shares of capital
stock. Specifically, not more than 50% in value of PCI's outstanding capital
stock may be owned, directly or indirectly, by five or fewer individuals (as
defined in the Code to include certain entities) during the last half of a
taxable year (other than its first REIT taxable year), and PCI must be
beneficially owned by 100 or more persons during at least 335 days of a
taxable year of 12 months or during a proportionate part of a shorter taxable
year (other than its first REIT taxable year). In addition, if PCI, or an
owner of 10% or more of PCI, actually or constructively owns 10% or more of a
tenant of PCI (or a tenant of any partnership in which PCI is a partner), the
rent received by PCI (either directly or through any such partnership) from
such tenant will not be qualifying income for purposes of the REIT gross
income tests of the Code. See "Certain Federal Income Tax Considerations--
Requirements for Qualification."
Because PCI expects to qualify as a REIT, the Articles of Incorporation
contain restrictions on the ownership and transfer of both Common Stock and
Preferred Stock which are intended to assist PCI in complying with these
requirements. The Ownership Limit set forth in the Articles of Incorporation
provides that, subject to certain specified exceptions, no person or entity
(other than certain "Look-Through Entities" (as defined below)) may own, or be
deemed to own by virtue of the applicable constructive ownership provisions of
the Code, more than (i) 9.9% (by number or value, whichever is more
restrictive) of the outstanding Common Stock or (ii) 9.9% (by number or value,
whichever is more restrictive) of the outstanding Preferred Stock (the
"Ownership Limit"). The constructive ownership rules of the Code are complex,
and may cause Common Stock or Preferred Stock owned actually or constructively
by a group of related individuals and/or entities to be deemed to be
constructively owned by one individual or entity. As a result, the acquisition
of Common Stock in an amount less than the Ownership Limit (or the acquisition
of an interest in an entity that owns, actually or constructively, Common
Stock or Preferred Stock) by an individual or entity, could, nevertheless
cause that individual or entity, or another individual or entity, to be deemed
to own constructively Common Stock or Preferred Stock in excess of the
Ownership Limit, or such other limit as provided in the Articles of
Incorporation
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or as otherwise permitted by the Board of Directors. The Articles of
Incorporation provides that pension plans described in Section 401(a) of the
Code and having 100 or more participants and mutual funds registered under the
Investment Company Act of 1940, as amended ("Look-Through Entities"), are
subject to a 15% "Look-Through Ownership Limit." Pension plans and mutual
funds are among the entities that are not treated as holders of stock under
the "five or fewer requirement" and instead the beneficial owners of such
entities are counted as holders of stock for this purpose. The Board of
Directors may, but in no event will be required to, waive the Ownership Limit,
the Look-Through Ownership Limit or such other limit as provided in the
Articles of Incorporation, as applicable, with respect to a particular
shareholder if it determines that such ownership will not jeopardize PCI's
status as a REIT and the Board of Directors otherwise decides such action
would be in the best interest of PCI. As a condition of such waiver, the Board
of Directors may require a ruling from the IRS or an opinion of counsel
satisfactory to it and/or undertakings or representations from the applicant
with respect to preserving the REIT status of PCI.
Subject to certain exceptions described below, the Articles of Incorporation
further prohibit any purported transfer of shares of Common Stock or Preferred
Stock that would (i) result in any person owning, directly or indirectly,
shares of Common Stock or Preferred Stock in excess of the Ownership Limit,
(ii) result in the shares of Common Stock and Preferred Stock, collectively,
being owned by fewer than 100 persons (determined without reference to any
rules of attribution), (iii) result in PCI being "closely held" within the
meaning of section 856(h) of the Code, or (iv) cause PCI to own, actually or
constructively, 10% or more of the ownership interests in a tenant of the
Company's real property, within the meaning of section 856(d)(2)(B) of the
Code. Any person who acquires or attempts or intends to acquire actual or
constructive ownership of shares of Common Stock of PCI that will or may
violate any of the foregoing restrictions on transferability of ownership is
required to give notice immediately to PCI and provide PCI with such other
information as PCI may request in order to determine the effect of such
transfer on PCI's status as a REIT.
Pursuant to the Articles of Incorporation, if any purported transfer of
Common Stock or Preferred Stock of PCI or any other event would otherwise
result in any person violating the Ownership Limit, the Look-Through Ownership
Limit or such other limit as provided in the Articles of Incorporation, as
applicable, then any such purported transfer will be void and of no force or
effect with respect to the purported transferee (the "Prohibited Transferee")
as to that number of shares in excess of the Ownership Limit, the Look-Through
Ownership Limit or such other limit as provided in the Articles of
Incorporation, as applicable, and the Prohibited Transferee shall acquire no
right or interest (or, in the case of any event other than a purported
transfer, the person or entity holding record title to any such shares in
excess of the Ownership Limit, the Look-Through Ownership Limit or such other
limit as provided in the Articles of Incorporation, as applicable (the
"Prohibited Owner") shall cease to own any right or interest) in such excess
shares. Any such excess shares described above will be converted automatically
into an equal number of shares of shares-in-trust (the "Shares-in-Trust") and
transferred automatically, by operation of law, to a trust (the "Share
Trust"), the beneficiary of which will be a qualified charitable organization
selected by PCI (the "Beneficiary"). Such automatic transfer shall be deemed
to be effective as of the close of business on the business day prior to the
date of such violative transfer. Within 20 days of receiving notice from PCI
of the transfer of shares to the Share Trust, the trustee of the Share Trust
(who shall be designated by PCI and be unaffiliated with PCI or any Prohibited
Transferee or Prohibited Owner) will be required to sell such Shares-in-Trust
to a person or entity who could own such shares without violating the
Ownership Limit, or such other limit as provided in the Articles of
Incorporation, and distribute to the Prohibited Transferee an amount equal to
the lesser of the price paid by the Prohibited Transferee for such Shares-in-
Trust or the sales proceeds received by the Share Trust for such Shares-in-
Trust. In the case of any Shares-in-Trust issued as a result of any event
other than a transfer, or from a transfer for no consideration (such as a
gift), the trustee will be required to sell such Shares-in-Trust to a
qualified person or entity and distribute to the Prohibited Owner an amount
equal to the lesser of the Market Price (as defined in the Articles of
Incorporation) of such Shares-in-Trust as of the date of such event or the
sales proceeds received by the trust for such Shares-in-Trust. In either case,
any proceeds in excess of the amount distributable to the Prohibited
Transferee or Prohibited Owner, as applicable, will be distributed to the
Beneficiary. Prior to a sale of any such Shares-in-Trust by the Share Trust,
the trustee will be entitled to receive, in trust for the Beneficiary, all
dividends and other distributions paid by PCI with respect to such Shares-in-
Trust, and also will be entitled to exercise all voting
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rights with respect to such Shares-in-Trust. Subject to Maryland law,
effective as of the date that such Shares-in-Trust have been transferred to
the Share Trust, the trustee shall have the authority (at the trustee's sole
discretion) (i) to rescind as void any vote cast by a Prohibited Transferee or
Prohibited Owner, as applicable, prior to the discovery by PCI that such
Shares-in-Trust have been transferred to the Share Trust and (ii) to recast
such vote in accordance with the desires of the trustee acting for the benefit
of the Beneficiary. However, if PCI has already taken irreversible trust
action, then the trustee shall not have the authority to rescind and recast
such vote. Any dividend or other distribution paid to the Prohibited
Transferee or Prohibited Owner (prior to the discovery by PCI that such
Shares-in-Trust have been automatically transferred to the Share Trust as
described above) will be required to be repaid to the trustee upon demand for
distribution to the Beneficiary, and any dividend declared but unpaid shall be
rescinded. In the event that the transfer to the Share Trust as described
above is not automatically effective (for any reason) to prevent violation of
the Ownership Limit or such other limit as provided in the Articles of
Incorporation, then the Articles of Incorporation provide that the transfer of
the Common Stock or Preferred Stock in excess of the Ownership Limit will be
void.
In addition, Shares-in-Trust held in the Share Trust shall be deemed to have
been offered for sale to PCI, or its designee, at a price per share equal to
the lesser of (i) the price per share in the transaction that resulted in such
transfer to the Share Trust (or in the case of a devise or gift, the Market
Price at the time of such devise or gift) and (ii) the Market Price on the
date PCI, or its designee, accepts such offer. PCI shall have the right to
accept such offer until the trustee has sold the Shares-in-Trust. Upon such a
sale to PCI, the interest of the Beneficiary in the Shares-in-Trust sold shall
terminate and the trustee shall distribute the net proceeds of the sale to the
Prohibited Transferee or Prohibited Owner.
If any purported transfer of Common Stock or Preferred Stock would cause PCI
to be beneficially owned by fewer than 100 persons, such transfer will be null
and void in its entirety and the intended transferee will acquire no rights to
Common Stock or Preferred Stock.
The foregoing restrictions on transferability and ownership will not apply
if the Board of Directors determines that it is no longer in the best interest
of PCI to attempt to qualify, or to continue to qualify, as a REIT and such
determination is approved by an affirmative vote of two-thirds of the votes
entitled to be cast on such matter at a regular or special meeting of the
shareholders of PCI. Except as otherwise described above, any change in the
Ownership Limit would require an amendment to the Articles of Incorporation.
Amendments to the Articles of Incorporation require the affirmative vote of
holders owning at least two-thirds of the shares of the Common Stock of PCI
outstanding and entitled to vote thereon.
All certificates representing shares of Common Stock of PCI will bear a
legend referring to the restrictions described above.
If the foregoing transfer restrictions are determined to be void or invalid
by virtue of any legal decision, statute, rule or regulation, then the
intended transferee of any excess shares may be deemed, at the option of PCI
to have acted as agent on behalf of PCI in acquiring such excess shares and to
hold such excess shares on behalf of PCI.
Under the Articles of Incorporation, every owner of more than 5% (or such
lower percentage as required by the Code or Treasury Regulations) of the
outstanding Common Stock or Preferred Stock must file a written notice with
PCI containing information regarding their ownership of such shares, as set
forth in the Treasury Regulations. Under current Treasury Regulations, the
percentage will be set between one-half of 1% and 5%, depending upon the
number of record holders of PCI's shares. Further, each shareholder shall upon
demand be required to disclose to PCI in writing such information as PCI may
request in order to determine the effect, if any, of such shareholder's actual
and constructive ownership of Common Stock or Preferred Stock on PCI's status
as a REIT.
The foregoing ownership limitations may have the effect of precluding
acquisition of control of PCI without the consent of the Board of Directors
and, consequently, shareholders may be unable to realize a premium for
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their shares over the then-prevailing market price which is customarily
associated with such acquisitions and to ensure compliance with the Ownership
Limit, or such other limit as provided in the Articles of Incorporation.
These restrictions will not preclude settlement for transactions through The
Nasdaq Stock Market.
DIVIDEND REINVESTMENT PLAN
PCI may implement a dividend reinvestment plan whereby stockholders may
automatically reinvest their dividends in PCI's Common Stock. Details about
any such plan would be sent to PCI's stockholders following adoption thereof
by the Board of Directors.
REPORTS TO STOCKHOLDERS
PCI will furnish its stockholders with annual reports containing information
regarding the business and performance of the Company, including audited
financial statements certified by independent public accountants and
distribute quarterly reports containing unaudited financial information for
each of the first three quarters of the year.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is [ ].
LIST OF COMMON STOCK
The Company will apply to have the Common Stock listed on The Nasdaq Stock
Market.
CERTAIN PROVISIONS OF MARYLAND LAW AND
OF PCI'S ARTICLES OF INCORPORATION AND BYLAWS
The following summary of certain provisions of Maryland law and of the
Articles of Incorporation and Bylaws of PCI does not purport to be complete
and is subject to and qualified in its entirety by reference to Maryland law
and the Articles of Incorporation and Bylaws of PCI. Certain provisions of
Maryland law and the Articles of Incorporation and Bylaws are described
elsewhere in this Prospectus.
CLASSIFICATION OF THE BOARD OF DIRECTORS
The Articles of Incorporation provide that the number of directors of PCI
shall be established by the Bylaws but shall not be less than the minimum
number required by the MGCL, which in the case of PCI is three. Any vacancy
will be filled, at any regular meeting or at any special meeting called for
that purpose, by a majority of the remaining directors, or in the case of a
vacancy resulting from an increase in the number of directors, by a majority
of the entire Board of Directors.
Pursuant to the terms of the Articles of Incorporation, the directors are
divided into three classes as nearly equal in size as practicable. One class
will hold office initially for a term expiring at the annual meeting of
stockholders to be held in 1999, another class will hold office initially for
a term expiring at the annual meeting of stockholders to be held in 2000 and
another class will hold office initially for a term expiring at the annual
meeting of stockholders to be held in 2001. As the term of each class expires,
directors in that class will be elected for a term of three years and until
their successors are duly elected and qualified, and the directors in the
other two classes will continue in office. PCI believes that classification of
the Board of Directors will help to assure the continuity and stability of the
PCI business strategies and policies as determined by the Board of Directors.
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The classified director provision could have the effect of making the
removal of incumbent directors more time-consuming and difficult, which could
discourage a third party from making a tender offer or otherwise attempting to
obtain control of PCI, even though such an attempt might be beneficial to PCI
and its stockholders. At least two annual meetings of stockholders, instead of
one, will generally be required to effect a change in a majority of the Board
of Directors. Thus, the classified board provision could increase they
likelihood that incumbent directors will retain their positions. Holders of
Common Stock will have no right to cumulative voting for the election of
directors. Consequently, at each annual meeting of stockholders, the holders
of a majority of the shares of Common Stock will be able to elect all of the
successors of the class of director whose term expires at that meeting.
REMOVAL OF DIRECTORS
While the Articles of Incorporation and the MGCL empower the stockholders to
fill vacancies in the Board of Directors that are caused by the removal of a
director, the Articles of Incorporation preclude stockholders from removing
incumbent directors except upon a substantial affirmative vote. Specifically,
the Articles of Incorporation provide that a director may be removed only for
cause and only by the affirmative vote of at least a majority of the votes
then entitled to be cast in the election of directors. Under the MGCL, the
term "cause" is not defined and is, therefore, subject to Maryland common law
and to judicial interpretation and review in the context of the unique facts
and circumstances of any particular situation. This provision, when coupled
with the provision in the Bylaws authorizing the Board of Directors to fill
vacant directorships, precludes stockholders from removing incumbent directors
except upon a substantial affirmative vote and filling the vacancies created
by such removal with their own nominees.
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 the Company and
any 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 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 Company's voting stock and (b) two-thirds of the votes
entitled to be cast by holders of outstanding voting shares of the Company's
voting stock other than shares held by the Interested Stockholder with whom
the business combination is to be effected, unless, among other things, the
Company's stockholders receive a minimum price (as defined in the MGCL) for
their shares of stock 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 the MGCL 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.
CONTROL SHARES ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control shares 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 such shares of stock
previously acquired by the acquiror, or in respect of which the acquiror is
able to exercise or direct the exercise of voting power (except solely by
revocable proxy), would entitle the acquiror to exercise voting power in
electing directors within one of the following ranges of voting power: (i)
one-fifth or more but less than one-third, (ii) one-third or more but less
than a majority, or (iii) a majority 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 shares
acquisition" means the acquisition of Control Shares, subject to certain
exceptions.
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A person who has made or proposes to make a control shares 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 stockholders' meeting or if the
acquiring person does not deliver an acquiring person statement as required by
the MGCL, then, subject to certain conditions and limitations, the Company may
redeem any or all of the Control Shares (except those for which voting rights
have previously been approved) for fair value determined, without regard to
the absence of voting rights for the Control Shares, as of the date of the
last control shares acquisition by the acquiror or of any meeting of
stockholders at which the voting rights of such shares of stock 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 of stock entitled to vote, all other stockholders may exercise
appraisal rights. The fair value of the shares of stock as determined for
purposes of such appraisal rights may not be less than the highest price per
share paid by the acquiror in the control shares acquisition, and certain
limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of a control share acquisition.
The control shares acquisition statute does not apply to shares acquired in
a merger, consolidation or share exchange if the Company is a party to the
transaction or to acquisitions approved or exempted by the Articles of
Incorporation or Bylaws.
PCI's Bylaws contain a provision exempting from the control shares
acquisition statute any and all acquisitions by any person of the Company's
shares of stock. There can be no assurance that such provision will not be
amended or eliminated by the Board of Directors at any point in the future.
If the foregoing exemption in the Bylaws is rescinded, the control shares
acquisition statute could have the effect of discouraging offers to acquire
the Company and of increasing the difficulty of consummating any such offer.
AMENDMENT TO THE ARTICLES OF INCORPORATION AND BYLAWS
The Company reserves the right from time to time to make any amendment to
its Articles of Incorporation now or hereafter authorized by law, including
any amendments which alter the contract rights as expressly set forth in the
Articles of Incorporation of any shares of outstanding stock, provided that no
such amendment which changes the terms or contract rights of any of its
outstanding stock shall be valid unless such amendment shall have been
authorized by not less than a majority of the outstanding shares entitled to
vote thereon. The Articles of Incorporation provides that provisions relating
to the Company's election to be taxed as a REIT, approval of certain matters
by the Independent Directors, dissolution of the Company and certain
restrictions on the transferability of Common Stock or Preferred Stock cannot
be amended without the affirmative vote of at least two-thirds of all of the
votes ordinarily entitled to be cast in the election of Directors voting
together as a single class. The Bylaws may be amended by the Board of
Directors or by the affirmative vote of at least two-thirds of all of the
votes ordinarily entitled to be cast in the election of Directors voting
together as a single class. The Articles of Incorporation provides that any
amendment of the provisions of the Articles of Incorporation relating to
indemnification of officers and directors shall not retroactively affect any
act or failure to act that occurred prior to the amendment.
ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS
The Bylaws provide that (a) with respect to an annual meeting of
stockholders, nominations of persons for election to the Board of Directors
and the proposal of business to be considered by stockholders may be made only
(i) pursuant to the Company's notice of the meeting, (ii) by or at the
direction of the Board of Directors or (iii) by a stockholder who is entitled
to vote at the meeting and has complied with the advance notice procedures set
forth in the Articles of Incorporation and (b) with respect to special
meetings of stockholders, only the business specified in the Company's notice
of meeting may be brought before the meeting of stockholders.
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The provisions in the Articles of Incorporation on classification of the
Board of Directors and amendments to the Articles of Incorporation and removal
of directors, the business combination statute and, if the applicable
provision in the Articles of Incorporation is revoked, control shares
acquisition provisions of the MGCL, and the advance notice provisions of the
Bylaws could have the effect of discouraging a takeover or other transaction
in which holders of some, or a majority, of the shares of Common Stock might
receive a premium for their shares over the then-prevailing market price or
which such holders might believe to be otherwise in their best interests.
MEETINGS OF STOCKHOLDERS
The Company's Bylaws provide for annual meetings of stockholders, commencing
with the year 1998, to elect the Board of Directors and transact such other
business as may properly be brought before the meeting. Special meetings of
stockholders may be called by the President, the Board of Directors or the
Chairman of the Board and shall be called at the request in writing of the
holders of 25% or more of the outstanding stock of the Company entitled to
vote.
The MGCL provides that any action required or permitted to be taken at a
meeting of stockholders may be taken without a meeting by unanimous written
consent, if such consent sets forth such action and is signed by each
stockholder entitled to vote on the matter and a written waiver of any right
to dissent is signed by each stockholder entitled to notice of the meeting but
not entitled to vote at it.
POSSIBLE ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE
ARTICLES OF INCORPORATION AND BYLAWS
The business combination provisions and the control shares acquisition
provisions of the MGCL, the provisions of the Articles of Incorporation on
removal of directors and the advance notice provisions of the Bylaws could
delay, defer or prevent a change in control of PCI or any other transaction
that might involve a premium price for holders of Common Stock or otherwise be
in their best interests. See "Risk Factors--Certain Anti-Takeover Provisions
May Inhibit a Change in Control of the Company."
COMMON STOCK AVAILABLE FOR FUTURE SALE
Upon the closing of the Offering, PCI will have outstanding 18,750,000 (or
20,625,000 including those shares reserved for issuance upon exercise of
options granted under the Option Plan) shares of Common Stock. The Common
Stock issued in the Offering will be freely tradeable by persons other than
"Affiliates" of the Company without restriction under the Securities Act,
subject to certain limitations on ownership set forth in the Articles of
Incorporation. See "Description of Capital Stock--Restrictions on Transfer."
Shares of Common Stock issued to holders of Units upon exercise of the
Redemption Rights will be "restricted" securities under the meaning of Rule
144 promulgated under the Securities Act ("Rule 144") and may not be sold in
the absence of registration under the Securities Act unless an exemption from
registration is available, including exemptions contained in Rule 144. See
"Operating Partnership Agreement--Redemption Rights." As described below, PCI
has granted certain holders registration rights with respect to their Common
Stock.
In general, under Rule 144 as currently in effect, if one year has elapsed
since the later of the date of acquisition of restricted shares from the
Company or any "Affiliate" of the Company, as that term is defined under the
Securities Act, the acquiror or subsequent holder thereof is entitled to sell
within any three-month period a number of shares that does not exceed the
greater of 1% of the then outstanding Common Stock or the average weekly
trading volume of the Common Stock during the four calendar weeks preceding
the date on which notice of the sale is filed with the Commission. Sales under
Rule 144 also are subject to certain manner of sale provisions, notice
requirements and the availability of current public information about the
Company. If two years have elapsed since the date of acquisition of restricted
shares from the Company or from any Affiliate of
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the Company, and the acquiror or subsequent holder thereof is deemed not to
have been an Affiliate of the Company at any time during the three months
preceding a sale, such person would be entitled to sell such shares in the
public market under Rule 144(k) without regard to the volume limitations,
manner of sale provisions, public information requirements or notice
requirements.
No prediction can be made as to the effect, if any, that future sales of
shares, or the availability of shares for future sale, will have on the market
price prevailing from time to time. Sales of substantial amounts of Common
Stock, or the perception that such sales could occur, may affect adversely
prevailing market prices of the Common Stock.
OPERATING PARTNERSHIP AGREEMENT
The Operating Partnership has been organized as a Delaware limited
partnership, the general partner of which is Prime Capital Partner, Inc., a
wholly-owned subsidiary of PCI, and the initial limited partner of which is
PCLP, Inc., a wholly-owned subsidiary of PCI. Because PCI indirectly owns 100%
of the partnership interests in the Operating Partnership, the Operating
Partnership will be disregarded as a separate entity from PCI for federal
income tax purposes until a third party is admitted as a partner of the
Operating Partnership. The Company organized the Operating Partnership in
order to provide future sellers of assets with the opportunity to transfer
those assets to the Company in a tax-deferred exchange. The Operating
Partnership Agreement currently does not contain many of the provisions
described below. Instead, the following summary of the Operating Partnership
Agreement, and the descriptions of certain provisions thereof set forth
elsewhere in this Prospectus, describe certain provisions that likely will
appear in the Operating Partnership Agreement when the Manager or third-party
sellers of assets who wish to achieve tax deferral are admitted as partners of
the Operating Partnership. The provisions described in this summary, however,
may not appear in the Operating Partnership Agreement that ultimately is
executed.
GENERAL
Pursuant to the Operating Partnership Agreement, the General Partner, as the
sole general partner of the Operating Partnership, will have full, exclusive
and complete responsibility and discretion in the management and control of
the Operating Partnership. The limited partners of the operating partnership
(the "Limited Partners") will have no authority in their capacity as Limited
Partners to transact business for, or participate in the management activities
or decisions of, the Operating Partnership except as required by applicable
law. Consequently, PCI, by virtue of its ownership of the General Partner,
will control the assets and business of the Operating Partnership. However, it
is anticipated that any amendment to the Operating Partnership Agreement that
would (i) affect the Redemption Rights (as defined below), (ii) adversely
affect the Limited Partners' rights to receive cash distributions, (iii) alter
the Operating Partnership's allocations of income or loss, or (iv) impose on
the Limited Partners any obligations to make additional contributions to the
capital of the Operating Partnership, will require the consent of Limited
Partners (other than the Initial Limited Partner) holding more than two-thirds
of the Units held by such partners.
GENERAL PARTNER NOT TO WITHDRAW
It is anticipated that the General Partner will not be able to voluntarily
withdraw from the Operating Partnership or transfer or assign its interest in
the Operating Partnership unless the transaction in which such withdrawal or
transfer occurs results in the Limited Partners receiving property in an
amount equal to the amount they would have received had they exercised the
Redemption Rights immediately prior to such transaction, or unless the
successor to the General Partner contributes substantially all of its assets
to the Operating Partnership in return for an interest in the Operating
Partnership.
CAPITAL CONTRIBUTION
PCI will contribute, through the General Partner and the Initial Limited
Partner, all of the net proceeds of the Offering to the Operating Partnership.
The General Partner will hold a 1% general partnership interest in the
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Operating Partnership, and the Initial Limited Partner will hold a 99% limited
partnership interest in the Operating Partnership.
After the completion of the Offering, PCI will have issued a total of
18,750,000 shares of Common Stock and will own, through the General Partner
and the Initial Limited Partner, 100% of the partnership interests in the
Operating Partnership. Although the Operating Partnership will receive the net
proceeds of the Offering, the Initial Limited Partner and the General Partner
will be deemed to have made a capital contribution to the Operating
Partnership in the aggregate amount of the gross proceeds of the Offering and
the Operating Partnership will be deemed simultaneously to have paid the
underwriter's discount and other expenses paid or incurred in connection with
the Offering.
It is anticipated that the Operating Partnership Agreement will provide that
if the Operating Partnership requires additional funds at any time or from
time to time in excess of funds available to the Operating Partnership from
borrowing or capital contributions, the General Partner may borrow such funds
from a financial institution or other lender and lend such funds to the
Operating Partnership on the same terms and conditions as are applicable to
the General Partner's borrowing of such funds. Moreover, it is anticipated
that the General Partner will be authorized to cause the Operating Partnership
to issue partnership interests for less than fair market value if the Company
(i) has concluded in good faith that such issuance is in the best interest of
the Company and the Operating Partnership and (ii) the General Partner makes a
capital contribution in an amount equal to the proceeds of such issuance.
Under the Operating Partnership Agreement, each of the General Partner and the
Initial Limited Partner is obligated to contribute the net proceeds of any
future share offering by PCI as additional capital to the Operating
Partnership in exchange for an additional partnership interest. Upon such
contribution, the General Partner's and the Initial Limited Partner's
percentage interests in the Operating Partnership would be increased on a
proportionate basis based upon the amount of such additional capital
contributions. The percentage interests of the Limited Partners (other than
the Initial Limited Partner) would be decreased on a proportionate basis in
the event of additional capital contributions by the General Partner and the
Initial Limited Partner. In addition, if the General Partner and the Initial
Limited Partner were to contribute additional capital to the Operating
Partnership, the General Partner would revalue the property of the Operating
Partnership to its fair market value (as determined by the General Partner)
and the capital accounts of the partners would be adjusted to reflect the
manner in which the unrealized gain or loss inherent in such property (that
has not been reflected in the capital accounts previously) would be allocated
among the partners under the terms of the Operating Partnership Agreement as
if there were a taxable disposition of such property for such fair market
value on the date of the revaluation.
REDEMPTION RIGHTS
It is anticipated that pursuant to the Operating Partnership Agreement, the
Limited Partners (other than the Initial Limited Partner) will have the right
(the "Redemption Rights") to cause the Operating Partnership to redeem their
Units for cash or, at the election of the General Partner, shares of Common
Stock on a one-for-one basis. The redemption price will be paid in cash in the
discretion of the Company or in the event that the issuance of shares of
Common Stock to the redeeming Limited Partner would (i) result in any person
owning, directly or indirectly, shares of Common Stock in excess of the
Ownership Limit, (ii) result in shares of capital stock of the Company being
owned by fewer than 100 persons (determined without reference to any rules of
attribution), (iii) result in the Company being "closely held" within the
meaning of section 856(h) of the Code, (iv) cause the Company to own, actually
or constructively, 10% or more of the ownership interests in a tenant of the
Company's or the Operating Partnership's real property, within the meaning of
section 856(d)(2)(B) of the Code, or (v) cause the acquisition of shares of
Common Stock by such redeeming Limited Partner to be "integrated" with any
other distribution of shares of Common Stock for purposes of complying with
the Securities Act. The Manager holds options to acquire shares of Common
Stock (or, at the option of the Company, Units), none of which is exercisable
until the first anniversary of the Closing Date. Upon an acquisition of Units,
the Manager may immediately exercise its Redemption Rights.
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If the Company decides to securitize some or all of its Mortgage Loans (or
to resecuritize some or all of its MBS) through the issuance of non-REMIC
CMOs, it is anticipated that the Mortgage Loans will be distributed, through
the General Partner and the Initial Limited Partner, to PCI in order to
prevent the Mortgage Loans from being treated as a taxable mortgage pool for
federal income tax purposes upon the issuance of the CMOs. Accordingly, it is
anticipated that the General Partner and the Initial Limited Partner will have
the right to redeem a portion of their partnership interests in the Operating
Partnership in exchange for Mortgage Loans to the extent necessary to
facilitate such a securitization transaction. The portion of the General
Partner's or Initial Limited Partner's partnership interest that is redeemed
will be based on the fair market value of the Mortgage Loans distributed, as
determined by the General Partner, but subject to review by the Independent
Directors to ensure compliance with the Guidelines.
OPERATIONS
The Operating Partnership Agreement requires that the Operating Partnership
be operated in a manner that will enable PCI to satisfy the requirements for
being classified as a REIT for federal tax purposes, to avoid any federal
income or excise tax liability imposed by the Code, and to ensure that the
Operating Partnership will not be classified as a "publicly traded
partnership" for purposes of section 7704 of the Code.
In addition to the administrative and operating costs and expenses incurred
by the Operating Partnership, it is anticipated that the Operating Partnership
will pay all administrative costs and expenses of the Company and the General
Partner (collectively, the "Company Expenses") and the Company Expenses will
be treated as expenses of the Operating Partnership. The Company Expenses
generally will include (i) all expenses relating to the formation and
continuity of existence of the Company and the General Partner, (ii) all
expenses relating to the Offering and registration of securities by the
Company, (iii) all expenses associated with the preparation and filing of any
periodic reports by the Company under federal, state or local laws or
regulations, (iv) all expenses associated with compliance by the Company and
the General Partner with laws, rules and regulations promulgated by any
regulatory body and (v) all other operating or administrative costs of the
General Partner incurred in the ordinary course of its business on behalf of
the Operating Partnership.
DISTRIBUTIONS
It is anticipated that the Operating Partnership Agreement will provide that
the Operating Partnership shall distribute cash from operations (including net
sale or refinancing proceeds, but excluding net proceeds from the sale of the
Operating Partnership's property in connection with the liquidation of the
Operating Partnership) on a quarterly (or, at the election of the General
Partner, more frequent) basis, in amounts determined by the General Partner in
its sole discretion, to the partners in accordance with their respective
percentage interests in the Operating Partnership. Upon liquidation of the
Operating Partnership, after payment of, or adequate provision for, debts and
obligations of the Operating Partnership, including any partner loans, it is
anticipated that any remaining assets of the Operating Partnership will be
distributed to all partners with positive capital accounts in accordance with
their respective positive capital account balances. If the General Partner has
a negative balance in its capital account following a liquidation of the
Operating Partnership, it will be obligated to contribute cash to the
Operating Partnership equal to the negative balance in its capital account.
ALLOCATIONS
It is anticipated that income, gain and loss of the Operating Partnership
for each fiscal year generally will be allocated among the partners in
accordance with their respective interests in the Operating Partnership,
subject to compliance with the provisions of Code sections 704(b) and 704(c)
and Treasury Regulations.
TERM
The Operating Partnership shall continue until December 31, 2050, or until
sooner terminated as provided in the Operating Partnership Agreement or by
operation of law.
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TAX MATTERS
Pursuant to the Operating Partnership Agreement, the General Partner is the
tax matters partner of the Operating Partnership and, as such, has authority
to handle tax audits and to make tax elections under the Code on behalf of the
Operating Partnership.
CERTAIN 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 who purchases
such stock in the Offering. Winston & Strawn has acted as special tax counsel
("Tax Counsel") to PCI in connection with the Offering and the preparation of
this Prospectus. This summary should not be construed as tax advice. The
discussion contained herein does not address all aspects of federal income
taxation that may be relevant to particular holders in light of their personal
investment or tax circumstances, or to certain types of holders (including,
without limitation, insurance companies, financial institutions, broker-
dealers, persons whose functional currency is other than the United States
dollar, persons who hold the Common Stock as part of a straddle, hedging, or
conversion transaction or, except as specifically described herein, tax-exempt
entities and foreign persons) who are subject to special treatment under the
federal income tax laws. In addition, this summary is generally limited to
investors who will hold the shares of Common Stock as "capital assets"
(generally, property held for investment) within the meaning of section 1221
of the Internal Revenue Code of 1986, as amended (the "Code").
The statements in this summary are based on current provisions of the Code
(including provisions newly enacted by the Taxpayer Relief Act of 1997 (the
"1997 Tax Act") which are effective for taxable years beginning after August
5, 1997), Treasury Regulations promulgated thereunder, and administrative and
judicial interpretations thereof, as of the date hereof, all of which are
subject to change, possibly with retroactive effect. The provisions of the
Code, the Treasury Regulations promulgated thereunder and the administrative
and judicial interpretations thereof that concern REITs are highly technical
and complex and this summary is qualified in its entirety by such Code
provisions, Treasury Regulations, and administrative and judicial
interpretations. No assurance can be given that future legislative, judicial,
or administrative actions or decisions will not affect the accuracy of any
statements in this summary. In addition, no ruling will be sought from the
Internal Revenue Service (the "IRS") with respect to any matter discussed
herein, and there can be no assurance that the IRS or a court will agree with
the statements made herein.
EACH PROSPECTIVE PURCHASER IS ADVISED TO CONSULT HIS OR HER OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OR HER OF THE PURCHASE,
OWNERSHIP, AND SALE OF COMMON STOCK AND OF PCI'S ELECTION TO BE TAXED AS A
REIT, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER TAX CONSEQUENCES
OF SUCH PURCHASE, OWNERSHIP, SALE, AND ELECTION AND OF POTENTIAL CHANGES IN
APPLICABLE TAX LAWS.
GENERAL
PCI intends to make an election to be taxed as a REIT under sections 856
through 860 of the Code and the applicable Treasury Regulations promulgated
thereunder, which together set forth the requirements for qualifying as a REIT
(the "REIT Requirements"), beginning with its taxable year beginning on
September 19, 1997 and ending on December 31, 1997. Because PCI's taxable year
will begin after August 5, 1997, the newly enacted provisions under the 1997
Tax Act will be fully applicable to PCI during its taxable year beginning on
September 19, 1997 and ending on December 31, 1997, as well as for all future
taxable years. PCI believes that it will be organized and will operate in such
a manner to qualify for taxation as a REIT under the Code. No assurance can be
given, however, that PCI actually will operate in such a manner to so qualify
as a REIT or will continue to operate in such a manner so as to remain
qualified as a REIT.
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Subject to the qualifications stated herein and in its opinion, Tax Counsel
has given PCI an opinion that PCI will qualify to be taxed as a REIT under the
Code beginning with its taxable year ending December 31, 1997. An opinion of
counsel is not binding on the IRS or a court and there can be no assurance
that the IRS or a court will not take a position different from that expressed
by Tax Counsel. It also must be emphasized that Tax Counsel's opinion is based
on various assumptions and is conditioned upon numerous representations made
by PCI and the Operating Partnership as to factual matters, including those
related to their businesses and properties as set forth in this Prospectus.
Tax Counsel has not independently verified PCI's representations. Moreover,
PCI's qualification and taxation as a REIT depend upon PCI's ability to meet
on a continuing basis the actual operating results, distribution levels,
diversity of stock ownership and the various other qualification tests imposed
by the Code as discussed below. Tax Counsel will not review PCI's compliance
with these tests on a continuing basis. Accordingly, no assurance can be given
that the actual results of PCI's operations for any given taxable year will
satisfy the requirements for qualification and taxation as a REIT. See
"Certain Federal Income Tax Considerations--Failure to Qualify".
TAXATION OF PCI
For any taxable year in which PCI qualifies for taxation as a REIT, it
generally will not be subject to federal corporate income tax on that portion
of its ordinary income or capital gain that is currently distributed to its
stockholders. The REIT provisions of the Code generally allow a REIT to deduct
dividends paid to its stockholders. This deduction for dividends paid to
stockholders substantially eliminates the federal "double taxation" on
earnings (once at the corporate level and once again at the stockholder level)
that generally results from an investment in a corporation.
Even if PCI continues to qualify for taxation as a REIT, it may be subject
to federal income tax in certain circumstances. First, PCI will be taxed at
regular corporate rates on any undistributed "REIT taxable income" and
undistributed net capital gains. Second, under certain circumstances, PCI may
be subject to the corporate "alternative minimum tax" on its undistributed
items of tax preference, if any. Third, if PCI 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
nonqualifying income from foreclosure property, PCI will be subject to tax on
such income at the highest regular corporate rate (currently, 35%). Fourth, if
PCI has net income from prohibited transactions (which are, in general,
certain sales or other dispositions of property held primarily for sale to
customers in the ordinary course of business, other than foreclosure property
or property that is involuntarily converted), such income will be subject to a
100% tax. Fifth, if PCI should fail to satisfy the 75% gross income test or
the 95% gross income test (as discussed below), but nonetheless maintain its
qualification as a REIT because certain other requirements are met, PCI will
be subject to a 100% tax on the gross income attributable to the greater of
the amount by which PCI fails the 75% or the 95% test, multiplied by a
fraction intended to reflect PCI's profitability. Sixth, if PCI should fail to
distribute for each calendar year at least the sum of (i) 85% of its REIT
ordinary income for such year, (ii) 95% of its REIT capital gain net income
for such year, and (iii) any undistributed taxable income from prior periods,
PCI will be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. However, to the extent PCI
elects to retain and pay income tax on net long-term capital gains it received
during the year such amounts will be treated as having been distributed for
purposes of the 4% excise tax. Finally, if PCI acquires any asset from a C
corporation (i.e., generally a corporation subject to full corporate level
tax) in a transaction in which the basis of the asset in PCI's hands is
determined by reference to the basis of the asset (or any other property) in
the hands of the C corporation, and PCI subsequently recognizes gain on the
disposition of such asset during the 10-year period (the "Recognition Period")
beginning on the date on which the asset was acquired by PCI, then, pursuant
to guidelines issued by the IRS, the excess of (i) the fair market value of
the asset as of the beginning of the applicable Recognition Period, over (ii)
PCI's adjusted basis in such asset as of the beginning of such Recognition
Period (i.e., "built-in gain") will be subject to tax at the highest regular
corporate rate. The results described above with respect to the tax on "built-
in-gain" assume that PCI will elect pursuant to IRS Notice 88-19 to be subject
to the rules described in the preceding sentence if it were to make any such
acquisition. Upon the acquisition of a corporation which is a "qualified REIT
subsidiary" PCI also would be taxed on any built-in gain attributable to the
built-in gain associated with the Qualified REIT Subsidiary's assets. See
"Certain Federal Income Tax Considerations--Requirements for Qualification--
Qualified REIT Subsidiary."
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PCI will be subject to tax at the highest marginal corporate rate on the
portion of any excess inclusion (see "Taxation of Taxable U.S. Stockholders"
for a fuller discussion of Excess Inclusion income) derived by PCI from REMIC
Residual Interests ("Excess Inclusion") equal to the percentage of the stock
of PCI held by the United States, any state or political subdivision thereof,
any foreign government, any international organization, any agency or
instrumentality of any of the foregoing, any other tax-exempt organization
(other than a farmer's cooperative described in section 521 of the Code) that
is exempt from taxation under the unrelated business taxable income provisions
of the Code, or any rural electrical or telephone cooperative (each, a
"Disqualified Organization"). Any such tax on the portion of any Excess
Inclusion allocable to stock of PCI held by a Disqualified Organization will
reduce the cash available for distribution from PCI to all stockholders.
If PCI invests in properties in foreign countries, PCI's profits from such
investments will generally be subject to tax in the countries where such
properties are located. The precise nature and amount of any such taxation
will depend on the laws of the countries where the properties are located. If
PCI satisfies the annual distribution requirements for qualification as a REIT
and is therefore not subject to federal corporate income tax on that portion
of its ordinary income and capital gain that is currently distributed to its
stockholders, PCI will generally not be able to recover the cost of any
foreign tax imposed on profits from its foreign investments by claiming
foreign tax credits against its U.S. tax liability on such profits. Moreover,
a REIT is not able to pass foreign tax credits through to its stockholders.
PCI will use the calendar year for both federal income tax purposes and
financial reporting purposes.
REQUIREMENTS FOR QUALIFICATION
To qualify as a REIT, PCI must meet and continue to meet the requirements,
discussed below, relating to PCI's organization, the sources of its gross
income, the nature of its assets, and the level of distributions to its
stockholders.
ORGANIZATIONAL REQUIREMENTS
The Code requires that a REIT be a corporation, trust, or association:
(i) which is managed by one or more trustees or directors;
(ii) the beneficial ownership of which is evidenced by transferable
shares or by transferable certificates of beneficial interest;
(iii) which would be taxable as a domestic corporation but for compliance
with the REIT Requirements;
(iv) which is neither a financial institution nor an insurance company
subject to certain special provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons;
(vi) at any time during the last half of each taxable year not more than
50% in value of the outstanding stock of which is owned, directly or
indirectly through the application of certain attribution rules, by or for
five or fewer individuals (as defined in the Code to include certain tax-
exempt entities other than, in general, qualified domestic pension
funds)(the "5/50 Rule");
(vii) that makes an election to be a REIT (or has made such election for
a previous taxable year) and satisfies all relevant filing and other
administrative requirements established by the IRS that must be met in
order to elect and maintain REIT status;
(viii) that uses a calendar year for federal income tax purposes and
complies with the recordkeeping requirements of the Code and Treasury
Regulations promulgated thereunder; and
(ix) which meets certain other tests, described below, regarding the
nature of its income and assets.
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The Code provides that conditions (i) through (iv), inclusive, must be met
during the entire taxable year and that condition (v) must be met 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. Conditions (v) and (vi) do not apply
until after the first taxable year for which a REIT election is made. For
purposes of determining stock ownership under the 5/50 Rule, a supplemental
unemployment compensation benefits plan, a private foundation, or a portion of
a trust permanently set aside or used exclusively for charitable purposes
generally is considered an individual. A trust that is a qualified trust under
Code section 401(a), however, generally is not considered an individual and
beneficiaries of such trust are treated as holding shares of a REIT in
proportion to their actuarial interests in such trust for purposes of the 5/50
Rule.
PCI anticipates issuing sufficient Common Stock with sufficient diversity of
ownership pursuant to the Offering to allow it to satisfy requirements (v) and
(vi). In addition, PCI's Articles of Incorporation provide for restrictions
regarding the transfer of the Common Stock that are intended to assist PCI in
continuing to satisfy the share ownership requirements described in clauses
(v) and (vi) above. Such transfer restrictions are described in "Description
of Common Stock--Restrictions on Transfer." For purposes of determining
ongoing compliance with the 100 holder requirement, Treasury Regulations
require PCI to issue letters to certain shareholders demanding information
regarding the amount of shares each such shareholder actually or
constructively owns ("shareholder demand letters"). If PCI fails to comply
with these regulatory rules it will be subject to a $25,000 penalty ($50,000
for intentional violations).
As set forth in (vi) above, to qualify as a REIT, PCI must also satisfy the
requirement set forth in Section 856(a)(6) of the Code that it not be closely
held. PCI will not be closely held so long as at all times during the last
half of any taxable year of PCI (other than the first taxable year for which
the REIT election is made) not more than 50% in value of its outstanding stock
is owned, directly or constructively under the applicable attribution rules of
the Code, by five or fewer individuals (as defined in the Code to include
certain tax-exempt entities, other than, in general, qualified domestic
pension funds). Although the Charter of PCI contains certain restrictions on
the ownership and transfer of the Common Stock, the restrictions do not ensure
that PCI will be able to satisfy the 5/50 Rule requirement. If PCI fails to
satisfy the 5/50 Rule, PCI's status as a REIT will terminate, and PCI will not
be able to prevent such termination. However, if PCI complies with the
procedures prescribed in the Treasury Regulations for issuing shareholder
demand letters and does not know, or with the exercise of reasonable diligence
would not have known, that the 5/50 Rule was violated, the requirement will be
deemed to be satisfied for the year. See "Certain Federal Income Tax
Considerations--Failure to Qualify."
QUALIFIED REIT SUBSIDIARY
If a REIT owns a corporate subsidiary that is a "qualified REIT subsidiary,"
within the meaning of section 856(i) of the Code that subsidiary is
disregarded for Federal income tax purposes, and all assets, liabilities, and
items of income, deduction, and credit of the subsidiary are treated as
assets, liabilities and such items of the REIT itself. A "qualified REIT
subsidiary" is a corporation all of the capital stock of which is owned by the
REIT. However, if an existing corporation is acquired by a REIT and is a
"qualified REIT subsidiary", all of its pre-REIT earnings and profits must be
distributed before the end of the REIT's taxable year.
PCI currently has two corporate subsidiaries, the General Partner and the
Initial Limited Partner, and may have additional corporate subsidiaries in the
future. The General Partner and the Initial Limited Partner are "qualified
REIT subsidiaries." Accordingly, neither the General Partner nor the Initial
Limited Partner will be subject to federal corporate income taxation, although
each may be subject to state and local taxation. Further, any corporation
formed directly by PCI to act as a general partner in any partnership will be
a qualified REIT subsidiary and thus all of its assets, liabilities, and items
of income, deduction, and credit will be treated as assets, liabilities, and
items of income, deduction and credit of PCI.
OWNERSHIP OF A PARTNERSHIP INTEREST
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT is deemed to own its proportionate share of
the assets of the partnership corresponding to the REIT's capital interest
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in such partnership and is deemed to be entitled to the income of the
partnership attributable to such proportionate share. In addition, the
character of the assets and gross income of the partnership retain the same
character in the hands of the REIT for purposes of the REIT requirements,
including satisfying the gross income tests and the asset tests. Pursuant to
Treasury Regulations effective January 1, 1997 relating to entity
classification (the "Check-the-Box Regulations"), an unincorporated entity
that has a single owner is disregarded as an entity separate from its owner
for federal income tax purposes. Because PCI is deemed to own 100% of the
partnership interests in the Operating Partnership for federal income tax
purposes, the Operating Partnership will be disregarded as an entity separate
from PCI under the Check-the-Box Regulations. If the Operating Partnership
admits a partner other than PCI or a qualified REIT subsidiary of PCI, PCI's
proportionate share of the assets and gross income of the Operating
Partnership will be treated as assets and gross income of PCI for purposes of
applying the requirements described herein.
INCOME TESTS
To maintain its qualification as a REIT, PCI must satisfy two gross income
requirements annually. First, at least 75% of PCI's gross income (excluding
gross income from prohibited transactions) for each taxable year must be
derived directly or indirectly from investments relating to real property or
mortgages on real property (including "rents from real property" and, in
certain circumstances, interest) or from certain types of temporary
investments. Second, at least 95% of PCI's gross income (excluding gross
income from prohibited transactions) for each taxable year must be derived
from such real property investments and from dividends, interest, and gain
from the sale or disposition of stock or securities or from any combination of
the foregoing.
The term "interest," as defined for purposes of the 75% and 95% gross income
tests, generally does not include any amount received or accrued (directly or
indirectly) if the determination of such amount depends in whole or in part on
the income or profits of any person. However, an amount received or accrued
generally will not be excluded from the term "interest" solely by reason of
being based on a fixed percentage or percentages of receipts or sales. In
addition, an amount received or accrued generally will not be excluded from
the term "interest" solely by reason of being based on the income or profits
of a debtor if the debtor derives substantially all of its gross income from
the related property through the leasing of substantially all of its interests
in the property, to the extent the amounts received by the debtor would be
characterized as rents from real property if received by a REIT. Furthermore,
to the extent that interest from a loan that is based on the cash proceeds
from the sale of the property securing the loan constitutes a "shared
appreciation provision" (as defined in the Code), income attributable to such
participation feature will be treated as gain from the sale of the secured
property, which generally is qualifying income for purposes of the 75% and 95%
gross income tests.
Interest on obligations secured by mortgages on real property or on
interests in real property generally 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 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 consists of real estate assets (determined as if PCI
held such assets), PCI will be treated as receiving directly its proportionate
share of the income of the REMIC. In addition, if PCI 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
PCI purchased the mortgage loan, the interest income will be apportioned
between the real property and the other property, which apportionment may
cause PCI to recognize income that is not qualifying income for purposes of
the 75% gross income test.
Winston & Strawn is of the opinion that the interest, OID, and any market
discount income that PCI derives from its investments in MBS Interests and
Mortgage Loans generally will be qualifying interest income for purposes of
both the 75% and the 95% gross income tests, except to the extent that less
than 95% of the assets of a REMIC in which PCI holds an interest consists of
real estate assets (determined as if PCI held such assets), and PCI's
proportionate share of the income of the REMIC includes income that is not
qualifying income for purposes of the 75% and 95% gross income tests. Most of
the income that PCI recognizes with respect to its
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investments in Mortgage Loans will be qualifying income for purposes of both
gross income tests. In some cases, however, the loan amount of a Mortgage
Loan, particularly with respect to a Distressed Mortgage Loan, a Performing
Mortgage Loan, or any Subordinated Interest, 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. It is also
possible that, in some instances, the interest income from a Mortgage Loan,
particularly a Distressed Mortgage Loan, may be based in part on the
borrower's profits or net income, which generally will disqualify the income
from the loan for purposes of both the 75% and the 95% gross income tests.
PCI may originate or acquire Construction or Mezzanine Loans that have
shared appreciation provisions. To the extent interest from a loan that is
based on the cash proceeds from the sale of property constitutes a "shared
appreciation provision" (as defined in the Code), income attributable to such
participation feature will be treated as gain from the sale of the secured
property, which generally is qualifying income for purposes of the 75% and 95%
gross income tests. Also, PCI may be required to recognize income from a
shared appreciation provision over the term of the related loan using the
constant yield method pursuant to certain Treasury Regulations.
PCI may originate or acquire Mortgage Loans and securitize such loans
through the issuance of non-REMIC CMOs. As a result of such transactions, PCI
will retain an equity ownership interest in the Mortgage Loans that has
economic characteristics similar to those of a MBS Interest or a Subordinated
Interest. In addition, PCI may securitize MBS (or non-REMIC CMOs) through the
issuance of REMIC or non-REMIC CMOs, retaining an equity interest in the MBS
used as collateral in the resecuritization transaction. Such transactions will
not cause PCI to fail to satisfy the gross income tests or the asset tests
described below.
PCI may receive income not described above that is not qualifying income for
purposes of the 75% and 95% gross income tests. For example, certain fees for
services rendered by the Operating Partnership will not be qualifying income
for purposes of the gross income tests. It is not anticipated that the
Operating Partnership will receive a significant amount of such fees. PCI will
monitor the amount of nonqualifying income produced by its assets and has
represented that it will manage its portfolio in order to comply at all times
with both the 75% and the 95% gross income tests.
Rents received by PCI will qualify as "rents from real property" in
satisfying the gross income requirements for a REIT described above only if
several conditions are met. First, the amount of rent received or accrued with
respect to any property must not be based in whole or in part on the income or
profits derived by any person from such property, although an amount received
or accrued generally will not be excluded from the term "rents from real
property" solely by reason of being based on a fixed percentage or percentages
of gross receipts or gross sales. Rents received from a tenant that are based
on the tenant's income from the property will not be treated as rents based on
income or profits and thus excluded from the term "rents from real property"
if the tenant derives substantially all of its income with respect to such
property from the leasing or subleasing of substantially all of such property,
provided that the tenant receives from subtenants only amounts that would be
treated as rents from real property if received directly by a REIT. Second,
rents received from a tenant will not qualify as "rents from real property" in
satisfying the gross income tests if the REIT, or an owner of 10% or more of
the REIT, directly or constructively owns 10% or more of such tenant (a
"Related Party Tenant"). Third, if rent attributable to personal property,
leased in connection with a lease of real property, is greater than 15% of the
total rent received under the lease, then the portion of rent attributable to
such personal property will not qualify as "rents from real property."
Finally, a REIT generally must not operate or manage the property or furnish
or render services to the tenants of such property, other than through an
"independent contractor" from whom the REIT derives no income. The independent
contractor requirement, however, does not apply to the extent the services
rendered by the REIT are customarily furnished or rendered in connection with
the rental of the real property such that they are services that a tax-exempt
organization could provide to its tenants without causing its rental income to
be unrelated business taxable income under the Code. A tax-exempt organization
may provide services which are "usually or customarily rendered" in connection
with the rental of space for
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occupancy only and are not otherwise considered "rendered to the occupant,"
without incurring unrelated business taxable income. A de minimis exception
allows a REIT to provide non-customary services to its tenants and not
disqualify income as rents from real property so long as the value of the
impermissible services does not exceed 1.0% of the Company's gross income from
the property. The amount the Company receives that is attributable to
impermissible services cannot be valued at less than 150% of the direct cost
to the REIT of providing these services.
PCI has represented that it will not charge Rent for any portion of any Real
Property that is based, in whole or in part, on the income or profits of any
person (except by reason of being based on a fixed percentage or percentages
of receipts of sales, as described above) to the extent that the receipt of
such Rent would jeopardize PCI's status as a REIT. In addition, PCI has
represented that, to the extent that it receives Rent from a Related Party
Tenant, such Rent will not cause PCI to fail to satisfy either the 75% or 95%
gross income test. PCI also has represented that it will not allow the Rent
attributable to personal property leased in connection with any lease of Real
Property to exceed 15% of the total Rent received under the lease, if the
receipt of such Rent would cause PCI to fail to satisfy either the 75% or 95%
gross income test. Finally, PCI has represented that it will not operate or
manage its Real Property or furnish or render noncustomary services to the
tenants of its Real Property other than through an "independent contractor,"
to the extent that such operation or the provision of such services would
jeopardize PCI's status as a REIT.
If the Company acquires an equity interest in a real estate operating
company through foreclosure, then PCI potentially could receive income which
would not qualify as gross income for purposes of the gross income tests if
the real estate operating company provides noncustomary services to the
tenants of the property that are above the acceptable de minimis amount. If
any foreclosure would cause such a problem then the Company may need to hire
an independent contractor, from which the Company receives no income to
operate the property on behalf of PCI.
Should the potential amount of nonqualifying income in the future create a
risk as to the qualification of PCI as a REIT, PCI intends to take action to
avoid not qualifying as a REIT. PCI may for instance transfer certain
nonqualifying activities to a taxable corporation, from which it would receive
dividends. If this should occur, the Operating Partnership would be entitled
to receive dividends as a stockholder of such corporation. The amount of
dividends available for distribution to PCI would be reduced below the
comparable amount of income that would otherwise be received by the Operating
Partnership because such a corporation would be subject to a corporate level
tax on its taxable income, thereby reducing the amount of cash available for
distribution. Furthermore, PCI would be required to structure the stock
interest owned by the Operating Partnership in such a corporation to ensure
that the various asset tests described below were not violated (i.e., the
Operating Partnership would not own more than 10% of the voting securities of
such corporation and the value of the stock interest would not exceed 5% of
the value of PCI's total assets).
REITs generally are subject to tax at the maximum corporate rate on any
income from foreclosure property (other than income that would be qualifying
income for purposes of the 75% gross income test), less expenses directly
connected with the production of such income. "Foreclosure property" is
defined as any real property (including interests in real property) and any
personal property incident to such real property (i) that is acquired by a
REIT as the result of such REIT having bid on such property at foreclosure, or
having otherwise reduced such property to ownership or possession by agreement
or process of law, after there was a default (or default was imminent) on a
lease of such property or on an indebtedness owed to the REIT that such
property secured, (ii) for which the related loan was acquired by the REIT at
a time when default was not imminent or anticipated, and (iii) for which such
REIT makes a proper election to treat such property as foreclosure property.
PCI does not anticipate that it will receive any income from foreclosure
property that is not qualifying income for purposes of the 75% and 95% gross
income tests, but, if PCI does receive any such income, PCI will make an
election to treat the related property as foreclosure property.
If property is not eligible for the election to be treated as foreclosure
property ("Ineligible Property") because the related loan was acquired by the
REIT at a time when default was imminent or anticipated, income received with
respect to such Ineligible Property may not be qualifying income for purposes
of the 75% or 95% gross income test. PCI anticipates that any income it
receives with respect to Ineligible Property will be qualifying income for
purposes of the 75% and 95% gross income tests.
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It is possible that, from time to time, PCI 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, futures or forward
contracts, and options. To the extent that PCI enters into an interest rate
swap or cap agreement, option, futures contract, forward rate agreement, or
any similar financial instrument to reduce its interest rate risk with respect
to debt that was or will be 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 PCI hedges with other types of financial
instruments that are not similar to the above or in other situations, it may
not be entirely clear how the income from those transactions will be treated
for purposes of the various income tests that apply to REITs under the Code.
PCI intends to structure any hedging transactions in a manner that does not
jeopardize its status as a REIT. If necessary, PCI may conduct some or all of
its hedging activities through a corporate subsidiary that is fully subject to
federal corporate income tax.
If PCI fails to satisfy one or both of the 75% or the 95% gross income tests
for any taxable year, it may nevertheless qualify as a REIT for such year if
it is entitled to relief under certain provisions of the Code. These relief
provisions generally will be available if (i) PCI's failure to meet such
test(s) was due to reasonable cause and not due to willful neglect, (ii) PCI
reported the nature and amount of each item of its income included in the
test(s) for such taxable year on a schedule attached to its return, and (iii)
any incorrect information on the schedule was not due to fraud with intent to
evade tax. It is not possible, however, to state whether, in all
circumstances, PCI would be entitled to the benefit of these relief
provisions. For example, if PCI fails to satisfy the gross income tests
because nonqualifying income that PCI intentionally earns exceeds the limits
on such income, the IRS could conclude that PCI's failure to satisfy the tests
was not due to reasonable cause. As discussed above in "Certain Federal Income
Tax Considerations--Taxation of PCI" even if these relief provisions apply,
PCI will still be subject to a 100% tax on the gross income attributable to
the greater of the amount of by which PCI failed the 75% or the 95% test,
multiplied by a fraction intended to reflect PCI's profitability.
ASSET TESTS
PCI, at the close of each quarter of each taxable year, also must satisfy
two tests relating to the nature of its assets. First, at least 75% of the
value of PCI's total assets must be represented by cash or cash items
(including certain receivables), government securities, "real estate assets,"
or, in cases where PCI raises new capital through stock or long-term (at least
five-year) debt offerings, temporary investments in stock or debt instruments
during the one-year period following PCI's receipt of such capital. The term
"real estate assets" includes interests in real property, interests in
mortgages on real property to the extent the principal balance of a mortgage
does not exceed the fair market value of the associated real property, regular
or residual interests in a REMIC (except that, if less than 95% of the assets
of a REMIC consists of "real estate assets" (determined as if PCI held such
assets), PCI will be treated as holding directly its proportionate share of
the assets of such REMIC), and shares of other REITs. For purposes of the 75%
asset test, the term "interest in real property" includes an interest in
mortgage loans or land and improvements thereon, such as buildings or other
inherently permanent structures (including items that are structural
components of such buildings or structures), a leasehold of real property, and
an option to acquire real property (or a leasehold of real property). An
"interest" in real property also generally includes an interest in mortgage
loans secured by controlling equity interests in entities treated as
partnerships for federal income tax purposes that own real property, to the
extent that the principal balance of the mortgage does not exceed the fair
market value of the real property that is allocable to the equity interest.
Second, of the investments not included in the 75% asset class, the value of
any one issuer's securities owned by PCI may not exceed 5% of the value of
PCI's total assets, and PCI may not own more than 10% of any one issuer's
outstanding voting securities (except for its interests in the Operating
Partnership, the General Partner, the Limited Partner, and any other qualified
REIT subsidiary).
PCI expects that any Net Leased Real Estate, MBS Interests, Mortgage Loans,
Subordinated Interests, IOs, Inverse IOs, and temporary investments that it
acquires generally will be 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 PCI owns an interest consists of "real estate assets" and PCI's
proportionate share of those assets includes assets that are non-qualifying
assets for purposes of the 75% asset test. In addition, PCI expects that any
Preferred Equity investments in partnerships that own real estate would also
be treated as qualifying real estate assets for
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such purposes as long as the assets were qualifying assets in the hands of
such partnership. Similarly, a preferred equity investment in a corporation,
which if acquired by PCI would constitute a Qualified REIT subsidiary, would
be treated as a qualifying asset to the extent that the principal balance of a
Mortgage Loan exceeds the value of the associated real property, such Mortgage
Loan will not be a qualifying asset for purposes of the 75% asset test. PCI
will monitor the status of the assets that it acquires for purposes of the
various asset tests and has represented that it will manage its portfolio in
order to comply at all times with such tests.
If PCI should fail to satisfy the 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 asset tests at the close of the preceding calendar quarter and
(ii) the discrepancy between the value of PCI's assets and the 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 non-qualifying
assets. If the condition described in clause (ii) of the preceding sentence
were not satisfied, PCI still could avoid disqualification by eliminating any
discrepancy within 30 days after the close of the calendar quarter in which it
arose.
ANNUAL DISTRIBUTION REQUIREMENTS
To continue to qualify as a REIT, PCI is required to distribute dividends
(other than capital gain dividends and retained capital gains) to its
stockholders each year in an amount at least equal to (i) the sum of (A) 95%
of PCI's "REIT taxable income" (computed without regard to the dividends paid
deduction and PCI's net capital gain) plus (B) 95% of the net income (after
tax), if any, from foreclosure property, minus (ii) the sum of certain items
of non-cash income. Such distributions must be paid in the taxable year to
which they relate, or in the following taxable year if declared before PCI
timely files its tax return for such year and if paid on or before the first
regular dividend payment after such declaration. A distribution which is not
pro rata within a class of stock entitled to a dividend or which is not
consistent with the rights to distributions between classes of stock (a
"preferential dividend") is not taken into consideration for the purpose of
meeting the distribution requirement. Accordingly, the payment of a
preferential dividend could affect PCI's ability to meet this distribution
requirement.
To the extent that PCI does not distribute all of its net capital gain or
distributes at least 95%, but less than 100%, of its "REIT taxable income," as
adjusted, it will be subject to tax on the undistributed amount at regular
capital gains or ordinary corporate tax rates, as the case may be.
Furthermore, if PCI should fail to distribute for each calendar year at least
the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its
REIT capital gain net income for such year, plus (iii) any undistributed
taxable income from prior periods, PCI will be subject to a 4% excise tax on
the excess of such required distribution over the amounts actually
distributed. However, to the extent PCI elects to retain and pay income tax on
net long-term capital gains it received during the year such amounts will be
treated as having been distributed for purposes of the 4% excise tax.
It is possible that, from time to time, PCI may experience timing
differences between (i) the actual receipt of income and actual payment of
deductible expenses and (ii) the inclusion of that income and deduction of
such expenses in arriving at its REIT taxable income. For example, PCI will
recognize taxable income in excess of its cash receipts when, as generally
happens, OID accrues with respect to its Subordinated Interests. Furthermore,
some Distressed and participating Mortgage Loans, may be deemed to have OID,
in which case PCI will be required to recognize taxable income in advance of
the related cash flow. OID generally will be accrued using a methodology that
does not allow credit losses to be reflected until they are actually incurred.
In addition, PCI may recognize taxable market discount income upon the receipt
of proceeds from the disposition of, or principal payments on, Subordinated
Interests and Mortgage Loans that are "market discount bonds" (i.e.,
obligations with a stated redemption price at maturity that is greater than
PCI's tax basis in such obligations), although such proceeds often will be
used to make non-deductible principal payments on related borrowings. PCI also
may recognize Excess Inclusion or other "phantom" taxable income from REMIC
Residual Interests. It also is possible that, from time to time, PCI may
recognize net capital gain attributable to the sale of depreciated property
that exceeds its cash receipts from the sale. In addition, pursuant to certain
Treasury Regulations, PCI may be required to recognize the amount of any
payment to be made pursuant to a shared appreciation provision over the term
of the related loan using the constant yield method. Also, because PCI is an
accrual-basis taxpayer, it may have to recognize income on Distressed Mortgage
Loans even though the borrower is unable to pay the full amount due. Finally,
PCI may recognize taxable income without receiving a corresponding cash
distribution if it forecloses on or makes a "significant modification" (as
defined in Regulations section 1.1001-3(e)) to a
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loan, to the extent that the fair market value of the underlying property or
the principal amount of the modified loan, as applicable, exceeds PCI's basis
in the original loan. Although the Code allows certain items of excess noncash
income (including OID) to be disregarded for purposes of the distribution
requirements, PCI may have less cash than is necessary to meet its annual 95%
distribution requirement or to avoid corporate income tax or the excise tax
imposed on certain undistributed income. In such a situation, PCI may find it
necessary to arrange for short-term (or possibly long-term) borrowings or to
raise funds through the issuance of Preferred Stock or additional Common
Stock.
If PCI fails to meet the 95% distribution requirement as a result of an
adjustment to PCI's tax return by the IRS upon audit, PCI may retroactively
cure the failure by paying "deficiency dividends" to its stockholders in a
later year, which may then be included in PCI's deduction for dividends paid
for the earlier year. PCI may thus be able to avoid being taxed on amounts
distributed as deficiency dividends; however, PCI will be required to pay
interest to the IRS based upon the amount of any deduction taken for
deficiency dividends.
PENALTY TAX ON PROHIBITED TRANSACTIONS
Any gross income derived from a prohibited transaction is not taken into
account in applying the 95% and 75% gross income tests necessary to qualify as
a REIT (but the net income from such a transaction is subject to a 100% tax).
The term "prohibited transaction" generally includes a sale or other
disposition of property (other than foreclosure property or property that was
involuntarily converted) that is held primarily for sale to customers in the
ordinary course of a trade or business. PCI believes that no asset owned by
PCI or the Operating Partnership will be held for sale to customers and that a
sale of any such asset will not be in the ordinary course of PCI's or the
Operating Partnership's business. Whether property is held "primarily for sale
to customers in the ordinary course of a trade or business" depends, however,
on the facts and circumstances in effect from time to time, including those
related to a particular property. When relevant, PCI will attempt to comply
with the terms of safe-harbor provisions in the Code prescribing when asset
sales will not be characterized as prohibited transactions. Complete assurance
cannot be given, however, that PCI can comply with the safe-harbor provisions
of the Code or avoid owning property that may be characterized as property
held "primarily for sale to customers in the ordinary course of a trade or
business."
FAILURE TO QUALIFY
If PCI fails to qualify for taxation as a REIT in any taxable year and the
relief provisions do not apply, PCI will be subject to tax (including any
applicable alternative minimum tax) on its taxable income at regular corporate
rates. Distributions to stockholders in any year in which PCI fails to qualify
as a REIT will not be required and, if made, will not be deductible by PCI. As
a result, PCI's failure to qualify as a REIT will reduce the cash available
for distribution by PCI to its stockholders. In addition, if PCI fails to
qualify as a REIT, all distributions to PCI's stockholders will be taxable as
ordinary dividend income to the extent of PCI's then current and accumulated
earnings and profits, and, subject to certain limitations in the Code,
corporate distributees may be eligible for the dividends-received deduction.
Unless entitled to relief under specific statutory provisions, PCI also will
be ineligible for qualification as a REIT for the four taxable years following
the year during which qualification was lost. It is not possible to determine
whether PCI would be entitled to such statutory relief in all circumstances.
TAXATION OF TAXABLE U.S. STOCKHOLDERS
As used herein, the term "U.S. Stockholder" means a holder of shares of
Common Stock who (for United States federal income tax purposes) (i) is a
citizen or resident of the United States, (ii) is a corporation, partnership,
or other entity created or organized in or under the laws of the United States
or of any political subdivision thereof, (iii) is an estate whose income is
subject to taxation in the United States regardless of its connection with the
conduct of a U.S. trade or business or (iv) is a trust if a court within the
United States is able to exercise primary supervision over the administration
of the trust and one or more United States fiduciaries have the authority to
control all substantial decisions of the trust.
As long as PCI continues to qualify as a REIT, distributions made by PCI out
of its current or accumulated earnings and profits (and not designated as
capital gain dividends) will constitute dividends taxable to its U.S.
Stockholders as ordinary income. Such distributions will not be eligible for
the dividends-received deduction in the case of U.S. Stockholders that are
corporations.
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Dividends paid to U.S. Stockholders will be treated as portfolio income.
Such income, therefore, will not be subject to reduction by losses from
passive activities (i.e., any interest in a rental activity or in a trade or
business in which the holder does not materially participate, such as certain
interests held as a limited partner) of any holder who is subject to the
passive activity loss rules. Such distributions will, however, be considered
investment income which may be offset by certain investment expense
deductions.
Distributions made by PCI that are properly designated by PCI as capital
gain dividends will be taxable to U.S. Stockholders as long-term capital gains
(to the extent that they do not exceed PCI's actual net capital gain for the
taxable year) without regard to the period for which a U.S. Stockholder has
held his/her shares of Common Stock. The highest marginal individual income
tax rate currently is 39.6%. The maximum tax rate on long-term capital gains
applicable to noncorporate taxpayers is 28% for sales and exchange of assets
held for more than one year but not more than 18 months and 20% for sales and
exchange of assets held for more than 18 months. Thus, the tax rate
differential between capital gain and ordinary income for noncorporate
taxpayers 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
noncorporate taxpayers' 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. U.S. Stockholders that are corporations may,
however, be required to treat up to 20% of certain capital gain dividends as
ordinary income.
PCI may elect to retain amounts representing long-term capital gain income
on which PCI will be taxed at regular corporate rates. In that case, each
shareholder will be taxed on a proportionate share of the total long-term
capital gains retained by PCI and will also receive a credit for a
proportionate share of the tax paid by PCI. Finally, each shareholder shall
increase the adjusted basis in his/her shares by the difference between the
allocable amount of long-term capital gain and the tax deemed paid by the
shareholder. If PCI should elect to retain long-term capital gains, it will
notify each shareholder of the relevant tax information within 60 days after
the close of the taxable year.
To the extent that PCI makes distributions (not designated as capital gain
dividends) in excess of its current and accumulated earnings and profits, such
distributions will be treated first as a tax-free return of capital to each
U.S. Stockholder, reducing the adjusted basis which such U.S. Stockholder has
in his/her shares of Common Stock for tax purposes by the amount of such
distribution (but not below zero), with distributions in excess of a U.S.
Stockholder's adjusted basis in his/her shares taxable as capital gains
(provided that the shares have been held as a capital asset). Dividends
declared by PCI in October, November, or December of any year and payable to a
stockholder of record on a specified date in any such month shall be treated
as both paid by PCI and received by the stockholder on December 31 of such
year, provided that the dividend is actually paid by PCI on or before January
31 of the following calendar year. Stockholders may not include in their own
income tax returns any net operating losses or capital losses of PCI.
PCI's investment in Subordinated Interests and certain types of MBS 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 may from time to time 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. Accordingly, if PCI 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 PCI
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
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stock of PCI at a time when the before-tax rate of return was 10%, his after-
tax rate of return on his stock might be somewhat less than 7% as a result of
PCI's phantom income. In general, as the ratio of PCI's phantom income to its
total income increases, the after-tax rate of return received by a taxable
stockholder of PCI will decrease. PCI will consider the potential effects of
phantom income on its taxable stockholders in managing its investments.
Because PCI expects to own REMIC Residual Interests, it is likely that
stockholders (other than certain thrift institutions) will not be permitted to
offset certain portions of the dividend income they derive from PCI with their
current deductions or net operating loss carryovers or carrybacks. The portion
of a stockholder's dividends that will be subject to this limitation will
equal his allocable share of any Excess Inclusion income derived by PCI with
respect to the REMIC Residual Interests. PCI's Excess Inclusion income for any
calendar quarter will equal the excess of its income from REMIC Residual
Interests over its "daily accruals" with respect to such REMIC Residual
Interests for the calendar quarter. Daily accruals for a calendar quarter are
computed by allocating to each day on which a REMIC Residual Interest is owned
a ratable portion of the product of (i) the "adjusted issue price" of the
REMIC Residual Interest at the beginning of the quarter and (ii) 120% of the
long-term federal interest rate (adjusted for quarterly compounding) on the
date of issuance of the REMIC Residual Interest. The adjusted issue price of a
REMIC Residual Interest at the beginning of a calendar quarter equals the
original issue price of the REMIC Residual Interest, increased by the amount
of daily accruals for prior quarters and decreased by all prior distributions
to PCI with respect to the REMIC Residual Interest. To the extent provided in
future Treasury regulations, the Excess Inclusion income with respect to any
REMIC Residual Interests owned by PCI that do not have significant value will
equal the entire amount of the income derived from such REMIC Residual
Interests. Furthermore, to the extent that PCI (or a qualified REIT
subsidiary) acquires or originates Mortgage Loans and uses those loans to
collateralize one or more multiple-class offerings of CMOs for which no REMIC
election is made ("Non-REMIC Transactions"), it is possible that, to the
extent provided in future Treasury regulations, stockholders (other than
certain thrift institutions) will not be permitted to offset certain portions
of the dividend income that they derive from PCI that are attributable to Non-
REMIC Transactions with current deductions or net operating loss carryovers or
carrybacks. Although no applicable Treasury regulations have yet been issued,
no assurance can be provided that such regulations will not be issued in the
future or that, if issued, such regulations will not prevent PCI's
stockholders from offsetting some portion of their dividend income with
deductions or losses from other sources.
Upon any sale or other disposition of shares of Common Stock, the holder
will generally recognize gain or loss for federal income tax purposes in an
amount equal to the difference between (i) the amount of cash and the fair
market value of any property received on such sale or other disposition, and
(ii) the holder's adjusted basis in the shares of stock. Such gain or loss
will generally be capital gain or loss and will be long-term gain, taxable at
a rate of 20%, or loss if such shares have been held for more than eighteen
months. In general, any loss recognized by a U.S. Stockholder upon the sale or
other disposition of shares of Common Stock that have been held 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 received by such U.S.
Stockholder from PCI which were required to be treated as long-term capital
gains.
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 unrelated business taxable income ("UBTI"). While many investments in
real estate generate UBTI, the IRS 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 PCI 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 PCI
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 Code section 501(c) are subject to different UBTI rules,
which generally will require them to characterize distributions from PCI as
UBTI.
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Special rules apply to certain tax-exempt pension funds (including 401(k)
plans but excluding IRAs or government pension plans) that own more than 10%
(measured by value) of a "pension held REIT" at any time during a taxable
year. Such a pension fund must treat a certain percentage of all dividends
received from the REIT during the year as unrelated business taxable income.
The percentage is equal to the ratio of the REIT's gross income (less direct
expenses related thereto) derived from the conduct of unrelated trades or
businesses determined as if the REIT were a tax-exempt pension fund, to the
REIT's gross income (less direct expenses related thereto) from all sources.
The special rules will not apply to require a pension fund to recharacterize a
portion of its dividends as unrelated business taxable income unless the
percentage computed is at least 5%.
A REIT will be treated as a "pension held REIT" if the REIT is predominantly
held by tax-exempt pension funds and if the REIT would fail to satisfy the
5/50 Rule discussed above, see "Certain Federal Income Tax Considerations--
Requirements for Qualification--Organizational Requirements," if the stock of
the REIT held by such tax-exempt pension funds were not treated as held
directly by their respective beneficiaries. A REIT is predominantly held by
tax-exempt pension funds if at least one tax-exempt pension fund holds more
than 25% (measured by value) of the REIT's stock, or if one or more tax-exempt
pension funds (each of which owns more than 10% (measured by value) of the
REIT's stock) own in the aggregate more than 50% (measured by value) of the
REIT's stock. PCI believes that it will not be treated as a pension-held REIT.
However, because the shares of PCI will be publicly traded, no assurance can
be given that PCI is not or will not become a pension-held REIT.
Any dividends received by an Exempt Organization that are allocable to
Excess Inclusion will be treated as UBTI. In addition, PCI will be subject to
tax at the highest marginal corporate rate on the portion of any Excess
Inclusion income derived by PCI from REMIC Residual Interests that is
allocable to stock of PCI held by Disqualified Organizations. Any such tax
would be deductible by PCI against its income that is not Excess Inclusion
income.
If PCI derives Excess Inclusion income from REMIC Residual Interests, a tax
similar to the tax on PCI described in the preceding paragraph may be imposed
on stockholders who are (i) pass-through entities (i.e., partnerships,
estates, trusts, regulated investment companies, REITs, common trust funds,
and certain types of cooperatives (including farmers' cooperatives described
in section 521 of the Code)) in which a Disqualified Organization is a record
holder of shares or interests and (ii) nominees who hold Common Stock on
behalf of Disqualified Organizations. Consequently, a brokerage firm that
holds shares of Common Stock in a "street name" account for a Disqualified
Organization may be subject to federal income tax on the Excess Inclusion
income derived from those shares.
The Treasury Department has been authorized to issue regulations regarding
issuances by a REIT of CMOs in Non-REMIC transactions. If such Treasury
regulations are issued in the future preventing taxable stockholders from
offsetting some percentage of the dividends paid by PCI with deductions or
losses from other sources, that same percentage of PCI's dividends would be
treated as UBTI for stockholders that are Exempt Organizations. See "Certain
Federal Income Tax Considerations--Taxation of Taxable U.S. Stockholders."
TAXATION OF NON-U.S. STOCKHOLDERS
The rules governing United States federal income taxation of nonresident
alien individuals, foreign corporations, foreign partnerships, foreign trusts
and estates and other foreign stockholders (collectively, "Non-U.S.
Stockholders") are highly complex, and the following discussion is intended
only as a summary of such rules. PROSPECTIVE NON-U.S. STOCKHOLDERS SHOULD
CONSULT WITH THEIR OWN TAX ADVISORS TO DETERMINE THE IMPACT OF UNITED STATES
FEDERAL, STATE, AND LOCAL INCOME TAX LAWS ON AN INVESTMENT IN SHARES OF COMMON
STOCK, INCLUDING ANY REPORTING REQUIREMENTS.
In general, Non-U.S. Stockholders are subject to regular United States
income tax with respect to their investment in shares of Common Stock in the
same manner as a U.S. Stockholder if such investment is "effectively
connected" with the Non-U.S. Stockholder's conduct of a trade or business in
the United States. A
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corporate Non-U.S. Stockholder that receives income with respect to its
investment in Common Stock that is (or is treated as) effectively connected
with the conduct of a trade or business in the United States also may be
subject to the 30% branch profits tax imposed by the Code, which is payable in
addition to regular United States corporate income tax. The following
discussion addresses only the United States taxation of Non-U.S. Stockholders
whose investment in shares of Common Stock is not effectively connected with
the conduct of a trade or business in the United States.
Distributions made by PCI that are not attributable to gain from the sale or
exchange by PCI of United States real property interests and that are not
designated by PCI as capital gain dividends will be treated as ordinary income
dividends to the extent made out of current or accumulated earnings and
profits of PCI. Generally, such ordinary income dividends will be subject to
United States withholding tax at the rate of 30% on the gross amount of the
dividends paid unless reduced or eliminated by an applicable United States
income tax treaty. PCI expects to withhold United States income tax at the
rate of 30% on the gross amount of any such dividends paid to a Non-U.S.
Stockholder unless a lower treaty rate applies and the Non-U.S. Stockholder
has filed an IRS Form 1001 with PCI certifying the Non-U.S. Stockholder's
entitlement to treaty benefits.
Distributions made by PCI in excess of its current and accumulated earnings
and profits will be treated first as a tax-free return of capital to each Non-
U.S. Stockholder, reducing the adjusted basis which such Non-U.S. Stockholder
has in his shares of Common Stock for U.S. tax purposes by the amount of such
distribution (but not below zero), with distributions in excess of a Non-U.S.
Stockholder's adjusted basis in his shares being treated as gain from the sale
or exchange of such shares, the tax treatment of which is described below. If
it cannot be determined at the time a distribution is made whether or not such
distribution will be in excess of PCI's current and accumulated earnings and
profits, the distribution will be subject to withholding at the rate
applicable to a dividend distribution. However, the Non-U.S. Stockholder may
seek a refund from the IRS of any amount withheld if it is subsequently
determined that such distribution was, in fact, in excess of PCI's then
current and accumulated earnings and profits.
If PCI derives Excess Inclusion income from REMIC Residual Interests, the
portion of the dividends paid to Non-U.S. Stockholders that is allocable to
the Excess Inclusion income may not be eligible for exemption from the 30%
withholding tax or a reduced treaty rate. In addition, the U.S. Treasury
Department has been authorized to issue regulations regarding issuances by a
REIT of Common Stock in Non-REMIC Transactions. If Treasury Regulations are
issued in the future preventing taxable stockholders from offsetting some
percentage of the dividends paid by PCI with deductions or losses from other
sources, that same percentage of PCI's dividends would not be eligible for
exemption from the 30% withholding tax or a reduced treaty rate. See "--
Taxation of Taxable U.S. Stockholders."
As long as PCI continues to qualify as a REIT, distributions made by PCI
that are attributable to gain from the sale or exchange by PCI of United
States real property interests will be taxed to a Non-U.S. Stockholder under
the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). Under
FIRPTA, such distributions are taxed to a Non-U.S. Stockholder as if such
distributions were gains "effectively connected" with the conduct of a trade
or business in the United States. Accordingly, a Non-U.S. Stockholder will be
taxed on such distributions at the same capital gain rates applicable to U.S.
Stockholders (subject to any applicable alternative minimum tax and a special
alternative minimum tax in the case of non-resident alien individuals).
Distributions subject to FIRPTA also may be subject to the 30% branch profits
tax in the case of a corporate Non-U.S. Stockholder that is not entitled to
treaty relief or exemption. PCI will be required to withhold tax from any
distribution to a Non-U.S. Stockholder that could be designated by PCI as a
capital gain dividend in an amount equal to 35% of the gross distribution. The
amount of tax withheld is fully creditable against the Non-U.S. Stockholder's
FIRPTA tax liability, and if such amount exceeds the Non-U.S. Stockholder's
federal income tax liability for the applicable taxable year, the Non-U.S.
Stockholder may seek a refund of the excess from the IRS. In addition, if PCI
designates prior distributions as capital gain dividends, subsequent
distributions, up to the amount of such prior distributions, will be treated
as capital gain dividends for purposes of withholding.
Gain recognized by a Non-U.S. Stockholder upon the sale or exchange of
shares of Common Stock generally will not be subject to United States taxation
unless the Common Stock constitutes a "United States
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real property interest" within the meaning of FIRPTA. The Common Stock will
not constitute a "United States real property interest" so long as PCI is a
"domestically controlled REIT." A "domestically controlled REIT" is a REIT in
which at all times during a specified testing period less than 50% in value of
its stock is held directly or indirectly by Non-U.S. Stockholders. However,
because the shares of Common Stock will be publicly traded, no assurance can
be given that PCI is or will continue to be a "domestically-controlled REIT."
Notwithstanding the foregoing, gain from the sale or exchange of shares of
Common Stock not otherwise subject to FIRPTA will be taxable to a Non-U.S.
Stockholder if the Non-U.S. Stockholder is a nonresident alien individual who
is present in the United States for 183 days or more during the taxable year
and has a "tax home" in the United States. In such case, the nonresident alien
individual will be subject to a 30% United States withholding tax on the
amount of such individual's gain.
If PCI did not constitute a "domestically-controlled REIT," gain arising
from the sale or exchange by a Non-U.S. Stockholder of shares of Common Stock
would be subject to United States taxation under FIRPTA as a sale of a "United
States real property interest" only if the selling Non-U.S. Stockholder's
interest in PCI exceeded 5% at any time during the 5 years preceding the sale
or exchange. If gain on the sale or exchange of shares of the Common Stock
were subject to taxation under FIRPTA, the Non-U.S. Stockholder would be
subject to regular United States income tax with respect to such gain in the
same manner as a U.S. Stockholder (subject to any applicable alternative
minimum tax, a special alternative minimum tax in the case of nonresident
alien individuals and the possible application of the 30% branch profits tax
in the case of foreign corporations), and the purchaser of the Common Stock
(including PCI in a redemption transaction) would be required to withhold and
remit to the IRS 10% of the purchase price. Additionally, in such case,
distributions on the Common Stock to the extent they represent a return of
capital or capital gain from the sale of the stock, rather than dividends,
would be subject to a 10% withholding tax.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX
PCI will report to its U.S. Stockholders and to the IRS the amount of
dividends paid during each calendar year and the amount of tax withheld, if
any, with respect thereto. Under the backup withholding rules, a U.S.
Stockholder may be subject to backup withholding at the rate of 31% on
dividends paid unless such U.S. Stockholder (i) is a corporation or falls
within certain other exempt categories and, when required, can demonstrate
this fact, or (ii) provides a taxpayer identification number, certifies as to
no loss of exemption from backup withholding, and otherwise complies with
applicable requirements of the backup withholding rules. A U.S. Stockholder
who does not provide PCI with his correct taxpayer identification number also
may be subject to penalties imposed by the IRS. Any amount paid as backup
withholding will be creditable against the U.S. Stockholder's federal income
tax liability. In addition, PCI may be required to withhold a portion of any
capital gain distributions made to U.S. Stockholders who fail to certify their
non-foreign status to PCI. See "Certain Federal Income Tax Considerations--
Taxation of Non-U.S. Stockholders."
Additional issues may arise pertaining to information reporting and backup
withholding with respect to Non-U.S. Stockholders, and Non-U.S. Stockholders
should consult their tax advisors with respect to any such information
reporting and backup withholding requirements.
OTHER TAX CONSIDERATIONS
POSSIBLE LEGISLATIVE OR OTHER ACTIONS AFFECTING TAX CONSEQUENCES
Prospective holders should recognize that the present federal income tax
treatment of PCI may be modified by future legislative, judicial or
administrative actions or decisions at any time, which may be retroactive in
effect, and, as a result, any such action or decision may affect investments
and commitments previously made. The rules dealing with federal income
taxation are constantly under review by persons involved in the legislative
process and by the IRS and the Treasury Department, resulting in statutory
changes as well as promulgation of new, or revisions to existing, regulations
and revised interpretations of established concepts. No prediction can be made
as to the likelihood of passage of any new tax legislation or other provisions
either directly or indirectly affecting PCI or its stockholders. Revisions in
federal income tax laws and interpretations thereof could adversely affect the
tax consequences of an investment in the Common Stock.
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PCI, the General Partner, the Limited Partner, the Operating Partnership or
PCI's 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 PCI
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 the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the
prohibited transaction provisions of section 4975 of the Code that may be
relevant to a prospective purchaser (including, with respect to the discussion
contained in
"--Status of PCI under ERISA," to a prospective purchaser that is not an
employee benefit plan, another tax-qualified retirement plan, or an individual
retirement account ("IRA")). The discussion does not purport to deal with all
aspects of ERISA or section 4975 of the Code that may be relevant to
particular stockholders (including plans subject to Title I of ERISA, other
retirement plans and IRAs subject to the prohibited transaction provisions of
section 4975 of the Code, and governmental plans or church plans that are
exempt from ERISA and section 4975 of the Code but that may be subject to
state law requirements) in light of their particular circumstances.
The discussion is based on current provisions of ERISA and the Code,
existing and currently proposed regulations under ERISA and the Code, the
legislative history of ERISA and the Code, existing administrative rulings of
the Department of Labor ("DOL") and reported judicial decisions. No assurance
can be given that legislative, judicial, or administrative changes will not
affect the accuracy of any statements herein with respect to transactions
entered into or contemplated prior to the effective date of such changes.
A FIDUCIARY MAKING THE DECISION TO INVEST IN THE COMMON STOCK ON BEHALF OF A
PROSPECTIVE PURCHASER THAT IS AN EMPLOYEE BENEFIT PLAN, A TAX QUALIFIED
RETIREMENT PLAN, OR AN IRA SHOULD CONSULT ITS OWN LEGAL ADVISOR REGARDING THE
SPECIFIC CONSIDERATIONS ARISING UNDER ERISA, SECTION 4975 OF THE CODE, AND
STATE LAW WITH RESPECT TO THE PURCHASE, OWNERSHIP, OR SALE OF THE COMMON STOCK
BY SUCH PLAN OR IRA.
EMPLOYEE BENEFIT PLANS, TAX-QUALIFIED RETIREMENT PLANS, AND IRAS
Each fiduciary of a pension, profit-sharing, or other employee benefit plan
(a "Plan") subject to Title I of ERISA 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.
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Fiduciaries of Plans and persons making the investment decision for an IRA
or other Non-ERISA Plan should consider the application of the prohibited
transaction provisions of ERISA and the Code in making their investment
decision. A "party in interest" or "disqualified person" with respect to a
Plan or with respect to a Plan or IRA subject to Code section 4975 is subject
to (i) an initial 15% excise tax on the amount involved in any prohibited
transaction involving the assets of the plan or IRA and (ii) an excise tax
equal to 100% of the amount involved if any prohibited transaction is not
corrected. If the disqualified person who engages in the transaction is the
individual on behalf of whom an IRA is maintained (or his beneficiary), the
IRA will lose its tax-exempt status and its assets will be deemed to have been
distributed to such individual in a taxable distribution (and no excise tax
will be imposed) on account of the prohibited transaction. In addition, a
fiduciary who permits a Plan to engage in a transaction that the fiduciary
knows or should know is a prohibited transaction may be liable to the Plan for
any loss the Plan incurs as a result of the transaction or for any profits
earned by the fiduciary in the transaction.
STATUS OF PCI 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 or is a Non-ERISA
Plan or IRA subject to section 4975 of the Code. A Plan fiduciary also should
consider the relevance of those principles to ERISA's prohibition on improper
delegation of control over or responsibility for "plan assets" and ERISA's
imposition of co-fiduciary liability on a fiduciary who participates in,
permits (by action or inaction) the occurrence of, or fails to remedy a known
breach by another fiduciary.
If the assets of the Company are deemed to be "plan assets" under ERISA, (i)
the prudence standards and other provisions of Part 4 of Title I of ERISA
would be applicable to any transactions involving the Company's assets, (ii)
persons who exercise any authority over the Company's assets, or who provide
investment advice to the Company, would (for purposes of the fiduciary
responsibility provisions of ERISA) be fiduciaries of each Plan that acquires
Common Stock, and transactions involving the Company's assets undertaken at
their direction or pursuant to their advice might violate their fiduciary
responsibilities under ERISA, especially with regard to conflicts of interest,
(iii) a fiduciary exercising 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.
Regulations of the DOL defining "plan assets" (the "Plan Asset Regulations")
generally provide that when a Plan or Non-ERISA Plan or IRA acquires a
security that is an equity interest in an entity and the security is neither a
"publicly-offered security" nor a security issued by an investment company
registered under the Investment Company Act of 1940, the Plan's or Non-ERISA
Plan's or IRA's assets include both the equity interest and an undivided
interest in each of the underlying assets of the issuer of such equity
interest, unless one or more exceptions specified in the Plan Asset
Regulations are satisfied.
The Plan Asset Regulations define a publicly-offered security as a security
that is "widely-held," "freely transferable," and either part of a class of
securities 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 this
offering, the Common Stock will be "widely held."
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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 this 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 Articles of Incorporation 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.
CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS
AND REAL PROPERTY INVESTMENTS
The Company intends to acquire Subordinated Interests as well as acquire
Mortgage Loans and other Real Property. Even though the Company will not own
Mortgage Loans directly in connection with its acquisition of Subordinated
Interests, its return thereon will depend upon, among other things, the
ability of the servicer of the underlying Mortgage Loans to foreclose upon
those Mortgage Loans in default and sell the underlying Real Property. There
are a number of legal considerations involved in the acquisition of Mortgage
Loans or Real Property or the foreclosure and sale of defaulted Mortgage Loans
(whether individually or as part of a series of mortgage-backed securities).
The following discussion provides general summaries of certain legal aspects
of mortgage loans and real property. Because such legal aspects are governed
by applicable state law (which laws vary from state to state), the summaries
do not purport to be complete, to reflect the laws of any particular state, or
to encompass the laws of all states. Accordingly, the summaries are qualified
in their entirety by reference to the applicable laws of the states where the
property is located.
GENERAL
Each mortgage loan will be evidenced by a note or bond and secured by an
instrument granting a security interest in real property, which may be a
mortgage, deed of trust or a deed to secure debt, depending upon the
prevailing practice and law in the state in which the related Mortgaged
Property is located. Mortgages, deeds of trust and deeds to secure debt are
herein collectively referred to as "mortgages." A mortgage creates a lien
upon, or grants a title interest in, the real property covered thereby, and
represents the security for the repayment of the indebtedness customarily
evidenced by a promissory note. The priority of the lien created or interest
granted will depend on the terms of the mortgage and, in some cases, on the
terms of separate subordination agreements or intercreditor agreements with
others that hold interests in the real property, the knowledge of the parties
to the mortgage and, generally, the order of recordation of the mortgage in
the appropriate public recording office. However, the lien of a recorded
mortgage will generally be subordinate to later-arising liens for real estate
taxes and assessments and other charges imposed under governmental police
powers.
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TYPES OF MORTGAGE INSTRUMENTS
There are two parties to a mortgage: a mortgagor (the borrower and usually
the owner of the subject property) and a mortgagee (the lender). In contrast,
a deed of trust is a three-party instrument, among a trustor (the equivalent
of a borrower), a trustee to whom the real property is conveyed, and a
beneficiary (the lender) for whose benefit the conveyance is made. Under a
deed of trust, the trustor grants the property, irrevocably until the debt is
paid, in trust and generally with a power of sale, to the trustee to secure
repayment of the indebtedness evidenced by the related note. A deed to secure
debt typically has two parties. The grantor (the borrower) conveys title to
the real property to the grantee (the lender), generally with a power of sale,
until such time as the debt is repaid. The mortgagee's authority under a
mortgage, the trustee's authority under a deed of trust and the grantee's
authority under a deed to secure debt are governed by the express provisions
of the related instrument, the law of the state in which the real property is
located, certain federal laws and, in some deed of trust transactions, the
directions of the beneficiary.
INTERESTS IN REAL PROPERTY
The interests in real property typically covered by a mortgage, deed of
trust or deed to secure debt is most often the fee simple estate in land and
improvements. However, such instruments may encumber other interests in real
property such a tenant's interest in the lease of land or improvements, or
both, and the leasehold estate created by such lease. An instrument covering
an interest in real property other than the fee estate requires special
provisions in the instrument creating such interest or in the mortgage, deed
of trust or deed to secure debt, to protect the mortgagee against termination
of such interest before the mortgage, deed of trust or deed to secure debt is
paid.
LEASES AND RENTS
Mortgages that encumber income-producing property often contain an
assignment of rents and leases, pursuant to which the borrower assigns to the
lender the borrower's right, title and interest as landlord under each lease
and the income derived therefrom, while (unless rents are to be paid directly
to the lender) retaining a revocable license to collect the rents for so long
as there is no default. If the borrower defaults, the license terminates and
the lender is entitled to collect the rents. Local law may require that the
lender take possession of the property and/or obtain a court-appointed
receiver before becoming entitled to collect the rents.
The potential payments from a property may be less than the periodic
payments due under the mortgage. For example, the net income that would
otherwise be generated from the property may be less than the amount that
would be needed to service the debt if the leases on the property are at
below-market rents, the market rents have fallen since the original financing,
vacancies have increased, or as a result of excessive or increased
maintenance, repair or other obligations to which a lender succeeds as
landlord.
CONDEMNATION AND INSURANCE
The form of the mortgage or deed of trust used by many lenders confers on
the mortgagee or beneficiary the right both to receive all proceeds collected
under any hazard insurance policy and all awards made in connection with any
condemnation proceedings, and to apply such proceeds and awards to any
indebtedness secured by the mortgage or deed of trust, in such order as the
mortgagee or beneficiary may determine. Thus, in the event improvements on the
property are damaged or destroyed by fire or other casualty, or in the event
the property is taken by condemnation, the mortgagee or beneficiary under the
senior mortgage or deed of trust will have the prior right to collect any
insurance proceeds payable under a hazard insurance policy and any award of
damages in connection with the condemnation and to apply the same to the
indebtedness secured by the senior mortgage or deed of trust. Proceeds in
excess of the amount of senior mortgage indebtedness will, in most cases, be
applied to the indebtedness of a junior mortgage or trust deed to the extent
the junior mortgage or deed of trust so provides. The laws of certain states
may limit the ability of mortgagees or beneficiaries to apply the proceeds of
hazard insurance and partial condemnation awards to the secured indebtedness.
In such states, the mortgagor or trustor must be allowed to use the proceeds
of hazard insurance to repair the damage unless the security of the mortgagee
or beneficiary has been impaired. Similarly, in certain states, the mortgagee
or beneficiary is entitled to the award for a partial condemnation of the real
property security only to the extent that its security is impaired.
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FORECLOSURE
General. Foreclosure is a legal procedure that allows the lender to recover
its mortgage debt by enforcing its rights and available legal remedies under
the mortgage. If the borrower defaults in payment or performance of its
obligations under the note or mortgage, the lender has the right to institute
foreclosure proceedings to sell the real property at public auction to satisfy
the indebtedness.
Foreclosure procedures vary from state to state. Two primary methods of
foreclosing a mortgage are judicial foreclosure, involving court proceedings,
and non-judicial foreclosure pursuant to a power of sale granted in the
mortgage instrument. Other foreclosure procedures are available in some
states, such as strict foreclosure, but they are either infrequently used or
available only in limited circumstances.
Judicial Foreclosure. A judicial foreclosure proceeding is conducted in a
court having jurisdiction over the mortgaged property. Generally, the action
is initiated by the service of legal pleadings upon all parties having a
subordinate interest of record in the real property and all parties in
possession of the property, under leases or otherwise, whose interests are
subordinate to the mortgage. A foreclosure action is subject to most of the
delays and expenses of other lawsuits if defenses are raised or counterclaims
are interposed, and sometimes requires several years to complete. When the
lender's right to foreclose is contested, the legal proceedings can be time-
consuming. Upon successful completion of a judicial foreclosure proceeding,
the court generally issues a judgment of foreclosure and appoints a referee or
other officer to conduct a public sale of the mortgaged property, the proceeds
of which are used to satisfy the judgment. Such sales are made in accordance
with procedures that vary from state to state.
Public Sale. A third party may be unwilling to purchase a mortgaged property
at a public sale following judicial foreclosure because of the difficulty in
determining the value of such property at the time of sale, due to, among
other things, redemption rights which may exist and the possibility of
physical deterioration of the property during the foreclosure proceedings. For
these reasons, it is common for the lender to purchase the mortgaged property
for an amount equal to or less than the underlying debt and accrued and unpaid
interests plus the expenses of foreclosure. Generally, state law controls the
amount of foreclosure costs and expenses which may be recovered by a lender.
Thereafter, subject to the mortgagors right in some states to remain in
possession during a redemption period, if applicable, the lender will become
the owner of the property and have both benefits and burdens of ownership of
the mortgaged property. For example, the lender will have the obligation to
pay debt service on any senior mortgages, to pay taxes, obtain casualty
insurance and make such repairs at its own expense as are necessary to render
the property suitable for sale. The costs of operating and maintaining a
commercial or multifamily residential property may be significant and may be
greater than the income derived from that property.
Non-Judicial Foreclosure/Power of Sale. Foreclosure of a deed of trust is
generally accomplished by a non-judicial trustee's sale pursuant to a power of
sale typically granted in the deed of trust. A power of sale may also be
contained in any other type of mortgage instrument if applicable law so
permits. A power of sale under a deed of trust allows a non-judicial public
sale to be conducted generally following a request from the beneficiary/lender
to the trustee to sell the property upon default by the borrower and after
notice of sale is given in accordance with the terms of the mortgage and
applicable state law. The borrower or junior lienholder may then have the
right, during a reinstatement period required in some states, to cure the
default by paying the entire actual amount in arrears (without regard to the
acceleration of the indebtedness), plus the lender's expenses incurred in
enforcing the obligation. In other states, the borrower or the junior
lienholder is not provided a period to reinstate the loan, but has only the
right to pay off the entire debt to prevent the foreclosure sale. Generally,
state law governs the procedure for public sale, the parties entitled to
notice, the method of giving notice and the applicable time periods.
Equitable Limitations on Enforceability of Certain Provisions. United States
courts have traditionally imposed general equitable principles to limit the
remedies available to lenders in foreclosure actions. These principles are
generally designed to relieve borrowers from the effects of mortgage defaults
perceived as harsh
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or unfair. Relying on such principles, a court may alter the specific terms of
a loan to the extent it considers necessary to prevent or remedy an injustice,
undue oppression or overreaching, or may require the lender to undertake
affirmative actions to determine the cause of the borrower's default and the
likelihood that the borrower will be able to reinstate the loan. In some
cases, courts have substituted their judgment for the lender's and have
required that lenders reinstate loans or recast payment schedules in order to
accommodate borrowers who are suffering from a temporary financial disability.
In other cases, courts have limited the right of the lender to foreclose in
the case of a non-monetary default, such as a failure to adequately maintain
the mortgaged property or an impermissible further encumbrance of the
mortgaged property.
Even if the lender is successful in the foreclosure action and is able to
take possession of the property, the costs of operating and maintaining a
commercial or multifamily property may be significant and may be greater than
the income derived from that property. The costs of management and operation
of those mortgaged properties which are hotels, motels, restaurants, nursing
homes, convalescent homes or hospitals may be particularly significant because
of the expertise, knowledge and, with respect to nursing or convalescent
homes, regulatory compliance, required to run such operations and the effect
which foreclosure and a change in ownership may have with respect to consent
requirements and on the public's and the industry's (including franchisors')
perception of the quality of such operations. The lender also will commonly
obtain the services of a real estate broker and pay the broker's commission in
connection with the sale or lease of the property. Depending upon market
conditions, the ultimate proceeds of the sale of the property may not equal
the lender's investment in the property. Moreover, because of the expenses
associated with acquiring, owning and selling a mortgaged property, a lender
could realize an overall loss on a mortgage loan even if the mortgaged
property is sold at foreclosure, or resold after it is acquired through
foreclosure, for an amount equal to the full outstanding principal amount of
the loan plus accrued interest.
The holder of a junior mortgage that forecloses on a mortgaged property does
so subject to senior mortgages and any other prior liens, and may be obliged
to keep senior mortgage loans current in order to avoid foreclosure of its
interest in the property. In addition, if the foreclosure of a junior mortgage
triggers the enforcement of a "due-on-sale" clause contained in a senior
mortgage, the junior mortgagee could be required to pay the full amount of the
senior mortgage indebtedness or face foreclosure.
Post-Sale Redemption. In a majority of states, after sale pursuant to a deed
of trust or foreclosure of a mortgage, the borrower and foreclosed junior
lienors are given a statutory period in which to redeem the property. In some
states, statutory redemption may occur only upon payment of the foreclosure
sale price. In other states, redemption may be permitted if the former
borrower pays only a portion of the sums due. In some states, the borrower
retains possession of the property during the statutory redemption period. The
effect of a statutory right of redemption is to diminish the ability of the
lender to sell the foreclosed property because the exercise of a right of
redemption would defeat the title of any purchaser through a foreclosure.
Consequently, the practical effect of the redemption right is to force the
lender to maintain the property and pay the expenses of ownership until the
redemption period has expired. In some states, a post-sale statutory right of
redemption may exist following a judicial foreclosure, but not following a
trustee's sale under a deed of trust.
Anti-Deficiency Legislation. Any commercial or multi-family residential
mortgage loans acquired by the Company are likely to be nonrecourse loans, as
to which recourse in the case of default will be limited to the property and
such other assets, if any, that were pledged to secure the mortgage loan.
However, even if a mortgage loan by its terms provides for recourse to the
borrower's other assets, a lender's ability to realize upon those assets may
be limited by state law. For example, in some states a lender cannot obtain a
deficiency judgment against the borrower following foreclosure or sale under a
deed of trust or by nonjudicial means. Other statutes may require the lender
to exhaust the security afforded under a mortgage before bringing a personal
action against the borrower. In certain other states, the lender has the
option of bringing a personal action against the borrower on the debt without
first exhausting such security; however, in some of those states, the lender,
following judgment on such personal action, may be deemed to have elected a
remedy and thus may be precluded from foreclosing upon the security.
Consequently, lenders in those states where such an election of remedy
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provision exists may choose to proceed first against the security. Finally,
other statutory provisions, designed to protect borrowers from exposure to
large deficiency judgments that might result from bidding at below-market
values at the foreclosure sale, limit any deficiency judgment to the excess of
the outstanding debt over the fair market value of the property at the time of
the sale.
Cooperatives. Mortgage loans may be secured by a security interest on the
borrower's ownership interest in shares, and the proprietary leases
appurtenant thereto (or cooperative contract rights), allocable to cooperative
dwelling units that may be vacant or occupied by non-owner tenants. Such loans
are subject to certain risks not associated with mortgage loans secured by a
lien on the fee estate of a borrower in real property. Such a loan typically
is subordinate to the mortgage, if any, on the cooperative's building which,
if foreclosed, could extinguish the equity in the building and the proprietary
leases of the dwelling units derived from ownership of the shares of the
cooperative. Further, transfer of shares in a cooperative are subject to
various regulations as well as to restrictions (including transfer
restrictions) under the governing documents of the cooperative, and the shares
may be canceled in the event that associated maintenance charges due under the
related proprietary leases are not paid. Typically, a recognition agreement
between the lender and the cooperative provides, among other things, the
lender with an opportunity to cure a default under a proprietary lease but
such recognition agreements may not have been obtained in the case of all the
mortgage loans secured by cooperative shares (or contract rights).
Under the laws applicable in many states, "foreclosure" on cooperative
shares is accomplished by a sale in accordance with the provisions of Article
9 of the UCC and the security agreement relating to the shares. Article 9 of
the UCC requires that a sale be conducted in a "commercially reasonable"
manner, which may be dependent upon, among other things, the notice given to
the debtor and the method, manner, time, place and terms of the sale. Article
9 of the UCC provides that the proceeds of the sale will be applied first to
pay the costs and expenses of the sale and then to satisfy the indebtedness
secured by the lender's security interest. A recognition agreement, however,
generally provides that the lender's right to reimbursement is subject to the
right of the cooperative to receive sums due under the proprietary leases.
GROUND LEASE RISKS
Mortgage Loans may be secured by a mortgage on a ground lease. Leasehold
mortgages are subject to certain risks not associated with Mortgage Loans
secured by a fee estate. The most significant of these risks is that the
ground lease creating the leasehold estate could terminate, leaving the
leasehold mortgagee without its security. The ground lease may terminate if,
among other reasons, the ground lessee breaches or defaults in its obligations
under the ground lease or there is a bankruptcy of the ground lessee or the
ground lessor. This risk may be minimized if the ground lease contains certain
provisions protective of the mortgagee, but the ground leases that secure
Mortgage Loans may not contain some of these protective provisions.
BANKRUPTCY LAWS
Operation of the Bankruptcy Code and related state laws may interfere with
or affect the ability of a lender to realize upon collateral and/or to enforce
a deficiency judgment. For example, under the Bankruptcy Code, virtually all
actions (including foreclosure actions and deficiency judgment proceedings) to
collect a debt are automatically stayed upon the filing of the bankruptcy
petition and, often, no interest or principal payments are made during the
course of the bankruptcy case. The delay and the consequences thereof caused
by such automatic stay can be significant. Also, under the Bankruptcy Code,
the filing of a petition in bankruptcy by or on behalf of a junior lien or may
stay the senior lender from taking action to foreclose out such junior lien.
Under the Bankruptcy Code, provided certain substantive and procedural
safeguards protective of the lender are met, the amount and terms of a
mortgage loan secured by a lien on property of the debtor may be modified
under certain circumstances. For example, the outstanding amount of the loan
may be reduced to the then-current value of the property (with a corresponding
partial reduction of the amount of lender's security interest) pursuant to a
confirmed plan or lien avoidance proceeding, thus leaving the lender a general
unsecured creditor for the difference between such value and the outstanding
balance of the loan. Other modifications may include the reduction in the
amount of each scheduled payment, by means of a reduction in the rate of
interest and/or an alteration of the repayment schedule (with or without
affecting the unpaid principal balance of the loan, and/or by an extension (or
shortening) of the term to maturity.
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Federal bankruptcy law may also have the effect of interfering with or
affecting the ability of the secured lender to enforce the borrower's
assignment of rents and leases related to the mortgaged property. Under
section 362 of the Bankruptcy Code, the lender will be stayed from enforcing
the assignment, and the legal proceedings necessary to resolve the issue could
be time-consuming, with resulting delays in the lender's receipt of the rents.
In addition, the Bankruptcy Code has been amended to provide that a lender's
perfected pre-petition security interest in leases, rents and hotel revenues
continues in the post-petition leases, rents and hotel revenues, unless a
bankruptcy court orders to the contrary "based on the equities of the case."
In a bankruptcy or similar proceeding, action may be taken seeking the
recovery as a preferential transfer of any payments made by the mortgagor
under the related mortgage loan to the owner of such mortgage loan. Payments
on long-term debt may be protected from recovery as preferences if they are
payments in the ordinary course of business made on debts incurred in the
ordinary course of business. Whether any particular payment would be protected
depends upon the facts specific to a particular transaction.
A trustee in bankruptcy, in some cases, may be entitled to collect its costs
and expenses in preserving or selling the mortgaged property ahead of payment
to the lender. In certain circumstances, a debtor in bankruptcy may have the
power to grant liens senior to the lien of a mortgage, and analogous state
statutes and general principles of equity may also provide a mortgagor with
means to halt a foreclosure proceeding or sale and to force a restructuring of
a mortgage loan on terms a lender would not otherwise accept. Moreover, the
laws of certain states also give priority to certain tax liens over the lien
of a mortgage or deed of trust. Under the Bankruptcy Code, if the court finds
that actions of the mortgagee have been unreasonable, the lien of the related
mortgage may be subordinated to the claims of unsecured creditors.
The Company's acquisition of real property, particularly REO Property, may
be affected by many of the considerations applicable to mortgage loan lending.
For example, the Company's acquisition of certain property at foreclosure sale
could be affected by a borrower's post-sale right of redemption. In addition,
the Company's ability to derive income from real property will generally be
dependent on its receipt of rent payments under leases of the related
property. The ability to collect rents may be impaired by the commencement of
a bankruptcy proceeding relating to a lessee under such lease. Under the
Bankruptcy Code, the filing of a petition in bankruptcy by or on behalf of a
lessee results in a stay in bankruptcy against the commencement or
continuation of any state court proceeding for past due rent, for accelerated
rent, for damages or for a summary eviction order with respect to a default
under the lease that occurred prior to the filing of the lessee's petition. In
addition, the Bankruptcy Code generally provides that a trustee or debtor-in-
possession may, subject to approval of the court, (i) assume the lease and
retain it or assign it to a third party or (ii) reject the lease. If the lease
is assumed, the trustee or debtor-in-possession (or assignee, if applicable)
must cure any defaults under the lease, compensate the lessor for its losses
and provide the lessor with "adequate assurance" of future performance. Such
remedies may be insufficient, and any assurances provided to the lessor may,
in fact, be inadequate. If the lease is rejected, the lessor will be treated
as an unsecured creditor with respect to its claim for damages for termination
of the lease. The Bankruptcy Code also limits a lessor's damages for lease
rejection to the rent reserved by the lease (without regard to acceleration)
for the greater of one year, or 15%, not to exceed three years, of the
remaining term of the lease.
DEFAULT INTEREST AND LIMITATIONS ON PREPAYMENTS
Notes and mortgages may contain provisions that obligate the borrower to pay
a late charge or additional interest if payments are not timely made, and in
some circumstances, may prohibit prepayments for a specified period and/or
condition prepayments upon the borrower's payment of prepayment fees or yield
maintenance penalties. In certain states, there are or may be specific
limitations upon the late charges that a lender may collect from a borrower
for delinquent payments. Certain states also limit the amounts that a lender
may collect from a borrower as an additional charge if the loan is prepaid. In
addition, the enforceability of provisions that provide for prepayment fees or
penalties upon an involuntary prepayment is unclear under the laws of many
states.
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DUE ON SALE AND DUE ON ENCUMBRANCE
Certain of the Mortgage Loans may contain due on sale and due on encumbrance
clauses. These clauses generally provide that the lender may accelerate the
maturity of the loan if the mortgagor sells or otherwise transfers or
encumbers the mortgaged property. The enforceability of due on sale clauses
has been subject of legislation or litigation in many states and, in some
cases, the enforceability of these clauses has been limited or denied.
However, with respect to certain loans, the Garn-St. Germain Depository
Institutions Act of 1982 pre-empts state constitutional, statutory and case
law that prohibits the enforcement of due on sale clauses and permits lenders
to enforce these clauses in accordance with their terms subject to certain
limited exceptions.
SUBORDINATE FINANCING
When a mortgagor encumbers mortgaged property with one or more junior liens,
the senior lender is subjected to additional risk. First, the mortgagor may
have difficulty servicing and repaying multiple loans. In addition, if the
junior loan permits recourse to the mortgagor (as junior loans often do) and
the senior loan does not, a mortgagor may be more likely to repay sums due on
the junior loan than those on the senior loan. Second, acts of the senior
lender that prejudice the junior lender can cause the senior lender to lose
its priority. For example, if the mortgagor and the senior lender agree to
increase the principal amount of or the interest rate payable on the senior
loan, the senior lender may lose its priority to the extent any existing
junior is harmed or the mortgagor is additionally burdened. Third, if the
mortgagor defaults on the senior loan and/or any junior loan or loans, the
existence of junior loans and the action taken by junior lenders can impair
the security available to the senior lender and can interfere with or delay
the taking of action by the senior lender.
ACCELERATION ON DEFAULT
Some of the Mortgage Loans may include "Debt--Acceleration" clauses, which
permit the lender to accelerate the full debt upon a monetary or nonmonetary
default of the mortgagor. The courts of all states will enforce clauses
providing for acceleration in the event of a material payment default after
giving effect to any appropriate notices. Such courts, however, may refuse to
foreclose on a mortgage or deed of trust when an acceleration of the
indebtedness would be inequitable or unjust under the circumstances or would
render the acceleration unconscionable. Furthermore, in some states, the
mortgagor may avoid foreclosure and reinstate an accelerated loan by paying
only the defaulted amounts and the costs and attorneys' fees incurred by the
lender in collecting such defaulted payments.
CERTAIN LAWS AND REGULATIONS; TYPES OF MORTGAGED PROPERTY
The real property securing the Mortgage Loans will be subject to compliance
with various federal, state and local statutes and regulations. Failure to
comply (together with an inability to remedy any such failure) could result in
material diminution in the value of the Mortgaged Properties which could,
together with the possibility of limited alternative uses for a particular
property (e.g., a nursing home or convalescent home or hospital), result in
the failure to realize the full principal amount of the related Mortgage Loan.
Mortgages on properties which are owned by a mortgagor under a condominium
form of ownership are subject to declarations, bylaws and other regulations of
the condominium association. Mortgaged properties which are hotels or motels
may present additional risks in that hotels and motels are typically operated
pursuant to franchise, management and operating agreements which may be
terminated by the operator, and the transferability of the hotel's operating
liquor and other licenses to the entity acquiring the hotel either through
purchases or foreclosure is subject to the peculiarities of local law
requirements. In addition, mortgaged properties which are multifamily
residential properties may be subject to rent control laws, which could impact
the future cash flows of such properties.
FORFEITURES IN DRUG AND RICO PROCEEDINGS
Federal law provides that property owned by persons convicted of drug-
related crimes or of criminal violations of the Racketeer Influenced and
Corrupt Organizations ("RICO") statute can be seized by the government if the
property was used in, or purchased with the proceeds of, such crimes. Under
procedures contained in the Comprehensive Crime Control Act of 1984 (the
"Crime Control Act"), the government may seize the property even before
conviction. The government must publish notice of the forfeiture proceeding
and may give notice to all parties "known to have an alleged interest in the
property," including the holders of mortgage loans.
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A lender may avoid forfeiture of its interest in the property if it
establishes that: (i) its mortgage was executed and recorded before commission
of the crime upon which the forfeiture is based, or (ii) the lender was, at
the time of execution of the mortgage, "reasonably without cause to believe"
that the property was used in, or purchased with the proceeds of, illegal drug
or RICO activities.
ENVIRONMENTAL RISKS
General. The Company will be subject to environmental risks when taking a
security interest in real property, as well as when it acquires any real
property. Of particular concern may be properties that are or have been used
for industrial, manufacturing, military or disposal activity. Such
environmental risks include the risk of the diminution of the value of a
contaminated property or, as discussed below, liability for the costs of
compliance with environmental regulatory requirements or the costs of clean-up
or other remedial actions. These compliance or clean-up costs could exceed the
value of the property or the amount of the lender's loan. In certain
circumstances, a lender could determine to abandon a contaminated mortgaged
property as collateral for its loan rather than foreclose and risk liability
for compliance or clean-up costs.
CERCLA. The federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980, as amended ("CERCLA"), imposes strict liability on
present and past "owners" and "operators" of contaminated real property for
the costs of clean-up. A secured lender may be liable as an "owner" or
"operator" of a contaminated mortgaged property if agents or employees of the
lender have become sufficiently involved in the management of such mortgaged
property or the operations of the borrower. Such liability may exist even if
the lender did not cause or contribute to the contamination and regardless of
whether the lender has actually taken possession of a mortgaged property
through foreclosure, deed in lieu of foreclosure or otherwise. The magnitude
of the CERCLA liability at any given contaminated site is a function of the
actions required to address adequately the risks to human health and the
environment posed by the particular conditions at the site. As a result, such
liability is not constrained by the value of the property or the amount of the
original or unamortized principal balance of any loans secured by the
property. Moreover, under certain circumstances, liability under CERCLA may be
joint and several--i.e., any liable party may be obligated to pay the entire
clean-up costs regardless of its relative contribution to the contamination.
The Asset Conservation, Lender Liability and Deposit Insurance Act of 1996
(the "1996 Lender Liability Act") provides for a safe harbor for secured
lenders from CERCLA liability even though the lender forecloses and sells the
real estate securing the loan, provided the secured lender sells "at the
earliest practicable, commercially reasonable time, at commercially reasonable
terms, taking into account market conditions and legal and regulatory
requirements." Although the 1996 Lender Liability Act provides significant
protection to secured lenders, it has not been construed by the courts and
there are circumstances in which actions taken could expose a secured lender
to CERCLA liability. And, the transferee from the secured lender is not
entitled to the protections enjoyed by a secured lender. Hence, the
marketability of any contaminated real estate continues to be suspect.
Certain Other Federal and State Laws. Many states have environmental clean-
up statutes similar to CERCLA, and not all those statutes provide for a
secured creditor exemption. In addition, underground storage tanks are
commonly found on a wide variety of commercial and industrial properties.
Federal and state laws impose liability on the owners and operators of
underground storage tanks for any clean-up that may be required as a result of
releases from such tanks. These laws also impose certain compliance
obligations on the tank owners and operators, such as regular monitoring for
leaks and upgrading of older tanks. The Company may become a tank owner or
operator and subject to compliance obligations and potential clean-up
liabilities, either as a result of becoming involved in the management of a
site at which a tank is located or, more commonly, by taking title to such a
property. Federal and state laws also obligate property owners and operators
to maintain and, under some circumstances, to remove asbestos-containing
building materials and lead-based paint. As a result, the presence of these
materials can increase the cost of operating a property and thus diminish its
value. In a few states, transfers of some types of properties are conditioned
upon clean-up of contamination prior to transfer. In these cases, a lender
that becomes the owner of a property through foreclosure, deed in lieu of
foreclosure or otherwise, may be required to clean up the contamination before
selling or otherwise transferring the property.
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Beyond statute-based environmental liability, there exist common law causes
of action (for example, actions based on nuisance or on toxic tort resulting
in death, personal injury or damage to property) related to hazardous
environmental conditions on a property.
Superlien Laws. Under the laws of many states, contamination of a property
may give rise to a lien on the property for clean-up costs. In several states,
such a lien has priority over all existing liens, including those of existing
mortgages. In these states, the lien of a mortgage may lose its priority to
such a "superlien."
Additional Considerations. The cost of remediating environmental
contamination at a property can be substantial. To reduce the likelihood of
exposure to such losses, the Company will not acquire title to a Mortgaged
Property or take over its operation unless, based on an environmental site
assessment prepared by a qualified environmental consultant, it has made the
determination that it is appropriate to do so. The Company expects that it
will organize a special purpose subsidiary to acquire any environmentally
contaminated real property.
Environmental Site Assessments. In addition to possibly allowing a lender to
qualify for the innocent landowner defense (see discussion under "--
Environmental Risks--CERCLA" above), environmental site assessments can be a
valuable tool in anticipating, managing and minimizing environmental risk.
They are commonly performed in many commercial real estate transactions.
Environmental site assessments vary considerably in their content and
quality. Even when adhering to good professional practices, environmental
consultants will sometimes not detect significant environmental problems
because an exhaustive environmental assessment would be far too costly and
time-consuming to be practical. Nevertheless, it is generally helpful in
assessing and addressing environmental risks in connection with commercial
real estate (including multifamily properties) to have an environmental site
assessment of a property because it enables anticipation of environmental
problems and, if agreements are structured appropriately, can allow a party to
decline to go forward with a transaction.
APPLICABILITY OF USURY LAWS
Title V of the Depository Institutions Deregulation and Monetary Control Act
of 1980 ("Title V") provides that state usury limitations shall not apply to
certain types of residential (including multifamily) first mortgage loans
originated by certain lenders after March 31, 1980. Title V authorized any
state to reimpose interest rate limits by adopting, before April 1, 1983, a
law or constitutional provision that expressly rejects application of the
federal law. In addition, even where Title V is not so rejected, any state is
authorized by the law to adopt a provision limiting discount points or other
charges on mortgage loans covered by Title V. Certain states have taken action
to reimpose interest rate limits and/or to limit discount points or other
charges.
AMERICANS WITH DISABILITIES ACT
Under Title III of the Americans with Disabilities Act of 1990 and rules
promulgated thereunder (collectively, the "ADA"), in order to protect
individuals with disabilities, public accommodations (such as hotels,
restaurants, shopping centers, hospitals, schools and social service center
establishments) must remove architectural and communication barriers that are
structural in nature from existing places of public accommodation to the
extent "readily achievable." In addition, under the ADA, alterations to a
place of public accommodation or a commercial facility are to be made so that,
to the maximum extent feasible, such altered portions are readily accessible
to and usable by disabled individuals. The "readily achievable" standard takes
into account, among other factors, the financial resources of the affected
site, owner, landlord or other applicable person. In addition to imposing a
possible financial burden on the borrower in its capacity as owner or
landlord, the ADA may also impose such requirements on a foreclosing lender
who succeeds to the interest of the borrower as owner or landlord.
Furthermore, since the "readily achievable" standard may vary depending on the
financial condition of the owner or landlord, a foreclosing lender who is
financially more capable than the borrower of complying with the requirements
of the ADA may be subject to more stringent requirements than those to which
the borrower is subject.
95
<PAGE>
SOLDIERS' AND SAILORS' CIVIL RELIEF ACT OF 1940
Under the terms of the Soldiers' and Sailors' Civil Relief Act of 1940, as
amended (the "Relief Act"), a mortgagor who enters military service after the
origination of such mortgagor's mortgage loan (including a mortgagor who is in
reserve status and is called to active duty after origination of the mortgage
loan), may not be charged interest (including fees and charges) above an
annual rate of 6% during the period of such mortgagor's active duty status,
unless a court orders otherwise upon application of the lender. Because the
Relief Act applies to mortgagors who enter military service after origination
of the related mortgage loan, no information can be provided as to the number
of Mortgage Loans that may be affected by the Relief Act. Application of the
Relief Act would adversely affect, for an indeterminate period of time, the
ability of any servicer to collect full amounts of interest on certain
Mortgage Loans. In addition, the Relief Act imposes limitations that would
impair the ability of a servicer to foreclosure on an affected Mortgage Loan
during the mortgagor's period of active duty status, and, under certain
circumstances, during an additional three month period thereafter.
UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting Agreement,
the Company has agreed to sell to the underwriter named below (the
"Underwriter") and the Underwriter has agreed to purchase from the Company,
the number of shares of Common Stock offered hereby and set forth below
opposite its name.
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
----------- ----------------
<S> <C>
Friedman, Billings, Ramsey & Co., Inc.................... [ ]
Total................................................ [ ]
===========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriter is committed to purchase all the shares of Common Stock offered
hereby if any are purchased.
The Underwriter proposes initially to offer shares of Common Stock
directly to the public at the public offering price set forth on the cover
page of this Prospectus and to certain dealers at such offering price less a
concession not to exceed [$ ] per share of Common Stock. The
Underwriter may allow and such dealers may reallow a concession not to exceed
$ per share of Common Stock to certain other dealers. After the shares of
Common Stock are released for sale to the public, the offering price and other
selling terms may be changed by the Underwriter.
At the request of the Company, the Underwriter has reserved up to
[ ] shares of Common Stock for sale to certain persons at the initial
public offering price. The number of shares of Common Stock available for sale
to the general public will be reduced to the extent such persons purchase such
reserved shares. Any reserved shares which are not so purchased will be
offered by the Underwriter to the general public on the same basis as the
other shares offered hereby.
The Company has granted to the Underwriter an option exercisable during a
30-day period after the date hereof to purchase, at the Offering Price less
underwriting discounts and commissions, up to an additional 2,812,500 shares
of Common Stock for the sole purpose of covering over-allotments, if any. To
the extent that the Underwriter exercises such option, the Underwriter will be
committed, subject to certain conditions, to purchase a number of the
additional shares of Common Stock proportionate to the Underwriter's initial
commitment.
The Company has agreed to indemnify the Underwriter against certain civil
liabilities under the Securities Act, or to contribute to payments the
Underwriter may be required to make in respect thereof.
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<PAGE>
Prior to this Offering, there has been no public market for the shares of
Common Stock. The initial public offering price has been determined by
negotiation between the Company and the representatives of the Underwriter.
Among the factors considered in making such determination were the history of,
and the prospects for, the industry in which the Company will compete, an
assessment of the skills of the Manager and the Company's prospects for future
earnings, the general conditions of the economy and the securities market and
the prices of offerings by similar issuers. There can, however, be no
assurance that the price at which the shares of Common Stock will sell in the
public market after the Offering will not be lower than the price at which
they are sold by the Underwriter.
[The representatives of the Underwriter have informed the Company that the
Underwriter does not intend to confirm sales of the shares offered hereby to
any accounts over which it exercises discretionary authority.]
Until the distribution of the Common Stock is completed, rules of the
Commission may limit the ability of the Underwriter and certain selling group
members to bid for or purchase the Common Stock. As an exception to these
rules, the representatives are permitted to engage in certain transactions
that stabilize the price of the Common Stock. Such transactions consist of
bids or purchases for the purpose of pegging, fixing or maintaining the price
of the Common Stock.
If the Underwriter creates a short position in the Common Stock in
connection with the Offering, i.e., if it sells more shares of Common Stock
than are set forth on the cover page of this Prospectus, the representatives
may reduce that short position by purchasing Common Stock in the open market.
The representatives may also elect to reduce any short position by exercising
all or part of the over-allotment option described above.
The representatives of the Underwriter may also impose [a penalty bid on
certain selling group members.] This means that if the representatives of the
Underwriter purchase Common Stock in the open market to reduce the
Underwriter's short position or to stabilize the price of the Common Stock, it
may reclaim the amount of the selling concession from the Underwriter and
selling group members who sold such shares as part of the Offering.
In general, purchases of securities for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher
than it might be in the absence of such purchases. The imposition of a penalty
bid might also have an effect on the price of a security to the extent that it
were to discourage resales of the security.
Neither the Company nor the Underwriter makes any representation or
prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the Common Stock. In
addition, neither the Company nor the Underwriter makes any representation
that the representatives will engage in such transactions or that such
transactions, once commenced, will not be discontinued without notice.
The Company has agreed not to offer, sell or contract to sell or otherwise
dispose of any Common Stock of PCI without the prior consent of Friedman,
Billings, Ramsey & Co., Inc. for a period of 120 days from the date of this
Prospectus.
Prime has agreed not to offer, sell or contract to sell or otherwise dispose
of the Common Stock acquired on the Closing Date without the prior consent of
Friedman, Billings, Ramsey & Co., Inc. for a period of two years from the date
of Closing, provided that the Manager continues to serve as the manager during
such period.
The Company will apply for inclusion of the Common Stock in The Nasdaq Stock
Market under the symbol "PCRI." The Underwriter has advised the Company that
it intends to make a market in the Common Stock upon completion of the
Offering. The Underwriter will have no obligation to make a market in the
Common Stock, however, and may cease market making activities, if commenced,
at any time.
97
<PAGE>
The Company has agreed to grant to the Underwriter, for nominal
consideration, warrants to purchase up to 468,750 shares of Common Stock
(539,063 shares if the Underwriter exercises over-allotment option in full) at
the Offering Price. The warrants will be exercisable for a period of five
years from the closing date of the Offering.
LEGAL MATTERS
Certain legal matters will be passed upon for the Company by Winston &
Strawn, Chicago, Illinois, and for the Underwriter by Hunton & Williams,
Richmond, Virginia.
EXPERTS
The balance sheet of Prime Capital Investment Corp. as of September 30,
1997, and the combined financial statements of the Brookdale Facilities as of
December 31, 1996 and 1995, and for each of the three years in the period
ended December 31, 1996, appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their reports thereon apprearing elsewhere herein, and are included
in reliance upon such reports given upon the authority of such firm as experts
in accounting and auditing.
98
<PAGE>
GLOSSARY OF TERMS
Except as otherwise specified or as the context may otherwise require, the
following terms used herein shall have the meanings assigned to them below.
All terms in the singular shall have the same meanings when used in the plural
and vice-versa.
"1996 Lender Liability Act" shall mean the Asset Conservation, Lender
Liability and Deposit Insurance Act of 1996.
"ADA" shall mean the Americans with Disabilities Act of 1990, as amended.
"Affiliate" shall mean (i) any person directly or indirectly owning,
controlling, or holding, with power to vote ten percent or more of the
outstanding voting securities of such other person, (ii) any person ten
percent or more of whose outstanding voting securities are directly or
indirectly owned, controlled, or held, with power to vote, by such other
person, (iii) any person directly or indirectly controlling, controlled by, or
under common control with such other person, (iv) any executive officer,
director, trustee or general partner of such other person, and (v) any legal
entity for which such person acts as an executive officer, director, trustee
or general partner. The term "person" means and includes any natural person,
corporation, partnership, association, limited liability company or any other
legal entity. An indirect relationship shall include circumstances in which a
person's spouse, children, parents, siblings or mothers-, fathers-, sisters-
or brothers-in-law is or has been associated with a person.
"Affiliated Transaction" shall mean any material acquisition transaction
between the Company and any Interested Stockholder.
"Articles of Incorporation" shall mean the Articles of Incorporation of the
Company.
"Average Invested Assets" shall mean the average of the aggregate book value
of the assets of the Company (including all of PCI's direct and indirect
subsidiaries), before reserves for depreciation or bad debts or other similar
noncash reserves, computed by taking the daily average of such values during
such period.
"Bankruptcy Code" shall mean Title 11 of the United States Code, as amended.
"Beneficiary" shall mean the beneficiary of the Trust.
"Board of Directors" shall mean the Board of Directors of PCI.
"Brookdale" shall mean Brookdale Living Communities, Inc., a Delaware
corporation.
"Brookdale Facilities" shall mean the four senior housing and assisted
living facilities to be purchased by the Company from Brookdale pursuant to a
non-binding term sheet.
"Bylaws" shall mean the Bylaws of the Company.
"CERCLA" shall mean the Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended.
"Closing" shall mean the date of closing of the Offering.
"Closing Date" shall mean on or about October , 1997.
"Closing Price" shall mean the average of the high bid and low asked prices
in the over-the-counter market, as reported by The Nasdaq Stock Market.
"CMBS" shall mean commercial or multifamily MBS.
"CMO or CMO Bonds" shall mean collateralized mortgage obligations.
"Code" shall mean the Internal Revenue Code of 1986, as amended.
G-1
<PAGE>
"Commission" shall mean the Securities and Exchange Commission.
"Common Stock" shall mean the Common Stock, par value $0.01 per share, of
PCI.
"Company" shall mean PCI, a Maryland corporation, together with its
subsidiaries, unless the context indicates otherwise.
"Company Expenses" shall mean all administrative costs and expenses of the
Company, the General Partner, the Initial Limited Partner and the Operating
Partnership.
"Construction Loan" shall mean a loan the proceeds of which are to be used to
finance the costs of construction or rehabilitation of Real Property.
"Control Share Acquisition" shall mean the acquisition of control shares,
subject to certain exceptions.
"Control shares" shall mean voting share of stock which, if aggregated with
all other such shares of stock previously acquired by the acquirer or in
respect of which the acquirer is able to exercise or direct the exercise of
voting power (except solely by virtue of a revocable proxy), would entitle the
acquirer to exercise voting power in electing directors within one of the
following ranges of voting power; (1) one-fifth or more but less than one-
third, (2) one-third or more but less than a majority, or (3) a majority or
more of all voting power; but "control shares" shall not include shares the
acquiring person is then entitled to vote as a result of having previously
obtained stockholder approval.
"Crime Control Act" shall mean the Comprehensive Crime Control Act of 1984.
"Directors" means the members of PCI's Board of Directors.
"Distressed Mortgage Loans" shall mean Subperforming Mortgage Loans and
Nonperforming Mortgage Loans.
"Distressed Real Properties" shall mean REO Properties and other
underperforming or otherwise distressed real property.
"DSCR" shall mean debt service coverage ratio, which is, for any period of
time with respect to a Mortgage Loan, the ratio of (i) the net operating income
derived from the Mortgaged Property securing such Mortgage Loan during that
period of time, to (ii) the amount of principal and interest due under such
Mortgage Loan during that period of time.
"DOL" shall mean the Department of Labor.
"ERISA" shall mean the Employee Retirement Income Security Act of 1974, as
amended.
"Excess Inclusion" shall have the meaning specified in section 860E(c) of the
Code.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as amended.
"Exempt Organizations" shall mean tax-exempt entities, including, but not
limited to, charitable organizations, qualified employee pension and profit
sharing trusts and individual retirement accounts.
"FHLB" shall mean the Federal Home Loan Bank.
"FIRPTA" shall mean the Foreign Investment in Real Property Tax Act of 1980.
"FLHMC" shall mean the Federal Loan Home Mortgage Corporation, a corporate
instrumentality of the United States created and existing under Title III of
the Emergency Home Finance Act of 1970, as amended, or any successor thereto.
G-2
<PAGE>
"FMAC" shall mean Franchise Mortgage Acceptance Company, L.L.C.
"FNMA" shall mean the Federal National Mortgage Association, a federally
chartered and privately owned corporation organized and existing under the
Federal National Mortgage Association Charter Act, or any successor thereto.
"Funds From Operations" shall mean, as defined by NAREIT, net income
(computed in accordance with GAAP), excluding gains (or losses) from debt
restructuring and sales of property, plus depreciation and amortization on
real estate assets, and after adjustments for unconsolidated partnerships and
joint ventures.
"GAAP" shall mean generally accepted accounting principles applied on a
consistent basis.
"Garn Act" shall mean the Garn-St. Germain Depository Institutions Act of
1982.
"General Partner" shall mean Prime Capital Partner, Inc., a Maryland
corporation and a wholly owned subsidiary of PCI, as the sole general partner
of the Operating Partnership.
"Guidelines" shall mean guidelines established by a majority of the
Independent Directors that set forth general parameters for the Company's
investments, borrowings and operations.
"HUD" shall mean the Department of Housing and Urban Development.
"Independent Director" shall mean a director who (a) does not own greater
than a de minimus interest in Prime, the Manager or any of their Affiliates,
and (b) within the last two years, has not (i) directly or indirectly been
employed by Prime, the Manager or any of their Affiliates, (ii) been an
officer or director of Prime, the Manager or any of their Affiliates, (iii)
performed services for Prime, the Manager or any of their Affiliates, (iv) had
any material business or professional relationship with Prime, the Manager or
any of their Affiliates.
"Initial Investments" shall mean the Brookdale Properties which are to be
acquired from Brookdale soon after the Closing.
"Initial Limited Partner", shall mean PCLP, Inc., a Maryland corporation and
a wholly owned subsidiary of PCI, as limited partner of the Operating
Partnership.
"Interested Stockholder" shall mean any person who beneficially owns 10% or
more of the voting power of a corporation's shares or an affiliate of a
corporation who, at any time within the two-year period prior to the date in
question, was the beneficial owner of 10% or more of the voting power of the
then outstanding voting stock of a corporation.
"Inverse IO" shall mean a class of MBS that is entitled to no (or only
nominal) distributions of principal, but is entitled to interest at a floating
rate that varies inversely with a specified index.
"Investment Company Act" shall mean the Investment Company Act of 1940, as
amended.
"IO" shall mean a class of MBS that is entitled to no (or only nominal)
distributions of principal.
"IRA" shall mean an individual retirement account.
"IRS" shall mean the Internal Revenue Service.
"Lease" shall mean, with respect to each Mortgaged Property or Real
Property, the agreement pursuant to which the borrower rents and leases to the
lessee and the lessee rents and leases from the borrower, such Mortgaged
Property or Real Property.
"LIBOR" shall mean the London Interbank Offering Rate for one-month U.S.
Dollar deposits.
G-3
<PAGE>
"Limited Partners" shall mean the Initial Limited Partner and any additional
persons subsequently admitted as limited partners of the Operating Partnership.
"Management Agreement" shall mean an agreement or agreements between the
Company and the Manager pursuant to which the Manager performs various services
for the Company.
"Manager" shall mean Prime Capital Management, LLC, a Delaware limited
liability corporation.
"Market Price" shall mean the average of the Closing Price for the five
consecutive Trading Days ending on such date.
"MBS" shall mean mortgage-backed securities (including RMBS and CMBS).
"MBS Interests" shall mean interests in CMBS and RMBS.
"Mezzanine Loan" shall mean a loan secured by a lien on Real Property that is
subordinate to a lien on such Real Property securing another loan.
"MGCL" shall mean the Maryland General Corporation Law.
"Mortgage Collateral" shall mean mortgage pass-through securities or pools of
whole loans securing or backing a series of MBS.
"Mortgage Loan" shall mean a mortgage loan underlying a series of MBS or a
mortgage loan held by the Company, as the context indicates.
"Mortgaged Property" shall mean the real property securing a Mortgage Loan.
"NAREIT" shall mean the National Association of Real Estate Investment
Trusts, Inc.
"NASD" shall mean the National Association of Securities Dealers, Inc.
"Net Income" shall mean the income of the Company as reported for federal
income tax purposes before the Manager's incentive compensation, net operating
loss deductions arising from losses in prior periods and the deduction for
dividends paid, plus the effects of adjustments, if any, necessary to record
hedging and interest transactions in accordance with GAAP.
"Non-ERISA Plan" shall mean a plan that does not cover common law employees.
"Nonperforming Mortgage Loans" shall mean commercial and residential mortgage
loans for which the payment of principal and interest is more than 90 days
delinquent.
"Non-REMIC Residual Interests" shall mean an ownership interest in Mortgage
Loans that are subject to CMO debt.
"Offering" shall mean the offering of Common Stock hereby.
"Offering Price" shall mean the initial offering price per share to the
public of the Common Stock offered hereby as set forth on the cover page of the
Company's final prospectus.
"OID" shall mean original issue discount.
"Operating Partnership" shall mean Prime Capital Investment Partnership,
L.P., a Delaware limited partnership.
"Operating Partnership Agreement" shall mean the agreement of limited
partnership of the Operating Partnership, as amended from time to time.
G-4
<PAGE>
"Option Plan" shall mean the Company's non-qualified stock option plan which
provides for options to purchase shares of Common Stock or, at the election of
the Company, Units.
"Other Assets" shall mean real or personal property or interests therein
acquired by the Company that are other than Real Estate Related Interests.
"OTS" shall mean the Office of Thrift Supervision.
"Ownership Limit" shall mean the restriction on ownership (or deemed
ownership by virtue of the attribution provisions of the Code) of (a) more than
9.9% of the outstanding shares of Common Stock by any stockholder, or (b) more
than 9.9% of the shares of any series of Preferred Stock by any stockholder.
"Pass-Through Certificates" shall mean interests in trusts, the assets of
which are primarily mortgage loans.
"PCC" shall mean Prime Commercial Credit, LLC, a Delaware limited liability
company.
"PCF" shall mean Prime Capital Funding, LLC, a Delaware limited liability
company.
"PCH" shall mean Prime Capital Holding, LLC, a Delaware limited liability
company.
"PCI" shall mean Prime Capital Investment Corp., a Maryland corporation.
"Plan" shall mean certain pension, profit-sharing, employee benefit, or
retirement plans subject to Title I of ERISA or individual retirement accounts.
"Plan Asset Regulations" shall mean regulations of the Department of Labor
that define "plan assets."
"PO" shall mean a class of MBS that is entitled to no distributions of
interest.
"Preferred Stock" shall mean the preferred stock of PCI.
"Pricing Date" shall mean the date of the pricing of the Common Stock
pursuant to the Offering.
"Prime" shall mean The Prime Group, Inc., an Illinois corporation.
"Prohibited Owner" shall mean the record holder of the shares of Common Stock
or Preferred Stock that are designated as Shares-in-Trust.
"Qualifying Interests" shall mean mortgages and other liens on and interests
in real estate.
"Real Estate Related Assets" shall mean Targeted Portfolio Investments and
Real Property.
"Real Property" shall mean real property owned by the Company.
"Realized Losses" shall mean, generally, the aggregate amount of losses
realized on loans that are liquidated and losses on loans due to fraud,
mortgagor bankruptcy, casualty or special hazards.
"Redemption Rights" shall mean the rights that it is anticipated the Limited
Partners (other than the Initial Limited Partner) will have pursuant to the
Operating Partnership Agreement to cause the Operating Partnership to redeem
all or a portion of their Units for Common Stock on a one-for-one basis or, at
the option of the Company, an equivalent amount of cash.
"REIT" shall mean real estate investment trust, as defined in section 856 of
the Code.
"Related Party Tenant" shall mean a tenant of PCI or the Operating
Partnership in which PCI owns 10% or more of the ownership interests, taking
into account both direct ownership and constructive ownership.
G-5
<PAGE>
"REMIC" shall mean real estate mortgage investment conduit, as defined in
section 860D of the Code.
"REMIC Residual Interest" shall mean a class of MBS that is designated as the
residual interest in one or more REMICs.
"Rent" shall mean rent received by the Company from tenants of Real Property
owned by the Company.
"REO Property" shall mean real property acquired by a mortgage lender at
foreclosure (or by deed in lieu of foreclosure).
"RICO" shall mean the Racketeer Influenced and Corrupt Organizations statute,
18 U.S.C.A. (S) 1961, et seq.
"RMBS" shall mean a series of one- to four-family residential MBS.
"Rule 144" shall mean the rule promulgated under the Securities Act that
permits holders of restricted securities as well as Affiliates of an issuer of
the securities, pursuant to certain conditions and subject to certain
restrictions, to sell their securities publicly without registration under the
Securities Act.
"SAIF" shall mean the Savings Association Insurance Fund.
"Securities Act" shall mean the Securities Act of 1933, as amended.
"Shares-in-Trust" shall mean shares of Common Stock or Preferred Stock the
purported transfer of which would result in a violation of the Ownership Limit,
result in the stock of PCI being held by fewer than 100 persons, result in PCI
being "closely held," or cause PCI to own 10% or more of the ownership
interests in a tenant of the Company's Real Property.
"Special Servicing" shall mean servicing of defaulted mortgage loans,
including oversight and management of the resolution of such mortgage loans by
modification, foreclosure, deed in lieu of foreclosure or otherwise.
"Sub IO" shall mean an IO with characteristics of a Subordinated Interest.
"Subordinated Interests" shall mean classes of MBS that are subordinated in
right of payments of principal and interest to more senior classes.
"Sub-Performing Mortgage Loans" shall mean multifamily and commercial
mortgage loans for which default is likely or imminent.
"Targeted Portfolio Investments" shall mean the Company's investments in MBS
Interests, Mortgage Loans, Preferred Equity and Net Leased Real Estate.
"Ten-Year U.S. Treasury Rate" shall mean the arithmetic average of the weekly
average 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, any Federal Reserve Bank or agency
or department of the federal government selected by the Company.
"Title V" shall mean Title V of the Depository Institutions Deregulation and
Monetary Control Act of 1980.
"Trading Day" shall mean any day other than a Saturday, a Sunday or a day on
which banking institutions in the State of New York are authorized or obligated
by law or executive order to close.
"Treasury Regulations" shall mean the income tax regulations promulgated
under the Code.
G-6
<PAGE>
"Trust" shall mean a trust created in the event of an impermissible transfer
of shares of Common Stock.
"Trustee" shall mean a trustee of the Trust.
"UBTI" shall mean unrelated business taxable income.
"UBTI Percentage" shall mean the gross income derived by the Company from an
unrelated trade or business divided by the gross income of the Company for the
year in which the dividends are paid.
"UCC" shall mean the Uniform Commercial Code.
"Underwriter" shall mean Friedman, Billings, Ramsey & Co., Inc.
"Underwriting Agreement" shall mean the agreement pursuant to which the
Underwriter will purchase and distribute the Common Stock offered hereby.
"Units" shall mean units of limited partnership interest in the Operating
Partnership.
G-7
<PAGE>
PRIME CAPITAL INVESTMENT CORP.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Prime Capital Investment Corp.
Report of Independent Auditors...........................................
Balance Sheet as of September 30, 1997...................................
Notes to Balance Sheet...................................................
Brookdale Facilities
Report of Independent Auditors...........................................
Combined Statements of Net Assets (Liabilities) as of June 30, 1997
(unaudited), and December 31, 1996 and 1995.............................
Combined Statements of Operations for the six months ended June 30, 1997
and 1996 (unaudited) and the three years ended December 31, 1996, 1995
and 1994................................................................
Combined Statements of Changes in Net Assets (Liabilities) for the six
months ended June 30, 1997 (unaudited) and the three years ended
December 31, 1996, 1995 and 1994........................................
Combined Statements of Cash Flows for the six months ended June 30, 1997
and 1996 (unaudited) and the three years ended December 31, 1996, 1995
and 1994................................................................
Notes to Combined Financial Statements...................................
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Prime Capital Investment Corp.
We have audited the accompanying balance sheet of Prime Capital Investment
Corp. as of September 30, 1997. This balance sheet is the responsibility of
the Company's management. Our responsibility is to express an opinion on this
balance sheet based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the balance sheet is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the balance sheet. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall balance sheet
presentation. We believe that our audit of the balance sheet provides a
reasonable basis for our opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material respects, the financial position of Prime Capital Investment Corp. at
September 30, 1997 in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Chicago, Illinois
September 30, 1997
F-2
<PAGE>
PRIME CAPITAL INVESTMENT CORP.
BALANCE SHEET
SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<S> <C>
ASSETS
Cash...................................................................... $ 1
Deferred offering costs................................................... 75
----
Total assets.............................................................. $ 76
====
LIABILITIES AND STOCKHOLDER'S EQUITY
Accrued expenses.......................................................... $ 75
----
Total liabilities......................................................... 75
STOCKHOLDER'S EQUITY
Common stock, $.01 par value per share, 200,000,000 shares authorized, 100
issued and outstanding................................................... --
Additional paid-in capital................................................ 1
----
Total stockholder's equity................................................ 1
----
Total liabilities and stockholder's equity................................ $ 76
====
</TABLE>
See notes to balance sheet.
F-3
<PAGE>
PRIME CAPITAL INVESTMENT CORP.
NOTES TO BALANCE SHEET
SEPTEMBER 30, 1997
NOTE 1--FORMATION AND BUSINESS OF THE COMPANY
Prime Capital Investment Corp. (the "Company") was organized as a Maryland
Corporation on September 19, 1997 and initially capitalized on September 30,
1997. The Company intends to file a Registration Statement on Form S-11 with
the Securities and Exchange Commission with respect to a proposed public
offering (the "Offering") of 18.75 million shares (exclusive of the
underwriter's over-allotment option of 2,812,500 shares and warrants of
539,063) of common stock. The Company intends to invest primarily in
subordinated interests in mortgage-backed securities, commercial and multi-
family mortgage loans, equity investments in specific real estate assets or
companies, and net leased real estate. The Company's sole activity through
September 30, 1997, consisted of the organization of the Company. Accordingly,
no statement of operations is presented.
The Company also intends to enter into a management agreement (the
"Management Agreement") with Prime Capital Management, L.L.C. (the "Manager"),
a wholly-owned subsidiary of Prime Capital Holding, L.L.C., an affiliate of
the Prime Group ("Prime"). Prime and senior executives of the Manager are
anticipated to own up to 10% of the common stock of the Company upon
completion of the Offering. The Manager will advise the Company on various
facets of its business and manage its day-to-day operations, subject to the
supervision of the Company's Board of Directors and will receive a base
management fee of 1% per annum on the first $500 million (.75% thereafter) of
average invested assets, payable quarterly, plus incentive compensation, as
further defined in the Management Agreement.
The Company intends to adopt a non-qualified stock option plan to provide a
means of incentive compensation for the Manager, whereby the Manager will be
granted an option to purchase shares of Common Stock in the Company (or, at
the Company's election, units of limited partnership interests in Prime
Capital Limited Partnership, L.P., an indirect subsidiary of the Company) in
an amount equal to 10% of the shares outstanding following the Offering,
exercisable at the initial public offering price. One fourth of the Manager's
options will be exercisable on each of the first four anniversaries of the
closing date of the Offering. The maximum aggregate number of shares of common
stock that may be issued pursuant to options granted under the plan is 5
million.
NOTE 2--INCOME TAXES
It is the intent of the Company to qualify as a real estate investment trust
(REIT) under the Internal Revenue Code of 1986, as amended. As a REIT, the
Company generally will not be subject to federal income tax to the extent that
it distributes at least 95% of its REIT taxable income to its Shareholders.
REITs are subject to a number of organizational and operations requirements.
If the Company fails to qualify as a REIT in any taxable year, the Company
will be subject to federal income tax (including any applicable alternative
minimum tax) on its taxable income at regular corporate tax rates.
NOTE 3--DEFERRED OFFERING COSTS
In connection with the Offering, the Company has and will incur legal,
accounting and related costs. These costs will be deducted from the gross
proceeds of the Offering.
NOTE 4--USE OF ESTIMATES
The preparation of the balance sheet in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts in the balance sheet and accompanying notes.
Actual results could differ from these estimates.
F-4
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors of
Prime Capital Investment Corp.
We have audited the accompanying combined statements of net assets
(liabilities) of the Brookdale Facilities as of December 31, 1996 and 1995, and
the related combined statements of operations, changes in net assets
(liabilities) and cash flows for each of the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Brookdale Facilities' management. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits 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 audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the combined net assets (liabilities) of the Brookdale
Facilities at December 31, 1996 and 1995, and the combined results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
Ernst & Young LLP
Chicago, Illinois
February 18, 1997
F-5
<PAGE>
BROOKDALE FACILITIES
COMBINED STATEMENTS OF NET ASSETS (LIABILITIES)
<TABLE>
<CAPTION>
DECEMBER 31
JUNE 30 --------------------------
1997 1996 1995
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......... $ 1,486,845 $ 5,195,419 $ 6,546,155
Cash--Restricted................... 12,702,835 1,136,430 1,153,854
Accounts receivable................ 134,542 89,114 168,108
Due from affiliates................ 774,569 15,119 32,680
------------ ------------ ------------
Total current assets................. 15,098,791 6,436,082 7,900,797
Real estate, at cost:
Land............................... 10,369,050 5,044,515 5,044,515
Buildings and improvements......... 109,219,904 79,501,399 79,388,348
Furniture and equipment............ 5,649,934 3,324,798 3,186,653
------------ ------------ ------------
125,238,888 87,870,712 87,619,516
Accumulated depreciation........... (10,204,981) (16,150,263) (13,765,330)
------------ ------------ ------------
115,033,907 71,720,449 73,854,186
Deferred financing costs, net........ 2,259,592 1,961,047 2,096,800
Other................................ 3,923,922 332,953 325,431
------------ ------------ ------------
Total assets......................... 136,316,212 80,450,531 84,177,214
LIABILITIES
Current liabilities:
Mortgage notes payable............. 274,260 263,328 242,682
Accrued interest payable........... 390,503 377,517 401,081
Accrued real estate taxes.......... 992,377 1,215,034 1,180,167
Accounts payable................... 594,250 439,156 387,679
Tenant security deposits........... 2,219,659 2,164,580 2,099,022
Due to affiliates.................. 575,804 2,102,057 2,103,836
Other.............................. -- 140,423 137,262
------------ ------------ ------------
Total current liabilities............ 5,046,853 6,702,095 6,551,729
Mortgage notes payable............... 28,026,831 30,779,811 30,679,335
Note payable......................... 3,000,000 -- --
Bonds payable........................ 65,000,000 65,000,000 65,000,000
------------ ------------ ------------
Total liabilities.................... 101,073,684 102,481,906 102,231,064
------------ ------------ ------------
Net assets (liabilities)............. $ 35,242,528 $(22,031,375) $(18,053,850)
============ ============ ============
</TABLE>
See notes to combined financial statements.
F-6
<PAGE>
BROOKDALE FACILITIES
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
30 YEAR ENDED DECEMBER 31
------------------------ -------------------------------------
1997 1996 1996 1995 1994
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUE
Resident fees............. $11,627,652 $11,020,510 $22,946,291 $21,724,417 $19,156,319
EXPENSES
Facility operating........ 6,204,395 5,700,347 11,445,277 11,687,127 11,206,031
Real estate taxes......... 229,685 646,638 1,240,481 1,190,544 1,148,569
Depreciation and
amortization............. 1,445,530 1,362,577 2,520,686 3,316,607 3,383,755
Interest.................. 2,456,339 2,382,842 4,782,676 5,072,700 4,417,129
Financing fees............ 352,227 481,163 581,441 877,500 743,002
Property management and
other fees--Affiliate.... 349,969 595,486 1,181,487 1,147,856 1,013,446
----------- ----------- ----------- ----------- -----------
Total expenses............ 11,038,145 11,169,053 21,752,048 23,292,334 21,911,932
----------- ----------- ----------- ----------- -----------
Income (loss) before
income taxes............. 589,507 (148,543) 1,194,243 (1,567,917) (2,755,613)
Provision for income
taxes.................... (171,781) -- -- -- --
----------- ----------- ----------- ----------- -----------
Net income (loss)......... $ 417,726 $ (148,543) $ 1,194,243 $(1,567,917) $(2,755,613)
=========== =========== =========== =========== ===========
Unaudited pro forma data:
Income (loss) before
income taxes........... $ 589,507 $ (148,543) $ 1,194,243 $(1,567,917) $(2,755,613)
Pro forma benefit
(provision) for income
taxes.................. (235,803) 59,417 (477,697) 627,167 1,102,245
----------- ----------- ----------- ----------- -----------
Pro forma net income
(loss)................... $ 353,704 $ (89,126) $ 716,546 $ (940,750) $(1,653,368)
=========== =========== =========== =========== ===========
</TABLE>
See notes to combined financial statements.
F-7
<PAGE>
BROOKDALE FACILITIES
COMBINED STATEMENTS OF CHANGES IN NET ASSETS (LIABILITIES)
<TABLE>
<S> <C>
Net liabilities at January 1, 1994................................ $(16,555,845)
Contributions................................................... 3,351,856
Distributions................................................... (206,481)
Net loss........................................................ (2,755,613)
------------
Net liabilities at December 31, 1994.............................. (16,166,083)
Contributions................................................... 54,875
Distributions................................................... (374,725)
Net loss........................................................ (1,567,917)
------------
Net liabilities at December 31, 1995.............................. (18,053,850)
Contributions................................................... 49,859
Distributions................................................... (690,000)
Advances made to partners....................................... (4,531,627)
Net income...................................................... 1,194,243
------------
Net liabilities at December 31, 1996.............................. (22,031,375)
Contributions (unaudited)....................................... 34,491,177
Distributions (unaudited)....................................... (3,391,227)
Purchase of properties and ownership interests (unaudited)...... 25,756,227
Net income (unaudited).......................................... 417,726
------------
Net assets at June 30, 1997....................................... $ 35,242,528
============
</TABLE>
See notes to combined financial statements.
F-8
<PAGE>
BROOKDALE FACILITIES
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30 YEAR ENDED DECEMBER 31
------------------------- -------------------------------------
1997 1996 1996 1995 1994
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)....... $ 417,726 $ (148,543) $ 1,194,243 $(1,567,917) $(2,755,613)
Adjustments to reconcile
net income (loss) to
net cash provided by
operating activities:
Depreciation and
amortization.......... 1,445,530 1,362,578 2,520,686 3,316,607 3,383,755
Interest expense added
to mortgage note
payable............... 69,397 94,135 193,803 172,774 151,524
Changes in operating
assets and
liabilities:
(Increase) decrease in
accounts receivable... (45,428) 64,308 78,994 14,569 (134,930)
(Increase) decrease in
other assets.......... (39,171) 62,752 (7,522) 13,522 (42,112)
Increase (decrease) in
accrued interest
payable............... 12,986 (52,046) (23,564) 7,110 22,091
Increase (decrease) in
accrued real estate
taxes................. (222,657) 78,510 (146,837) 12,579 35,414
Increase (decrease) in
accounts payable...... 155,094 (131,562) 325,223 (32,538) 15,861
Increase (decrease) in
tenant security
deposits.............. 55,079 15,730 65,558 (4,916) 278,525
Decrease in arbitrage
rebate payable........ -- -- -- (806,418) (73,678)
Increase (decrease) in
other liabilities..... (140,423) (71,349) (88,881) (109,363) 77,400
------------ ----------- ----------- ----------- -----------
Net cash provided by
operating activities... 1,708,133 1,274,513 4,111,703 1,016,009 958,237
INVESTING ACTIVITIES
Additions to real
estate................. (24,704,585) (99,117) (251,196) (252,477) (1,165,444)
Reimbursement of
building improvements
from tenants........... -- -- -- 139,559 --
(Increase) decrease in
due from affiliates.... (759,450) (6,864) 17,561 20,389 14,215
------------ ----------- ----------- ----------- -----------
Net cash used in
investing activities... (25,464,035) (105,981) (233,635) (92,529) (1,151,229)
FINANCING ACTIVITIES
Proceeds from mortgage
note payable........... 42,501 85,000 170,000 170,000 170,000
Proceeds from note
payable................ 3,000,000 -- -- -- --
Repayment of mortgage
note payable........... (129,022) (118,868) (242,681) (223,680) (206,167)
Repayment of bonds
payable................ -- -- -- -- (4,000,000)
Repayment of note
payable--Affiliate..... -- -- -- -- (2,510,081)
(Increase) decrease in
cash--Restricted....... (11,566,405) (1,004,048) 17,424 1,607,980 5,783,087
Increase in deferred
financing costs........ (873,443) -- -- (27,075) --
Increase in deferred
leasing costs.......... -- -- -- -- (110,126)
Increase (decrease) in
due to affiliate....... (1,526,253) 325,791 (1,779) 314,805 257,289
Contributions from
current owners......... 34,491,177 -- -- -- --
Distributions to current
owners................. (1,929,012) -- -- -- --
Advances to previous
owners................. -- -- (4,531,627) -- --
Contributions from
previous owners........ -- 26,251 49,859 54,875 3,351,856
Distributions to
previous owners........ (1,462,215) (390,000) (690,000) (374,725) (206,481)
------------ ----------- ----------- ----------- -----------
Net cash provided by
(used in) financing
activities............. 20,047,328 (1,075,874) (5,228,804) 1,522,180 2,529,377
------------ ----------- ----------- ----------- -----------
Net increase (decrease)
in cash................ (3,708,574) 92,658 (1,350,736) 2,445,660 2,336,385
Cash and cash
equivalents at
beginning of period.... 5,195,419 6,546,155 6,546,155 4,100,495 1,764,110
------------ ----------- ----------- ----------- -----------
Cash and cash
equivalents at end of
period................. $ 1,486,845 $ 6,638,813 $ 5,195,419 $ 6,546,155 $ 4,100,495
============ =========== =========== =========== ===========
</TABLE>
See notes to combined financial statements.
F-9
<PAGE>
BROOKDALE FACILITIES
NOTES TO COMBINED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Brookdale Facilities represent a combination of four assisted living
facilities (Properties) currently owned, operated and managed by Brookdale
Living Communities, Inc. (Brookdale). The Properties were either contributed
to or acquired by Brookdale on May 7, 1997 in connection with an initial
public offering of Brookdale's common stock on that date. Prior to May 7, 1997
the Properties were owned by four separate partnerships. Pursuant to the
formation transactions more fully described elsewhere in this Registration
Statement and Prospectus, the Properties will be acquired by a newly formed
corporation, Prime Capital Investment Corp. (the Company), whose shares are
being registered pursuant to this Registration Statement. The Company will
lease the Properties back to Brookdale under a long-term operating lease.
The Properties and their locations are as follows:
<TABLE>
<CAPTION>
PROPERTY LOCATION
-------- ----------------------
<S> <C>
The Devonshire..................................... Lisle, Illinois
The Heritage....................................... Des Plaines, Illinois
Edina Park Plaza................................... Edina, Minnesota
Hawthorne Lakes.................................... Vernon Hills, Illinois
</TABLE>
The previous owners of The Devonshire and The Heritage properties
representing the sponsors of the Brookdale initial public offering contributed
their ownership interests to Brookdale in exchange for shares of Brookdale's
common stock; the non-sponsors sold their ownership interests to Brookdale for
cash. The assets and liabilities of The Devonshire and The Heritage properties
were recorded by Brookdale at the sponsor's historical cost, and at historical
cost adjusted for the purchase of the non-sponsor interests. Brookdale
acquired the Edina Park Plaza and Hawthorne Lakes properties from their
previous owners for a total purchase price of approximately $54.3 million,
including the assumption of debt of approximately $28.3 million. The recording
of the adjustments to historical cost bases of the Properties related to the
acquisition of non-sponsor ownership interests resulted in the elimination of
historical partner deficits of $25,756,227.
The previous owners of the Edina Park Plaza and Hawthorne Lakes properties
maintained their books and records on the basis of accounting used for federal
income tax purposes. The differences between federal income tax basis and
generally accepted accounting principles affecting the properties relate to
differences in the basis of real estate and the use of accelerated
depreciation methods with shorter depreciable lives used for federal income
tax basis.
All significant intercompany accounts and transactions have been eliminated
in combination.
The combined financial statements as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 are unaudited. In the opinions of management,
such financial statements and the related footnote disclosures reflect all
adjustment necessary for a fair presentation. All such adjustments are of a
normal and reoccurring nature.
RESIDENT FEE REVENUE
Resident fee revenue is recorded when services are rendered and consists of
fees for basic housing, support services, and fees associated with additional
services such as personalized health and assisted living care.
CASH EQUIVALENTS
All highly liquid investments, with a maturity of three months or less when
purchased, are considered to be cash equivalents.
F-10
<PAGE>
BROOKDALE FACILITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
REAL ESTATE
In March 1995, the Financial Accounting Standards Board issued Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to be Disposed Of," which was adopted by the Properties on January 1, 1995 and
under which they would be required to recognize impairment loses for the
Properties when indicators of impairment are present and the Properties'
expected undiscounted cash flows are not sufficient to recover the Properties'
carrying value. There was no impairment to the Properties at June 30, 1997,
December 31, 1996 and 1995.
Expenditures for ordinary maintenance and repairs are expensed to operations
as incurred. Significant renovations and improvements which improve and/or
extend the useful lives of the assets are capitalized and depreciated over
their estimated useful lives.
Depreciation is calculated using the straight-line method over the estimated
useful lives of assets, which are as follows:
<TABLE>
<S> <C>
Buildings and improvements 45 years
Furniture and fixtures 5 years
</TABLE>
DEFERRED FINANCING COSTS
Deferred financing costs are amortized using the straight-line method over
the term of the mortgage notes and bonds and related leases of credit.
Deferred financing costs are stated net of accumulated amortization of
$885,567 at June 30, 1997, and $2,076,854 and $1,941,101 at December 31, 1996
and 1995, respectively. As a result of the Company's purchase of the
Properties, $437,270 of deferred financing costs were written-off.
INCOME TAXES
Brookdale's net basis of real estate assets as reported in the combined
financial statements at June 30, 1997, exceeds the basis used for federal
income tax purposes by approximately $8.9 million due to differences in the
initial carryover basis of certain real estate assets and the use of
accelerated depreciation methods for federal income tax purposes.
Subsequent to May 7, 1997, the Properties are includable in the consolidated
income tax return of Brookdale. A provision for income taxes for the six
months ended June 30, 1997 relates to $429,453 of income for the period
subsequent to May 7, 1997. The liability for income taxes is included in due
to affiliates at June 30, 1997. The owners of the Properties prior to May 7,
1997 were partnerships. The partnerships were not subject to income taxes as
the income or loss from the partnerships were includable on the respective
federal income tax returns of the partners.
The unaudited pro forma (provision) benefit for income taxes for the
Brookdale Facilities is based on the historical combined financial data of the
Brookdale Facilities as if the entities comprising the Brookdale Facilities
had operated as taxable corporations for all periods presented and is recorded
at the federal and state statutory rates in effect during the period (40%).
USE OF ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the combined financial statements
and accompanying notes. Actual results could differ from those estimates.
2. CASH RESTRICTED
In accordance with the bonds payable described in Note 3, The Heritage and
The Devonshire have cash collateral pledge agreements which require quarterly
deposit payments in addition to the original deposit made on May 1, 1997. The
aggregate amount on deposit at June 30, 1997 was $11,313,302.
F-11
<PAGE>
BROOKDALE FACILITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The Heritage has life care escrow deposits required under Section 7(b) of
the Illinois Life Care Facility Act. The amount on deposit at June 30, 1997
and December 31, 1996 and 1995 was $431,049, $420,758, and $402,096,
respectively.
In accordance with the mortgage notes payable described in Note 3, the
Brookdale and the previous owners of the Edina Park Place and Hawthorne Lakes
properties is required to maintain escrow deposits for real estate taxes,
repairs and other operating activities. The aggregate amount on deposit at
June 30, 1997 and December 31, 1996 and 1995 was $958,484, $715,672 and
$751,758, respectively.
Pursuant to Internal Revenue Code Section 148(f). The Heritage was required
to rebate to the United States government any interest earnings in excess of
the interest cost of the Bond proceeds not yet used for Project costs. During
1995, the previous owners paid $806,418 from unused restricted Bond proceeds
to the United States government as a final settlement of its arbitrage of its
arbitrage rebate payable. No amounts were paid during the six months ended
June 30, 1997 or for the years ended December 31, 1996 and 1994.
3. LONG TERM DEBT
<TABLE>
<CAPTION>
JUNE 30 DECEMBER 31
----------- -----------------------
1997 1996 1995
<S> <C> <C> <C>
Mortgage notes payable:
Fixed rate mortgage notes payable issued
by local municipalities (A)............. $28,301,091 $28,430,113 $28,672,794
Interest reduction loan provided by
Housing and Redevelopment Authority of
Edina, Minnesota (B).................... -- 2,613,026 2,249,223
----------- ----------- -----------
$28,301,091 $31,043,139 $30,922,017
=========== =========== ===========
Note payable (C)......................... $ 3,000,000 $ -- $ --
=========== =========== ===========
Bonds payable............................
Variable rate tax-exempt bonds issued by
state and local governmental authorities
(D)..................................... $65,000,000 $65,000,000 $65,000,000
=========== =========== ===========
</TABLE>
- ---------------------
(A) The mortgage notes bear interest at 8% ($15,021,618 at June 30, 1997) and
8.525% ($13,279,473 at June 30, 1997), with monthly principal and interest
payments through maturity in 2027 and are collateralized by Edina Park
Plaza and Hawthorne Lakes.
(B) The Elderly Housing Interest Reduction Agreement arose out of tax
increment financing. Included in the balance is accrued interest of
$982,915 and $789,112 at December 31, 1996 and 1995, respectively. This
loan was not assumed by Brookdale.
(C) The note bears interest at an imputed rate of 8.25% per annum with
principal and interest due at maturity on April 1, 1999 and is unsecured.
The note requires interest to be paid on overdue payments at 12%. The
principal balance and any accrued interest may be prepaid without penalty.
(D) Permanent financing for the development for The Devonshire and The
Heritage has been provided by $65,000,000 (The Devonshire--$33,000,000;
The Heritage--$32,000,000) of tax-exempt Qualified Residential Rental
Bonds (the Bonds). The Bonds mature on December 15, 2019 and December 15,
2025, respectively.
Under the terms of the bond loan agreement, The Devonshire and The Heritage
are to make interest-only payments monthly, calculated using a floating
rate determined by the Remarketing Agent of the Bonds. The rates ranged
from 3.00% to 4.70% during the six months ended June 30, 1997, 2.30% to
4.40% during 1996, 2.55% to 5.20% during 1995 and 1.65% to 5.50% during
1994. The rates at June 30, 1997 were 4.18% and 4.30%, at December 31, 1996
were 4.00% and 4.10%, and December 31, 1995 were 5.05% and 5.20%.
F-12
<PAGE>
BROOKDALE FACILITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The maximum annual interest rate on the Bonds is 15%. Under certain
conditions the interest rate on the Bonds may be converted to a fixed rate
at the request of Brookdale.
The Bonds are collateralized by irrevocable letters of credit issued by two
banks in the aggregate amount of $66,714,932 (the Letters of Credit) that
expire May 18, 2000. The Letters of Credit are collateralized by a first
mortgage lien on the property and a cash collateral pledge agreement for
which an initial cash collateral deposit of $11,000,000 was made on May 7,
1997. Additionally, the Company makes scheduled quarterly deposit payments.
Letters of Credit fees equal to 1.3% of the stated amount of the Letters of
Credit, less the initial cash collateral deposit, and 0.25% of the initial
cash collateral deposit, are payable semi-annually in advance. Prior to May
7, 1997, the Letter of Credit fees equaled 0.5% per annum of the stated
amount of the Letters of Credit. The Devonshire and the Heritage incurred
financing fees of $352,227, $481,163, $581,441, $887,500 and $743,002,
during the six months ended June 30, 1997 and 1996 and the years ended
December 31, 1996, 1995 and 1994, respectively.
Each bondholder may tender bonds on any business day and receive a price
equal to the principal amount thereof, plus accrued interest through the
tender date. Upon tender, the Remarketing Agent fails to remarket any
bonds, Brookdale is obligated to purchase those bonds, for which they may
draw on the Letters of Credit.
Included in interest expense for the year ended December 31, 1994 is
$117,318 related to a $2,510,081 note payable to an affiliate that was repaid
in 1994. The note payable bore interest at 10% per annum.
Total interest paid on the mortgage notes payable, note payable and bonds
payable was $2,373,956, $2,340,753, $4,612,437, $4,892,816 and $4,243,514 for
the six months ended June 30, 1997 and 1996 and for the years ended December
31, 1996, 1995 and 1994, respectively.
The aggregate amount of all principal payments for all long-term debt as of
June 30, 1997, are as follows:
<TABLE>
<S> <C>
YEAR ENDED DECEMBER 31
1997.................................. $ 134,306
1998.................................. 285,904
1999.................................. 3,309,959
2000.................................. 336,211
2001.................................. 364,696
Thereafter............................ 91,870,015
-----------
$96,301,091
===========
</TABLE>
4. TAX INCREMENTAL FINANCING
The Heritage is located in a redevelopment area designated by a local
municipality as a tax incremental financing district (TIF). Under the terms of
the redevelopment agreement, The Heritage is eligible to receive up to
$1,136,889 for all eligible development costs, as defined through a Tax
Incremental Financing Bond (Bond). The Bond matures on December 1, 2007 and
bears interest at 10%, with principal and interest payable annually on each
December 1. The Bond is subject to optional redemption in whole, or in part,
at any time, at a redemption price equal to the principal outstanding at the
date redeemed. The Bond is subject to mandatory redemption, in part, by the
application of annual sinking fund installments by the municipality on each
December 1 thereafter, at a redemption price equal to the principal
outstanding at the date redeemed. The Bond is payable solely from real estate
tax incremental revenues and certain sales tax receipts generated in the TIF.
Payments are to be made to the extent of available TIF revenues. The
insufficiency of TIF revenues generated in the redevelopment area for any
given year shall not be considered a default in payment, but all past due
amounts shall be a continuing obligation payable from future TIF revenues. Any
unpaid amounts including interest, at maturity, will be forgiven. As the
collectibility of the bond principal and interest is dependent upon sufficient
revenues being generated in the redevelopment area, revenue is recognized by
The Heritage when principal and interest are
F-13
<PAGE>
BROOKDALE FACILITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
received. For the years ended December 31, 1996, 1995 and 1994, The Heritage
received principal and interest payments totaling $610,804, $144,089, and
$144,389, respectively. The Heritage did not receive any principal or interest
payments during the six months ended June 30, 1997 and 1996.
5. RELATED PARTY TRANSACTIONS
Historically, in connection with the management development and financing of
the Properties, affiliates of the previous owner were entitled to payments and
fees for various services provided. However, after May 7, 1997 the Properties
no longer incurred these fees. Such amounts incurred for the six months ended
June 30, 1997 and 1996 and for the years ended December 31, 1996, 1995 and
1994 are summarized as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30 YEAR ENDED DECEMBER 31
----------------- --------------------------------
1997 1996 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Property management
fees(a)................ $349,969 $595,486 $1,181,487 $1,147,856 $1,013,446
Administration fees(b).. 130,357 186,000 372,000 372,000 291,247
Development fees(c)..... 2,842 63,504 135,249 224,396 79,394
</TABLE>
- ---------------------
(a) Affiliates of the previous owners were entitled to a property management
fee ranging from 3% to 5% of gross revenues to 5% of total operating
income.
(b) Affiliates of the previous owners were entitled to an annual
administration fees of $186,000 for providing administrative services to
The Devonshire and The Heritage. The fee is included in facility operating
expense in the combined statements of operations.
(c) Affiliates of the previous owners were entitled to fees for services
rendered in connection with the identification, financings, computer usage
and leasing of Edina Park Plaza and Hawthorne Lakes.
Amounts due to affiliates are for amounts due for advances made by
affiliates. Amounts due from affiliates are for advances made by the
Properties to affiliates. Amounts due from and due to affiliates are non-
interest bearing and payable upon demand.
Average balances of amounts due from and due to affiliates for the six
months ended June 30, 1997 and 1996 and for the years ended December 31, 1996,
1995 and 1994 are summarized as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30 YEAR ENDED DECEMBER 31
--------------------- --------------------------------
1997 1996 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Due from affiliates...... $ 394,844 $ 35,241 $ 47,799 $ 42,875 $ 60,721
Due to affiliates........ 1,253,040 2,254,215 2,103,223 1,946,710 1,274,741
</TABLE>
In 1996, The Devonshire and The Heritage made advances to an affiliate of
the previous owners in the amount of $4,531,627. The advances are non-interest
bearing and have been reflected as an increase in the excess of liabilities
over net assets in the combined financial statements.
6. FAIR VALUES OF FINANCIAL INSTRUMENTS
Cash and cash equivalents, cash-restricted and variable rate and fixed rate
mortgage notes payable and note payable are reflected in the accompanying
combined balance sheets at amounts considered by management to reasonably
approximate fair value. Management estimates the fair value of its long-term
fixed rate mortgage notes payable and note payable generally using discounted
cash flow analysis based upon the Brookdale Facilities' current borrowing rate
for debt with similar maturities.
F-14
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY ANY SECU-
RITY OTHER THAN THE SHARES OF COMMON STOCK OFFERED BY THIS PROSPECTUS, NOR
DOES IT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE
SHARES OF COMMON STOCK BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAW-
FUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPEC-
TUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IM-
PLICATION THAT ANY INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUB-
SEQUENT TO THE DATE HEREOF.
------------
SUMMARY TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Organization and Relationships............................................ 13
Risk Factors.............................................................. 14
Operating Policies and Objectives......................................... 30
Management of Operations.................................................. 41
The Company............................................................... 48
Distribution Policy....................................................... 49
Yield Considerations Related to the Company's Investments................. 50
Initial Investments....................................................... 53
Yield Considerations Related to the Initial Investments................... 55
Capitalization............................................................ 56
Use of Proceeds........................................................... 57
Management's Discussion and Analysis of Liquidity and Capital Resources... 57
Principal Shareholders of the Company..................................... 58
Description of Capital Stock.............................................. 58
Certain Provisions of Maryland Law and of PCI's Articles of Incorporation
and Bylaws............................................................... 62
Common Stock Available for Future Sale.................................... 65
Operating Partnership Agreement........................................... 66
Certain Federal Income Tax Considerations................................. 69
ERISA Considerations...................................................... 84
Certain Legal Aspects of Mortgage Loans and Real Property Investments..... 86
Underwriting.............................................................. 95
Legal Matters............................................................. 97
Experts................................................................... 97
Glossary of Terms......................................................... G-1
Financial Statements...................................................... F-1
</TABLE>
------------
UNTIL [ ], (25 DAYS AFTER COMMENCEMENT OF THE OFFERING) ALL DEALERS EF-
FECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPAT-
ING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN
ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
18,750,000 SHARES
PRIME CAPITAL INVESTMENT CORP.
COMMON STOCK
-----------------
PROSPECTUS
-----------------
FRIEDMAN, BILLINGS,
RAMSEY & CO., INC.
OCTOBER , 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 30. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Set forth below is an estimate of the approximate amount of the fees and
expenses (other than sales commissions) payable by the Registrant in
connection with the issuance and distribution of the Common Stock.
<TABLE>
<S> <C>
SEC Registration Fee............................................ $107,159
Blue Sky Fees and Expenses......................................
NASD Filing Fee.................................................
The Nasdaq Stock Market Filing Fee..............................
Printing and Mailing Fees.......................................
Counsel Fees and Expenses.......................................
Accounting Fees and Expenses....................................
Miscellaneous...................................................
--------
Total....................................................... $
========
</TABLE>
ITEM 31. SALES TO SPECIAL PARTIES
Not Applicable.
ITEM 32. RECENT SALES OF UNREGISTERED SECURITIES
On September 24, 1997, Michael W. Reschke purchased 100 shares of Common
Stock of a purchase price of $10.00 per share pursuant to a Subscription
Agreement dated September 24, 1997 ("Subscription Agreement") executed by
Michael W. Reschke in favor of the Company. Pursuant to the terms of the
Subscription Agreement, the Company has the option to repurchase any or all of
the shares issued to Michael W. Reschke under the Subscription Agreement at
any time at a purchase price of $10.00 per share.
ITEM 33. INDEMNIFICATION OF DIRECTORS AND OFFICERS
PCI's Articles of Incorporation limits the liability of its directors and
officers to PCI and its stockholders to the fullest extent permitted from time
to time by Maryland law. Maryland law presently permits the liability of
directors and officers to a corporation or its stockholders for money damages
to be limited, except (i) to the extent that it is proved that the director or
officer 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) if a judgment or other final adjudication
is entered in a proceeding based on a finding that the director's or officer'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. This
provision does not limit the ability of PCI or its stockholders to obtain
other relief, such as an injunction or rescission.
The Articles of Incorporation and Bylaws require PCI to indemnify and hold
harmless and, without requiring a determination of the ultimate entitlement to
indemnification, pay reasonable expenses in advance of the final disposition
of any proceeding to its present and former directors and officers and certain
other parties to the fullest extent permitted from time to time by Maryland
law. The Maryland General Corporation Law ("MGCL") permits a corporation to
indemnify its directors, officers and certain other parties against judgments,
penalties, fines, settlements and reasonable expenses incurred by them in
connection with any proceeding to which they may be made a party by reason of
their service to or at the request of the corporation, unless it is
established that (i) the act or omission of the indemnified party was material
to the matter giving rise to the proceeding and (x) was committed in bad faith
or (y) was the result of active and deliberate dishonesty, (ii) the
II-1
<PAGE>
indemnified party actually received an improper personal benefit in money,
property or services or (iii) in the case of any criminal proceeding, the
indemnified party had reasonable cause to believe that the act or omission was
unlawful. Indemnification may be made against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by the director or
officer in connection with the proceeding. Indemnification is limited to court
ordered reimbursement for expenses, however, if the proceeding is one by or in
the right of the corporation, and the director or officer was adjudged to be
liable to the corporation or if the proceeding is one charging improper
personal benefit was improperly received. The termination of any proceeding by
conviction, or upon a plea of nolo contendere or its equivalent, or an entry of
any order of probation prior to judgment, creates a rebuttal presumption that
the director or officer did not meet the requisite standard of conduct required
for indemnification to be permitted. The MGCL requires a corporation (unless
its charter provides otherwise, which PCI's Articles of Incorporation does not)
to indemnify a director or officer who has been successful, on the merits or
otherwise, in the defense of any proceeding to which he is made a party by
reason of his service in that capacity. It is the position of the Securities
and Exchange Commission that indemnification of directors and officers for
liabilities arising under the Securities Act of 1933, as amended (the
"Securities Act"), is against public policy and is unenforceable pursuant to
Section 14 of the Securities Act.
The Registrant will carry an insurance policy providing directors' and
officers' liability insurance for any liability its directors or officers or
the directors or officers of any of its subsidiaries may incur in their
capacities as such.
The Registrant will indemnify Prime Capital Management, L.L.C., a Delaware
limited liability corporation (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
otherwise is accountable or liable for the debts or obligations of the
Registrant or its affiliates. In addition, the Manager and its officers and
directors will not be liable to the Registrant, and the Registrant will
indemnify the Manager and its officers and directors for acts performed
pursuant to the Management Agreement, filed as Exhibit 10.1 hereto, except for
claims arising from acts constituting bad faith, willful misconduct, gross
negligence or reckless disregard of their duties under the Management
Agreement.
The form of Underwriting Agreement, filed as Exhibit 1.1 hereto, provides for
the reciprocal indemnification by the Underwriter of Registrant and its
directors, officers and controlling persons, and by the Registrant of the
Underwriter and its directors, officers and controlling persons, against
certain liabilities under the Securities Act.
ITEM 34. TREATMENT OF PROCEEDS FROM SHARES BEING REGISTERED
Not Applicable.
II-2
<PAGE>
ITEM 35. FINANCIAL STATEMENTS AND EXHIBITS
(a) INDEX TO FINANCIAL STATEMENTS.
<TABLE>
<S> <C>
Prime Capital Investment Corp.
Report of Independent Auditors...........................................
Balance Sheet as of September 30, 1997...................................
Notes to Balance Sheet...................................................
Brookdale Facilities
Report of Independent Auditors...........................................
Combined Statements of Net Assets (Liabilities) as of June 30, 1997
(unaudited), and December 31, 1996 and 1995.............................
Combined Statements of Operations for the six months ended June 30, 1997
and 1996 (unaudited) and the three years ended December 31, 1996, 1995
and 1994................................................................
Combined Statements of Changes in Net Assets (Liabilities) for the six
months ended June 30, 1997 (unaudited) and the three years ended
December 31, 1996, 1995 and 1994........................................
Combined Statements of Cash Flows for the six months ended June 30, 1997
and 1996 (unaudited) and the three years ended December 31, 1996, 1995
and 1994................................................................
Notes to Combined Financial Statements...................................
</TABLE>
(b) EXHIBITS.
<TABLE>
<C> <S> <C> <C>
1.1* Form of Underwriting Agreement.........................
3.1* Articles of Incorporation of the Registrant............
3.2* Form of Bylaws of the Registrant.......................
4.1* Form of Common Stock Certificate.......................
5.1* Opinion of Winston & Strawn............................
8.1* Opinion of Winston & Strawn as to Tax Matters..........
10.1* Form of Management Agreement...........................
10.2* Form of Registration Rights Agreement between the Com-
pany and the persons named therein.....................
10.3* Partnership Agreement of Prime Capital Investment Part-
nership, L.P...........................................
10.4* Form of Stock Option Plan..............................
21.1* List of Subsidiaries of the Registrant.................
23.1* Consent of Winston & Strawn (included in Exhibits 5.1
and 8.1)...............................................
23.3 Consent of Ernst & Young LLP...........................
24.1 Powers of Attorney (included on Signature Page)........
27.1 Financial Data Schedule................................
</TABLE>
- ---------------------
* To be filed by amendment.
II-3
<PAGE>
ITEM 36. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (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 Securities and Exchange 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 against the Registrant 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 issues.
The undersigned Registrant hereby undertakes to provide to the Underwriter at
the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriter to
permit prompt delivery to each purchaser.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purposes of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THE
REGISTRANT CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS
ALL OF THE REQUIREMENTS FOR FILING ON FORM S-11 AND HAS DULY CAUSED THIS
REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED,
THEREUNTO DULY AUTHORIZED IN THE CITY OF CHICAGO, STATE OF ILLINOIS, ON THE
7TH DAY OF OCTOBER, 1997.
Prime Capital Investment Corp.,
a Maryland corporation
(Registrant)
/s/ James W. Roiter
By: _________________________________
James W. Roiter
President and Chief Executive
Officer
POWER OF ATTORNEY
EACH PERSON WHOSE SIGNATURE APPEARS BELOW HEREBY CONSTITUTES AND APPOINTS
JAMES W. ROITER HIS TRUE AND LAWFUL ATTORNEY-IN-FACT AND AGENT, WITH FULL
POWERS OF SUBSTITUTION, FOR HIM AND IN HIS NAME, PLACE AND STEAD, IN ANY AND
ALL CAPACITIES, TO SIGN AND TO FILE ANY AND ALL AMENDMENTS, INCLUDING POST-
EFFECTIVE AMENDMENTS AND ANY REGISTRATION STATEMENTS FILED PURSUANT TO RULE
462(B), TO THIS REGISTRATION STATEMENT WITH THE SECURITIES AND EXCHANGE
COMMISSION, GRANTING TO SAID ATTORNEY-IN-FACT POWER AND AUTHORITY TO PERFORM
ANY OTHER ACT ON BEHALF OF THE UNDERSIGNED REQUIRED TO BE DONE IN CONNECTION
THEREWITH.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON THE 7TH DAY
OF OCTOBER, 1997, IN THE CAPACITIES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ Michael W. Reschke Chairman of the Board, Director
___________________________________________
Michael W. Reschke
/s/ James W. Roiter President, Chief Executive Officer,
___________________________________________ Director
</TABLE> James W. Roiter
James W. Roiter
*By _________________________________
James W. Roiter
as attorney in fact
II-5
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our reports dated September 30, 1997, with respect to the balance
sheet of Prime Capital Investment Corp., and dated February 18, 1997, with
respect to the combined financial statements of the Brookdale Facilities in
the Registration Statement (Form S-11) and related Prospectus of Prime Capital
Investment Corp. for the registration of 22,101,563 shares of its common
stock.
Ernst & Young LLP
Chicago, Illinois
October 2, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,000
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 75,000<F1>
<DEPRECIATION> 0
<TOTAL-ASSETS> 76,000
<CURRENT-LIABILITIES> 75,000<F2>
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 1,000<F3>
<TOTAL-LIABILITY-AND-EQUITY> 76,000
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 0
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1> Amount consists of 75,000 in deferred in costs related to offering.
<F2> Amount consists of 75,000 in accrued expenses.
<F3> Amount represents additional paid-in capital on common stock
</FN>
</TABLE>
