<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 12, 1998
REGISTRATION NO. 333-48653
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 4
TO
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
REALTRUST ASSET CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENTS)
2855 EAST COTTONWOOD PARKWAY, SUITE 500
SALT LAKE CITY, UTAH 84121
(ADDRESS OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
JOHN D. FRY, CHIEF EXECUTIVE OFFICER
REALTRUST ASSET CORPORATION
2855 EAST COTTONWOOD PARKWAY, SUITE 500
SALT LAKE CITY, UTAH 84121
(801) 365-3000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
COPIES TO:
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CHRISTOPHER A. WILSON, ESQ. PETER T. HEALY, ESQ.
JEFFERS, WILSON, SHAFF & FALK, LLP O'MELVENY & MYERS LLP
18881 VON KARMAN AVENUE, SUITE 1400 275 BATTERY STREET
IRVINE, CALIFORNIA 92612 SAN FRANCISCO, CALIFORNIA 94111
TELEPHONE: (714) 660-7700 TELEPHONE : (415) 984-8700
FACSIMILE: (714) 660-7799 FACSIMILE: (415) 984-8701
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF THE PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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<CAPTION>
- --------------------------------
TITLE OF EACH CLASS OF AMOUNT TO BE PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED(1) OFFERING PRICE PER SHARE AGGREGATE OFFERING PRICE(2) REGISTRATION FEE
<S> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
Units........................... 4,600,000 $16.00 $ 73,600,000 $21,712.00
Common Stock, par value $.001... 4,600,000 (3) (3) (3)
Common Stock Purchase
Warrants...................... 4,600,000 (3) (3) (3)
Representative's Warrants....... 138,000 $ 0.01 $ 1,380 $ 0.41
Common Stock, par value $.001
per share, issuable upon
exercise of Common Stock
Purchase Warrants(4).......... 4,600,000 $16.00 $ 73,600,000 $21,712.00
Common Stock, par value $.001
per share, issuable upon
exercise of Representative's
Warrants(4)................... 138,000 $16.00 $ 2,208,000 $ 651.36
------------ ----------
Total................. $149,409,380 $44,075.77
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(1) Assumes exercise of an over-allotment option granted to the Underwriters to
purchase 600,000 Units.
(2) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(a).
(3) Included in the Units at no additional cost.
(4) This Registration Statement also covers any additional shares of Common
Stock which may become issuable by virtue of the anti-dilution provisions of
the Common Stock Purchase Warrants and Representative's Warrants. No
additional registration fee is included for these shares.
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 THE REGISTRATION STATEMENT
SHALL BE COME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
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<PAGE> 2
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 SALES 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.
PROSPECTUS SUBJECT TO COMPLETION, DATED JUNE 12, 1998
realtrust logo
4,000,000 UNITS
REALTRUST ASSET CORPORATION
EACH UNIT TO CONSIST OF ONE SHARE OF COMMON STOCK AND ONE STOCK PURCHASE WARRANT
All of the units (the "Units") offered hereby are being sold by RealTrust
Asset Corporation, a newly formed Maryland corporation (the "Company"). Each
Unit consists of one share of Company common stock, par value $.001 per share
("Common Stock"), and one warrant to purchase one share of Common Stock (a
"Warrant"). The Warrants included with the Units will automatically detach from
the Common Stock six months after the closing of this offering (the "Offering").
See "Description of Capital Stock." Each Warrant entitles the holder thereof to
purchase one share of Common Stock (a "Warrant Share"), subject to certain
anti-dilution adjustments. The Warrants will become exercisable six months after
the initial closing of this Offering and will remain exercisable until 5:00 p.m.
New York Time on the third anniversary of the date the Warrants first become
exercisable, at an exercise price equal to the Price to Public (as set forth
below). The Company will elect to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"), and
generally will not be subject to federal taxation on its income to the extent
that it distributes its net income to its stockholders and maintains its
qualification as a REIT.
------------------------
SEE "RISK FACTORS" COMMENCING ON PAGE 19 FOR MATERIAL RISK FACTORS THAT SHOULD
BE CONSIDERED BY PROSPECTIVE INVESTORS. THESE RISKS INCLUDE:
- - Adoption of the President's 1999 Budget Plan would prohibit a REIT from
owning, by vote or value, more than 10% of the stock of a corporation and
would require the Company to combine and/or fully divest itself of its
interest in CMG Funding Corp., a Delaware corporation and a taxable subsidiary
of the Company (the "Taxable Subsidiary"), and to make other significant
changes in the Company's operations, which may reduce earnings and
distributions.
- - The Company has no commitments to purchase specific assets and none of the
anticipated net proceeds from the Offering have been allocated to specific
investments. Inability to acquire or delays in investing the net proceeds from
this Offering will reduce the Company's anticipated income and may have a
material adverse effect on its results of operations. The Company will have
broad discretion (i) in the allocation of the net proceeds, (ii) in the types
and percentages of any type of Mortgage Assets included in its investment
portfolio, and (iii) in changing its investment and operating policies and
strategies without the consent of the stockholders. Such discretion creates
uncertainty for stockholders and could adversely affect results of operations.
- - The Company intends to acquire most of its Subprime Mortgage Loans from the
Taxable Subsidiary. There can be no assurance that the Taxable Subsidiary will
originate and sell to the Company a sufficient quantity of Subprime Mortgage
Loans, which may require the Company to acquire Subprime Mortgage Loans from
third parties at a higher cost, thereby adversely affecting results of
operations.
(continued on next page)
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- --------------------------------------------------------------------------------------------------------------------
Per Unit.................. $ $ $
- --------------------------------------------------------------------------------------------------------------------
Total(3).................. $ $ $
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</TABLE>
(1) Excludes value of the Warrants to be issued to Stifel, Nicolaus & Company,
Incorporated (the "Representative"), to purchase 120,000 shares of Common
Stock (138,000 shares of Common Stock if the Underwriters' over-allotment
option is exercised) at an exercise price equal to the Price to Public (the
"Representative's Warrants"). The Company and certain of its affiliates have
agreed to indemnify the Underwriters against certain liabilities, including
liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
(2) Before deducting expenses of the Offering payable by the Company, estimated
to be $1,100,000.
(3) The Company has granted the Underwriters an option exercisable within 30
days after the date of this Prospectus to purchase up to 600,000 additional
Units on the same terms and conditions set forth above to cover
over-allotments, if any. If all such additional Units are purchased, the
total Price to Public, Underwriting Discount and Proceeds to Company will be
$ , $ and $ , respectively. See "Underwriting."
------------------------
The Securities are offered by the Underwriters subject to receipt and
acceptance by them, prior sale and the Underwriters' right to reject any order
in whole or in part and to withdraw, cancel or modify the offer without notice.
It is expected that delivery of certificates for the Securities will be made
through The Depository Trust Company, on or about , 1998.
STIFEL, NICOLAUS & COMPANY
INCORPORATED
, 1998
<PAGE> 3
(continued from previous page)
- - The Taxable Subsidiary commenced operations in April, 1996 and has experienced
losses of $1,774,311 and $1,305,866 for fiscal years ended December 31, 1997
and 1996, respectively, and had an accumulated deficit of $1,494,072 as of
December 31, 1997. The Company's management of an investment portfolio is a
change from the historical operations of the Taxable Subsidiary. The Company
will not control the operations of the Taxable Subsidiary. Management of the
Company has no experience in managing a REIT, which could adversely affect the
Company's results of operations.
- - Conflicts of interest arising from the relationships between the Company and
each of ContiFinancial Corporation and the Founders may result in decisions
regarding the Company and its operations, which may not be in the best
interest of the other stockholders or the Company as a whole. The Taxable
Subsidiary has agreed to sell 75% of its fixed rate Subprime Mortgage Loans to
ContiFinancial Corporation at prices established by ContiFinancial Corporation
(or pay a 40 basis point penalty on the principal shortfall). The Company has
appointed ContiFinancial Corporation as exclusive placement agent for
structured debt offerings at fees which may exceed those offered by third
parties. Of the net proceeds of the Offering, $2.0 million will be used to
repay the Taxable Subsidiary's working capital debt to ContiFinancial
Corporation and $2.2 million will be paid to redeem the Company's preferred
stock held by ContiFinancial Corporation.
- - The Founders and ContiFinancial Corporation own in the aggregate 19.7% of the
Common Stock of the Company outstanding immediately after the closing of the
Offering and could exert significant influence over the Company. The Founders
will own approximately 66.7% of the voting stock of the Taxable Subsidiary and
will control its operations. Investors in the Offering will not acquire an
interest in any entity that controls the Taxable Subsidiary.
- - The Company intends to invest in Subprime Mortgage Loans, which are generally
subject to higher delinquency and loss rates than Prime Mortgage Loans and no
assurance can be given that the Company's underwriting criteria or methods
will adequately protect the Company.
- - Subprime Mortgage Loans are subject to prepayment risks even during periods of
stable or rising interest rates in that Subprime Mortgage Loan borrowers may
be able to improve their credit ratings and refinance their Mortgage Loans to
benefit from reduced interest rate costs.
- - The Company will face substantial competition for Subprime Mortgage Loans,
which may adversely affect future performance and results of operations.
- - The Company may invest in Mortgage Loans with high loan-to-value ratios and
subordinated Mortgage Securities, which are subject to greater loss and credit
risks than senior or more adequately collateralized Mortgage Loans.
- - The Company intends to invest in Mortgage Securities, which may include
interest-only and principal-only Mortgage Securities and non-investment grade
Mortgage Securities, which may be subject to a greater risk of loss than
investments in senior, investment-grade securities.
- - Sudden and significant increases in interest rates may adversely affect the
Company's cost of short-term borrowings used to finance the purchase of
long-term Mortgage Assets, and may thereby substantially reduce the Company's
income or result in losses from operations.
- - Declining interest rates may increase prepayment rates and reduce net interest
income.
- - The Company intends to use hedging strategies, including interest rate swaps
and interest rate collars, caps or floors, which have significant transaction
costs (and therefore will reduce the Company's overall returns on its
investments) and may not be effective in mitigating interest rate and
prepayment risks. The Company has no specific hedging policies and generally
will have broad discretion in the types of hedging transactions it utilizes.
- - The Company intends to borrow against a substantial portion of the market
value of its assets (up to approximately 92%) and to maintain a ratio of
equity to total assets of approximately 8% to 15%; such leverage is likely to
increase the volatility of income and asset value and may result in losses.
The Company's governing instruments do not restrict management's ability to
leverage the Company's assets.
- - Mortgage Loan prepayments may reduce the average lives of certain Mortgage
Assets and thereby reduce the Company's operating income.
- - Defaults on Mortgage Loans held by the Company may reduce earnings and
distributions or result in losses.
- - Purchasers of the Units will be subject to immediate and substantial dilution
of $4.22 per share prior to exercise of the Warrants and Representative's
Warrants or $2.31 per share assuming exercise of the Warrants and
Representative's Warrants and may be subject to further and substantial
dilution resulting from additional equity offerings in the future.
- - Failure to acquire, by June 30, 1998, assets having a value of approximately
$325.0 million would preclude the Company from electing REIT status for 1998.
Failure to elect or maintain REIT status will subject the Company to
corporate-level tax and thereby reduce or eliminate earnings and the amount of
cash available for distributions to shareholders.
<PAGE> 4
See "Underwriting." For purposes of this Prospectus, the Units, the Common
Stock, the Warrants and the Warrant Shares are referred to collectively as the
"Securities" unless the context indicates otherwise.
Prior to the closing of the Offering, there has been no public market for
the Securities. It is currently estimated that the Price to Public for the Units
will be between $14.00 and $16.00 per Unit. See "Underwriting" for information
relating to the factors considered in determining the Price to Public. The
Company intends to apply for quotation of the Units on the American Stock
Exchange under the symbol "RAC.U" The Company intends to apply for quotation of
the Common Stock and Warrants on the American Stock Exchange effective on the
date the Warrants automatically detach from the Common Stock under the symbols
"RAC" and "RAC.WS," respectively. There can be no guarantee that a public market
for the Securities will develop or be sustained.
------------------------
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE UNITS. SUCH
TRANSACTIONS MAY INCLUDE STABILIZING BIDS AND PURCHASES IN THE OPEN MARKET,
OVER-ALLOTMENTS, SYNDICATE SHORT COVERING TRANSACTIONS AND PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE> 5
TABLE OF CONTENTS
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PROSPECTUS SUMMARY............................... 1
The Company.................................... 1
Summary Risk Factors........................... 2
Competitive Advantages......................... 7
Management..................................... 8
Business Strategies............................ 8
Marketing and Production Strategy............ 8
Underwriting and Quality Control............. 10
Loan Sales for Cash.......................... 10
Mortgage Investment Portfolio................ 10
Structured Debt Instruments.................. 12
Capital Allocation Guidelines................ 12
Servicing Activities......................... 12
Structure and Formation Transactions........... 13
Structure of the Company..................... 13
Formation Transactions and Post-Closing
Transactions............................... 13
Dividend Policy and Distributions.............. 16
The Offering................................... 16
Conflicts of Interest and Related Party
Transactions................................. 17
ContiFinancial Corporation................... 17
Capstone Investments, Inc. .................. 18
Control of Taxable Subsidiary................ 18
Formation Transactions....................... 18
Employment Agreements........................ 18
RISK FACTORS..................................... 19
General........................................ 19
President's 1999 Budget Plan, If Enacted, Would
Adversely Affect Results of Operations....... 19
Operation of a New Enterprise Involves
Uncertainty.................................. 20
Inability to Acquire or Delays in Acquiring
Mortgage Assets Will Reduce Income to the
Company.................................... 20
The Taxable Subsidiary May Not Provide
Sufficient Subprime Mortgage Loans to the
Company Which May Adversely Affect Results
of Operations.............................. 20
Limited Operating History of the Company
Creates Uncertainty About Future Results... 21
The Management of an Investment Portfolio of
Mortgage Assets is a Change in
Operations................................. 21
Lack of Experience Managing a REIT May
Adversely Affect Operating Results......... 21
Loss of Any Key Personnel May Adversely
Affect Operations.......................... 21
Future Revisions in Investment and Operating
Policies and Strategies by Board of
Directors Creates Uncertainty.............. 21
Failure to Raise Additional Capital May
Adversely Affect Future Growth and Results
of Operations.............................. 22
Conflicts of Interest May Result in Decisions
That Do Not Fully Reflect the Stockholders'
Best Interest................................ 22
Conflicts of Interest With and Dependence
Upon ContiFinancial Corporation May Not be
in the Stockholders' Best Interest......... 22
A Portion of the Net Proceeds From This
Offering Will Be Used to Retire Debt to and
Redeem Stock of ContiFinancial
Corporation................................ 23
Investors Will Have No Voting Control of the
Taxable Subsidiary......................... 23
The Founders and ContiFinancial Corporation
May Exert Influence Over the Company....... 23
Investments in Subprime Mortgage Loans Involve
Greater Risk of Loss......................... 23
Higher Delinquency and Loss Rates on Subprime
Mortgage Loans May Result in Losses........ 23
Subprime Mortgage Loans May Experience High
Prepayment Rates Which Reduces Income From
Operations................................. 24
Competition in the Subprime Mortgage Lending
Market May Have a Material Adverse Effect
on Results of Operations................... 24
Investments in High LTV Mortgage Loans and
Subordinated Mortgage Securities Involve
Greater Risks of Loss........................ 25
Defaults on High LTV Mortgage Loans May
Result in Losses........................... 25
Subordinated Classes of Mortgage Securities
Are Subject to Greater Credit Risks Than
Senior Classes............................. 25
Interest Rate Fluctuations May Adversely Affect
Operations and Net Interest Income........... 26
Interest Rate Mismatches Between Mortgage
Assets and Borrowings May Result in Reduced
Income or Losses........................... 26
Interest Rate Increases May Reduce Mortgage
Loan Originations and Income............... 27
Declining Interest Rates May Increase
Prepayment Rates and Reduce Net Interest
Income..................................... 27
Hedging Transactions Limit Gains and May
Increase Exposure to Losses................ 27
Interest-Only and Principal-Only Mortgage
Securities Are Subject to Substantial
Interest Rate and Prepayment Risks Which
May Adversely Affect Results of
Operations................................. 28
The Company Has No Specific Hedging Policies
and Failure to Appropriately Hedge May
Adversely Affect Results of Operations..... 28
Counterparty and Unenforceability Risk in
Hedging Transactions May Result in
Losses..................................... 28
Basis Risk in Hedging Transactions May Result
in Losses.................................. 29
Borrowing to Finance Investment Portfolio May
Adversely Affect Results of Operations....... 29
Leverage Increases Exposure to Loss.......... 29
Inability to Implement Leveraging Strategy
May Reduce Income or Result in Losses...... 30
Inability to Renew or Replace Maturing
Borrowings May Result in Losses............ 30
Decline in Market Value of Mortgage Asset May
Limit the Company's Ability to Borrow or
Result in Losses........................... 30
Contingent and Residual Risks in Structured
Debt Financings May Adversely Affect
Results of Operations...................... 31
Unavailability of Structured Debt Financing
May Adversely Affect Results of
Operations................................. 31
The Company Depends Upon Several Lenders to
Finance Operations......................... 31
Lender Bankruptcy May Result in Losses....... 32
Risks Relating to Mortgage Lending
Operations................................... 32
Default on Mortgage Loans May Result in
Losses..................................... 32
Competition for Mortgage Loans from
Independent Mortgage Brokers and
Correspondents May Adversely Affect Results
of Operations.............................. 33
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Commitments to Purchase Mortgage Assets
Exposes the Company to Interest Rate
Risk....................................... 33
Payments to Brokers in Violation of RESPA May
Result in Adverse Claims................... 33
Lack of Geographic Diversification Exposes
the Company to Greater Default Risk........ 33
Inadequate or Ineffective Servicing May
Increase Delinquency and Default Rates..... 34
Inability to Sell Mortgage Loans May
Adversely Affect Results of Operations..... 34
Legislation and Regulation May Subject the
Company to Costs of Compliance and Adverse
Claims For Noncompliance................... 34
Mortgage Loans Secured By Properties With
Environmental Problems May Result in
Liability and Losses....................... 35
Changes in Economic Conditions May Adversely
Affect Results of Operations............... 36
Factors Beyond Control of the Company May
Affect Performance of the Investment
Portfolio.................................... 36
Investors Will Incur Immediate and Substantial
Economic Dilution............................ 36
Future Debt and Equity Offerings May Dilute
Investors.................................... 37
Failure to Develop a Trading Market May Result
in Depressed Common Stock Price.............. 37
Failure to Maintain REIT Status Would Have
Adverse Tax Consequences..................... 37
Failure to Qualify for Exemption from
Investment Company Act May Adversely Affect
the Company.................................. 38
Issuances of Preferred Stock May Adversely
Affect the Value of Common Stock............. 38
Restrictions on Ownership of Capital Stock
Could Discourage a Change of Control......... 38
THE COMPANY...................................... 40
USE OF PROCEEDS.................................. 40
DIVIDEND POLICY AND DISTRIBUTIONS................ 41
DIVIDEND REINVESTMENT PLAN....................... 42
DILUTION......................................... 43
CAPITALIZATION................................... 44
REALTRUST ASSET CORPORATION
PRO FORMA FINANCIAL DATA....................... 44
REALTRUST ASSET CORPORATION
PRO FORMA BALANCE SHEET (unaudited)............ 45
REALTRUST ASSET CORPORATION
PRO FORMA STATEMENT OF OPERATIONS
(unaudited).................................... 46
SELECTED FINANCIAL DATA OF REALTRUST ASSET
CORPORATION AND CMG FUNDING CORP............... 47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............ 48
Overview....................................... 48
Certain Accounting Policies and Procedures..... 48
Results of Operations.......................... 49
Liquidity and Capital Resources................ 50
Inflation...................................... 51
Year 2000 Compliance........................... 51
BUSINESS......................................... 52
General........................................ 52
Competitive Advantages......................... 53
Overview of Subprime Mortgage Market........... 55
Industry Developments.......................... 56
Mortgage Lending Business...................... 57
Marketing and Production Strategy.............. 58
Underwriting and Quality Control Strategies.... 64
Financing Loans Held for Sale and Investment
Prior to Structured Debt Financing........... 68
Information Management Systems................. 70
Mortgage Investment Portfolio.................. 71
Retained Interests in Structured Debt
Instruments.................................. 72
Capital and Liquidity Management............... 73
Capital Allocation Guidelines.................. 74
Servicing Activities........................... 75
Interest Rate Risk Management.................. 77
Credit Risk Management......................... 79
Mortgage Loan Prepayments...................... 80
Future Changes in Operating, Investment and
Accounting Policies.......................... 81
MANAGEMENT....................................... 83
Directors and Executive Officers............... 83
Key Employees.................................. 84
Terms of Directors and Officers................ 85
Committees of the Board........................ 86
Compensation of Directors...................... 86
Compensation Committee Interlocks.............. 86
Executive Compensation......................... 86
Stock Option Grants............................ 92
Individual Grants.............................. 92
STRUCTURE AND FORMATION TRANSACTIONS............. 93
Structure of the Company....................... 93
RealTrust Asset Corporation.................... 93
The Taxable Subsidiary......................... 94
Formation Transactions and Post-Closing
Transactions................................. 94
CONFLICTS OF INTEREST AND RELATED PARTY
TRANSACTIONS................................... 95
ContiFinancial Corporation..................... 95
Capstone Investments, Inc...................... 97
Control of Taxable Subsidiary.................. 97
Formation Transactions......................... 97
Employment Agreements.......................... 97
PRINCIPAL STOCKHOLDERS........................... 98
DESCRIPTION OF CAPITAL STOCK..................... 99
General........................................ 99
Historical Capital Structure................... 99
Common Stock................................... 99
Preferred Stock................................ 99
Warrants and Options........................... 100
Repurchase of Shares and Restriction on
Transfer..................................... 103
Limitation of Liability and Indemnification.... 105
Control Share Acquisitions..................... 106
Business Acquisitions Statutes................. 107
Transfer Agent and Registrar................... 107
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(ii)
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SHARES ELIGIBLE FOR FUTURE SALE.................. 108
General........................................ 108
Registration Rights............................ 108
FEDERAL INCOME TAX CONSIDERATIONS................ 110
General........................................ 110
Opinion of Counsel............................. 110
Qualification as a REIT........................ 111
Taxation of the Company........................ 114
Taxation of Taxable Subsidiary................. 114
Termination or Revocation of REIT Status....... 115
Taxation of the Company's Stockholders......... 115
Taxation of Tax-Exempt Entities................ 116
Foreign Investors.............................. 117
Recordkeeping Requirement...................... 117
Backup Withholding............................. 117
Recent Legislative Proposals................... 118
State and Local Taxes.......................... 118
ERISA Considerations........................... 118
UNDERWRITING..................................... 119
LEGAL MATTERS.................................... 121
EXPERTS.......................................... 121
ADDITIONAL INFORMATION........................... 121
GLOSSARY......................................... 122
TABLE OF CONTENTS TO FINANCIAL STATEMENTS........ F-1
</TABLE>
(iii)
<PAGE> 8
PROSPECTUS SUMMARY
The summary information below should be read in conjunction with, and is
qualified in its entirety by, the detailed information appearing elsewhere in
this Prospectus. Capitalized terms used herein shall have the definitive
meanings assigned to them in the text below and in the Glossary beginning at
page 122.
THE COMPANY
RealTrust Asset Corporation, a Maryland corporation formed on April 1, 1998
("RealTrust" or the "Company"), is a specialty finance company engaged in the
business of originating, purchasing, selling and servicing mortgage loans
secured (i) primarily by first mortgages on single-family residences ("First
Lien Mortgage Loans") and (ii) to a much lesser extent by second lien Mortgage
Loans ("Second Lien Mortgage Loans"; collectively with First Lien Mortgage
Loans, "Mortgage Loans"). RealTrust will own and manage a portfolio composed
primarily of First Lien Mortgage Loans that do not conform to one or more of the
underwriting criteria of Federal Home Loan Mortgage Corporation ("FHLMC") and
Federal National Mortgage Association ("FNMA"). Such Mortgage Loans are referred
to as "Subprime Mortgage Loans." RealTrust expects to acquire Subprime Mortgage
Loans primarily from CMG Funding Corp., a Delaware corporation and RealTrust's
taxable subsidiary (the "Taxable Subsidiary"). The Company has entered into a
Mortgage Loan Purchase Agreement (the "Purchase Agreement") with the Taxable
Subsidiary pursuant to which the Company has the right of first refusal on all
Mortgage Loans originated and acquired by the Taxable Subsidiary (except the 75%
of fixed-rate Subprime Mortgage Loans required to be sold to ContiFinancial
Corporation).
RealTrust intends to build a portfolio of primarily Subprime Mortgage Loans
and securities backed by Mortgage Loans ("Mortgage Securities"; together with
Mortgage Loans, "Mortgage Assets") financed with structured debt instruments and
reverse repurchase agreements. The portfolio is expected to generate net
interest income, which, upon election to be taxed as a real estate investment
trust ("REIT"), will not be taxed at the corporate level. RealTrust is now and
intends to remain self-advised and self-managed.
The Taxable Subsidiary has operated a mortgage lending business since
April, 1996 and currently originates Mortgage Loans through 14 wholesale and two
retail branch offices. The Taxable Subsidiary's mortgage lending operations
originate and purchase fixed and adjustable-rate Subprime Mortgage Loans, as
well as Mortgage Loans that conform to FHLMC or FNMA underwriting criteria
("Prime Mortgage Loans"). In addition, the Taxable Subsidiary has built a
correspondent lending operation that began purchasing Subprime Mortgage Loans in
the fourth quarter of 1997. Pursuant to the Purchase Agreement, the Company
intends to purchase adjustable-rate Subprime Mortgage Loans originated or
acquired by the Taxable Subsidiary, as well as fixed-rate Subprime Mortgage
Loans not sold to ContiFinancial Corporation. However, the Company does not
intend to purchase Prime Mortgage Loans from the Taxable Subsidiary.
The Taxable Subsidiary will sell its Prime Mortgage Loans and selected
Subprime Mortgage Loans to generate current income and cash flow to partially
fund the Company's mortgage lending operations. See "Business -- Industry
Developments." For the fiscal quarter ended March 31, 1998, the Taxable
Subsidiary had originated or purchased $60.5 million of Subprime Mortgage Loans,
including $2.8 million of Subprime Mortgage Loans purchased through its
correspondent operations, and originated $91.6 million of Prime Mortgage Loans.
RealTrust owns 100% of the preferred stock (representing 95% of the economic
interest) of the Taxable Subsidiary but does not control its operations. The
Founders own approximately 66.7% of the voting common stock of the Taxable
Subsidiary and, therefore, control its operations. See "Structure and Formation
Transactions."
To date, the Taxable Subsidiary has sold all of its Subprime Mortgage Loan
production in whole loan sales for cash. From September 1, 1996 to March 31,
1998, the Taxable Subsidiary sold approximately $150.5 million of Subprime
Mortgage Loans, or approximately 54% of all Subprime Mortgage Loan sales during
such period, to ContiFinancial Corporation (with its affiliates ContiMortgage
Corporation, ContiTrade Services L.L.C., and ContiFinancial Services
Corporation, "ContiFinancial Corporation"). Subsequent to the closing of the
Offering, the Company, a newly-established entity, will commence building a
portfolio of Subprime Mortgage Loans and financed with structured debt. See
"Business -- Industry Developments" and
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"Risk Factors -- Operation of a New Enterprise Involves Uncertainty." The
Taxable Subsidiary will continue to sell certain Mortgage Loans for cash,
primarily to the Company, but also to third party investors, including the sale
of 75% of its fixed-rate Subprime Mortgage Loans to ContiFinancial Corporation.
See "Conflicts of Interest and Related Party Transactions."
RealTrust will elect to be taxed as a REIT under the Internal Revenue Code
of 1986, as amended (the "Code"), beginning with the tax year ending December
31, 1998. Upon such election, RealTrust will generally not be subject to Federal
income tax to the extent that it distributes its earnings to its stockholders
and maintains its qualification as a REIT. The Taxable Subsidiary has been and
will continue to be taxed as a "C" corporation and, therefore, was subject to
tax on any earnings.
The Company's principal business objectives are to increase earnings per
share, to increase cash available for distribution to stockholders and to
enhance stockholder value. The Company intends to accomplish these goals
primarily by capitalizing on the yields available from investing in Subprime
Mortgage Loans compared to Prime Mortgage Loans, and managing the risks of such
investments. The Company will derive income from two principal business
activities, as follows:
(i) the management of an investment portfolio of Mortgage Assets which
will generate net interest income based upon the difference between the
interest earned on its Mortgage Assets and the interest paid on its
borrowings used to acquire the Mortgage Assets; and
(ii) the operation of the Taxable Subsidiary's mortgage origination
business, which will generate income from its mortgage lending activities
and will supply adjustable-rate Subprime Mortgage Loans for long-term
investment through the proposed REIT structure which avoids Federal income
tax at the corporate level.
RealTrust will conduct the investment portfolio operations. Specifically,
RealTrust will determine which Mortgage Loans will be held for long-term
investment, will establish underwriting guidelines for the Mortgage Loans, will
arrange financing for the investment portfolio (including the issuance of
structured debt offerings), will administer the capital allocation guidelines
and other risk management policies, and will supervise the servicing operations
of third-party servicers.
The Taxable Subsidiary will conduct the mortgage lending operations. The
Taxable Subsidiary will establish and maintain the wholesale, retail and
correspondent channels of production, will perform all underwriting and quality
control processes, will sell all Mortgage Loans that RealTrust does not desire
to hold for long-term investment (either through whole loan sales or
securitizations) and will maintain all necessary state mortgage lending
licenses.
SUMMARY RISK FACTORS
Each prospective purchaser of the Units offered hereby should review the
"Risk Factors" beginning on page 19 for a discussion of material risk factors
that should be considered before acquiring the Units, including the following:
- President's 1999 Budget Plan, if Enacted, Would Adversely Affect Results
of Operations. Provisions of the President's 1999 Budget Plan would
prohibit REITs from owning, by vote or value, more than 10% of the stock
of any corporation. If enacted, the 1999 Budget Plan would cause the
Company to either combine and/or divest itself of the Taxable Subsidiary
and its mortgage lending operations and impair the Company's ability to
qualify as a REIT for the fiscal year ending December 31, 1998,
subjecting the Company to federal taxation on its income, and thereby
reducing or eliminating earnings and cash available for distributions,
and may otherwise adversely affect the Company's operations.
- Inability to Acquire or Delays in Acquiring Mortgage Assets Will Reduce
Income to the Company. The Company has not entered into any commitment
to purchase Mortgage Assets. There can be no assurance that a sufficient
quantity or quality of Mortgage Assets will be provided by the Taxable
Subsidiary or otherwise available at all to the Company. The Company's
results of operations also
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may be adversely affected during the period in which it is initially
implementing its investment, leveraging and hedging strategies, at which
time the Company will likely invest in short-term Mortgage Assets which
generally provide a lower rate of return than long-term investments. The
Company's inability to acquire quality long-term Mortgage Assets in a
sufficient quantity will reduce the Company's income and may adversely
affect its results of operations. In addition, management will have
broad discretion in the allocation of the net proceeds of this Offering
and in the type and percentages of Mortgage Assets included in its
investment portfolio. Such discretion further creates uncertainty for
stockholders and could result in losses to the Company.
- The Taxable Subsidiary May Not Provide Sufficient Subprime Mortgage
Loans to RealTrust Which May Adversely Affect Results of Operations. The
Company intends to acquire most of its Subprime Mortgage Loan Portfolio
from the Taxable Subsidiary. If the Taxable Subsidiary is unable to
supply a sufficient quantity of Subprime Mortgage Loans, whether as a
result of its commitment to sell 75% of its fixed-rate Subprime Mortgage
Loans to ContiFinancial Corporation or otherwise, the Company would be
forced to acquire Subprime Mortgage Loans from third parties. Such
Mortgage Loans may not be available or may be available only at higher
costs, adversely affecting the Company's results of operations.
- Limited Operating History of the Company Creates Uncertainty About
Future Results. RealTrust was organized on April 1, 1998 and the Taxable
Subsidiary began its operations in April, 1996; as such, the Company has
not developed an extensive earnings history. Since its inception, the
Taxable Subsidiary has experienced net losses of $1,774,311 and
$1,305,866 for the fiscal years ended December 31, 1997 and 1996,
respectively, and had an accumulated deficit of $1,494,072 as of
December 31, 1997. Accordingly, there is substantial uncertainty
regarding the Company's future performance and results of operations.
- The Management of an Investment Portfolio of Mortgage Assets is a Change
in Operations. The Company's plans to invest in and manage a portfolio
of Mortgage Assets represent a substantial departure from the Taxable
Subsidiary's historic operations and the development of an entirely new
business enterprise. The management of an investment portfolio requires
the Company's involvement in activities in which the Company has not
previously engaged, namely financing with structured debt information,
hedging activities and the investment in Mortgage Securities. The
Company's management may not have the experience in these particular
activities necessary to successfully develop or manage such new and
expanded business enterprise.
- Lack of Relevant Experience Managing a REIT May Adversely Affect
Operating Results. The Company's management has had no prior experience
in managing a REIT. The Company's results of operation and earnings will
be adversely affected if the Company is unable to manage a REIT
successfully in the manner described in this Prospectus or otherwise.
- Loss of Any Key Personnel May Adversely Affect Operations. The Company's
operations depend in significant part upon the skills and experience of
Messrs. John D. Fry, Terry L. Mott, John P. McMurray and Steven K.
Passey. The loss of any such persons could have a material adverse
effect on the Company's business. The Company's employment agreements
with each of Messrs. John D. Fry, Terry L. Mott, John P. McMurray and
Steven K. Passey, and the non-competition provisions thereof, are
unlikely to be enforceable by the Company against the employees since
state law and public policy generally prohibit forced employment and
severely restrict the scope of non-competition provisions. As a result,
there can be no assurance that such employees will remain with the
Company and that they will not compete after termination.
- Future Revisions in Investment and Operating Policies and Strategies by
Board of Directors Creates Uncertainty. The Board of Directors has
established, but generally can waive and modify, the investment and
operating policies and strategies of the Company. These policies and
strategies do not limit the amount of capital which may be invested in
any one type of Mortgage Asset. These changes may have a material
adverse effect on the Company's business, results of operations and
financial condition.
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- Conflicts of Interest May Result in Decisions That Do Not Fully Reflect
the Stockholders' Best Interest. The Company is subject to various
potential conflicts of interest arising from its relationship with
ContiFinancial Corporation and the Founders. ContiFinancial Corporation
may be in a position to exercise significant influence over the
Company's operations in that it will beneficially own a substantial
portion of the Company's Common Stock (6.6% after this Offering) and
because of the Company's dependence on ContiFinancial Corporation for
many financial and financial advisory services. The Company has
appointed ContiFinancial Corporation as its exclusive placement agent
for structured debt offerings at a fee which may be higher than those
available from third parties. The Company is unable to quantify, with
any degree of reasonable accuracy, the amount of fees which would be
paid to ContiFinancial Corporation. Such fees depend on market
conditions which cannot be predicted at this time. Further, such fees
could be misleading if not placed in the context of the Company's
earnings and distributions, which the Company is unable to reasonably
calculate at this time. In addition, the Taxable Subsidiary has agreed
to sell to ContiFinancial Corporation 75% of its fixed-rate Subprime
Mortgage Loan production at prices established by ContiFinancial
Corporation (or pay a 40 basis point penalty on the principal
shortfall). In addition, $2.0 million of the proceeds from the Offering
will be used to retire the Taxable Subsidiary's outstanding balance on a
working capital line and $2.2 million of the proceeds will be used to
redeem shares of preferred stock held by ContiFinancial Corporation. The
Founders and ContiFinancial Corporation also control 100% of the voting
stock of the Taxable Subsidiary. Investors in the Offering will not
acquire an interest in any entity that controls the Taxable Subsidiary.
The Founders and ContiFinancial Corporation will also collectively own
approximately 19.7% of the Common Stock of the Company outstanding after
the closing of the Offering and can collectively exert substantial
influence on its operations. These relationships may create potential
conflicts of interest which may result in decisions that do not fully
reflect the best interest of the stockholders or the Company as a whole
and may materially reduce the Company's earnings and distributions.
- Higher Delinquency and Loss Rates on Subprime Mortgage Loans May Result
in Losses. Subprime Mortgage Loans are made to borrowers who do not
qualify for Prime Mortgage Loans, generally as a result of past
derogatory credit items. Thus, Subprime Mortgage Loans may result in
increased delinquency rates and/or credit losses which could have an
adverse effect on the Company's business and results of operations.
- Subprime Mortgage Loans May Experience High Prepayment Rates Which
Reduces Income From Operations. Prepayment rates on Subprime Mortgage
Loans may increase even in periods of stable or rising interest rates
since subprime borrowers may be able to improve their credit ratings and
refinance the Mortgage Loan to reduce their interest rate. Rapid
prepayments could reduce the Company's income from operations.
- Competition in the Subprime Mortgage Lending Market May Have a Material
Adverse Effect on Results of Operations. The market for Subprime
Mortgage Loans is highly competitive and dynamic. The Company faces
competition from numerous institutions, including other mortgage REITs
such as NovaStar Financial, Inc. and IMPAC Mortgage Holdings, Inc. As
the Company expands into particular geographic markets, it will face
increasing competition from larger lenders with substantially easier
access to capital and other resources than the Company. Continued and
increasing competition from new entrants into the market and the
changing competitive environment may have a material adverse effect on
the Company's financial condition and its future results of operation.
- Investments in High LTV Mortgage Loans and Subordinated Mortgage
Securities Involve Greater Risks of Loss. The Company's current
underwriting guidelines allow for the acquisition of Mortgage Loans with
up to a 90% loan-to-value ratio ("LTV"), which creates a substantial
risk that the Company will not be able to recover full amounts due on
its Mortgage Loans in the event the borrower defaults and the Company
forecloses and sells the underlying collateral. The Company's planned
investments in other subordinated classes of debt are subject to similar
risks of loss upon default, which could have a material adverse effect
on the Company's business and results of operations.
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- Interest Rate Mismatches Between Mortgage Assets and Borrowings May
Result in Reduced Income or Losses. Sudden and significant increases in
interest rates may increase the cost of the Company's short-term
borrowings more rapidly than the earnings on its long-term Mortgage
Assets, and thereby may substantially reduce income from operations and
adversely affect the Company's business and its results of operations.
In addition, such interest rate increases may also reduce Mortgage Loan
originations.
- Declining Interest Rates May Increase Prepayment Rates and Reduce Net
Interest Income. In the event that prepayments on the Company's Mortgage
Assets exceed expectations, the Company may (i) lose the opportunity to
receive interest at the fully indexed rate, (ii) need to write-off
capitalized premium amounts and (iii) be unable to acquire new or
replacement Mortgage Assets with similar yields.
- Hedging Transactions Limit Gains and May Increase Exposure to Losses;
Company Has No Specific Hedging Policies. The Company intends to
purchase interest rate caps, swaps and other financial instruments such
as interest-only Mortgage Securities ("IOs") and principal-only Mortgage
Securities ("POs") to mitigate the risk of interest rate fluctuations.
Hedging transactions involve costs which costs increase as the period
covered by the hedge increases and which increase in periods of rising
or volatile interest rates. The Company does not have specific hedging
policies and no hedging policy can entirely eliminate interest rate
risk. Failure to inappropriately hedge may affect the Company's results
of operations. The value of IOs and POs are highly sensitive to
fluctuations in prepayment and interest rates, which may adversely
affect the Company's results of operations.
- Counterparty, Unenforceability and Basis Risks in Hedging Transactions
May Result in Losses. The Company bears the risk that the counterparty
in any hedging transaction will be unable to perform its obligations.
Such risk could arise from insufficient documentation, insufficient
capacity or authority of the counterparty or from the bankruptcy or
insolvency of the counterparty. In addition, the Company will be subject
to exposure to differences in price performance between the Company's
Mortgage Assets and the hedges. Such risks may result in losses on
hedging transactions.
- Leverage Increases Exposure to Loss. The Company expects to borrow
against a substantial portion of the market value of its assets (up to
approximately 92%, depending upon the nature of the underlying Mortgage
Asset). The Company expects to maintain a ratio of equity to total
assets of approximately 8% to 15%. Such ratio may change depending upon
market conditions. The Company does not have any limits on the amount of
indebtedness. Leverage increases the volatility of income and asset
value. Failure to implement the Company's leveraging strategy may result
in losses if the return on its Mortgage Assets is less than its
borrowing cost and result in reduced profits if the optimal degree of
leverage is not achieved.
- Inability to Renew or Replace Maturing Borrowings May Result in
Losses. The Company relies on short-term borrowings to fund acquisitions
of long-term Mortgage Assets. Any failure to obtain or renew adequate
funding on favorable terms could have a material adverse effect on the
Company's operations. In such event, the Company could be required to
sell Mortgage Assets under adverse market conditions and incur losses as
a result.
- Defaults on Mortgage Loans May Result in Losses. In the event of a
default on any Mortgage Loan held by the Company, the Company will bear
the risk of loss of principal and the Mortgage Loan will cease to be
eligible collateral for borrowings. To the extent any property
collateralizing Mortgage Loans is contaminated by hazardous substances,
the Company may bear the costs of cleanup which could result in losses.
- Lack of Geographic Diversification Exposes the Company to Greater
Default Risk. The Mortgage Loans originated by the Taxable Subsidiary in
the first quarter of 1998 were predominantly concentrated in the
following states: Florida (32.92%), Utah (17.80%), California (14.04%),
Georgia (9.43%) and Arizona (5.16%). Lack of geographic diversification
may subject the Company to a greater default risk in the event of
adverse economic, political, business developments and material hazards.
- Inadequate or Ineffective Servicing May Increase Delinquency and Default
Rates. The Company will initially contract for servicing of its Mortgage
Loans by third-party servicers. The Company is subject to risks
associated with insufficient or untimely services which may result in
increased delinquency
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and default rates. The Company has entered into a servicing agreement
with Advanta which requires the payment of termination fees of $100 per
Mortgage Loan serviced by Advanta at the time of termination. As the
Company expects to assume responsibility for the servicing of the
Mortgage Loans, the corresponding termination fee may increase costs and
reduce the Company's net income from operations, if any.
- Legislation and Regulation May Subject the Company to Costs of
Compliance and Claims for Noncompliance. The mortgage lending operations
of the Taxable Subsidiary are subject to extensive state and federal
laws, regulations, supervision and licensing. The Taxable Subsidiary
incurs costs to comply with such laws and regulations and may be subject
to regulatory or enforcement actions and private proceedings for
non-compliance. The Real Estate Settlement Procedures Act ("RESPA")
prohibits certain yield spread premium payments to brokers. While the
Taxable Subsidiary has adopted procedures to mitigate the risk of claims
for violation of RESPA, the Taxable Subsidiary may be required to change
its broker compensation program or be subject to adverse claims.
- Changes in Economic Conditions May Adversely Affect Results of
Operations. The Company's business may be adversely affected by periods
of economic slowdown or recession which may be accompanied by decreasing
demand for consumer credit and declining real estate values. Declining
real estate values decrease the demand for borrowings and increases the
loan-to-value ratios of Mortgage Loans previously made by the Company,
thereby impairing collateral coverage and increasing the possibility of
a loss in the event of default. Depressed economic conditions also
increase the risk of delinquencies, foreclosures and losses. Improving
economic conditions, on the other hand, may increase prepayments and
lead to further losses. As such, any substantial changes in economic
conditions could have a material adverse effect on the Company and its
results of operations.
- Purchasers Will Incur Immediate and Substantial Dilution. Purchasers of
the Units offered hereby will be subject to immediate and substantial
economic dilution of $4.22 per share (28.1%) prior to exercise of the
Warrants and the Representative's Warrants or $2.31 per share (15.4%) if
all of the Warrants and the Representative's Warrants are exercised, in
the per share net tangible book value of the Common Stock components of
such Units (assuming sale of all the Units offered hereby at $15.00 per
Unit).
- Future Debt and Equity Offerings May Dilute Investors. In addition, the
Company plans to increase its capital resources in the future through
additional offerings of equity and debt securities. Accordingly,
purchasers of the Units offered hereby can expect further and
substantial dilution of their equity in the future.
- Failure to Develop a Trading Market May Result in Depressed Common Stock
Price. There has not been a public market for the securities prior to
this Offering and there can be no assurance that a trading market for
the securities will develop immediately after the closing of the
Offering or at all. The price of the Units have been determined by the
Underwriters and may not reflect the fair value of the Units. As such,
there can be no assurance that the price of the Units will not fall
below the public offering price. Even if a public market for the
Company's securities develops in the future, such market price may not
reflect the Company's earnings performance and may be subject to
substantial volatility as a result of fluctuations in interest rates and
other factors.
- Consequences of Failure to Maintain REIT Status Would Have Adverse Tax
Consequences. Failure to acquire, by June 30, 1998, assets having a
value of approximately $325.0 million would preclude the Company from
electing REIT status for 1998. If the Company fails to qualify as a REIT
in any taxable year, the Company may be subject to federal income tax as
a regular, domestic corporation, thereby significantly reducing or
eliminating the amount of cash available for distribution to its
stockholders. Failure to qualify for REIT status may reduce or eliminate
any advantage over non-REIT companies.
- Restrictions on Ownership of Capital Stock Could Discourage a Change of
Control. The Company's Amended and Restated Articles of Incorporation
prohibit any person from owning more than 9.8% in value of the capital
stock of the Company. Such a restriction on ownership may inhibit market
activity and reduce or eliminate any premium that may otherwise have
existed on the Securities.
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COMPETITIVE ADVANTAGES
Management believes that the Company will be able to compete effectively
against its competitors (including certain "C" corporations and mortgage REITs,
see "Risk Factors -- Investments in Subprime Mortgage Loans Involve Greater Risk
of Loss -- Competition in the Subprime Mortgage Lending Market May Have a
Material Adverse Effect on Results of Operations" as a result of the following
factors:
- The Company's management team has previously built extensive mortgage
banking operations which allows the Company to intensively manage the
cost and quality of the Mortgage Loans held for investment.
- The Taxable Subsidiary's Mortgage Loan production franchise and the
Company's investment portfolio will focus on Subprime Mortgage Loans.
- The use of structured debt instruments to finance Mortgage Assets held
in the Company's investment portfolio is expected to mitigate interest
rate risk.
- The Company's status as a REIT offers tax advantages by eliminating
corporate level Federal income tax.
- The Company is self-advised and self-managed which limits potential
conflicts of interest between the stockholders and management.
- The Taxable Subsidiary structure affords the Company the ability to sell
Mortgage Loans for cash gains when management determines that such sales
will provide favorable returns (see "Business -- Industry
Developments").
The Company is, however, subject to numerous risks and uncertainties with
respect to its operations. Such risks and uncertainties include the following.
The Company's management has never managed a REIT and lacks experience in
certain activities associated with managing an investment portfolio, including
the use of structured debt financing, certain hedging strategies and investing
in Mortgage Securities. REITs are subject to numerous asset, income and other
tests, the failure of which could result in loss of REIT status. Subprime
Mortgage Loans are subject to increased risks of delinquency and default which
could result in losses. The use of substantial leverage exposes the Company to
increased risk of loss. The Company has no established limits on the amount of
debt it may incur. The Company is subject to numerous potential conflicts of
interest with each of ContiFinancial Corporation and the Founders. The Founders
will own approximately 66.7% of the voting common stock of the Taxable
Subsidiary and, therefore, will control its operations. Provisions of the
President's 1999 Budget Plan would prohibit the Company from owning more than
10% of the Taxable Subsidiary's capital stock, requiring significant changes to
the currently intended manner of operations. For a description of these and
other risks associated with an investment in the Units, see "-- Summary Risk
Factors" above.
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MANAGEMENT
The Company will be governed by a Board of Directors comprised of five
members, three of whom are not officers or employees of the Company or its
affiliates ("Independent Directors"). Day-to-day operations will be conducted by
the Company's executive officers. Although the Company's management does not
have experience managing or operating a REIT, management does have experience
managing taxable entities with similar operations including originating,
purchasing, underwriting, and securitizing Mortgage Loans as well as the
management of Mortgage Asset portfolios.
The Company's two primary executive officers, Mr. John D. Fry and Mr. Terry
L. Mott, collectively have extensive experience in building and operating
mortgage banking operations in a variety of environments, including building
Mortgage Loan production and management teams and creating and implementing
policies, budgets and controls. Mr. Fry, Certified Mortgage Banker (CMB), formed
the Company in February, 1996 and has been the President, Chief Executive
Officer and Chairman of the Board of Directors since inception. Mr. Fry began
his mortgage banking career in 1966. From 1989 to 1994, Mr. Fry was Senior Vice
President of Wholesale Lending of ComUnity Lending, Inc., a mortgage bank
located in San Jose, California. From 1984 to 1989, Mr. Fry was Vice President
and Western Division Manager of Goldome Realty Credit Corp., a thrift located in
Buffalo, New York. See "Management."
Mr. Mott has been the Executive Vice President of the Company primarily
responsible for Mortgage Loan production and a Director since inception. Mr.
Mott began his career in mortgage banking in 1977. From 1980 to 1988, Mr. Mott
was the regional Vice President at Fleet Mortgage Corp. where he developed and
managed the retail and wholesale mortgage loan production for the western United
States. From 1988 to 1994, Mr. Mott was Executive Vice President and served on
the executive committee for Medallion Mortgage Company. Mr. Mott left AccuBanc
Mortgage, the successor to Medallion Mortgage Company, in December, 1995, to
form the Company with Mr. Fry. See "Management."
In contemplation of the Offering and the proposed business strategy of the
Company, the Company has hired additional executive management team members,
including Mr. John P. McMurray and Mr. Steven K. Passey. Mr. McMurray joined the
Company in February, 1998, as the Executive Vice President of Secondary
Marketing and Asset Liability Management. Prior to joining the Company, Mr.
McMurray was the President of Keystroke Financial, Inc., a start-up internet
mortgage origination company. From 1995 to 1996, Mr. McMurray was Executive Vice
President and Director, Risk Management and Capital Markets for Crestar Mortgage
Corporation where he was responsible for interest rate and credit risk
management, as well as hedging, securitization and loan/securities trading
activities. From 1982 to 1995, Mr. McMurray served in various management
positions with BancPlus Mortgage Corp., most recently serving as the Senior Vice
President, Capital Markets. Mr. McMurray is a Chartered Financial Analyst and a
Certified Public Accountant. He received a Master of Science degree in Real
Estate from Massachusetts Institute of Technology, a Masters of Business
Administration degree from the University of Texas, San Antonio and a Bachelor
of Science degree from Trinity University. Mr. Passey joined the Company in
October, 1997 as the Senior Vice President and Chief Financial Officer. Prior to
joining the Company, Mr. Passey was employed by KPMG Peat Marwick LLP in the
financial services area for eight years, most recently as a manager responsible
for accounting and audit work for financial services companies. Mr. Passey is a
Certified Public Accountant. See "Management."
BUSINESS STRATEGIES
MARKETING AND PRODUCTION STRATEGY
The Taxable Subsidiary acquires or will acquire Mortgage Loans from four
sources: (i) its wholesale channel through which Mortgage Loans are acquired
from a network of independent wholesale brokers, (ii) its correspondent channel
through which closed Mortgage Loans are purchased from other lenders, (iii) its
retail channel through which direct originations are obtained from its retail
branches, and (iv) to a lesser extent, its bulk acquisitions of Mortgage Loans
from other mortgage banks and financial institutions.
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<PAGE> 16
The wholesale channel, which originates Mortgage Loans through independent
wholesale brokers, accounted for $115.9 million, or 76.2%, of the Taxable
Subsidiary's Mortgage Loan production during the first quarter of 1998. Of the
wholesale channel Mortgage Loans originated during the first quarter of 1998,
$56.6 million, or 48.8%, were Subprime Mortgage Loans. As of March 31, 1998, the
wholesale channel originated Mortgage Loans through 14 branch offices located
nationwide. These offices are owned by the Taxable Subsidiary and are staffed
with the Taxable Subsidiary's employees, generally between one and 15 loan
officers, zero to five underwriters and two to 20 support personnel. The Taxable
Subsidiary's believes that the Taxable Subsidiary has been successful in
penetrating the broker market by providing prompt, consistent service, which
includes (i) response time efficiencies in the purchase process as a result of
decentralized underwriting, (ii) direct and frequent contact with brokers
through a trained sales force, (iii) competitive pricing, and (iv) a variety of
pricing programs and Mortgage Loan products. The Taxable Subsidiary intends to
initially increase wholesale Mortgage Loan production through expanded marketing
efforts by existing branches and to identify new areas of the United States
where it will establish additional wholesale branches. The Taxable Subsidiary
intends to continue to increase the percentage of Subprime Mortgage Loans
originated through its wholesale channel. The Taxable Subsidiary does not have
exclusive arrangements with any wholesale brokers who remain free to sell
Mortgage Loans to others.
The correspondent lending channel acquires closed Subprime Mortgage Loans
through a national network of approved Mortgage Loan originators that fund and
close each Subprime Mortgage Loan using their own funds and subsequently sell
the Mortgage Loans to the Taxable Subsidiary. The correspondent lending channel
accounted for $2.8 million, or 1.8%, of the Taxable Subsidiary's Mortgage Loan
production during the first quarter of 1998, all of which were Subprime Mortgage
Loans. The goal of the correspondent lending channel is to increase the volume
of Subprime Mortgage Loan production while maintaining the comprehensive quality
control systems currently employed by the wholesale and retail channels of the
Taxable Subsidiary. Subprime Mortgage Loans will be purchased from mortgage
bankers, commercial bankers and savings and loans on a servicing released basis.
Each seller will maintain certain eligibility criteria such as net worth
requirements, Mortgage Loan origination experience and warehouse line
capability. In October, 1997, the Taxable Subsidiary entered into a letter
agreement with Nomura Asset Capital Corporation ("Nomura") to acquire from
Nomura Subprime Mortgage Loans and certain non-binding seller relationships
between Nomura and several sellers through which Nomura has actively purchased
Subprime Mortgage Loans since 1994. See "Business -- Marketing and Production
Strategy -- Correspondent Lending." Pursuant to the terms of the letter
agreement, the Taxable Subsidiary agreed to purchase certain Subprime Mortgage
Loans from Nomura and Nomura agreed to introduce to the Taxable Subsidiary
correspondents and sellers from whom Nomura formerly acquired Subprime Mortgage
Loans. The Taxable Subsidiary agreed to pay Nomura a fee of 25 basis points to
the extent that the Taxable Subsidiary purchases more than $90.0 million of
Subprime Mortgage Loans from such correspondents prior to June 30, 1998. The
Taxable Subsidiary does not expect to purchase any additional loans from such
correspondents until after June 30, 1998 and, therefore, does not expect to pay
any additional fees to Nomura under the agreement. Nomura also agreed to provide
a $100 million reverse repurchase facility. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources." The Company views the assumption of the Nomura seller
relationships as a platform to build and develop the Subprime Mortgage Loans
necessary to implement the Company's Mortgage Asset portfolio strategy.
The retail channel, which originates Mortgage Loans through the direct
solicitation of borrowers, accounted for $33.4 million, or 22.0%, of the Taxable
Subsidiary's Mortgage Loan production during the first quarter of 1998. Of the
Mortgage Loans originated through the retail channels during the first quarter
of 1998, $1.2 million, or 3.5%, were Subprime Mortgage Loans. As of March 31,
1998, the retail channel originated Mortgage Loans through two branch offices
located in Salt Lake City, Utah and Las Vegas, Nevada. Such offices are staffed
with five to 10 loan officers, one underwriter and five to seven support
personnel. The retail channel includes traditional marketing activities
conducted by retail loan officers, all of whom are commissioned employees of the
Taxable Subsidiary, who seek to identify potential borrowers through referral
sources and individual sales efforts, as well as high-volume targeted direct
mail and telephone solicitation. The Taxable Subsidiary intends to maintain
Prime Mortgage Loan production and to focus on increasing Subprime Mortgage Loan
production within its existing retail branch offices by staffing each retail
office with a
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<PAGE> 17
minimum of two Subprime Mortgage Loan officers who will utilize direct mail and
telephone solicitation methods to generate such Mortgage Loans.
The Taxable Subsidiary may also acquire a portion of its Mortgage Asset
portfolio through occasional bulk acquisitions of Mortgage Asset pools ranging
in size from $2.0 million to $50.0 million. The Taxable Subsidiary has made bulk
acquisitions of Mortgage Loans in an aggregate principal amount of $65.9
million.
UNDERWRITING AND QUALITY CONTROL
The Taxable Subsidiary underwrites all Mortgage Loans originated through
its retail and wholesale channels with a staff of in-house underwriters. The
Taxable Subsidiary staffs each office with senior underwriters with a minimum of
five years experience and trains each underwriter on the Taxable Subsidiary's
underwriting policies and procedures at the Taxable Subsidiary's headquarters in
Salt Lake City, Utah. The underwriters are permitted to staff retail or
wholesale offices after approval by the Chief Credit Officer, and are subject to
a 30-day probation, during which their work is closely scrutinized by the
Taxable Subsidiary. The Taxable Subsidiary has an extensive, systematized
quality control and audit plan currently in place to monitor the quality of the
Mortgage Loans originated and purchased, personnel and processes.
LOAN SALES FOR CASH
The Taxable Subsidiary has historically followed a strategy of selling for
cash gains all of its Mortgage Loan originations and purchases through Mortgage
Loan sales in which the Taxable Subsidiary disposes of its entire economic
interest in the Mortgage Loans (including servicing rights) for a cash price
that represents a premium over the principal balance of the Mortgage Loans sold.
For the fiscal year ended December 31, 1997, the Taxable Subsidiary sold $477.1
million of Mortgage Loans through whole Mortgage Loan sales transactions. The
Taxable Subsidiary did not sell any Mortgage Loans through securitization during
this period; however, substantially all of the Mortgage Loans sold during this
period were ultimately securitized by the purchasers thereof. Ultimately, the
Company plans to build an investment portfolio by retaining selected Subprime
Mortgage Loans. The Taxable Subsidiary, however, intends to continue to sell to
various Mortgage Loan investors for cash gains, all of its Prime Mortgage Loans,
all of its Second Lien Mortgage Loans and certain of its Subprime Mortgage
Loans. See "Business -- Industry Developments." The sale of these Mortgage Loans
is expected to generate current income and cash flow to partially fund the
Taxable Subsidiary's mortgage lending operations. See "Risk Factors -- Risks
Relating to Mortgage Lending Operations."
MORTGAGE INVESTMENT PORTFOLIO
The Company will acquire and manage a portfolio of Mortgage Assets,
primarily composed of Subprime Mortgage Loans originated and purchased by the
Taxable Subsidiary and financed with structured debt instruments. As with a bank
or savings and loan association, the Company's portfolio of Mortgage Assets is
expected to generate net income to the extent that the yield on its Mortgage
Assets exceeds the overall cost of its borrowings. The Company will attempt to
construct a portfolio of Mortgage Assets which will provide a relatively
consistent level of net interest income through a variety of interest rate
environments. The Company intends to develop and manage this portfolio of
Mortgage Assets to maximize net interest income within prescribed risk
constraints.
The Company's Mortgage Assets will be comprised of both whole Subprime
Mortgage Loans and Subprime Mortgage Securities. The Company anticipates that
such Mortgage Assets will be subject to numerous risks, primarily interest rate
risk, credit risk and prepayment risk, among others. The Company has established
policies to attempt to manage the risks relating to the use of substantial
leverage, interest rate risks, credit risks and prepayment risks associated with
its long-term investment in Mortgage Assets. The Board of Directors and
management have broad discretion to amend such policies without the consent of
the stockholders. See "Risk Factors -- Operation of a New Enterprise Involves
Uncertainty -- Future Revisions in Investment and Operating Policies and
Strategies by Board of Directors Creates Uncertainty."
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<PAGE> 18
USE OF LEVERAGE
The Company employs capital allocation guidelines to manage the risks
associated with the use of substantial leverage. See "Summary -- Capital
Allocation Guidelines."
CREDIT RISK MANAGEMENT
The Company attempts to manage credit risk through a number of policies and
strategies, including early intervention and aggressive collection servicing
techniques. See "Summary -- Servicing Activities." In addition, the Company
attempts to mitigate credit risk through its underwriting, appraisal and quality
control programs. To manage credit risk, the Company has adopted underwriting
guidelines wherein all Mortgage Loans are subjected to a detailed review by
Company underwriters. The underwriting guidelines determine maximum LTV ratios
that will be accepted (generally not in excess of 90%), which LTVs are expected
to provide sufficient protection in the event of default and foreclosure. In
addition, the Company requires appraisals by FIRREA-qualified appraisers to
determine the LTV. The Taxable Subsidiary purchases loans only from
Correspondents who meet minimum net worth requirements ($400,000), and each of
whom make extensive representations and warranties regarding Mortgage Loans sold
to the Taxable Subsidiary. Upon any breach of such representations or
warranties, the Correspondents are required to repurchase the corresponding
Mortgage Loan. Finally, the Taxable Subsidiary employs a quality assurance
program to monitor the performance of its underwriters as well as Correspondents
and brokers which sell Mortgage Loans to the Taxable Subsidiary. See
"Business -- Credit Risk Management."
INTEREST RATE RISK MANAGEMENT
To manage interest rate risk, which arises primarily from potential
mismatches in the interest rate on the Company's borrowings and those on its
Mortgage Assets, the Company has adopted a number of policies. The Company will
attempt to structure its liabilities to have interest rate indices and
adjustment periods that correspond as closely as possible with the indices and
adjustment periods on its Mortgage Assets. The Company also intends to use
interest rate caps, swaps and similar instruments to limit, fix or partially
offset changes in interest rates on its borrowings. See "Business -- Interest
Rate Risk Management" and "Risk Factors -- Interest Rate Fluctuations May
Adversely Affect Operations and Net Interest Income." The Company will finance
its Mortgage Assets with CMOs which mitigate some interest rate risk. See
"Summary -- Structured Debt Financing." No interest rate management strategy can
completely insulate the Company from interest rate risks. Moreover, certain
provisions of the Code limit the hedging strategies of REITs. See "Risk
Factors -- Interest Rate Fluctuations May Adversely Affect Operations and Net
Interest Income -- Hedging Transactions Limit Gains and May Increase Exposure to
Losses."
PREPAYMENT RISK MANAGEMENT
Prepayments of Mortgage Loans prior to their maturity date generally
increase as interest rates decline. Subprime Mortgage Loans may be subject to
increased rates of prepayment in stable or rising interest rates if borrowers
are able to repair their credit ratings and refinance at lower rates. Prepayment
affects the Company in several ways. First, to the extent the Company pays a
premium over the outstanding principal balance of the Mortgage Loan, significant
unexpected expenses may be recognized upon prepayment. Second, since prepayments
tend to accelerate in declining interest rate environments, it may be difficult
to replace prepaid Mortgage Loans with Mortgage Loans offering similar yields.
Replacement Mortgage Loans may have low introductory rates that would reduce the
Company's earnings. The Company attempts to mitigate prepayment rates by
acquiring Mortgage Loans that carry prepayment penalties. During the first
quarter of 1998, 84.5% of the Taxable Subsidiary's Subprime Mortgage Loans had
prepayment fees. The Company also intends to structure into its CMO financing
with certain hedging instruments which may mitigate some prepayment risk. The
Company further intends to implement procedures for soliciting borrowers who are
expected to refinance and prepay. No policies or procedures can fully protect
the Company from prepayment risks. See "Risk Factors -- Interest Rate
Fluctuations May Adversely Affect Operations and Reduce Net Interest Income --
Declining Interest Rates May Increase Prepayment Rate and Reduce Net Interest
Income."
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<PAGE> 19
STRUCTURED DEBT INSTRUMENTS
The Company intends to hold for long-term investment Subprime Mortgage
Loans originated or acquired by its mortgage lending operation and to finance
such Mortgage Loans with long-term financings through the issuance of structured
debt instruments, or collateralized mortgage obligations ("CMOs"). Pursuant to
this approach, for accounting purposes, the Mortgage Loans collateralizing any
CMO remain on the balance sheet as assets and the debt obligations (i.e., CMOs)
appear as liabilities, if such obligations meet the requirements of Statement of
Financial Accounting Standards No. 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities, to be accounted for as
financings. The Company's retained interest under this approach is reflected by
the excess of the assets over the related liabilities on its balance sheet. The
Company will recognize net interest income to the extent that the interest rate
on the Mortgage Loans collateralizing CMOs exceeds the interest payable to the
holders of the CMOs. Unlike other forms of securitization, CMOs are not
considered sales of the Mortgage Loans which result in immediate accounting
recognition of the expected stream of future income, referred to as "gain on
sale." Gain-on-sale securitizations result in income recognition in excess of
actual cash received. In the event that the actual income is less than expected
at the time of the gain-on-sale securitization, the issuer may be required to
restate income or take losses. The Company believes that CMO financing is
preferable because it reflects only actual net interest income and reduces the
risk of future earnings volatility.
CAPITAL ALLOCATION GUIDELINES
The Company's goal is to maintain a balance between the under-utilization
of leverage, which may diminish returns to stockholders, and the
over-utilization of leverage, which could limit the Company's funding
alternatives during adverse market conditions. See "Risk Factors -- Borrowing to
Finance Investment Portfolio May Adversely Affect Results of
Operations -- Leverage Increases Exposure to Loss." Therefore, the Company has
adopted Capital Allocation Guidelines (the "CAG"). The primary factors
influencing the Company under circumstances of adverse market conditions are (i)
increases in interest rates, and (ii) increases in general market perception of
credit risk associated with residential Mortgage Loans. Interest rate increases
reduce the market value of the Company's Mortgage Assets and therefore reduce
the amount of available financing since financing is dependent on market values.
An increase in the perceived credit risk tends to increase the level of
over-collateralization required by rating agencies so that the Company can
obtain investment grade ratings on its senior classes of structured financings,
such as CMOs. Higher levels of over-collateralization reduce the quantity of
total financing prospectively available to the Company for a given quantity of
Mortgage Loans. The Company's CAG are designed for purposes of sustaining
liquidity and funding alternatives during each of these adverse market
conditions.
SERVICING ACTIVITIES
Initially, the Company intends to engage a third-party servicer to service
all Mortgage Loans in the Company's investment portfolio while management
focuses on Mortgage Loan production, Mortgage Loan processing, asset/liability
management, administrative operations and securitization. Such a subservicing
agreement will allow the Company to take advantage of the experience of
Advanta's servicing staff, their computer and customer service systems and
collection procedure. Although there can be no assurances, the Company intends
to develop its own servicing capability in order to oversee the performance of
its Mortgage Loans more directly and to manage the servicing relationship with
its borrowers. The timing of this action will be based on the time required to
obtain the personnel and computer systems necessary to properly manage a
servicing department capable of servicing over $1.0 billion in Subprime Mortgage
Loans.
The Company currently has a Loan Servicing Agreement with Advanta Mortgage
Corp. (the "Advanta Servicing Agreement"). Under the Advanta Servicing
Agreement, the Company is obligated to pay Advanta a monthly servicing fee on
the declining principal of each Mortgage Loan serviced and a set-up fee for each
Mortgage Loan delivered to Advanta for servicing. Upon termination by the
Company of this servicing agreement, the Company will be obligated to pay a
termination fee equal to $100 per Mortgage Loan then serviced by Advanta, and
will incur additional costs incident to such termination. See
"Business -- Servicing Activities." As of March 31, 1998, the Company had an
immaterial number and principal amount of
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<PAGE> 20
Mortgage Loans under the Advanta Servicing Agreement (five Mortgage Loans with a
principal balance of $0.4 million). The Company intends to select the servicer
offering the most favorable terms and highest quality services and believes the
Advanta Servicing Agreement will not, now or in the future, deter the Company
from selecting another servicer.
STRUCTURE AND FORMATION TRANSACTIONS
STRUCTURE OF THE COMPANY
The Company will initially conduct its operations through at least two
entities as follows: (i) RealTrust Asset Corporation, a newly formed Maryland
corporation which will elect REIT status beginning with the taxable year ending
December 31, 1998 (for purposes of this discussion, sometimes referred to as
"RealTrust"), and (ii) CMG Funding Corp., a Delaware corporation which will not
elect REIT status (for purposes of this discussion, sometimes referred to as the
"Taxable Subsidiary"). This structure is designed primarily to permit RealTrust
to acquire the ownership of a substantial portion of the economic interest of
the Taxable Subsidiary while qualifying for REIT status. See "Federal Income Tax
Considerations -- Qualification as a REIT -- Nature of Assets" and "Risk
Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely Affect
Results of Operations."
[STRUCTURE CHART]
FORMATION TRANSACTIONS AND POST-CLOSING TRANSACTIONS
FORMATION TRANSACTIONS
Immediately prior to or upon the closing of this Offering, the following
transactions will be consummated (the "Formation Transactions"):
- As of April 15, 1998, the stockholders of the Taxable Subsidiary have
contributed 95% of their capital stock of the Taxable Subsidiary to
RealTrust in exchange for shares of capital stock issuable by RealTrust,
including the Common Stock and preferred stock (the "Capital Stock");
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<PAGE> 21
- The capital stock of the Taxable Subsidiary will be recapitalized such
that RealTrust will own 100% of the non-voting preferred stock
representing 95% of the economic interest of the Taxable Subsidiary and
the stockholders of the Taxable Subsidiary prior to this Offering (other
than ContiFinancial Corporation, the "Founders") (66.7%) and
ContiFinancial Corporation (33.3%), will own all of the common stock
representing five percent of the economic interest of the Taxable
Subsidiary (reflecting their respective ownership percentages of the
Taxable Subsidiary's entire capital stock);
- The outstanding shares of preferred stock of RealTrust, owned by
ContiFinancial Corporation, John Fry and Terry Mott, and all of the
shares of Common Stock of RealTrust held by the Founders and
ContiFinancial Corporation will be converted into an aggregate of
984,370 shares of Common Stock of RealTrust, par value $.001 per share
(the "Common Stock"); except the 410,581 shares of Class B Redeemable
Preferred Stock owned by ContiFinancial Corporation which will be
redeemed after the closing of this Offering (see "Conflicts of Interest
and Related Party Transactions -- ContiFinancial Corporation" and "Use
of Proceeds");
- The Company will amend its Articles of Incorporation to adopt provisions
necessary for qualification as a REIT;
- The Company will sell 4,000,000 Units in the Offering (assuming no
exercise of the Underwriters' over-allotment option); and
- The Company will grant the Representative's Warrants.
POST-CLOSING TRANSACTIONS
Following the closing of the Offering, the following transactions will be
consummated (the "Post-Closing Transactions"):
- The Company will elect to be taxed as a REIT;
- The Company will conduct certain aspects of its mortgage lending
operations through the Taxable Subsidiary. The Company will own all of
the shares of non-voting preferred stock of the Taxable Subsidiary,
which shares shall represent 95% of the economic interest of the Taxable
Subsidiary. See "Risk Factors -- President's 1999 Budget Plan, If
Enacted, Would Adversely Affect Results of Operations";
- The Founders will own approximately 66.7% and ContiFinancial Corporation
will own approximately 33.3% of the voting common stock of the Taxable
Subsidiary, which shares shall represent five percent of the economic
interest of the Taxable Subsidiary;
- The Company will redeem the 410,581 shares of Class B Redeemable
Preferred Stock held by ContiFinancial Corporation for $2,000,000, plus
dividends accrued since January 1, 1998, at the rate of 18% per annum;
and
- In addition to the options to purchase 64,325 shares of Common Stock
granted to officers, directors and employees under the 1996 Stock Option
Plan, the Company will also grant to officers, directors and employees
(including ContiFinancial Corporation) options to purchase an aggregate
of 407,569 shares of Common Stock under the 1998 Stock Option Plan (See
"Management -- Executive Compensation -- 1998 Stock Option Plan").
CONSEQUENCES OF FORMATION TRANSACTIONS AND POST-CLOSING TRANSACTIONS
The consummation of the Formation Transactions and the Post-Closing
Transactions will have the following consequences:
- The purchasers of Units in the Offering will own 80.3% of the
outstanding shares of Common Stock (assuming no exercise of the
Warrants, the Representative's Warrants, the over-allotment option or
outstanding stock options) and will own all of these Warrants, except
the Representative's Warrants;
- The Founders and ContiFinancial Corporation will collectively own 19.7%
of the outstanding shares of Common Stock of the Company (assuming no
exercise of the Warrants, the Representative's Warrants, the
over-allotment option or outstanding stock options);
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<PAGE> 22
- In addition to options granted to officers, directors and employees of
the Company to purchase 64,325 shares of Common Stock at exercise prices
ranging from $9.17 to $15.00 under the 1996 Stock Option Plan, officers,
directors and employees of the Company (including ContiFinancial
Corporation) will have options to purchase an aggregate of 407,569
shares of Common Stock, subject to certain vesting provisions, at an
exercise price equal to the Price to Public (See "Management --
Executive Compensation -- 1998 Stock Option Plan);
- The Company will own all of the non-voting preferred stock of the
Taxable Subsidiary, which shares will represent 95% of the economic
interest of the Taxable Subsidiary; and
- The Founders will own 66.7% and ContiFinancial Corporation will own
33.3% of the voting shares of common stock of the Taxable Subsidiary,
which stock will collectively represent five percent of the economic
value of the Taxable Subsidiary.
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<PAGE> 23
DIVIDEND POLICY AND DISTRIBUTIONS
As a REIT, the Company must distribute substantially all of its taxable
income to stockholders during each year. See "Dividend Policy and Distributions"
and "Federal Income Tax Considerations -- Qualification as a
REIT -- Distributions." The Company expects to declare four regular
distributions each year commencing with a pro rata distribution for the quarter
ending June, 1998. After the closing of this Offering, the Company intends to
adopt a Dividend Reinvestment Plan (the "DRP") that will allow stockholders to
have their distributions reinvested automatically in additional shares of Common
Stock. Upon adoption of the DRP, each stockholder will be notified in writing of
the procedure for enrolling in the DRP. See "Dividend Reinvestment Plan."
THE OFFERING
<TABLE>
<S> <C>
Units Offered by the Company and Outstanding After This
Offering(1).......................................................... 4,000,000
Common Stock to be Outstanding After the Offering(2)(3)................ 4,984,370
Common Stock Purchase Warrants to be Outstanding After the
Offering(4).......................................................... 4,000,000
Common Stock Options Outstanding After the Offering(5)................. 471,894
Use of Proceeds............ Mortgage Asset acquisition................ $45,425,000
Redemption of ContiFinancial Corporation
Preferred Stock......................... 2,180,000
Repayment of ContiFinancial Corporation
Working Capital Debt.................... 2,025,000
Repayment of Capstone Note................ 850,000
Working Capital........................... 4,220,000
-----------
Net Proceeds.............................. $54,700,000
===========
American Stock Exchange Symbol
For the Units........................................................ RAC.U
For the Common Stock(6).............................................. RAC
For the Warrants(6).................................................. RAC.WS
</TABLE>
- ---------------
(1) Assumes the Underwriters' over-allotment option to purchase up to 600,000
additional Units is not exercised. Includes Units issuable upon exercise of
the option granted to Capstone Investments, Inc. to convert all or any
portion of a Convertible Secured Promissory Note into Units of the Company
offered hereby at the Price to Public. See "Conflicts of Interest and
Related Party Transactions -- Capstone Investments, Inc."
(2) Does not include (i) 4,000,000 shares of Common Stock reserved for issuance
upon exercise of the Warrants which will be a part of the outstanding Units
(4,600,000 if the over-allotment option is exercised), or (ii) 120,000
shares of Common Stock reserved for issuance upon exercise of the
Representative's Warrants (138,000 if the over-allotment option is
exercised).
(3) Excludes the 410,581 shares of Class B Redeemable Preferred Stock owned by
ContiFinancial Corporation which will be redeemed after the closing of the
Offering. See "Conflicts of Interest and Related Party
Transactions -- ContiFinancial Corporation."
(4) Exercisable at the Price to Public. Excludes the Representative's Warrants.
The Warrants shall automatically detach from the Common Stock six months
after the closing of the Offering. Also excludes warrants granted to
ContiFinancial Corporation which terminate upon the closing of the Offering
and excludes warrants to purchase 50,000 shares of Common Stock at the Price
to Public granted to Capstone Investments, Inc. See "Conflicts of Interest
and Related Party Transactions -- ContiFinancial Corporation" and
" -- Capstone Investments, Inc."
(5) Includes options to purchase 34,325 shares of Common Stock at an exercise
price of $9.17 per share and options to purchase 30,000 shares at an
exercise price of $15.00 per share granted to employees of the Company under
the 1996 Stock Option Plan and options to purchase 407,569 shares of Common
Stock at
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<PAGE> 24
an exercise price equal to the Price to Public granted to employees of the
Company under the 1998 Stock Option Plan. See "Management -- Executive
Compensation -- 1998 Stock Option Plan."
(6) The Common Stock and Warrants will not be separately listed and traded until
the Warrants are automatically detached, six months after the closing of the
Offering.
CONFLICTS OF INTEREST AND RELATED PARTY TRANSACTIONS
CONTIFINANCIAL CORPORATION
The Taxable Subsidiary and the Company have entered into the following
transactions with ContiFinancial Corporation.
Stock Ownership. Immediately prior to the closing of the Offering,
ContiFinancial Corporation will own 506,933 shares of Common Stock, 252,117
shares of Class A Convertible Preferred Stock and 410,581 shares of Class B
Redeemable Preferred Stock, which in the aggregate represents approximately
43.0% of the outstanding shares of Capital Stock (approximately 42.0% on a fully
diluted basis). Immediately prior to the closing of the Offering, each share of
Class A Convertible Preferred Stock, including those owned by ContiFinancial
Corporation, will be converted into one share of Common Stock. All of the
outstanding shares of Common Stock will be reverse split into an aggregate of
984,370 shares of Common Stock. As a result, immediately prior to the closing of
the Offering, ContiFinancial Corporation will own 327,730 shares of Common
Stock, representing 33.3% of the outstanding shares (32.2% on a fully diluted
basis, excluding the Class B Redeemable Preferred Stock to be redeemed upon
closing of the Offering). Upon closing of the Offering, the Company intends to
redeem the Class B Redeemable Preferred.
The redemption price for all shares of the Class B Redeemable Preferred
Stock equals the original purchase price of $2,000,000, plus dividends accrued
from January 1, 1998 at the rate of 18% per annum, for a total redemption price
of $2,180,000, assuming redemption occurs on June 30, 1998. The Class B
Redeemable Preferred Stock is also entitled to a liquidation preference of
$2,000,000 plus accrued dividends. The Class B Redeemable Preferred Stock is not
convertible into Common Stock.
Agreements to Sell Mortgage Loans. Upon the closing of the Offering until
December 31, 2001, the Taxable Subsidiary has agreed to sell to ContiFinancial
Corporation not less than 75% of the fixed-rate Subprime Mortgage Loans
originated or acquired by the Taxable Subsidiary in each month. The purchase
price for such Subprime Mortgage Loans shall be the fair market value as
determined by the best published rate sheet at ContiMortgage Corporation, an
affiliate of ContiFinancial Corporation. In any month, the Taxable Subsidiary
may substitute adjustable-rate Subprime Mortgage Loans for up to 50% of the
amount required to be offered for sale to ContiFinancial Corporation. To the
extent that the Taxable Subsidiary offers to sell less than 75% of the monthly
fixed-rate Subprime Mortgage Loan production, the Taxable Subsidiary has agreed
to pay ContiFinancial Corporation a fee equal to 40 basis points multiplied by
the amount of the principal shortfall.
Warehouse, Standby and Working Capital Financing Agreements. The Taxable
Subsidiary currently has a warehouse facility with ContiFinancial Corporation in
the principal amount of $50.0 million and a working capital facility in the
maximum principal amount of $2.0 million. As of March 31, 1998, the Taxable
Subsidiary had outstanding borrowings under such lines of $40.0 million and $2.0
million, respectively. The Company anticipates that, immediately after the
closing of this Offering, the Company will advance to the Taxable Subsidiary an
amount sufficient to repay all amounts borrowed under the working capital
facility. See "Use of Proceeds." The Taxable Subsidiary may continue to finance
the acquisition of Mortgage Loans under the warehouse facility. Although the
Taxable Subsidiary anticipates that it will be able to obtain financing on terms
more favorable than those provided by the warehouse facility after the closing
of the Offering, the Taxable Subsidiary believes that the warehouse facility is
currently on terms not less favorable to the Taxable Subsidiary than those
available from independent third parties in arm's-length transactions.
Warrants to Purchase Capital Stock. The Taxable Subsidiary has granted to
ContiFinancial Corporation two warrants to purchase shares of common stock. If
the amount of principal and interest due under the working capital facility is
not repaid in full by January 1, 1999, the first warrant allows ContiFinancial
Corporation to purchase, for a nominal amount, shares of common stock
representing up to five percent of the
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<PAGE> 25
outstanding shares (on a fully diluted basis) of the Taxable Subsidiary. If the
Company repays in full the working capital facility, the warrant is not
exercisable and automatically terminates. The Company anticipates that the
working capital facility will be repaid upon closing of the Offering from the
net proceeds thereof. See "Use of Proceeds."
The Taxable Subsidiary has also granted ContiFinancial Corporation a
warrant to purchase, for a nominal amount, shares of common stock representing
one percent of the outstanding shares (on a fully diluted basis) for each
quarter ending prior to the closing of the Offering in which the Taxable
Subsidiary does not attain at least 90% of its pre-tax net income target. Such
warrant automatically expires and may not be exercised by ContiFinancial
Corporation after the closing of the Offering. The Taxable Subsidiary has
established the pre-tax net income targets.
Structured Debt Placement Agent/Underwriter. Until December, 2001, the
Company has appointed ContiFinancial Corporation as its exclusive placement
agent for structured debt offerings and other securitizations and has agreed to
pay to ContiFinancial Corporation a fee of 25 basis points of the principal
amount of any such structured debt public offering and 50 basis points of the
gross proceeds of any such structured debt private offering. These fees are
payable to ContiFinancial Corporation for financial advisory services to be
rendered pursuant to the Investment Banking Services Agreement and will not be
reduced by any fees payable or paid to others, including the underwriters, the
placement agent or to other agents or advisors, if any, in connection with any
structured debt offering. Such combined fees may exceed those available from a
single third party. See "Conflicts of Interest and Related Party
Transactions -- ContiFinancial Corporation" and "Risk Factors -- Conflicts of
Interest May Result in Decisions That Do Not Fully Reflect the Stockholders'
Best Interests."
CAPSTONE INVESTMENTS, INC.
In March, 1998 and April, 1998, the Taxable Subsidiary borrowed an
aggregate $850,000 from Capstone Investments, Inc., a Nevada corporation,
evidenced by a Convertible Secured Promissory Note (the "Note") bearing simple
interest at 9% per annum. The Note matures upon the earlier of (i) January 1,
1999 or (ii) the closing of the Offering. Interest on the Note is payable
monthly and principal is payable upon maturity. Capstone Investments, Inc. has
the option to convert all or any portion of the Note into Units of the Company
offered hereby at the Price to Public. In addition, the Company has granted
Capstone Investments, Inc. warrants to purchase 50,000 shares of Common Stock at
a price equal to the Price to Public. See "Conflicts of Interest and Related
Party Transactions -- Capstone Investments, Inc."
CONTROL OF TAXABLE SUBSIDIARY
Although RealTrust will be entitled to 95% of the economic benefits of the
Taxable Subsidiary, it will not own any voting securities. All voting securities
will be owned by the Founders and ContiFinancial Corporation. As a result, the
Founders and ContiFinancial Corporation can conduct the affairs of the Taxable
Subsidiary in a manner that may not be in the best interests of the Stockholders
of RealTrust. See "Risk Factors -- Conflicts of Interest May Result in Decisions
That Do Not Fully Reflect the Stockholders' Best Interests."
FORMATION TRANSACTIONS
The Formation Transactions that will occur on or prior to the closing of
the Offering will benefit the Founders of the Company. See "Structure and
Formation Transactions."
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with each of Messrs.
Fry, Mott, McMurray and Passey. Such employment agreements will provide for an
initial term of five years for Messrs. Fry and Mott and three years for Messrs.
McMurray and Passey, among other benefits. See "Management -- Executive
Compensation -- Employment Agreements."
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RISK FACTORS
In addition to the other information contained in this Prospectus, the
following material risk factors should be carefully considered in evaluating the
Company and its business before purchasing any of the Units offered hereby. This
Prospectus contains forward-looking statements which are indicated by the words
"may," "will," "expect," "anticipate," "continue," "believe," "intend," and
similar expressions. Discussions containing such forward-looking statements may
be found in the material set forth under "Prospectus Summary," "Use of
Proceeds," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business," as well as within the Prospectus
generally. Actual results may differ materially from those described in the
forward-looking statements as a result of the risks and uncertainties set forth
below and within the Prospectus generally.
GENERAL
The Company's mortgage lending operations conducted through CMG Funding
Corp., a Delaware corporation (the "Taxable Subsidiary" or "CMG Funding Corp.")
and the proposed management of a portfolio of Mortgage Assets involve numerous
risk factors, many of which overlap. For example, the risks associated with
changes in interest rates affect the mortgage lending business (e.g., by
impacting the level of Mortgage Loan originations) as well as the Mortgage Asset
portfolio business (e.g., by impacting the value of the Mortgage Assets and the
prepayment rate and, hence, the rate of amortization of premium and discount).
In addition, both of the Company's lines of business are subject to risks
generally impacting the Company as a whole, such as loss of REIT status for tax
purposes. See "-- Failure to Maintain REIT Status Would Have Adverse Tax
Consequences."
The reader is cautioned, however, that the risk factors must be read in
their entirety for a full understanding of the Company's risk profile. It should
be noted that many of the risk factors discussed below apply to both lines of
business in different ways which could have offsetting effects on the Company's
combined businesses.
PRESIDENT'S 1999 BUDGET PLAN, IF ENACTED, WOULD ADVERSELY AFFECT RESULTS OF
OPERATIONS
Certain provisions in the President's 1999 Budget Plan, if enacted, would
adversely affect both the Company's ability to conduct operations through the
Taxable Subsidiary and the Company's ability to qualify as a REIT for the fiscal
year ended December 31, 1998. The President's 1999 Budget Plan, as presented to
Congress on February 2, 1998, contains several provisions which affect REITs.
One such provision, if enacted, could have a potentially adverse effect on the
way that the Company intends to operate its mortgage conduit operations. That
provision would prohibit a REIT from owning, by vote or value, more than 10% of
the stock of another corporation. The rules currently in place for REIT
compliance limit (i) a REIT to owning less than 10% of the outstanding voting
securities of another corporation and (ii) the value of a REIT's ownership of
the securities of any one issuer to less than five percent of the value of the
REIT's assets. See "Federal Income Tax Considerations -- Qualification as a
REIT -- Nature of Assets." By limiting a REIT's ownership of the securities of
another corporation to 10% of the value of the issuing corporation, the
proposal, if enacted, would force the Company to divest itself of most of the
preferred stock of the Taxable Subsidiary that the Company currently owns or
terminate activities in the Taxable Subsidiary that would be prohibited
activities by a REIT, including, but not limited to, the origination of Mortgage
Loans for sale. In such an event the Company would not receive the dividends
that the Company expects to earn from the Taxable Subsidiary, which could have a
material adverse effect on the Company's net earning (loss) after such
divestiture. See "Business -- Industry Developments" and "Federal Income Tax
Considerations -- Recent Legislative Proposals." In addition, in the event the
Taxable Subsidiary could no longer engage in Mortgage Loan sales, the Taxable
Subsidiary would be unable to fulfill its contractual obligation to sell certain
fixed-rate Mortgage Loans to ContiFinancial Corporation. See "Certain
Transactions -- ContiFinancial Corporation." If the Taxable Subsidiary fails to
sell to ContiFinancial Corporation 75% of the Company's fixed-rate Mortgage Loan
production, the Taxable Subsidiary would have to pay ContiFinancial Corporation
a fee equal to 40 basis points multiplied by the principal amount of the
shortfall. Such payment may reduce the earnings and distributions of the
Company.
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In addition, if the 1999 Budget Plan is adopted with a retroactive date of
application which is after the effective date of a quarterly REIT test date, the
Company would not be able to qualify as REIT for 1998. See "Business -- Industry
Developments." As a result, the Company would be taxed as a "C" corporation for
1998, and would be subject to corporate level tax on all of its net earnings. In
such an event, the anticipated dividends and distributions of the Company would
be materially reduced.
Further, the 1999 Budget Plan, if adopted as proposed, would result in the
recognition by the Company of tax on the built-in gain on its assets. Under
current law, a "C" corporation may be acquired by or converted into a REIT on a
tax-free basis. If the REIT makes the appropriate election, the tax on the
built-in gain (the difference between (a) the purchase price for the "C"
corporation or the fair market value of the "C" corporation's stock and (b) the
adjusted tax basis of the "C" corporation's assets) would only be imposed if the
REIT disposed of an asset of the acquired corporation within 10 years after the
acquisition of the "C" corporation. The 1999 Budget Plan proposes to treat the
acquisition of a "C" corporation by a REIT as a taxable liquidation by the "C"
corporation to its shareholders followed by a deemed contribution of the "C"
corporation's assets to the REIT. Such treatment would result in corporate level
tax to the "C" corporation in the amount of the built-in gain on the "C"
corporation's assets followed by shareholder level tax to the extent that the
value of the assets deemed distributed from the "C" corporation to its
shareholders exceeds the shareholders' tax basis in their stock in the "C"
corporation. The 1999 Budget Plan proposes that such changes would first be
effective for years beginning after January 1, 1999.
Adoption of the 1999 Budget Plan could have a material adverse effect on
the Company's operations and profitability. No assurance can be given that
future legislation, regulations, administrative interpretations or court
decisions will not significantly change the tax laws with respect to the
Company's qualification as a REIT or the federal income tax consequences of such
qualification, which may reduce or eliminate the Company's competitive advantage
over non-REIT competitors. See "Federal Income Tax Considerations --
Qualification as a REIT" and "Federal Income Tax Considerations -- Taxation of
the Company."
OPERATION OF A NEW ENTERPRISE INVOLVES UNCERTAINTY
INABILITY TO ACQUIRE OR DELAYS IN ACQUIRING MORTGAGE ASSETS WILL REDUCE INCOME
TO THE COMPANY
As of the date of this Prospectus, the Company has not entered into
commitments to purchase any specific Mortgage Assets. The Company's income and
its ability to make distributions to its stockholders will depend upon its
ability to acquire investments on acceptable terms and at favorable spreads over
the Company's borrowing costs. The Company expects that a significant portion of
its portfolio of Mortgage Assets will be originated or otherwise made available
to it through the Taxable Subsidiary. See "-- President's 1999 Budget Plan, If
Effected, Would Adversely Affect Results of Operations." There can be no
assurance, however, that a sufficient quantity or quality of Mortgage Assets
will be provided by the Taxable Subsidiary or will be otherwise available to the
Company. The Company presently intends to fully invest the net proceeds of this
Offering in Mortgage Assets within 12 months after the closing of the Offering.
The Company's results of operations may be adversely affected during the period
in which the Company is initially implementing its investment, leveraging and
hedging strategies, because during this time the Company may be primarily
investing in short-term investments in Mortgage Securities which are expected to
provide a lower net return than the Company expects to achieve from its
long-term investments in Subprime Mortgage Loans. See "Use of Proceeds." To the
extent that the Company is unable to acquire and maintain a sufficient volume of
Subprime Mortgage Loans, the Company's income and, thus, the Company's ability
to make distributions to its stockholders, will be adversely affected.
THE TAXABLE SUBSIDIARY MAY NOT PROVIDE SUFFICIENT SUBPRIME MORTGAGE LOANS TO
THE COMPANY WHICH MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company intends to acquire most of its Subprime Mortgage Loan Portfolio
from the Taxable Subsidiary. If the Taxable Subsidiary is unable to supply a
sufficient quantity of Subprime Mortgage Loans, whether as a result of its
commitment to sell 75% of its fixed-rate Subprime Mortgage Loans to
ContiFinancial Corporation or otherwise, the Company would be forced to acquire
Subprime Mortgage Loans
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from third parties. Such Mortgage Loans may not be available or may be available
only at higher costs, adversely affecting the Company's results of operations.
LIMITED OPERATING HISTORY OF THE COMPANY CREATES UNCERTAINTY ABOUT FUTURE
RESULTS
The Taxable Subsidiary began mortgage lending operations in April, 1996 and
RealTrust was formed on April 1, 1998. Accordingly, the Company has not yet
developed an extensive earnings history or experienced a wide variety of
interest rate or market conditions. Although the Taxable Subsidiary has grown
its Mortgage Loan origination volume significantly since the beginning of
operations, there can be no assurances that it will be able to successfully
operate its business as described in this Prospectus. Therefore, the Taxable
Subsidiary's historical operating performance may be of limited relevance in
predicting future performance.
Further, the Taxable Subsidiary has experienced net losses of $1,774,311
and $1,305,866 for the fiscal years ended December 31, 1997 and 1996,
respectively, and had an accumulated deficit of $1,494,072 as of December 31,
1997.
THE MANAGEMENT OF AN INVESTMENT PORTFOLIO OF MORTGAGE ASSETS IS A CHANGE IN
OPERATIONS
The Company's earnings will depend primarily upon management's ability to
acquire and manage a portfolio of Mortgage Assets, which is a new and unproven
business for the Company. The past experience of the officers and directors of
the Company may not be sufficient for the successful management of an investment
portfolio of Mortgage Assets. Specifically, management of an investment
portfolio entails certain activities not previously engaged in by the Company,
such as the issuance of structured debt financing, the purchase of Mortgage
Securities, the retention of subordinated classes of Mortgage Securities and
certain hedging activities. Therefore, there can be no assurance that the
Company will be able to successfully develop or manage its new business
operations. The past performance of the Taxable Subsidiary may not be indicative
of future results.
LACK OF EXPERIENCE MANAGING A REIT MAY ADVERSELY AFFECT OPERATING RESULTS
None of the officers or directors have managed a REIT. See
"Management -- Directors and Executive Officers." There can be no assurance that
the Company will be able to successfully manage a REIT in the manner described
in this Prospectus or in compliance with the Code. The Company's results of
operation and earnings will be adversely affected if the Company is unable to
manage a REIT successfully in the manner described in this Prospectus and in
compliance with the Code. See "-- Failure To Maintain REIT Status Would Have
Adverse Tax Consequences."
LOSS OF ANY KEY PERSONNEL MAY ADVERSELY AFFECT OPERATIONS
The Company's operations will depend heavily upon the contributions of
Messrs. John D. Fry, Terry L. Mott, John McMurray and Steven K. Passey, each of
whom may be difficult to replace. There can be no assurance that they will
remain in the Company's employ. The loss of any of these individuals could have
a material adverse effect upon the Company's business and results of operations.
See "Management -- Executive Compensation -- Employment Agreements." The
Company's employment agreements with each of Messrs. Fry, Mott, McMurray and
Passey, and the non-competition provisions thereof, are unlikely to be
enforceable by the Company against the employees since state law and public
policy generally prohibit forced employment and severely restrict the scope of
non-competition provisions. As a result, there can be no assurance that such
employees will remain with the Company and that they will not compete after
termination.
FUTURE REVISIONS IN INVESTMENT AND OPERATING POLICIES AND STRATEGIES BY BOARD
OF DIRECTORS CREATES UNCERTAINTY
Management has established the Company's investment and operating policies
and strategies as set forth in this Prospectus. However, these policies and
strategies may be modified or waived by the Board of Directors, subject in
certain cases to approval by a majority of the Independent Directors, without
stockholder
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approval. Ultimately, these changes may have a material adverse effect on the
Company's business, results of operations or financial condition.
FAILURE TO RAISE ADDITIONAL CAPITAL MAY ADVERSELY AFFECT FUTURE GROWTH AND
RESULTS OF OPERATIONS
To implement fully the Company's strategy to rapidly grow a portfolio of
Mortgage Assets, the Company will be required to raise capital in addition to
the capital raised in the Offering. Accordingly, the Company expects to increase
its capital resources by making additional offerings of equity and debt
securities, which may include classes of preferred stock, Common Stock,
commercial paper, medium-term notes, mortgage-backed obligations and senior or
subordinated debt. There can be no assurances that such additional capital
resources will be available on terms acceptable to the Company. Further, there
can be no assurance that the Company will successfully or economically raise the
capital required to implement its business plan. If the Company is unable to
raise sufficient capital or raise capital on favorable terms, the Company's
business, results of operation and financial condition may be materially
adversely affected.
CONFLICTS OF INTEREST MAY RESULT IN DECISIONS THAT DO NOT FULLY REFLECT THE
STOCKHOLDERS' BEST INTEREST
CONFLICTS OF INTEREST WITH AND DEPENDENCE UPON CONTIFINANCIAL CORPORATION MAY
NOT BE IN THE STOCKHOLDERS' BEST INTEREST
The Company is subject to various potential conflicts of interest arising
from its relationship with ContiFinancial Corporation. See "Conflicts of
Interest and Related Party Transactions." In summary, immediately prior to the
Offering, ContiFinancial Corporation (a) will beneficially own 32.2% (on a fully
diluted basis) of the outstanding Common Stock of the Company (excluding the
Class B Redeemable Preferred Stock to be redeemed upon closing of the Offering),
(b) will beneficially own all of the Class B Redeemable Preferred, (c) until
December, 2001, will have the right to purchase not less than 75% of the fixed
rate Subprime Mortgage Loans originated or acquired by the Taxable Subsidiary at
a price determined by the best published rates of ContiFinancial Corporation,
(d) will have lent the Taxable Subsidiary substantial funds under the warehouse
credit facility ($40.0 million at March 31, 1998), (e) may beneficially own
warrants to purchase additional shares of the Common Stock, and (f) will have
the right to be the Company's exclusive placement agent for all structured debt
offerings and other securitizations for a fee. See "Conflicts of Interest and
Related Party Transactions -- ContiFinancial Corporation."
As a stockholder, ContiFinancial Corporation may be in a position to
exercise significant direct and indirect influence over the affairs of the
Company. Consequently, ContiFinancial Corporation may be able to influence the
election of certain members of the Board of Directors.
In addition, in light of the Company's or the Taxable Subsidiary's
dependence upon ContiFinancial Corporation for many financial and financial
advisory services, the Company may act in a manner which does not fully reflect
the best interests of all of the Company's stockholders. For example, the
Taxable Subsidiary may elect to retain certain of its credit facilities with
ContiFinancial Corporation when credit facilities from others third parties may
be obtained at a lower cost. Moreover, if the fees payable to ContiFinancial
Corporation are higher than those required by other third parties, the Company's
earnings and distributions to stockholders may be materially reduced.
Further, pursuant to an Investment Banking Services Agreement, until
December, 2001, the Company has appointed ContiFinancial Corporation as its
exclusive placement agent for structured debt offerings and other
securitizations and has agreed to pay a placement agent fee of 25 basis points
of the principal amount of any such structured debt on public offerings and 50
basis points of the gross proceeds of any such private offering. Such fees are
payable to ContiFinancial Corporation for financial advisory services to be
rendered and will not be reduced by any fees payable or paid to others,
including the underwriters, placement agent or to other agents or advisors, if
any, in connection with any structured debt offering. If the fees payable to
ContiFinancial Corporation are higher than those available from other third
parties, the Company's earnings and distributions may be materially reduced. See
"Conflicts of Interest and Related Party Transactions -- ContiFinancial
Corporation." The Company is unable to quantify, with any degree of reasonable
accuracy, the amount of fees which would be paid to ContiFinancial Corporation.
Such fees depend on market conditions which cannot be predicted at this time.
Further, such fees could be misleading if not placed in the context of
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the Company's earnings and distributions, which the Company is unable to
accurately calculate at this time with any degree of certainty.
In an effort to mitigate the foregoing potential conflicts of interest, the
Company has implemented policies and procedures which require, among other
things, that each decision that implicates a conflict of interest must be
approved by a majority of the Independent Directors. However, there can be no
assurance that the Company's policies or procedures will be successful in
eliminating the influence of such conflicts and, thus, the Company may take
courses of action which fail to fully represent the best interests of all
stockholders of the Company.
A PORTION OF THE NET PROCEEDS FROM THIS OFFERING WILL BE USED TO RETIRE DEBT TO
AND REDEEM STOCK OF CONTIFINANCIAL CORPORATION
The Taxable Subsidiary has obtained a working capital credit facility from
ContiFinancial Corporation in the maximum principal amount of $2.0 million. See
"Conflicts of Interest and Related Party Transactions -- ContiFinancial
Corporation." Any outstanding principal balance and accrued interest under this
facility ($2.0 million as of March 31, 1998) is expected to be retired with a
portion of the net proceeds of the Offering. In addition, $2.2 million of the
net proceeds of the Offering will be used to redeem the outstanding shares of
Class B Redeemable Preferred Stock held by ContiFinancial Corporation (which was
issued in exchange for $2.0 million of working capital debt). Thus,
ContiFinancial Corporation will receive a portion of the net proceeds from the
Offering as repayment of debt.
INVESTORS WILL HAVE NO VOTING CONTROL OF THE TAXABLE SUBSIDIARY
The Company will own 95% of the economic value of the Taxable Subsidiary,
but will not own any voting securities. In fact, the Founders own 66.7% of the
voting common stock of the Taxable Subsidiary and, therefore, control its
operations. As a result, the Company will not control the management or
operations of the Taxable Subsidiary. Therefore, the Founders and ContiFinancial
Corporation, and not the Company, will own or control the voting stock of the
Taxable Subsidiary and, thus, may direct the business and operations of the
Taxable Subsidiary in a manner inconsistent with the best interests of the
Company and its stockholders.
THE FOUNDERS AND CONTIFINANCIAL CORPORATION MAY EXERT INFLUENCE OVER THE
COMPANY
The Founders and ContiFinancial Corporation will beneficially own or have a
right to control approximately 19.7% of the outstanding shares of Common Stock
of the Company (assuming no exercise of the Warrants, the Representative's
Warrants, the Underwriter's over-allotment option or options granted under the
1996 and 1998 Stock Option Plans). As stockholders, the Founders and
ContiFinancial Corporation could exert significant influence over corporate
actions requiring stockholder approval.
INVESTMENTS IN SUBPRIME MORTGAGE LOANS INVOLVE GREATER RISK OF LOSS
HIGHER DELINQUENCY AND LOSS RATES ON SUBPRIME MORTGAGE LOANS MAY RESULT IN
LOSSES
A large portion of the Company's Mortgage Loans are made to borrowers who
do not qualify for Mortgage Loans from conventional Mortgage Loan lenders. For
the year ended December 31, 1997, approximately 2.73% and 0.57% of the Company's
Subprime Mortgage Loan purchases and originations were comprised of Mortgage
Loans made to borrowers graded "C" or "C-" respectively, the Company's two
lowest credit grade classifications. See "Business -- Underwriting and Quality
Control Strategies." No assurances can be given that the Company's underwriting
criteria or methods will afford adequate protection against the higher risks
associated with Mortgage Loans made to Subprime Mortgage Loan borrowers. The
failure of the Company to adequately address the risk of Subprime Mortgage Loan
lending would have a material adverse impact on the Company's results of
operations, financial condition or business prospects.
Credit risks associated with Subprime Mortgage Loans may be relatively
greater than those associated with Prime Mortgage Loans. Certain of the
important differences between Subprime Mortgage Loans and Prime Mortgage Loans
include the applicable loan-to-value ratios ("LTV"), the credit and income
histories of the borrowers, the documentation required for approval of the
borrowers, the types of properties securing
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the Mortgage Loans, Mortgage Loan sizes and the borrowers' occupancy status with
respect to the related mortgaged property. As a result of these and other
factors, the interest rates charged on Subprime Mortgage Loans are often higher
than those charged for Prime Mortgage Loans. The combination of different
underwriting criteria and higher rates of interest may lead to higher
delinquency rates and/or credit losses for Subprime Mortgage Loans as compared
to Prime Mortgage Loans and could have an adverse effect on the Company to the
extent that the Company invests in such Mortgage Loans or Mortgage Securities
secured by such Mortgage Loans.
SUBPRIME MORTGAGE LOANS MAY EXPERIENCE HIGH PREPAYMENT RATES WHICH REDUCES
INCOME FROM OPERATIONS
Rapid prepayments of Mortgage Loans in the Company's investment portfolio
adversely affects the Company's income and distributions to stockholders. See
"-- Interest Rate Fluctuations May Adversely Affect the Company's Investments
and Results of Operations -- Declining Interest Rates May Increase Prepayment
Rates and Reduce Net Interest Income." Since there is less information and
historical data than exists for Prime Mortgage Loans, there is uncertainty about
prepayment rates on Subprime Mortgage Loans.
Prepayment rates on Subprime Mortgage Loans may increase even in periods
when interest rates are stable or rising since subprime borrowers may be able to
improve their credit ratings and refinance their Mortgage Loans to reduce the
interest rate. The Company intends to minimize the effect of rapid prepayment by
investing in Mortgage Loans with prepayment penalties. However, not all Subprime
Mortgage Loans will have prepayment penalties. Ultimately, increasing prepayment
rates could materially reduce income from operations.
COMPETITION IN THE SUBPRIME MORTGAGE LENDING MARKET MAY HAVE A MATERIAL ADVERSE
EFFECT ON RESULTS OF OPERATIONS
As an originator and purchaser of Subprime Mortgage Loans, the Company will
face intense competition, primarily from commercial banks, savings and loans,
other independent mortgage lenders and certain other mortgage REITs and
specialty finance companies. Such competitors include other mortgage REITs,
including Novastar Financial, Inc., and IMPAC Mortgage Holdings, Inc. As the
Company expands into particular geographic markets across the nation, it will
face competition from lenders with established positions in these locations.
Many of the Company's competitors in the financial services business are
substantially larger and have more capital and other resources than the Company.
In addition, competition can take place on various other levels, including
convenience in obtaining a Mortgage Loan, service, marketing, origination
channels and pricing. Failure to be competitive on these levels could have a
material adverse effect on the Company's results of operations.
Additionally, the Subprime Mortgage Loan market is currently undergoing
substantial changes. There are new entrants into the market, which is a changing
competitive environment. Furthermore, certain large national finance companies
and Prime Mortgage Loan originators have announced their intention to adapt
their Prime Mortgage Loan origination programs by allocating resources to the
origination of Subprime Mortgage Loans. Certain of these larger mortgage
companies and commercial banks have begun to offer products similar to those
offered by the Company and to target customers similar to those that the Company
targets. For example, FHLMC has announced its intention to make a secondary
marketplace for Subprime Mortgage Loans originated by certain financial
institutions. The entrance of these and other potential competitors into the
Company's markets could have a material adverse effect upon the Company's
results of operations and financial condition. In particular, the increasing
level of capital resources being devoted to Subprime Mortgage Loan lending may
increase the competition among lenders to originate or purchase Subprime
Mortgage Loans and result in either (i) reduced interest rates and, thus,
compressed spreads on such Mortgage Loans compared to present levels, which
would decrease potential profit margins, or (ii) revised underwriting standards
permitting higher loan-to-value ratios on properties securing Subprime Mortgage
Loans, which would increase the risk of loss in the event of default. There can
be no assurance that the Company will be able to compete successfully in this
market environment and any failure in this regard could have a material adverse
effect on the Company's results of operations and financial condition.
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INVESTMENTS IN HIGH LTV MORTGAGE LOANS AND SUBORDINATED MORTGAGE SECURITIES
INVOLVE GREATER RISKS OF LOSS
DEFAULTS ON HIGH LTV MORTGAGE LOANS MAY RESULT IN LOSSES
The Company's current underwriting guidelines allow for the acquisition of
Mortgage Loans with up to a 90% loan-to-value ratio ("LTV"). See
"Business -- Underwriting and Quality Control Strategies." The higher the LTV,
the greater the risk that the Company may be unable to recover full amounts due
on its Mortgage Loans in the event the borrower defaults and the Company
forecloses and sells the underlying collateral. The failure of the Company to
adequately address the risk of high LTV Mortgage Loan products could have a
material adverse effect on the Company's results of operations and financial
condition.
SUBORDINATED CLASSES OF MORTGAGE SECURITIES ARE SUBJECT TO GREATER CREDIT
RISKS THAN SENIOR CLASSES
The Company expects its investment portfolio to include Mortgage Securities
acquired from third parties, including "first loss" classes of subordinated
Mortgage Securities. A "first loss" class is the most subordinated class of
securities and is the first to bear the loss upon a default on the underlying
Mortgage Loans. Subordinated Mortgage Securities are subject to special risks
than more senior classes, including a substantially greater risk of loss of
principal and non-payment of interest. While the market value of most
subordinated interest classes tend to react less to fluctuations in interest
rate levels than more senior classes, the market values of subordinated Mortgage
Securities tend to be more sensitive to changes in economic conditions than more
senior classes. As a result of these and other factors, subordinated Mortgage
Securities generally are not actively traded, are more difficult to pledge as
collateral for borrowings and may not provide the holders thereof with
liquidity.
Additionally, the yield to maturity on subordinated Mortgage Securities of
the type that 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 Mortgage Securities and
the timing of any such defaults or losses. Because the subordinated Mortgage
Securities of the type the Company intends to acquire generally have no credit
support, to the extent there are realized losses on the Mortgage Loans
collateralizing such classes, the Company may recover less than the full amount,
if any, of its initial investment in such subordinated Mortgage Securities.
Further, the subordination of Mortgage Securities to more senior classes
may adversely affect the yield on such Mortgage Securities 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 Mortgage Securities.
Finally, the Mortgage Securities that the Company retains from its
structured debt financings may be subordinated Mortgage Securities that are not
supported by credit enhancements, are not investment grade and have limited
liquidity. To the extent third parties have been contracted to provide the
credit enhancement, the Company is dependent in part upon the creditworthiness
and the ability of the insurer to pay claims and the timeliness of reimbursement
in the event of a default on the underlying obligations. The insurance coverage
for various types of losses is limited in amount and, consequently, losses in
excess of the limitation would be borne by the Company. Credit enhancements on
non-investment grade Mortgage Securities are less likely to fully absorb the
losses from mortgage defaults which tend to be significantly higher for non-
investment grade Mortgage Securities as compared to investment grade Mortgage
Securities. Non-investment grade Mortgage Securities are also generally less
liquid than investment grade securities. Accordingly, to the extent that the
Company invests in non-investment grade securities, it will be subject to
greater credit and liquidity risks the consequences of which may result in
losses and adversely affect results of operations.
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INTEREST RATE FLUCTUATIONS MAY ADVERSELY AFFECT OPERATIONS AND NET INTEREST
INCOME
INTEREST RATE MISMATCHES BETWEEN MORTGAGE ASSETS AND BORROWINGS MAY RESULT IN
REDUCED INCOME OR LOSSES
A substantial portion of all Mortgage Assets are expected to have
adjustable rates or are fixed initially, but have interest rate indices that
will adjust at some point in the future. Interest rates on the Company's
borrowings are, and generally will be, based on short-term indices. To the
extent any of the Company's Mortgage Assets are financed with borrowings bearing
interest based on, or varying with, an index different from that used for the
related Mortgage Assets, so-called "basis" interest rate risk will arise. In
such event, if the index used for the Mortgage Assets is a "lagging" index (such
as the 11th District Cost of Funds) that reflects market interest rate changes
on a delayed basis, and the rate borne by the related borrowings reflects market
rate changes more rapidly, the Company's net interest income will be adversely
affected in periods of increasing market interest rates.
Additionally, the Company's adjustable-rate Mortgage Assets will be subject
to periodic rate adjustments which may be more or less frequent than the
increases or decreases in rates borne by the borrowings or financings utilized
by the Company. Accordingly, in a period of increasing interest rates, the
Company could experience a decrease in net interest income or a net loss because
the interest rates on borrowings could adjust faster than the interest rates on
the Company's adjustable-rate Mortgage Loans ("ARMs") or Mortgage Assets backed
by ARMs. Moreover. ARMs are typically subject to periodic and lifetime interest
rate caps which limit the amount an ARMs interest rate can change during any
given period. The Company's borrowings will not be subject to similar
restrictions. Hence, in a period of rapidly increasing interest rates, the
Company could also experience a decrease in net interest income or a net loss in
the absence of effective hedging because the interest rates on borrowings could
increase without limitation while the interest rates on the Company's ARMs and
Mortgage Assets backed by ARMs would be limited by caps. Furthermore, some ARMs
may be subject to periodic payment caps that result in some portion of the
interest accruing on the ARM being deferred and added to the principal
outstanding. This could result in receipt by the Company of less cash income on
its ARMs than the debt service that the Company is required to pay on the
related borrowings, which will not have such payment caps. The Company expects
that the net effect of these factors, all other factors being equal, will be to
lower the Company's net interest income or cause a net loss during periods of
rapidly rising market interest rates (but not necessarily in an environment of
gradually rising market interest rates), which could negatively impact the level
of dividend distributions and the market price of the Common Stock.
The Company acquires the majority of its Mortgage Assets at a premium over
face amount. For financial reporting purposes, these premiums are amortized as
an adjustment to the yield of the acquired Mortgage Asset. During periods of
decreasing interest rates, borrowers are more likely to refinance Mortgage
Loans. As Mortgage Loans are prepaid, premiums may be amortized faster than
originally expected. Sudden declines in interest rates may increase prepayments,
which would cause a significant portion of premiums to be amortized, resulting
in a significant negative impact on net interest income or result in a net loss.
Although many of the Mortgage Loans originated by the Company have penalties for
prepayment, certain Mortgage Loans originated and Mortgage Loans acquired from
third-party correspondents may not have prepayment penalties, thereby increasing
the Company's exposure to prepayment risks.
Changes in anticipated prepayment rates of Mortgage Assets could affect the
Company in several adverse ways. A portion of the ARMs acquired by the Company
will have been recently originated and will still bear initial interest rates
which are lower than their "fully-indexed" rates (the applicable index, plus a
margin). In the event that such an ARM is prepaid faster than anticipated, such
as prior to or soon after the time of adjustment to a fully-indexed rate, the
Company will have experienced an adverse effect on its net interest income
during the time it held such ARM (compared with holding a fully-indexed ARM) and
will have lost the opportunity to receive interest at the fully-indexed rate
over the expected life of the ARM. In addition, the faster than anticipated
prepayment of any Mortgage Asset that had been purchased at a premium by the
Company would generally result in a faster than anticipated write-off of any
remaining capitalized premium amount and consequent reduction of the Company's
net interest income by such amount.
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INTEREST RATE INCREASES MAY REDUCE MORTGAGE LOAN ORIGINATIONS AND INCOME
A substantial or sustained increase in interest rates could adversely
affect the ability of the Company to originate and purchase Mortgage Loans and
would reduce the interest rate differential between newly originated Mortgage
Loans and the pass-through rate on Mortgage Loans that are financed.
Historically, interest rate increases have resulted in a reduction in the level
of re-financed Mortgage Loan originations. In such event, the Company's
origination volume may significantly decrease, prohibiting the Company from
acquiring or originating sufficient new Mortgage Loans to replace those Mortgage
Loans that are prepaid. In periods of declining production, the Company may be
required to purchase Mortgage Assets in the secondary market at higher costs,
thereby reducing earnings and income.
DECLINING INTEREST RATES MAY INCREASE PREPAYMENT RATES AND REDUCE NET INTEREST
INCOME
Prepayment rates vary from time to time and may cause changes in the amount
of the Company's net interest income. Prepayments of ARMs and Mortgage Assets
backed by ARMs usually can be expected to increase when mortgage interest rates
fall below the then-current interest rates on such ARMs and decrease when
mortgage interest rates exceed the then-current interest rate on the ARMs,
although such effects are not predictable. Prepayment experience also may be
affected by the geographic location of the property securing the Mortgage Loans,
the assumability of the Mortgage Loans, conditions in the housing and financial
markets and general economic conditions. In addition, prepayments on certain
ARMs may be affected by the ability of the borrower to convert an ARM to a
fixed-rate Mortgage Loan and by conditions in the fixed-rate Mortgage Loan
market. If the interest rates on ARMs increase at a rate greater than the
interest rates on fixed-rate Mortgage Loans, prepayments on ARMs may tend to
increase. In periods of fluctuating interest rates, interest rates on ARMs may
exceed interest rates on fixed-rate Mortgage Loans, which may tend to cause
prepayments on ARMs to increase at a rate greater than anticipated. Mortgage
Securities backed by Mortgage Loans are often structured so that certain classes
are provided protection from prepayments for a period of time. However, in a
period of extremely rapid prepayments, during which earlier-paying classes may
be retired faster than expected, the protected classes may receive unscheduled
payments of principal earlier than expected and would have average lives that,
while longer than the average lives of the earlier-paying classes, would be
shorter than originally expected. The Company will seek to minimize prepayment
risk through a variety of means, including structuring a diversified portfolio
of Mortgage Assets with a variety of prepayment characteristics, originating and
investing in Mortgage Assets with prepayment prohibitions and penalties,
investing in certain Mortgage Security structures which have prepayment
protection, and balancing Mortgage Assets purchased at a premium with Mortgage
Assets purchased at a discount. In addition, the Company may in the future
purchase IOs as part of its hedging strategy. However, no strategy can
completely insulate the Company from prepayment risks arising from the effects
of interest rate changes.
HEDGING TRANSACTIONS LIMIT GAINS AND MAY INCREASE EXPOSURE TO LOSSES
The Company follows an asset/liability management strategy intended to
protect against interest rate changes and prepayments. See "Business
-- Interest Rate Risk Management." Nevertheless, developing an effective
asset/liability management strategy is complex and no strategy can completely
insulate the Company from risks associated with interest rate changes and
prepayments. In addition, there can be no assurance that the Company's hedging
activities will have the desired beneficial impact on the Company's results of
operations or financial condition. Hedging typically involves costs, including
transaction costs, which increase dramatically as the period covered by the
hedge increases and which also increase during periods of rising and volatile
interest rates. The Company may increase its hedging activity, and, thus,
increase its hedging costs, during such periods when interest rates are volatile
or rising and hedging costs have increased. Moreover, federal tax laws
applicable to REITs may substantially limit the Company's ability to engage in
certain asset/ liability management transactions. Such federal tax laws may
prevent the Company from effectively implementing particular hedging strategies
that the Company determines, absent such restrictions, would best insulate the
Company from the risks associated with changing interest rates and prepayments.
See "Federal Income Tax Considerations -- Taxation of the Company."
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INTEREST-ONLY AND PRINCIPAL-ONLY MORTGAGE SECURITIES ARE SUBJECT TO SUBSTANTIAL
INTEREST RATE AND PREPAYMENT RISKS WHICH MAY ADVERSELY AFFECT RESULTS OF
OPERATIONS.
The Company may invest a portion of its assets in interest-only Mortgage
Securities ("IOs") and principal-only Mortgage Securities ("POs"), which are
subject to substantial interest rate and related risks, in conjunction with its
other hedging activities. IOs represent investments in the interest payments
from a pool of Mortgage Loans, whereas POs represent investments in the
principal payments from a pool of Mortgage Loans. The returns from IOs and POs
are subject to significant prepayment risks. To the extent that the average
prepayment rate on a pool of Mortgage Loans is higher than expected, the IOs
issued on such pool will generate less interest income than IOs issued on pools
of Mortgage Loans with lower prepayment rates. As interest rates decline,
prepayment rates will generally increase and thereby reduce the stream of income
which can be generated through an investment in IOs. Conversely, POs benefit
from higher prepayment rates since the holders are entitled to receive such
prepayments. The present value of the cash flow generated from POs will
generally decline in the event that prepayments are slower than expected. In
addition, rising interest rates will negatively impact the present value of the
future cash flows from both IOs and POs. Accordingly, any such fluctuations in
interest rates or prepayment rates may reduce or eliminate the effectiveness of
hedging strategies using IOs and POs, and thereby may have an adverse effect on
the Company's results of operations.
THE COMPANY HAS NO SPECIFIC HEDGING POLICIES AND FAILURE TO APPROPRIATELY HEDGE
MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company intends to purchase interest rate caps, interest rate swaps and
other appropriate financial instruments to mitigate the risk of the interest
cost of its variable rate liabilities increasing at a faster rate than the
earnings on its Mortgage Assets during a period of rising rates. In this way,
the Company intends generally to hedge as much of the interest rate risk as
management determines is in the best interests of the Company given the cost of
such hedging transactions and the need to maintain the Company's status as a
REIT. In this regard, the amount of income the Company may earn from its hedging
is subject to limitation under the REIT provisions of the Code. The Company may
hedge the risk of its borrowing costs on its liabilities increasing faster than
its income, due to the effect of the periodic and lifetime caps on its Mortgage
Assets, through the acquisition of (i) Qualified REIT Assets, such as
interest-only REMIC regular interests, that function in a manner similar to
hedging instruments, (ii) Qualified Hedges, the income from which qualifies for
the 95% income test, but not the 75% income test for REIT qualification
purposes, and (iii) other hedging instruments, whose income qualifies for
neither the 95% income test nor the 75% income test. See "Federal Income Tax
Considerations -- Qualification as a REIT -- Sources of Income." The latter form
of hedging may be accomplished through the Taxable Subsidiary. See
"Business -- Industry Developments," "Business -- Interest Rate Risk Management"
and "Federal Income Tax Considerations -- Taxation of the Company." The
Company's policies do not contain specific requirements as to the percentage or
amount of interest rate risks which the Company is required to hedge. The Board
of Directors will, from time to time, review the extent and effectiveness of
hedging transactions conducted by the Company. The Company may attempt to
increase its overall yield by saving the cost of acquiring and carrying hedging
instruments by not hedging certain periodic interest rate adjustments when the
Company determines, based on all relevant facts, that bearing such risk is
advisable and does not present an unacceptable risk. However, there can be no
assurance that the Company's estimation of the risks will be accurate and
failure to hedge appropriately may effect the Company's results of operations.
COUNTERPARTY AND UNENFORCEABILITY RISK IN HEDGING TRANSACTIONS MAY RESULT IN
LOSSES
Hedging instruments are not always traded on regulated exchanges,
guaranteed by an exchange or its clearing house, or regulated by any U.S. or
foreign governmental authorities. Consequently, there are no requirements with
respect to record-keeping, financial responsibility or segregation of customer
funds and positions. Hedging transactions subject the Company to risks that the
counterparty will be unable or unwilling to perform its obligations. Such risks
could result from insufficient documentation, insufficient capacity or authority
of a counterparty and unenforceability in the event of bankruptcy or insolvency.
If a hedging
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transaction entered into by the Company was determined to be unenforceable, the
Company could incur unrecoverable losses from such transaction. The business
failure of a counterparty with which the Company has entered into a hedging
transaction will most likely result in a default. Default by a party with which
the Company has entered into a hedging transaction may result in the loss of
unrealized profits and force the Company to cover its resale commitments, if
any, at their then current market price. Although generally the Company will
seek to reserve for itself the right to terminate its hedging positions, it may
not always be possible to dispose of or close out a hedging position without the
consent of the counterparty, and the Company may not be able to enter into an
offsetting contract in order to cover its risk. There can be no assurance that a
liquid secondary market will exist for hedging instruments purchased or sold,
and the Company may be required to maintain a position until exercise or
expiration which could result in losses.
BASIS RISK IN HEDGING TRANSACTIONS MAY RESULT IN LOSSES
To the extent the Company utilizes a derivatives transaction to hedge
another position, such transaction will also subject the Company to basis or
correlation risk. Basis or correlation risk refers to the exposure of a
transaction or portfolio to the differences in the price performance of the
derivatives it contains and their hedges. If the Company enters into a
transaction in which an instrument and its hedge are not perfectly correlated,
changes in applicable indices or other price movements will result in a change
(which could include a loss) in the market value of the combined hedge position.
The Company does not have any policies limiting the amount of derivatives used
for hedging transactions which increases uncertainty for stockholders.
BORROWING TO FINANCE INVESTMENT PORTFOLIO MAY ADVERSELY AFFECT RESULTS OF
OPERATIONS
LEVERAGE INCREASES EXPOSURE TO LOSS
The Company's operations are expected be highly leveraged. The Company
expects to borrow against a substantial portion of the market value of its
assets (up to approximately 92%, depending upon the nature of the underlying
Mortgage Assets). The Company generally expects to maintain a ratio of equity
capital to book value of total assets of approximately 8% to 15%. The actual
ratio may be higher or lower from time to time depending upon market conditions
and other factors deemed relevant by management, subject to the review of the
Board of Directors. The Company's Amended and Restated Articles of Incorporation
and Bylaws do not limit the amount of indebtedness the Company can incur, and
management will have the discretion to deviate from or change its indebtedness
policy at any time, without consent from or notice to the Company's
stockholders. See "-- Operations of a New Enterprise Involves
Uncertainty -- Future Revisions in Investment and Operating Policies and
Strategies by Board of Directors Creates Uncertainty." The Company intends to
finance its acquisition of Mortgage Assets through the net proceeds of the
Offering and by borrowing against or "leveraging" its investment portfolio. The
Company will leverage primarily with reverse repurchase agreements,
securitizations of its Mortgage Loans and secured and unsecured borrowings.
Leverage increases the volatility in the Company's income and the value of
its investment portfolio of Mortgage Assets. The Company will leverage its
investment portfolio only when there is an expectation that it will enhance
returns; however, there can be no assurance that the Company's use of leverage
will prove to be beneficial or advantageous to the Company, relative to the
Company's risks. Moreover, there can be no assurance that the Company will be
able to meet its debt service obligations. The Company's ability to meet its
debt service obligations will depend upon the Company's receipt of sufficient
income from its Mortgage Assets investment portfolio. In the event of a mismatch
in interest rates between the Company's borrowings and the yield on its Mortgage
Assets investment portfolio or other reductions in cash flow, including without
limitation reductions resulting from payment defaults on the Company's Mortgage
Assets, the Company may not have sufficient cash flow to meet its debt service
obligations.
A substantial portion of the Company's borrowings are expected to be in the
form of securitizations and reverse repurchase agreements. If the value of the
Mortgage Assets pledged to secure such borrowings were to decline, the Company
would be required to post additional collateral in order to reduce the amount
borrowed or suffer forced sales of its collateral. If sales were made at prices
lower than the carrying value of the collateral, the Company would experience
additional losses. If the Company is forced to liquidate its Mortgage
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Assets, there can be no assurance that it will be able to maintain compliance
with the REIT provisions of the Code regarding asset and source of income
requirements. See "-- Failure to Maintain REIT Status Would Have Adverse Tax
Consequences."
INABILITY TO IMPLEMENT LEVERAGING STRATEGY MAY REDUCE INCOME OR RESULT IN
LOSSES
The Company employs a financing strategy to increase the size of its
Mortgage Asset portfolio by borrowing a substantial portion (which may vary
depending upon the mix of the Mortgage Assets in the Company's portfolio and the
application of the Company's Capital Allocation Guidelines with respect to such
mix of Mortgage Assets) of the market value of its Mortgage Assets. If the
returns on the Mortgage Assets purchased with borrowed funds fail to cover the
cost of its borrowings, the Company will experience net interest losses. In
addition, through increases in haircuts (i.e., the equity capital required by a
lender or purchaser to finance the Company's Mortgage Assets), decreases in the
market value of the Company's Mortgage Assets, increases in interest rate
volatility, availability of financing in the market, circumstances then
applicable in the lending market and other factors, the Company may not be able
to achieve the degree of leverage it believes to be optimal, which may cause the
Company to be less profitable than it might be otherwise.
INABILITY TO RENEW OR REPLACE MATURING BORROWINGS MAY RESULT IN LOSSES
The ability of the Company to achieve its investment objectives depends not
only on its ability to borrow money in sufficient amounts and on favorable
terms, but also on the Company's ability to renew or replace on a continuous
basis its maturing short-term borrowings. The Company's business strategy relies
on warehouse facilities and short-term reverse repurchase agreements to fund
Mortgage Loan originations and purchases. See "Business -- Capital and Liquidity
Management." In the event the Company is not able to renew or replace maturing
borrowings, the Company could be required to sell Mortgage Assets under adverse
market conditions and could incur losses as a result. See "Business -- Industry
Developments." In addition, in such event, the Company may be required to
terminate hedge positions, which could result in further costs to the Company.
An event or development such as a sharp rise in interest rates or increasing
market concern about the value or liquidity of a type or types of Mortgage
Assets in which the Company's Mortgage Loan portfolio is concentrated will
reduce the market value of the Mortgage Assets, which would likely cause lenders
to require additional collateral. At the same time, the market value of the
Mortgage Assets in which the Company's liquid capital is invested may have
decreased. A number of such factors in combination may cause difficulties for
the Company, including a possible liquidation of a major portion of the
Company's Mortgage Asset portfolio at disadvantageous prices with consequent
losses, which could have a material adverse effect on the Company and its
solvency.
DECLINE IN MARKET VALUE OF MORTGAGE ASSET MAY LIMIT THE COMPANY'S ABILITY TO
BORROW OR RESULT IN LOSSES
A decline in the market value of the Company's portfolio of Mortgage Assets
may limit the Company's ability to borrow or result in lenders initiating margin
calls (i.e., requiring a pledge of cash or additional Mortgage Assets to
re-establish the ratio of the amount of the borrowing to the value of the
collateral). This remains true despite effective hedging against such
fluctuations because the hedging instruments may not be part of the collateral
securing the collateralized borrowings. Additionally, it may be difficult to
realize the full value of the hedging instrument when desired for liquidity
purposes due to the applicable REIT provisions of the Code. See "Federal Income
Tax Considerations -- Qualification as a REIT -- Sources of Income -- The 95%
Test." The Company could be required to sell Mortgage Assets under adverse
market conditions in order to maintain liquidity. See "Business -- Industry
Developments." Such sales may be effected by management when deemed by it to be
necessary in order to preserve the capital base of the Company. If these sales
were made at prices lower than the amortized cost of the Mortgage Assets, the
Company would experience additional losses. A default by the Company under its
collateralized borrowings could also result in a forced liquidation of
collateral, including any cross-collateralized assets, and resulting in a loss
equal to the difference between the value of the collateral and the amount
borrowed.
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CONTINGENT AND RESIDUAL RISKS IN STRUCTURED DEBT FINANCINGS MAY ADVERSELY
AFFECT RESULTS OF OPERATIONS
In connection with any structured debt financings the Company may
undertake, the Company will be required to repurchase or substitute Mortgage
Loans in the event of a breach of representation or warranty made by the
Company. While the Company may have recourse to the sellers of Mortgage Loans it
purchases, there can be no assurance of the sellers' abilities to honor their
obligations to the Company. Likewise, in connection with any whole loan sales
made by the Company, the Company will enter into agreements with the purchaser
thereof, which generally will require the Company to repurchase or substitute
Mortgage Loans in the event of a breach of a representation or warranty made by
the Company to the Mortgage Loan purchaser, any misrepresentation during the
Mortgage Loan origination process or, in some cases, upon any fraud or default
on such Mortgage Loans. The remedies available to a purchaser of Mortgage Loans
from the Company may be generally broader than those available to the Company
against the sellers of such Mortgage Loans. If a purchaser enforces its remedies
against the Company, the Company may not be able to enforce on a cost-effective
basis whatever remedies the Company may have against its sellers. During the
period of time that the Mortgage Loans are held by the Company, the Company is
subject to the various business risks associated with the lending business,
including borrower default, foreclosure and the risk that a rapid increase in
interest rates would result in a decline in the value of Mortgage Loans held for
sale to potential purchasers. To the extent the Company maintains an interest in
structured debt financings backed by Mortgage Loans it acquires or originates,
the Company retains some degree of prepayment, credit, default and interest rate
risk.
In addition, borrowers, purchasers of the Company's Mortgage Loans,
monoline insurance carriers and trustees in any structured debt financing
undertaken by the Company may make claims against the Company arising from (i)
alleged breaches of fiduciary obligations, misrepresentations, errors and
omissions of employees, officers and agents of the Company, including
appraisers, (ii) incomplete documentation, and (iii) failure by the Company to
comply with various laws and regulations applicable to its business. Any claims
asserted in the future may result in liabilities or legal expenses that could
have a material adverse effect on the Company's results of operations, financial
conditions and business prospects.
UNAVAILABILITY OF STRUCTURED DEBT FINANCING MAY ADVERSELY AFFECT RESULTS OF
OPERATIONS
The Company intends to pool and finance through structured debt financing a
substantial portion of the Mortgage Loans it acquires or originates. The Company
may be required in such financings to continue to bear some risk of loss on the
underlying Mortgage Loans. Adverse changes in the structured debt financing
market could impair the Company's ability to originate, acquire and finance
Mortgage Loans through financings on a favorable or timely basis. Any such
impairment could have a material adverse effect upon the Company's results of
operations or financial condition. In addition, in order to gain access to the
structured debt financing market, the Company may rely upon credit enhancements
provided by one or more monoline insurance carriers. Any substantial reductions
in the size or availability of the structured debt financing market for the
Company's Mortgage Loans, or the unwillingness of insurance companies to provide
credit enhancement for the Company's Mortgage Securities could have a material
adverse effect upon the Company's results of operations or financial condition.
THE COMPANY DEPENDS UPON SEVERAL LENDERS TO FINANCE OPERATIONS
The Company and the Taxable Subsidiary finance substantially all of the
Mortgage Loans which they originate or acquire through interim financing
facilities, including its warehouse credit line and reverse repurchase
agreements. See "Business -- Capital and Liquidity Management." In the case of
the Taxable Subsidiary, these borrowings historically have been repaid with the
proceeds received by the Company through Mortgage Loan sales. See
"-- President's 1999 Budget Plan, If Enacted Would Adversely Affect Results of
Operation." The Taxable Subsidiary is currently dependent upon ContiFinancial
Corporation and Nomura Asset Capital Corporation to provide the primary credit
facilities for its Mortgage Loan originations and acquisitions. For a
description of the terms of the Taxable Subsidiary's arrangements and agreements
with ContiFinancial Corporation and Nomura Asset Capital Corporation, see
"Business -- Marketing and Production Strategy -- Correspondent
Lending -- Initial Correspondent Platform" and "Conflicts of Interest and
Related Party Transactions -- ContiFinancial Corporation." Any failure to renew
or obtain adequate funding
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under these financing arrangements, or any substantial reduction in the size of,
or pricing in, the market for the Taxable Subsidiary's Mortgage Loans, could
have a material adverse effect on the Company's operations. Furthermore, the
Company would not be able to hold a large volume of Mortgage Loans pending
structured debt financing, and, therefore, would have to curtail its Mortgage
Loan production or sell Mortgage Loans either through whole loan sales or
through smaller structured debt financing, potentially having a material adverse
effect on the Company's results of operations. Upon the sale of Mortgage Loans,
the Company would terminate the hedge positions associated with such Mortgage
Loans, which could result in further costs to the Company. A sharp rise in
interest rates or increasing market concern about the value or liquidity of a
type or types of Mortgage Assets being held by the Company will reduce the
market value of the Mortgage Assets, which may cause lenders to require
additional collateral. A number of such factors in combination may cause
difficulties for the Company, including a possible liquidation of a major
portion of the Company's Mortgage Assets at disadvantageous prices, which can
cause additional losses and could have a material adverse effect on the Company
and its solvency.
LENDER BANKRUPTCY MAY RESULT IN LOSSES
Additionally, in the event of a bankruptcy of the Company, certain reverse
repurchase agreements may qualify for special treatment under the Bankruptcy
Code, the effect of which is, among other things, to allow the creditors under
such agreements to avoid the automatic stay provisions of the Bankruptcy Code
and to liquidate the collateral under such agreements without delay. Conversely,
in the event of the bankruptcy of a party with whom the Company had a reverse
repurchase agreement, the Company might experience difficulty recovering the
collateral subject to such agreement if the agreement were repudiated by the
bankrupt lender and the Company's claim against the bankrupt lender for damages
resulting therefrom were to be treated simply as one of an unsecured creditor.
Should this occur, the Company's claims would be subject to significant delay
and recoveries, if and when received, and may be substantially less than the
damages actually suffered by the Company. Although the Company has, and intends
to continue to, enter into reverse repurchase agreements with several different
parties and has developed policies to reduce its exposure to such risks, no
assurance can be given that the Company will be able to avoid such third-party
risks.
RISKS RELATING TO MORTGAGE LENDING OPERATIONS
DEFAULT ON MORTGAGE LOANS MAY RESULT IN LOSSES
Prior to completing a structured debt financing with respect to any
Mortgage Assets, the Company generally does not intend to obtain credit
enhancements such as mortgage pool or special hazard insurance for its Mortgage
Loans, other than Federal Housing Association ("FHA") insurance, Veterans
Association ("VA") guarantees and private mortgage insurance, in each case
relating only to individual Mortgage Loans. Accordingly, during the time it
holds such Mortgage Loans for which third-party insurance is not obtained, the
Company will be subject to risks of borrower defaults, bankruptcies and special
hazard losses that are not covered by standard hazard insurance (including,
without limitation, those occurring from earthquakes or floods). In the event of
a default on any Mortgage Loan held by the Company, including, without
limitation, resulting from declining property values and worsening economic
conditions, among other factors, the Company would bear the risk of loss of
principal to the extent of any deficiency between the market value of the
underlying real property, plus any payments from an insurer or guarantor, and
the amount owing on the Mortgage Loan. Defaulted Mortgage Loans would also cease
to be eligible collateral for borrowings and would have to be financed by the
Company out of other funds until ultimately liquidated, resulting in increased
financing costs and reduced net income or a net loss.
Many of the risks of holding Subprime Mortgage Loans and retaining, after
structured debt financing, a portion of the credit risk derived therefrom
reflect the risks of investing directly in the real estate securing the
underlying Mortgage Loans. This may be especially true in the case of a
relatively small or less diverse pool of Subprime Mortgage Loans. In the event
of a default on the underlying Mortgage Loan, the ultimate extent of the loss,
if any, may only be determined after a foreclosure of the Mortgage Loan
encumbering the property and, if the Company takes title to the property, upon
liquidation of the property. Factors such as title or the property's physical
condition (including environmental considerations) may make a third-party
unwilling to
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purchase the property at a foreclosure sale or for a price sufficient to satisfy
the obligations with respect to the related Mortgage Loans. Foreclosure laws in
various states may protract the foreclosure process. In addition, the condition
of a property may deteriorate during the pendency of foreclosure proceedings.
Moreover, certain Mortgage Loan borrowers may become subject to bankruptcy
proceedings, preventing the Company from immediately liquidating the underlying
real property. In each of the foregoing cases, the amount and timing of amounts
due to the Company may be materially adversely affected.
COMPETITION FOR MORTGAGE LOANS FROM INDEPENDENT MORTGAGE BROKERS AND
CORRESPONDENTS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Taxable Subsidiary depends upon independent Mortgage Loan brokers and
correspondent lenders for a portion of its originations and purchases of new
Mortgage Loans. The Taxable Subsidiary has not entered into any exclusive
arrangements with independent brokers or correspondent lenders, who thus remain
free to sell Mortgage Loans to others. The Taxable Subsidiary competes with many
other purchasers for the correspondents' business based on pricing, service,
loan fees, costs and other factors. The Taxable Subsidiary's competitors also
seek to establish relationships with brokers and correspondents. The Taxable
Subsidiary's future results may become more exposed to fluctuations in the
volume and cost of acquiring its Mortgage Loans resulting from, among other
things, competition from other prospective purchasers of such Mortgage Loans.
COMMITMENTS TO PURCHASE MORTGAGE ASSETS EXPOSES THE COMPANY TO INTEREST RATE
RISK
The Taxable Subsidiary may issue commitments obligating it to purchase a
specific aggregate principal amount of Mortgage Assets from time to time during
the commitment term. As of the date of this Prospectus, the Taxable Subsidiary
has not entered into any commitments to purchase specific Mortgage Assets but
may do so if management believes the offered price is favorable and such
commitment does not expose the Company to excessive risk. From the date the
price for the Mortgage Assets to be acquired by the Taxable Subsidiary is
determined and the date of delivery of such Mortgage Assets occurs, interest
rates on borrowings of the type to be used to finance the purchase of such
Mortgage Assets may rise. If the interest rates on the Mortgage Assets do not
rise by a corresponding amount and the Taxable Subsidiary's hedge, if any,
against the commitments does not perform as expected, the Taxable Subsidiary
will nonetheless be required to purchase such Mortgage Assets and such Mortgage
Assets may produce a lower than anticipated net earnings or a net loss, which
could have a material adverse effect upon the Taxable Subsidiary's results of
operations.
PAYMENTS TO BROKERS IN VIOLATION OF RESPA MAY RESULT IN ADVERSE CLAIMS
Class action lawsuits have been filed against a number of mortgage lenders
alleging that such lenders have violated the Federal Real Estate Settlement
Procedures Act ("RESPA") by making certain payments to independent brokers.
These lawsuits have generally been filed on behalf of a purported nationwide
class of borrowers and allege that payments made by a lender to a broker in
addition to payments made by the borrower to a broker are prohibited by RESPA,
and are therefore illegal. In Culpepper v. Inland Mortgage Corporation, U.S.
Court of Appeals for the 11th Circuit, 1998 U.S. App. LEXIS 274 (January 9,
1998), the Court of Appeals determined that the payment of yield spread premiums
was an illegal referral fee. The Taxable Subsidiary has adopted disclosure
requirements for brokers as suggested by the Mortgage Bankers Association. While
the Taxable Subsidiary has been advised that such disclosure may mitigate the
risk of claims, the Culpepper decision may require the Taxable Subsidiary to
change its broker compensation programs or subject it to material monetary
judgments or other penalties. Any such changes or penalties may have a material
adverse effect on the Taxable Subsidiary's results of operations, financial
condition or business prospects.
LACK OF GEOGRAPHIC DIVERSIFICATION EXPOSES THE COMPANY TO GREATER DEFAULT RISK
The Company seeks geographic diversification of the properties underlying
its Mortgage Assets and has originated Mortgage Loans in more than 25 states.
Nevertheless, properties underlying such Mortgage Assets may be located in the
same or a limited number of geographical regions. The loans originated by the
Taxable
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<PAGE> 41
Subsidiary in 1997 were predominantly concentrated in the following states:
Florida (23.0%), Utah (17.92%), Georgia (11.66%), California (11.33%), Colorado
(5.55%) and New York (5.02%). To the extent that properties underlying such
Mortgage Assets are located in the same geographical region, such Mortgage
Assets may be subject to a greater risk of default than other comparable,
geographically dispersed Mortgage Assets in the event of adverse economic,
political or business developments and natural hazard risks in such region and,
ultimately, the ability of property owners to make payments of principal and
interest on the underlying Mortgage Loans.
INADEQUATE OR INEFFECTIVE SERVICING MAY INCREASE DELINQUENCY AND DEFAULT RATES
Initially, the Company intends to contract for the servicing of all
Mortgage Loans it originates, purchases and holds to maturity with a third-party
mortgage servicer pursuant to an interim servicing agreement. See
"Business -- Servicing Activities." In addition, a third-party mortgage servicer
will subservice each structured debt financing of the Company's Mortgage Loans
pursuant to a related pooling and servicing agreement and a corresponding
subservicing agreement between the Company and the third-party servicer. As with
any external service provider, the Company is subject to risks associated with
insufficient or untimely services. Many of the Company's borrowers will require
notices and reminders to keep their Mortgage Loans current and to prevent
delinquencies and foreclosures. Any failure of the subservicer to adequately
service the Company's Mortgage Loans could cause a substantial increase in the
Company's delinquency or foreclosure rates, which could adversely effect the
Company's ability to access equity or debt capital resources. Ultimately,
inadequate or ineffective servicing could have a material adverse effect on the
Company's results of operations, financial condition and business prospects.
Additionally, the Company has entered into a servicing agreement with
Advanta which requires the Company to pay certain termination or transfer
penalties, fees and costs in the event the Company terminates such servicing
agreement without cause or transfers the servicing of any Mortgage Loans
serviced thereunder to another servicer. The Company will be subject to a fee
equal to $100 per Mortgage Loan upon termination of the servicing agreement. The
payment of such a termination fee may reduce the Company's earnings and amounts
available for distribution to stockholders. See "Business -- Servicing
Activities -- Advanta Servicing Agreement."
INABILITY TO SELL MORTGAGE LOANS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Taxable Subsidiary plans to sell certain Mortgage Loans (primarily
fixed-rate Subprime Mortgage Loans, Prime Mortgage Loans and Second Lien
Mortgage Loans) to secondary market purchasers. See "-- President's 1999 Budget
Plan, If Enacted, Would Adversely Affect Results of Operations" and
"Business -- Industry Developments." The Company's ability to manage its
Mortgage Loan portfolio according to its plan necessitates the existence of
purchasers for such Mortgage Loans. Any such difficulty may have a material
adverse effect on the Company's results of operations, financial condition or
business prospects.
LEGISLATION AND REGULATION MAY SUBJECT THE COMPANY TO COSTS OF COMPLIANCE AND
ADVERSE CLAIMS FOR NONCOMPLIANCE
Members of Congress and government officials from time to time have
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of
Mortgage Loan or principal amount. Since many of the Taxable Subsidiary's
Mortgage Loans will be made to borrowers for the purpose of consolidating
consumer debt or financing other consumer needs, the competitive advantages of
tax-deductible interest, when compared with alternative sources of financing,
could be eliminated or seriously impaired by such government action.
Accordingly, the reduction or elimination of these tax benefits could have a
material adverse effect on the demand for the Mortgage Loans offered by the
Taxable Subsidiary.
The Taxable Subsidiary's business is subject to extensive regulation,
supervision and licensing by federal, state and local governmental authorities
and will be subject to various laws and judicial and administrative decisions
imposing requirements and restrictions on part or all of its operations.
Regulated matters include,
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<PAGE> 42
without limitation, Mortgage Loan origination marketing efforts, credit
application and underwriting activities, maximum finance and other charges,
disclosure to customers, certain rights of rescission on Mortgage Loans, closing
and servicing Mortgage Loans, collection and foreclosure procedures,
qualification and licensing requirements for doing business in various
jurisdictions and other trade practices. Mortgage Loan origination activities
are subject to the laws and regulations in each of the states in which those
activities are conducted. Activities as a lender are also subject to various
federal laws including the Truth in Lending Act ("TILA"), the Equal Credit
Opportunity Act of 1974, as amended ("ECOA"), the Home Mortgage Disclosure Act
("HMDA") and the Debt Collection Practices Act and the Fair Credit Reporting
Act. TILA and Regulation Z, issued under TILA, as amended, contain disclosure
requirements designed to provide consumers with uniform, understandable
information with respect to the terms and conditions of loans and credit
transactions in order to give them the ability to compare credit terms. TILA
also guarantees consumers a three-day right to cancel certain credit
transactions. TILA further imposes disclosure, underwriting and documentation
requirements on Mortgage Loans, known as "Section 32 loans," which are Mortgage
Loans with (i) total points and fees upon origination in excess of 8% of the
Mortgage Loan amount or (ii) an annual percentage rate of more than 10% higher
than comparably maturing United States Treasury securities. The Taxable
Subsidiary is also required to comply with the ECOA, which prohibits creditors
from discriminating against applicants on the basis of race, color, sex, age or
marital status. Regulation B interpreting ECOA restricts creditors from
obtaining certain types of information from loan applicants. It also requires
certain disclosures by the lender regarding consumer rights and requires lenders
to advise applicants of the reasons for any credit denial. In instances where
the applicant is denied credit or the rate or charge for a Mortgage Loan
increases as a result of information obtained from a consumer credit agency, the
Fair Credit Reporting Act of 1970, as amended, requires the lender to supply the
applicant with the name and address of the reporting agency.
The Taxable Subsidiary will also be subject to the RESPA and will be
required to file an annual report with the Department of Housing and Urban
Development ("HUD") pursuant to the HMDA. The Taxable Subsidiary will also be
subject to the rules and regulations of, and examinations by, GNMA, HUD and
state regulatory authorities with respect to originating, processing,
underwriting, selling and servicing Mortgage Loans. Failure to comply with these
requirements can lead to loss of approved status, termination or suspension of
servicing contracts without compensation to the servicer, demands for
indemnifications or Mortgage Loan repurchases, certain rights of rescission for
Mortgage Loans, class action lawsuits and administrative enforcement actions.
There can be no assurance that the Taxable Subsidiary will maintain compliance
with these requirements in the future without additional expenses, or that more
restrictive local, state or federal laws, rules and regulations will not be
adopted or that existing laws and regulations will not be interpreted in a more
restrictive manner, which would make compliance more difficult for the Taxable
Subsidiary.
The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and certain of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently enacted regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the regulations to which the Taxable Subsidiary is subject
may lead to regulatory investigations or enforcement actions and private causes
of action, such as class action lawsuits, with respect to the Taxable
Subsidiary's compliance with the applicable laws and regulations. As a mortgage
lender, the Taxable Subsidiary will be subject to regulatory enforcement actions
and private causes of action from time to time with respect to its compliance
with applicable laws and regulations.
MORTGAGE LOANS SECURED BY PROPERTIES WITH ENVIRONMENTAL PROBLEMS MAY RESULT IN
LIABILITY AND LOSSES
Certain properties securing Mortgage Loans may be contaminated by hazardous
substances. As a result, the value of the real property may be diminished. In
the event that the Company is forced to foreclose on a defaulted Mortgage Loan
on such a property, the Company may be subject to environmental liabilities
regardless of whether the Company was responsible for the contamination. While
the Company intends to exercise due diligence to discover potential
environmental liabilities prior to the acquisition of any such
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<PAGE> 43
property through foreclosure, hazardous substances or wastes, contaminants,
pollutants or sources thereof (as defined by state and federal laws and
regulations) may be discovered on properties during the Company's ownership or
after a sale thereof to a third-party. If such hazardous substances are
discovered on a property, the Company may be required to remove those substances
or sources and clean-up the property. The Company may also be liable to tenants
and other users of neighboring properties. In addition, the Company may find it
difficult or impossible to sell the property prior to or following any such
clean-up. Any exposure to environmental liability could have a material adverse
effect on the Company's results of operations or financial condition.
CHANGES IN ECONOMIC CONDITIONS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company's business may be adversely affected by periods of economic
slowdown or recession which may be accompanied by decreased demand for consumer
credit and declining real estate values. Any material decline in real estate
values reduces the ability of borrowers to use home equity to support borrowings
and increases the LTVs of Mortgage Loans owned by the Company, thereby weakening
collateral coverage and increasing the possibility of a loss in the event of
default. Further, delinquencies, foreclosures and losses generally increase
during economic slowdowns or recessions. Because of the Company's focus on
borrowers who are unable or unwilling to obtain Mortgage Loans from conventional
mortgage sources, the actual rates of delinquencies, foreclosures and losses on
Subprime Mortgage Loans could be higher under adverse economic conditions than
those experienced in the conventional mortgage lending industry. Any sustained
period of such increased delinquencies, foreclosures and losses would adversely
affect the pricing of the Taxable Subsidiary's Mortgage Loan sales, the rate
paid to investors and the over-collateralization required on the Taxable
Subsidiary's long-term financing or whole loan sales. On the other hand, the
Company faces certain risks related to an improving economy, including, but not
limited to, the risk that during times of falling interest rates borrowers tend
to prepay their Mortgage Loans. See "-- Interest Rate Fluctuations May Adversely
Affect Operations and Net Interest Income -- Declining Interest Rates May
Increase Prepayment Rates and Reduce Net Interest Income."
FACTORS BEYOND CONTROL OF THE COMPANY MAY AFFECT PERFORMANCE OF THE INVESTMENT
PORTFOLIO
Although the Company hedges certain aspects of its interest rate risk, the
results of the Company's Mortgage Assets portfolio operation is affected by
various factors, many of which are difficult to predict or are beyond the
control of the Company. The performance of the Company's Mortgage Assets
portfolio depends on, among other things, the level of net interest income
generated by the Company's Mortgage Assets, the market value of such Mortgage
Assets, credit losses on Mortgage Assets held and the supply of, and demand for,
such Mortgage Assets. The Company's net interest income varies primarily as a
result of changes in short-term interest rates, borrowing costs and prepayment
rates, the behavior of which involve various risks and uncertainties as set
forth below. Prepayment rates, interest rates, borrowing costs and credit losses
depend upon the nature and terms of the Mortgage Assets, the geographic location
of the properties securing the Mortgage Loans included in or underlying the
Mortgage Assets, conditions in financial markets, the fiscal and monetary
policies of the United States government and the Board of Governors of the
Federal Reserve System, international economic and financial conditions,
competition and other factors, none of which can be predicted with any
certainty. Because changes in interest rates may significantly affect the
Company's activities, the operating results of the Company depend, in large
part, upon the ability of the Company to effectively manage its interest rate
and prepayment risks while maintaining its status as a REIT. See "-- Interest
Rate Fluctuations May Adversely Affect Operations and Net Interest Income" and
"Borrowing to Finance Investment Portfolio May Adversely Affect Results of
Operations."
INVESTORS WILL INCUR IMMEDIATE AND SUBSTANTIAL ECONOMIC DILUTION
The Price to Public of the Units offered hereby is higher than the net
tangible book per share of the Common Stock. Because prior purchasers of Common
Stock paid less than the Price to Public, purchasers of the Units offered hereby
will be subject to immediate and substantial economic dilution in the net
tangible book value attributable to the Common Stock included as a component of
the Units purchased by them of
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<PAGE> 44
$4.22 per share (assuming the sale of 4,000,000 Units offered hereby at $15.00
per Unit) or $2.31 per share if the Warrants and the Representative's Warrants
are exercised.
FUTURE DEBT AND EQUITY OFFERINGS MAY DILUTE INVESTORS
The Company expects in the future to increase its capital resources by
making additional offerings of equity and debt securities, including classes of
preferred stock, Common Stock, commercial paper, medium-term notes,
mortgage-backed obligations and senior or subordinated debt. See "-- Operation
of a New Enterprise Involves Uncertainty -- Failure to Raise Additional Capital
May Adversely Affect Future Growth and Results of Operations." All debt
securities and classes of preferred stock will be senior to the Common Stock in
the event of a liquidation of the Company. Additional equity offerings may
dilute the equity of stockholders of the Company or reduce the price of shares
of the Company's Common Stock, or both. The Company is unable to estimate the
amount, timing or nature of additional offerings as they will depend upon market
conditions and other factors.
FAILURE TO DEVELOP A TRADING MARKET MAY RESULT IN DEPRESSED COMMON STOCK PRICE
There has not been a public market for the Securities prior to the
Offering. Accordingly, there can be no assurance that a liquid trading market
for the Securities offered hereby will develop or, if developed, that the market
will be sustained. In the absence of a public trading market, an investor may be
unable to liquidate his investment in the Company. The Price to Public was
determined by the Company and the Underwriter. See "Underwriting." There can be
no assurance that the price of the Units in the public market after the closing
of the Offering will not be lower than the Price to Public. While there can be
no assurance that a market for the Company's Securities will develop, the
Company intends to apply for listing of the Units, the Common Stock and the
Warrants on the American Stock Exchange.
If a public market for the Securities exists, it is likely that the market
price of the Securities will be influenced by any variation between the net
yield on the Company's Mortgage Assets and prevailing market interest rates.
However, earnings will not necessarily be greater in high interest rate
environments than in low interest rate environments. Moreover, in periods of
high interest rates, the net earnings of the Company, and, therefore, the
dividend yield on the Common Stock, may be less attractive compared with
alternative investments, which could negatively impact the price of the
Securities. If the anticipated or actual net yield on the Company's Mortgage
Assets declines or if prevailing market interest rates rise, thereby decreasing
the positive spread between the net yield on such investments and the cost of
the Company's borrowings, the market price of the Securities may be adversely
affected.
FAILURE TO MAINTAIN REIT STATUS WOULD HAVE ADVERSE TAX CONSEQUENCES
The Company intends, for the fiscal year ending December 31, 1998, and all
times thereafter, to operate so as to qualify as a REIT for federal income tax
purposes. In order to maintain its qualification as a REIT for federal income
tax purposes, the Company must satisfy certain tests with respect to the sources
of its income, the nature and diversification of its assets, the amount of its
distributions to stockholders and the ownership of its Capital Stock. See
"Federal Income Tax Considerations -- Qualification as a REIT -- Distributions."
If the Company fails to qualify as a REIT in any taxable year and certain relief
provisions of the Code do not apply, the Company would be subject to federal
income tax as a regular, domestic corporation for four subsequent years, and its
stockholders would be subject to tax in the same manner as stockholders of such
a corporation. Distributions to stockholders in any year in which the Company
fails to qualify as a REIT, including the fiscal year 1998, would not be
deductible by the Company in computing its taxable income. As a result, the
Company could be subject to income tax liability, thereby significantly reducing
or eliminating the amount of cash available for distribution to its
stockholders. Further, the Company could also be disqualified from re-electing
REIT status for the four taxable years following the year during which it became
disqualified.
One requirement to maintain REIT status is that the value of the securities
of any other corporation beneficially owned by the Company may not exceed five
percent of value of the Company's total assets. See "Federal Income Tax
Considerations -- Qualification as a REIT -- Nature of Assets." In order to
comply with such requirement on June 30, 1998, the Company must acquire
approximately $325.0 million of assets by June 30, 1998. Failure to acquire
sufficient assets would preclude the Company from electing REIT status for 1998.
This asset test may be satisfied by acquiring U.S. treasury and other
securities.
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<PAGE> 45
FAILURE TO QUALIFY FOR EXEMPTION FROM INVESTMENT COMPANY ACT MAY ADVERSELY
AFFECT THE COMPANY
The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act of
1940, as amended (the "Investment Company Act"). Accordingly, the Company does
not expect to be subject to the restrictive provisions of the Investment Company
Act. The Investment Company Act exempts entities that are "primarily engaged in
the business of purchasing or otherwise acquiring mortgages and other liens on
and interests in real estate" ("Qualifying Interests"). Under the current
interpretation of the staff of the Commission, in order to qualify for this
exemption, the Company must maintain at least 55% of its assets directly in
Mortgage Loans, qualifying Pass-Through Certificates and certain other
qualifying interests in real estate. In addition, unless certain Mortgage Assets
owned by the Company represent all the certificates representing economic
interests issued with respect to an underlying pool of Mortgage Loans, such
Mortgage Assets may be treated as securities separate from the underlying
Mortgage Loans and, thus, may not qualify as Qualifying Interests for purposes
of the 55% safe harbor. Therefore, the Company's ownership of certain Mortgage
Assets may be limited by the provisions of the Investment Company Act. If the
Company fails to qualify for exemption from registration as an investment
company, its ability to use leverage would be substantially reduced and it would
be unable to conduct its business as described herein. Any such failure to
qualify for such exemption could have a material adverse effect on the Company.
ISSUANCES OF PREFERRED STOCK MAY ADVERSELY AFFECT THE VALUE OF COMMON STOCK
Subject to the limitations set forth in the Amended and Restated Articles
of Incorporation, the Board of Directors is authorized to reclassify any of the
unissued shares of authorized capital stock into a class or classes of preferred
stock. The issuance of additional preferred stock could have the effect of
making an attempt to gain control of the Company more difficult by means of a
merger, tender offer, proxy contest or otherwise. The additional preferred
stock, if issued, could have a preference on dividend payments over the Common
Stock which could affect the ability of the Company to make dividend
distributions to the holders of Common Stock. Further, the shares of preferred
stock may be entitled to preferential liquidation, voting and other rights which
could have a material adverse effect on the value of the Company's other
Securities.
RESTRICTIONS ON OWNERSHIP OF CAPITAL STOCK COULD DISCOURAGE A CHANGE OF CONTROL
In order that the Company may meet the requirements for qualification as a
REIT at all times, the Amended and Restated Articles of Incorporation prohibit
any person from acquiring or holding, directly or indirectly, shares of Capital
Stock in excess of 9.8% in value of the aggregate of the outstanding shares of
Capital Stock or in excess of 9.8% (in value or in number of shares, whichever
is more restrictive) of the aggregate of the outstanding shares of Common Stock
of the Company. For this purpose, the term "ownership" is defined in accordance
with REIT provisions of the Code and the constructive ownership provisions of
Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code. Under
such rules, for example, certain types of entities such as widely-held
corporations may hold in excess of the 9.8% limit because shares held by such
entities are attributed to such entities' stockholders. Conversely, shares of
Capital Stock owned or deemed to be owned by a person who individually owns less
than 9.8% of the shares outstanding may nevertheless be in violation of the
ownership limitations set forth in the Amended and Restated Articles of
Incorporation if, under certain circumstances, shares owned by others (such as
family members) are attributed to such individual. See "Federal Income Tax
Considerations -- Qualification as a REIT -- Ownership of Stock." The Amended
and Restated Articles of Incorporation further prohibit (i) any person from
beneficially or constructively owning shares of Capital Stock that would result
in the Company being "closely held" under Section 856(h) of the Code or
otherwise cause the Company to fail to qualify as a REIT, and (ii) any person
from transferring shares of Capital Stock if such transfer would result in
shares of Capital Stock being owned by fewer than 100 persons.
Subject to certain limitations, the Board of Directors may increase or
decrease the ownership limitations. In addition, to the extent consistent with
the REIT provisions of the Code, the Board of Directors may waive the ownership
limitations for and at the request of certain purchasers in this Offering. The
provisions described above may inhibit market activity and the resulting
opportunity for the holders of the Company's Capital
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<PAGE> 46
Stock and Warrants to receive a premium for their Securities that might
otherwise exist in the absence of such provisions. Such provisions also may make
the Company an unsuitable investment vehicle for any person seeking to obtain
ownership of more than 9.8% of the outstanding shares of Capital Stock.
In addition, the provisions of the Amended and Restated Articles and Bylaws
of the Company which stagger the Board of Directors into three classes, require
advance notification of stockholder proposals and require a supermajority vote
to remove directors may also have the effect of delaying, deterring or
preventing take over attempt thereby reducing the price of the Common Stock.
Further, the provisions of Maryland law which restrict business acquisitions by
certain beneficial owners of stock and owners of "control shares" also have the
effect of delaying, deterring or preventing a takeover attempt or change in
control that might be beneficial to stockholders or result in a premium over
their prevailing market prices. See "Description of Capital Stock -- Control
Share Acquisitions" and "-- Business Acquisitions Statutes" and "Management --
Terms of Directors and Officers."
Further, the employment agreements with Messrs. Fry, Mott and McMurray
provide for severence payments of three times their respective and bonus
compensation upon termination following a "Change in Control," as defined
therein. Such provisions would result in minimum payments to Messrs. Fry, Mott
and McMurray of $750,000, $600,000 and $600,000, respectively, which may also
defer or prohibit takeover attempts.
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<PAGE> 47
THE COMPANY
RealTrust Asset Corporation is a newly formed Maryland corporation
incorporated on April 1, 1998. The Taxable Subsidiary, CMG Funding Corp., was
organized in February, 1996 as a mortgage banking company and is located in Salt
Lake City, Utah. The Taxable Subsidiary now has 16 branch offices located in 13
states which originated or purchased approximately $507.4 million in
single-family residential Mortgage Loans during the calendar year ended December
31, 1997 and $152.1 million during the first quarter of 1998.
The Company intends to avail itself of the federal income tax advantages of
electing REIT status for the tax year ending December 31, 1998, subject to the
discussion under "Business -- Industry Developments" and "Risk
Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely Affect
Results of Operations." As a REIT, the Company must distribute to its
stockholders on a pro rata basis each year an amount equal to 95% of its taxable
income before deduction of dividends paid and excluding net capital gain, plus
(ii) 95% of the excess of the net income from foreclosure property over the tax
imposed on such income by the Code, less (iii) any "excess noncash income." See
"Federal Income Tax Considerations -- Qualification as a REIT." The Company
intends to make distributions to its stockholders in amounts sufficient to meet
these 95% distribution requirements. In any year in which the Company qualifies
as a REIT, it generally will not be subject to federal income tax on that
portion of its taxable income or net capital gain which is distributed to its
stockholders. See "Federal Income Tax Considerations."
The Company will manage a portfolio of Mortgage Assets. In addition, the
Company conducts a mortgage lending business through the Taxable Subsidiary. See
"Business -- Industry Developments" and "Risk Factors -- President's 1999 Budget
Plan, If Enacted, Would Adversely Affect Results of Operations." The Company
owns all of the issued and outstanding shares of non-voting preferred stock of
the Taxable Subsidiary which entitles the Company to 95% of the economic value
of the Taxable Subsidiary. The Founders of the Company own all of the issued and
outstanding shares of voting common stock of the Taxable Subsidiary which
entitle them to voting control but only five percent of the economic value of
the Taxable Subsidiary. The Taxable Subsidiary will not be consolidated with the
Company for accounting purposes because the Company will not own any of the
Taxable Subsidiary's voting common stock and, thus, the Company will not control
the Taxable Subsidiary.
As a REIT, the Company will be self-advised and self-managed. Management of
the Company conducts the day-to-day operations of the Company, subject to the
direction of the Board of Directors. The Company's offices are located at 2855
East Cottonwood Parkway, Suite 500, Salt Lake City, Utah 84121, and its
telephone number is (801) 365-3000.
USE OF PROCEEDS
The net proceeds of the Offering, assuming a Price to Public of $15.00 per
Unit, are estimated to be $54,700,000 ($63,070,000 if the Underwriters'
over-allotment option is exercised). The net proceeds will be used to acquire a
portfolio of Mortgage Assets, to fund the origination and purchase of Mortgage
Loans through the Taxable Subsidiary's mortgage lending operation, to expand the
Mortgage Loan production capacity, to repay the outstanding balance on the
working capital credit facility from ContiFinancial Corporation ($2.0 million as
of March 31, 1998), to redeem shares of Class B Redeemable Preferred Stock held
by ContiFinancial Corporation ($2.2 million), to repay the Convertible Secured
Promissory Note to Capstone Investments, Inc. ($850,000), and for general
working capital and other corporate purposes. Any proceeds resulting from the
exercise of the Underwriters' over-allotment option will be entirely used to
purchase Mortgage Assets which have not been identified. Pending the use of the
net proceeds of the Offering for such purposes, the net proceeds will be
invested in Mortgage Assets acquired in the secondary mortgage market. The
Company intends to increase its investment in Mortgage Assets by borrowing
against existing Mortgage Assets and using the loan proceeds to acquire
additional Mortgage Assets. The Company's borrowings generally will be secured
by the Mortgage Assets owned by the Company. Until the Company has fully
implemented this financing strategy and increased its Mortgage Asset investments
to the desired level, the net earnings on the Company's portfolio of Mortgage
Assets are expected to be lower than would be the case if the investment
strategy were fully implemented promptly after the closing of the Offering.
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<PAGE> 48
The following table sets forth certain information concerning the estimated
use of the gross proceeds of the Offering:
<TABLE>
<CAPTION>
PERCENTAGE OF
AMOUNT TOTAL FUNDS
----------- -------------
<S> <C> <C>
Estimated Offering Expenses:
Underwriting Discount(1)............................. $ 4,200,000 7.0%
Offering Expenses(2)................................. 1,100,000 1.9
Funding of Mortgage Loan Originations and Purchases of
Mortgage Assets(3)...................................... 45,425,000 75.7
Repayment of ContiFinancial Corporation's Working Capital
Debt(4)................................................. 2,025,000 3.4
Repayment of Capstone Note(5)............................. 850,000 1.4
Redemption of Preferred Stock and Accrued Dividends(4).... 2,180,000 3.6
Working Capital and Other Corporate Purposes.............. 4,220,000 7.0
----------- -----
Gross Offering Proceeds(6)................................ $60,000,000 100.0%
=========== =====
</TABLE>
- ---------------
(1) The underwriting discount is seven percent, plus Representative's Warrants
to acquire, at the Price to Public, a number of Warrant Shares equal to
three percent of the number of Units sold (including those sold pursuant to
the over-allotment option).
(2) This amount consists of estimated legal, accounting, printing and other
expenses of the Offering, and organizational expenses, which have been or
will be paid by the Company.
(3) See "Business."
(4) See "Conflicts of Interest and Related Party Transactions -- ContiFinancial
Corporation."
(5) See "Conflicts of Interest and Related Party Transactions -- Capstone
Investments, Inc."
(6) Assumes no exercise of the Underwriter's over-allotment option.
DIVIDEND POLICY AND DISTRIBUTIONS
Commencing with the 1998 fiscal year, the Company generally intends to
distribute substantially all of its taxable income each year (which does not
ordinarily equal net income as calculated in accordance with GAAP) to its
stockholders so as to comply with the REIT provisions of the Code. The Company
intends to make distributions quarterly. Any taxable income remaining after the
distribution of the final regular quarterly distribution each year will be
distributed together with the first regular quarterly dividend payment of the
following taxable year or in a special distribution distributed prior thereto.
The dividend policy is subject to revision at the discretion of the Board of
Directors. All distributions will be made by the Company at the discretion of
the Board of Directors and will depend on the taxable income of the Company, the
financial condition of the Company, maintenance of REIT status and such other
factors as the Board of Directors deems relevant. See "Federal Income Tax
Considerations -- Qualification as a REIT -- Distributions."
Distributions to stockholders will generally be subject to tax as ordinary
income, although a portion of such distributions may be designated by the
Company as capital gain or may constitute a tax-free return of capital. The
Company will annually furnish to each of its stockholders a statement setting
forth distributions paid during the preceding year and their characterization as
ordinary income, capital gains, or return of capital. For a discussion of the
Federal income tax treatment of distributions by the Company, see "Federal
Income Tax Considerations -- Taxation of the Company's Stockholders."
41
<PAGE> 49
DIVIDEND REINVESTMENT PLAN
The Company will, after the closing of the Offering, adopt a dividend
reinvestment plan ("DRP") for stockholders who wish to reinvest their
distributions in additional shares of Common Stock. The DRP will be administered
by American Securities Transfer & Trust Incorporated which will maintain
records, prepare and send out statements to all participants, provide
safe-keeping for the shares purchased under the DRP and perform other duties
related to the DRP. Generally, under a DRP, dividends paid with respect to
shares of Capital Stock are automatically invested in additional shares of
Common Stock at a discount to the then current market price. Such discount will
be determined, from time to time, by the Board of Directors consistent with the
REIT provisions of the Code. The DRP will also allow each stockholder to make
additional investments in Common Stock by contributing cash to the DRP
administrator (up to a specified maximum). Upon adoption of the DRP, each
stockholder will be notified in writing of the procedure for enrolling in the
DRP.
42
<PAGE> 50
DILUTION
As of April 1, 1998, on a pro forma basis after giving effect to the
Formation Transactions and Post-Closing Transactions, there were 984,370 shares
of the Company's Common Stock outstanding, having a net negative tangible book
value per share of approximately $0.98. Net tangible book value per share
represents the amount of the Company's total tangible assets less its total
liabilities, divided by the number of shares of its Capital Stock outstanding.
On a pro forma basis after giving effect to the Formation Transactions (other
than the issuance and sale of the Units offered hereby) and the Post-Closing
Transactions, the net negative tangible book value of the Company was $965,545
(the net negative book value of the CMG Funding Corp. capital stock being
contributed).
After giving effect to the net proceeds from the sale of Units offered
hereby at the Price to Public of $15.00 per Unit, assuming no exercise of the
Underwriters' over-allotment option, the pro forma net tangible book value of
the Company as of April 1, 1998 would have been $53,734,455 or $10.78 per share.
This represents a dilution of $4.22 per share to new investors purchasing Units
at $15.00 per Unit. If the Warrants and the Representative's Warrants were
exercised, the pro forma net tangible book value of the Company as of April 1,
1998 would be $115,534,455 or $12.69 per share.
<TABLE>
<CAPTION>
PER SHARE
---------
<S> <C> <C>
Price to Public per Unit................................. $15.00
Dilution attributable to underwriting discount and
offering expenses................................. (1.32)
Dilution attributable to Formation Transactions and
Post-Closing Transactions......................... (2.90)
------
(4.22)
------
Book value per share after underwriting discount and
offering expenses, Formation Transactions.............. 10.78
======
Accretion attributable to exercise of the Warrants
and Representative's Warrants(1).................. 1.91
------
Book value per share after accretion for Warrants and
Representative's Warrants.............................. $12.69
======
</TABLE>
- ------------
(1) Exercise of the Warrants and the Representative's Warrants is entirely at
the discretion of the holders of such Warrants and the Company cannot compel
such holders to exercise. Therefore, there can be no assurance that the
Warrant's or Representative's Warrants will ever be exercised or that the
book value of the Company will increase.
The following table summarizes, on a pro forma basis as of April 1, 1998,
after giving effect to the Formation Transactions and Post-Closing Transactions,
the difference between the existing stockholders and the investors in the
Offering with respect to the number of shares of Common Stock (assuming no
exercise of the Underwriters' over-allotment option, the Warrants or the
Representative's Warrants) purchased from the Company, the total consideration
paid and the average price per share:
<TABLE>
<CAPTION>
SHARES OF THE COMPANY TOTAL CONSIDERATION
---------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- -------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............... 984,370 19.7% $ 2,289,997(1) 3.7% $ 2.33
New investors(2).................... 4,000,000 80.3 60,000,000 96.3 15.00
--------- ----- ----------- -----
Total.......................... 4,984,370 100.0% $62,289,997 100.0%
========= ===== =========== =====
</TABLE>
- ---------------
(1) Reflects the capital contributions to CMG Funding Corp. by each of the
Founders and ContiFinancial Corporation, and excludes the $2.0 million paid
by ContiFinancial Corporation for its 410,581 shares of Class B Redeemable
Preferred Stock, which will be redeemed after the closing of the Offering
for the purchase price plus accrued dividends at 18% per annum, for a total
price of $2.18 million, assuming redemption occurs on June 30, 1998.
(2) Assumes no exercise of the Warrants, the warrants granted to Capstone
Investments, Inc., the Representative's Warrants or the Underwriters'
over-allotment option.
43
<PAGE> 51
CAPITALIZATION
The table below sets forth the capitalization of the Company, as of April
1, 1998 and as adjusted to reflect the issuance of the Units offered in the
Offering at a Price to Public of $15.00 per Unit and the application of the
estimated net proceeds therefrom as described under "Use of Proceeds."
<TABLE>
<CAPTION>
PRO FORMA
APRIL 1, 1998 --------------------------
------------- AS AS
ACTUAL ADJUSTED(1) ADJUSTED(2)
------------- ----------- -----------
<S> <C> <C> <C>
STOCKHOLDERS' EQUITY:
Class A Convertible Preferred Stock, par value $0.001
per share; 1,263,472 shares authorized; no shares
issued and outstanding; As adjusted: 5,000,000 shares
authorized; no shares issued and outstanding......... $ -- $ -- $ --
Class B Redeemable Preferred Stock, par value $.001;
410,581 shares authorized; no shares issued and
outstanding; As adjusted: 410,581 and no shares
issued and outstanding, respectively................. -- 410 --
Common Stock, par value $.001 per share; 2,810,455
authorized; 66 shares issued and outstanding; As
adjusted: 100,000,000 shares authorized; 984,370 and
4,984,370 shares issued and outstanding,
respectively......................................... -0- 984 4,984
Additional paid-in capital............................. 1,000 1,214,061 53,729,471
------ ---------- -----------
Total Stockholders' Equity........................ $1,000 $1,215,455 $53,734,455
====== ========== ===========
</TABLE>
- ---------------
(1) Gives effect to the shares of RealTrust Capital Stock issued to Founders and
ContiFinancial Corporation in the Formation Transactions. Total
Stockholders' Equity reflects 95% of the stockholders' equity of CMG Funding
Corp. as of March 31, 1998.
(2) Assumes the sale of 4,000,000 Units in the Offering and that none of the
Underwriters' over-allotment option, the Warrants, the warrants granted to
Capstone Investments, Inc. or the Representative's Warrants are exercised.
After deducting the underwriting discount of seven percent and estimated
offering expenses of $1,100,000 payable by the Company. Excludes all options
granted to officers, directors and employees of the Company pursuant to the
1996 Stock Option Plan and the 1998 Stock Option Plan. See
"Management -- Executive Compensation -- 1996 Stock Option Plan" and
"-- 1998 Stock Option Plan."
44
<PAGE> 52
REALTRUST ASSET CORPORATION
PRO FORMA FINANCIAL DATA
RealTrust Asset Corporation was incorporated on April 1, 1998 to engage in
business activities that will consist of (i) investing in and managing Mortgage
Loans acquired from CMG Funding Corp. as well as other independent mortgage
brokers and banks; (ii) investing in and managing Mortgage Securities, and (iii)
owning a preferred stock interest in CMG Funding Corp. Except for the initial
capitalization ($1,000), RealTrust currently has no assets, liabilities or
operations. Accordingly, pro forma financial statements of RealTrust are not
deemed to be meaningful, inasmuch as the application of the proceeds to the
acquisition of a specific Mortgage Asset portfolio and the income and expense
related thereto are not factually supportable.
Upon completion of the Formation Transactions, RealTrust intends to invest
substantially all of the net proceeds of the Offering in Qualified REIT Assets,
which will comprise the investment portfolio. The investment portfolio is
expected to generate in excess of 95% of RealTrust's gross revenue. The balance
of RealTrust's gross revenues is expected to be generated from its equity
investment in CMG Funding Corp. RealTrust will acquire its equity interest CMG
Funding Corp. through the Formation Transactions in the form of non-voting
preferred stock resulting in a 95% economic interest. RealTrust's equity
interest in the net income or losses of CMG Funding Corp. will be accounted for
using the equity method of accounting, and will be adjusted for the elimination
of intercompany gains and/or losses related to sales of loans to RealTrust.
45
<PAGE> 53
SELECTED FINANCIAL DATA OF REALTRUST ASSET CORPORATION
AND CMG FUNDING CORP.
REALTRUST ASSET CORPORATION
RealTrust was organized and capitalized on April 1, 1998, with $1,000.
Operations have not commenced as of the date of this Prospectus. The balance
sheet of RealTrust, which has been audited by KPMG Peat Marwick LLP, independent
auditors, and the report thereon, are included elsewhere in this Prospectus.
RealTrust is not acquiring any of the operating assets of CMG Funding Corp.
However, RealTrust will acquire, in the Formation Transactions, all of the
preferred stock of CMG Funding Corp.
CMG FUNDING CORP.
The following selected financial data are derived from the audited
financial statements of CMG Funding Corp. as of December 31, 1997 and 1996, and
for the year ended December 31, 1997, and the period February 7, 1996 (date of
inception) to December 31, 1996, respectively, and from unaudited financial
information as of and for the three months ended March 31, 1998 and 1997. Such
selected financial data should be read in conjunction with the audited financial
statements of CMG Funding Corp. as of December 31, 1997 and 1996, and for the
year ended December 31, 1997, and the period February 7, 1996 (date of
inception) to December 31, 1996, respectively, which financial statements have
been audited by KPMG Peat Marwick LLP, independent auditors, whose report
appears elsewhere in this Prospectus. In the opinion of management, the
unaudited information reflects all adjustments, consisting only of normal
recurring adjustments necessary for a fair presentation of such financial
information for those periods. Results for the three months ended March 31, 1998
are not necessarily indicative of results for the year ending December 31, 1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED PERIOD FROM
MARCH 31, FEBRUARY 7, 1996
------------------------- YEAR ENDED (DATE OF INCEPTION) TO
1998 1997 DECEMBER 31, 1997 DECEMBER 31, 1996
----------- ----------- ----------------- ----------------------
(UNAUDITED)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues:
Interest................................... $ 1,731,480 $ 218,321 $ 3,756,870 $ 621,601
Gain-on-sale of mortgage loans, net........ 1,971,551 644,701 5,967,647 446,771
Mortgage servicing fees.................... 1,886 37,028 38,826 --
Other...................................... 269,296 68 269,248 92,063
----------- ----------- ----------- -----------
Total revenues..................... 3,974,213 900,118 10,032,591 1,160,435
----------- ----------- ----------- -----------
Expenses:
Salaries and Employee Benefits............. 1,567,600 596,768 4,474,357 390,018
General Operating.......................... 1,316,603 606,731 4,313,236 1,285,156
Interest................................... 1,133,174 400,558 2,965,685 731,519
Other...................................... 28,118 15,184 53,624 59,608
----------- ----------- ----------- -----------
Total expenses..................... 4,045,495 1,619,241 11,806,902 2,466,301
----------- ----------- ----------- -----------
Net loss................................... $ (71,282) $ (719,123) $(1,774,311) $(1,305,866)
=========== =========== =========== ===========
BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 968,954 $ 617,925 $ 708,962 $ 272,308
Mortgage loans held for sale................. 53,306,731 16,504,558 54,451,067 24,147,713
Other assets................................. 3,525,317 1,292,441 3,707,274 938,031
----------- ----------- ----------- -----------
Total assets....................... $57,801,002 $18,414,924 $58,867,303 $25,358,052
=========== =========== =========== ===========
Warehouse and revolving working capital lines
of credit.................................. $54,440,517 $16,762,751 $55,603,021 $23,996,471
Other liabilities............................ 2,082,111 1,737,165 1,802,051 1,227,450
----------- ----------- ----------- -----------
Total liabilities.................. 56,522,628 18,499,916 57,405,072 25,223,921
Stockholders' equity......................... 1,278,374 (84,992) 1,462,231 134,131
----------- ----------- ----------- -----------
Total liabilities and stockholders'
equity........................... $57,801,002 $18,414,924 $58,867,303 $25,358,052
=========== =========== =========== ===========
</TABLE>
47
<PAGE> 54
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
As further discussed in other sections of this Prospectus, RealTrust is a
Maryland corporation formed on April 1, 1998 and has not conducted any
operations to date. As a result of the Formation Transaction, RealTrust will own
100% of the non-voting preferred stock of CMG Funding Corp. which entitles
RealTrust to receive 95% of any dividends paid by CMG Funding Corp. RealTrust
accounts for its ownership of CMG Funding Corp. using the equity method. The
following discussion of financial condition and results of operations relates to
the operations of CMG Funding Corp.
CMG Funding Corp. has operated as a specialty finance company primarily
engaged in originating, purchasing, selling and servicing Prime Mortgage Loans
and Subprime Mortgage Loans. CMG Funding Corp. funded its first Mortgage Loans
in April, 1996. Prior to the closing of the Offering, the Taxable Subsidiary
generated revenue from the following activities: (i) Mortgage Loan origination
fees, (ii) cash gains from the sale of Mortgage Loans, (iii) servicing income,
and (iv) interest income from Mortgage Loans prior to their sale. The Taxable
Subsidiary has generated profits before expenses incurred in connection with the
Offering; however, prior to such time, the Taxable Subsidiary's monthly expenses
exceeded monthly revenue. Such expenses were primarily to support rapid
expansion of its wholesale and retail branch network, and included salaries and
benefits, general operating expenses and debt service, among other expenses.
Included in these expense categories are the cost of certain computer and other
equipment, the purchase and creation of software systems and customary office
costs which were expensed in the current period.
After the closing of the Offering, the business focus of the Company will
be to generate income from the net interest earned on a portfolio of Mortgage
Assets. In undertaking this new business, the Company has five principal
strategies: (i) to continue to increase the Taxable Subsidiary's Mortgage Loan
originations through high levels of service to independent brokers and borrowers
in its wholesale and retail channels, (ii) to expand the Taxable Subsidiary's
correspondent mortgage lending activities, (iii) to convert from selling the
Taxable Subsidiary's entire Mortgage Loan production to building a portfolio of
Subprime Mortgage Loans, (iv) through the Taxable Subsidiary to sell certain
Mortgage Loans for cash gains (see "Business -- Industry Developments"), and (v)
to elect to be taxed as a REIT under the Code beginning with the tax year ending
December 31, 1998.
Until December, 2001, CMG Funding Corp. is required to sell certain
Mortgage Loans to ContiFinancial Corporation. See "Conflicts of Interest and
Related Party Transactions -- ContiFinancial Corporation." All such sales are
sold servicing released in cash transactions. Since ContiFinancial Corporation
acquires the Mortgage Loans with all servicing rights, CMG Funding Corp. does
not pay any servicing fees; all such fees are paid out of the interest collected
on the Mortgage Loans by the owner thereof. RealTrust estimates that the amount
of Mortgage Loans to be sold to ContiFinancial Corporation will not materially
impair its ability to acquire a portfolio of Subprime Mortgage Loans because the
adjustable-rate Subprime Mortgage Loans (and remaining 25% of fixed-rate) will
be sufficient to acquire the intended portfolio. See "Risk Factors --
President's 1999 Budget Plan, If Enacted, Would Adversely Affect Results of
Operations." There can be no assurance that the Company's strategies can be
successfully implemented or that such strategies will result in improved
revenues and earnings.
CERTAIN ACCOUNTING POLICIES AND PROCEDURES
TAXABLE INCOME AND GAAP INCOME
Income calculated for tax purposes ("taxable income") differs from income
calculated according to generally accepted accounting principles ("GAAP income")
for various reasons. Income from interest earned in Mortgage Loans differs for
purposes of taxable income and GAAP income because each uses a different method
to calculate the rate of amortization of the premium or discount when Mortgage
Assets are acquired at a price above or below the stated principal amount of the
Mortgage Loans. Credit losses differ for purposes of tax and GAAP methods of
accounting because GAAP requires the Company to take credit provisions in order
to build a credit allowance whereas only actual credit losses are deducted in
calculating taxable income.
48
<PAGE> 55
General and administrative expenses differ due to differing treatment of
leasehold amortization and other items. However, interest expense is calculated
in the same manner for GAAP and tax purposes.
These distinctions are important to the Company's stockholders since
distributions are based on taxable income. The Company generally will not pay
Federal taxes so long as it meets the REIT provisions of the Code and
distributes dividends to stockholders in an amount equal to its taxable income.
See "Federal Income Tax Considerations -- Qualification as a REIT."
TAXABLE INCOME AND DIVIDENDS
RealTrust intends to declare and pay distributions equal to its taxable
income over time. In general, the Company expects to declare a quarterly
distributions per share of Capital Stock which would result in the distribution
of most or all of the taxable income earned in that quarter. See "Dividend
Policy and Distributions" and "Risk Factors -- Operation of a New Enterprise
Involves Uncertainty -- Limited Operating History of the Company Creates
Uncertainty About Future Results" and "Federal Income Tax Considerations."
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997
Net loss for the three months ended March 31, 1998 was $(71,282) as
compared to a net loss of $(719,123) for the same period in 1997.
Total revenues for the first three months of 1998 was $3,974,213, an
increase of 341.5% from total revenues of $900,118 for the first three months of
1997. Approximately 49% and 43% of the total revenue increase was attributable
to the increase in revenues generated by interest income and net gain-on-sale of
mortgage loans held for sale, respectively. The increase in interest income and
net gain-on-sale of mortgage loans held for sale is a result in the increase in
volume of Mortgage Loans mainly in Subprime Mortgage Loans. During the first
three months of 1998, Subprime Mortgage Loan production increased $46.0 million
or 316.6% from $14.5 million for the first three months of 1997 to $60.5 million
for the same period in 1998. Prime Mortgage Loan production increased $38.1
million or 71.4% from $53.4 million for the first three months of 1997 to $91.6
million for the first three months of 1998.
Total expenses for the first three months of 1998 were $4,045,495 as
compared to $1,619,241 for the same period in 1997, an increase of $2,426,254,
or 149.8%. Salaries and employee benefits increased by $970,832 or 162.7% in the
first three months of 1998, as compared to the same period in 1997. The majority
of the increase in salaries and employee benefits related to normal merit
increases from 1997 to 1998, and an increase of 76 employees or 71.0% from 107
for the first quarter 1997 as compared to 183 for the same period in 1998, as a
result of four additional branches operating during the first three months of
1998 compared to 1997.
General operating expense increased from $606,731 during the first three
months of 1997 to $1,316,603 during the first three months of 1998, a $709,872
increase. Approximately 20% of this increase was related to cost associated with
an increased number of branches in 1998 compared to 1997 (i.e. rent, telephone
office expense, etc.)
Interest expense was $1,133,174 for the first three months of 1998 as
compared to $400,558 during the same period in 1997. The increase in interest
expense was a result of the increased usage of the warehouse and revolving
working capital lines of credit (average credit balance for the first three
months of 1998 and 1997 was $55.0 million and $20.4 million, respectively).
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE PERIOD FEBRUARY 7, 1996 (DATE OF
INCEPTION) TO DECEMBER 31, 1996
For the year ended December 31, 1997, the net loss of CMG Funding Corp. was
$(1,774,311) as compared to $(1,305,866) for the period from February 7, 1996
(date of inception) to December 31, 1996.
49
<PAGE> 56
For the year ended December 31, 1997, revenues were $10,032,591 as compared to
$1,160,435 for the period from February 7, 1996 (date of inception) to December
31, 1996, an increase of 764.6% from total revenues. For the year ended December
31, 1997, net gain-on-sale of mortgage loans was $5,967,647 as compared to
$446,771 for the period from February 7, 1996 (date of inception) to December
31, 1996, an increase of 1,235.7%. For the year ended December 31, 1997,
interest income was $3,756,870 as compared to $621,601 for the period from
February 7, 1996 (date of inception) to December 31, 1996. Revenues, net
gain-on-sale of mortgage loans and interest income all increased as a result of
increased Mortgage Loan production with an emphasis on higher profit margin
Subprime Mortgage Loans as compared to Prime Mortgage Loans.
Total expenses for the year ended December 31, 1997 was $11,806,902 as
compared to $2,466,301 for the period from February 7, 1996 (date of inception)
to December 31, 1996, an increase of $9,340,601 or 378.7%. Salaries and employee
benefits expenses increased by $4,084,339 or 1,047.2% for the year ended
December 1997 as compared to the period from February 7, 1996 (date of
inception) to December 31, 1996. General operating expenses increased from
$4,313,236 for the year ended December 31, 1997 as compared to $1,285,156 for
the period from February 7, 1996 (date of inception) to December 31, 1996.
Salaries and benefits and general operating expenses increased as a result of
opening branches outside the Mountain West region and the accompanying corporate
support staff.
For the year ended December 31, 1997, interest expense was $2,965,685 as
compared to $731,519 for the period from February 7, 1996 (date of inception) to
December 31, 1996. Interest expense increased as a result of increased warehouse
lines of credit and working capital borrowings required as a result of increased
Mortgage Loan production.
As of December 31, 1997, mortgage loans held for sale amounted to
$54,451,067 as compared to $24,147,713 as of December 31, 1996. Mortgage loans
held for sale increased as a result of increased production.
LIQUIDITY AND CAPITAL RESOURCES
Prior to July 31, 1997, CMG Funding Corp.'s principal need for capital
resulted from the expansion of its wholesale and retail branches and the need to
fund originations of Mortgage Loans. Such capital was provided by contributions
from the Founders and from the sale of preferred stock and subordinated debt to
ContiFinancial Corporation. CMG Funding Corp. has a limited amount of cash on
hand to fund operations. CMG Funding Corp. requires access to short-term
warehouse and credit facilities to fund the acquisition of Mortgage Loans. Sales
of Mortgage Loans provide cash to support the needs of CMG Funding Corp. pending
closing of the Offering. As of March 31, 1998, CMG Funding Corp. had borrowed
approximately $40.0 million under its warehouse facility and $2.0 million under
its working capital facility with ContiFinancial Corporation. As of December 31,
1997, ContiFinancial Corporation had converted $2.0 million of the working
capital facility into preferred stock.
CMG Funding Corp. has financed, and until the closing of the Offering CMG
Funding Corp. will finance, the origination and acquisition of Mortgage Loans in
its mortgage lending operations through warehouse facilities and reverse
repurchase facilities from several banks and financial institutions. At March
31, 1998, CMG Funding Corp. had committed warehouse facilities and reverse
repurchase facilities of $150.0 million from ContiFinancial Corporation ($50.0
million) and Nomura Asset Capital Corporation ($100.0 million). Such warehouse
and reverse repurchase facilities expire on January 1, 1999 and June 30, 1998,
respectively, and are currently at various interest rates ranging from London
Inter-Bank Offered Rate ("LIBOR") plus 1.1% to LIBOR plus 3.25%, depending on
the nature of the Mortgage Loans collateralizing the applicable borrowing. Both
agreements contain customary and usual negative covenants.
In March, 1998 and April, 1998, the Taxable Subsidiary borrowed an
aggregate $850,000 from Capstone Investments, Inc., a Nevada corporation,
evidenced by a Convertible Secured Promissory Note (the "Note") bearing simple
interest at 9% per annum. The Note matures upon the earlier of (i) January 1,
1999 or (ii) the closing of the Offering. Interest on the Note is payable
monthly and principal is payable upon maturity. Capstone Investments, Inc. has
the option to convert all or any portion of the Note into Units of the Company
offered hereby at the Price to Public. In addition, the Company has granted
Capstone Investments, Inc.
50
<PAGE> 57
warrants to purchase 50,000 shares of Common Stock at a price equal to the Price
to Public. See "Conflicts of Interest and Related Party Transactions -- Capstone
Investments, Inc."
RealTrust is dependent upon the closing of the Offering for the capital
necessary to fund the acquisition of, and long-term investment in, its Mortgage
Asset portfolio. RealTrust will also require additional warehouse and reverse
repurchase facilities and will need to arrange structured debt financing.
Management believes that such facilities are readily available from various
counterparties and has entered into negotiations for such facilities. No
commitments have been received to date. The Company will require additional
capital offerings to continue the proposed growth of the Mortgage Asset
portfolio. Additional capital may not be available on terms satisfactory to
management or at all. If so, the Company would be limited in achieving asset
growth beyond the Mortgage Assets acquired with the net proceeds of the
Offering. See "Risk Factors -- Operation of a New Enterprise Involves
Uncertainty -- Failure to Raise Additional Capital May Adversely Affect Future
Growth and Results of Operations."
Neither RealTrust nor CMG Funding Corp. has made any commitments for
material capital expenditures and has no long-term debt obligations, except the
obligations (i) to repay ContiFinancial Corporation's working capital facility
before January 1, 1999, (ii) to redeem ContiFinancial Corporation's Class B
Preferred Stock and (iii) to repay Capstone's Convertible Secured Promissory
Note. See "Conflicts of Interest and Related Party Transactions." All of such
long-term obligations are expected to be repaid with the net proceeds of the
Offering.
INFLATION
The financial statements and notes thereto presented herein have been
prepared in accordance with GAAP, which require the measurements of financial
position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased costs of the
Company's operations. Unlike industrial companies, nearly all of the assets and
liabilities of the Company's operations are monetary in nature. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. Inflation affects the Company's
operations, however, primarily through its effect on interest rates, which
normally increase during periods of high inflation and decrease during periods
of low inflation. During periods of increasing interest rates, demand for
Mortgage Loans and a borrower's ability to qualify for mortgage financing in a
transaction may be adversely affected.
YEAR 2000 COMPLIANCE
The Company will rely upon a significant number of computer software
programs and operating systems in conducting its operations, including software
purchased from third-party vendors and internally developed programs. To the
extent that these software applications contain source code that is unable to
correctly interpret the upcoming calendar year "2000," some level of
modification or even possible replacement of such source code or applications
will be necessary. The Company has received written confirmation from its
primary software vendors that their applications are Year 2000 compliant or will
be before December 31, 1998. Additionally, the Company is creating or revising
all internally developed software to be Year 2000 compliant. Given the
information known at this time, it is currently not anticipated that these "Year
2000" costs will have any material adverse impact on the Company's business,
financial condition or results of operations.
The Company is, however, dependent on vendor compliance to some extent, for
example third party services. The Company is requiring its systems and software
vendors to represent that the services and products provided are, or will be,
Year 2000 compliant, and contemplate a program of testing compliance. Although
no assurances can be provided regarding compliance by third-party vendors, the
Company does not expect that noncompliance by any such vendors will have a
material adverse effect on the Company's operations. In the event of
noncompliance by any such vendor, the Company believes that alternative vendors
will be available to the Company.
51
<PAGE> 58
BUSINESS
GENERAL
RealTrust Asset Corporation, a Maryland corporation formed on April 1, 1998
("RealTrust" or the "Company"), is a specialty finance company engaged in the
business of originating, purchasing, selling and servicing mortgage loans
secured (i) primarily by first mortgages on single-family residences ("First
Lien Mortgage Loans") and (ii) to a much lesser extent by second lien Mortgage
Loans ("Second Lien Mortgage Loans"; collectively with First Lien Mortgage
Loans, "Mortgage Loans"). RealTrust will own and manage a portfolio composed
primarily of First Lien Mortgage Loans that do not conform to one or more of the
underwriting criteria of Federal Home Loan Mortgage Corporation ("FHLMC") and
Federal National Mortgage Association ("FNMA"). Such Mortgage Loans are referred
to as "Subprime Mortgage Loans." RealTrust expects to acquire Subprime Mortgage
Loans primarily from CMG Funding Corp., a Delaware corporation and RealTrust's
taxable subsidiary (the "Taxable Subsidiary"). The Company has entered into a
Mortgage Loan Purchase Agreement (the "Purchase Agreement") with the Taxable
Subsidiary pursuant to which the Company has the right of first refusal on all
Mortgage Loans originated and acquired by the Taxable Subsidiary (except the 75%
of fixed-rate Subprime Mortgage Loans required to be sold to ContiFinancial
Corporation).
RealTrust intends to build a portfolio of primarily Subprime Mortgage Loans
and securities backed by Mortgage Loans ("Mortgage Securities"; together with
Mortgage Loans, "Mortgage Assets") financed with structured debt instruments and
reverse repurchase agreements. The portfolio is expected to generate net
interest income, which, upon election to be taxed as a real estate investment
trust ("REIT"), will not be taxed at the corporate level. RealTrust is now and
intends to remain self-advised and self-managed.
The Taxable Subsidiary has operated a mortgage lending business since
April, 1996 and currently originates Mortgage Loans through 14 wholesale and two
retail branch offices. The Taxable Subsidiary's mortgage lending operations
originate and purchase fixed and adjustable-rate Subprime Mortgage Loans, as
well as Mortgage Loans that conform to FHLMC or FNMA underwriting criteria
("Prime Mortgage Loans"). In addition, the Taxable Subsidiary has built a
correspondent lending operation that began purchasing Subprime Mortgage Loans in
the fourth quarter of 1997. Pursuant to the Purchase Agreement, the Company
intends to purchase adjustable-rate Subprime Mortgage Loans originated or
acquired by the Taxable Subsidiary, as well as fixed-rate Subprime Mortgage
Loans not sold to ContiFinancial Corporation. However, the Company does not
intend to purchase Prime Mortgage Loans from the Taxable Subsidiary.
The Taxable Subsidiary will sell its Prime Mortgage Loans and selected
Subprime Mortgage Loans to generate current income and cash flow to partially
fund the Company's mortgage lending operations. See "Business -- Industry
Developments." For the fiscal quarter ended March 31, 1998, the Taxable
Subsidiary had originated or purchased $60.5 million of Subprime Mortgage Loans,
including $2.8 million of Subprime Mortgage Loans purchased through its
correspondent operations, and originated $91.6 million of Prime Mortgage Loans.
RealTrust owns 100% of the preferred stock (representing 95% of the economic
interest) of the Taxable Subsidiary but does not control its operations. The
Founders own approximately 66.7% of the voting common stock of the Taxable
Subsidiary and, therefore, control its operations. See "Structure and Formation
Transactions."
To date, the Taxable Subsidiary has sold all of its Subprime Mortgage Loan
production in whole loan sales for cash. From September 1, 1996 to March 31,
1998, the Taxable Subsidiary sold approximately $150.5 million of Subprime
Mortgage Loans, or approximately 54% of all Subprime Mortgage Loan sales during
such period, to ContiFinancial Corporation (with its affiliates ContiMortgage
Corporation, ContiTrade Services L.L.C., and ContiFinancial Services
Corporation, "ContiFinancial Corporation"). Subsequent to the closing of the
Offering, the Company, a newly-established entity, will commence building a
portfolio of Subprime Mortgage Loans and financed with structured debt. See
"Business -- Industry Developments" and "Risk Factors -- Operation of a New
Enterprise Involves Uncertainty." The Taxable Subsidiary will continue to sell
certain Mortgage Loans for cash, primarily to the Company, but also to third
party investors, including the sale of 75% of its fixed-rate Subprime Mortgage
Loans to ContiFinancial Corporation. See "Conflicts of Interest and Related
Party Transactions."
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RealTrust will elect to be taxed as a REIT under the Internal Revenue Code
of 1986, as amended (the "Code"), beginning with the tax year ending December
31, 1998. Upon such election, RealTrust will generally not be subject to Federal
income tax to the extent that it distributes its earnings to its stockholders
and maintains its qualification as a REIT. The Taxable Subsidiary has been and
will continue to be taxed as a "C" corporation and, therefore, was subject to
tax on any earnings.
The Company's principal business objectives are to increase earnings per
share, to increase cash available for distribution to stockholders and to
enhance stockholder value. The Company intends to accomplish these goals
primarily by capitalizing on the yields available from investing in Subprime
Mortgage Loans compared to Prime Mortgage Loans, and managing the risks of such
investments. The Company will derive income from two principal business
activities, as follows:
(i) the management of an investment portfolio of Mortgage Assets which
will generate net interest income based upon the difference between the
interest earned on its Mortgage Assets and the interest paid on its
borrowings used to acquire the Mortgage Assets; and
(ii) the operation of the Taxable Subsidiary's mortgage origination
business, which will generate income from its mortgage lending activities
and will supply adjustable-rate Subprime Mortgage Loans for long-term
investment through the proposed REIT structure which avoids Federal income
tax at the corporate level.
RealTrust will conduct the investment portfolio operations. Specifically,
RealTrust will determine which Mortgage Loans will be held for long-term
investment, will establish underwriting guidelines for the Mortgage Loans, will
arrange financing for the investment portfolio (including the issuance of
structured debt offerings), will administer the capital allocation guidelines
and other risk management policies, and will supervise the servicing operations
of third-party servicers.
The Taxable Subsidiary will conduct the mortgage lending operations. The
Taxable Subsidiary will establish and maintain the wholesale, retail and
correspondent channels of production, will perform all underwriting and quality
control processes, will sell all Mortgage Loans that RealTrust does not desire
to hold for long-term investment (either through whole loan sales or
securitizations) and will maintain all necessary state mortgage lending
licenses.
COMPETITIVE ADVANTAGES
EXPERIENCED MANAGEMENT TEAM
The Company's two primary executive officers, John D. Fry and Terry L.
Mott, collectively have extensive experience in building and operating mortgage
banking operations in a variety of environments, including building Mortgage
Loan production and management teams, and creating and implementing policies,
budgets and controls. Mr. Fry, CMB, formed the Company in February, 1996 and has
been the President, Chief Executive Officer and Chairman of the Board since
inception. Mr. Mott has been the Executive Vice President of the Company
primarily responsible for Mortgage Loan production and a Director since
inception. Mr. Fry began his mortgage banking career in 1966. From 1984 to 1989,
Mr. Fry was the Vice President and Western Division Manager of Goldome Realty
Credit Corp., located in Buffalo, New York. From 1989 to 1994, served as the
Senior Vice President of Wholesale Lending of ComUnity Lending, Inc., in San
Jose, California. Mr. Mott began his career in mortgage banking in 1977. From
1980 to 1988, Mr. Mott was the regional Vice President at Fleet Mortgage Corp.
where he developed and managed the retail and wholesale production for the
western United States. From 1988 to 1994, Mr. Mott was the Executive Vice
President and served on the executive committee for Medallion Mortgage Company.
Mr. Mott left AccuBanc Mortgage, the successor to Medallion Mortgage Company, in
December, 1995 to form the Company with Mr. Fry.
In contemplation of the Offering and the proposed business strategy of the
Company, the Company has hired additional executive management team members,
including John P. McMurray and Steven K. Passey. Mr. McMurray joined the Company
in February, 1998, as the Executive Vice President of Secondary Marketing and
Asset Liability Management. Prior to joining the Company, Mr. McMurray was the
President
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of Keystroke Financial, Inc., a start-up internet mortgage origination company.
From 1995 to 1996, Mr. McMurray was the Executive Vice President and Director,
Risk Management and Capital Markets for Crestar Mortgage Corporation where he
was responsible for interest rate and credit risk management, as well as
hedging, securitization and loan/securities trading activities. From 1982 to
1995, Mr. McMurray served in various management positions with BancPlus Mortgage
Corp., most recently serving as the Senior Vice President, Capital Markets. Mr.
McMurray is a Chartered Financial Analyst and a Certified Public Accountant. Mr.
McMurray received a Master of Science degree in Real Estate from Massachusetts
Institute of Technology, a Masters of Business Administration degree from the
University of Texas, San Antonio and a Bachelor of Science degree from Trinity
University. Mr. Passey joined the Company in October, 1997 as the Senior Vice
President and Chief Financial Officer. Prior to joining the Company, Mr. Passey
was in the financial services area at KPMG Peat Marwick LLP for eight years,
most recently as a manager responsible for accounting and audit work for
financial companies. Mr. Passey is a Certified Public Accountant and received a
Bachelor of Science degree in accounting from the University of Utah.
FOCUS ON SUBPRIME MORTGAGE LOANS
The Company will to focus its Mortgage Asset portfolio on Subprime Mortgage
Loans. Subprime Mortgage Loans are generally secured by substantial equity in
the underlying property, but are made to borrowers who have impaired or limited
credit profiles or higher debt-to-income ratios than traditional mortgage
lenders allow. Subprime Mortgage Loan borrowers also include individuals who,
due to self-employment or other circumstances, have difficulty verifying their
income, and may be individuals who prefer the prompt and personalized service
provided by the Company. These types of borrowers are generally willing to pay
higher origination fees and interest rates than those charged by conventional
lending sources. One important consideration in underwriting Subprime Mortgage
Loans is the nature and value of the collateral securing the Mortgage Loans. The
Company believes that the amount of equity required in the real estate securing
the Mortgage Loans, together with the fact that a substantial majority of the
Mortgage Loans originated or purchased by the Company are secured by borrowers'
primary residences, reduces the risks inherent in Subprime lending. See "Risk
Factors -- Investments in Subprime Mortgage Loans Involve Greater Risk of Loss."
Subprime Mortgage Loans are generally associated with higher risks of
delinquency and foreclosure, and are more likely to result in losses due to
underwriting guidelines which permit an LTV ratio of up to 90%. See "Risk
Factors -- Investments in Subprime Mortgage Loans Involve Greater Risk of Loss."
STRUCTURED DEBT INSTRUMENTS
The Company intends to finance adjustable-rate Subprime Mortgage Loans held
in its investment portfolio through structured debt instruments, where the
emphasis is on earning net interest income over time. This leverage strategy
allows the Company to take full advantage of its REIT status. Moreover, the
Company's Mortgage Asset investment portfolio which will be financed with
structured debt instruments will allow it to produce income not subject to
Federal income tax at the corporate level. Thus, distributions to stockholders
will be generated from net interest income, rather than through fully taxable
gain-on-sale income in REMIC transactions. The accounting for gain-on-sale REMIC
transactions presents as current income the present value of expected future
cash flows from the Mortgage Loans sold. Actual income is subject to revision if
actual losses, interest rates and prepayment experience differ from the assumed
levels.
ADVANTAGES OF REIT TAX STATUS
As a REIT, the Company will generally pass through earnings to stockholders
without Federal income tax at the corporate level. Thus, the Company expects
higher net earnings available to holders of Capital Stock than traditional
mortgage lending institutions which are subject to Federal income tax.
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CORPORATE GOVERNANCE WHICH LIMITS POTENTIAL CONFLICTS OF INTEREST
RealTrust and the Taxable Subsidiary will be a vertically integrated
organization, which is self-advised and self-managed. The Company is structured
to minimize the potential conflicts of interest between the mortgage lending
operation and the Mortgage Asset portfolio management operation. Such conflicts
can arise in REITs where the incentives and interests of management are
dependent on the size of the Mortgage Loan portfolio rather than on return on
equity or stockholder returns. Such conflicts are common in entities which are
externally advised and which have management contracts or structures where
management's compensation is not directly related to the Company's performance
or return to stockholders. The Company's primary management incentive programs
are dependent on return on equity (the incentive bonus plan, one-half of which
is paid in Common Stock of the Company and the other half of which is paid in
cash) and stock price appreciation (stock option plans). See
"Management -- Executive Compensation." However, the Company will be subject to
certain potential conflicts of interest because the voting control of the
Taxable Subsidiary is held by the Founders (who collectively own approximately
66.7% of the voting common stock) and other conflicts of interest arising from
transactions with ContiFinancial Corporation. See "Risk Factors -- Conflicts Of
Interest May Result in Decisions That Do Not Fully Reflect the Stockholders'
Best Interest."
In an effort to mitigate the foregoing potential conflicts of interest, the
Company has implemented policies and procedures which require, among other
things, that each decision that implicates a potential conflict of interest must
be approved by a majority of the Independent Directors. However, there can be no
assurance that the Company's policies or procedures will be successful in
eliminating the influence of such conflicts and, thus, the Company may take
courses of action which fail to fully represent the best interests of all
stockholders of the Company.
LOAN SALES FOR CASH GAINS
The Company's wholesale, retail and correspondent channels originate and
purchase Prime and Subprime, fixed- and adjustable-rate Mortgage Loans. The
Company plans to build its Mortgage Asset portfolio primarily by retaining
selected Subprime Mortgage Loans originated and purchased by the Taxable
Subsidiary. The remaining Mortgage Loans will be sold for cash gains to various
mortgage investors. See "Business -- Industry Developments." The Taxable
Subsidiary expects to sell all of the Prime Mortgage Loans and certain of the
Subprime Mortgage Loans and Second Lien Mortgage Loans originated through its
wholesale and retail channels. The Taxable Subsidiary intends to sell its entire
economic interest in these Mortgage Loans and does not intend to hold residual
interests. The sale of these Mortgage Loans is expected to generate substantial
current income and cash flow to fund, in part, the mortgage lending operations.
See "Risk Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely
Affect Results of Operations" and "Risk Factors -- Operation of a New Enterprise
Involves Uncertainty."
OVERVIEW OF SUBPRIME MORTGAGE MARKET
According to Inside Mortgage Finance Publications, Inc., for the years 1995
through 1997, the residential Mortgage Loan market generated annual Mortgage
Loan volume in excess of $630.0 billion per year. The majority of these
originations (approximately 80% to 90%) were Prime Mortgage Loans. The remaining
balance of 10% to 20% (approximately $85.0 to $150.0 billion) of the
originations were Subprime Mortgage Loans.
Based on its experience originating Subprime Mortgage Loans, the Company
believes there is strong national demand by borrowers for Subprime Mortgage
Loans. Across the country, many borrowers have suffered dislocation and
temporary unemployment, resulting in negative entries on their credit reports.
Erratic market and economic conditions and other factors have resulted in high
ratios of debts to assets and high levels of credit card and other installment
debt for these individuals. In addition, more borrowers are choosing to become
self-employed. The Company believes these circumstances create an attractive
market for Subprime Mortgage Loans.
One of the significant differences between the Prime Mortgage Loan and the
Subprime Mortgage Loan markets has been the comparative dependence upon the
overall level of interest rates. Generally, the
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Subprime Mortgage Loan market's historical performance has been less sensitive
to interest rate changes. This is evident by the growth in Subprime Mortgage
Loan originations from 1993 through 1995. While the Prime Mortgage Loan market
experienced a decline in originations of more than 40% during that period, due
primarily to an increase in interest rates, Mortgage Loan originations in the
Subprime Mortgage Loan market continued to grow at an annual rate of 10% to 15%
over the same three-year period.
According to Inside Mortgage Finance Publications, Inc., the estimated size
of the Subprime Mortgage Loan originations in 1997 was approximately $124.5
billion. Historically, the Subprime Mortgage Loan market has been a highly
fragmented niche market dominated by local brokers with direct ties to investors
who owned and serviced Subprime Mortgage Loans. Although there have recently
been several new entrants into the Subprime Mortgage Loan business, the Company
believes the Subprime Mortgage Loan market is still highly fragmented, with no
single competitor having more than a 5.6% market share by volume for the
year-ended December 31, 1997. However, the Company does compete with other
mortgage REITs for Subprime Mortgage Loans, namely Novastar Financial, Inc. and
IMPAC Mortgage Holdings, Inc. The growth and profitability of the Subprime
Mortgage Loan market, the demise of numerous depository financial institutions
in the late 1980s which had served this market, and reduced profits and Mortgage
Loan volume at traditional financial institutions have together drawn new
participants and capital to the Subprime Mortgage Loan market. The Subprime
Mortgage Loan market requires more business judgment from underwriters in
evaluating borrowers with previous credit problems. Subprime Mortgage Loan
lending is also more capital intensive than the Prime Mortgage Loan market due
to the fact that the securitization function requires a higher level of credit
enhancement which must be provided by the issuer in the form of
over-collateralization or subordination.
Based on its recent experience in the Subprime Mortgage Loan market, the
Company believes that the Subprime Mortgage Loan market will continue to grow,
due in part to the following reasons: (i) growth in the number of existing
homeowners with negative entries on their credit reports; (ii) growth in the
number of immigrants with limited credit histories who are in the prime home
buying ages of 25 to 34; (iii) growth in the number of self-employed individuals
who have sources of income which are inconsistent and difficult to document;
(iv) growth in consumer debt levels which are causing many borrowers to have
higher debt/income ratios; and (v) growth in consumer bankruptcy filings, which
cause borrowers to be classified as Subprime Mortgage Loan borrowers.
INDUSTRY DEVELOPMENTS
The President's tax proposals contained in the 1999 Budget Plan released by
the Treasury Department on February 2, 1998 (the "1999 Budget Plan") include
several provisions that could adversely affect REITs. The 1999 Budget Plan has
been submitted to the Ways and Means Committee of the U.S. House of
Representatives (the "Ways and Means Committee") for review, which held its
first hearing on February 25, 1998, but has not taken any action to date. See
"Risk Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely
Affect Results of Operations."
Several industry and trade organizations representing REITs and mortgage
bankers, including the National Association of Real Estate Investment Trusts and
The Mortgage Bankers Association have expressed their opposition to those
provisions of the 1999 Budget Plan which affect REITs. However, despite such
opposition, the 1999 Budget Plan may be adopted as proposed.
In summary, the 1999 Budget Plan proposes to prohibit a REIT from owning,
by vote or value, more than 10% of the capital stock of any corporation. Such
proposal is intended to prevent REITs from conducting through a taxable
subsidiary any business which would be prohibited by the REIT itself. If
adopted, such proposal would require the Company to change the nature of its
ownership in the Taxable Subsidiary and the manner in which it conducts its
business.
If adopted, the 1999 Budget Plan would require that RealTrust either (i)
acquire all of the capital stock of the Taxable Subsidiary and convert it into a
Qualified REIT Subsidiary, or (ii) divest itself of the preferred stock of the
Taxable Subsidiary. To convert the Taxable Subsidiary into a Qualified REIT
Subsidiary would require the Taxable Subsidiary to comply with all of the income
and assets tests for a REIT. While the active
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origination of Mortgage Loans in itself does not violate any of the income or
assets tests for maintaining REIT status, the Service could attempt to treat the
income from frequent sales of Mortgage Loans as subject to the 100% tax on
income from prohibited transactions. Rather than pay the prohibited transaction
tax, the Company would likely curtail production of the Mortgage Loans it does
not intend to retain in its investment portfolio. See "Risk
Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely Affect
Results of Operations."
MORTGAGE LENDING BUSINESS
The Taxable Subsidiary originated its first Mortgage Loans in April, 1996.
Since its inception, the Taxable Subsidiary's Mortgage Loan origination volume
has increased significantly. The following table describes the Taxable
Subsidiary's Mortgage Loan production volume by quarter since the third quarter
of 1996:
QUARTERLY MORTGAGE LOAN PRODUCTION
(dollars in thousands)
<TABLE>
<CAPTION>
WHOLESALE RETAIL CORRESPONDENT TOTAL
------------------ ------------------ ------------- ------------------
QUARTER ENDED PRIME SUBPRIME PRIME SUBPRIME SUBPRIME PRIME SUBPRIME
------------- ------- -------- ------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
March 31, 1998.................................. $59,331 $56,564 $32,223 $1,170 $ 2,778 $91,555 $ 60,512
December 31, 1997............................... 46,008 68,480 34,628 3,816 63,132 80,636 135,428(1)
September 30, 1997.............................. 41,313 59,226 32,614 5,502 0 73,927 64,728
June 30, 1997................................... 25,716 27,439 26,811 4,784 0 52,527 32,223
March 31, 1997.................................. 33,513 12,456 19,913 2,068 0 53,426 14,524
December 31, 1996............................... 43,277 14,687 22,055 1,918 0 65,332 16,605
September 30, 1996.............................. 46,806 5,500 14,374 941 0 61,180 6,441
</TABLE>
- ---------------
(1) Includes $63.1 million of Subprime Mortgage Loans originated through the
correspondent channel, which production channel is expected to be fully
reactivated only after closing of the Offering.
The Taxable Subsidiary has demonstrated its ability to successfully expand
its mortgage lending operations while implementing policies and controls. The
Taxable Subsidiary's accomplishments to date include:
- Operating a wholesale channel which, as of March 31, 1998, consisted of
14 branch offices in 13 states that originated $146.6 million of Prime
Mortgage Loans and $167.6 million of Subprime Mortgage Loans for the
year ended December 31, 1997 ($59.3 million and $56.6 million,
respectively, for the quarter ended March 31, 1998);
- Developing and staffing a correspondent channel which produced $63.1
million of Subprime Mortgage Loans for the fourth quarter of 1997 and
$2.8 million of Subprime Mortgage Loans in the first quarter of 1998;
- Operating a retail channel which, as of March 31, 1998, consisted of two
branch offices (Salt Lake City, Utah and Las Vegas, Nevada) that
originated $114.0 million of Prime Mortgage Loans and $16.2 million of
Subprime Mortgage Loans for the year ended December 31, 1997 ($32.2
million and $1.2 million, respectively, for the quarter ended March 31,
1998);
- Becoming licensed to conduct mortgage lending in 27 states;
- Preparing policies and procedures for underwriting, selling and
brokering Mortgage Loans, quality control, and asset management;
- Obtaining $150.0 million in warehouse financing facilities from
ContiFinancial Corporation and Nomura Asset Capital Corporation;
- Establishing Mortgage Loan sales relationships with Mortgage Loan
investors;
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- Creating its management information system to monitor and analyze
operations and financial performance; and
- Establishing a servicing relationship as the Company builds its own
servicing infrastructure.
MARKETING AND PRODUCTION STRATEGY
GENERAL
The Taxable Subsidiary acquires or will acquire Mortgage Loans from four
sources: (i) its wholesale channel, through which Mortgage Loans are acquired
from a network of independent wholesale brokers, (ii) its correspondent channel,
through which closed Mortgage Loans are purchased from other lenders, (iii) its
retail channel, through which direct originations are obtained from its retail
branches, and (iv) to a lesser extent, its bulk acquisitions of Mortgage Loans
from other mortgage banks and financial institutions.
WHOLESALE CHANNEL
The wholesale channel, which originates Mortgage Loans through independent
loan brokers, accounted for $115.9 million, or 76.2%, of the Taxable
Subsidiary's Mortgage Loan production during the first quarter of 1998. As of
March 31, 1998, the wholesale channel originated Mortgage Loans through 14
branch offices located in Atlanta, Boca Raton, Denver, Green Bay, Honolulu,
Kansas City, Las Vegas, Newport Beach, Phoenix, Portland, Richmond, Sacramento,
Salt Lake City and Spokane. Such offices are owned by the Taxable Subsidiary and
are staffed with Taxable Subsidiary employees, generally between one and 15 loan
officers, zero to five underwriters and two to 20 support personnel.
Wholesale originations of Mortgage Loans involve a network of unaffiliated
mortgage brokers that will offer the Taxable Subsidiary's Mortgage Loan
products. Such mortgage brokers are generally unable or unwilling to acquire and
hold Mortgage Loans. Typically, either brokers do not have the capital necessary
to obtain warehousing facilities or they prefer or require the cash generated
from Mortgage Loan sales to sustain operations. The Taxable Subsidiary generally
acquires Mortgage Loans in the wholesale channel at a lower cost than
acquisitions of Mortgage Loans either through bulk purchases or purchases of
securities in the secondary mortgage market. During the 12 months preceding
March 31, 1998, the Taxable Subsidiary has purchased Mortgage Loans from more
than 600 mortgage brokers and banks on a non-exclusive basis.
The Taxable Subsidiary provides prompt, consistent service, which includes
(i) a quick response time in the Mortgage Loan purchase process as a result of
decentralized underwriting, (ii) direct and frequent contact with brokers
through a trained sales force, (iii) competitive pricing, and (iv) a variety of
pricing programs and Mortgage Loan products.
One of the most important factor in attracting and retaining Mortgage Loan
originations from independent brokers is an efficient Mortgage Loan processing
system. The Taxable Subsidiary staffs each wholesale branch with an experienced
underwriter. By locating underwriters in branch offices, the Taxable Subsidiary
avoids delays resulting from the need to ship the Mortgage Loan applications to
a central processing site, as is frequently the case with the Taxable
Subsidiary's competitors. The Taxable Subsidiary can generally underwrite and
approve wholesale Mortgage Loan purchases within 24 hours after receipt of a
completed file.
The Taxable Subsidiary trains its loan officers, account executives and
branch managers in its Mortgage Loan products and processes. Such personnel then
maintain regular contact with independent brokers through scheduled sales visits
and telephone calls. Regular and frequent contact with high-volume producers
results in greater broker loyalty and more consistent production.
The Company has a pricing model that takes into account changing market
conditions and is designed to allow the Company to purchase Mortgage Loans at
competitive prices that maintain adequate profit margins. After its election of
REIT status, the Company anticipates that it will offer more competitive pricing
relative to tax-paying competitors as a result of the elimination of Federal
income tax at the corporate level.
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The following table sets forth selected information relating to the Taxable
Subsidiary's wholesale Mortgage Loan originations during the periods shown:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
----------------------------------------------------------------------------------------------
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
1998 1997 1997 1997 1997 1996 1996
--------- ------------ ------------- -------- --------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
SUBPRIME:
Principal balance (in
thousands)......... $56,564 $68,480 $59,226 $27,439 $12,456 $14,687 $ 5,500
Average principal
balance per
Mortgage Loan (in
thousands)......... $ 100 $ 104 $ 111 $ 100 $ 100 $ 96 $ 98
Principal Balance:
Fixed-rate (in
thousands)...... $13,255 $18,079 $23,421 $10,677 $ 6,124 $ 8,162 $ 2,124
ARMs (in
thousands)...... $43,309 $50,401 $35,805 $16,762 $ 6,332 $ 6,525 $ 3,376
Combined weighted
average initial
loan-to-value
ratio.............. 79.67% 80.41% 79.24% 77.26% 79.13% 78.19% 79.03%
Percent of First Lien
Mortgage Loans..... 98.89% 99.11% 97.65% 97.24% 92.95% 94.04% 96.31%
Percent of Mortgage
Loans with prepay
protection......... 85.33% 93.07% 91.37% 79.24% 46.16% 37.18% 37.98%
Property securing
Mortgage Loans:
Owner occupied..... 91.48% 95.34% 96.55% 91.04% 99.36% 93.17% 97.51%
Non-owner
occupied........ 8.52% 4.66% 3.45% 8.96% 0.64% 6.83% 2.49%
PRIME:
Principal Balance (in
thousands)......... $59,331 $46,008 $41,313 $25,716 $33,513 $43,277 $46,806
</TABLE>
The Taxable Subsidiary initially intends to increase wholesale Mortgage
Loan production through expanded marketing efforts by existing branches. Such
marketing efforts are intended to obtain greater percentages of production by
independent brokers who already sell to the Taxable Subsidiary. The Taxable
Subsidiary intends to continue to increase the percentage of Subprime Mortgage
Loans originated through its wholesale channel. The Company also intends to
identify new areas of the United States within which to establish wholesale
branches, if such areas are generating significant Subprime Mortgage Loan
production.
CORRESPONDENT LENDING
In addition to the wholesale and retail operations, the Taxable Subsdiary
has formed a correspondent lending channel which is specifically directed at the
acquisition of Subprime Mortgage Loans. The correspondent lending channel
acquires closed Subprime Mortgage Loans through a national network of approved
Mortgage Loan originators ("Correspondents") that fund and close each Subprime
Mortgage Loan using their own funds and, subsequently, sell the Mortgage Loans
to the Taxable Subsidiary.
Correspondent Lending Objective. The goal of the correspondent lending
channel is to expand Subprime Mortgage Loan production while maintaining the
comprehensive quality control approach employed by the wholesale and retail
channels of the Taxable Subsidiary. Correspondents will originate Subprime
Mortgage Loans to underwriting guidelines prepared or approved by the credit
risk personnel of the Company and administered by the Taxable Subsidiary. In
addition, the correspondent lending channel provides approved
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Correspondents with the Taxable Subsidiary's operational guidelines to control
pricing, delivery and funding of Subprime Mortgage Loans into the program.
The correspondent lending channel will purchase Subprime Mortgage Loans
from mortgage bankers, commercial bankers and savings institutions on a
servicing released basis. Each Correspondent will maintain certain eligibility
criteria such as net worth requirements, an unqualified auditor opinion from a
nationally recognized or Taxable Subsidiary-approved accounting firm, mortgage
origination experience, quality control procedures and warehouse line
capability, among other requirements. Also, Correspondents make certain
representations and warranties with respect to, among other things, the Subprime
Mortgage Loans, the financial condition of the borrowers, the adequacy of
disclosure, first payment default and premium recapture.
Sales and delivery of Subprime Mortgage Loans to the correspondent lending
channel will be conducted in two ways: (i) on a best efforts, loan-by-loan flow
basis and (ii) bulk purchases. For flow delivery, daily pricing is provided by
the secondary marketing department of the Taxable Subsidiary and the
Correspondent may lock in Mortgage Loan purchase prices through the toll free
commitment desk. Subprime Mortgage Loans identified for purchase by the Taxable
Subsidiary are either re-underwritten by the Taxable Subsidiary or by
independent contractors engaged by the Taxable Subsidiary, or subject to a
post-purchase quality control audit to assure guideline and documentation
conformity. This flow method of acquisition is a major target for the Taxable
Subsidiary primarily because of the lower cost of acquisition. Alternatively,
the Taxable Subsidiary intends to acquire Subprime Mortgage Loans from these and
other Correspondents in bulk purchases that range from $1.0 million to $50.0
million in principal amount. Depending on Mortgage Loan and pool
characteristics, such as weighted average coupon ("WAC"), weighted average
loan-to-value ("WLTV"), weighted average maturity ("WAM"), prepayment penalties
and pool size, the premiums paid for bulk purchase can range between 50 to 200
basis points above those paid on a flow basis. Despite the higher cost, bulk
acquisitions enable economies-of-scale and may provide the Taxable Subsidiary
with market arbitrage opportunities.
Initial Correspondent Platform. In October, 1997, the Taxable Subsidiary
entered into a letter agreement with Nomura Asset Capital Corporation ("Nomura")
to acquire from Nomura Subprime Mortgage Loans and certain non-binding
Correspondent relationships between Nomura and several Correspondents through
which Nomura has actively purchased Subprime Mortgage Loans since 1994. Through
October, 1997, Nomura has purchased over $1.75 billion of Subprime Mortgage
Loans through its Subprime Mortgage Loan conduit operations. The letter
agreement required the Taxable Subsidiary to purchase certain Subprime Mortgage
Loans directly from Nomura, which Subprime Mortgage Loans the Taxable Subsidiary
acquired during the fourth quarter of 1997. The letter agreement also required
Nomura to introduce the Taxable Subsidiary to certain of the Correspondents
formerly selling Subprime Mortgage Loans to Nomura. Such relationships are not
contractually binding on the Correspondents, who remain free to sell to others.
However, the Taxable Subsidiary commenced purchasing Subprime Mortgage Loans
from many of such Correspondents in 1997. The Taxable Subsidiary acquired $2.8
million of Subprime Mortgage Loans through such Correspondents during the first
quarter of 1998.
The Taxable Subsidiary pre-paid Nomura an initial fee of $225,000 which
represented a fee of 25 basis points for the first $90 million of Mortgage Loans
to be acquired from Nomura Correspondent relationships. To the extent that the
Taxable Subsidiary purchases more than $90.0 million of Subprime Mortgage Loans
from such Correspondents before June 30, 1998, the Taxable Subsidiary has agreed
to pay Nomura a fee equal to 25 basis points of the principal amount of such
purchases. The Company does not expect to acquire any additional Mortgage Loans
from such Correspondents until after June 30, 1998 and, therefore, no additional
fees will be paid to Nomura under this letter agreement. In connection
therewith, Nomura also provides to the Taxable Subsidiary a $100.0 million
reverse repurchase facility for a period of one year. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources." The Taxable Subsidiary has also
agreed to allow Nomura to participate as co-underwriter in any public offering
of securities backed by fixed-rate Subprime Mortgage Loans financed through such
facility during the term of the financing facility.
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<PAGE> 67
The Taxable Subsidiary views the assumption of the Nomura Correspondent
relationships and subsequent pipeline as a platform to build and develop the
correspondent production necessary to implement the Company's Mortgage Asset
portfolio strategy. The Taxable Subsidiary intends to expand the correspondent
lending channel by developing relationships with additional Correspondents who
can accumulate and sell pools of Mortgage Loans in sizes ranging from $500,000
to $5.0 million. The Taxable Subsidiary believes that such relationships can
provide attractive Subprime Mortgage Loans at prices that meet the Company's
business plan objectives. However, Given the capital intensive nature of
correspondent lending, the Taxable Subsidiary will not fully utilize its
correspondent lending operations until after the closing of the Offering.
The following table sets forth selected information relating to the Taxable
Subsidiary's correspondent Mortgage Loan originations during the period shown:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
-------------------------
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
SUBPRIME:
Principal balance (in thousands)..................... $ 2,778 $63,132
Average principal balance per Mortgage Loan (in
thousands)......................................... $ 139 $ 114
Principal Balance:
Fixed-rate (in thousands).......................... $ 589 $20,259
ARMs (in thousands)................................ $ 2,189 $42,873
Combined weighted average initial LTV ratio.......... 81.53% 76.78%
Percent of First Lien Mortgage Loans................. 100.00% 96.30%
Percent of Mortgage Loans with prepay protection..... 90.41% 22.80%
Property securing Mortgage Loans:
Owner occupied..................................... 92.07% 96.04%
Non-owner occupied................................. 7.93% 3.96%
PRIME:
Principal balance (in thousands)..................... $ 0 $ 0
</TABLE>
The Taxable Subsidiary is preparing to manage the increased Subprime
Mortgage Loan volume that is anticipated to be generated by the correspondent
lending channel upon the closing of the Offering. The Taxable Subsidiary has
entered into contractual relationships with industry-recognized vendors who will
provide operational services to support the additional Mortgage Loan production.
The Taxable Subsidiary will contract with a third-party due diligence
underwriter and a bonded custodian for the review of legal documentation. The
Taxable Subsidiary will also contract with a third-party servicer to service the
increased volume of Mortgage Loans expected to be acquired through the
correspondent channel.
RETAIL CHANNEL
The retail channel, which originates primarily Prime Mortgage Loans through
the direct solicitation of borrowers, accounted for $33.4 million, or 22.0%, of
the Taxable Subsidiary's Mortgage Loan production during the first quarter of
1998. As of March 31, 1998, the retail channel originated Mortgage Loans through
branch offices located in Salt Lake City and Las Vegas. Such offices are staffed
with five to 10 loan officers, one underwriter and five to seven support
personnel. The retail channel includes traditional marketing activities
conducted by retail loan officers, who seek to identify potential borrowers
through referral sources and individual sales efforts, as well as high-volume
targeted direct mail and telephone solicitation. By creating a direct
relationship with the borrower, retail lending generally creates a more
sustainable Mortgage Loan origination franchise and provides the Taxable
Subsidiary with greater control over the lending process. For Mortgage Loans
originated in the retail channel, the Taxable Subsidiary also receives the
origination fees paid by the borrower which offset the higher costs of retail
lending and may contribute to increased profitability. In addition, the Company
believes that the Taxable Subsidiary is able to maintain the highest quality
control over Mortgage Loans originated through its retail branches.
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<PAGE> 68
The following table sets forth selected information relating to the Taxable
Subsidiary's retail Mortgage Loan originations during the periods shown:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
----------------------------------------------------------------------------------------------
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
1998 1997 1997 1997 1997 1996 1996
--------- ------------ ------------- -------- --------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
SUBPRIME:
Principal balance (in
thousands)......... $ 1,170 $ 3,816 $ 5,502 $ 4,784 $ 2,068 $ 1,918 $ 941
Average principal
balance per
Mortgage Loan (in
thousands)......... $ 117 $ 89 $ 79 $ 71 $ 52 $ 68 $ 157
Principal Balance:
Fixed-rate (in
thousands)...... $ 122 $ 1,496 $ 2,490 $ 2,134 $ 1,447 $ 1,232 $ 434
ARMs (in
thousands)...... $ 1,048 $ 2,320 $ 3,012 $ 2,650 $ 621 $ 686 $ 507
Combined weighted
average initial
LTV................ 70.46% 75.88% 74.44% 73.40% 73.17% 75.16% 73.75%
Percent of First Lien
Mortgage Loans..... 89.59% 82.39% 79.02% 74.34% 62.66% 80.01% 89.58%
Percent of Mortgage
Loans with prepay
protection......... 30.05% 57.53% 64.09% 64.72% 30.05% 22.29% 10.12%
Property securing
Mortgage Loans:
Owner occupied..... 87.78% 95.34% 89.42% 98.44% 100.00% 100.00% 100.00%
Non-owner
occupied........ 12.22% 4.78% 10.58% 1.56% 0.00% 0.00% 0.00%
PRIME:
Principal Balance (in
thousands)......... $32,223 $34,628 $32,614 $26,811 $19,913 $22,055 $14,374
</TABLE>
The Company believes that targeted direct mail and telephone campaigns
offer opportunities to increase Subprime Mortgage Loan originations within the
Taxable Subsidiary's existing retail branch offices. The Taxable Subsidiary
intends to staff each retail office with a minimum of two Subprime Mortgage Loan
officers who will utilize direct mail and telephone solicitation methods to
generate Subprime Mortgage Loans. The Taxable Subsidiary intends to focus on
growing production within its existing retail branch offices utilizing such
origination methods rather than opening new retail branch offices in the
immediate future.
BULK PURCHASES
The Taxable Subsidiary may initially acquire a portion of its Mortgage
Asset portfolio through bulk acquisitions due to the fact that this channel
generally allows the Taxable Subsidiary the opportunity to invest the net
proceeds of the Offering more quickly than the other channels. Bulk purchases of
Mortgage Loan pools ranging from $2.0 million to $50.0 million may be acquired
from large originators or from mortgage conduits. Bulk acquisitions of Mortgage
Loans will be conducted by the same personnel that manage the correspondent
channel. Although similar in process, the bulk acquisition process differs from
the correspondent channel in that Correspondents have generally established
regular selling relationships with the Taxable Subsidiary and may even have
Taxable Subsidiary underwriting personnel on the Correspondent's premises. Bulk
sellers have no such continuing relationship. This method of acquiring Mortgage
Loans provides the lowest profit margin to the Taxable Subsidiary. During
periods in which access to growth capital is limited, the Taxable Subsidiary
will tend to reduce its bulk purchases of Mortgage Loans in order to allow for
greater wholesale, retail and
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<PAGE> 69
correspondent volume to be acquired. Through March 31, 1998, the Taxable
Subsidiary has made bulk acquisitions in an aggregate amount of $65.9 million.
MORTGAGE LOAN PRODUCTS
The Taxable Subsidiary offers a broad variety of Mortgage Loan products
through its wholesale, retail and correspondent channels. Such products include
both Subprime Mortgage Loans for long-term investment by the Taxable Subsidiary
and Prime Mortgage Loans held for sale to investors. The Taxable Subsidiary's
Mortgage Loan products currently include:
- Six month LIBOR indexed ARMs;
- Two and three year LIBOR indexed ARMs;
- One, three, five and seven year CMT indexed ARMs;
- 15, 20 and 30 year fixed-rate First and Second Lien Mortgage Loans;
- 30 year amortizing balloon Mortgage Loans; and
- Jumbo fixed-rate and adjustable-rate Mortgage Loans.
PRICING OF MORTGAGE LOANS
The Company will set purchase prices for the Mortgage Loans it acquires
from the mortgage lending operations of the Taxable Subsidiary based on
prevailing market conditions. Different prices will be established for the
various types of Mortgage Loans, commitment periods and types of commitments
(mandatory or best efforts). The Taxable Subsidiary's standard pricing is based
on the anticipated price it will receive upon sale or financing of the Mortgage
Loans, the anticipated interest spread realized during the accumulation period,
the targeted profit margin and the anticipated issuance, credit enhancement and
ongoing administrative costs associated with such sale or financing.
Alternatively, such pricing may be based on the anticipated cost of financing
such Mortgage Loans to maturity plus the anticipated associated costs. The
Taxable Subsidiary is able to acquire Subprime Mortgage Loans at attractive
prices due to the high level of service delivered to Mortgage Loan brokers,
borrowers and Correspondents.
Following the issuance of a specific pricing commitment, the Company will
be subject to the risk of interest rate fluctuations and will enter into hedging
transactions to diminish such risk. Hedging transactions may include mandatory
or optional forward sales of Mortgage Loans or Mortgage Securities, mandatory or
optional sales of futures and other financial futures transactions. The nature
and quantity of hedging transactions will be determined by the management of the
Company based on various factors, including market conditions and the expected
volume of Mortgage Loan purchases. See "-- Interest Rate Risk Management" and
"Risk Factors -- Interest Rate Fluctuations May Adversely Affect Operations and
Net Interest Income -- The Company Has No Specific Hedging Policies and Failure
to Appropriately Hedge May Adversely Affect Results of Operations" and
"-- Hedging Transactions Limit Gains and May Increase Exposure to Losses."
STATE LICENSES
The Taxable Subsidiary has applied for and is licensed to conduct mortgage
banking operations in 31 states (including certain states which do not have
formal licensing requirements or in which the Taxable Subsidiary is exempt from
registration): Arizona, Arkansas, California, Colorado, Florida, Georgia,
Hawaii, Idaho, Indiana, Iowa, Kansas, Kentucky, Minnesota, Missouri, Montana,
Nebraska, Nevada, New Mexico, North Carolina, Ohio, Oklahoma, Oregon, South
Carolina, South Dakota (wholesale only), Tennessee, Texas, Utah, Virginia,
Washington, Wisconsin and Wyoming. Registration is pending in Illinois and
Michigan.
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<PAGE> 70
UNDERWRITING AND QUALITY CONTROL STRATEGIES
UNDERWRITING GUIDELINES
The Taxable Subsidiary has created a comprehensive underwriting manual for
use by its Correspondents as well as its internal staff. Generally, the
underwriting standards have been prepared in accordance with the financing
requirements of the rating agencies under the guidance of the Chief Credit
Officer. The Taxable Subsidiary's quality assurance guidelines provide for
various tests of the Mortgage Loans to be performed both before and after
purchase.
The Taxable Subsidiary underwrites all Mortgage Loans originated through
its retail and wholesale channels with a staff of in-house underwriters. The
Taxable Subsidiary staffs most offices with a senior underwriter with a minimum
of five years experience. In larger offices, the Taxable Subsidiary may hire
junior underwriters with more limited experience to work directly with the
senior underwriters. Upon being hired by the Taxable Subsidiary, the underwriter
undergoes an intensive three day training of the Taxable Subsidiary's
underwriting policies and procedures at the Taxable Subsidiary's headquarters in
Salt Lake City. After the underwriter is trained to the satisfaction of the
Chief Credit Officer, the new underwriter is then placed at a retail or
wholesale office. New underwriters are subject to a 30-day probation, during
which their work is more closely scrutinized by the Taxable Subsidiary.
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<PAGE> 71
The following is a general guideline of the eligibility criteria expected
to be adopted by the Taxable Subsidiary after the closing of the Offering:
UNDERWRITING GUIDELINES (1)
FIRST LIEN MORTGAGE LOANS
<TABLE>
<CAPTION>
A+ RISK (2) A RISK A- RISK B RISK C RISK C- RISK
---------------- ---------------- ---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Existing mortgage No 30-day late Maximum one Maximum two Maximum three Maximum four Maximum of two
history............ payments within 30-day late 30-day late 30-day late 30-day and two 90-day late
last 12 months; payment and no payments and no payments and one 60-day late payments and one
one 30-day late 60-day late 60-day late 60-day late payments and 120-day late
payment in last payments within payments within payment within maximum of one payment, there
24 months; must last 12 months; last 12 months; last 12 months; 90-day late may be a current
be current at must be current not required to not required to payment within notice of
application at application be current at be current at last 12 months; default; not
time. time. application application not required to required to be
time. time. be current at current at
application application
time. time.
Other credit(3)...... No open No open Minor derogatory Prior defaults Significant Significant
collections collection items allowed; acceptable; not prior defaults defaults
accounts or accounts or not more than more than $1,500 acceptable; acceptable; open
charge-offs charge-offs. $500 in open in open generally, not charge-offs or
within last 12 Generally must collection collection more than $2,500 collection
months. be paid through accounts or accounts or in open amounts may
funding not charge-offs open charge-offs open collection remain open
exceeding $300. after funding. after funding. accounts or after funding.
charge-offs open
after funding.
Bankruptcy filings... Generally, no Chapter 7 must Chapter 7 must Generally, no Generally, no Bankruptcy,
bankruptcy or have been have been bankruptcy or bankruptcy or notice of sale
notice of discharged at discharged at notice of notice of filings, notice
default filings least two years least two years default filings default filings of default
in last three prior; Chapter prior; Chapter in last two in last 18 filing or
years. 13 must have 13 must have years. Chapter months. One year foreclosure
been discharged been discharged 13 allowed at seasoning for permitted on a
at least one at least one least one year Chapter 13 with case by case
year prior. year prior. prior with reestablished basis.
reestablished credit. Generally, one
credit. year seasoning
for Chapter 7
and notices of
default. No
seasoning for
Chapter 13 paid
at funding.
Debt service to 45% 50% 50% or less 50% or less 55% or less 60% or less
income ratio.......
Maximum loan-
to-value ratio: (4)
Owner occupied: 95% 90% 90% 85% 80% 70%
single family......
Owner occupied: 90% 90% 90% 85% 80% 70%
condo/two-to-four
unit...............
Non-owner 90% 85% 80% 75% 70% 65%
occupied...........
</TABLE>
- ---------------
(1) The letter grades applied to each risk classification reflect the Taxable
Subsidiary's internal standards and do not necessarily correspond to the
classifications used by other mortgage lenders. "LTV" means loan-to-value
ratio. With respect to "A" through "C" credit grades, the combined LTV of
all Mortgage Loans secured by any property is permitted to be up to 100%,
with the first lien Mortgage Loan at the percentages indicated.
(2) On A+ product Private Mortgage Insurance ("PMI") is obtained on LTV's above
90% with 30% coverage; and 25% coverage from 85.01 to 90%; no PMI is
required for 85% LTV or less.
(3) Liens, judgments, collections and other garnishments not affecting title are
not considered.
(4) The maximum LTV set forth in the table is for borrowers providing full
documentation. The LTV is reduced five percent for stated and limited
documentation and 10% for non-owner applications.
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<PAGE> 72
The following table sets forth information concerning the Taxable
Subsidiary's principal balance of fixed-rate and adjustable-rate Mortgage Loan
originations by borrower risk classification for the periods shown:
MORTGAGE LOAN PRODUCTION BY BORROWER RISK CLASSIFICATION
<TABLE>
<CAPTION>
FOR THE FOR THE
YEAR ENDED PERIOD ENDED
MARCH 31, MARCH 31, DECEMBER 31, DECEMBER 31,
1998 1997 1997 1996(1)
--------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
PRIME:
Percent of total purchases and origination.... 60.21% 78.63% 51.27% 86.68%
Combined weighted average initial
loan-to-value ratio........................ 77.62% 79.53% 79.28% 79.34%
Weighted average interest rate:
Fixed-rate................................. 7.41% 8.13% 7.97% 8.32%
ARMs....................................... 6.01% 6.74% 6.64% 6.94%
Margin-ARMs................................ 2.76% 2.75% 2.78% 1.00%
SUBPRIME:
"A"-Risk Grade:
Percent of total purchases and origination.... 26.95% 12.71% 29.36% 9.16%
Combined weighted average initial
loan-to-value ratio........................ 80.46% 82.24% 80.12% 78.40%
Weighted average interest rate:
Fixed-rate................................. 10.46% 11.06% 10.54% 10.96%
ARMs....................................... 9.74% 9.62% 9.90% 9.29%
Margin-ARMs................................ 5.90% 5.90% 6.25% 5.52%
"B" Risk Grade:
Percent of total purchases and origination.... 7.35% 6.32% 7.48% 2.95%
Combined weighted average initial
loan-to-value ratio........................ 79.11% 75.14% 75.30% 78.19%
Weighted average interest rate:
Fixed-rate................................. 11.16% 10.95% 11.02% 11.19%
ARMs....................................... 10.36% 9.87% 10.41% 9.74%
Margin-ARMs................................ 6.63% 6.48% 6.67% 6.32%
"C" Risk Grade:
Percent of total purchases and origination.... 3.01% 1.97% 2.73% 0.54%
Combined weighted average initial
loan-to-value ratio........................ 74.48% 72.18% 71.20% 77.31%
Weighted average interest rate:
Fixed-rate................................. 12.32% 12.04% 11.55% 12.12%
ARMs....................................... 11.14% 10.29% 11.14% 10.52%
Margin-ARMs................................ 6.85% 6.37% 6.94% 6.66%
"C"- Risk Grade:
Percent of total purchases and origination.... 0.32% 0.43% 0.57% 0.08%
Combined weighted average initial
loan-to-value ratio........................ 66.24% 59.55% 62.54% 61.62%
Weighted average interest rate:
Fixed-rate................................. 0% 14.53% 13.16% 13.86%
ARMs....................................... 12.28% 13.50% 12.06% n/a
Margin-ARMs................................ 7.18% 8.88% 7.03% n/a
Unclassified (2)................................ 2.16% 0.00% 8.59% 0.59%
</TABLE>
- ---------------
(1) For the period from February, 1996 (inception) to December 31, 1996.
(2) Includes certain Mortgage Loans which the Taxable Subsidiary sold to
third-party investors without determining the credit classification.
GEOGRAPHIC DIVERSIFICATION
Although the Taxable Subsidiary does not have specific policies or targets
regarding geographic diversification of its Mortgage Loans, close attention will
be paid to geographic diversification in managing the
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<PAGE> 73
Taxable Subsidiary's credit risk. While there will initially be some geographic
concentration in Mortgage Loans originated though the correspondent acquisition
channel, over time the Taxable Subsidiary plans to diversify its credit risk by
selecting target markets through both the wholesale and correspondent channels.
The Taxable Subsidiary believes that one of the best tools for managing credit
risk is to diversify the markets in which the Taxable Subsidiary originates and
purchases Mortgage Loans.
Currently, the Mortgage Loans originated by the Taxable Subsidiary are
geographically concentrated in Florida, Utah, Georgia and California. However,
as newly established retail and wholesale branches increase production,
geographic diversification will naturally occur. The following table sets forth
aggregate dollar amounts (in thousands) and the percentage of all Subprime
Mortgage Loans originated or purchased by the Taxable Subsidiary by state for
the periods shown:
GEOGRAPHIC DISTRIBUTION OF SUBPRIME MORTGAGE LOANS
(Dollars in thousands)
<TABLE>
<CAPTION>
FOR THE FOR THE
YEAR ENDED YEAR ENDED
MARCH 31, MARCH 31, DECEMBER 31, DECEMBER 31,
1998 1997 1997 1996(1)
--------- --------- ------------ ------------
<S> <C> <C> <C> <C>
Arizona..................................................... $ 3,125 $ 948 $ 5,634 $ 260
Percent of total for period............................... 5.16% 6.53% 2.28% 1.13%
California.................................................. 8,493 585 27,970 0
Percent of total for period............................... 14.04% 4.03% 11.33% 0.00%
Colorado.................................................... 1,892 2,158 13,695 2,817
Percent of total for period............................... 3.13% 14.86% 5.55% 12.22%
Florida..................................................... 19,921 0 56,779 0
Percent of total for period............................... 32.92% 0.00% 23.00% 0.00%
Georgia..................................................... 5,704 0 28,794 0
Percent of total for period............................... 9.43% 0.00% 11.66% 0.00%
Hawaii...................................................... 1,495 0 4,239 0
Percent of total for period............................... 2.47% 0.00% 1.72% 0.00%
Idaho....................................................... 854 317 2,277 460
Percent of total for period............................... 1.41% 2.18% 0.92% 2.00%
Illinois.................................................... 144 0 5,750 0
Percent of total for period............................... 0.24% 0.00% 2.33% 0.00%
Kansas...................................................... 296 80 1,642 0
Percent of total for period............................... 0.49% 0.55% 0.67% 0.00%
Massachusetts............................................... 0 0 2,213 0
Percent of total for period............................... 0.00% 0.00% 0.90% 0.00%
Montana..................................................... 0 145 1,003 279
Percent of total for period............................... 0.00% 1.00% 0.41% 1.21%
New York.................................................... 0 0 12,393 0
Percent of total for period............................... 0.00% 0.00% 5.02% 0.00
Nevada...................................................... 1,735 791 8,904 759
Percent of total for period............................... 2.87% 5.45% 3.61% 3.29%
Oregon...................................................... 1,968 358 7,041 80
Percent of total for period............................... 3.25% 2.46% 2.85% 0.35%
Utah........................................................ 10,773 8,639 44,244 17,584
Percent of total for period............................... 17.80% 59.48% 17.92% 76.30%
Virginia.................................................... 458 0 2,159 0
Percent of total for period............................... 0.76% 0.00% 0.87% 0.00%
Washington.................................................. 1,146 308 5,946 709
Percent of total for period............................... 1.89% 2.12% 2.41% 3.08%
Wisconsin................................................... 910 0 4,713 0
Percent of total for period............................... 1.50% 0.00% 1.91% 0.00%
Other States Combined (10 states)........................... 1,596 195 11,507 98
Percent of total for period............................... 2.64% 1.34% 4.66% 0.43%
------- ------- -------- -------
Total............................................... $60,512 $14,524 $246,904 $23,046
======= ======= ======== =======
</TABLE>
COLLATERAL APPRAISAL
The Taxable Subsidiary's underwriting standards are also intended to assess
the value of the mortgaged property and to evaluate the adequacy of such
property as collateral for the Mortgage Loan. All of the
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<PAGE> 74
Mortgage Loans originated by the Taxable Subsidiary's wholesale and retail
channels, and purchased by the Taxable Subsidiary through Correspondents will be
appraised by qualified independent appraisers. Such appraisers inspect and
appraise the subject property and verify that such property is in acceptable
condition. Following each appraisal, the appraiser prepares a report which
includes a market value analysis based on recent sales of comparable homes in
the area, and when deemed appropriate, replacement cost analysis based on the
current cost of constructing a similar home. The Taxable Subsidiary intends to
use only Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") licensed appraisers as part of its approval process. All appraisals
are required to conform to the Uniform Standards of Professional Appraisal
Practice adopted by the Appraisal Standards Board of the Appraisal Foundation
and must be on forms acceptable to FNMA and FHLMC. It is anticipated that
substantially all Mortgage Loans purchased through Correspondents will be
subject to a second full appraisal or appraisal review prior to purchase by the
Taxable Subsidiary. The Taxable Subsidiary has a formal review process for all
appraisers, verifies licenses annually and conducts new appraisals under its
Quality Control Program.
QUALITY CONTROL PROGRAM
The Taxable Subsidiary has an extensive, systemized quality control and
audit plan currently in place. Each month, the Taxable Subsidiary randomly
selects 10% to 15% of all Mortgage Loans, including 10% from each branch and
product type (with at least one per month from each) to review. Representations
and information from each Mortgage Loan are verified against a checklist of over
60 items. Among such verifications are completeness of the Mortgage Loan
documents, additional scrutiny of the borrower's credit report, employment and
salary re-verifications (or tax return scrutiny if the borrower is
self-employed), closer scrutiny of the appraisal, general review of the legal
and closing documents, verification of the owner occupancy status (if
applicable) and a re-evaluation of the creditworthiness of the borrower. Each
discrepancy is given a grade based on its severity, from inadvertent,
non-impairing errors to a guideline violation requiring immediate action against
the borrower and the broker. Additionally, 10% of all Mortgage Loans selected
for review each month are further selected for closer scrutiny, including a new
appraisal and a new credit report ordered from different agencies. To date, all
quality control has been performed by the Taxable Subsidiary itself; however, it
may outsource some or all of these functions in the future. The Taxable
Subsidiary will not, however, outsource any pre-closing quality control.
CORRESPONDENT ELIGIBILITY REQUIREMENTS
Closed Mortgage Loans purchased by the Taxable Subsidiary will be
originated by various mortgage bankers and other mortgage lenders.
Correspondents are required to meet certain performance requirements established
by the Taxable Subsidiary before they are eligible to participate in the Taxable
Subsidiary's Correspondent program and must submit to periodic reviews by the
Taxable Subsidiary to ensure continued compliance with these requirements. The
Taxable Subsidiary's current criteria for Correspondent participation generally
include a tangible net worth of at least $400,000. In addition, Correspondents
are required to have comprehensive loan origination quality control procedures
and must be approved and in good standing with HUD, among other criteria. Each
Correspondent is expected to enter into an agreement that provides for recourse
by the Taxable Subsidiary against the Correspondent in the event of any material
breach of a representation or warranty made by the Correspondent with respect to
Mortgage Loans sold to the Taxable Subsidiary or any fraud or misrepresentation
during the Mortgage Loan origination process. There is no assurance that such
requirements will be applicable in the future.
FINANCING LOANS HELD FOR SALE AND INVESTMENT PRIOR TO STRUCTURED DEBT FINANCING
The Taxable Subsidiary will finance its Mortgage Loan originations and
purchases through interim financing facilities such as bank warehouse credit
lines and reverse repurchase agreements. As of March 31, 1998, the Taxable
Subsidiary had committed warehouse lines and reverse repurchase facilities in
place totaling $150.0 million with Nomura Asset Capital Corporation and
ContiFinancial Corporation. A reverse repurchase agreement is a borrowing device
evidenced by an agreement to sell securities or other assets to a third-party
and a simultaneous agreement to repurchase them at a specified future date and
price, with the price
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differential constituting interest on the borrowing. The Taxable Subsidiary is
currently in negotiations with dealer firms for additional reverse repurchase
facilities to fund production prior to long-term financing. However, no such
facility is in place.
The Taxable Subsidiary's Subprime Mortgage Loan lending operation will be a
capital intensive business. Depending on the type of Mortgage Loan product
originated, the production channel and the financing source, the amount of
capital required as a percentage of the balance of Mortgage Loans originated may
range from two percent to eight percent. See "-- Capital and Liquidity
Management -- Capital Allocation Guidelines." For illustration purposes only, a
hypothetical monthly Mortgage Loan volume of $25.0 million would equate to a
capital requirement of $500,000 to $1.75 million per month, respectively and a
hypothetical monthly volume of $50.0 million would equate to $1.0 to $3.5
million per month, respectively. Due to the capital intensive nature of this
business, the Company's Subprime Mortgage Loan lending will be operated through
the Taxable Subsidiary. Operating though the Taxable Subsidiary would give the
Company the flexibility to sell its Mortgage Loan production as whole loans or
in the form of pass-through Mortgage Securities in the event it encountered
restrictions in accessing the capital markets in order to fund its Subprime
Mortgage Loan lending operation. See " -- Industry Developments" and "Risk
Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely Affect
Results of Operations." The Company intends to raise the required capital in
order to implement its preferred strategy of realizing the income from
adjustable Subprime Mortgage Loans through net interest income. The Company
intends to sell certain Mortgage Loans, which are expected to be Prime and
fixed-rate Subprime Mortgage Loans.
LOAN SALES FOR CASH
The Taxable Subsidiary has historically followed a strategy of selling for
cash all of its Mortgage Loan originations and purchases through Mortgage Loan
sales in which the Taxable Subsidiary disposes of its entire economic interest
in the Mortgage Loans (including servicing rights) for a cash price that
represents a premium over the principal balance of the Mortgage Loans sold. See
"-- Industry Developments" and "Risk Factors -- President's 1999 Budget Plan, If
Enacted, Would Adversely Affect Results of Operations." For the fiscal year
ended December 31, 1997, the Taxable Subsidiary sold $477.1 million of Mortgage
Loans through whole Mortgage Loan sales transactions. The Taxable Subsidiary did
not sell any Mortgage Loans through securitization during this period; however,
substantially all of the Mortgage Loans sold during this period were ultimately
securitized by the purchasers thereof.
The Company plans to build its Mortgage Asset investment portfolio by
retaining Subprime Mortgage Loans originated and purchased by its mortgage
operations. Prime Mortgage Loans, certain Subprime Mortgage Loans and Second
Lien Mortgage Loans originated and purchased by the Taxable Subsidiary, will,
however, be sold for cash to various mortgage investors. The sale of these
Mortgage Loans is expected to generate current income and cash flow to fund in
part the mortgage lending operations.
The Taxable Subsidiary seeks to maximize its revenue on whole Mortgage Loan
sales by closely monitoring institutional purchasers' requirements and focusing
on originating or purchasing the types of Mortgage Loans that meet those
requirements and for which institutional purchasers tend to pay higher premiums.
Whole Mortgage Loan sales are made on a non-recourse basis pursuant to a
purchase agreement containing customary representations and warranties by the
Taxable Subsidiary based upon the underwriting criteria applied by the Taxable
Subsidiary and the origination process. The Taxable Subsidiary, therefore, may
be required to repurchase or substitute Mortgage Loans in the event of a breach
of its representations and warranties. In addition, the Company sometimes
commits to repurchase or substitute a Mortgage Loan if a payment default occurs
within the first month following the date the Mortgage Loan is funded, unless
other arrangements are made between the Taxable Subsidiary and the purchaser.
The Taxable Subsidiary is also required in some cases to repurchase or
substitute a Mortgage Loan if the Mortgage Loan documentation is alleged to
contain fraudulent misrepresentations made by the borrower.
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INFORMATION MANAGEMENT SYSTEMS
The Taxable Subsidiary has established, and continues to enhance,
information gathering and reporting systems to monitor and analyze virtually
every aspect of the mortgage lending business. The Taxable Subsidiary employs a
combination of commercially available and internally developed software to
process and track each Mortgage Loan in the Taxable Subsidiary's system from
application to closing and sale.
Management reviews Mortgage Loan production data on a daily basis. The
Taxable Subsidiary's systems provide management with detailed reports on all
material aspects of the business, including Mortgage Loan processing,
underwriting, funding, secondary marketing and accounting. Such reports include
Mortgage Loan production to date (i) by branch, (ii) by loan type, (iii) by
geographic location of the property, (iv) by pre-payment penalty, and (v) by
LTV.
The Management Information Systems Department is structured into two teams:
Hardware/Software Support and Development. The Hardware/Software Support team
has built the client server network operating on a Windows NT platform. The
backbone of the Taxable Subsidiary information system is a wide area network
("WAN") employing high speed lines to each of its retail and wholesale branch
offices, with the exception of the Hawaii branch which connects to the WAN via
the internet. In addition, construction of a Taxable Subsidiary intranet site is
underway. The intranet site is expected to permit video-teleconferencing between
all Taxable Subsidiary sites, enabling face-to-face Company meetings and
on-going procedural training, and will enable the Taxable Subsidiary's
underwriting and other manual guidelines to be available on-line, with
instantaneous updates as management refines or changes any provision.
The development team has focused on building a Microsoft-standard network
of software solutions. The Taxable Subsidiary's accounting system, Accuity,
built by State of the Art Software, allows management to generate a vast number
of reports focusing on: (i) costs of origination or acquisition of Mortgage
Loans; (ii) pricing and timing of secondary sales by investor, loan type and
other factors; (iii) funding and usage of warehouse lines; and (iv) monthly and
year-to-date accounting statements. The integration of the management
information system is ongoing and is expected to link all of the Mortgage Loan
production and processing to both treasury and secondary marketing functions,
permitting management to plan and better monitor Mortgage Loan fundings and
subsequent sales. The Taxable Subsidiary believes that the integration of its
information and accounting systems will offer efficiency and information
advantages over those of certain of its competitors.
The Taxable Subsidiary is dedicated to building and maintaining an
integrated, leading edge information environment. The Taxable Subsidiary has
been selected by several software providers as a beta-site for several
advancements in their current software systems. Both Interlinq, the manufacturer
of MortgageWare (the Taxable Subsidiary's loan processing, underwriting and
funding software) and State of the Art Software have requested the Taxable
Subsidiary's participation in an advisory capacity for current and future
development of certain of their products. One innovation which is currently in
testing will enable management to determine the status of any Mortgage Loan in
any branch in virtually real time.
The fundamental integration of the Taxable Subsidiary's information systems
will enable the asset-liability manager to monitor and report on all Mortgage
Loans by asset class, age and credit rating, to relate such positions to the
Taxable Subsidiary's hedge positions at any given time, permitting management to
instantaneously determine a net value of assets and hedges. Sophisticated
analytics including option-adjusted spreads, price sensitivity, time-basis
change, residual cash flow analysis, and simulations will be performed on an
independent software model, utilizing the Taxable Subsidiary's asset and hedging
position data.
The Taxable Subsidiary maintains a secure computing environment. The file
server is located in a locked central room. All external data lines are
monitored for intrusive activity and internal access if granted by administrator
security clearance only. A routine onsite/offsite backup procedure is maintained
to enable rapid recovery in the event of a catastrophic event. Accounting
records are protected on a period-by-period basis, and are entered on
write-once, read-only compact discs which are stored in a protected off-site
location.
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MORTGAGE INVESTMENT PORTFOLIO
The Company will acquire and manage a portfolio of Mortgage Assets,
primarily comprised of Subprime Mortgage Loans originated and acquired by the
Taxable Subsidiary and financed with structured debt instruments. As with a bank
or savings and loan association, the Company's Mortgage Asset portfolio is
expected to generate net income to the extent that the yield on its Mortgage
Assets exceeds the overall cost of its borrowings. The Company will attempt to
construct a portfolio which will provide a relatively consistent level of net
interest income through a variety of interest rate environments. The Company
will acquire and manage this portfolio of Mortgage Assets to maximize net
interest income within prescribed risk constraints. See "Risk
Factors -- Interest Rate Fluctuations May Adversely Affect Operations and Net
Interest Income."
The Company's strategy will be to earn a relatively attractive
risk-adjusted return on equity by originating and purchasing Subprime Mortgage
Loans for investment in the Mortgage Loan portfolio. Management's expectation is
that the highest long-term risk adjusted return on equity will be earned through
investing its capital in the residual class of long-term financings of Subprime
whole Mortgage Loans originated through its Mortgage Loan acquisition channels.
The Company will not acquire residuals and has not and generally will not
acquire first loss subordinated bonds rated below BBB, or Mortgage Securities
rated below B. The Company could indirectly retain the subordinate class from
Mortgage Loans securitized by the Taxable Subsidiary. The Company may acquire
IOs or POs to assist in the hedging of prepayment or other risks. In addition,
as discussed above, the Company may create a variety of different types of
assets, including the types mentioned in this paragraph, through the normal
process of CMO financing of the Company's own Mortgage Assets. In no event will
the Company (exclusive of its Taxable Subsidiaries) acquire or retain any REMIC
residual interest that may give rise to excess inclusion income as defined under
Section 860E of the Code. Generally, excess inclusion income may be recognized
by the holder of a REMIC residual (or a residual from a taxable mortgage pool)
to the extent income from the residual exceed 120% of the long-term applicable
federal interest rate. Excess inclusion income may be taxed as unrelated
business taxable income to certain tax-exempt entities. Excess inclusion income
realized by the Taxable Subsidiary is not passed through to stockholders of the
Company. See "Risk Factors -- Interest Rate Fluctuations May Adversely Affect
Operations and Net Interest Income -- Hedging Transactions Limit Gains and May
Increase Exposure to Losses" and "Federal Income Tax Considerations -- Taxation
of Tax-Exempt Entities."
The Company will review each Mortgage Asset to be acquired to assess its
expected return, credit and liquidity risk, financing costs, the quality of the
issuer and the expected prepayment rate. The Company has developed a financial
model to evaluate each potential Mortgage Asset's impact upon the Mortgage Loan
portfolio as a whole. The Company will regularly monitor its purchases of
Mortgage Assets and the income from such Mortgage Assets, including income from
its hedging strategies, so as to ensure at all times that it maintains
RealTrust's qualification as a REIT and RealTrust's exempt status under the
Investment Company Act of 1940, as amended (the "Investment Company Act"). The
Company has engaged qualified accountants and tax experts to assist it in
developing appropriate accounting systems and testing procedures, and to conduct
quarterly compliance reviews designed to assist RealTrust in assuring compliance
with the REIT provisions of the Code and to ensure RealTrust's exempt status
under the Investment Company Act. See "Federal Income Tax
Considerations -- Qualification as a REIT" and "Risk Factors -- Failure to
Qualify for Exemption from Investment Company Act May Adversely Affect the
Company."
TYPES OF MORTGAGE ASSETS
The Company's Mortgage Assets will be comprised of Mortgage Loans and
Mortgage Securities.
Mortgage Loans. The Company expects to retain primarily Subprime Mortgage
Loans, all of which are secured by first mortgages or deeds of trust on
single-family (one-to-four-units) residences. A substantial portion of the
Subprime Mortgage Loans originated and purchased by the Company are expected to
meet the long-term investment requirements of the Company. Those Mortgage Loans
which the Company does not intend to hold to maturity will be offered for sale
by the Taxable Subsidiary to various investors, including national private
mortgage conduit programs in the secondary mortgage market. See
"Business -- Industry
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Developments" and "Risk Factors -- President's 1999 Budget Plan, If Enacted,
Would Adversely Affect Results of Operations."
Subprime single-family Mortgage Loans are single family Mortgage Loans that
do not qualify in one or more respects for purchase by FNMA or FHLMC. The
Company expects that a majority of the Subprime Mortgage Loans it purchases will
be Subprime because generally they vary in certain other respects from the
requirements of such programs including the requirements relating to
creditworthiness of the borrowers or they have original principal balances which
exceed the requirements for FHLMC or FNMA programs.
The Company may invest a small portion of its assets in Prime Mortgage
Loans, including FHA Loans or VA Loans, which qualify for inclusion in a pool of
Mortgage Loans guaranteed by GNMA. Under current regulations, the maximum
principal balance allowed on conforming Mortgage Loans ranges from $227,150
($321,900 for Mortgage Loans secured by properties located in either Alaska or
Hawaii) for one-unit to $436,600 ($618,675 for Mortgage Loans secured by
properties located in either Alaska or Hawaii) for four-unit residential loans.
The Company may also retain Subprime Mortgage Loans.
The Company expects to hold primarily ARMs. The interest rate on an ARM is
typically tied to an index (such as LIBOR or the interest rate on United States
Treasury Bills), and is adjustable periodically at various intervals, typically
from one month to one year. Such Mortgage Loans are typically subject to
lifetime interest rate caps and periodic interest rate and/or payment caps. The
Company anticipates that the majority of the Mortgage Loans will have lifetime
interest rate caps of six percent over the initial Mortgage Loan interest rate,
although some Mortgage Loans may have lifetime interest rate caps of as high as
seven percent or as low as five percent over such initial rate. The Company
expects the Mortgage Loans to have periodic interest rate caps of either one
percent every six months or two percent per year. Lifetime and periodic interest
rate caps are a function of market and competitive factors and are, therefore,
subject to change from the levels anticipated herein. A portion of the Subprime
Mortgage Loans may be fixed-rate Mortgage Loans.
The Company may obtain credit enhancements such as mortgage pool or special
hazard insurance for its Mortgage Loans, in addition to private mortgage
insurance when specified by its underwriting criteria. Accordingly, during the
time it holds Mortgage Loans, the Company will be subject to risks of borrower
defaults, fraud and bankruptcies and special hazard losses that are not covered
by standard hazard insurance (such as those occurring from earthquakes or
floods). In the event of a default on any Mortgage Loan held by the Company, the
Company will bear the risk of loss of principal to the extent of any deficiency
between (i) the net proceeds from liquidation of the mortgage collateral and any
related insurance or guarantee and (ii) the principal amount of the Mortgage
Loan.
Mortgage Securities. The Company plans to purchase Mortgage Securities in
the capital markets. These Mortgage Securities generally have a higher level of
liquidity than the Mortgage Loans to be acquired or originated and are expected
to provide a relatively stable flow of interest income with relatively low
levels of credit risk compared to such Mortgage Loans. The Mortgage Securities
to be acquired by the Company will be backed by a pool of ARMs. These Mortgage
Securities entitle the holder to receive a pass-through of principal and
interest payments on the underlying pool of Mortgage Loans and will be
guaranteed by the Federal government sponsored agencies or issued by certain
private institutions. Mortgage Securities issued by private institutions are
usually, but not always, rated by one of the major rating services. The Company
may, from time to time, invest in Mortgage Securities that are not investment
grade. See "Risk Factors -- Investments in High LTV Mortgage Loans and
Subordinated Mortgage Securities Involve Greater Risk of Loss." The Company may
also acquire IOs and POs in conjunction with its hedging activities. See "Risk
Factors -- Interest Rate Fluctuations May Adversely Affect Operations and Net
Interest Income -- Interest-Only and Principal-Only Mortgage Securities Are
Subject to Substantial Interest Rate and Prepayment Risks Which May Adversely
Affect Results of Operations." The Company does not intend to invest in any
unregistered Mortgage Securities.
RETAINED INTERESTS IN STRUCTURED DEBT INSTRUMENTS
The Company intends to hold for long-term investment Subprime Mortgage
Loans produced by its mortgage lending operation and to finance such Subprime
Mortgage Loans with long-term financings through
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the issuance of CMOs. Under this approach, for accounting purposes, the Mortgage
Loans collateralizing any CMO remain on the balance sheet as assets and the debt
obligations (i.e., CMOs) appear as liabilities. The Company's retained interest
under this approach is reflected by the excess of the assets over the related
liabilities on the balance sheet. The resulting stream of expected "spread"
income will be recognized over time through the proposed tax-advantaged REIT
structure. Other forms of financing may also be employed from time to time under
which a "sale" of interests in the Mortgage Loans will be reflected and gain or
loss reflected for accounting purposes at the time of sale. Under this form,
only the net retained interest in the securitized Mortgage Loans will remain on
the balance sheet. Such sales will be made through the Taxable Subsidiaries. See
"-- Interest Rate Risk Management."
The Company expects that its retained interests in its long-term financing,
regardless of the form used, will be subordinated to the classes of securities
issued to investors in such securitizations with respect to losses of principal
and interest on the underlying Mortgage Loans. Accordingly, any such losses
incurred on the underlying Mortgage Loans will be applied first to reduce the
remaining amount of the Company's retained interest, until reduced to zero.
Thereafter, any further losses would be borne by the investors or the insurers
in such securitizations rather than the Company.
The Company may also use financing as a tool to transfer some of the
interest rate risk of the Mortgage Loan collateral to the CMO bondholder and
credit risk to monoline bond insurers. Financing structures may include
floating-rate debt classes with life caps. The life cap structured in the bond
class pays down with the collateral, reducing the basis risk inherent in other
hedging strategies. The Company may pay a monoline bond insurer a monthly fee to
assume a portion of the credit risk in a pool of Mortgage Loans. The monoline
insurer would also require the issuer to retain a portion of the credit risk and
over-collateralize a particular pool of Mortgage Loans. The Company will
structure its financing so as to avoid the attribution of any excess inclusion
income to the Company's stockholders. See "Federal Income Tax
Considerations -- Taxation of the Company's Stockholders."
Proceeds from such financing will be available to support new Mortgage Loan
originations. The Company's CMOs are expected to reduce the Company's interest
rate risk on assets held for long-term investment. CMOs are permanent financing
and are not subject to a margin call if a rapid increase in rates would reduce
the value of the underlying mortgages. The Company plans to finance the retained
interests in its CMOs through a combination of equity and secured debt
financings, including reverse repurchase agreements.
Neither the Amended and Restated Articles of Incorporation nor the Bylaws
of the Company impose any limitations on the Company's ability to incur
borrowings, either secured or unsecured. See "Risk Factors -- Borrowing to
Finance Investment Portfolio May Adversely Affect Results of Operations."
CAPITAL AND LIQUIDITY MANAGEMENT
CAPITAL ALLOCATION GUIDELINES
The Company's goal is to maintain a balance between the under-utilization
of leverage, which may diminish returns to stockholders, and over-utilization of
leverage, which could limit the Company's funding alternatives during adverse
market conditions. Therefore, the Company has adopted Capital Allocation
Guidelines (the "CAG"). The Board will review the actual amount of leverage on a
quarterly basis for purposes of ensuring that the Company is in compliance with
the CAG. The CAG are intended to keep the Company leveraged as follows: (i) by
matching the amount of leverage with the current perceived risk of the Company's
assets, and (ii) by retaining excess capital to provide for market conditions
that may substantially alter or increase the market's general assessment of
perceived risk for those Mortgage Assets.
The primary factors influencing the Company's liquidity under circumstances
of adverse market conditions are increases in interest rates and increases in
the general market perception of credit risk associated with residential
Mortgage Loans. Interest rate increases reduce the market value of the Company's
Mortgage Assets and, therefore, reduce the quantity of financing that is
dependent on market values. Any increase in the credit risk as perceived by
rating agencies tends to increase the quantity of over-collateralization
required by rating agencies to award various investment grade ratings to the
senior classes of structured
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financings such as CMOs. Increased over-collateralization requirements reduce
the quantity of total financing prospectively available to the Company because
the excess collateral implied by the rate of over-collateralization required on
the CMO must be financed by the Company's equity rather than by the CMO.
To estimate the quantity of capital required for such adverse
circumstances, management has simulated capital requirements under adverse
conditions whereby interest rates increased instantaneously by 200 basis points
and foreclosure frequencies increased by over 77% above those currently
estimated as required to support a AAA rating on the senior class of CMOs issued
by the Company. To estimate the amount of capital required to support assets
financed by repurchase agreements, management used an option-adjusted pricing
framework and a sophisticated mortgage prepayment and pricing model. To estimate
the amount of potential over-collateralization for CMOs, the Company employed a
general rule that determines the amount of over-collateralization based on the
potential loss severity per Mortgage Loan and the rate of foreclosure frequency.
In general, over-collateralization equals potential loss severity times
foreclosure frequency. Applying this general rule to future CMOs, the 4.5% rate
of over-collateralization equates to a potential loss severity of 40% with a
foreclosure frequency of 11.25% (i.e., 40% X 11.25% = 4.5%). The CAG are to be
structured to allow for a substantial increase in the foreclosure frequency to
20% providing the capability to continue CMO issuance under circumstances of a
required eight percent over-collateralization (i.e., 40% X 20% = 8%).
The following table depicts CAG requirements by asset/liability combination
under currently expected financing requirements and under adverse market
conditions.
CAPITAL ALLOCATION GUIDELINES
<TABLE>
<CAPTION>
(a) (b)
INCREMENT (c) = a+b
REQUIRED BY TOTAL
REQUIRED ADVERSE CAG
ASSET/LIABILITY COMBINATION EQUITY(1) MARKET(2) REQUIRED(3)
--------------------------- --------- ----------- -----------
<S> <C> <C> <C>
Subprime Mortgage Loans Financed by CMOs.................... 4.50% 3.50% 8.00%
Subprime Mortgage Loans Financed by Reverse Repurchase
Agreements................................................ 5.00% 3.78% 8.78%
Mortgage Securities Financed by Reverse Repurchase
Agreements................................................ 3.00% 4.99% 7.99%
</TABLE>
- ---------------
(1) "Required equity" is the expected amount of equity required by a typical
financing alternative for the types of Mortgage Assets held by the Company.
There is some variation in the equity requirements from time to time, and
across the spectrum of specific negotiated terms. From the lender or debt
investor's perspective, the required equity represents an incremental value
secured by the financing agreement to which the lender or debt investor may
immediately recognize through collateral liquidation to cover liquidation
costs on the collateral should the debt obligor be unable to perform under
the terms of the financing agreement.
(2) "Increment Required by Adverse Market" is the amount of excess capital
retained by the Company for each type of asset/liability combination in the
CAG for purposes of sustaining liquidity and funding alternatives during
adverse market conditions. The stress test conditions are a 200 basis point
increase in interest rates and an increase in foreclosure frequencies to
20%.
(3) "Total CAG Required" is the sum of the amount of equity required in various
forms of financing alternatives and the increment required to sustain these
resources under adverse conditions.
Implementation of the CAG. The Company will implement the CAG under a
two-dimensional framework that considers the net market value of the Mortgage
Asset portfolio equity and the potential total over-collateralization in terms
of Mortgage Loan principal balance that may be required under adverse
conditions. By sustaining the net excess market value required by the CAG, the
Company will possess the ongoing capacity to finance its Mortgage Assets. By
tracking requirements for structured financings, the Company will maintain an
updated expectation for the required equity component of prospective
transactions.
Portfolio Financed with Reverse Repurchase Agreements. Each quarter the
Company marks to market its Mortgage Securities carried as available-for-sale.
This process is accomplished by obtaining market quotes
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from third parties, including dealers that make markets in Mortgage Assets
similar in nature to the Company's and from mortgage banking concerns currently
engaged in the business of originating Mortgage Assets similar to those held by
the Company. Market values are then computed for the Company's assets using
those market quotes along with the Company's internally established assumptions
related to prepayments, losses, discount rates, and interest rate volatility.
The market value for all financing used by the Company, net of the market value
of hedges in place as of the valuation date, is then deducted from the current
market value of the Mortgage Assets. The remainder, which is the theoretical
market value of equity, is then compared to the weighted average amount required
by the CAG as of the date of market valuation and actual required equity as
established by the financing agreements then in place. If the theoretical market
value of equity is less than required by the CAG, management of the Company must
prepare a plan for presentation and approval by the Board of Directors to bring
capital to the required level.
Portfolio Financed with CMOs. Each quarter the Company will solicit updates
on the required over-collateralization from dealers and rating agencies for the
various types of Mortgage Assets the Company holds and produces. Should the
required equity increase substantially, the Company will evaluate at that time
the necessity for increasing the total capital allocation required for the
Company's net asset/liability position in light of the historical performance of
transactions in place to date and other financing vehicles then available to the
Company.
SERVICING ACTIVITIES
Mortgage servicing represents the contractual right to receive a portion of
the interest payments (typically 25 to 50 basis points) of a Mortgage Loan in
exchange for the performance of certain services, including collection,
foreclosure, recordkeeping, disbursement of principal and interest to the
investor and payment of taxes and insurance. Mortgage Loan servicing also
includes the loss mitigation activities of contacting delinquent borrowers and
supervising foreclosures and property disposition in the event of unremediated
defaults. The Company will acquire Subprime Mortgage Loans with the servicing
rights retained.
Until the Company develops internal servicing capabilities, the Company
will rely upon third-party servicers. The Company has entered into a
subservicing agreement with Advanta pursuant to which Advanta will provide
subservicing for the Company while management focuses on Mortgage Loan
production, Mortgage Loan processing, asset/liability management, administrative
operations and securitization. The Company is also in discussions with other
third-party servicers and intends to select the servicer offering the most
favorable terms.
Third party servicing will allow the Company to take advantage of the
experience of the servicer's staff, computer and customer service systems and
collection procedure. Eventually, the Company intends to develop its own
servicing capability in order to oversee the performance of its Mortgage Loans
more directly and to manage the servicing relationship with its borrowers. The
timing of this action will be based on the completion of construction of the
personnel and computer systems necessary to properly manage a servicing
department capable of servicing over $1.0 billion in Subprime Mortgage Loans.
While management expects that the income from its servicing activities will
exceed its cost of servicing, the primary reason for servicing Mortgage Loans on
which the Company has credit risk exposure is as a loss mitigation strategy.
EARLY INTERVENTION, ASSET MANAGEMENT, AGGRESSIVE COLLECTION AND LOSS
MITIGATION TECHNIQUES
The Company intends to emphasize the use of early intervention, asset
management, aggressive collection and loss mitigation techniques in its
servicing process to minimize losses on its whole loans and to preserve the
value of its residual interest in its CMO financings. The collections policy for
Subprime Mortgage Loans will be designed (i) to curtail payment problems by
establishing early customer contact to communicate payment expectations and by
maintaining frequent customer contact to emphasize the priority of Mortgage Loan
repayment and (ii) to identify payment problems sufficiently early to permit the
Company to quickly address delinquency problems and, when necessary, to act to
preserve equity in a pre-foreclosure property.
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With respect to Subprime Mortgage Loans, the Company will implement strict
servicing procedures. All mortgage payments are due on the first day of the
month. Late payment fees will accrue on the earliest day permitted by state law.
The late payment fees on Subprime Mortgage Loans will be the maximum allowable
under applicable state law. The subservicer will assign a counselor to each
borrower immediately upon closing of each Subprime Mortgage Loan who will alert
the borrowers of the Company's strict enforcement procedures and legal remedies
available upon nonpayment. The subservicer will generally mail payment coupons
as a monthly reminder to borrowers, enforce the late period and file notice of
default by the end of the grace period. See "-- Overview of Subprime Mortgage
Market."
ADVANTA SERVICING AGREEMENT
Although the Company may select another servicer after the closing of the
Offering, the Company had as of March 31, 1998 a servicing agreement with
Advanta (the "Advanta Servicing Agreement"). As of March 31, 1998, Advanta did
not service a material number or principal amount of Mortgage Loans (five
Mortgage Loans with an aggregate principal balance of $0.4 million). Under the
Advanta Servicing Agreement, the Company is obligated to pay Advanta a monthly
servicing fee on the declining principal balance of each Mortgage Loan serviced
and a set-up fee for each Mortgage Loan delivered to Advanta for servicing.
Advanta is required to pay all expenses related to the performance of its duties
under the Advanta Servicing Agreement. Further, Advanta is required to make
advances of taxes and required insurance premiums that are not collected from
borrowers with respect to any Mortgage Loan, only if it determines that such
advances are recoverable from the borrower, insurance proceeds or other sources
with respect to such Mortgage Loan. If such advances are made, Advanta generally
will be reimbursed prior to the Company receiving the remaining proceeds.
Advanta also will be entitled to reimbursement by the Company for expenses
incurred by it in connection with the liquidation of defaulted Mortgage Loans
and in connection with the restoration of mortgaged property. If claims are not
made or paid under applicable insurance policies or if coverage thereunder has
ceased, the Company will suffer a loss to the extent that the proceeds from
liquidation of the mortgaged property, after reimbursement of Advanta's expenses
in the sale, are less than the principal balance of the related Mortgage Loan.
Advanta is entitled to retain any late payment charge and assumption fees
collected in connection with the Mortgage Loans. Advanta receives any benefit
derived from interest earned on collected principal and interest payments
between the date of collection and the date of remittance to the Company and
from interest earned on tax and insurance impound funds. Under the Advanta
Servicing Agreement, Advanta is generally required to remit all principal and
interest scheduled to be collected from borrowers during the prior monthly
reporting period generally no later than the eighteenth day of each month.
Under the Advanta Servicing Agreement, if the Company terminates such
agreement without cause or transfers the servicing of any amount of the Mortgage
Loans serviced by Advanta to another servicer, the Company must pay Advanta
certain penalties, fees and costs, including a termination fee of $100 per
Mortgage Loan. Depending on the size of the Company's Mortgage Loan portfolio
serviced by Advanta, at any point in time, the termination or transfer penalties
that the Company will be obligated to pay Advanta may be substantial. As of
March 31, 1998, the termination fee pursuant to the Advanta Servicing Agreement
would have been immaterial and the Company does not anticipate that such
termination fee will, now or in the future, deter the Company from selecting
another servicer.
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DELINQUENCY AND DEFAULT DATA
To date, the Taxable Subsidiary has sold its Mortgage Loans to investors
servicing-released. That is, the purchaser of the Mortgage Loan obtains all
rights to collect payments on the Mortgage Loan. As a result, the Taxable
Subsidiary does not maintain any delinquency or default data; however,
ContiFinancial Corporation, the largest purchaser of the Taxable Subsidiary's
Subprime Mortgage Loans, provides the Company with quarterly reports setting
forth the delinquency and default rates on Mortgage Loans purchased from the
Taxable Subsidiary. The following table sets forth the delinquency and default
information provided to the Taxable Subsidiary by ContiFinancial Corporation
from inception to February 28, 1998:
<TABLE>
<CAPTION>
QUARTER PERCENT OF
OF DELINQUENT
ORIGINATION MORTGAGE LOANS(1)
-------------- -----------------
<S> <C> <C> <C>
1996
3rd Quarter 0.00%
4th Quarter 4.77%
1997
1st Quarter 11.24%
2nd Quarter 4.84%
3rd Quarter 6.07%
4th Quarter 2.94%
1998
1st Quarter (through February 28) 0.00%
</TABLE>
- ---------------
(1) Determined on the basis of principal balance of delinquent Mortgage Loans
compared to the aggregate principal balance of all Mortgage Loans purchased
by ContiFinancial Corporation and still outstanding.
Since July, 1996, ContiFinancial Corporation has charged-off one Mortgage
Loan acquired from the Taxable Subsidiary. Such charged-off loan resulted in a
loss of $9,896, or 9.83% of the principal balance of such Mortgage Loan.
The delinquency and default data provided above is not compiled or verified
by the Taxable Subsidiary, and reflects only a portion of the Mortgage Loans
sold by the Taxable Subsidiary. Therefore, the Company cannot confirm the
accuracy of the data, which may not reflect the performance of Mortgage Loans
sold to other investors. Further, the low level of delinquencies of Mortgage
Loans originated in recent quarters is directly attributable to the nominal
amount of time such Mortgage Loans have been outstanding. The Taxable Subsidiary
and the Company expect that delinquency rates will increase as such Mortgage
Loans mature.
INTEREST RATE RISK MANAGEMENT
The Company is subject to interest rate risk to the extent that the
interest rates on the Company's liabilities (i.e., reverse repurchase agreements
and CMOs) reprice more frequently, or on a different basis, than the interest
rates on the Company's Mortgage Assets. To mitigate this risk, the Company will
follow a strict interest rate risk management program managed by the Company's
Asset/Liability Manager, who has extensive experience in mortgage banking and
interest rate risk management for other financial institutions prior to his
employment with the Company. The Company's interest rate risk management program
will be formulated with the intent to mitigate the potential adverse effects
resulting from interest rate adjustment limitations on its Mortgage Assets and
the differences between the interest rate adjustment indices and interest rate
adjustment periods of its Mortgage Assets and related borrowings.
The Company's interest rate risk management program will encompass a number
of procedures. First, the Company will structure the liabilities of the Company
to have interest rate indices and adjustment periods that, on an aggregate
basis, correspond as closely as practicable to the interest rate adjustment
indices and interest rate adjustment periods of the Mortgage Assets. In
addition, the Company intends to structure its borrowing agreements to have a
range of different maturities (although substantially all will have maturities
of less than one year). As a result, the Company expects to be able to adjust
the average maturity of its
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<PAGE> 84
borrowings on an ongoing basis by changing the mix of maturities as borrowings
come due and are renewed. In this way, the Company will attempt to minimize any
differences between interest rate adjustment periods of Mortgage Assets and
related borrowings.
The Company intends to use interest rate caps, interest rate swaps and
similar instruments to attempt to limit, fix or partially offset changes in
interest rates associated with its borrowings and changes in the value of its
Mortgage Assets. In a typical interest rate cap agreement, the cap purchaser
makes an initial lump sum cash payment to the cap seller in exchange for the
seller's promise to make cash payments to the purchaser on fixed dates during
the contract term if prevailing interest rates exceed the rate specified in the
contract. In this way, the Company intends generally to hedge as much of the
interest rate risk arising from lifetime rate caps on its Mortgage Assets and
from periodic rate and/or payment caps as the Company determines is in the best
interests of the stockholders of the Company, given the cost of such hedging
transactions and the need to maintain RealTrust's status as a REIT. See "Federal
Income Tax Considerations -- Qualification as a REIT -- Sources of Income." The
Company may also, to the extent consistent with its compliance with the REIT
provisions of the Code, buy and sell financial futures contracts, options and
trade forward contracts as a hedge against future interest rate changes;
however, the Company will not acquire such instruments unless the Company is
exempt from the registration requirements of the Commodities Exchange Act or
otherwise complies with the provisions of that Act.
The Company also considers its use of CMOs as a component of its interest
rate management strategy. CMOs address two of the problems caused by rapid
changes (primarily increases) in interest rates, margin calls and the potential
for negative interest spread on a Mortgage Loan. A rapid increase in interest
rates may cause the value of the Company's collateral used to secure reverse
repurchase agreements to decline, thereby forcing a "margin call" in which the
Company would be required to pledge additional collateral in order to support
the reverse repurchase agreement. When the Company is fully leveraged, all of
its assets may be encumbered as part of different financing arrangements, and
the only response to a margin call will be to sell Mortgage Assets. Selling
Mortgage Assets during periods of rapidly increasing interest rates may result
in the Company receiving a lower purchase price than may otherwise be received.
CMOs do not allow the investor the right to exercise a margin call, and in
periods of rapidly rising rates, the financing remains in place.
Another risk of rapidly rising interest rates is that the lifetime caps on
the Mortgage Loans are exceeded by the level of short-term rates (or the cost of
reverse repurchase agreements). To protect against this risk, the Company may
imbed an interest rate cap into the CMO structure which will approximately match
the interest rate cap on the underlying pool of Mortgage Assets. This structure
is not available to be imbedded within the Company's warehouse or reverse
repurchase agreements. While the purchase of a separate cap is available through
financial market intermediaries, the use of imbedding the cap in the CMO
structure may be preferred due to the fact that the Company is always evenly
matched within the Mortgage Assets of the CMO structure and, as Mortgage Assets
are paid down, the Company always retains a cap over the entire balance of the
Mortgage Assets.
The Company believes that it can implement a cost-effective interest rate
risk management program to provide a level of protection against interest rate
risks. However, an effective hedging strategy is complex, and no hedging
strategy can completely insulate the Company from interest rate risks. Moreover,
as noted above, certain of the Federal income tax requirements limit the
Company's ability to fully hedge its interest rate risks. The Company intends to
monitor carefully, and may have to limit, its hedging strategies to assure that
it does not realize excessive hedging income or hold hedging Mortgage Assets
having excess value in relation to total Mortgage Assets, which would result in
the Company's disqualification as a REIT or, in the case of excess hedging
income, the payment of a penalty tax for failure to satisfy certain REIT income
tests under the Code, provided such failure was for reasonable cause. See
"Federal Income Tax Considerations -- Qualification as a REIT -- Sources of
Income." The Company may elect to conduct a portion of its interest rate risk
management operations through the Taxable Subsidiary. See "Risk
Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely Affect
Results of Operations."
In addition, hedging involves transaction and other costs, and such costs
increase as the level of protection and period covered by the hedging
transaction increases. Hedging transaction costs also increase in periods of
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<PAGE> 85
rising or extremely volatile interest rates. See "Risk Factors -- Interest Rate
Fluctuations May Adversely Affect Operations and Net Interest Income -- Hedging
Transactions Limit Gains and May Increase Exposure to Losses." Therefore,
management does not believe it will be cost effective to hedge all of its
adjustable-rate indebtedness and other interest rate risk. Further, certain
losses on hedging activities would be capital losses and would not be deductible
to offset ordinary income. In such a situation, the Company would have incurred
an economic loss of capital that would not be deductible to offset the ordinary
income from which dividends must be paid.
CREDIT RISK MANAGEMENT
To limit its risk both of default and of loss on the sale of foreclosed
property, the Company has instituted the following policies as part of its
overall credit policy. These policies are currently being followed in the
origination of Mortgage Loans.
Underwriting Policies. Initially, all Mortgage Loans submitted by
correspondents and brokers will be fully underwritten or re-underwritten by
the Taxable Subsidiary. All Mortgage Loans will be subject to a detailed
review of the underwriting decision prior to purchase.
LTV Limitations. The Company has determined maximum LTV ratios that
will be accepted depending upon the credit rating and other risk factors
assigned to the Mortgage Loans. (See "-- Underwriting and Quality Control
Strategies.") These LTV ratios are expected to provide significant
protection to the Company in the event of foreclosure, as well as provide
the borrower with a strong incentive to protect the Mortgage Loan from
being foreclosed.
Appraisal Review Requirements. The Taxable Subsidiary intends to
generally require a review appraisal for each Mortgage Loan prior to
purchase. The Taxable Subsidiary intends to use only FIRREA qualified
appraisals and must be on forms acceptable to FNMA and/or FHLMC as part of
its approval process. Additionally, appraisals for Mortgage Loans being
considered at the 90% LTV ratio and those Mortgage Loans randomly selected
as part of quality control will be reviewed by designated underwriters. The
Taxable Subsidiary intends to use only FIRREA qualified appraisers as part
of its approval process. All appraisals are required by the Taxable
Subsidiary to conform to the Uniform Standards of Professional Appraisal
Practice adopted by the Appraisal Standards Board of the Appraisal
Foundation and must be on forms acceptable to FNMA and FHLMC.
Repurchase Requirements. Mortgage Loans will be acquired through
Correspondents who have entered into an agreement requiring repurchase of
Mortgage Loans found to breach any of a comprehensive list of
representations and warranties included in the applicable correspondent
agreement. Such warranties include failure by the borrower to make the
first payment, fraud in any of the Mortgage Loan documents, and errors in
the processing or underwriting of the Mortgage Loan.
Selection and Approval of Correspondents. Correspondents are subject
to a thorough analysis, including checking of references and review of
financial statements, before submission to an executive committee of the
Taxable Subsidiary for approval. The Company will generally require its
Correspondents to maintain a minimum net worth of $400,000 in order to
ensure their ability to meet repurchase requirements.
Pre-purchase Quality Assurance Program. The Taxable Subsidiary will
continue to implement the thorough quality assurance procedures currently
in use, which generally include verifications of Mortgage Assets and
employment and obtaining an independent credit report prior to the purchase
of the Mortgage Loans. The post-purchase quality control is administered by
one full-time employee and one contract person focusing on quality control
and assurance, who are under the oversight of the Chief Executive Officer.
The Taxable Subsidiary intends to increase this staff as required by the
level of origination volume.
The Company will establish Mortgage Loan loss allowances on the balance
sheet in advance of anticipated losses. Such allowances are expected to be
sufficient to absorb losses from the sale of foreclosed properties, as well as
operating expenses related to delinquencies and foreclosures and carrying costs
of
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Mortgage Loans in default. Management believes that actual losses will not be
commensurate with the delinquency rates, however, due to two factors: (i)
Subprime Mortgage Loan borrowers tend to be late on payments from time to time
without going to foreclosure, thus inflating the delinquency rates, and (ii) the
lower LTV ratios tend to result in reduced losses on the sale of foreclosed real
estate. Management believes its allowance for Mortgage Loan loss policies should
result in adequate coverage for losses while maintaining net yields, although
actual experience may be more or less than management's allowance.
MORTGAGE LOAN PREPAYMENTS
Mortgage Loans are generally paid in full prior to the maturity date of the
note which is typically 30 years from the date of the note. Prepayment rates are
affected by several factors, the most important of which is the change in
prevailing interest rates. Mortgage Loans will typically be prepaid more rapidly
in periods of declining interest rates as borrowers refinance to reduce monthly
payments. In periods of increasing interest rates, Mortgage Loan prepayment
rates will generally decline. Another factor which affects prepayment rates,
although to a less significant degree, is the level of home sales activity,
which generally increases when home prices are rising. Prepayment rates may also
be affected by changes in the borrower's credit rating or circumstances
following origination. Borrowers with improving credit may elect to prepay the
Mortgage Loans to take advantage of the lower rates associated with their higher
credit grades, even in periods of stable or rising interest rates. Conversely,
borrowers with deteriorating credit may be unable to take advantage of declining
interest rates as a result of their deteriorating credit.
Prepayments affect the Company in several ways. First, the amortization of
premiums or discounts related to the acquisition of the Mortgage Loans will be
affected by the speed of prepayment. Amortization of such premiums or discounts
is accounted for by the interest method by which the expense or income
recognition occurs on the basis of a fixed yield over the expected life of the
Mortgage Loan. The amortization of this premium or discount is included in the
interest income recognized each period. This method requires the use of
assumptions as to the timing of prepayments. Significant deviations in the
actual prepayment rate from the assumed rate may cause the Company to recognize
greater amortization expense for the period, and thereby reduce net interest
income. The Company's financial expectations assume a certain level of
prepayments. Actual prepayment speeds may accelerate to the point that the
return on equity earned from a given Mortgage Loan acquisition is less than
expected, and could even become negative. Second, prepayment of Mortgage Loans
will require that Mortgage Loans be acquired to replace those that have been
prepaid. The Mortgage Loans acquired may be at low introductory rates (i.e.,
"teaser rates") which may negatively impact the Company's earnings until the
rates on these Mortgage Loans reprice to the full margin over the respective
index (the "fully indexed" rate). Third, hedging instruments may have been
purchased to protect against interest rate changes related to Mortgage Loans
which may have prepaid more rapidly than anticipated, resulting in excess
coverage. Conversely, if the Mortgage Loans prepay more slowly than anticipated,
the Company may have less hedging coverage than planned, and may have to acquire
additional coverage. The Company's use of the CMO financing structure may have
these types of hedging instruments imbedded within them, and be structured in
order to better match the hedge and the Mortgage Loans. See "Risk Factors --
Interest Rate Fluctuations May Adversely Affect Operations and Net Interest
Income -- Hedging Transactions Limit Gains and May Increase Exposure to Losses."
As an additional hedge against the risk of rapid prepayments, the Company
will offer ARM programs which carry a prepayment penalty. The borrower will be
required to pay a significantly higher starting interest rate and margin to
eliminate the prepayment penalty. Prepayment penalties are subject to market and
competitive factors and may, therefore, be subject to reduction or elimination.
State laws may also restrict the Company's ability to collect prepayment
penalties. As an additional protection against the negative financial impact of
Mortgage Loan prepayments, the Company intends to adopt as soon as practicable
after the closing of the Offering policies and guidelines for its servicing
operations that will attempt to focus on borrowers that have an incentive to
refinance. The Company expects to implement a program to recapture those
Mortgage Loans by soliciting these borrowers directly rather than losing them to
another mortgage lender. The negative impact of the amortization of the premium
on these Mortgage Loans is expected to be somewhat mitigated by the fact that
the refinancing of these Mortgage Loans will be at a price at or near par.
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FUTURE CHANGES IN OPERATING, INVESTMENT AND ACCOUNTING POLICIES
The Board of Directors has established the investment, accounting and
operating policies and strategies set forth in this Prospectus. The Board of
Directors has the power to modify or waive such policies and strategies, such as
the mortgage investment policies, the leverage policies and the counterparty
credit policies, without the consent of stockholders, to the extent that the
Board Directors determine that such modification or waiver is in the best
interests of stockholders. However, if such modification or waiver relates to
the relationship of, or any transaction between, the Company and ContiFinancial
Corporation or any other Affiliated Person (as such term is defined in the
Glossary), the approval of a majority of the Independent Directors is also
required. Among other factors, developments in the market which affect the
operating policies and strategies mentioned herein or which change the Company's
assessment of the market may cause the Board of Directors to revise the
Company's policies and strategies.
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[ORGANIZATIONAL CHART]
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company and their positions are
as follows:
<TABLE>
<CAPTION>
NAME POSITIONS CLASS OF DIRECTOR
---- --------- ------------------
<S> <C> <C>
John D. Fry, CMB Chairman of the Board and Chief Executive Officer III
Terry L. Mott Executive Vice President and Director II
John P. McMurray, Executive Vice President of Secondary Marketing
CFA, CPA and Asset Liability Management
Steven K. Passey, Senior Vice President and Chief Financial Officer
CPA
Carter E. Jones Independent Director II
Jeff K. Thredgold* Independent Director I
Daniel W. Campbell* Independent Director I
</TABLE>
- ---------------
* To be appointed upon the closing of the Offering.
Information regarding the business background and experience of the
Company's directors and executive officers follows:
JOHN D. FRY, CMB, age 59, has been the President, Chief Executive Officer
and Chairman of the Board of the Company since inception in February, 1996.
During 1995, Mr. Fry commenced preparations for the organization of the Company.
From 1989 to 1994, Mr. Fry commenced the Subprime Mortgage Loan operations of
ComUnity Lending, Inc., a mortgage bank located in San Jose, California. From
1984 to 1989, Mr. Fry was Vice President and Western Division Manager of Goldome
Realty Credit Corp., a thrift in Buffalo, New York. Mr. Fry received the
"Certified Mortgage Banker" (CMB) designation from the Mortgage Bankers
Association of America in 1990 and his Bachelor of Science degree in Real Estate
Finance and Economics from Brigham Young University.
TERRY L. MOTT, age 48, is the Executive Vice President of the Company and
serves on the Board of Directors. Mr. Mott joined Mr. Fry in December, 1995, to
form the Company. From 1988 to 1995, Mr. Mott was an Executive Vice President of
Medallion Mortgage Company. Upon the sale of Medallion Mortgage Company to
AccuBanc Mortgage in 1994, Mr. Mott became an Executive Vice President at
AccuBanc Mortgage, where he supervised both retail and wholesale branches. From
1980 to 1988, Mr. Mott was employed with Fleet Mortgage Corp. where he developed
and managed the retail and wholesale production for the western United States.
Mr. Mott began his career in mortgage banking in 1977.
JOHN P. MCMURRAY, CFA, CPA, age 40, joined the Company in February, 1998,
as the Executive Vice President of Secondary Marketing and Asset Liability
Management. Prior to joining the Company, Mr. McMurray was the President of
Keystroke Financial, Inc., a start-up internet mortgage origination company.
From 1995 to 1996, Mr. McMurray was the Executive Vice President and Director,
Risk Management and Capital Markets for Crestar Mortgage Corporation where he
was responsible for interest rate and credit risk management, as well as
hedging, securitization and loan/securities trading activities. From 1982 to
1995, Mr. McMurray served in various management positions with BancPlus Mortgage
Corp., most recently serving as the Senior Vice President, Capital Markets. Mr.
McMurray is a Chartered Financial Analyst (CFA) and a Certified Public
Accountant (CPA). He received a Master of Science degree in real estate from
Massachusetts Institute of Technology, a Masters of Business Administration
degree from the University of Texas, San Antonio and a Bachelor of Science
degree from Trinity University.
STEVEN K. PASSEY, CPA, age 36, is the Senior Vice President and the Chief
Financial Officer of the Company. Mr. Passey joined the Company in October,
1997, after eight years with KPMG Peat Marwick LLP ("KPMG"). As a manager at
KPMG, Mr. Passey's responsibilities included managing audits within the
financial services area, including the mortgage banking industry. Mr. Passey
received his Bachelor of Science degree in Accounting from the University of
Utah and is a Certified Public Accountant (CPA).
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CARTER E. JONES, age 55, is an Independent Director of the Company. Since
1990, Mr. Jones has been a Senior Vice President of EVEREN Securities, Inc.,
where he specializes in management of client assets. Mr. Jones has previously
served as a member of the Board of Directors and operating committee for EVEREN
Securities, Inc. From 1987 to 1990, Mr. Jones was Executive Vice President,
Chief Operating Officer and a member of the Board of Directors and the Executive
Committee for Boettcher & Company in Denver.
JEFF K. THREDGOLD, age 46, will become an Independent Director upon the
closing of the Offering. Mr. Thredgold is the President and Chief Executive
Officer of Thredgold Economic Associates, LLC, and Economic Consulting and
Professional Speaking Company based in Salt Lake City, Utah. Mr. Thredgold's
career includes 23 years with KeyCorp, one of the nation's largest financial
services companies, with assets of nearly $70 billion, where he served as the
Senior Vice President and Chief Economist. Mr. Thredgold appears regularly on
CNBC-TV and CNN, and is quoted frequently in The Wall Street Journal, USA Today,
Investor's Business Daily, Fortune and Business Week. Mr. Thredgold is also a
monthly contributor for the national publication, Blue Chip Financial Forecasts
and writes a weekly economic and financial newsletter entitled The Tea Leaf.
DANIEL W. CAMPBELL, age 43, will become an Independent Director upon the
closing of the Offering. Mr. Campbell is currently a Managing General Partner of
EsNet, Ltd., a limited partnership engaged in the business of owning, leasing,
managing and developing commercial properties and investing in companies with
high growth potential. From 1992 to 1994, Mr. Campbell was the Senior Vice
President and Chief Financial Officer of WordPerfect Corporation. From 1979 to
1992, Mr. Campbell was an Associate and then Partner at Price Waterhouse, where
he serviced the worldwide accounting and consulting needs of multi-national
Fortune 500 companies.
KEY EMPLOYEES
WAYNE A. MOLL, age 50, is Senior Vice President and Chief Credit Officer.
Mr. Moll has a diverse career experience in loan operations, credit management,
business development, underwriting, lending, loan sales, quality control,
appraising and personnel management. His background includes 30 years in the
lending industry, most recently as the Senior Vice President of Fairfield
Mortgage from 1995 through 1996. He was employed as the Vice President and
Regional Manager at Colonial Bancorp from 1994 to 1995, and as the Vice
President and Chief Underwriter at Medallion Mortgage Company from 1990 to 1994.
VICTOR R. CALANDRA, age 38, is the Senior Vice President in charge of
Correspondent lending. Mr. Calandra has over 12 years experience in the mortgage
banking business. Mr. Calandra was formerly a Vice President for Nomura
Securities International ("Nomura") in the fixed income and structured finance
department. At Nomura, Mr. Calandra established nationwide correspondent
relationships with sellers to Nomura's conduit and was responsible for the
marketing and sale of securities and whole loans acquired through Nomura's home
equity loan conduit.
PATRICK W. CROGHAN, age 38, is the Senior Vice President, Wholesale
Production for the eastern United States. His responsibilities include
recruiting, expanding and supervising wholesale branch operations for both Prime
and Subprime Mortgage Loan origination. Mr. Croghan has over 10 years of
experience in mortgage banking, all of which has been in loan production. Prior
to joining the Company, he was a Regional Vice President for AccuBanc Mortgage
and Medallion Mortgage.
KENT G. BILLS, age 32, is the Senior Vice President, Wholesale Production
for the western United States and the Secretary of the Company. Mr. Bills was
previously a Vice President with Security National Mortgage Corporation from
1995 through 1996. Prior to joining Security National Mortgage Corporation, he
was a Vice President at ComUnity Lending, Inc. in charge of the Company's
wholesale lending operations from 1989 through 1995.
WILLIAM J. REED, age 49, is the Senior Vice President, Information Systems.
Mr. Reed's primary responsibilities include managing the MIS department,
including software and hardware support for the Company's WAN and the
development of a company-wide integrated software network. Mr. Reed was
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previously Senior Product Analyst at Interlinq Software, where he was the lead
designer for the MortgageWare Secondary Marketing System. Prior to that he was
the Vice President, Secondary Marketing at Commercial Center Bank, where he
established their correspondent purchase program, and the Executive Vice
President at Government Mortgage Corporation, where he established their
secondary marketing department. Mr. Reed has more than 14 years experience in
mortgage and mortgage-related industries.
SHAUNA L. REIMANN, age 42, is the Senior Vice President in charge of Retail
Lending. Ms. Reimann has over 20 years of experience in all facets of loan
production and operations, including processing, shipping, warehousing,
underwriting, correspondent lenders and retail originations. She was elected
President of the Utah Mortgage Bankers Association in 1993 and has served on the
Board of Governors for seven years. Prior to joining the Company, she served as
Regional Vice President, Retail Production for AccuBanc and Medallion Mortgage
Companies.
TERMS OF DIRECTORS AND OFFICERS
After the Offering, the Company's Board of Directors will consist of five
persons (as such number may be changed by the Board of Directors from time to
time by resolution) and is divided into three classes, designated Class I, Class
II and Class III, with each class to be as nearly equal in number of directors
as possible. Mr. Fry is a Class III Director, Mr. Mott and Mr. Jones are Class
II Directors. Upon closing of this Offering, Mr. Thredgold and Mr. Campbell will
serve as Class I Directors. Class I, Class II and Class III directors will stand
for reelection at the annual meetings of stockholders held in 1999, 2000 and
2001, respectively. At each annual meeting, the successors to the class of
directors whose term expires at that time are to be elected to hold office for a
term of three years, and until their respective successors are elected and
qualified, so that the term of one class of directors expires at each such
annual meeting. The Company intends to maintain the composition of the Board of
Directors so that there will be no more than seven directors, with a majority of
Independent Directors at all times after the closing of the Offering, each of
whom shall serve on the Audit and/or Compensation Committees. In the case of any
vacancy on the Board of Directors, including a vacancy created by an increase in
the number of directors, the vacancy may be filled by election of the Board of
Directors or the stockholders, with the director so elected to serve until the
next annual meeting of stockholders (if elected by the Board of Directors) or
for the remainder of the term of the director being replaced (if elected by the
stockholders). Any newly-created directorships or decreases in directorships are
to be assigned by the Board of Directors so as to make all classes as nearly
equal in number as possible. Directors may be removed only for cause and then
only by vote of a majority of the combined voting power of stockholders entitled
to vote in the election for directors.
The Amended and Restated Articles of Incorporation may be amended by the
vote of a majority of the combined voting power of stockholders, provided that
amendments to the article dealing with directors may only be amended if it is
advised by at least two-thirds of the Board of Directors and approved by vote of
at least two-thirds of the combined voting power of stockholders. The effect of
the foregoing and other provisions in the Company's Amended and Restated
Articles of Incorporation, which restrict stock ownership to 9.8% in value of
the aggregate of the outstanding shares of Capital Stock or in excess of 9.8% of
the aggregate of the outstanding shares of the Company's Common Stock, as well
as the control share and business acquisitions statutes under Maryland law, may
discourage takeover attempts and make attempts by stockholders to change
management more difficult. Prospective investors are encouraged to review the
Amended and Restated Articles of Incorporation and Bylaws in their entirety. See
"Description of Capital Stock -- Repurchase of Shares and Restrictions on
Transfer," "-- Control Share Acquisitions" and "-- Business Acquisitions
Statutes."
The Bylaws of the Company provide that, except in the case of a vacancy, a
majority of the members of the Board of Directors will at all times be
Independent Directors. Independent Directors are defined as directors who are
not officers or employees of the Company or any affiliate or subsidiary of the
Company. Vacancies occurring on the Board of Directors among the Independent
Directors may be filled by a vote of a majority of the remaining directors,
including a majority of the remaining Independent Directors. Officers are
elected annually and serve at the discretion of the Board of Directors. There
are no family relationships between the executive officers or directors.
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COMMITTEES OF THE BOARD
AUDIT COMMITTEE.
The Company has established an Audit Committee composed of three
Independent Directors. The Audit Committee will make recommendations concerning
the engagement of independent auditors, review with the independent auditors the
plans and results of the audit engagement, approve professional services
provided by the independent auditors, review the independence of the independent
auditors, consider the range of audit and non-audit fees and review the adequacy
of the Company's internal accounting controls.
COMPENSATION COMMITTEE.
The Company has established a Compensation Committee composed of two
Independent Directors and John Fry, Chairman of the Board. The Compensation
Committee will determine the compensation of the Company's executive officers.
OTHER COMMITTEES.
The Board of Directors may establish other committees as deemed necessary
or appropriate from time to time, including, but not limited to, an Executive
Committee of the Board of Directors.
COMPENSATION OF DIRECTORS
The Company pays Independent Directors of the Company $10,000 per year plus
$500 for each meeting attended in person. Independent Directors of the Company
also receive automatic stock options pursuant to the Company's Stock Option
Plan. See "-- Executive Compensation -- 1998 Stock Option Plan -- Automatic
Grants to Independent Directors." In addition, each Independent Director will be
granted options to purchase 5,000 shares of Common Stock at the Price to Public
upon the closing of the Offering. In addition, each Independent Director will
receive options to purchase 2,500 shares of Common Stock at the fair market
value of the Common Stock on the day after each annual meeting of stockholders.
All directors receive reimbursement of reasonable out-of-pocket expenses
incurred in connection with meetings of the Board of Directors. No Director who
is an employee of the Company will receive separate compensation for services
rendered as a Director.
COMPENSATION COMMITTEE INTERLOCKS
No interlocking relationship exists between the Company's Board of
Directors or officers responsible for compensation decisions and the board of
directors or compensation committee of any other company, nor has any such
interlocking relationship existed in the past.
EXECUTIVE COMPENSATION
The objective of the Compensation Committee in constructing the
compensation packages of the Company is to align the interests of management as
closely as possible with those of the stockholders. This is accomplished by
basing a large percentage of senior management's compensation on the
profitability of the Company (measured by return on stockholders' equity or
"ROE") and the Common Stock price.
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<PAGE> 93
BASE COMPENSATION
The base compensation packages for Messrs. Fry, Mott, McMurray and Passey
for 1996 and 1997 has been and for 1998 will be as follows pursuant to the terms
of their employment agreements (described below), unless subsequently amended by
the Compensation Committee:
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
----------------------------------------------------
ALL OTHER
AWARDS PAYOUTS COMPENSATION
ANNUAL COMPENSATION(1) --------------------------- ------- ------------
----------------------------------------- SECURITIES
OTHER ANNUAL RESTRICTED UNDERLYING LTIP
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS(2) COMPENSATION STOCK AWARDS OPTIONS/SARS PAYOUTS
--------------------------- ---- -------- -------- ------------ ------------ ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John D. Fry.................... 1996 $ 32,500 $ -0- $ -0- $-0- $ -0- $-0- $ -0-
Chairman of the Board and 1997 $172,500 $ -0- $ -0- -0- -0- -0- -0-
Chief Executive Officer 1998 $250,000 $ (3) $ -0- -0- 126,874 -0- 12,000(4)
Terry L. Mott.................. 1996 $ 16,000 $ -0- $ -0- -0- -0- -0- -0-
Executive Vice President and 1997 $138,997 $107,834 $ -0- -0- -0- -0- -0-
Director 1998 $200,000 $ (5) $ -0- -0- 39,537 -0- -0-
John P. McMurray............... 1996 $ -0- $ -0- $ -0- -0- -0- -0- -0-
Executive Vice President of 1997 $ -0- $ -0- $ -0- -0- -0- -0- -0-
Secondary Marketing and 1998 $200,000 $ 75,000(6) $ -0- -0- 30,000 -0- -0-
Asset Liability Management
Steven K. Passey............... 1996 $ -0- $ -0- $ -0- -0- -0- -0- -0-
Senior Vice President and 1997 $ 22,195 $ -0- $ -0- -0- 4,318 -0- -0-
Chief Financial Officer 1998 $120,000 $ (7) $ -0- -0- 5,000 -0- -0-
</TABLE>
- ---------------
(1) The base compensation packages for 1998 and thereafter will be as presented
for the three- or five-year term of their employment agreements (described
below), unless subsequently amended by the Compensation Committee.
(2) For the fiscal year ended December 31, 1997. For 1998 and beyond, subject to
the Bonus Incentive Plan.
(3) Pursuant to his employment agreement, Mr. Fry will receive 33% of the annual
bonus payable under the Bonus Incentive Compensation Plan (the "Annual
Bonus").
(4) Representing a monthly car allowance of $1,000.
(5) Pursuant to his employment agreement, Mr. Mott will receive 20% of the
Annual Bonus.
(6) For 1998, payable upon closing of the Offering. For 1999 and thereafter, Mr.
McMurray will receive 20% of the Annual Bonus.
(7) Pursuant to his employment agreement, Mr. Passey will receive 7% of the
Annual Bonus.
BONUS INCENTIVE COMPENSATION PLAN
Upon closing of the Offering, a Bonus Incentive Compensation Plan will be
established for certain executive and key officers of the Company and its
subsidiaries. The annual bonus pursuant to the Bonus Incentive Compensation Plan
(the "Annual Bonus") will be paid one-half in cash and one-half in shares of
Common Stock, annually, following receipt of the audit for the related fiscal
year. This program will award bonuses annually to those officers out of a total
pool determined by stockholder ROE as follows:
<TABLE>
<CAPTION>
ROE(1) IN EXCESS OF BASE RATE(2) BY: ANNUAL BONUS AS PERCENT OF AVERAGE NET WORTH(3) OUTSTANDING
- ------------------------------------ -----------------------------------------------------------
<S> <C>
Zero or less 0%
Greater than 0% but less than 6% 10% * (Actual ROE - Base Rate)
Greater than 6% (10% * 6%) + 15% * (Actual
ROE - (Base Rate + 6%))
</TABLE>
- ---------------
(1) "ROE" is determined for the fiscal year by averaging the monthly ratios
calculated each month by dividing (i) the Company's monthly Net Income
(adjusted to an annual rate) by (ii) its Average Net Worth for such month.
For such calculations, the "Net Income" of the Company means the net income
or net loss of the Company determined according to GAAP, after deducting any
dividends paid or
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<PAGE> 94
payable with respect to preferred stock and before giving effect to the bonus
incentive compensation or any valuation allowance adjustment to stockholders'
equity. The definition "ROE" is used only for purposes of calculating the bonus
incentive compensation payable pursuant to the Bonus Incentive Compensation
Plan, and is not related to the actual distributions received by
stockholders. The bonus payments will be made before any income
distributions are made to stockholders.
(2) "Base Rate" is the average for each month of the 10-Year U.S. Treasury Rate,
plus 4%.
(3) "Average Net Worth" for any month means the arithmetic average of the sum of
(i) the net proceeds from all offerings of equity securities by the Company
since formation including exercise of warrants and stock options and
pursuant to the DRP (but excluding any offerings of preferred stock
subsequent to the Offering), after deducting any underwriting discounts and
commissions and other expenses and costs relating to the Offering, plus (ii)
the Company's retained earnings (without taking into account any losses
incurred in prior fiscal years, after deducting any amounts reflecting
taxable income to be distributed as dividends and without giving effect to
any valuation allowance adjustment to stockholders' equity) computed by
taking the daily average of such values during such period.
Of the amount so determined, one-half will be deemed contributed to the
total pool in cash and the other half deemed contributed to the total pool in
the form of shares of Common Stock, with the number of shares to be calculated
based on the average price per share during the preceding year. Pursuant to
their respective employment agreements, the Company has agreed to pay to Messrs.
Fry, Mott, McMurray and Passey an aggregate of 80% of the Annual Bonus. See
"-- Executive Compensation -- Base Compensation." The remaining Annual Bonus
will be distributed as determined by the Board of Directors or the Compensation
Committee.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with Messrs. Fry, Mott,
McMurray and Passey. The employment agreements with Mr. Fry and Mr. Mott provide
for a five-year term through December, 2002, and the employment agreements with
Mr. McMurray and Mr. Passey provide for a three-year term through December,
2000. Each of the employment agreements will be automatically extended for an
additional year at the end of the initial term and each annual renewal, unless
either party provides a prescribed prior written notice to the contrary. Each
employment agreement provides for the annual base salary set forth in the
compensation table above and for participation by the subject officer in the
Bonus Incentive Compensation Plan. Each employment agreement provides for the
subject officer to receive his annual base salary and bonus compensation to the
date of the termination of employment by reason of death, disability or
resignation and to receive base compensation to the date of the termination of
employment by reason of a termination of employment for cause, as defined in the
agreement. The employment agreements of Messrs. Fry, Mott and McMurray also
provide for Messrs. Fry, Mott and McMurray to receive, if Messrs. Fry, Mott and
McMurray are terminated without cause after a "Change in Control" of the Company
as such term is defined in the agreement, an amount, 50% payable immediately and
50% payable in monthly installments over the succeeding 12 months, equal to
three times their respective combined maximum base salary and actual bonus
compensation for the preceding year, subject in each case to a maximum amount of
one percent of the Company's book equity value (exclusive of valuation
adjustments) but in no case less than three times their respective base
compensation. In addition, all outstanding options granted to the subject
officer under the 1998 Stock Option Plan shall immediately vest. "Change of
Control" for purposes of the agreements would include a merger or consolidation
of the Company, a sale of all or substantially all of the assets of the Company,
changes in the identity of a majority of the members of the Board of Directors
of the Company (other than due to the death, disability or age of a director) or
acquisitions of more than 25% of the combined voting power of the Company's
capital stock, subject to certain limitations. If the Company terminates any
officer's employment without cause, or, with respect to Mr. Fry, if he resigns
for "good reason," the officer receives a severance amount. The severance
amount, which varies from six-months' base salary to one-year's full base and
bonus compensation, is payable immediately, subject in each case to a maximum
amount of one percent of the Company's book value (exclusive of valuation
adjustments). If the officer resigns for any other
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<PAGE> 95
reason, there is no severance payment. Each of the officers is prohibited from
competing with the Company for a period of two years following any termination
of employment, except upon termination by the Company without cause.
The employment agreements, and the non-competition provisions thereof, are
unlikely to be enforceable by the Company against the employees since state law
and public policy generally prohibit forced employment and severely restrict the
scope of non-competition provisions. As a result, there can be no assurance that
such employees will remain with the Company and that they will not compete after
termination.
1996 STOCK OPTION PLAN
The Board of Directors adopted CMG Funding Corp.'s 1996 Stock Option Plan
(the "1996 Stock Option Plan") pursuant to which options to purchase an
aggregate of 226,905 shares of CMG Funding Corp.'s common stock (prior to the
reverse stock split described below) can be granted to officers, directors and
employees, and to consultants, vendors, customers and others expected to provide
significant services to CMG Funding Corp. or its subsidiaries. Upon closing of
the Offering, the Company will adopt CMG Funding Corp.'s 1996 Stock Option Plan
and will convert such options into options to purchase Company Common Stock. If
an option granted under the 1996 Stock Option Plan expires or terminates, the
shares subject to any unexercised portion of that option will again become
available for the issuance of further options under the applicable plan. Options
may be granted under the 1996 Stock Option Plan which are intended to qualify as
"incentive stock options" under Section 422 of the Code ("ISOs") or,
alternatively, as stock options which will not so qualify ("NQSOs"). The plans
will terminate on December 16, 2006, and no more options may be granted under
the 1996 Stock Option Plan once it has been terminated. The Board or a committee
designated by the Board is empowered to determine the terms and conditions of
each option granted under the 1996 Stock Option Plan. However, the exercise
price of an ISO cannot be less than the fair market value of the Common Stock on
the date of grant (110% if granted to an employee who owns 10% or more of the
Common Stock), and the exercise price of an NQSO option cannot be less than 85%
of the fair market value on the date of grant. No option can have a term in
excess of ten years (five years if granted to an employee owning 10% or more of
the Common Stock), and no ISO can be granted to anyone other than a full-time
employee of the Company or its subsidiaries. As of the date hereof, options to
purchase 79,500 shares of CMG Funding Corp. common stock at an exercise price of
$3.96 per share have been granted under the 1996 Stock Option Plan. Such options
will be reverse split and converted into options to purchase 34,324 shares of
Company Common Stock upon the closing of the Offering at an exercise price of
$9.17 per share. In addition, options to purchase 30,000 shares (post-split) at
an exercise price of $15.00 per share have been granted under the 1996 Stock
Option Plan.
1998 STOCK OPTION PLAN
General. The Company's 1998 Stock Option Plan (the "1998 Stock Option
Plan") provides for the grant of ISOs and NQSOs.
Purpose. The 1998 Stock Option Plan is intended to provide a means of
performance-based compensation in order to attract and retain qualified
personnel and to afford additional incentive to others to increase their efforts
in providing significant services to the Company.
Administration. The 1998 Stock Option Plan will be administered by the
Compensation Committee, which shall be comprised of the two Independent
Directors and John D. Fry. Independent Directors are eligible to receive only
NQSOs pursuant to automatic grants of stock options discussed below.
Options and Awards. Stock options granted under the 1998 Stock Option Plan
will become exercisable in accordance with the terms of grant made by the
Compensation Committee. Awards will be subject to the terms and restrictions of
the awards made by the Compensation Committee. Stock option and award recipients
shall enter into a written stock option agreement with the Company. The
Compensation Committee has discretionary authority to select participants from
among eligible persons and to determine at the time a stock option or award is
granted when and in what increments shares covered by the stock option or award
may be purchased or will vest and, in the case of options, whether it is
intended to be an ISO or a NQSO
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<PAGE> 96
provided, however, that certain restrictions applicable to ISOs are mandatory,
including a requirement that ISOs not be issued for less than 100% of the then
fair market value of the Common Stock (110% in the case of a grantee who holds
more than 10% of the outstanding Common Stock) and a maximum term of 10 years
(five years in the case of a grantee who holds more than 10% of the outstanding
Common Stock). Fair market value means as of any given date, with respect to any
stock option or award granted, at the discretion of the Board of Directors or
the Compensation Committee, (i) the closing sale price of the Common Stock on
such date as reported in the Western Edition of the Wall Street Journal or (ii)
the average of the closing price of the Common Stock on each day of which it was
traded over a period of up to 20 trading days immediately prior to such date, or
(iii) if the Common Stock is not publicly traded (e.g., prior to an initial
public offering), the fair market value of the Common Stock as otherwise
determined by the Board of Directors or the Compensation Committee in the good
faith exercise of its discretion.
Vesting of Options and Awards. The Stock Options granted under the 1998
Stock Option Plan shall vest on the following terms. For each annual period over
a five-year period that the Company delivers a total return (stock price
appreciation, warrant value, appreciation and dividends) to investors in the
Offering equal to or exceeding 20%, one-third of the stock options will vest,
until all such stock options have vested. Alternatively, if at any time prior to
the end of the five-year period the total return to investors equals or exceeds
100%, all of the stock options will vest.
For purposes of calculating the returns to such investors, the term "fiscal
period" will refer to each of five periods, the first commencing with the last
closing of the Offering and ending on December 31, 1999, and each succeeding
fiscal period extending for 12 months and ending on each December 31. The term
"return" for each fiscal period will mean the sum of (on a per share of Capital
Stock basis) (a) all cash dividends paid during (or declared with respect to)
such fiscal period per share of Common Stock, (b) any increase or decrease in
the price per share of Common Stock during such fiscal period, measured by using
the price per share of Capital Stock to investors in the Offering, and using the
average public trading price during the last 90 days of each succeeding fiscal
period for such succeeding periods, and (c) any increase or decrease in the
price per Warrant during such fiscal period, determined in the same manner as in
(b) above. For purposes of the fiscal period 20% return test, the total return
for a given period will be equal to the sum of (a), (b) and (c) will all be
measured from the beginning of the first fiscal period. The amount of that
"return" will then be measured as a percentage of the investors' investment in
the Units (on a per share of Capital Stock basis) without regard to timing of
receipt of dividends or timing of increases in per share or per Warrant prices.
Automatic grants of stock options to the Independent Directors vest 25% on
the anniversary date in the year following the date of the grant and 25% on each
anniversary date thereafter.
Eligible Persons. Officers and directors and employees of the Company and
other persons expected to provide significant services to the Company are
eligible to participate in the 1998 Stock Option Plan. ISOs may be granted to
the officers and key employees of the Company. NQSOs may be granted to the
directors, officers, key employees, agents and consultants of the Company or any
of its subsidiaries.
Under current law, ISOs may not be granted to any director of the Company
who is not an employee, or to directors, officers and other employees of
entities unrelated to the Company. No options may be granted under the 1998
Stock Option Plan to any person who, assuming exercise of all options held by
such person, would own or be deemed to own more than 25% of the outstanding
shares of equity stock of the Company.
Shares Subject to the Plan. Subject to anti-dilution provisions for stock
splits, stock dividends and similar events, the 1998 Stock Option Plan
authorizes the grant of stock options to purchase an aggregate of up to 407,569
shares of the Company's Common Stock. If an option granted under the 1998 Stock
Option Plan expires or terminates, the shares subject to any unexercised portion
of such Stock Option will again become available for the issuance of further
stock options under the 1998 Stock Option Plan. The maximum number of shares
covered by the 1998 Stock Option Plan will increase (from and after such time as
the number of outstanding shares of Common Stock exceeds the number of shares
outstanding after this Offering) to 10% of the Company's total outstanding
shares at any time.
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<PAGE> 97
Term of the Plan. Unless previously terminated by the Board of Directors,
the 1998 Stock Option Plan will terminate on April 1, 2008, and no options may
be granted under the 1998 Stock Option Plan thereafter, but existing options
remain in effect until the options are exercised or terminated by their terms.
Term of Options. Each stock option must terminate no more than ten years
from the date it is granted (or five years in the case of ISOs granted to an
employee who is deemed to own an excess of 10% of the combined voting power of
the Company's outstanding equity stock). Stock options may be granted on terms
providing for exercise either in whole or in part at any time or times during
their restrictive terms, or only in specified percentages at stated time periods
or intervals during the term of the stock option.
Option Exercise. The exercise price of any stock option granted under the
1998 Stock Option Plan is payable in full in cash, or its equivalent as
determined by the Compensation Committee. The Company may make loans available
to option holders to exercise stock options evidenced by a promissory note
executed by the option holder and secured by a pledge of Common Stock with fair
value at least equal to the principal of the promissory note unless otherwise
determined by the Compensation Committee.
Automatic Grants to Independent Directors. Each Independent Director of the
Company is automatically granted NQSOs to purchase 5,000 shares of Common Stock
upon becoming a director of the Company, and is also automatically granted NQSOs
to purchase 2,500 shares of Common Stock the day after each annual meeting of
stockholders upon re-election to or continuation on the Board. Such automatic
grants of stock options vest 25% on the anniversary date in the year following
the date of the grant and 25% on each anniversary date thereafter. The exercise
price for such automatic grants of stock options is the fair market value of the
Common Stock on the date of grant, and is required to be paid in cash.
Amendment and Termination of Stock Option Plan. The Board of Directors may,
without affecting any outstanding stock options, from time to time revise or
amend the 1998 Stock Option Plan, and may suspend or discontinue it at any time.
However, no such revision or amendment may, without stockholder approval,
increase the number of shares subject to the 1998 Stock Option Plan, modify the
class of participants eligible to receive options granted under the 1998 Stock
Option Plan or extend the maximum option term under the 1998 Stock Option Plan.
Outstanding Options. Under the Company's 1998 Stock Option Plan, options to
acquire 407,569 shares will be granted upon closing of the Offering. Of these
stock options, 15,000 will be granted to the three Independent Directors and
will vest 25% on the closing of this Offering and 25% on each anniversary of
such date thereafter. All stock options granted to employees and directors upon
closing of this Offering are exercisable at the Price to Public. The 1998 Stock
Option Plan provides that, in connection with any reorganization, merger,
consolidation, recapitalization, stock split or similar transaction, the
Compensation Committee shall appropriately adjust the number of shares of Common
Stock subject to outstanding Stock Options and the total number of shares for
which stock options may be granted under the Plan.
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<PAGE> 98
STOCK OPTION GRANTS
The following table sets forth information concerning all stock options
granted during 1997 and to date in 1998 to each member of the Board of Directors
and Executive Officers.
INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
AT
ASSUMED ANNUAL RATES OF
STOCK
APPRECIATION FOR
PERCENT OF TOTAL OPTIONS EXERCISE PLAN OPTION TERM
GRANTED TO EMPLOYEES OR BASE PICE ---------------------------
NAME GRANT DURING THE YEAR(1) ($/SHARE) DATE 5% ($) 10% ($)
---- ------- ------------------------ ------------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
John D. Fry.......... 126,874 36.8% $ (2) 04/01/98 $1,196,856 $3,033,067
Terry L. Mott........ 39,537 11.5% $ (2) 04/01/98 $ 372,969 $ 945,177
John P. McMurray..... 30,000* 8.7% $15.00 04/01/98 $ 283,003 $ 717,184
Steven K. Passey..... 4,318* 1.3% $ 9.17 10/27/97 $ 24,904 $ 63,112
5,000 1.4% $ (2) 04/01/98 $ 47,167 $ 119,531
Carter E. Jones...... 5,000 1.4% $ (2) 04/01/98 $ 47,167 $ 119,531
Jeff K. Thredgold.... 5,000 1.4% $ (2) 04/01/98 $ 47,167 $ 119,531
Daniel W. Campbell... 5,000 1.4% $ (2) 04/01/98 $ 47,167 $ 119,531
</TABLE>
- ---------------
* Granted under the 1996 Stock Option Plan.
(1) Calculation of the percentages excludes Stock Options to purchase 126,667
shares of the Company's Common Stock granted to ContiFinancial Corporation
in April, 1998.
(2) Exercise price equals the Price to Public.
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<PAGE> 99
STRUCTURE AND FORMATION TRANSACTIONS
The following discussion is qualified in its entirety by the description of
the potential effects of the 1999 Budget Plan set forth above under
"Business -- Industry Developments."
STRUCTURE OF THE COMPANY
Initially, the Company will conduct its operations through at least two
entities, (i) RealTrust Asset Corporation, a newly-formed Maryland corporation
that will elect REIT status (for purposes of this discussion, sometimes referred
to as "RealTrust"), and (ii) CMG Funding Corp., a Delaware corporation, that
will not elect REIT status (for purposes of this discussion, sometimes referred
to as the "Taxable Subsidiary"). See "Business -- Industry Developments." The
structure is designed primarily to permit RealTrust to acquire the ownership of
95% of the economic interest of the Taxable Subsidiary (including the right to
95% of all dividend distributions) while qualifying for REIT status. See
"Federal Income Tax Considerations -- Qualification as a REIT -- Nature of
Assets."
REALTRUST ASSET CORPORATION
RealTrust Asset Corporation will acquire a portfolio of Mortgage Assets
using the net proceeds of the Offering and the net proceeds of borrowings and
structured debt vehicles. It is anticipated that RealTrust's assets will consist
primarily of Mortgage Assets and the preferred stock of the Taxable Subsidiary.
On April 15, 1998, the Founders contributed shares of CMG Funding Corp.
preferred stock and common stock for shares of Capital Stock of RealTrust, while
retaining a portion of their shares of the Taxable Subsidiary common stock. The
shares of the Taxable Subsidiary capital stock held by RealTrust were then
recapitalized into shares of non-voting preferred stock, such that RealTrust
owned all of the non-voting preferred stock of the Taxable Subsidiary
representing 95% of the economic interest. The shares of voting common stock of
the Taxable Subsidiary retained by the Founders represent five percent of the
economic interest. RealTrust will not control the Taxable Subsidiary.
Accordingly, the purchase of Units in the Offering will not own an interest in
any entity that control the Taxable Subsidiary. See "Risk Factors -- Conflicts
of Interest May Result in Decisions That Do Not Fully Reflect the Stockholders'
Best Interests -- Investors Will Have No Voting Control of the Taxable
Subsidiary."
RealTrust will conduct the investment portfolio operations of the Company.
Specifically, RealTrust will determine which Mortgage Loans will be held for
long-term investment, will establish underwriting guidelines for the Mortgage
Loans, will arrange financing for the investment portfolio (including the
issuance of structured debt offerings), will administer the capital allocation
guidelines and other risk management policies, and will supervise the servicing
operations of third-party servicers.
For 1998 and thereafter, RealTrust intends to qualify and elect to be taxed
as a REIT. As a REIT, RealTrust generally will not be taxed on its earnings to
the extent that such earnings are distributed as dividends to its stockholders.
See "Dividend Policy and Distributions" and "Federal Income Tax
Considerations -- Taxation of the Company."
RealTrust owns all of the preferred stock of the Taxable Subsidiary,
representing 95% of the economic interest thereof, but will generally have no
right to control the affairs of the Taxable Subsidiary (other than to approve
certain fundamental transactions such as mergers, consolidations, sales of all
or substantially all of the assets, and voluntary liquidation) because the
preferred stock is non-voting. Instead, the Founders and ContiFinancial
Corporation, as the holders of all of the common stock of the Taxable
Subsidiary, control the operations and affairs of the Taxable Subsidiary. See
"Risk Factors -- Conflicts of Interest May Result in Decisions That Do Not Fully
Reflect the Stockholders' Best Interests -- Conflicts of Interest with and
Dependence Upon ContiFinancial Corporation May Not Be in the Stockholders' Best
Interests." This ownership structure is required because, as a REIT, RealTrust
generally may not own more than 10% of the voting securities of any other
issuer. See "Federal Income Tax Considerations -- Qualification as a REIT --
Nature of Assets" and "Risk Factors -- President's 1999 Budget Plan, If Enacted,
Would Adversely Affect
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<PAGE> 100
Results of Operations." Accordingly, the purchasers of the Units in the Offering
will not own an interest in any entity that controls the Taxable Subsidiary.
THE TAXABLE SUBSIDIARY
The Taxable Subsidiary is taxable as a "C" corporation. The Taxable
Subsidiary will not be making a REIT election. The Taxable Subsidiary will
perform those tasks and engage in those lines of business that would result in a
loss of REIT status or the imposition of taxation if RealTrust were to engage in
them. In particular, the Taxable Subsidiary will originate, sell and service
Mortgage Loans and will serve as a source of Mortgage Loans for RealTrust. See
"Risk Factors -- President's 1999 Budget Plan, If Enacted, Would Adversely
Affect Results of Operations."
The Taxable Subsidiary will conduct the mortgage lending operations of the
Company. The Taxable Subsidiary will establish and maintain the wholesale,
retail and correspondent channels of production, will perform all underwriting
and quality control processes, will sell all Mortgage Loans that RealTrust does
not desire to hold for long-term investment (either through whole loan sales or
securitizations) and will maintain all necessary state mortgage lending
licenses.
The Taxable Subsidiary will make dividend distributions to the extent
consistent with RealTrust's qualification as a REIT. For purposes of receiving
dividends, there is no difference between a share of the preferred stock of the
Taxable Subsidiary and a share of the common stock of the Taxable Subsidiary so
that the preferred stock of the Taxable Subsidiary will have no dividend rate or
preference over the common stock of the Taxable Subsidiary. Instead, dividend
distributions by the Taxable Subsidiary will be made in the same amount per
share of the preferred stock and common stock of the Taxable Subsidiary.
FORMATION TRANSACTIONS AND POST-CLOSING TRANSACTIONS
FORMATION TRANSACTIONS
Immediately prior to or upon the closing of this Offering, the following
transactions (the "Formation Transactions") will be consummated:
- As of April 15, 1998, the stockholders of the Taxable Subsidiary have
contributed 95% of their capital stock of the Taxable Subsidiary to
RealTrust in exchange for shares of RealTrust Capital Stock;
- The capital stock of the Taxable Subsidiary will be recapitalized such
that RealTrust will own non-voting preferred stock representing 95% of
the economic interest of the Taxable Subsidiary and the Founders and
ContiFinancial Corporation will own common stock representing five
percent of the economic interest of the Taxable Subsidiary (reflecting
their respective percentage ownership of the Taxable Subsidiary's entire
capital stock);
- The outstanding shares of preferred stock of RealTrust, owned by
ContiFinancial Corporation, John Fry and Terry Mott, and all of the
shares of Common Stock of RealTrust held by the Founders and
ContiFinancial Corporation will be converted into an aggregate of
984,370 shares of Common Stock of RealTrust, par value $.001 per share
(the "Common Stock"); except the 410,581 shares of Class B Redeemable
Preferred Stock owned by ContiFinancial Corporation which will be
redeemed after the closing of the Offering (see "Conflicts of Interest
and Related Party Transactions -- ContiFinancial Corporation" and "Use
of Proceeds");
- The Company will amend its Articles of Incorporation to adopt provisions
necessary for qualification as a REIT;
- The Company will sell 4,000,000 Units in this Offering (assuming no
exercise of the Underwriters' over-allotment option); and
- The Company will grant the Representative's Warrants.
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POST-CLOSING TRANSACTIONS
Following the closing of the Offering, the following transactions will be
consummated (the "Post-Closing Transactions"):
- The Company will elect to be taxed as a REIT;
- The Company will conduct certain aspects of its mortgage lending
operations through the Taxable Subsidiary. The Company will own all of
the shares of non-voting preferred stock of the Taxable Subsidiary,
which shares shall represent 95% of the economic interest of the Taxable
Subsidiary. See "Risk Factors -- President's 1999 Budget Plan, If
Enacted, Would Adversely Affect Results of Operations";
- The Founders will own approximately 66.7% and ContiFinancial Corporation
will own approximately 33.3% of the voting common stock of the Taxable
Subsidiary, which shares shall represent five percent of the economic
interest of the Taxable Subsidiary;
- The Company will redeem the 410,581 shares of Class B Redeemable
Preferred Stock held by ContiFinancial Corporation for $2,000,000, plus
dividends accrued since January 1, 1998, at the rate of 18% per annum;
and
- In addition to the options to purchase 64,325 shares of Common Stock
granted to officers, directors and employees under the 1996 Stock Option
Plan, the Company will also grant to officers, directors and employees
(including ContiFinancial Corporation) options to purchase an aggregate
of 407,569 shares of Common Stock under the 1998 Stock Option Plan.
CONSEQUENCES OF FORMATION TRANSACTIONS AND POST-CLOSING TRANSACTIONS
The consummation of the Formation Transactions and the Post-Closing
Transactions will have the following consequences:
- The purchasers of Units in the Offering will own 80.3% of the
outstanding shares of Common Stock (assuming no exercise of the
Warrants, the Representative's Warrants, the over-allotment option or
outstanding stock options) and will own all of the Warrants, except the
Representative's Warrants;
- The Founders and ContiFinancial Corporation will collectively own 19.7%
of the outstanding shares of Common Stock outstanding (assuming no
exercise of the Warrants, the Representative's Warrants, the
over-allotment option or outstanding stock options);
- In addition to options granted to officers, directors and employees of
the Company to purchase 64,325 shares of Common Stock at exercise prices
ranging from $9.17 to $15.00, officers, directors and employees of the
Company and ContiFinancial Corporation will be granted options to
purchase an aggregate of 407,569 shares of Common Stock, subject to
certain vesting provisions, at an exercise price equal to the Price to
Public;
- The Company will own all of the non-voting preferred stock of the
Taxable Subsidiary, which shares will represent 95% of the economic
interest of the Taxable Subsidiary; and
- The Founders and ContiFinancial Corporation will own all of the voting
shares of common stock of the Taxable Subsidiary, which stock will
represent five percent of the economic value and voting control of the
Taxable Subsidiary.
CONFLICTS OF INTEREST AND RELATED PARTY TRANSACTIONS
CONTIFINANCIAL CORPORATION
The Taxable Subsidiary and the Company have entered into the following
transactions with ContiFinancial Corporation:
Stock Ownership. Immediately prior to the closing of the Offering,
ContiFinancial Corporation will own 506,933 shares of Common Stock, 252,117
shares of Class A Convertible Preferred Stock and 410,581 shares of Class B
Redeemable Preferred Stock, which in the aggregate represents approximately
43.0% of the
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outstanding shares of Capital Stock (approximately 42.0% on a fully diluted
basis). Immediately prior to the closing of this Offering, each share of Class A
Convertible Preferred Stock, including those owned by ContiFinancial
Corporation, will be converted into one share of Common Stock. All of the
outstanding shares of Common Stock will be reverse split into an aggregate of
984,370 shares of Common Stock. As a result, immediately prior to the closing of
the Offering, ContiFinancial Corporation will own 327,730 shares of Common
Stock, representing 33.3% of the outstanding shares (32.2% on a fully diluted
basis). Upon closing of the Offering, the Company intends to redeem the Class B
Redeemable Preferred.
The redemption price for all shares of the Class B Redeemable Preferred
Stock equals the original purchase price of $2,000,000, plus dividends accrued
from January 1, 1998 at the rate of 18% per annum, for a total redemption price
of $2,180,000, assuming redemption occurs on June 30, 1998. The Class B
Redeemable Preferred Stock is also entitled to a liquidation preference of
$2,000,000 plus accrued dividends. The Class B Redeemable Preferred Stock is not
convertible into Common Stock.
Agreements to Sell Mortgage Loans. Upon the closing of the Offering until
December 31, 2001, the Taxable Subsidiary has agreed to sell to ContiFinancial
Corporation not less than 75% of the fixed rate Subprime Mortgage Loans
originated or acquired by the Taxable Subsidiary in each month. The purchase
price for such Subprime Mortgage Loans shall be the fair market value for such
Mortgage Loans as determined by the best published rate sheet at ContiMortgage
Corporation, an affiliate of ContiFinancial Corporation. In any month, the
Taxable Subsidiary may substitute adjustable-rate Subprime Mortgage Loans for up
to 50% of the amount required to be offered for sale to ContiFinancial
Corporation. To the extent that the Taxable Subsidiary offers to sell less than
75% of the monthly fixed rate Subprime Mortgage Loan production, the Taxable
Subsidiary has agreed to pay ContiFinancial Corporation a fee equal to 40 basis
points multiplied by the amount of the principal shortfall.
Warehouse, Standby and Working Capital Financing Agreements. The Taxable
Subsidiary currently has a warehouse facility with ContiFinancial Corporation in
the principal amount of $50.0 million and a working capital facility in the
maximum principal amount of $2.0 million. As of March 31, 1998, the Taxable
Subsidiary had outstanding borrowings under such lines of $40.0 million and $2.0
million, respectively. The Company anticipates that, immediately after the
closing of this Offering, the Taxable Subsidiary will repay all amounts borrowed
under the working capital facility. See "Use of Proceeds." The Taxable
Subsidiary may continue to finance the acquisition of Mortgage Loans under the
warehouse facility. Although the Taxable Subsidiary anticipates that it will be
able to obtain financing on terms more favorable than those provided by the
warehouse facility after the closing of the Offering, the Taxable Subsidiary
believes that the warehouse facility is currently on terms not less favorable to
the Taxable Subsidiary than those available from independent third parties in
arm's-length transactions.
Warrants to Purchase Capital Stock. The Taxable Subsidiary has granted to
ContiFinancial Corporation two warrants to purchase shares of common stock. If
the amount of principal and interest due under the working capital facility is
not repaid in full by January 1, 1999, the first warrant allows ContiFinancial
Corporation to purchase, for a nominal amount, shares of common stock
representing up to five percent of the outstanding shares (on a fully diluted
basis) of the Taxable Subsidiary. If the Taxable Subsidiary repays in full the
working capital facility, the warrant is not exercisable and automatically
terminates. The Taxable Subsidiary anticipates that the working capital facility
will be repaid upon closing of the Offering from the net proceeds thereof. See
"Use of Proceeds."
The Taxable Subsidiary has also granted ContiFinancial Corporation a
warrant to purchase, for a nominal amount, shares of common stock representing
one percent of the outstanding shares (on a fully diluted basis) for each
quarter ending prior to the closing of the Offering in which the Taxable
Subsidiary does not attain at least 90% of its pre-tax net income target. Such
warrant automatically expires and may not be exercised by ContiFinancial
Corporation after the closing of this Offering. The Taxable Subsidiary has
established the pre-tax net income targets.
Structured Debt Placement Agent/Underwriter. Until December, 2001, the
Company has appointed ContiFinancial Corporation as its exclusive placement
agent for structured debt offerings and other securitizations and has agreed to
pay to ContiFinancial Corporation a fee of 25 basis points of the principal
amount of
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any such structured debt public offering and 50 basis points of the gross
proceeds of any such structured debt private offering. These fees are payable to
ContiFinancial Corporation for financial advisory services to be rendered
pursuant to an Investment Banking Services Agreement and will not be reduced by
any fees payable or paid to others, including the underwriters, the placement
agent or to other agents or advisors, if any, in connection with any structured
debt offering. Such combined fees may exceed those available from a single third
party. See "Risk Factors -- Conflicts of Interest, May Result in Decisions That
Do Not Fully Reflect the Stockholders' Best Interest."
CAPSTONE INVESTMENTS, INC.
In March, 1998 and April, 1998, the Taxable Subsidiary borrowed an
aggregate of $850,000 from Capstone Investments, Inc., a Nevada corporation, the
sole shareholders of which are David and Sarah Ferradino, who are Founders. The
loan is evidenced by a Convertible Secured Promissory Note (the "Note") bearing
simple interest at 9% per annum and maturing upon the earlier of the following
to occur: (i) January 1, 1999, or (ii) the completion of the Offering. The Note
is secured by a pledge of Company Common Stock by certain of the Founders. Upon
completion of the Offering, Capstone Investments, Inc. will have the option to
convert all or any portion of the Note into a number of Units offered in the
Offering. The number of Units will be determined by dividing the amount to be
converted by the Price to Public. The Company also has granted Capstone
Investments, Inc. warrants to purchase 50,000 shares of the Company's Common
Stock. The warrants have an exercise price equal to the Price to Public and
expire three years from their grant date. The Company believes that the terms of
the Note and warrants are no less favorable to the Company than those available
from an independent third party in an arm's-length transaction.
CONTROL OF TAXABLE SUBSIDIARY
Although RealTrust will be entitled to 95% of the economic benefits of the
Taxable Subsidiary, it will not own any voting securities. The Founders will own
66.7% of the voting securities of the Taxable Subsidiary. As a result, the
Founders can conduct the affairs of the Taxable Subsidiary in a manner that may
not be in the best interests of the stockholders of RealTrust. See "Risk
Factors -- Conflicts of Interest May Result in Decisions That Do Not Fully
Reflect the Stockholders' Best Interests."
FORMATION TRANSACTIONS
The Formation Transactions that will occur on or prior to the closing of
the Offering will benefit the Founders of the Company. The Post-Closing
Transactions will occur on or after the closing of the Offering. See "Structure
and Formation Transactions."
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with each of Messrs.
Fry, Mott, McMurray and Passey. Such employment agreements will provide for an
initial term of five years for Messrs. Fry and Mott and three years for Messrs.
McMurray and Passey, among other benefits. See "Management -- Executive
Compensation -- Employment Agreements." During the term of the employment
agreements, each of such employees has agreed not to compete with the Company.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of April 1, 1998, adjusted to give
effect to the Formation Transactions, of: (i) each of the Company's directors
and executive officers, (ii) each person who beneficially owns more than five
percent of the outstanding shares of Capital Stock, and (iii) all directors and
officers of the Company as a group. Unless otherwise indicated, the address of
each named beneficial owner is the same as that of the Company's principal
executive office located at 2855 East Cottonwood Parkway, Suite 500, Salt Lake
City, Utah 84121.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES OF COMMON
NUMBER OF SHARES STOCK BENEFICIALLY OWNED
OF COMMON STOCK ---------------------------------------
NAME BENEFICIALLY OWNED(1) BEFORE OFFERING AFTER OFFERING(1)(2)
---- --------------------- --------------- --------------------
<S> <C> <C> <C>
ContiFinancial Corporation(3)........ 327,730 33.3% 6.6%
277 Park Avenue
New York, NY 10172
John D. Fry.......................... 298,392 30.3% 6.0%
David and Sara Ferradino(4).......... 93,028 7.9% 1.9%
1601 North Rancho Drive
Las Vegas, NV 89106
Terry L. Mott........................ 92,987 9.4% 1.9%
John P. McMurray(5).................. 30,000 3.0% *
Steven K. Passey(6).................. 4,318 * *
All executive officers and directors
as................................. 425,697 41.8% 8.5%
a group (4 persons)
</TABLE>
- ---------------
* Less than one percent.
(1) Unless otherwise noted, the Company believes that each person named in the
table has sole voting and investment power with respect to all Common Stock
owned by it. A person is deemed to be the beneficial owner of securities
that can be acquired by such person within 60 days from the date of this
Prospectus upon the exercise of warrants or options. Each beneficial owner's
percentage ownership is determined by assuming that options or warrants that
are held by such person (but not those held by any other person) and which
are exercisable within 60 days from the date of this Prospectus have been
exercised.
(2) Assuming no exercise of outstanding Warrants or the Representative's
Warrants.
(3) Excludes 410,581 shares of Class B Redeemable Preferred Stock which the
Company intends to redeem upon the closing of the Offering. See "Conflicts
of Interest and Related Party Transactions -- ContiFinancial Corporation."
(4) Includes warrants to purchase 50,000 shares of Common Stock exercisable at a
price per share equal to the Price to Public which are immediately
exercisable. Excludes 56,667 Units in the Offering issuable upon conversion
of the $850,000 convertible note Capstone Investments, Inc.
(5) Includes options to purchase 30,000 shares of Common Stock exercisable at
$15.00 per share granted under the 1996 Stock Option Plan which are
immediately exercisable.
(6) Includes options to purchase 4,318 shares of Common Stock exercisable at
$9.17 per share granted under the 1996 Stock Option Plan which are
immediately exercisable.
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\DESCRIPTION OF CAPITAL STOCK
GENERAL
Upon the closing of the Offering, the authorized capital stock of the
Company will consist of 100,000,000 shares of Common Stock, of which 4,984,370
will be outstanding and 5,000,000 shares of preferred stock, none of which will
be outstanding.
HISTORICAL CAPITAL STRUCTURE
Prior to the closing of this Offering (see "Structure and Formation
Transactions"), the Company was authorized to issue 4,484,508 shares of Capital
Stock, of which 2,810,455 shares of Common Stock were authorized and 1,546,983
were outstanding, 1,263,472 shares of Class A Convertible Preferred Stock were
authorized and 852,891 were outstanding and 410,581 shares of Class B Redeemable
Preferred Stock were authorized and all of which were outstanding. In addition,
the Company had granted options to purchase 79,500 shares of Common Stock at an
exercise price of $3.96 per share and options to purchase 30,000 shares at an
exercise of $15.00 per share. As a result of the Formation Transactions, the
outstanding shares of Class A Convertible Preferred Stock will be converted on a
one-for-one basis into shares of Common Stock and such shares of Class A
Convertible Preferred Stock will be cancelled. The total number of outstanding
shares of Common Stock, excluding the options granted under the 1996 Stock
Option Plan, at such time will be 2,399,874. The Common Stock will then be
reverse split at a ratio of approximately 0.4318 shares for 1 immediately prior
to the closing. As a result of such split, the number of shares owned by the
Founders and ContiFinancial Corporation, excluding shares issuable upon exercise
of the options granted under the 1996 Stock Option Plan and excluding the Class
B Redeemable Preferred Stock, after the Offering will be 984,370 shares.
Immediately after the closing, the Class B Redeemable Preferred Stock will be
redeemed for $2,000,000, plus accrued dividends.
The following summary of the respective rights of the Common Stock and the
preferred stock is qualified in its entirety by reference to the Company's
Amended and Restated Articles of Incorporation.
COMMON STOCK
VOTING
Each holder of Common Stock is entitled to one vote for each share of
record on each matter submitted to a vote of holders of Capital Stock of the
Company. The Company's Amended and Restated Articles of Incorporation do not
provide for cumulative voting and, accordingly, the holders of a majority of the
outstanding shares of Capital Stock have the power to elect all directors to be
elected each year.
Annual meetings of the stockholders of the Company will be held, and
special meetings may be called by any member of the Board of Directors, by the
President or generally by stockholders holding at least 20% of the outstanding
shares of Capital Stock entitled to be voted at the meeting. The Amended and
Restated Articles of Incorporation of the Company may be amended in accordance
with Maryland law, subject to certain limitations set forth in the Amended and
Restated Articles of Incorporation.
DIVIDENDS; LIQUIDATION; OTHER RIGHTS
The holders of shares of Common Stock are entitled to receive dividends
when, as, and if declared by the Board of Directors out of funds legally
available therefor. In the event of liquidation, dissolution or winding up of
the Company, the holders of Common Stock will share ratably in all assets of the
Company remaining after the payment of liabilities and after payment of the
liquidation preference of any shares or series of preferred stock that may be
issued. There are no preemptive or other subscription rights, conversion rights
or redemption or sinking fund provisions with respect to shares of Common Stock.
PREFERRED STOCK
The Company's Board of Directors is authorized by the charter to fix or
alter the rights, preferences, privileges and restrictions of any series of
preferred stock, including the dividend rights, original issue price,
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conversion rights, voting rights, terms of redemption, liquidation preferences
and sinking fund terms thereof, and the number of shares of such series
subsequent to the issuance of shares of such series (but not below the number of
shares outstanding). As the terms of the preferred stock can be fixed by the
Board of Directors without shareholder action, the Board of Directors may issue
preferred stock with terms calculated to defeat a proposed takeover of the
Company or to make the removal of management more difficult. The Board of
Directors, without shareholder approval, could issue preferred stock with
dividend, voting, conversion and other rights which could adversely affect the
rights of the holders of Common Stock. The Company's Board of Directors
currently has no plans to issue shares of preferred stock in the Company. See
"Risk Factors -- Issuances of Preferred Stock May Adversely Affect the Value of
Common Stock."
WARRANTS AND OPTIONS
Under the 1996 Stock Option Plan, the Company has granted options to
purchase an aggregate of 79,500 shares at an exercise price of $3.96 per share.
As a result of the reverse stock split described in "Structure and Formation
Transactions," such options will be converted into options to purchase a total
of 34,325 shares of Common Stock at an exercise price of $9.17 per share. In
addition, the Company has granted options to purchase 30,000 shares (post-split)
of Common Stock at an exercise price of $15.00 per share. All of such options
are immediately exercisable.
Under the 1998 Stock Option Plan, the Company will issue options to
purchase a total of 407,569 shares of Common Stock at a price equal to the Price
to Public. None of such options are currently exercisable, and are subject to
the vesting provisions set forth in the Company's 1998 Stock Option Plan. See
"Management -- Executive Compensation -- 1998 Stock Option Plan."
Each Unit consists of one share of Common Stock and one Warrant. Prior to
automatic separation of the related Warrant, the Units will be represented by
the Common Stock, which will bear an endorsement representing beneficial
ownership of the related Warrants on deposit with the Warrant Agent (as defined
below) as custodian for the registered holders of the Common Stock. Prior to
automatic separation, transfer of a share of Common Stock to which the related
Warrant has not been exercised will also constitute transfer of a holder's
beneficial interest in the related Warrant. The Warrants to be issued to the
Representative will be evidenced by a Warrant Certificate at the time initially
issued. The Warrants are exercisable beginning six months following the closing
of this Offering and will remain exercisable until 5:00 p.m. Eastern Time on the
third anniversary of the date the Warrants first become exercisable (the
"Expiration Date"), at an exercise price equal to the Price to Public per share.
At 5:00 p.m. Eastern Time on the Expiration Date the Warrants will become wholly
void and of no value.
The Warrants will be issued pursuant to a warrant agreement (the "Warrant
Agreement") dated as of the date of this Prospectus between the Company and the
warrant agent (the "Warrant Agent"). The Company's stock transfer agent,
American Securities Transfer & Trust Incorporated, will initially act as Warrant
Agent. The following summary of certain provisions of the Warrant Agreement does
not purport to be complete and is qualified in its entirety by reference to the
Warrant Agreement including the definitions therein of certain terms used below.
A copy of the proposed form of Warrant Agreement is available from the Company
upon request and is filed as an exhibit to the Registration Statement of which
this Prospectus is a part. See "Additional Information."
Each Warrant, when exercised, will entitle the holder thereof to receive
one share (subject to certain adjustments) of Common Stock at an exercise price
equal to the Price to Public (the "Exercise Price").
Initial delivery of the Securities from the Company to the Underwriters is
expected to occur through the book-entry facilities of The Depository Trust
Company ("DTC"). See "-- Book Entry Issuance" below. Thereafter, a beneficial
owner of such book-entry Securities (a "Beneficial Owner") will be entitled to
receive physical delivery of certificates representing its Securities only in
accordance with procedures established among DTC and its Direct and Indirect
Participants (as defined below), and in accordance with procedures, if any,
established between the Beneficial Owner and the Direct or Indirect Participant
through which the Beneficial Owner holds an interest in the Securities.
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The Warrants, held in certificated form, may be exercised by surrendering
to the Warrant Agent the definitive Warrant Certificate evidencing such
Warrants, with the accompanying form of election to purchase properly completed
and executed, together with payment of the exercise price which initially equals
the Price to Public, subject to adjustment (the "Exercise Price").
Warrants held in book-entry form may be exercised only in accordance with
procedures established among DTC and its Direct and Indirect Participants.
Pursuant thereto, a Beneficial Owner wishing to exercise a Warrant shall give
notice, through its Participant, to the Warrant Agent, and shall effect delivery
of the Warrant by causing the Direct Participant to transfer the Participant's
interest in the Warrant, on DTC's records, to the Warrant Agent. The requirement
for physical delivery of the Warrant Certificate in connection with the exercise
thereof will be deemed satisfied when the ownership rights in the Warrant are
transferred by Direct Participants on DTC's records and followed by a book-entry
credit of the tendered Warrant to the Warrant Agent's account.
Payment of the Exercise Price may be made (a) in the form of cash or by
certified or official bank check payable to the order of the Company, or (b) by
surrendering additional Warrants or shares of Common Stock for cancellation to
the extent the Company may lawfully accept shares of Common Stock, with the
value of such shares of Common Stock for such purpose to equal the average
trading price of the Common Stock during the 10 trading days preceding the date
surrendered and the value of the Warrants to equal the difference between the
value of a share of Common Stock and the Exercise Price, or (c) pursuant to such
other payment procedures as may be established by the Warrant Agent from time to
time in accordance with the Warrant Agreement. Upon surrender of the Warrant
Certificate and payment of the Exercise Price and any other applicable amounts,
the Warrant Agent will deliver or cause to be delivered, to or upon the written
order of such holder or its DTC Participant, stock certificates or DTC
book-entry positions representing the number of whole shares of Common Stock or
other securities or property to which such holder is entitled. If less than all
of the Warrants evidenced by a Warrant Certificate are to be exercised, a new
Warrant Certificate will be issued for the remaining number of Warrants.
Both (a) the initial sale of the Warrants, and (b) the issuance of the
underlying shares of Common Stock upon exercise of the Warrants, have been
registered by the Company under the Securities Act of 1933, as amended, pursuant
to the Registration Statement of which this Prospectus is a part. The Company
intends to apply to have the Warrants approved for listing on the American Stock
Exchange. If a market for the Warrants develops, a Warrant holder may choose to
sell the Warrants instead of exercising them. There can be no assurance that the
American Stock Exchange, or any other market, will list the Warrants or that a
market for the Warrants will develop or continue.
No fractional shares of Common Stock will be issued upon exercise of the
Warrants. The holders of the Warrants have no right to vote on matters submitted
to the stockholders of the Company and have no right to receive dividends. The
holders of the Warrants not yet exercised are not entitled to share in the
assets of the Company in the event of liquidation, dissolution or the winding up
of the affairs of the Company.
Additionally, in March, 1998, the Company granted warrants to purchase
50,000 shares of Common Stock to Capstone Investments, Inc. ("Capstone"), in
connection with Capstone's $850,000 loan to the Company. See "Use of Proceeds"
and "Conflicts of Interest and Related Party Transactions -- Capstone
Investments, Inc."
The Company has also agreed to issue, to the Representative, Warrants to
purchase shares of Common Stock equal to three percent of the Units sold in this
Offering at an exercise price equal to the Price to Public.
ADJUSTMENTS
The Exercise Price of the Warrants will be appropriately adjusted if the
Company (i) pays a dividend or makes a distribution on its Common Stock in
shares of its Common Stock; (ii) subdivides its outstanding shares of Common
Stock into a greater number of shares, (iii) combines its outstanding shares of
Common Stock into a smaller number of shares, (iv) issues by reclassification of
its Common Stock any shares of its
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Capital Stock, or (v) issues shares of Capital Stock at a price below the
greater of (a) the Price to Public or (b) fair market value, provided that this
clause (v) shall not apply to firm underwriting offerings.
In case of certain consolidations or mergers of the Company, or the
liquidation of the Company or the sale of all or substantially all of the assets
of the Company to another corporation, each Warrant will thereafter be deemed
exercised for the right to receive the kind and amount of shares of stock or
other securities or property to which such holder would have been entitled as a
result of such consolidation, merger or sale had the Warrants been exercised
immediately prior thereto, less the Exercise Price.
BOOK-ENTRY ISSUANCE -- THE DEPOSITORY TRUST COMPANY
The Depository Trust Company will act as securities depository for a
portion of the Securities. One or more fully registered Common Stock
certificates representing such Securities will be registered in the name of DTC
or its nominee. Upon the detachment of the related Warrants, one or more Warrant
Certificates will be issued in the name of DTC or its nominee.
DTC is a limited-purpose trust company organized under the New York Banking
Law, a "banking organization" within the meaning of the New York Banking Law, a
member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code, and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
holds securities that its participants ("Participants") deposit with DTC. DTC
also facilitates the settlement among Participants of securities transactions,
such as transfers and pledges, in deposited securities through electronic
computerized book-entry changes in Participants' accounts, thereby eliminating
the need for physical movement of securities certificates. Direct Participants
include securities brokers and dealers, banks, trust companies, clearing
corporations, and certain other organization ("Direct Participants"). DTC is
owned by a number of its Direct Participants and by the New York Stock Exchange,
the American Stock Exchange, Inc., and the National Association of Securities
Dealers, Inc. Access to the DTC system is also available to others such as
securities brokers and dealers, banks and trust companies that clear through or
maintain a custodial relationship with a Direct Participant, either directly or
indirectly ("Indirect Participants"). The rules applicable to DTC and its
Participants are on file with the Securities and Exchange Commission.
Upon issuance of a Warrant Certificate in the name of DTC or its nominee,
DTC will credit on its book-entry registration and transfer system the number of
Warrants represented by such Warrant Certificate to the accounts of institutions
that have accounts with DTC. Ownership of beneficial interests in such a Warrant
Certificate will be limited to Participants or persons that may hold interests
through Participants. The ownership interest of each actual purchaser of such
Warrant ("Beneficial Owner") is in turn to be recorded on the Direct and
Indirect Participants' records. Beneficial Owners will not receive written
confirmation from DTC of their purchases, but Beneficial Owners are expected to
receive written confirmations providing details of the transactions, as well as
periodic statements of their holdings, from the Direct or Indirect Participants
through which the Beneficial Owners purchased Warrants. Transfers of ownership
interests in the Warrants are to be accomplished by entries made on the books of
Participants acting on behalf of Beneficial Owners.
DTC has no knowledge of the actual Beneficial Owners of such Warrants;
DTC's records reflect only the identity of the Direct Participants to whose
accounts such Warrants are credited, which may or may not be the Beneficial
Owners. The Participants will remain responsible for keeping account of their
holdings on behalf of their customers. So long as DTC, or its nominee, is the
owner of such Warrant Certificate, DTC or such nominee, as the case may be, will
be considered the sole owner and holder of record of the Warrants represented by
such Warrant Certificate for all purposes.
Conveyance of notices and other communications by DTC to Direct
Participants, by Direct Participants to Indirect Participants, and by Direct
Participants and Indirect Participants to Beneficial Owners will be governed by
arrangements among them, subject to any statutory or regulatory requirements as
may be in effect from time to time.
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Company believes to be reliable but the
Company takes no responsibility for the accuracy of
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such information. In addition, the Company has no responsibility for the
performance by DTC or its Participants of their respective obligations as
described hereunder or under the rules and procedures governing their respective
operations.
REPURCHASE OF SHARES AND RESTRICTION ON TRANSFER
Two of the requirements for qualification for the tax benefits accorded by
the REIT provisions of the Code are that for all taxable years of the REIT after
the first taxable year for which its REIT election is made (1) during the last
half of each such taxable year not more than 50% in value of the outstanding
shares may be owned directly or indirectly by five or fewer individuals (the
"50%/5 stockholder test") and (2) there must be at least 100 stockholders on 335
days of each such taxable year of 12 months and during a proportionate part
during any such shorter taxable year.
In order that the Company may meet these requirements at all times, the
Amended and Restated Articles of Incorporation prohibit any person from
acquiring or holding, directly or indirectly, shares of Capital Stock in excess
of 9.8% in value of the aggregate of the outstanding shares of Capital Stock or
in excess of 9.8% (in value or in number of shares, whichever is more
restrictive) of the aggregate of the outstanding shares of Common Stock of the
Company. For this purpose, the term "ownership" is defined in accordance with
the REIT provisions of the Code and the constructive ownership provisions of
Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code.
For purposes of the 50%/5 stockholder test, the constructive ownership
provisions applicable under Section 544 of the Code attribute ownership of
securities owned by a corporation, partnership, estate or trust proportionately
to its stockholders, partners or beneficiaries, attribute ownership of
securities owned by family members and partners to other members of the same
family, treat securities with respect to which a person has an option to
purchase as actually owned by that person, and set forth rules as to when
securities constructively owned by a person are considered to be actually owned
for the application of such attribution provisions (i.e., "reattribution").
Thus, for purposes of determining whether a person holds shares of Capital Stock
in violation of the ownership limitations set forth in the Amended and Restated
Articles of Incorporation, many types of entities may own directly more than the
9.8% limit because such entities' shares are attributed to its individual
stockholders. On the other hand, a person will be treated as owning not only
shares of Capital Stock actually or beneficially owned, but also any shares of
Capital Stock attributed to such person under the attribution rules described
above. Accordingly, under certain circumstances, shares of Capital Stock owned
by a person who individually owns less than 9.8% of the shares outstanding may
nevertheless be in violation of the ownership limitations set forth in the
Amended and Restated Articles of Incorporation. Ownership of shares of the
Company's Capital Stock through such attribution is generally referred to as
constructive ownership. The 100 stockholder test is determined by actual, and
not constructive, ownership.
Notwithstanding any of the foregoing ownership limits, no holder may own or
acquire, either directly or constructively under the applicable attribution
rules of the Code, any shares of any class of the Company's Capital Stock if
such ownership or acquisition (i) would cause more than 50% in value of the
Company's outstanding stock to be owned, either 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), (ii) would result in the Company's
Capital Stock being beneficially owned by less than 100 persons (determined
without reference to any rules of attribution), or (iii) would otherwise result
in the Company failing to qualify as a REIT.
The Board of Directors may, subject to the receipt of certain
representations and a ruling from the Service or an opinion of counsel
satisfactory to it, waive the ownership restrictions with respect to a holder if
such waiver will not jeopardize the Company's status as a REIT. In addition,
under the Amended and Restated Articles of Incorporation, certain parties will
not be subject to the stock ownership limit in the event such parties (i)
deliver to the Company either a ruling from the Service or an opinion from
counsel satisfactory to the Company that such ownership will result in no
individual (as defined in the Code) beneficially or constructively owning in
excess of 9.8% of the outstanding common stock and (ii) represent to the Company
that it does not and will not own more than a 9.8% interest in any tenant of the
Company.
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If any stockholder purports to transfer Capital Stock to a person and
either the transfer would result in the Company failing to qualify as a REIT or
such transfer would cause the transferee to hold capital stock in excess of an
applicable ownership restriction, the purported transfer shall be null and void,
the intended transferee will acquire no rights or economic interest in the
capital stock and the stockholder will be deemed to have transferred the capital
stock to the Company in exchange for Excess Stock of the same class or classes
as were purportedly transferred, which Excess Stock will be deemed to be held by
the Company as trustee of a trust for the exclusive benefit of the person or
persons to whom the shares can be transferred without violating the ownership
restrictions. In addition, if any person owns, either directly or constructively
under the applicable attribution rules of the Code, shares of Capital Stock in
excess of an applicable ownership restriction, such person will be deemed to
have exchanged the shares of Capital Stock that cause the applicable ownership
restriction to be exceeded for an equal number of shares of Excess Stock of the
appropriate class, which will be deemed to be held by the Company as trustee of
a trust for the exclusive benefit of the person or persons to whom the shares
can be transferred without violating the ownership restrictions. A person who
holds or transfers shares such that shares of capital stock shall have been
deemed to be exchanged for Excess Stock will not be entitled to vote the Excess
Stock and will not be entitled to receive any dividends or distributions (any
dividend or distribution paid on shares of capital stock prior to the discovery
by the Company that such shares have been exchanged for Excess Shares shall be
repaid to the Company upon demand, and any dividend or distribution declared but
unpaid shall be rescinded). Such person shall have the right to designate a
transferee of such Excess Stock so long as consideration received for
designating such transferee does not exceed a price (the "Limitation Price")
that is equal to the lesser of (i) in the case of a deemed exchange for Excess
Stock resulting from a transfer, the price paid for such shares in the transfer
or, in the case of a deemed exchange for Excess Stock resulting from some other
event, the fair market value on the date of the deemed exchange, of the shares
deemed exchanged, or (ii) the fair market value of the shares for which such
Excess Stock will be deemed to be exchanged on the date of the designation of
the transferee (or, in the case of a purchase by the Company, on the date the
Company accepts the offer to sell). The shares of Excess Stock so transferred
will automatically be deemed reexchanged for the appropriate shares of capital
stock. In addition, the Company will have the right to purchase the Excess Stock
for a period of 90 days at a price equal to the Limitation Price.
If the foregoing transfer restrictions are determined to be void or invalid
by virtue of any legal decisions, statute, rule or regulation, then the intended
transferee of any Excess Stock may be deemed, at the option of the Company, to
have acted as an agent on behalf of the Company in acquiring such Excess Stock
and to hold such Excess Stock on behalf of the Company.
The Amended & Restated Articles of Incorporation further provide that if
any transfer of shares of Capital Stock occurs which, if effective, would result
in any person beneficially or constructively owning shares of Capital Stock in
excess or in violation of the above transfer or ownership limitations, then that
number of shares of Capital Stock the beneficial or constructive ownership of
which otherwise would cause such person to violate such limitations (rounded to
the nearest whole shares) shall be automatically transferred to a trustee (the
"Trustee") as trustee of a trust (the "Trust") for the exclusive benefit of one
or more charitable beneficiaries (the "Charitable Beneficiary"), and the
intended transferee shall not acquire any rights in such shares. Shares held by
the Trustee shall be issued and outstanding shares of Capital Stock. The
intended transferee shall not benefit economically from ownership of any shares
held in the Trust, shall have no rights to dividends, and shall not possess any
rights to vote or other rights attributable to the shares held in the Trust. The
Trustee shall have all voting rights and rights to dividends or other
distributions with respect to shares held in the Trust, which rights shall be
exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend
or other distribution paid to the intended transferee prior to the discovery by
the Company that shares of Common Stock have been transferred to the Trustee
shall be paid with respect to such shares to the Trustee by the intended
transferee upon demand and any dividend or other distribution authorized but
unpaid shall be paid when due to the Trustee. The Board of Directors may, in
their discretion, waive these requirements on owning shares in excess of the
ownership limitations.
Within 20 days of receiving notice from the Company that shares of Capital
Stock have been transferred to the Trust, the Trustee shall sell the shares held
in the Trust to a person, designated by the Trustee, whose
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ownership of the shares will not violate the ownership limitations set forth in
the Charter. Upon such sale, the interest of the Charitable Beneficiary in the
shares sold shall terminate and the Trustee shall distribute the net proceeds of
the sale to the intended transferee and to the Charitable Beneficiary as
follows. The intended transferee shall receive the lesser of (1) the price paid
by the intended transferee for the shares or, if the intended transferee did not
give value for the shares in connection with the event causing the shares to be
held in the Trust (e.g., in the case of a gift, devise or other such
transaction), the market price (as defined in the Company's Amended and Restated
Articles of Incorporation) of the shares on the day of the event causing the
shares to be held in the Trust and (2) the price per share received by the
Trustee from the sale or other disposition of the shares held in the Trust. Any
net sales proceeds in excess of the amount payable to the intended transferee
shall be immediately paid to the Charitable Beneficiary. In addition, shares of
Capital Stock transferred to the Trustee shall be deemed to have been offered
for sale to the Company, or its designee, at a price per share equal to the
lesser of (i) the price per share in the transaction that resulted in such
transfer to the Trust (or, in the case of a devise or gift, the Market Price at
the time of such devise or gift) and (ii) the Market Price on the date the
Company, or its designee, accepts such offer. The Company shall have the right
to accept such offer until the Trustee has sold shares held in the Trust. Upon
such a sale to the Company, the interest of the Charitable Beneficiary in the
shares sold shall terminate and the Trustee shall distribute the net proceeds of
the sale to the intended transferee.
All certificates representing shares of Capital Stock will bear a legend
referring to the restrictions described above.
Every owner of more than five percent (or such lower percentage as required
by the Code or the regulations promulgated thereunder) of all classes or series
of the Company's stock, within 30 days after the end of each taxable year, is
required to give written notice to the Company stating the name and address of
such owner, the number of shares of each class and series of stock of the
Company beneficially owned and a description of the manner in which such shares
are held. Each such owner shall provide to the Company such additional
information as the Company may request in order to determine the effect, if any,
of such beneficial ownership on the Company's status as a REIT and to ensure
compliance with the ownership limitations.
Subject to certain limitations, the Board of Directors may increase or
decrease the ownership limitations. In addition, to the extent consistent with
the REIT provisions of the Code, the Board of Directors may waive the ownership
limitations for and at the request of certain purchasers in this Offering or
subsequent purchasers.
The provisions described above may inhibit market activity and the
resulting opportunity for the holders of the Company's Capital Stock and
Warrants to receive a premium for their shares or Warrants that might otherwise
exist in the absence of such provisions. Such provisions also may make the
Company an unsuitable investment vehicle for any person seeking to obtain
ownership of more than 9.8% of the outstanding shares of Capital Stock.
LIMITATION OF LIABILITY AND INDEMNIFICATION
The Maryland GCL permits the charter of a Maryland corporation to include a
provision limiting the liability of its directors and officers to the
corporation and its stockholder for money damages, except to the extent that (i)
it is proved that the person actually received an improper benefit or profit in
money, property or services, or (ii) a judgment or other final adjudication
adverse to the person is entered in a proceeding based on a finding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's Amended and Restated Articles of Incorporation contain
such a provision, which eliminates the liability of a director or officer to the
Company or its stockholders for money damages to the fullest extent permitted by
Maryland law.
Additionally, the Company's Amended and Restated Articles of Incorporation
provide for indemnification of its officers and directors to the fullest extent
permitted by the Maryland General Corporation Law (the "Maryland GCL"). The
Maryland GCL also permits the Company to indemnify and advance expenses to any
person who served a predecessor of the Company in any of the capacities
described above and to any employee or agent of the Company or a predecessor of
the Company.
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Unless the corporation's charter provides otherwise, the Maryland GCL
requires a corporation 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. The Maryland
GCL permits a corporation to indemnify its present and former directors and
officers, among others, against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by them in connection with any proceeding
to which they may be made a party by reason their service in those or other
capacities unless it is established that (a) the act or omission of the director
or officer was material to the matter giving rise to the proceeding and (1) was
committed in bad faith or (2) was the result of active and deliberate
dishonesty, (b) the director or officer actually received an improper personal
benefit in money, property or services or (c) in the case of any criminal
proceeding, the director or officer had reasonable cause to believe that the act
or omission was unlawful. However, a Maryland corporation may not indemnify for
an adverse judgment in a suit by or in the right of the corporation. In
addition, the Maryland GCL requires the Company, as a condition to advancing
expenses, to obtain (a) a written affirmation by the director or officer of his
good faith belief that he has met the standard of conduct necessary for
indemnification by the Company as authorized by the bylaws and (b) a written
undertaking by or on his behalf to repay the amount paid or reimbursed by the
Company if it shall ultimately be determined that the standard of conduct was
not met. A corporation may not indemnify a director unless the proposed
indemnification has been authorized for a specific proceeding pursuant to a
determination by the board of directors, special counsel (as may be appointed
for such purpose) or the stockholders that indemnification is permissible
because the director satisfied the requisite standard of conduct. Unless
otherwise provided by a corporation's charter, bylaws or board resolution
consistent with law, a corporation may not indemnify an officer or any other
person unless the proposed indemnification has been authorized for a specific
proceeding pursuant to a determination by the board of directors, special
counsel (as may be appointed for such purpose) or the stockholders that
indemnification is permissible because the officer or such other person
satisfied the requisite standard of conduct. The Company expects to enter into
indemnification agreements with its officers and directors which will provide
for the indemnification of such officers and directors to the fullest extent
permitted under Maryland law.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, the registrant has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is
therefore unenforceable.
CONTROL SHARE ACQUISITIONS
The Maryland GCL provides that "control shares" of a Maryland corporation
acquired in a "control share acquisition"have no voting rights except to the
extent approved by a vote of two-thirds of the votes entitled to be cast on the
matter, excluding shares of stock owned by the acquiror or by officers or
directors who are employees of the corporation. "Control shares" are voting
shares of stock which, if aggregated with all other shares of stock owned by
such a person, would entitle the acquiror to exercise voting power in electing
directors within one of the following ranges of voting power: (i) one-fifth or
more but less than one third, (ii) one-third or more but less than a majority,
or (iii) a majority or more of all voting power. "Control shares" do not include
shares of stock the acquiring person is then entitled to vote as a result of
having owned stockholder approval. A "control share acquisition" means, subject
to certain exceptions, the acquisition of, ownership of, or the power to direct
the exercise of voting power with respect to, control shares.
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an acquiring
person statement as permitted by the statute, then, subject to certain
conditions and limitations, the corporation may redeem any or all of the
"control shares" (except those for which voting rights have previously been
approved) for fair value determined, without regard to absence of voting rights,
as of the date of the last control share acquisition or of any meeting of
stockholders at which the voting rights of such shares are considered and not
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approved. If voting rights for "control shares" are approved at a stockholders
meeting and the acquiror becomes entitled to vote a majority of the shares
entitled to vote, all other stockholders may exercise appraisal rights. The fair
value of the stock, as determined for purposes of such appraisal rights, may not
be less than the highest price per share paid in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters rights do not apply in the context of "control share acquisitions."
The "control share acquisition" statute does not apply to stock acquired in
a merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by a provision of the
articles of incorporation or bylaws of the corporation adopted prior to the
acquisition of the shares. The Company has adopted a provision in its Amended
and Restated Articles of Incorporation that exempts the Company's shares of
Capital Stock from application of the control share acquisition statute. No
assurance can be given, however, that such Amended and Restated Articles of
Incorporation provision may not be removed at any time by amendment of the
Amended and Restated Articles of Incorporation.
BUSINESS ACQUISITIONS STATUTES
Under the Maryland GCL, certain "business combinations" (including a
merger, consolidation, share exchange, or, in certain circumstances, an asset
transfer or issuance or reclassification of equity securities) between a
Maryland corporation and any person who beneficially owns ten percent or more of
the voting power of the corporations 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% or more of the voting power of the then-outstanding
voting stock of the corporation (an "Interested Stockholder") or an affiliate
thereof are prohibited for five years after the most recent date on which the
Interested Stockholder became an Interested Stockholder. Thereafter, any such
business combination must be recommended by the board of directors of such
corporation and approved by the affirmative vote of at least (a) 80% of the
votes entitled to be cast by holders of outstanding voting shares of the
corporation and (b) two-thirds of the votes entitled to be cast by holders of
outstanding voting shares of the corporation other than shares held by the
Interested Stockholder with whom the business combination is to be effected,
unless, among other things, the corporation's stockholders receive a minimum
price (as defined in the Maryland GCL) for their shares and the consideration is
received in cash or in the same form as previously paid by the Interested
Stockholder for its shares. These provisions of Maryland law do not apply,
however, to business combinations that are approved or exempted by the board of
directors of the corporation prior to the time that the Interested Stockholder
becomes an Interested Stockholder. The Company has adopted a provision in its
Amended and Restated Articles of Incorporation that exempts the Company from
application of the business acquisition statute. No assurance can be given that
such provision will not be amended or eliminated at any point in the future with
respect to business combinations not involving a purchaser of Units.
TRANSFER AGENT AND REGISTRAR
American Securities Transfer & Trust Incorporated will initially act as
transfer agent and registrar with respect to the Units, Common Stock and
Warrants.
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SHARES ELIGIBLE FOR FUTURE SALE
GENERAL
Upon the closing of the Offering, the Company will have outstanding
4,984,370 shares of Common Stock (assuming the over-allotment option is not
exercised), 4,000,000 shares of Common Stock reserved for the Warrants
(4,600,000 shares if the over-allotment option is exercised) and 120,000 shares
of Common Stock (135,000 shares if the over-allotment option is exercised)
reserved for the Representative's Warrants. The Units issued in the Offering
will be freely tradable immediately after the Offering, and the Warrants and
Common Stock issued in the Offering will be freely tradable six months after the
Offering, in each case by persons other than "affiliates" of the Company without
restriction under the Securities Act, subject to the limitations on ownership
set forth in the charter. See "Description of Capital Stock." The Common Stock
to be owned by the Founders and ContiFinancial Corporation (collectively, the
"Restricted Stock"), will be "restricted securities" within the meaning of Rule
144 promulgated under the Securities Act ("Rule 144") and may not be sold except
pursuant to registration under the Securities Act or pursuant to an exemption
from registration, including exemptions contained in Rule 144. As described
below under "Registration Rights," the Company has granted certain holders
registration rights with respect to their Common Stock. See "-- Registration
Rights."
In general, under Rule 144 as currently in effect, if one year has elapsed
since the later of the date of acquisition of Restricted Stock from the Company
or any "affiliate" of the Company, as that term is defined under the Securities
Act, the acquirer or subsequent holder thereof is entitled to sell within any
three-month period a number of shares of Common Stock that does not exceed the
greater of one percent 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 are also subject to certain manner of sale provisions,
public information requirements and notice requirements. After one year has
elapsed since the date of acquisition of Restricted Stock from the Company or
from any "affiliate" of the Company, and the acquirer or subsequent holder
thereof is deemed not to have been an "affiliate" of the Company at any time
during the 90 days 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
limitation, manner of sale, public information or notice requirements.
Prior to the date of this Prospectus, there has been no public market for
the Units. Trading of the Units on the American Stock Exchange is expected to
commence effective upon the closing of the Offering. Sales of substantial
amounts of Common Stock or Warrants (including shares issued upon the exercise
of stock options), or the perception that such sales occur, could adversely
affect prevailing market prices of the Units, the Common Stock and Warrants. See
"Risk Factors -- Failure to Develop a Trading Market May Result in Depressed
Common Stock Price."
The Company has reserved for issuance an aggregate of 64,325 shares of
Common Stock to be issued upon exercise of the stock options granted under the
1996 Stock Option Plan. All of such options have vested and are immediately
exercisable. The Company has reserved for issuance an aggregate of 407,569
shares of Common Stock to be issued pursuant to the exercise of Stock Options to
be granted under the 1998 Stock Option Plan. All stock options granted pursuant
to the 1998 Stock Option Plan will be contingent, with vesting based upon the
financial performance of the Company and such other criteria as the Compensation
Committee determines to be appropriate. See "Management -- Executive
Compensation -- 1998 Stock Option Plan."
For a description of certain restrictions on transfers of Common Stock held
by the Founders, see "Underwriting."
REGISTRATION RIGHTS
Pursuant to a registration rights agreement, the Company has granted the
Founders certain additional registration rights. Under such agreement, the
Founders may request, on any two occasions on or after one year after the
closing of the Offering, that the Company file a shelf registration on Form S-3
with respect to
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the number of registrable shares requested by the Founders, with the Company
paying all registration expenses in connection with the first such shelf
registration and the Founders paying all registration expenses for the second
such shelf registration. In addition, in the event the Company proposes to
register any of its Securities under the Securities Act, whether for its own
account or otherwise, the Founders are entitled to notice of such registration
and are entitled to include their registrable shares, subject to certain
conditions and limitations.
Pursuant to a registration rights agreement, the Company has granted
ContiFinancial Corporation certain registration rights. Under such agreement,
ContiFinancial Corporation may request, on any three occasions after the
Offering that the Company register such shares as ContiFinancial Corporation may
request, provided that such shares amount to at least five percent of the
Company's Common Stock then outstanding and that such request comes at least one
year after the effective date of a registration statement filed by the Company
covering a firm commitment underwritten public offering in which ContiFinancial
Corporation shall have been entitled to join. In addition, in the event the
Company proposes to register any of its Securities under the Securities Act,
whether for its own account or otherwise, ContiFinancial Corporation shall be
entitled to notice of such registration shall be entitled to include their
registrable shares, subject to certain conditions and limitations.
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FEDERAL INCOME TAX CONSIDERATIONS
THE FOLLOWING DISCUSSION SUMMARIZES THE MATERIAL FEDERAL INCOME TAX
CONSIDERATIONS THAT MAY BE RELEVANT TO A PROSPECTIVE PURCHASER OF UNITS. THIS
DISCUSSION IS BASED ON CURRENT LAW. THE FOLLOWING DISCUSSION IS NOT EXHAUSTIVE
OF ALL POSSIBLE TAX CONSIDERATIONS. IT DOES NOT GIVE A DETAILED DISCUSSION OF
ANY STATE, LOCAL OR FOREIGN TAX CONSIDERATIONS, NOR DOES IT DISCUSS ALL OF THE
ASPECTS OF FEDERAL INCOME TAXATION THAT MAY BE RELEVANT TO A PROSPECTIVE
INVESTOR IN LIGHT OF SUCH INVESTOR'S PARTICULAR CIRCUMSTANCES OR TO CERTAIN
TYPES OF INVESTORS (INCLUDING INSURANCE COMPANIES, CERTAIN TAX-EXEMPT ENTITIES,
FINANCIAL INSTITUTIONS, BROKER/DEALERS, FOREIGN CORPORATIONS AND PERSONS WHO ARE
NOT CITIZENS OR RESIDENTS OF THE UNITED STATES) SUBJECT TO SPECIAL TREATMENT
UNDER FEDERAL INCOME TAX LAWS.
EACH PROSPECTIVE PURCHASER OF UNITS IS URGED TO CONSULT WITH HIS OR HER OWN
TAX ADVISOR REGARDING THE SPECIFIC CONSEQUENCES TO HIM OR HER OF THE PURCHASE,
OWNERSHIP AND SALE OF UNITS, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND
OTHER TAX CONSIDERATIONS OF SUCH PURCHASE, OWNERSHIP AND SALE AND THE POTENTIAL
CHANGES IN APPLICABLE TAX LAWS.
GENERAL
The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussion below summarizes the material
provisions applicable to the Company as a REIT for federal income tax purposes
and to its stockholders in connection with their ownership of shares of stock of
the Company. However, it is impractical to set forth in this Prospectus all
aspects of federal, state, local and foreign tax law that may have tax
consequences with respect to an investor's purchase of Units. The discussion of
various aspects of federal taxation contained herein is based on the Code,
administrative regulations, judicial decisions, administrative rulings and
practice, all of which are subject to change. In brief, if certain detailed
conditions imposed by the Code are met, entities that invest primarily in real
estate assets, including Mortgage Loans, and that otherwise would be taxed as
corporations, with certain limited exceptions, are not taxed at the corporate
level on their taxable income that is currently distributed to their
stockholders. This treatment eliminates most of the "double taxation" (at the
corporate level and then again at the stockholder level when the income is
distributed) that typically results from the use of corporate investment
vehicles. A qualifying REIT, however, may be subject to certain excise and other
taxes, as well as normal corporate tax, on Taxable Income that is not currently
distributed to its stockholders. See "-- Taxation of the Company."
The Company intends to elect to be taxed as a REIT under the Code
commencing with its taxable year ending December 31, 1998.
OPINION OF COUNSEL
Jeffers, Wilson, Shaff & Falk, LLP, counsel to the Company ("Counsel"), has
advised the Company in connection with the Offering of Units and the Company's
election to be taxed as a REIT. Based on existing law and certain factual
representations made to Counsel by the Company and assuming that the Company
operates in the manner described in this Prospectus, in the opinion of Counsel,
commencing with the Company's taxable year ending December 31, 1998, RealTrust
has been organized in conformity with the requirements for qualification as a
REIT under the Code and the Company's proposed method of operation described in
this Prospectus and as represented by the Company to Counsel will enable
RealTrust to qualify as a REIT. The Company's organization and proposed method
of operation described in this Prospectus is the same in all material respects
as represented to Counsel. However, whether RealTrust will in fact so qualify
will depend on actual operating results and compliance with the various tests
for qualification as a REIT relating to its income, assets, distributions,
ownership and certain administrative matters, the results of which may not be
reviewed by Counsel. Moreover, certain aspects of RealTrust's method of
operations have not been considered by the courts or the Service. There can be
no assurance that the courts or the Service will agree with this opinion. In
addition, qualification as a REIT depends on future transactions and events that
cannot be known
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at this time. Accordingly, Counsel is unable to opine whether RealTrust will in
fact qualify as a REIT under the Code in all events. In the opinion of Counsel,
the section of the Prospectus entitled "Federal Income Tax Considerations"
identifies and fairly summarizes the federal income tax considerations that are
likely to be material to a holder of the Units and to the extent such summaries
involve matters of law, such statements of law are correct under the Code.
Counsel's opinions are based on various assumptions and on the factual
representations of RealTrust concerning its business and assets. Accordingly, no
assurance can be given that the actual results of RealTrust's operation for any
one taxable year will satisfy such requirements. See "-- Termination or
Revocation of REIT Status."
The opinions of Counsel are based upon existing law including the Internal
Revenue Code of 1986, as amended, existing Treasury Regulations, Revenue
Rulings, Revenue Procedures, proposed regulations and case law, all of which is
subject to change either prospectively or retroactively. Moreover, relevant laws
or other legal authorities may change in a manner that could adversely affect
RealTrust or its stockholders.
In the event that RealTrust does not qualify as a REIT in any year, it will
be subject to federal income tax as a domestic corporation and its stockholders
will be taxed in the same manner as stockholders of ordinary corporations. To
the extent that RealTrust would, as a consequence, be subject to potentially
significant tax liabilities, the amount of earnings and cash available for
distribution to its stockholders would be reduced. See "-- Termination or
Revocation of REIT Status."
QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must
meet certain tests which are described immediately below.
OWNERSHIP OF STOCK
The Company's shares of stock must be transferable and, for all taxable
years after the first taxable year for which a REIT election is made, must be
held by a minimum of 100 persons for at least 335 days of a 12 month year (or a
proportionate part of a short tax year), and at all times during the second half
of each taxable year, no more than 50% in value of the shares of any class of
the stock of the Company may be owned directly or indirectly by five or fewer
individuals. In determining whether the Company's shares are held by five or
fewer individuals, the attribution rules of Section 544 of the Code (as modified
by the REIT provisions of the Code) apply. For a description of these
attribution rules, see "Description of Capital Stock." Failure of the Company to
comply with such test may be waived if the failure was unintentional and the
Company otherwise complied with the requirements for monitoring stockholders.
See "-- Recordkeeping Requirement." The Company's Amended and Restated Articles
of Incorporation impose certain transfer restrictions to avoid more than 50% by
value of any class of the Company's stock being held by five or fewer
individuals (directly or constructively) at any time during the last half of any
taxable year. Such transfer restrictions will not cause the stock not to be
treated as "transferable" for purposes of qualification as a REIT. The Company
intends to satisfy both the 100 stockholder and 50%/5 stockholder individual
ownership limitations described above for as long as it seeks qualification as a
REIT. See "Description of Capital Stock." Even if the Company were to
inadvertently violate one of the stock ownership tests, the Company would not
lose its status as a REIT for tax purposes provided the Company exercised
reasonable diligence in attempting to comply with these requirements. The
Company uses the calendar year as its taxable year for income tax purposes.
NATURE OF ASSETS
On the last day of each calendar quarter at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government securities,
cash and cash items (the "75% of assets test"). The Company expects that
substantially all of its assets, other than the preferred stock of the Company's
Taxable Subsidiary, will be "Qualified REIT Assets" or "Qualified Hedges."
Qualified REIT Assets include interests in real property, interests in Mortgage
Loans secured by real property and interests in REMICs. Qualified Hedges are
discussed under "-- Sources of Income -- The 95% Test" below.
On the last day of each calendar quarter, of the investments in securities
not included in the 75% of assets test, the value of any one issuer's equity and
debt securities may not exceed five percent by value of the Company's total
assets and the Company may not own more than 10% of any one issuer's outstanding
voting
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securities. See "Business -- Industry Developments." Pursuant to its compliance
guidelines, the Company intends to monitor closely (on not less than a quarterly
basis) the purchase and holding of the Company's assets in order to comply with
the above assets tests. In particular, as of the end of each calendar quarter
the Company intends to limit and diversify its ownership of securities of any
Taxable Subsidiary of the Company, hedging contracts and other mortgage
securities that do not constitute Qualified REIT Assets to less than 25%, in the
aggregate, by value of its portfolio, to less than five percent by value as to
any single issuer, including the stock of any Taxable Subsidiary of the Company,
and to less than 10% of the voting stock of any single issuer (collectively the
"25% of assets limits"). If such limits are ever exceeded, the Company intends
to take appropriate remedial action to dispose of such excess assets within the
30 day period after the end of the calendar quarter, as permitted under the
Code. In order to help maintain compliance with the requirement that it limit
the value of the securities of any issuer to less than five percent of the value
of the Company's assets, the Company expects to obtain an appraisal report from
a qualified independent business appraiser, to ensure that the value of the
assets contributed to the Taxable Subsidiary is less than five percent of the
gross value of the Company's assets.
When purchasing mortgage-related securities, the Company may rely on
opinions of counsel for the issuer or sponsor of such securities given in
connection with the offering of such securities, or statements made in related
offering documents, for purposes of determining whether and to what extent those
securities (and the income therefrom) constitute Qualified REIT Assets (and
income) for purposes of the 75% of assets test (and the source of income tests
discussed below). If the Company invests in a partnership, the Company will be
treated as receiving its share of the income and loss of the partnership and
owning a proportionate share of the assets of the partnership and any income
from the partnership will retain the character that it had in the hands of the
partnership.
SOURCES OF INCOME
The Company must meet two separate income-based tests for each year in
order to qualify as a REIT.
1. The 75% Test. At least 75% of the Company's gross income (the "75% of
income test") for the taxable year must be derived from the following sources
among others: (i) interest (other than interest based in whole or in part on the
income or profits of any person) on obligations secured by mortgages on real
property or on interests in real property, (ii) gains from the sale or other
disposition of interests in real property and real estate mortgages, other than
gain from property held primarily for sale to customers in the ordinary course
of the Company's business ("dealer property"), (iii) income from the operation,
and gain from the sale, of property acquired at or in lieu of a foreclosure of
the mortgage secured by such property or as a result of a default under a lease
of such property ("foreclosure property"), (iv) income received as consideration
for entering into agreements to make loans secured by real property or to
purchase or lease real property (including interests in real property and
interests in mortgages on real property) (for example, commitment fees), (v)
rents from real property, and (vi) income attributable to stock or debt
instruments acquired with the proceeds from the sale of stock or certain debt
obligations ("new capital") of the Company received during the one-year period
beginning on the day such proceeds were received ("qualified temporary
investment income"). The investments that the Company intends to make (as
described under "Business -- Mortgage Investment Portfolio") will give rise
primarily to mortgage interest qualifying under the 75% of income test.
2. The 95% Test. In addition to deriving 75% of its gross income from the
sources listed above, at least an additional 20% of the Company's gross income
for the taxable year must be derived from those sources, or from dividends,
interest or gains from the sale or disposition of stock or other securities that
are not dealer property (the "95% of income test"). Income attributable to
assets other than Qualified REIT Assets, such as income from or gain on the
disposition of Qualified Hedges, that the Company holds, dividends on non-REIT
stock (including any dividends from the Taxable Subsidiary), interest on any
other obligations not secured by real property, and gains from the sale or
disposition of stock or other securities that are not Qualified REIT Assets or
Qualified Hedges will constitute qualified income for purposes of the 95% of
income test only, and will not be qualified income for purposes of the 75% of
income test. Income from mortgage servicing, loan guarantee fees (or other
contracts under which the Company would earn fees for performing services) and
hedging (other than from Qualified REIT Assets) will not qualify for either the
95% or 75% of income tests.
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Income from Qualified Hedges (including gain on the sale of Qualified Hedges)
qualifies for the 95% of income test. The Code defines a Qualified Hedge as a
swap, cap or similar financial instrument entered into by a REIT to reduce
interest rate risks with respect to debt that the REIT incurred to acquire or
carry real estate assets, such as Mortgage Loans. The Company intends to
severely limit its acquisition of any assets or investments the income from
which does not qualify for purposes of the 95% of income test. Moreover, in
order to help ensure compliance with the 95% of income test and the 75% of
income test, the Company intends to limit substantially all of the assets that
it acquires (other than the shares of the preferred stock of any Taxable
Subsidiary and Qualified Hedges) to Qualified REIT Assets. The policy of the
Company to maintain REIT status may limit the type of assets, including hedging
contracts, that the Company otherwise might acquire.
For purposes of determining whether the Company complies with the 75% of
income test and the 95% of income test detailed above, gross income does not
include gross income from "prohibited transactions." A "prohibited transaction"
is one involving a sale of dealer property, other than foreclosure property. Net
income from "prohibited transactions" is subject to a 100% tax. See "-- Taxation
of the Company."
The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions, futures contracts and sales
of Mortgage Assets to comply with the 75% of income test and the 95% of income
test. See "-- Taxation of the Company" for a discussion of the potential tax
cost of the Company's selling certain Mortgage Assets on a regular basis. In
order to help insure its compliance with the REIT requirements of the Code, the
Company has adopted guidelines the effect of which will be to limit the
Company's ability to earn certain types of income, including income from
hedging, other than hedging income from Qualified REIT Assets and from Qualified
Hedges. See "Business -- Interest Rate Risk Management."
If the Company fails to satisfy one or both of the 75% or 95% of income
tests for any year, it may face either (a) assuming such failure was for
reasonable cause and not willful neglect, and a schedule is submitted to the
Service setting forth the nature and amount of each item of the Company's gross
income qualifying under the 75% or 95% income tests, a 100% tax on the greater
of the amounts of income by which it failed to comply with the 75% test of
income or the 95% of income test, reduced by estimated related expenses or (b)
loss of REIT status. There can be no assurance that the Company will always be
able to maintain compliance with the gross income tests for REIT qualification
despite the Company's periodic monitoring procedures. Moreover, there is no
assurance that the relief provisions for a failure to satisfy either the 95% or
the 75% of income tests will be available in any particular circumstance.
DISTRIBUTIONS
The Company must distribute to its stockholders on a pro rata basis each
year an amount equal to (i) 95% of its Taxable Income before deduction of
dividends paid and excluding net capital gain, plus (ii) 95% of the excess of
the net income from foreclosure property over the tax imposed on such income by
the Code, less (iii) any "excess noncash income" (the "95% distribution test").
See "Dividend Policy and Distributions." The Company intends to make
distributions to its stockholders in amounts sufficient to meet this 95%
distribution requirement. Such distributions must be made in the taxable year to
which they relate, or during January of the subsequent taxable year when
declared during the last quarter of such taxable year and payable to
shareholders of record on a specified date during such quarter, or, if declared
before the timely filing of the Company's tax return for such year and paid not
later than the first regular dividend payment after such declaration, in the
following taxable year. A nondeductible excise tax, equal to four percent of the
excess of such required distributions over the amounts actually distributed will
be imposed on the Company for each calendar year to the extent that the sum of
the dividends paid during the year (or declared during the last quarter of the
year and paid during January of the succeeding year) and any tax imposed on the
REIT taxable income or capital gains of the Company is less than the sum of (i)
85% of the Company's "ordinary income," (ii) 95% of the Company's capital gain
net income, and (iii) income not distributed in earlier years.
If the Company fails to meet the 95% distribution test as a result of an
adjustment to the Company's tax returns by the Service, the Company by following
certain requirements set forth in the Code, may pay a deficiency dividend within
a specified period which will be permitted as a deduction in the taxable year to
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which the adjustment is made. The Company would be liable for interest based on
the amount of the deficiency dividend. A deficiency dividend is not permitted if
the deficiency is due to fraud with intent to evade tax or to a willful failure
to file timely tax returns.
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, it generally will not
be subject to federal income tax on that portion of its taxable income or net
capital gain which is distributed to its stockholders. The Company will,
however, be subject to tax at normal corporate rates upon any net income or net
capital gain not distributed. The Company intends to distribute substantially
all of its taxable income to its stockholders on a pro rata basis in each year.
See "Dividend Policy and Distributions." If the Company recognizes net income at
a time when its cash receipts from Mortgage Assets are subject to the claims of
creditors, such as counterparties on reverse repurchase agreements, the Company
may be compelled to borrow to distribute dividends and avoid the imposition of
corporate level tax.
In addition, the Company will also be subject to a tax of 100% of net
income from any prohibited transaction and will be subject to a 100% tax on the
greater of the amount by which it fails either the 75% or 95% of income tests,
reduced by approximated expenses, if the failure to satisfy such tests is due to
reasonable cause and not willful neglect and if certain other requirements are
met. The Company may be subject to the alternative minimum tax on certain items
of tax preference.
If the Company acquires any real property as a result of foreclosure, or by
a deed in lieu of foreclosure, the Company may elect to treat such real property
as "foreclosure property." Net income from the sale of foreclosure property is
taxable at the maximum federal corporate rate, currently 35%. Income from
foreclosure property will not be subject to the 100% tax on prohibited
transactions. The Company will determine whether to treat such real property as
foreclosure property on the tax return for the fiscal year in which such
property is acquired.
The Company will finance Mortgage Loans and sell such Mortgage Loans
through one or more Taxable Subsidiaries. However, if the Company itself were to
sell such Mortgage Assets on a regular basis, there is a substantial risk that
they would be deemed "dealer property" and that all of the profits from such
sales would be subject to tax at the rate of 100% as income from prohibited
transactions. The Taxable Subsidiary will not be subject to this 100% tax on
income from prohibited transactions, which is only applicable to REITs, rather,
it will be subject to tax on such income at regular corporate rates. See
"Business -- Industry Developments" for a discussion of the possible effect of a
recent proposal, if enacted, on such proposed activities of the Company.
The Company will also be subject to the nondeductible four percent excise
tax discussed above if it fails to make timely dividend distributions for each
calendar year. See "-- Qualification as a REIT -- Distributions." The Company
intends to declare its fourth regular annual dividend during the final quarter
of the year and to make such dividend distribution no later than thirty-one (31)
days after the end of the year in order to avoid imposition of the excise tax.
Such a distribution would be taxed to the stockholders in the year that the
distribution was declared, not in the year paid. Imposition of the excise tax on
the Company would reduce the amount of cash available for distribution to the
Company's stockholders.
TAXATION OF TAXABLE SUBSIDIARY
The Company may cause the creation and sale of Mortgage Assets or conduct
certain hedging activities through one or more Taxable Subsidiaries. The Company
and one or more persons or entities will own all of the capital stock of such
Taxable Subsidiary. In order to ensure that the Company will not violate the
prohibition on ownership of more than 10% of the voting stock of a single issuer
and the prohibition on investing more than five percent of the value of its
assets in the stock or securities of a single issuer, the Company will own only
shares of nonvoting preferred stock of the Taxable Subsidiary and will not own
any of the Taxable Subsidiary's common stock. The Company will monitor the value
of its investment in the Taxable Subsidiary on a quarterly basis to limit the
risk of violating any of the tests that comprise the 25% of assets limits. In
addition, the dividends that the Taxable Subsidiary pays to the Company will not
qualify as income from Qualified REIT Assets for purposes of the 75% of income
test, and in all events would have to be limited,
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along with the Company's other interest, dividends, gains on the sale of
securities, hedging income, and other income not derived from Qualified REIT
Assets to less than 25 percent of the Company's gross revenues in each year.
Before the Company forms any such Taxable Subsidiary, the Company intends to
obtain an opinion of counsel to the effect that the formation and contemplated
operation of such a corporation will not cause the Company to fail the REIT
asset and income tests. See "-- Qualification as a REIT -- Nature of Assets" and
"-- Qualification as a REIT -- Sources of Income." The Taxable Subsidiary will
not elect REIT status, will be subject to income taxation on its net earnings
and will generally be able to distribute only its net after-tax earnings to its
stockholders, including the Company, as dividend distributions. If the Taxable
Subsidiary creates a taxable mortgage pool, such pool itself will constitute a
separate taxable subsidiary of the Taxable Subsidiary. The Taxable Subsidiary
would be unable to offset the income derived from such a taxable mortgage pool
with losses derived from any other activities.
TERMINATION OR REVOCATION OF REIT STATUS
The Company's election to be treated as a REIT will be terminated
automatically (i) if the Company fails to meet the requirements described above
or (ii) if the President's 1999 Budget Plan is adopted, as presently proposed.
See "Risk Factors." In that event, the Company will not be eligible again to
elect REIT status until the fifth taxable year which begins after the year for
which the Company's election was terminated unless all of the following relief
provisions apply: (i) the Company did not willfully fail to file a timely return
with respect to the termination taxable year, (ii) inclusion of incorrect
information in such return was not due to fraud with intent to evade tax, and
(iii) the Company establishes that failure to meet requirements was due to
reasonable cause and not willful neglect. The Company may also voluntarily
revoke its election, although it has no intention of doing so, in which event
the Company will be prohibited, without exception, from electing REIT status for
the year to which the revocation relates and the following four taxable years.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company would be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to stockholders of the Company with
respect to any year in which the Company fails to qualify as a REIT would not be
deductible by the Company nor would they be required to be made. Failure to
qualify as a REIT would result in the Company's reduction of amounts available
for distribution to its stockholders in order to pay the resulting taxes. If,
after forfeiting REIT status, the Company later qualifies and elects to be taxed
as a REIT again, the Company could face significant adverse tax consequences.
TAXATION OF THE COMPANY'S STOCKHOLDERS
GENERAL
For any taxable year in which the Company is treated as a REIT for federal
income tax purposes, amounts distributed by the Company to its stockholders out
of current or accumulated earnings and profits will be includible by the
stockholders as ordinary income for federal income tax purposes unless properly
designated by the Company as capital gain dividends. In the latter case, the
distributions will be taxable to the stockholders as long-term capital gains.
Additionally, the Company may elect to retain and pay taxes on all or a
portion of its net long-term capital gains for any taxable year, in which case,
the stockholders would include in their income as long-term capital gains their
proportionate share of such undistributed capital gains. The stockholders would
be treated as having paid their proportionate share of any taxes paid by the
Company on any undistributed capital gains, which proportionate amounts would be
credited or refunded to the stockholders.
Distributions of the Company will not be eligible for the dividends
received deduction for corporations. Stockholders may not deduct any net
operating losses or capital losses of the Company.
Any loss on the sale or exchange of shares of the stock of the Company held
by a stockholder for six months or less will be treated as a long-term capital
loss to the extent of any capital gain dividend received, or undistributed
capital gains treated as received, on the stock held by such stockholders.
If the Company makes distributions to its stockholders in excess of its
current and accumulated earnings and profits, those distributions will be
considered first a tax-free return of capital, reducing the tax basis of a
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stockholder's shares until the tax basis is zero. Such distributions in excess
of the tax basis will be taxable as gain realized from the sale of the Company's
shares.
The Company (exclusive of its Taxable Subsidiary) does not expect to
acquire or retain residual interests issued by REMICs. Such residual interests,
if acquired by a REIT, would generate excess inclusion income. Excess inclusion
income cannot be offset by net operating losses of a stockholder. If the
stockholder is a Tax-Exempt Entity, the excess inclusion income is fully taxable
as UBTI. If allocated to a foreign stockholder, the excess inclusion income is
subject to Federal income tax withholding without reduction pursuant to any
otherwise applicable tax treaty. Excess inclusion income realized by a Taxable
Subsidiary is not passed through to stockholders of the Company. Potential
investors, and in particular Tax Exempt Entities, are urged to consult with
their tax advisors concerning this issue.
The Company intends to finance the acquisition of Mortgage Assets by
entering into reverse repurchase agreements, which are essentially loans secured
by the Company's Mortgage Assets. The Company expects to enter into master
repurchase agreements with secured lenders known as "counterparties." Typically,
such master repurchase agreements have cross-collateralization provisions that
afford the counterparty the right to foreclose on the Mortgage Assets pledged as
collateral. If the Service were to successfully take the position that the
cross-collateralization provisions of the master repurchase agreements result in
the Company having issued debt instruments (the reverse repurchase agreements)
with differing maturity dates secured by a pool of Mortgage Loans, a portion of
the Company's income could be characterized as "excess inclusion income."
Counsel has advised the Company that it is more likely than not that the
cross-collateralization provisions of the master repurchase agreements will not
cause the Company to realize excess inclusion income. Nevertheless, in the
absence of any definitive authority on this issue, Counsel cannot give complete
assurance.
The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to stockholders of record on a specified
date in such month will be deemed to have been received by the stockholders and
paid by the Company on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year.
WARRANTS
Upon the exercise of a Warrant, a holder will not recognize gain or loss
and will have a tax basis in the Common Stock received equal to the tax basis in
such holder's Warrant plus the exercise price thereof. The holding period for
the Common Stock purchased pursuant to the exercise of a Warrant will begin on
the day following the date of exercise and will not include the period that the
holder held the Warrant.
Upon a sale or other disposition of a Warrant, a holder will recognize
capital gain or loss in an amount equal to the difference between the amount
realized and the holder's tax basis in the Warrant. Such a gain or loss will be
long-term if the holding period is more than one year. In the event that a
Warrant lapses unexercised, a holder will recognize a capital loss in an amount
equal to his tax basis in the Warrant. Such loss will be long-term if the
Warrant has been held for more than one year.
ADJUSTMENTS TO EXERCISE PRICE OF THE WARRANTS
Adjustments in the Exercise Price (or the failure to make such adjustments)
pursuant to the anti-dilution provisions of the Warrants or otherwise may result
in constructive distributions to the holder of Warrants that could, under
certain circumstances, be taxable to them as dividends pursuant to Section 305
of the Code. If such a constructive distribution were to occur, a holder of
Warrants could be required to recognize ordinary income for tax purposes without
receiving a corresponding distribution of cash.
TAXATION OF TAX-EXEMPT ENTITIES
In general, a Tax-Exempt Entity that is a stockholder of the Company is not
subject to tax on distributions. The Service has ruled that amounts distributed
by a REIT to an exempt employees' pension trust do not constitute UBTI and thus
should be nontaxable to such a Tax-Exempt Entity. Based on that ruling, but
subject to the discussion of excess inclusion income set forth under the heading
"Taxation of the Company's Stockholders," Counsel is of the opinion that
indebtedness incurred by the Company in connection
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with the acquisition of real estate assets such as Mortgage Loans will not cause
dividends of the Company paid to a stockholder that is a Tax-Exempt Entity to be
UBTI, provided that the Tax-Exempt Entity has not financed the acquisition of
its stock with "acquisition indebtedness" within the meaning of the Code. Under
certain conditions, if a tax-exempt employee pension or profit sharing trust
were to acquire more than 10% of the Company's stock, a portion of the dividends
on such stock could be treated as UBTI.
For social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts, and qualified group legal services plans exempt
from federal income taxation under Code Sections 501(c)(7), (c)(9), (c)(17) and
(c)(20), respectively, income from an investment in the Company, including gain
realized on the sale of such an investment, will constitute UBTI unless the
organization is able to properly deduct amounts set aside or placed in reserve
for certain purposes so as to offset the UBTI generated by its investment in the
Company. Such entities should review Code Section 512(a)(3) and should consult
their own tax advisors concerning these "set aside" and reserve requirements.
FOREIGN INVESTORS
The preceding discussion does not address the federal income tax
consequences to foreign investors (non-resident aliens and foreign corporations
as defined in the Code) of an investment in the Company. In general, foreign
investors will be subject to special withholding tax requirements on income and
capital gains distributions attributable to their ownership of the Company's
stock. Foreign investors in the Company should consult their own tax advisors
concerning the federal income tax consequences to them of a purchase of shares
of the Company's stock including the federal income tax treatment of
dispositions of interests in, and the receipt of distributions from, REITs by
foreign investors. In addition, federal income taxes must be withheld on certain
distributions by a REIT to foreign investors unless reduced or eliminated by an
income tax treaty between the United States and the foreign investor's country.
A foreign investor eligible for reduction or elimination of withholding must
file an appropriate form with the Company in order to claim such treatment.
RECORDKEEPING REQUIREMENT
A REIT is required to maintain records regarding the actual and
constructive ownership of its shares, and other information, and within 30 days
after the end of its taxable year, to demand statements from persons owning
above a specified level of the REIT's shares (e.g., if the Company has over 200
but fewer than 2,000 stockholders of record, from persons holding one percent or
more of the Company's outstanding shares of stock and if the Company has 200 or
fewer stockholders of record, from persons holding 1/2% or more of the stock)
regarding their ownership of shares. The Company must maintain, as part of the
Company's records, a list of those persons failing or refusing to comply with
this demand. Stockholders who fail or refuse to comply with the demand must
submit a statement with their tax returns setting forth their actual stock
ownership and other information. The Company intends to maintain the records and
demand statements as required by these regulations.
BACKUP WITHHOLDING
The Code imposes a modified form of "backup withholding" for payments of
interest and dividends. This withholding applies only if a stockholder, among
other things, (i) fails to furnish the Company with a properly certified
taxpayer identification number, (ii) furnishes the Company with an incorrect
taxpayer identification number, (iii) fails properly to report interest or
dividends from any source, or (iv) under certain circumstances fails to provide
the Company or the stockholder's securities broker with a certified statements,
under penalty of perjury, that he or she is not subject to backup withholding.
The backup withholding rate is 31% of "reportable payments," which include
the Company's dividends. Stockholders should consult their tax advisors as to
the procedure for insuring that Company distributions to them will not be
subject to backup withholding.
The Company will report to its stockholders and the Service the amount of
dividends paid during each calendar year and the amount of tax withheld, if any.
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RECENT LEGISLATIVE PROPOSALS
The President's 1999 Budget Plan, as presented to Congress on February 2,
1998, contains several provisions which affect REITs. One such provision, if
enacted, could have a potential adverse effect on the way that the Company
intends to operate its mortgage conduit operations. That provision would
prohibit the ownership by a REIT of more than 10% the stock of another
corporation, by vote or value. The rules currently in place for qualification as
a REIT limit (i) a REIT to owning less than 10% of the outstanding voting
securities of another corporation and (ii) the value of a REIT's ownership of
the securities of any one issuer to less than five percent of the value of the
REIT's assets. (See "Qualification as a REIT -- Nature of Assets" above). By
limiting a REIT's ownership of the securities of another corporation to 10% of
the value of the issuing corporation, the proposal, if enacted, could cause the
Company to have to divest itself of most of the preferred stock of the Taxable
Subsidiary that the Company currently owns. In such an event the Company would
not receive the dividends that the Company expects to earn from the Taxable
Subsidiary, which could have a material adverse effect on the Company's net
profits after such divestiture. If that proposal is enacted in substantially the
form proposed, the Company would originate and acquire only those Mortgage Loans
that it intends to retain for investment. See "Business -- Industry
Developments" for a more detailed discussion of the budget proposal.
STATE AND LOCAL TAXES
State and local tax laws may not correspond to the federal income tax
principles discussed in this section. Accordingly, prospective stockholders
should consult their tax advisers concerning the state and local tax
consequences of an investment in the Company's stock.
ERISA CONSIDERATIONS
In considering an investment in the Common Stock of the Company, a
fiduciary of a profit-sharing, pension stock bonus plan, or individual
retirement account, including a plan for self-employed individuals and their
employees or any other employee benefit plan subject to prohibited transaction
provisions of the Code or the fiduciary responsibility provisions of ERISA (an
"ERISA Plan") should consider (a) whether the ownership of Common Stock is in
accordance with the documents and instruments governing such ERISA Plan, (b)
whether the ownership of Common Stock is consistent with the fiduciary's
responsibilities and satisfies the requirements of Part 4 of Subtitle B of Title
I of ERISA (where applicable) and, in particular, the diversification, prudence
and liquidity requirements of Section 404 of ERISA, (c) ERISA's prohibitions in
improper delegation of control over, or responsibility for, "plan assets" and
ERISA's imposition of co-fiduciary liability on a fiduciary who participates in,
permits (by action or inaction) the occurrence of, or fails to remedy a known
breach of duty by another fiduciary, and (d) the need to value the assets of the
ERISA Plan annually.
In regard to the "plan assets" issue noted in clause (c) above, Counsel is
of the opinion that, effective as of the date of the closing of this Offering
and the listing of the shares of Common Stock on the American Stock Exchange,
and based on certain representations of the Company, the Common Stock should
qualify as a "publicly-offered security," and, therefore, the acquisition of
such Common Stock by ERISA Plans should not cause the Company's assets to be
treated as assets of such investing ERISA Plans for purposes of the fiduciary
responsibility provisions of ERISA or the prohibited transaction provisions of
the Code. Fiduciaries of ERISA Plans and IRA's should consult with and rely upon
their own advisors in evaluating the consequences under the fiduciary provisions
of ERISA and the Code of an investment in Common Stock in light of their own
circumstances.
118
<PAGE> 125
UNDERWRITING
Under the terms of and subject to the conditions contained in the
underwriting agreement (the "Underwriting Agreement") between the Company and
the Underwriters named below (the "Underwriters"), for whom Stifel, Nicolaus &
Company, Incorporated is acting as representative (the "Representative"), the
Underwriters have severally agreed to purchase from the Company and the Company
has agreed to sell to the Underwriters severally the respective number of Units
set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF UNITS
TO BE
UNDERWRITER PURCHASED
----------- ---------------
<S> <C>
Stifel, Nicolaus & Company, Incorporated....................
Total............................................. 4,000,000
=========
</TABLE>
In the Underwriting Agreement, the Underwriters have severally agreed,
subject to the terms and conditions set forth therein, to purchase all of the
Units being sold pursuant to the Underwriting Agreement (other than those
covered by the over-allotment option described below). In the event of a default
by any Underwriter, the Underwriting Agreement provides that, in certain
circumstances, the purchase commitments of the nondefaulting Underwriters may be
increased or the Underwriting Agreement may be terminated.
The Company has been advised by the Representative that the Underwriters
propose to offer the Units in part to the public at the Price to Public set
forth on the cover page of this Prospectus, and in part to certain securities
dealers (who may include Underwriters) at such price less a concession not in
excess of $ per Unit, and that the Underwriters and such dealers may reallow
to certain dealers, a discount not in excess of $ per Unit. After
commencement of the public offering, the Price to Public, concessions to
selected dealers and the discount to other dealers may be changed by the
Representatives.
The Company has granted an option to the Underwriters, exercisable during
the 30-day period after the date of this Prospectus, to purchase, at the Price
to Public less the underwriting discount set forth on the cover page of this
Prospectus, up to 600,000 additional Units. The Underwriters may exercise such
option only to cover over-allotments, if any, made in connection with the
Offering of the Units offered hereby. To the extent the Underwriters exercise
such option, each of the Underwriters will become obligated, subject to certain
conditions, to purchase approximately the same percentage of such option Units
as it was obligated to purchase pursuant to the Underwriting Agreement.
The Company and certain of its affiliates have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Federal securities laws, or to contribute to payments which the Underwriters may
be required to make in respect thereof. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted to officers,
directors or persons controlling the Company, the Company has been informed that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is therefore
unenforceable.
The Company, the Founders and ContiFinancial Corporation have agreed with
the Underwriters that, for a period of one year following the closing of the
Offering, they will not offer, sell, contract to sell or otherwise dispose of
any shares of Common Stock or rights to acquire such shares without the prior
written consent of the Representatives. See "Shares Eligible For Future Sale."
The Company has agreed to grant to the Representative warrants to purchase
120,000 (138,000 if the over-allotment option is exercised) shares of Common
Stock at an exercise price equal to the Price to Public of the Units (the
"Representative's Warrants"). The Representative's Warrants are exercisable for
a period of three years beginning six months after the initial closing of the
Offering. The Representative's Warrants and, if exercised, the underlying
securities, may not be sold, transferred, assigned, pledged or hypothecated for
a
119
<PAGE> 126
period of one year following the effective date of the Offering except to any
officer or partner of a Representative or by operation of law. The
Representative's Warrants contain anti-dilution provisions providing for
appropriate adjustment upon the occurrence of certain events. See "Description
of Capital Stock."
The Representative has informed the Company that it does not expect the
Underwriters to confirm sales of Units offered by this Prospectus to any
accounts over which they exercise discretionary authority.
The Company intends to apply for listing of the Units, the Warrants and the
Common Stock on the American Stock Exchange. See "Prospectus Summary -- The
Offering."
Prior to the closing of the Offering, there has been no public market for
the Units. Accordingly, the Price to Public for the Units has been determined by
negotiations between the Company and the Representative. Among the factors which
were considered in determining the Price to Public were the Company's future
prospects, the experience of its management, the economic condition of the
financial services industry in general, the general condition of the equity
securities market, the demand for similar securities of companies considered
comparable to the Company and other relevant factors.
The Price to Public set forth on the cover page of this Prospectus should
not be considered an indication of the actual value of the Units. Such price is
subject to change as a result of market conditions and other factors and no
assurance can be given that the Units can be resold at the Price to Public of
the Units after the closing of this Offering.
Until the distribution of the Units is completed, rules of the Commission
may limit the ability of the Underwriters and certain selling group members to
bid for and purchase the Units. As an exception to these rules, the
Representative is permitted to engage in certain transactions that stabilize the
prices of the Units. Such transactions consist of bids or purchases for the
purpose of pegging, fixing or maintaining the price of such securities. If the
Underwriters create a short position in the Units in connection with this
Offering, i.e., if they sell a greater number of Units than is set forth in the
cover page of this Prospectus, then the Lead Underwriters may reduce that short
position by purchasing Units in the open market. The Representative may also
elect to reduce any short position by exercising all or part of the
over-allotment option described herein. The Representative may also impose a
penalty bid on certain Underwriters and selling group members. This means that
if the Representative purchases Units in the open market to reduce the
Underwriters' short position or to stabilize the price of the Units, it may
reclaim the amount of the selling concession from the Underwriters and selling
group members who sold those securities as part of the Offering. In general,
purchases of a security for the purpose of stabilization or to reduce a short
position could cause the price of the security to be higher than it might be in
the absence of such purchases. The imposition of a penalty bid might also have
an effect on the price of a security to the extent that it were to discourage
resales of the security. These transactions may be effected on the American
Stock Exchange or otherwise. Neither the Company nor any of the Underwriters
makes any representation or prediction as to the direction or magnitude of any
effect that the transactions described above may have on the prices of the
Units. In addition, neither the Company nor any of the Underwriters makes any
representation that the Representative will engage in such transactions, or that
such transactions, once commenced, will not be discontinued without notice.
120
<PAGE> 127
LEGAL MATTERS
The validity of the Securities offered hereby and certain tax matters will
be passed on by Jeffers, Wilson, Shaff & Falk, LLP, Irvine, California.
Christopher A. Wilson, Esq. and Michael E. Shaff, Esq., partners of Jeffers,
Wilson, Shaff & Falk, LLP, have been granted options to purchase 2,159 and 863
shares of Common Stock, respectively. Certain legal matters will be passed upon
for the Underwriters by O'Melveny & Myers LLP, San Francisco, California.
EXPERTS
The balance sheet of RealTrust Asset Corporation as of April 1, 1998 and
financial statements of CMG Funding Corp. (formerly Continental Mortgage Group,
L.C.) as of December 31, 1997 and 1996, and for the year ended December 31, 1997
and the period from February 7, 1996 (date of inception) to December 31, 1996,
have been included herein and in the registration statement in reliance upon the
reports of KPMG Peat Marwick LLP, independent certified public accountants
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission, Washington, D.C. 20549, a
Registration Statement (the "Registration Statement") under the Securities Act
of 1933, as amended (the "Securities Act"), with respect to the Units offered
hereby. Copies of the Registration Statement and the exhibits thereto are on
file at the offices of the Commission in Washington, D.C. and may be obtained at
rates prescribed by the Commission upon request to the Commission and inspected,
without charge, at the offices of the Commission. Prior to the Offering, the
Company has not been required to file reports under the Exchange Act. However,
following the closing of this Offering, the Company will be required to file
reports and other information with the Commission pursuant to the Exchange Act.
Such reports and other information can be inspected and copied at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the Commission's regional offices at Northwestern
Atrium Center, 500 West Madison Street (Suite 1400), Chicago, Illinois 60661 and
7 World Trade Center, New York, New York 10048. Copies of such material can also
be obtained from the Commission at prescribed rates through its Public Reference
Section at 450 Fifth Street, N.W., Washington, D.C. 20549. The Commission
maintains a Web site that contains reports, proxy, 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 any contract or other
document referred to are not necessarily complete, and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respect by such reference.
121
<PAGE> 128
GLOSSARY
As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.
"Affiliated Person" means of any entity: (i) any person directly or
indirectly owning, controlling, or holding with the power to vote, five percent
or more of the outstanding securities of such entity; (ii) any person five
percent or more of whose outstanding voting securities are directly or
indirectly owned, controlled, or held with power to vote, by such entity; (iii)
any person directly or indirectly controlling, controlled by, or under common
control with, such entity; or (iv) any officer, director or employee of such
entity or any person set forth in (i), (ii) or (iii) above. Any person who owns
beneficially, either directly or through one or more controlled companies, more
than twenty-five percent (25%) of the voting securities of any entity shall be
presumed to control such entity. Any person who does not so own more than
twenty-five percent (25%) of the voting securities of any entity shall be
presumed not to control such entity. A natural person shall be presumed not to
be a controlled entity.
"Agency" means FNMA, FHLMC or GNMA.
"Agency Certificates" means pass-through certificates guaranteed by FNMA,
FHLMC or GNMA.
"ARM" means a Mortgage Loan (including any Mortgage Loan underlying a
Mortgage Security) that features adjustments of the underlying interest rate at
predetermined times based on an agreed margin to an established index. An ARM is
usually subject to periodic interest rate and/or payment caps and a lifetime
interest rate cap.
"Beneficial Owner" means any actual purchaser of a Warrant.
"CAG" means Capital Allocation Guidelines.
"Capital Stock" means the shares of capital stock issuable by the Company
under its Amended and Restated Articles of Incorporation, and includes Common
Stock and preferred stock.
"Capstone" means Capstone Investments, Inc., a Nevada corporation.
"Charitable Beneficiary" means one or more charitable beneficiaries for the
exclusive benefit of which Capital Stock is transferred, where absent such
transfer the intended transferee of such Capital Stock would beneficially or
constructively own more than a 9.8% interest in any tenant of the Company.
"CMO" or "Collateralized Mortgage Obligations" means adjustable or
short-term fixed-rate debt obligations (bonds) that are collateralized by
Mortgage Loans and issued by private institutions or issued or guaranteed by
GNMA, FNMA or FHLMC.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commitments" means commitments issued by the Company which will obligate
the Company to purchase Mortgage Assets from the holders of the commitment for a
specified period of time, in a specified aggregate principal amount and at a
specified price.
"Common Stock" means one share of the Company common stock, par value
$.001.
"Company" means RealTrust Asset Corporation, a Maryland corporation, and
includes any subsidiaries thereof when the context otherwise requires.
"ContiFinancial Corporation" means ContiFinancial Corporation and each of
its affiliates, including ContiMortgage Corporation, ContiTrade Services L.L.C.,
and ContiFinancial Services Corporation.
"Direct Participant" means Participants which are securities brokers and
dealers, banks, trust companies, clearing corporations and certain other
organizations.
"DRP" means a Dividend Reinvestment Plan the Company intends to adopt
following this Offering.
"DTC" means the Depository Trust Company.
"ERISA" means the Employee Retirement Income Security Act of 1974.
122
<PAGE> 129
"ERISA Plan" or "Plan" means a pension, profit-sharing, retirement or other
employee benefit plan which is subject to ERISA.
"Excess inclusion income" means income recognized by the holder of a REMIC
residual (or a residual from a taxable mortgage pool) which exceeds 120% of the
long-term applicable Federal interest rate.
"Excess Shares" means the number of shares of Capital Stock of the Company
held by any person or group of persons in excess of 9.8% of the outstanding
shares.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Exercise Price" means the price equal to the Price to Public.
"Expiration Date" means the date and time after which the Warrants are no
longer exercisable or 5:00 p.m. Eastern Time on the third anniversary of the
date the Warrants first become exercisable.
"FHA" means the United States Federal Housing Administration.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"First Lien Mortgage Loans" means Mortgage Loans secured by first mortgages
or deeds of trust.
"FNMA" means the Federal National Mortgage Association.
"Formation Transaction" means the transactions and actions to be taken by
the Company prior to this Offering.
"Founders" means the stockholders of the Taxable Subsidiary prior to this
Offering, excluding ContiFinancial Corporation. The Founders are John D. Fry,
Terry L. Mott, William J. Reed, Shauna L. Reimann, Patrick W. Craghan, David and
Sara Ferradino, Kent G. Bills and Brenda Colson.
"GAAP" means generally accepted accounting principles.
"GNMA" means the Government National Mortgage Association.
"HUD" means the Department of Housing and Urban Development.
"Independent Directors" means a director of the Company who is not an
officer or employee of the Company or any affiliate or subsidiary of the
Company.
"Indirect Participants" means Participants which are securities brokers and
dealers, banks and trust companies that clear through or maintain a custodial
relationship with a Direct Participant, either directly or indirectly.
"Investment Company Act" means the Investment Company Act of 1940, as
amended.
"IOs" means interest only Mortgage Securities.
"IRAs" means Individual Retirement Accounts.
"ISOs" means qualified incentive stock options granted under the Stock
Option Plan which meet the requirements of Section 422 of the Code.
"Keogh Plans" means H.R. 10 Plans.
"LIBOR" means London Inter-Bank Offered Rate.
"Limitation Price" means the price for which any holder of Excess Stock may
designate a transferee of such Excess Stock, which price is equal to the lesser
of (i) in the case of a deemed exchange for Excess Stock resulting from a
transfer, the price paid for such shares in the transfer or, in the case of a
deemed exchange for Excess Stock resulting from some other event, the fair
market value on the date of the deemed exchange, of the shares deemed exchanged,
or (ii) the fair market value of the shares for which such Excess Stock will be
deemed to be exchanged on the date of the designation of the transferee (or, in
the case of a purchase by the Company, on the date the Company accepts the offer
to sell).
123
<PAGE> 130
"LTV" means loan-to-value ratio which is the percentage obtained by
dividing the principal amount of a loan by the lower of the sales price or
appraised value of the mortgaged property when the loan is originated.
"Maryland GCL" means the Maryland General Corporation Law as in effect on
the date hereof, or as subsequently amended and revised.
"Mortgage Assets" means (i) Mortgage Loans and (ii) Mortgage Securities.
"Mortgage Loans" means mortgage loans which are secured by mortgages or
deeds of trust on single-family (one to four unit) residences, and includes
Subprime Mortgage Loans and Prime Mortgage Loans.
"Mortgage Securities" means CMOs and securities (or interests therein)
which are Qualified REIT Assets evidencing undivided ownership interests in a
pool of Mortgage Loans, the holders of which receive a "pass-through" of the
principal and interest paid in connection with the underlying Mortgage Loans in
accordance with the holders' respective, undivided interests in the pool.
"Ownership Limit" means 9.8% of the outstanding shares of each class of
stock, as may be increased or reduced by the Board of Directors of the Company.
"Participants" means participants in the DTC.
"POs" means principal only Mortgage Securities.
"Post-closing Transactions" means the transaction and actions to be taken
by the Company subsequent to this Offering.
"Prime Mortgage Loans" means Mortgage Loans that either comply with
requirements for inclusion in credit support programs sponsored by FHLMC or FNMA
or are FHA or VA Loans, all of which are secured by first mortgages or deeds of
trust on single-family (one to four units) residences.
"Purchase Agreement" means the Mortgage Loan Purchase Agreement between the
Company and the Taxable Subsidiary.
"Qualified Hedge" means a hedging contract that has each of the following
attributes: (a) a financial instrument; (b) entered into by the Company to hedge
any variable rate indebtedness of the Company incurred or to be incurred to
acquire or carry real estate assets; (c) the Company will not treat as a
Qualified Hedge any hedging instrument acquired to hedge an asset of the
Company; and (d) the Company will only treat as a Qualified Hedge a hedging
instrument acquired to hedge a variable rate indebtedness secured by a variable
rate asset that itself is subject to periodic or lifetime interest rate caps, or
a variable rate indebtedness that is subject to a different interest rate index
from that of the Company's asset securing such variable rate indebtedness.
"Qualified REIT Assets" means pass-through certificates, Mortgage Loans,
Agency Certificates and other assets of the type described in Code Section
856(c)(5)(B).
"Qualified REIT Subsidiary" means a corporation whose stock is entirely
owned by the REIT. The income and assets of a Qualified REIT Subsidiary are
treated as those of the Company for tax purposes.
"Qualifying Interests" means "mortgages and other liens on and interests in
real estate," as defined in Section 3(c)(5)(C) under the Investment Company Act.
"RealTrust" means RealTrust Asset Corporation, a newly formed Maryland
corporation.
"REIT" means Real Estate Investment Trust as defined under Section 856 of
the Code.
"REMIC" means Real Estate Mortgage Investment Conduit as defined under
Section 860D of the Code.
"Representative" means Stifel, Nicolaus & Company, Incorporated.
"Representative's Warrants" means the Warrants to purchase 120,000 shares
of Common Stock (138,000 shares if the over-allotment option is exercised)
granted to the Representative.
124
<PAGE> 131
"Reverse Repurchase Agreement" means a borrowing device evidenced by an
agreement to sell securities or other assets to a third-party and a simultaneous
agreement to repurchase them at a specified future date and price, the price
difference constituting the interest on the borrowing.
"Second Lien Mortgage Loans" means Mortgage Loans secured by second
mortgages or deeds of trust.
"Securities Act" means the Securities Act of 1933, as amended.
"Strategic Alliance" means the certain strategic alliance between the
Company and ContiFinancial Corporation.
"Subordinated Mortgage Securities" means a class of Mortgage Securities
that is subordinated to one or more of classes of Mortgage Securities, all of
which classes share the same collateral.
"Subprime Mortgage Loans" means Mortgage Loans that do not conform to one
or more underwriting criteria of FHLMC and FNMA (other than the mortgage loan
limits) for participation in one or more of such agencies' mortgage loan
programs, and may also exceed the maximum loan limits
"Tax-Exempt Entity" means a qualified pension, profit-sharing or other
employee retirement benefit plan, Keogh Plans, bank commingled trust funds for
such plans, IRAs and other similar entities intended to be exempt from Federal
income taxation.
"Taxable Income" means for any year the taxable income of the Company for
such year (excluding any net income derived either from property held primarily
for sale to customers or from foreclosure property) subject to certain
adjustments provided in Section 857 of the Code.
"Taxable Subsidiary" means CMG Funding Corp., a Delaware corporation.
"UBTI" means "unrelated trade or business income" as defined in Section 512
of the Code.
"Unit" means one share of Common Stock and one Warrant.
"Warrant" means a warrant to purchase one share of Common Stock at the
Price to Public, and included in the Unit.
"Warrant Agent" means the warrant agent named in the Warrant Agreement,
which initially shall be the American Securities Transfer & Trust Incorporated.
"Warrant Agreement" means the warrant agreement pursuant to which the
Warrants will be issued.
"Warrant Share" means a Warrant to purchase one share of Common Stock.
125
<PAGE> 132
TABLE OF CONTENTS TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
REALTRUST ASSET CORPORATION
Independent Auditors' Report................................ F-2
Balance Sheet as of April 1, 1998......................... F-3
Note to Balance Sheet..................................... F-4
CMG FUNDING CORP.
Independent Auditors' Report................................ F-5
Financial Statements as of December 31, 1997 and 1996 and
for the year ended December 31, 1997 and the period from
February 7, 1996 (date of inception) to December 31, 1996:
Balance Sheets............................................ F-6
Statements of Operations.................................. F-7
Statements of Stockholders' Equity........................ F-8
Statements of Cash Flows.................................. F-9
Notes to Financial Statements............................. F-10
Unaudited Financial Statements as of March 31, 1998 and for
the three months ended March 31, 1998 and 1997:
Balance Sheet (unaudited)................................. F-20
Statements of Operations (unaudited)...................... F-21
Statement of Stockholders' Equity (unaudited)............. F-22
Statements of Cash Flows (unaudited)...................... F-23
Note to Financial Statements.............................. F-24
</TABLE>
F-1
<PAGE> 133
INDEPENDENT AUDITORS' REPORT
To The Board of Directors
RealTrust Asset Corporation
We have audited the accompanying balance sheet of RealTrust Asset
Corporation as of April 1, 1998 (date of inception). This financial statement is
the responsibility of the Company's management. Our responsibility is to express
an opinion on this financial statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the balance sheet is free of material
misstatement. An audit of a balance sheet includes examining, on a test basis,
evidence supporting the amounts and disclosures in the balance sheet. An audit
of a balance sheet 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 RealTrust Asset Corporation as of
April 1, 1998, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Salt Lake City, Utah
May 4, 1998
F-2
<PAGE> 134
REALTRUST ASSET CORPORATION
BALANCE SHEET
APRIL 1, 1998
ASSETS
<TABLE>
<S> <C>
Cash........................................................ $1,000
======
STOCKHOLDERS' EQUITY
Class A Convertible Preferred Stock, par value $.001;
1,263,472 shares authorized;
no shares issued and outstanding.......................... $ --
Class B Redeemable Preferred Stock, par value $.001; 410,581
shares authorized;
no shares issued and outstanding.......................... --
Common Stock, par value $.001; 2,810,455 shares authorized;
66 shares issued and outstanding.......................... --
Additional paid-in capital.................................. 1,000
------
$1,000
======
</TABLE>
See accompanying note to balance sheet at F-4.
F-3
<PAGE> 135
REALTRUST ASSET CORPORATION
NOTE TO BALANCE SHEET
APRIL 1, 1998
BUSINESS DESCRIPTION
RealTrust Asset Corporation (the "Company") was incorporated in the state
of Maryland on April 1, 1998. The Company's business activities will consist of
(i) investing in Mortgage Loans acquired from CMG Funding Corp. and independent
mortgage brokers and banks; (ii) investing in Mortgage Securities, and (iii)
owning preferred stock investment in CMG Funding Corp., which it will account
for on the equity basis of accounting. The Company will operate in a manner that
permits it to elect, and intends to elect, REIT status for Federal income tax
purposes. The Company intends to distribute at least 95% or more of its taxable
income to its holders of Common Stock on a quarterly basis each year so as to
comply with the REIT provisions of the Internal Revenue Code.
In connection with its formation, the Company has filed a registration
statement for the sale of 4,000,000 units. Each unit consists of one share of
Common Stock, par value $.001 per share, and one Common Stock Purchase Warrant.
There has been no public market for the Units and the Company has not yet
commenced operations. Upon the closing of the Offering of the Units, the Company
will use substantially all of the net proceeds of the Offering to provide
funding for investing in Mortgage Loans and Mortgage Securities.
F-4
<PAGE> 136
INDEPENDENT AUDITORS' REPORT
The Board of Directors
CMG Funding Corp.:
We have audited the accompanying balance sheets of CMG Funding Corp.
(formerly Continental Mortgage Group L.C.) as of December 31, 1997 and 1996, and
the related statements of operations, stockholders' equity, and cash flows for
the year ended December 31, 1997 and the period from February 7, 1996 (date of
inception) to December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our 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 financial position of CMG Funding Corp. as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for the year ended December 31, 1997 and the period from February 7, 1996 (date
of inception) to December 31, 1996, in conformity with generally accepted
accounting principles.
KPMG PEAT MARWICK LLP
Salt Lake City, Utah
March 10, 1998
F-5
<PAGE> 137
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
ASSETS
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Cash and cash equivalents................................... $ 708,962 272,308
Mortgage loans held for sale................................ 54,451,067 24,147,713
Receivables................................................. 1,379,878 120,731
Furniture, fixtures, and equipment, net..................... 1,325,969 500,570
Other real estate owned..................................... -- 147,740
Deposits.................................................... 86,549 56,762
Restricted cash............................................. 56,478 90,009
Organization costs, net of accumulated amortization of
$6,824 at December 31, 1997 and $2,573 at December 31,
1996...................................................... 38,669 16,105
Prepaid expense............................................. 500,174 6,114
Other assets................................................ 319,557 --
----------- -----------
$58,867,303 25,358,052
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 377,110 207,442
Accrued interest and other liabilities...................... 796,376 536,026
Warehouse and revolving working capital lines of credit..... 55,603,021 23,996,471
Notes payable............................................... 188,690 250,000
Obligations under capital leases............................ 366,687 233,982
Dividends payable........................................... 73,188 --
----------- -----------
Total liabilities................................. 57,405,072 25,223,921
Stockholders' equity:
Class A convertible preferred stock, $.001 par value,
1,268,950 shares authorized, 1,263,472 issued, and
outstanding............................................ 1,263 --
Common stock, $.001 par value, 2,609,407 shares
authorized, 1,546,983 issued, and outstanding.......... 1,547 --
Additional paid-in capital................................ 2,953,493 --
Members' capital.......................................... -- 1,439,997
Accumulated deficit....................................... (1,494,072) (1,305,866)
----------- -----------
Total stockholders' equity........................ 1,462,231 134,131
----------- -----------
$58,867,303 25,358,052
=========== ===========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 138
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Revenues:
Interest.................................................. $ 3,756,870 621,601
Gain-on-sale of mortgage loans, net....................... 5,967,647 446,771
Mortgage servicing fees................................... 38,826 --
Other..................................................... 269,248 92,063
----------- -----------
10,032,591 1,160,435
----------- -----------
Expenses:
Salaries and employee benefits............................ 4,474,357 390,018
General operating......................................... 4,313,236 1,285,156
Interest.................................................. 2,965,685 731,519
Other..................................................... 53,624 59,608
----------- -----------
11,806,902 2,466,301
----------- -----------
Net loss.......................................... $(1,774,311) (1,305,866)
=========== ===========
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE> 139
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
STATEMENTS OF STOCKHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
<TABLE>
<CAPTION>
CLASS A
CONVERTIBLE ADDITIONAL TOTAL
PREFERRED COMMON PAID-IN MEMBERS' ACCUMULATED STOCKHOLDERS'
STOCK STOCK CAPITAL CAPITAL DEFICIT EQUITY
----------- ------- ---------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balances at February 7, 1996
(date of inception)....... $ -- -- -- -- -- --
Members' capital
contribution.............. -- -- -- 1,562,664 -- 1,562,664
Members' withdrawals........ -- -- -- (122,667) -- (122,667)
Net loss.................... -- -- -- -- (1,305,866) (1,305,866)
------ ----- ---------- ---------- ----------- -----------
Balances at December
31,1996................... -- -- -- 1,439,997 (1,305,866) 134,131
Transfer of Continental
Mortgage Group L.C.
accumulated deficit at
March 7, 1997 (see note
1)........................ -- -- (1,833,694) -- 1,833,694 --
Conversions of members'
capital to Class A
convertible preferred
stock (600,774 shares) and
common stock (1,000,100
shares)................... 601 1,000 1,438,396 (1,439,997) -- --
Issuance of Class A
convertible preferred
stock (252,117 shares).... 252 -- 499,748 -- -- 500,000
Conversion of subordinated
debt to common stock
(546,883 shares).......... -- 547 849,453 -- -- 850,000
Conversion of $2,000,000
revolving working capital
line of credit to Class A
convertible preferred
stock (410,581 shares).... 410 -- 1,999,590 -- -- 2,000,000
Cumulative dividend -- Class
A convertible preferred
stock..................... -- -- -- -- (247,589) (247,589)
Net loss.................... -- -- -- -- (1,774,311) (1,774,311)
------ ----- ---------- ---------- ----------- -----------
Balances at December 31,
1997...................... $1,263 1,547 2,953,493 -- (1,494,072) 1,462,231
====== ===== ========== ========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-8
<PAGE> 140
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (1,774,311) (1,305,866)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 248,395 54,283
Proceeds from mortgage loans held for sale.............. 462,824,615 148,300,974
Increase in mortgage loans held for sale................ (487,160,322) (172,174,656)
Gain on sales of mortgage loans, net.................... (5,967,647) (446,771)
Write-down of other real estate owned................... -- 25,000
Gain on sale of other real estate owned................. (8,874) --
Changes in operating assets and liabilities:
Increase in receivables.............................. (1,259,147) (120,731)
Increase in deposits................................. (29,787) (56,762)
Decrease (increase) in restricted cash............... 33,531 (90,009)
Increase in organization costs....................... (42,310) (18,678)
Increase in prepaid expense.......................... (494,060) (6,114)
Increase in other assets............................. (319,557) --
Increase in accounts payable......................... 169,668 207,442
Increase in accrued interest and other liabilities... 260,350 536,026
------------- -------------
Net cash used in operating activities.............. (33,519,456) (25,095,862)
------------- -------------
Cash flows from investing activities:
Purchase of furniture, fixtures, and equipment............ (784,762) (256,858)
Proceeds from sale of land held for investment............ -- 177,734
Proceeds from sale of other real estate owned............. 156,614 --
------------- -------------
Net cash used in investing activities.............. (628,148) (79,124)
------------- -------------
Cash flows from financing activities:
Proceeds from warehouse and revolving working capital
lines of credit, net.................................... 33,606,550 23,996,471
Proceeds from notes payable............................... 200,000 250,000
Payments on notes payable................................. (261,310) (65,000)
Payments on obligations under capital leases.............. (136,581) (48,726)
Proceeds from subordinated debt........................... 850,000 --
Proceeds from issuance of preferred stock................. 500,000 --
Members' capital contributions, net of withdrawals........ -- 1,314,549
Dividends paid............................................ (174,401) --
------------- -------------
Net cash provided by financing activities.......... 34,584,258 25,447,294
------------- -------------
Net increase in cash and cash equivalents................... 436,654 272,308
Cash and cash equivalents at the beginning of period........ 272,308 --
------------- -------------
Cash and cash equivalents at end of period.................. $ 708,962 272,308
============= =============
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Interest paid............................................... $ 2,599,437 599,020
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES
Transfer from mortgage loans held for sale to other real
estate owned.............................................. $ -- 172,740
Land contributed by member, net of note payable in amount of
$65,000................................................... -- 112,734
Office machinery and equipment contributed by member........ -- 12,714
Capital lease obligations incurred for furniture, fixture,
and equipment............................................. 269,286 282,708
Conversion of members capital to preferred, common stock,
and additional paid-in capital............................ 1,439,997 --
Conversion of subordinated debt to common stock and
additional paid-in capital................................ 850,000 --
Conversion of revolving working capital line of credit to
Class A convertible preferred stock and additional paid-in
capital................................................... 2,000,000 --
Dividends payable on cumulative Class A convertible
preferred stock........................................... 73,188 --
</TABLE>
See accompanying notes to financial statements.
F-9
<PAGE> 141
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
(1) DESCRIPTION OF BUSINESS
CMG Funding Corp. (the Company) was incorporated on December 12, 1996,
under the laws of the State of Delaware and began operations on March 7, 1997.
Prior to this, the Company was organized on February 7, 1996, in the State of
Utah as a limited liability company and operated as Continental Mortgage Group.
The Company is engaged in mortgage banking activities located throughout the
United States.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Financial Statement Presentation
The financial statements have been prepared in conformity with generally
accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and revenues and expenses for the period. Actual results could differ from those
estimates.
(b) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly liquid
investments with original maturities of three months or less. The carrying
amount of cash equivalents approximates their value.
The Company has cash in a financial institution which is insured by the
Federal Deposit Insurance Corporation (FDIC) up to $100,000 per institution. As
of December 31, 1997, the Company had amounts on deposit with the financial
institution in excess of FDIC limits. The Company limits its risk by placing its
cash in a high quality financial institution.
At December 31, 1997 and 1996, restricted cash includes $56,478 and
$90,009, respectively, representing cash restricted for the purpose of warehouse
loan fundings.
(c) Mortgage Loans Held for Sale
Mortgage loans held for sale are valued at the lower of cost or estimated
market value as determined by outstanding commitments from investors or current
investor yield requirements calculated on a loan-by-loan basis. Mortgage loans
held for sale include loan premiums of $1,322,339 and $242,553 at December 31,
1997 and 1996, respectively.
The Company has limited its exposure to credit losses on its mortgage loans
held for sale by performing an in-depth due diligence on every loan originated
and purchased. The due diligence encompasses the borrowers credit, the
enforceability of the documents, and the value of the mortgage property. The
Company has not experienced any credit losses to date.
(d) Loan Origination Fees and Related Costs
Loan origination fees and certain direct loan origination costs are
deferred, and the net fee or cost is recognized in income using the interest
method over the contractual life of the loans, adjusted for estimated
prepayments based on the Company's historical prepayment experience. The net
deferred loan fee or cost is used in calculating the Company's gain or loss when
the related loans are sold to investors.
F-10
<PAGE> 142
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
(e) Furniture, Fixtures, and Equipment
Furniture, fixtures, and equipment are stated at cost. Depreciation and
amortization are computed using the straight-line method based on the estimated
useful lives of the related assets. Useful lives range from five to seven years,
with the exception of leasehold improvements which are amortized over the lease
term or estimated useful life, whichever is less. Software is amortized over a
three-year life.
Furniture and equipment under capital lease is stated at the present value
of minimum lease payments at the inception of the lease. Depreciation under
capital leases is computed using the straight-line method over the estimated
useful life of the underlying asset.
(f) Organization Costs
Organization costs associated with the organization of the Company are
amortized on a straight-line basis over five years.
(g) Gain/Loss on Sale of Mortgage Loans
When loans are sold, a gain or loss is recognized to the extent that the
sales proceeds exceed or are less than the net book value of the loans. Net
deferred loan fees or costs are included in calculating gains and losses from
sales on loans.
(h) Mortgage Servicing Fees
Mortgage servicing fees represent the fees earned for servicing mortgage
loans under servicing agreements with the Federal National Mortgage Association
(FNMA). The fees are based on a fixed amount per loan and are recorded as income
when received.
(i) Income Taxes
Prior to March 7, 1997, the Company was a limited liability company under
the provisions of the Internal Revenue Code. As a result, the Company paid no
federal or state income taxes, and the elements of income or loss were
includable in the individual members' income tax returns.
Upon the merger of CMG Funding Corp. into Continental Mortgage Group L.C.,
with CMG Funding Corp., a "C" Corporation, the survivor, the Company became
subject to income taxes which are recognized using the asset and liability
method. Under the asset and liability method, deferred tax assets and deferred
tax liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and deferred tax liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and deferred tax liabilities of a change in tax
rates is recognized in operations in the period that includes the enactment
date.
(j) Recent Accounting Pronouncements
On March 7, 1997, the Company adopted Statement of Financial Accounting
Standards (Statement) No. 123, Accounting for Stock-Based Compensation, which
permits entities to recognize as expense over the vesting period, the fair value
of all stock-based awards on the date of the grant. Alternatively, Statement No.
123 also allows entities to continue to apply the provisions of APB Opinion No.
25 and provide pro forma
F-11
<PAGE> 143
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
earnings (loss) and pro forma earnings (loss) per share disclosure for employee
stock option grants made in 1995 and future years as if the fair-value-based
method defined in Statement No. 123 had been applied. The Company has elected to
apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure
provisions of Statement No. 123.
Statement No. 125, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, as amended by Statement No. 127, is
effective for all transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, except for
secured borrowings and collateral, repurchase agreements, dollar rolls,
securities lending, and similar transactions, which transfers will be effective
for transactions occurring after December 31, 1996. This statement provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities based on consistent application of
financial-components approach that focuses on control. It distinguishes
transfers of financial assets that are sales from transfers that are secured
borrowings. Under the financial-components approach, after a transfer of
financial assets, an entity recognizes all financial and servicing assets it
controls and liabilities it has incurred and derecognizes financial assets it no
longer controls and liabilities that have been extinguished. Many of these
assets and liabilities are components of financial assets that existed prior to
the transfer. If a transfer does not meet the criteria for a sale, the transfer
is accounted for as a secured borrowing with a pledge of collateral.
(k) Financial Statement Presentation
The Company prepares its financial statements using an unclassified balance
sheet presentation as is customary in the mortgage banking industry. A
classified balance sheet presentation would have aggregated current assets,
current liabilities, and net working capital (deficit) as follows as of December
31:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Current assets............................................. $57,040,081 24,636,875
Current liabilities........................................ 55,227,715 24,901,914
----------- ----------
Net working capital (deficit).............................. $ 1,812,366 (265,039)
=========== ==========
</TABLE>
(l) Reclassification
Certain balances in 1996 have been reclassified to conform to the 1997
presentation
(3) RECEIVABLES
Receivables as of December 31, 1997 and 1996, consist of the following:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Mortgage payments........................................... $ 831,547 40,721
Accrued interest............................................ 463,720 71,616
Investor bonus.............................................. 79,134 --
Other receivables........................................... 5,477 8,394
---------- ----------
$1,379,878 120,731
========== ==========
</TABLE>
F-12
<PAGE> 144
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
(4) FURNITURE, FIXTURES, AND EQUIPMENT
Furniture, fixtures, and equipment at December 31, 1997 and 1996, consist
of the following:
<TABLE>
<CAPTION>
USEFUL LIVES 1997 1996
------------ ----------- -------
<S> <C> <C> <C>
Furniture and fixtures............................ 7 years $ 323,105 146,836
Office machinery and equipment.................... 5 - 7 years 438,544 112,989
Computers......................................... 5 years 514,957 186,591
Software.......................................... 3 years 265,912 92,396
Leasehold improvements............................ 2 - 5 years 63,809 13,468
----------- -------
1,606,327 552,280
Less accumulated depreciation and amortization.... 280,358 51,710
----------- -------
$ 1,325,969 500,570
=========== =======
</TABLE>
(5) WAREHOUSE AND REVOLVING WORKING CAPITAL LINES OF CREDIT
The Company had the following lines of credit for the periods ending
December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
2,000,000 revolving working capital line of credit with a
finance company, maturing in January of 1999, with
interest on outstanding balance accruing at LIBOR plus
4.5% to 8.5%, secured by general assets (note 15)......... $ 1,785,225 200,000
7,000,000 warehousing line of credit with a finance company,
maturing in June of 1997, with interest on outstanding
balance accruing at the bank's prime rate plus 0.25%,
payable monthly, secured by loans and servicing rights in
loans warehoused.......................................... -- 6,888,713
12,000,000 warehousing line of credit with a financial
institution, matures in July of 1997, with interest
accruing on outstanding balance ranging from LIBOR plus
2.15% to 2.75%, payable monthly, secured by loans
warehoused and associated servicing rights................ -- 10,248,546
4,000,000 warehousing line of credit with a financial
institution, maturing in April of 1997, with interest on
outstanding balance accruing at the bank's prime rate plus
0.50%, payable monthly, secured by loans warehoused and
associated servicing rights............................... -- 2,590,759
50,000,000 warehousing line of credit with a finance
company, maturing in January of 1999, with interest on
outstanding balance accruing at LIBOR plus 2.25%, payable
monthly, secured by loans warehoused and associated
servicing rights (note 15)................................ 31,692,828 4,068,453
10,000,000 warehousing line of credit with a financial
institution, maturing in May of 1998, with interest
accruing on outstanding balance ranging from LIBOR plus 2%
to 3%, payable monthly, secured by loans warehoused and
associated servicing rights............................... 57,362 --
100,000,000 reverse repurchase agreement with a finance
company, maturing in October of 1998, with interest on
outstanding balance ranging from LIBOR plus 1.10% to
3.25%..................................................... 22,067,606 --
----------- ----------
Total warehouse and revolving working capital
lines of credit................................. $55,603,021 23,996,471
=========== ==========
</TABLE>
F-13
<PAGE> 145
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
The average interest rates pertaining to outstanding short-term borrowings
at December 31, 1997 and 1996, was 7.91 percent and 8.38 percent, respectively.
Effective November 24, 1997, the $2 million revolving line of credit was
renewed and amended to provide $4 million of revolving credit, maturing August
1, 1998. In connection therewith the Company issued a common stock warrant to
the finance company (note 15). The terms of the warrant provided that it could
only be exercised if the Company did not repay in full, the outstanding balance
on the line of credit. If exercised, the warrant entitled the finance company to
purchase for one dollar a number of shares equivalent to a maximum of 13 percent
of the Company's equity on a fully-diluted basis.
Effective December 31, 1997, the finance company converted $2 million of
the $4 million revolving line of credit for 410,581 shares of Class A
convertible preferred stock. Further, the revolving line of credit was renewed
and amended to provide a $2 million revolving credit, maturing January 1, 1999.
In connection with the above noted conversion, the Company granted to the
finance company two warrants to purchase shares of common stock. The first
warrant allows the finance company to purchase, for a nominal amount, up to five
percent of the Company's outstanding common shares (on a fully-diluted basis) if
all principal and interest due under the revolving line of credit is not repaid
on or prior to January 1, 1999. This warrant, if it becomes exercisable, will
remain exercisable for a period of ten years. The second warrant entitles the
finance company to purchase, for a nominal amount, one percent of the Company's
outstanding stock (on a fully-diluted basis) for each calendar quarter during
1998 in which, the Company fails to attain at least 90 percent of a pretax
income target described in the agreement. Entitlements under this warrant may be
exercised prior to the earlier of repayment or January 1, 1999.
Additionally, the warrant issued to the finance company in November 1997
was canceled upon the granting of the two warrants described above.
The Company's warehousing and revolving working capital line of credit
agreements referred to above contain both financial and nonfinancial covenants.
As of December 31, 1997, the Company, with the exception of the $10 million
warehouse line of credit, was in compliance with all covenants under the credit
agreements.
(6) NOTES PAYABLE
Notes payable consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Note payable to a related party, unsecured, with interest on
outstanding balance accruing at 12.0%, paid quarterly,
principal due on December 31, 2000........................ $150,000 --
Note payable to a financial institution, maturing March
2000, with interest on outstanding balance accruing at
11.5%, payable monthly, secured by furniture and
equipment................................................. 38,690 --
Note payable to a financial institution, at a fixed rate of
10.25%, due February 1997................................. -- 250,000
-------- --------
$188,690 250,000
======== ========
</TABLE>
(7) SUBORDINATED DEBT
On December 17, 1996, the Company entered into a subordinated debt
agreement with a finance company that permitted the Company to borrow $850,000
at 15 percent interest if certain origination volumes
F-14
<PAGE> 146
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
were met as described in the agreement; otherwise, the interest rate was 18
percent. The subordinated debt was originally convertible into 429,293 shares of
convertible preferred stock, at the option of the finance company, for a
conversion price of $1.98 per share.
Effective, November 24, 1997, the Company and the finance company modified
the agreement providing for a conversion privilege to common stock. In
accordance with such modifications, the finance company exercised its conversion
privilege by converting the subordinated debt into 546,883 shares of common
stock.
(8) CAPITAL STOCK
The Company's convertible preferred stock entitles the stockholder to
receive a dividend at the annual rate of 18 percent of the original issue price,
of $1.98 per share. The dividends are cumulative and are payable quarterly, in
arrears on the last day of each quarter end. The dividends accrue whether or not
the Company has earnings, funds are legally available for payment, and dividends
are declared. In addition, each share is convertible to common stock at any time
subsequent to issuance, at the option of the stockholder, as determined by
dividing the original issue price by the conversion price defined in the
Certification of Incorporation of the Company.
During December 1996, the Company adopted a stock option plan (the Plan),
which provides for grants of incentive and nonqualified stock options. Under
this Plan, the Company has granted nonqualified stock options to officers,
directors, and other key individuals providing significant services to the
Company. The number of shares, terms, and exercise periods are determined by the
Board of Directors on an option-by-option basis. All options granted have a
ten-year exercise period and vest over a three-year period. An aggregate of
226,905 shares have been authorized for issuance under this plan. None of the
options outstanding as of December 31, 1997 are exercisable.
A summary of the activity for the year ended December 31, 1997 under this
Plan follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
------ ----------------
<S> <C> <C>
Outstanding at beginning of period.......................... -- $ --
Granted..................................................... 97,000 3.96
------ -----
Outstanding at end of period................................ 97,000 $3.96
====== =====
Weighted-average:
Fair value of options granted during the period........... $ 0.68
Remaining contractual life................................ 8.96years
</TABLE>
The Company accounts for the Plan according to APB 25, under which
compensation cost will be recognized over the expected life of the options for
the difference between the exercise price and the related fair value. Inasmuch
as the Company's Board of Directors and management believes, the exercise price
to reflect the fair value of the options at date of grant, no compensation cost
was recorded for the year ended December 31, 1997. Had compensation cost for the
Plan been determined consistent with Statement No. 123, the Company's December
31, 1997 net loss would have been increased as follows:
<TABLE>
<S> <C>
Net loss:
As reported............................................... $1,774,311
Pro forma................................................. 1,786,661
</TABLE>
F-15
<PAGE> 147
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
The effect that calculating compensation cost for stock-based compensation
under Statement No. 123 has on the pro forma net loss as presented above may not
be representative of the effects on reported net earnings or losses for future
years.
The fair value of each option grant is estimated on the date of grant using
an option pricing model with the following weighted-average assumptions: risk
free interest rate of six percent; expected dividend yields of zero percent; and
expected lives of three years.
Subsequent to December 31, 1997, the Company canceled 27,500 options to
employees and a director to acquire shares of common stock at an exercise price
of $3.96.
(9) LOAN SERVICING
For the year ended December 31, 1997, the Company was servicing
approximately eight loans, owned by investors, aggregating $993,384. In
connection with its loan administration activities, the Company makes certain
payments of property taxes, insurance premiums, and guaranteed payments in
advance of collecting them from specific mortgagors.
(10) EMPLOYEE BENEFIT PLANS
The Company has a qualified 401(k) retirement plan for all employees who
have completed three months of service and have attained the age of 21.
Participants are able to contribute, on a pre-tax basis, up to 15 percent of
their earnings to the plan. Employer matching contributions are discretionary,
to be set prior to the end of the plan year, computed quarterly, and allocated
based on the ratio of the participants' compensation to total participants'
compensation.
(11) INCOME TAXES
As discussed in note 2, the Company became subject to income taxes
following the merger on March 7, 1997. There is no income tax subsequent to that
date due to operating losses. The difference between the expected tax benefit
and the actual benefit is primarily attributable to the effect of net operating
losses being offset by the Company's valuation allowance.
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1997, are presented below:
<TABLE>
<S> <C>
Deferred tax asset:
Net operating loss carryforwards.......................... $472,150
Mark to market adjustment................................. 8,750
Other..................................................... 4,000
--------
Total gross deferred tax assets................... 484,900
Deferred tax liabilities -- furniture, fixtures, and
equipment due to differences in depreciation.............. 40,000
--------
Net deferred tax asset before valuation allowance........... 444,900
Less valuation allowance.................................... 444,900
--------
Net deferred tax asset............................ $ --
========
</TABLE>
Subsequently recognized tax benefits relating to the valuation allowance
for deferred tax assets will be allocated as an income tax benefit to be
reported in the statements of operations. At December 31, 1997, the
F-16
<PAGE> 148
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
Company had tax net operating losses approximately of $1,269,000, which can be
carried forward to reduce federal income taxes.
(12) LEASES
The Company is obligated under operating leases for furniture, equipment,
and office space. In addition, the Company leases certain office equipment under
agreements that are recorded as capital leases. Future minimum lease payments
under noncancelable operating leases (with initial or remaining lease terms in
excess of one year) and minimum capital lease payments as of December 31, 1997,
are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
Period ending December 31:
1998...................................................... $216,835 $ 763,387
1999...................................................... 160,310 705,032
2000...................................................... 48,544 627,884
2001...................................................... 5,701 595,820
2002...................................................... 2,315 155,272
-------- ----------
Total minimum lease payments...................... 433,705 $2,847,395
==========
Less amount representing interest........................... 67,018
--------
Present value of net minimum lease payments....... $366,687
========
</TABLE>
Furniture and equipment held under capital leases and the related
accumulated amortization at December 31, 1997, is as follows:
<TABLE>
<S> <C>
Furniture and fixtures...................................... $111,114
Office machinery and equipment.............................. 363,416
Computers................................................... 68,093
--------
542,623
Less accumulated amortization............................... 109,586
--------
$433,037
========
</TABLE>
Rental expense under operating leases was $648,314 and $277,377 for the
year ending December 31, 1997 and the period from February 7, 1996 (date of
inception) to December 31, 1996, respectively.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made using amounts that have been determined using available
market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts that could be realized in a current market
exchange. The use of the different market assumptions or estimation
methodologies could have a material impact on the estimated fair value amounts.
F-17
<PAGE> 149
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------ -----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents..................... $ 708,962 708,962 272,308 272,308
Mortgage loans held for sale.................. 54,451,067 56,127,600 24,147,713 24,402,600
Receivables................................... 1,379,878 1,379,878 120,731 120,731
Deposits...................................... 86,549 86,549 56,762 56,762
Restricted cash............................... 56,478 56,478 90,009 90,009
Financial liabilities:
Accounts payable.............................. $ 377,110 377,110 207,442 207,442
Accrued interest and other liabilities........ 796,376 796,376 536,026 536,026
Warehouse and revolving working capital lines
of credit.................................. 55,603,021 55,603,021 23,996,471 23,996,471
Notes payable................................. 188,690 188,690 250,000 250,000
</TABLE>
The carrying amounts reported in the balance sheets for cash and cash
equivalents, receivables, deposits, restricted cash, accounts payable, accrued
interest, and other liabilities approximate fair value because of the immediate
or short-term maturity of these financial instruments. The fair value of
mortgage loans held for sale is estimated based on quoted marked prices from
dealers and brokers for similar types of mortgage loans. The warehouse and
revolving working capital lines of credit are variable-rate debt which reprice
with the change in market rates, as such, their carrying amounts are deemed to
approximate fair value.
(14) COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company.
(15) CONCENTRATIONS OF CREDIT RISK
A significant portion of loans originated and purchased, and held for sale
are single family residence mortgage loans.
For the year ended December 31, 1997, mortgage loans purchased and
originated by the Company were geographically concentrated in Utah, Florida,
Georgia, and California. The Company has no other significant concentration of
credit risk. The Company manages its credit risk through diversification of
markets in which the Company originates and purchases mortgage loans.
F-18
<PAGE> 150
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM FEBRUARY 7, 1996
(DATE OF INCEPTION) TO DECEMBER 31, 1996
(16) RELATED PARTY
One of the Company's holders of 662,698 shares Class A convertible
preferred stock and 546,883 shares common stock is a finance company from which
the Company has borrowings as follows as of December 31, 1997 and 1996,
respectively (notes 5 and 7):
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Warehouse line of credit................... $31,692,828 $4,068,453
=========== ==========
Revolving working capital line of credit... $ 1,785,225 $ 200,000
=========== ==========
</TABLE>
The Company is obligated to offer to sell to the finance company 75 percent
of the principal balance of all subprime mortgage loan monthly production by the
Company for 1997 and 1996, 50 percent in 1998, and 25 percent thereafter until
2000. For the periods ended December 31, 1997 and 1996, the Company sold, under
this agreement, loan production in the amounts of $98,042,000 and $16,140,000,
respectively.
F-19
<PAGE> 151
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
BALANCE SHEET
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, 1998
--------------
<S> <C>
ASSETS
Cash and cash equivalents................................... $ 968,954
Mortgage loans held for sale................................ 53,306,731
Receivables................................................. 1,143,520
Furniture, fixtures, and equipment, net..................... 1,308,996
Deposits.................................................... 92,466
Restricted Cash............................................. 49,573
Organization costs, net of accumulated amortization of
$9,099 March 31, 1998 and $6,824 at December 31, 1997..... 36,394
Prepaid expense............................................. 380,564
Other assets................................................ 513,804
-----------
Total assets........................................... $57,801,002
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Accounts payable............................................ $ 274,909
Accrued interest and other liabilities...................... 746,872
Warehouse and revolving working capital lines of credit..... 54,440,517
Notes payable............................................... 534,866
Obligations under capital leases............................ 339,701
Dividends payable........................................... 185,763
-----------
Total liabilities...................................... 56,522,628
Stockholders' Equity
Class A Convertible Preferred Stock, $.001 par value,
1,268,950 shares authorized; 1,263,472 issued and
outstanding............................................... 1,263
Common Stock, $.001 par value, 2,609,407 shares authorized;
1,546,983 issued and outstanding.......................... 1,547
Additional paid-in capital.................................. 2,953,493
Accumulated deficit......................................... (1,677,929)
-----------
Total stockholders' equity............................. 1,278,374
-----------
Total liabilities and stockholders' equity............. $57,801,002
===========
</TABLE>
See accompanying note to financial statements.
F-20
<PAGE> 152
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Revenues:
Interest.................................................. $1,731,480 218,321
Gain-on-sale of mortgage loans, net....................... 1,971,551 644,701
Mortgage servicing fees................................... 1,886 37,028
Other..................................................... 269,296 68
---------- ----------
3,974,213 900,118
---------- ----------
Expenses:
Salaries and employee benefits............................ 1,567,600 596,768
General operating......................................... 1,316,603 606,731
Interest.................................................. 1,133,174 400,558
Other..................................................... 28,118 15,184
---------- ----------
4,045,495 1,619,241
---------- ----------
Net loss.................................................... $ (71,282) (719,123)
========== ==========
</TABLE>
See accompanying note to financial statements.
F-21
<PAGE> 153
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
CLASS A
CONVERTIBLE ADDITIONAL TOTAL
PREFERRED COMMON PAID-IN ACCUMULATED STOCKHOLDERS'
STOCK STOCK CAPITAL DEFICIT EQUITY
----------- ------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balances at January 1, 1998.............. $1,263 1,547 2,953,493 (1,494,072) 1,462,231
Cumulative dividend -- Class A
convertible preferred stock............ (112,575) (112,575)
Net loss................................. (71,282) (71,282)
------ ----- --------- ---------- ---------
Balances at March 31, 1998............... $1,263 1,547 2,953,493 (1,677,929) 1,278,374
====== ===== ========= ========== =========
</TABLE>
See accompanying note to financial statements.
F-22
<PAGE> 154
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (71,282) (719,123)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization.......................... 84,806 20,834
Net decrease in mortgage loans held for sale........... 3,115,887 8,287,856
Gain on sales of mortgage loans held for sale, net..... (1,971,551) (644,701)
Changes in operating assets and liabilities:
Decrease (increase) in receivables................... 236,358 (197,017)
Decrease (increase) in deposits...................... (5,917) 6,000
Decrease in restricted cash.......................... 6,905 56,607
Increase in organization costs....................... -- (23,447)
Decrease in prepaid expense.......................... 119,610 1,807
Increase in other assets............................. (194,247) --
Increase (decrease) in accounts payable.............. (49,504) 39,370
Decrease in accrued interest and other liabilities... (102,201) (205,286)
----------- -----------
Net cash provided by operating activities......... 1,168,864 6,622,900
----------- -----------
Cash flows from investing activities:
Purchase of furniture, fixtures, and equipment............ (65,558) (101,180)
----------- -----------
Net cash used in investing activities............. (65,558) (101,180)
----------- -----------
Cash flows from financing activities:
Proceeds from warehouse and revolving working capital
lines of credit, net................................... (1,162,504) (7,233,720)
Proceeds from issuance of notes payable................... 350,000 --
Payments on notes payable................................. (3,824) (250,000)
Payments on obligations under capital leases.............. (26,986) (42,383)
Proceeds from subordinated debt........................... -- 850,000
Proceeds from issuance of preferred stock................. -- 500,000
----------- -----------
Net cash used in financing activities............. (843,314) (6,176,103)
----------- -----------
Net increase in cash and cash equivalents................... 259,992 345,617
Cash and cash equivalents at the beginning of the period.... 708,962 272,308
----------- -----------
Cash and cash equivalents at end of the period.............. $ 968,954 617,925
=========== ===========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest.................................... $ 1,167,836 361,784
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES
Capital lease obligations incurred for furniture, fixture,
and equipment............................................. $ -- 118,013
Conversion of members capital to preferred, common stock,
and additional paid-in capital............................ -- 1,438,396
Transfer of Continental Mortgage Group L.C. accumulated
deficit to additional paid-in capital..................... -- 1,833,694
</TABLE>
See accompanying note to financial statements.
F-23
<PAGE> 155
CMG FUNDING CORP.
(FORMERLY CONTINENTAL MORTGAGE GROUP L.C.)
NOTE TO FINANCIAL STATEMENTS
(UNAUDITED)
BASIS OF PRESENTATION
The unaudited financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included.
F-24
<PAGE> 156
======================================================
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 1
Risk Factors.......................... 19
The Company........................... 40
Use of Proceeds....................... 40
Dividend Policy and Distributions..... 41
Dividend Reinvestment Plan............ 42
Dilution.............................. 43
Capitalization........................ 44
Selected Financial Data of RealTrust
Asset Corporation and CMG Funding
Corp. .............................. 47
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 48
Business.............................. 52
Management............................ 83
Structure and Formation
Transactions........................ 93
Conflicts of Interest and Related
Party Transactions.................. 95
Principal Stockholders................ 98
Description of Capital Stock.......... 99
Shares Eligible for Future Sale....... 108
Federal Income Tax Considerations..... 110
Underwriting.......................... 119
Legal Matters......................... 121
Experts............................... 121
Additional Information................ 121
Glossary.............................. 122
Table of Contents to Financial
Statements.......................... F-1
- --------------------------------------------
NO DEALER, SALES REPRESENTATIVE OR OTHER
PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS IN
CONNECTION WITH THIS OFFERING OTHER THAN
THOSE CONTAIN IN THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH OTHER INFORMATION AND
REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE
UNDERWRITERS. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN
THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT
TO ITS DATE. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES OTHER THAN THE REGISTERED
SECURITIES TO WHICH IT RELATES. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY
SUCH SECURITIES IN ANY CIRCUMSTANCES IN
WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL.
UNTIL , 1998, ALL DEALERS
EFFECTING TRANSACTIONS IN THE UNITS, WHETHER
OR NOT PARTICIPATING IN THIS DISTRIBUTION,
MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT 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.
============================================
</TABLE>
======================================================
[RealTrust logo]
4,000,000 UNITS
REALTRUST ASSET
CORPORATION
CONSISTING OF ONE SHARE
OF COMMON STOCK AND
ONE STOCK PURCHASE
WARRANT
------------------------
Prospectus
June , 1998
------------------------
STIFEL, NICOLAUS & COMPANY
INCORPORATED
======================================================
<PAGE> 157
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 30. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the sale of Common Stock being registered. All amounts are estimates except
the SEC registration fee and the American Stock Exchange ("AMEX") filing fee.
<TABLE>
<CAPTION>
AMOUNT
TO BE
PAID
------
<S> <C>
SEC Registration Fee........................................ $ 55,094.71
AMEX filing fee............................................. $ 50,000.00
NASD filing fee............................................. $ 8,000.00
Printing and engraving expenses............................. $ 150,000.00
Legal fees and expenses..................................... $ 300,000.00
Accounting fees and expenses................................ $ 300,000.00
Blue Sky fees and expenses.................................. $ 50,000.00
Transfer agent and custodian fee............................ $ 5,000.00
Miscellaneous............................................... $ 181,902.29
-------------
Total............................................. $1,100,000.00
=============
</TABLE>
- ---------------
* To be filed by amendment
All amounts estimated except for Securities and Exchange Commission
registration fee.
ITEM 32. SALES TO SPECIAL PARTIES.
See Item 33 for description of securities of the Company issued to
affiliates of the Company for cash and other consideration.
II-1
<PAGE> 158
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
Issuance to CMG Funding Shareholders
On April 15, 1998, the shareholders of the Taxable Subsidiary contributed
certain shares of the Taxable Subsidiary capital stock to RealTrust in exchange
for the issuance of identical classes and number of RealTrust shares. This
issuance was contemplated as part of the Formation Transaction, and is described
in the Prospectus. Set forth below are the names of each stockholder of the
Taxable Subsidiary receiving shares and the number of shares (after giving
effect to the stock split anticipated to occur immediately prior to the
closing).
<TABLE>
<CAPTION>
NO. OF
RECIPIENT RELATIONSHIP TO COMPANY SHARES
--------- ----------------------- -------
<S> <C> <C>
John D. Fry............................. Chairman, Chief Executive Officer & President 298,392
Terry L. Mott........................... Executive Vice President & Director 92,987
Patrick Croghan......................... Vice President 72,478
Shauna Reimann.......................... Vice President 72,478
William Reed............................ Vice President 48,319
David and Sara Ferradino................ None -- accredited investor 14,479
Brenda Colson........................... Employee 14,479
Kent Bills.............................. Secretary 43,028
ContiFinancial Corporation.............. None -- accredited investor 327,730
410,581*
</TABLE>
* Shares of the Company's Class B Preferred Stock, which are expected to be
redeemed after the closing of this Offering.
All of such shares were issued pursuant to exemptions from registration
provided by Section 4(2) and Rule 506 of Regulation D. The sale was made to nine
persons, most of whom are accredited investors either as a result of their
financial status and degree of sophistication or as a result of their position
as an officer or director of the Registrant. The consideration paid in all cases
was the capital stock of the Taxable Subsidiary.
Issuance to Capstone Investments, Inc.
On March 18, 1998, RealTrust issued to Capstone Investments, Inc., a
corporation controlled by stockholders David and Sara Ferradino, a Convertible
Secured Promissory Note in the principal amount of $850,000 and warrants to
purchase 50,000 shares of Registrant's Common Stock at an exercise price equal
to the Price to Public in this offering. The Note is convertible into Units to
be issued in the Offering at a conversion price equal to the Price to Public.
The consideration paid was $850,000 of cash, without any discount or
commissions. The issuance was exempt from registration pursuant to the
exemptions provided by Section 4(2) and Rule 505 of Regulation D. The Registrant
believes that the one investor is accredited under Rule 501.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Maryland GCL provides that a Maryland corporation may indemnify any person
who is or was serving at the request of the corporation as a director, officer,
partner, trustee, employee, or agent of another foreign or domestic corporation,
partnership, joint venture, trust or other enterprise or employee benefit plan
("director"), that is made a party to any proceeding by reason of service in
that capacity unless it is established that the act or omission of the director
was material to the matter giving rise to the proceeding and was committed in
bad faith or was the result of active and deliberate dishonesty; or the director
actually received an improper personal benefit in money, property or services;
or, in the case of any criminal proceeding, the director had reasonable cause to
believe that the act or omission was unlawful. Indemnification may be against
judgments, penalties, fines, settlements, and reasonable expenses actually
incurred by the director in connection with the proceeding, but if the
proceeding was won by or in the right of the corporation, indemnification may
not be made in respect of any proceeding in which the director shall be adjudged
to be liable to the corporation. Such
II-2
<PAGE> 159
indemnification may not be made unless authorized for a specific proceeding
after a determination has been made, in a manner prescribed by law, that
indemnification is permissible in the circumstances because the director has met
the applicable standard of conduct. The director must be indemnified for
expenses, however, if he has been successful in the defense of the proceeding or
as otherwise ordered by a court. The law also prescribes the circumstances under
which a corporation may advance expenses to, or obtain insurance or similar
coverage for directors.
The Company's Amended and Restated Articles of Incorporation provide for
indemnification of the officers and directors of the Company and eliminate the
liability of a director or officer to the Company or its stockholders for money
damages to the fullest extent permitted by Maryland law.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements
(b) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
** 1.1 Underwriting Agreement with Stifel, Nicolaus & Company,
Incorporated.
** 3.1 Amended and Restated Articles of Incorporation.
* 3.2 Bylaws.
* 4.1 Specimen Stock Certificate for Common Stock of RealTrust
Asset Corporation.
* 4.2 Warrant Agreement.
* 4.3 1996 Stock Option Plan of CMG Funding Corp.
** 4.4 Form of 1996 Stock Option Agreement.
* 4.5 1998 Stock Option Plan of RealTrust Asset Corporation.
** 4.6 Form of 1998 Stock Option Agreement.
** 4.7 Form of Registration Rights Agreement.
* 4.8 Warrant Agreement No. 2 with ContiFinancial Corporation.
* 4.9 Warrant Agreement No. 3 with ContiFinancial Corporation.
* 4.10 Warrant Agreement with Capstone Investments, Inc.
* 4.11 Convertible Secured Note in favor of Capstone Investments,
Inc.
* 4.12 Contribution Agreement with stockholders of CMG Funding
Corp. and RealTrust Asset Corporation.
* 4.13 Bonus Incentive Plan of RealTrust Asset Corporation.
** 5.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP regarding
legality of Securities.
* 8.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP regarding
certain tax matters.
*10.1 Employment Agreement with John D. Fry.
*10.2 Employment Agreement with Terry L. Mott.
*10.3 Employment Agreement with John P. McMurray.
*10.4 Employment Agreement with Steven K. Passey.
*10.5 Investment Banking Service Agreement with ContiFinancial
Corporation, as amended.
*10.6 Loan Servicing Agreement with Advanta Mortgage Corp USA for
CMG Funding Corp., as amended.
</TABLE>
II-3
<PAGE> 160
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
*10.7 Loan Servicing Agreement with Nomura Asset Capital
Corporation for CMG Funding Corp.
*10.8 Purchase and Sale Agreement between ContiTrade Services LLC
and CMG Funding Corp., as amended.
*10.9 Master Repurchase Agreement Governing Purchase and Sales of
Mortgage Loans with Nomura Asset Capital Corporation.
*10.10 Standby and Working Capital Agreement between ContiTrade
Services LLC and CMG Funding Corp., as amended.
*10.11 Conversion Letter No. 1 from ContiFinancial Corporation.
*10.12 Conversion Letter No. 2 from ContiFinancial Corporation.
*10.13 Registration Rights Agreement with ContiFinancial
Corporation.
*10.14 Mortgage Loan Purchase Agreement between RealTrust Asset
Corporation and CMG Funding Corp.
*21.1 List of subsidiaries.
*23.1 Consent of Counsel (included in Exhibit (5.1).
**23.2 Consents of independent auditors.
*23.3 Consents of Independent Directors.
24.1 Power of Attorney (included in signature page).
*27.1 Financial Data Schedule.
</TABLE>
- ---------------
* Previously Filed.
** Filed herewith.
ITEM 37. UNDERTAKINGS
A. The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) To include any Prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the Prospectus any facts or events arising after
the effective date to the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the Registration Statement; and
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the Registration Statement
or any material change to such information in the Registration
Statement;
Provided, however, that paragraphs A(1)(i) and A(1)(ii) do not apply
if the information required to be included in a post-effective amendment by
those paragraphs is contained in the periodic reports filed by the
Registrant pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 that are incorporated by reference in the Registration Statement
(2) That, for the purpose of determining liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new Registration Statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof;
II-4
<PAGE> 161
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
B. The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at the time shall be deemed to be the initial bona fide offering thereof.
II-5
<PAGE> 162
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the undersigned
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 Salt Lake City, Utah, on the 11th day of June, 1998.
REALTRUST ASSET CORPORATION
By: /s/ JOHN D. FRY
------------------------------------
John D. Fry
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints John D. Fry and Terry L. Mott, and each of them,
his true and lawful attorneys-in-fact and agent, with full power of substitution
and resubstitution, for him and in his name, and in any and all capacities, to
sign any and all amendments (including post-effective amendments) to the
Registration Statement to which this power of attorney is attached, as well as
any registration statement (or amendment thereto) relating to one or more of the
offerings covered hereby filed pursuant to Rule 462(b) promulgated under the
Securities Act of 1933, as amended, and to file the same and all exhibits to
them and other documents to be filed in connection with them, with the
Securities and Exchange Commission.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities as Directors and Officers of RealTrust Asset Corporation on the date
indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ JOHN D. FRY Chairman, Chief Executive June 11, 1998
- ----------------------------------------------------- Officer and President
John D. Fry
/s/ STEVEN K. PASSEY Chief Financial Officer June 11, 1998
- ----------------------------------------------------- and Treasurer
Steven K. Passey (principal accounting officer)
/s/ TERRY L. MOTT Director June 11, 1998
- -----------------------------------------------------
Terry L. Mott
/s/ CARTER E. JONES Director June 11, 1998
- -----------------------------------------------------
Carter E. Jones
</TABLE>
II-6
<PAGE> 163
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
------- ----------- ------------
<C> <S> <C>
** 1.1 Underwriting Agreement with Stifel, Nicolaus & Company,
Incorporated.
** 3.1 Amended and Restated Articles of Incorporation.
* 3.2 Bylaws.
* 4.1 Specimen Stock Certificate for Common Stock of RealTrust
Asset Corporation.
* 4.2 Warrant Agreement.
* 4.3 1996 Stock Option Plan of CMG Funding Corp.
** 4.4 Form of 1996 Stock Option Agreement.
* 4.5 1998 Stock Option Plan of RealTrust Asset Corporation.
** 4.6 Form of 1998 Stock Option Agreement.
** 4.7 Form of Registration Rights Agreement.
* 4.8 Warrant Agreement No. 2 with ContiFinancial Corporation.
* 4.9 Warrant Agreement No. 3 with ContiFinancial Corporation.
* 4.10 Warrant Agreement with Capstone Investments, Inc.
* 4.11 Convertible Secured Note in favor of Capstone Investments,
Inc.
* 4.12 Contribution Agreement with stockholders of CMG Funding
Corp. and RealTrust Asset Corporation.
* 4.13 Bonus Incentive Plan of RealTrust Asset Corporation.
** 5.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP regarding
legality of Securities.
* 8.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP regarding
certain tax matters.
*10.1 Employment Agreement with John D. Fry.
*10.2 Employment Agreement with Terry L. Mott.
*10.3 Employment Agreement with John P. McMurray.
*10.4 Employment Agreement with Steven K. Passey.
*10.5 Investment Banking Service Agreement with ContiFinancial
Corporation, as amended.
*10.6 Loan Servicing Agreement with Advanta Mortgage Corp USA for
CMG Funding Corp., as amended.
*10.7 Loan Servicing Agreement with Nomura Asset Capital
Corporation for CMG Funding Corp.
*10.8 Purchase and Sale Agreement between ContiTrade Services LLC
and CMG Funding Corp., as amended.
*10.9 Master Repurchase Agreement Governing Purchase and Sales of
Mortgage Loans with Nomura Asset Capital Corporation.
*10.10 Standby and Working Capital Agreement between ContiTrade
Services LLC and CMG Funding Corp., as amended.
*10.11 Conversion Letter No. 1 from ContiFinancial Corporation.
*10.12 Conversion Letter No. 2 from ContiFinancial Corporation.
*10.13 Registration Rights Agreement with ContiFinancial
Corporation.
*10.14 Mortgage Loan Purchase Agreement between RealTrust Asset
Corporation and CMG Funding Corp.
*21.1 List of subsidiaries.
</TABLE>
<PAGE> 164
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
------- ----------- ------------
<C> <S> <C>
*23.1 Consent of Counsel (included in Exhibit (5.1).
**23.2 Consents of independent auditors.
*23.3 Consents of Independent Directors.
24.1 Power of Attorney (included in signature page).
*27.1 Financial Data Schedule.
</TABLE>
- ---------------
* Previously Filed.
** Filed herewith.
<PAGE> 1
EXHIBIT 1.1
- --------------------------------------------------------------------------------
4,000,000 UNITS
REALTRUST ASSET CORPORATION
EACH UNIT TO CONSIST OF
ONE SHARE OF COMMON STOCK AND
ONE STOCK PURCHASE WARRANT
FORM OF
UNDERWRITING AGREEMENT
DATED _____ __, 1998
STIFEL, NICOLAUS & COMPANY, INCORPORATED
- --------------------------------------------------------------------------------
<PAGE> 2
UNDERWRITING AGREEMENT
________ __, 1998
STIFEL, NICOLAUS & COMPANY, INCORPORATED
As Representative of the several Underwriters
c/o STIFEL, NICOLAUS & COMPANY, INCORPORATED
500 North Broadway, Suite 1500
St. Louis, Missouri 63102
Ladies and Gentlemen:
INTRODUCTORY. RealTrust Asset Corporation (the "Company"), a Maryland
corporation intending to qualify for federal income tax purposes as a real
estate investment trust ("REIT") pursuant to Sections 856 through 860 of the
Internal Revenue Code of 1986, as amended, and the rules and regulations
thereunder, as may be amended from time to time (the "Tax Code"), proposes to
issue and sell to the several underwriters named in Schedule 1 (the
"Underwriters") an aggregate of 4,000,000 units (the "Firm Units"), each Firm
Unit consisting of one share of the Company's common stock, par value $0.001
per share (the "Common Stock"), and one warrant to purchase one share of Common
Stock (a "Warrant"). In addition, the Company has granted to the Underwriters
an option to purchase up to an additional 600,000 units (the "Optional Units"),
as provided in Section 2. The Firm Units and, if and to the extent such option
is exercised, the Optional Units are collectively called the "Units." Stifel,
Nicolaus & Company, Incorporated has agreed to act as representative of the
several Underwriters (in such capacity, the "Representative") in connection
with the offering and sale of the Units.
The terms of the Warrants shall be as set forth in the warrant
agreement (the "Warrant Agreement") to be entered into by the Company and the
warrant agent on the First Closing Date (as hereinafter defined) in
substantially the form filed as Exhibit 4.2 to the Registration Statement (as
hereinafter defined). Each Warrant entitles the holders thereof to purchase
one share (subject to certain antidilution provisions) of the Company's Common
Stock for [______ Dollars ($__.00)]. The Warrants will become exercisable six
months after the First Closing Date and will remain exercisable until 5:00
p.m., New York time, on the third anniversary of the date the Warrants first
become exercisable.
The shares of Common Stock which in part comprise the Units are herein
referred to as the "Unit Shares." The shares of Common Stock issuable upon
exercise of the Warrants and the Representative's Warrants (as hereinafter
defined) are herein referred to as the "Warrant Shares." The Unit Shares and
the Warrant Shares are herein collectively referred to as the "Shares."
1
<PAGE> 3
The Company has prepared and filed with the Securities and Exchange
Commission (the "Commission") a registration statement on Form S-11 (File No.
333-[_____]), which contains a form of prospectus to be used in connection with
the public offering and sale of the Units. Such registration statement, as
amended, including the financial statements, exhibits and schedules thereto, in
the form in which it was declared effective by the Commission under the
Securities Act of 1933 and the rules and regulations promulgated thereunder
(collectively, the "Securities Act"), including any information deemed to be a
part thereof at the time of effectiveness pursuant to Rule 430A or Rule 434
under the Securities Act, is called the "Registration Statement." Any
registration statement filed by the Company pursuant to Rule 462(b) under the
Securities Act is called the "Rule 462(b) Registration Statement," and from and
after the date and time of filing of the Rule 462(b) Registration Statement the
term "Registration Statement" shall include the Rule 462(b) Registration
Statement. Such prospectus, in the form first used by the Underwriters to
confirm sales of the Units, is called the "Prospectus"; provided, however, if
the Company has, with the consent of the Representative, elected to rely upon
Rule 434 under the Securities Act, the term "Prospectus" shall mean the
Company's prospectus subject to completion (each, a "preliminary prospectus")
dated [June __, 1998] (such preliminary prospectus is called the "Rule 434
preliminary prospectus"), together with the applicable term sheet (the "Term
Sheet") prepared and filed by the Company with the Commission under Rules 434
and 424(b) under the Securities Act and all references in this Agreement to the
date of the Prospectus shall mean the date of the Term Sheet. All references
in this Agreement to the Registration Statement, the Rule 462(b) Registration
Statement, a preliminary prospectus, the Prospectus or the Term Sheet, or any
amendments or supplements to any of the foregoing, shall include any copy
thereof filed with the Commission pursuant to its Electronic Data Gathering,
Analysis and Retrieval System ("EDGAR").
On or before the First Closing Date (as hereinafter defined), the
following transactions: (i) the stockholders of CMG Funding Corp., a Delaware
corporation (the "Taxable Subsidiary"), will have contributed 95% of their
capital stock of the Taxable Subsidiary to the Company for shares of the
Company's capital stock and (ii) the other transactions to be consummated on or
before the First Closing Date as set forth in the Prospectus under the caption
"Structure and Formation Transactions" (all of the foregoing, collectively, the
"Formation Transactions") shall be consummated. The documents required to be
executed and delivered in order to consummate the Formation Transactions,
including, without limitation, the documents listed on Schedule 2 hereto, are
hereinafter collectively referred to as the "Formation Documents," and each
Formation Document constituting an agreement is hereinafter referred to as a
"Formation Agreement."
For purposes of this Agreement, the term "Subsidiary," with
respect to the Company, refers to each corporation, partnership, association,
limited liability company, joint venture or other business entity of which more
than 50% of the total voting power of shares of stock or other ownership
interest entitled (without regard to the occurrence of any contingency) to vote
in the election of the person or persons (whether directors, managers,
partners, trustees or other persons performing similar functions) having the
power to direct or cause the direction of the management and policies thereof
is at the time owned or controlled, directly or indirectly, by the Company
2
<PAGE> 4
or one or more of the other Subsidiaries of the Company or a combination
thereof, including, without limitation, the Taxable Subsidiary and CMG Funding
Securities Corp.
The Company hereby confirms its agreements with the Underwriters as
follows:
SECTION 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY.
The Company hereby represents, warrants and covenants to each
Underwriter as follows:
(a) Compliance with Registration Requirements. The Registration
Statement and any Rule 462(b) Registration Statement have been declared
effective by the Commission under the Securities Act. The Company has
complied to the Commission's satisfaction with all requests of the
Commission for additional or supplemental information. No stop order
suspending the effectiveness of the Registration Statement or any Rule
462(b) Registration Statement is in effect and no proceedings for such
purpose have been instituted or are pending or, to the best knowledge of
the Company, are contemplated or threatened by the Commission.
Each preliminary prospectus and the Prospectus when filed complied in
all material respects with the Securities Act and, if filed by electronic
transmission pursuant to EDGAR, was identical (except as may be permitted
by Regulation S-T under the Securities Act) to the copy thereof delivered
to the Underwriters for use in connection with the offer and sale of the
Units. Each of the Registration Statement, any Rule 462(b) Registration
Statement and any post-effective amendment thereto, at the time it became
effective and at all subsequent times, complied and shall comply in all
material respects with the Securities Act and did not and shall not contain
any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein
not misleading. The Prospectus, as amended or supplemented, as of its date
and at all subsequent times, did not and will not contain any untrue
statement of a material fact or omit to state a material fact necessary in
order to make the statements therein, in the light of the circumstances
under which they were made, not misleading. The representations and
warranties set forth in the two immediately preceding sentences do not
apply to statements in or omissions from the Registration Statement, any
Rule 462(b) Registration Statement, or any post-effective amendment
thereto, or the Prospectus, or any amendments or supplements thereto, made
in reliance upon and in conformity with information relating to any
Underwriter furnished to the Company in writing by the Representative
expressly for use therein. The Company acknowledges that, for all purposes
of this agreement, the only information relating to any Underwriter
furnished by the Representative for inclusion in the Registration Statement
or the Prospectus is the information set forth in Schedule 3. There are no
contracts or other documents required to be described in the Prospectus or
to be filed as exhibits to the Registration Statement which have not been
described or filed as required.
(b) Offering Materials Furnished to Underwriters. The Company has
delivered to counsel for the Representative one complete manually signed
copy of the Registration Statement (and
3
<PAGE> 5
each amendment thereto) and of each consent and certificate of experts
filed as a part thereof, and conformed copies of the Registration Statement
(without exhibits) and preliminary prospectuses and the Prospectus, as
amended or supplemented, in such quantities and at such places as the
Representative has reasonably requested for each of the Underwriters.
(c) Distribution of Offering Material By the Company. The Company
has not distributed and will not distribute, prior to the later of the
Second Closing Date (as hereinafter defined) and the completion of the
Underwriters' distribution of the Units, any offering material in
connection with the offering and sale of the Units other than a preliminary
prospectus, the Prospectus or the Registration Statement, and other
materials, if any, permitted by the Securities Act.
(d) The Underwriting Agreement. This Agreement has been duly
authorized, executed and delivered by, and is a valid and binding agreement
of, the Company enforceable in accordance with its terms, except as rights
to indemnification hereunder may be limited by applicable law and except as
the enforcement hereof may be limited by bankruptcy, insolvency,
reorganization, moratorium or other similar laws relating to or affecting
the rights and remedies of creditors or by general equitable principles.
(e) Warrant Agreement and Formation Agreements. The Warrant
Agreement and each Formation Agreement to which the Company or any
Subsidiary is a party has been, or will be upon execution and delivery
thereof, duly authorized, executed and delivered by the Company and each
Subsidiary party thereto. The Company, each Subsidiary and, to the
knowledge of the Company, each other party to the Warrant Agreement and
each Formation Agreement has full legal right, power and authority to enter
into each such agreement and to consummate the transactions contemplated
therein. The Warrant Agreement and each Formation Agreement does or will,
as applicable, constitute a valid and binding agreement of the Company and
each Subsidiary which is a party thereto enforceable in accordance with its
terms, except as the enforcement thereof may be limited by bankruptcy,
insolvency, reorganization, moratorium or other similar laws relating to or
affecting the rights and remedies of creditors or by general equitable
principles. Neither the Company nor any Subsidiary nor, to the knowledge
of the Company, any other party is or upon completion of the offering and
all related transactions will be in breach of or default under the Warrant
Agreement or any Formation Agreement.
(f) Authorization of the Shares, Warrants, Representative's Warrants
and Units. The Shares, Warrants, Representative's Warrants and Units have
been duly authorized for issuance and sale pursuant to this Agreement and
the Warrant Agreement and, when issued and delivered by the Company
pursuant to this Agreement or the Warrant Agreement, will be validly
issued, fully paid and nonassessable. Additionally, the Company has
reserved a sufficient number of shares of Common Stock to permit the
issuance of shares of Common Stock upon exercise of the Representative's
Warrants and Warrants in accordance with the terms thereof.
4
<PAGE> 6
(g) No Applicable Registration or Other Similar Rights. There are no
persons with registration or other similar rights to have any equity or
debt securities registered for sale under the Registration Statement or
included in the offering contemplated by this Agreement, except for such
rights as have been duly waived.
(h) No Material Adverse Change. Except as otherwise disclosed in the
Prospectus, subsequent to the respective dates as of which information is
given in the Prospectus: (i) there has been no material adverse change, or
any development that could reasonably be expected to result in a material
adverse change, in the condition, financial or otherwise, or in the
earnings, business, operations or prospects, whether or not arising from
transactions in the ordinary course of business, of the Company and its
Subsidiaries, considered as one entity (any such change is called a
"Material Adverse Change"); (ii) the Company and its Subsidiaries,
considered as one entity, has not incurred any material liability or
obligation, indirect, direct or contingent, not in the ordinary course of
business nor entered into any material transaction or agreement not in the
ordinary course of business; (iii) there has been no dividend or
distribution of any kind declared, paid or made by the Company or, except
for dividends paid to the Company or other Subsidiaries, any of its
Subsidiaries on any class of capital stock or repurchase or redemption by
the Company or any of its Subsidiaries of any class of capital stock,
provided that the Company may declare and pay in the ordinary course of
business any dividend required by the rights, preferences and privileges of
the Series A Preferred Stock held by ContiFinancial Corporation, and
provided further that the Company may declare and pay any dividend required
by the REIT provisions of the Tax Code; and (iv) neither the Company nor
any Subsidiary has sustained any material loss or interference with its
respective businesses or properties from fire, flood, windstorm, accident
or other calamity, whether or not covered by insurance.
(i) Independent Accountants. KPMG Peat Marwick LLP, who have
expressed their opinion with respect to the financial statements (which
term as used in this Agreement includes the related notes thereto) and
supporting schedules filed with the Commission as a part of the
Registration Statement and included in the Prospectus, are independent
public or certified public accountants as required by the Securities Act.
(j) Preparation of the Financial Statements. The financial
statements filed with the Commission as a part of the Registration
Statement and included in the Prospectus present fairly the consolidated
financial position of the Company and its consolidated Subsidiaries as of
and at the dates indicated and the results of their operations and cash
flows for the periods specified. The supporting schedules included in the
Registration Statement present fairly the information required to be stated
therein. Such financial statements and supporting schedules have been
prepared in conformity with generally accepted accounting principles
applied on a consistent basis throughout the periods involved, except as
may be expressly stated in the related notes thereto. No other financial
statements or supporting schedules are required to be included in the
Registration Statement. The financial data set forth in the Prospectus
under the captions "Selected Financial Data" and "Capitalization" fairly
present the information set forth therein on a basis consistent with that
of the audited financial statements contained in the
5
<PAGE> 7
Registration Statement. The pro forma consolidated financial statement of
the Company and its Subsidiaries and the related notes thereto included
under the caption [___________] and elsewhere in the Prospectus and in the
Registration Statement present fairly the information contained therein,
have been prepared in accordance with the Commission's rules and guidelines
with respect to pro forma financial statements and have been properly
presented on the bases described therein, and the assumptions used in the
preparation thereof are reasonable and the adjustments used therein are
appropriate to give effect to the transactions and circumstances referred
to therein.
(k) Incorporation and Good Standing of the Company and its
Subsidiaries. Each of the Company and its Subsidiaries has been duly
incorporated or formed, as the case may be, and is validly existing and in
good standing under the laws of the jurisdiction of its incorporation or
formation and has all requisite power and authority to own, lease and
operate its properties and to conduct its business as described in the
Prospectus and, in the case of the Company, to enter into and perform its
obligations under this Agreement; and no proceeding has been instituted or,
to the knowledge of the Company, threatened in any such jurisdiction
seeking to revoke, limit or curtail such qualification, power and
authority. Each of the Company and its Subsidiaries is duly qualified as a
foreign corporation, partnership or limited liability company, as
applicable, to transact business and is in good standing in each other
jurisdiction in which such qualification is required, whether by reason of
the ownership or leasing of property or the conduct of business, except for
such jurisdictions where the failure to so qualify or to be in good
standing would not, individually or in the aggregate, result in a Material
Adverse Change; and no proceeding has been instituted or, to the knowledge
of the Company, threatened in any such jurisdiction seeking to revoke,
limit or curtail such qualification. Except as otherwise disclosed in the
Prospectus, all of the issued and outstanding capital stock, partnership
interests or membership interests of each Subsidiary have been duly
authorized and validly issued, are fully paid and nonassessable and are
owned by the Company, directly or through Subsidiaries, free and clear of
any security interest, mortgage, pledge, lien, encumbrance or claim. The
Company does not own or control, directly or indirectly, any corporation,
association or other entity other than the Subsidiaries listed in Exhibit
21 to the Registration Statement.
(l) Capitalization and Other Capital Stock Matters. On the First
Closing Date, as hereinafter defined, the authorized, issued and
outstanding capital stock of the Company will be as set forth in the
Prospectus under the caption "Capitalization" (other than for subsequent
issuances, if any, pursuant to employee benefit plans described in the
Prospectus or upon exercise of outstanding options or warrants described in
the Prospectus). The Shares, Warrants, Representative's Warrants and Units
conform in all material respects to the description thereof contained in
the Prospectus. All of the issued and outstanding shares of Common Stock
have been duly authorized and validly issued, are fully paid and
nonassessable and have been issued in compliance with federal and state
securities laws. No further approval or authority of the shareholders or
the Board of Directors of the Company is required for the issuance and sale
of the Units as contemplated herein. The issuance of the outstanding
capital stock did not, and the issuance of the Shares, Warrants,
Representative's Warrants and Units
6
<PAGE> 8
will not, violate any preemptive rights, rights of first refusal or other
similar rights to subscribe for or purchase securities of the Company.
There are no authorized or outstanding options, warrants, preemptive
rights, rights of first refusal or other rights to purchase, or equity or
debt securities convertible into or exchangeable or exercisable for, any
capital stock of the Company or any of its Subsidiaries other than those
accurately described in the Prospectus. The issued and outstanding capital
stock of each Subsidiary has been validly issued and is fully paid and
nonassessable and has been issued in compliance with all federal and state
securities laws. The description of the Company's stock option, stock
bonus and other stock plans or arrangements, and the options or other
rights granted thereunder, set forth in the Prospectus accurately and
fairly presents the information required to be shown with respect to such
plans, arrangements, options and rights.
(m) Stock Exchange Listing. The Common Stock is registered on Form
8-A (or other appropriate form) pursuant to Section 12(g) of the Securities
Exchange Act of 1934, as amended (including the rules and regulations
promulgated thereunder, the "Exchange Act"), which registration has been
declared effective by the Commission. The Shares, Warrants,
Representative's Warrants and Units have been approved for listing on the
American Stock Exchange, subject only to official notice of issuance. The
Company has taken no action designed to, or likely to have the effect of,
terminating the registration of the Shares, Warrants, Representative's
Warrants or Units under the Exchange Act or delisting the Shares, Warrants,
Representative's Warrants or Units from the American Stock Exchange, nor
has the Company received any notification that the Commission or the
American Stock Exchange is contemplating terminating such registration or
listing.
(n) No Current Material Defaults. Neither the Company nor any
Subsidiary is (i) in violation of its charter, bylaws, partnership
agreement, certificate of partnership or other organizational documents, as
applicable, or (ii) is in default (or, with the giving of notice or lapse
of time, would be in default) ("Default") under any indenture, mortgage,
loan or credit agreement, note, contract, settlement agreement, franchise,
lease or other instrument to which it is a party or by which it may be
bound, or to which any of the property or assets of the Company or any of
its Subsidiaries is subject (each of the instruments or agreements listed
in clauses (i) and (ii), an "Existing Instrument"), including, without
limitation, the Existing Instruments listed in Schedule 4, except, in the
case of clause (ii), for such Defaults as would not, individually or in the
aggregate, result in a Material Adverse Change.
(o) Authorization and Non-Contravention of Existing Instruments. The
execution, delivery and performance by the Company and each Subsidiary, as
applicable, of this Agreement, each Formation Agreement and the Warrant
Agreement and consummation of the transactions contemplated hereby and
thereby and by the Prospectus (i) have been duly authorized by all
necessary corporate or partnership or member action, as applicable, and
will not result in any violation of the provisions of the charter, bylaws,
partnership agreement, partnership certificate or other organizational
documents, as applicable, of the Company or any Subsidiary, (ii) will not
conflict with or constitute a breach of, a Default or a Debt Repayment
Triggering Event (as defined below) under, or result in the creation or
imposition of any lien,
7
<PAGE> 9
charge or encumbrance upon any property or assets of the Company or any of
the Subsidiaries pursuant to, any Existing Instrument, except for such
conflicts, breaches, Defaults, liens, charges or encumbrances as would not,
individually or in the aggregate, result in a Material Adverse Change,
(iii) will not require the consent of any other party to any Existing
Instrument except for such consents which have been obtained in writing
(the "Written Consents") and except for such consents as the failure of
which to obtain would not, individually or in the aggregate, result in a
Material Adverse Change, and (iv) will not result in any violation of any
law, administrative regulation or administrative or court decree applicable
to the Company or any Subsidiary. As used herein, a "Debt Repayment
Triggering Event" means any event or condition which gives, or with the
giving of notice or lapse of time or both would give, the holder of any
note, debenture or other evidence of indebtedness (or any person acting on
such holder's behalf) the right to require the repurchase, redemption or
repayment of all or a portion of such indebtedness by the Company or any of
the Subsidiaries.
(p) No Further Authorizations or Approvals Required. No consent,
approval, authorization or other order of, or registration or filing with,
any court or other governmental or regulatory authority or agency, is
required for the execution, delivery and performance by the Company and
each Subsidiary, as applicable, of this Agreement, the Warrant Agreement
and each Formation Agreement and for consummation of the transactions
contemplated hereby and thereby and by the Prospectus, except such as have
been obtained or made and are in full force and effect under the Securities
Act, applicable state securities or blue sky laws and from the National
Association of Securities Dealers, Inc., and NASD Regulation, Inc.
(collectively, the "NASD").
(q) Formation Transactions Otherwise Exempt from Registration. The
issuance of all of the capital stock of the Company and its Subsidiaries to
be issued in connection with the Formation Transactions are exempt from
registration under the Securities Act. The consummation of the Formation
Transactions constitutes neither a "roll-up transaction", as such term is
defined in Item 901(c) of Regulation S-K of the Securities Act, nor a
"limited partnership roll-up transaction", as such term is defined in Rule
2810(a)(10) of the Conduct Rule of the NASD.
(r) No Material Actions or Proceedings. Except as otherwise
disclosed in the Prospectus, there is no legal or governmental action, suit
or proceeding pending or, to the best knowledge of the Company, threatened
(i) against or affecting the Company or any of the Subsidiaries, (ii) which
has as the subject thereof any officer or director of, or property owned or
leased by, the Company or any of the Subsidiaries or (iii) relating to
environmental or discrimination matters, where in any such case (1) there
is a reasonable possibility that such action, suit or proceeding might be
determined adversely to the Company or such Subsidiary, as applicable, and
(2) any such action, suit or proceeding, if so determined adversely, would
reasonably be expected to result in a Material Adverse Change or adversely
affect the consummation of the transactions contemplated by this Agreement
or the Formation Agreements. Neither the Company nor any Subsidiary is a
party or subject to the provisions of any material injunction, judgment,
decree or order of any court, regulatory body, administrative agency or
other
8
<PAGE> 10
governmental body. A list of all legal or governmental actions, suits or
proceedings pending or, to the best of the Company's knowledge threatened,
to which the Company or any Subsidiary or any officer thereof is a party is
set forth on Schedule 5 attached hereto (the "Legal Proceedings"). No
material labor dispute with the employees of the Company or any of the
Subsidiaries exists or, to the best knowledge of the Company, is threatened
or imminent.
(s) Intellectual Property Rights. The Company and the Subsidiaries
own or possess all material trademarks, trade names, patent rights,
copyrights, licenses, approvals, trade secrets, service marks and other
similar rights including, without limitation, rights to the name "RealTrust
Asset Corporation," "CMG Funding Corp." and "CMG Funding Securities Corp."
(collectively, "Intellectual Property Rights") reasonably necessary to
conduct their businesses as now conducted; and the expected expiration of
any of such Intellectual Property Rights would not result in a Material
Adverse Change. Neither the Company nor any Subsidiary has received any
notice of infringement or conflict with asserted Intellectual Property
Rights of others, which infringement or conflict, if the subject of an
unfavorable decision, could reasonably be expected to result in a Material
Adverse Change. The Company does not have any knowledge of any material
infringement by it of any Intellectual Property Rights of others.
(t) All Necessary Permits, Licenses, etc. The Company and each
Subsidiary possesses such valid and current certificates, authorizations,
licenses and permits issued by the appropriate state, federal or foreign
regulatory agencies or bodies as are necessary to conduct its respective
business, and neither the Company nor any Subsidiary has received any
notice of proceedings relating to the revocation or modification of, or
non-compliance with, any such certificate, authorization, license or permit
which, singly or in the aggregate, if the subject of an unfavorable
decision, ruling or finding, could reasonably be expected to result in a
Material Adverse Change.
(u) Title to Properties. The Company and each of the Subsidiaries
has good and marketable title to all the properties and assets reflected as
owned in the financial statements referred to in Section 1(j) above (or
elsewhere in the Prospectus), in each case free and clear of any security
interests, mortgages, liens, encumbrances, equities, claims and other
defects, except such as do not materially and adversely affect the value of
such property and do not materially interfere with the use made or proposed
to be made of such property by the Company or such Subsidiary. The real
property, improvements, equipment and personal property held under lease by
the Company or any Subsidiary are held under valid and enforceable leases,
with such exceptions as are not material and do not materially interfere
with the use made or proposed to be made of such real property,
improvements, equipment or personal property by the Company or such
Subsidiary. Each of the Company and the Subsidiaries owns or leases all
such real and personal property as is reasonably necessary to its
operations as now conducted and as proposed to be conducted.
(v) Tax Law Compliance. The Company and the Subsidiaries have filed
all necessary federal, state and foreign income and franchise tax returns
and have paid all taxes required to be paid by any of them and, if due and
payable, any related or similar assessment, fine or
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penalty levied against any of them, except those being contested in good
faith and for which adequate reserves have been taken in conformity with
generally accepted accounting principles and the nonpayment of which does
not in any way jeopardize the Company's status as a REIT. The Company has
made adequate charges, accruals and reserves in the applicable financial
statements referred to in Section 1(j) above in respect of all federal,
state and foreign income and franchise taxes for all periods as to which
the tax liability of the Company or any of its Subsidiaries has not been
finally determined.
(w) REIT Status. The Company intends to operate and will operate in
such a manner as to qualify as a REIT under Sections 856 through 860 of the
Tax Code; and the Company intends to elect to and will elect to be taxed as
a REIT under the Tax Code beginning with its taxable year ending December
31, 1998. The Company does not know of any event or condition which would
cause or is likely to cause the Company to fail to qualify as a REIT at any
time.
(x) Company Not an "Investment Company". The Company has been
advised of the rules and requirements under the Investment Company Act of
1940, as amended (the "Investment Company Act"). Neither the Company nor
any Subsidiary is, or after the Company's receipt of payment for the
Shares, Warrants, Representative's Warrants and Units, consummation of the
Formation Transactions and use of proceeds as described in the Prospectus,
will be, an "investment company" within the meaning of Investment Company
Act. The Company and each Subsidiary will conduct its business in a manner
so that it will not become subject to the Investment Company Act.
(y) Company Not a "Broker" or "Dealer." The Company is not and,
after receipt of payment for the Shares, Warrants, Representative's Warrant
and Units, consummation of the Formation Transactions and use of proceeds
as described in the Prospectus, will not be a "broker" within the meaning
of Section 3(a)(4) of the Exchange Act or a "dealer" within the meaning of
Section 3(a)(5) of the Exchange Act or required to be registered pursuant
to Section 15(a) of the Exchange Act.
(z) Insurance. Except as otherwise disclosed in the Prospectus, the
Company and each of the Subsidiaries is insured by recognized, financially
sound and reputable institutions with policies in such amounts and with
such deductibles and covering such risks as are generally deemed adequate
and customary for its business including, but not limited to, policies
covering the Company and its Subsidiaries against business interruptions
and policies covering real and personal property owned or leased by the
Company and its Subsidiaries against theft, damage, destruction, acts of
vandalism and earthquakes. The Company has no reason to believe that the
Company or any Subsidiary will not be able (i) to renew its existing
insurance coverage as and when such policies expire or (ii) to obtain
comparable coverage from similar institutions as may be necessary or
appropriate to conduct its business as now conducted and at a cost that
would not result in a Material Adverse Change. Neither the Company, any of
its Subsidiaries nor any of their respective directors or officers have
been denied any insurance coverage which it has sought or for which it has
applied.
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(aa) No Price Stabilization or Manipulation. Neither the Company nor
any Subsidiary has taken or will take, directly or indirectly, any action
designed to or that might be reasonably expected to cause or result in
stabilization or manipulation of the price of any security of the Company
to facilitate the sale or resale of the Shares, Warrants, Representative's
Warrants or Units.
(bb) No Broker or Finder Fees. Except as otherwise disclosed in the
Prospectus, neither the Company nor any affiliate of the Company has
incurred any liability for a fee, commission or other compensation on
account of the employment or engagement of a broker or finder in connection
with the transactions contemplated by this Agreement.
(cc) Related Party Transactions. There are no business relationships
or related-party transactions of the type described in Item 404 of
Regulation S-K of the Commission involving the Company which have not been
described in the Prospectus, except for such transactions that would be
considered immaterial under such Item 404. The descriptions in the
Prospectus under the captions "Prospectus Summary -- Certain Relationships
and Related Party Transactions" and "Certain Transactions" are complete and
accurate in all material respects.
(dd) Material Contracts. There are no contracts or other documents
required to be described in the Registration Statement or to be filed as
exhibits to the Registration Statement by the Securities Act which have not
been described or filed as required. Neither the Company nor any
Subsidiary is subject to any collective bargaining agreements.
(ee) No Unlawful Contributions or Other Payments. Neither the Company
nor any of the Subsidiaries nor, to the knowledge of the Company, any
employee or agent of the Company or any Subsidiary, has (i) made any
contribution or other payment to any official of, or candidate for, any
federal, state or foreign office in violation of any law or of the
character required to be disclosed in the Prospectus or (ii) made any
payment to any federal or state governmental officer or official, or other
person charged with similar public or quasi- public duties, other than
payments required or permitted by the laws of the United States or any
jurisdiction thereof.
(ff) Company's Accounting System. The Company and the Subsidiaries
maintain and will continue to maintain a system of accounting controls
sufficient to provide reasonable assurances that (i) transactions are
executed in accordance with management's general or specific authorization;
(ii) transactions are recorded as necessary to permit preparation of
financial statements in conformity with generally accepted accounting
principles and to maintain accountability for assets; (iii) access to
assets is permitted only in accordance with management's general or
specific authorization; and (iv) the recorded accountability for assets is
compared with existing assets at reasonable intervals and appropriate
action is taken with respect to any differences.
(gg) Policies. The Company has prepared written policies for each
policy referenced in the Registration Statement, including the capital
allocation guidelines, hedging policies and the
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underwriting guidelines, and the Board of Directors of the Company has
approved each such policy. A copy of each such policy has been delivered
by the Company to counsel to the Company, the Representative and counsel to
the Representative.
(hh) Compliance with Environmental Laws. Except as would not,
individually or in the aggregate, result in a Material Adverse Change (i)
neither the Company nor any of its Subsidiaries is in violation of any
federal, state, local or foreign law or regulation relating to pollution or
protection of human health or the environment (including, without
limitation, ambient air, surface water, groundwater, land surface or
subsurface strata) or wildlife, including without limitation, laws and
regulations relating to emissions, discharges, releases or threatened
releases of chemicals, pollutants, contaminants, wastes, toxic substances,
hazardous substances, petroleum and petroleum products (collectively,
"Materials of Environmental Concern"), or otherwise relating to the
manufacture, processing, distribution, use, treatment, storage, disposal,
transport or handling of Materials of Environment Concern (collectively,
"Environmental Laws"), which violation includes, but is not limited to,
noncompliance with any permits or other governmental authorizations
required for the operation of the business of the Company or its
Subsidiaries under applicable Environmental Laws, or noncompliance with the
terms and conditions thereof, nor has the Company or any of its
Subsidiaries received any written communication, whether from a
governmental authority, citizens group, employee or otherwise, that alleges
that the Company or any of its Subsidiaries is in violation of any
Environmental Law; (ii) there is no claim, action or cause of action filed
with a court or governmental authority, no investigation with respect to
which the Company has received written notice, and no written notice by any
person or entity alleging potential liability for investigatory costs,
cleanup costs, governmental responses costs, natural resources damages,
property damages, personal injuries, attorneys' fees or penalties arising
out of, based on or resulting from the presence, or release into the
environment, of any Material of Environmental Concern at any location
owned, leased or operated by the Company or any of its Subsidiaries, now or
in the past (collectively, "Environmental Claims"), pending or, to the
knowledge of the Company, threatened against the Company or any of its
Subsidiaries or any person or entity whose liability for any Environmental
Claim the Company or any of its Subsidiaries has retained or assumed either
contractually or by operation of law; and (iii) to the knowledge of the
Company, there are no past or present actions, activities, circumstances,
conditions, events or incidents, including, without limitation, the
release, emission, discharge, presence or disposal of any Material of
Environmental Concern, that reasonably could result in a violation of any
Environmental Law or form the basis of a potential Environmental Claim
against the Company or any of its Subsidiaries or against any person or
entity whose liability for any Environmental Claim the Company or any of
its Subsidiaries has retained or assumed either contractually or by
operation of law.
(ii) No Material or Undisclosed Environmental Liability. There is no
liability, alleged liability or potential liability (including, without
limitation, liability, alleged liability or potential liability for
investigatory costs, cleanup costs, governmental response costs, natural
resources damages, property damages, personal injuries or penalties), of
the Company or any of the Subsidiaries arising out of, based on or
resulting from (a) the presence or release into
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<PAGE> 14
the environment of any Material of Environmental Concern at any location,
whether or not owned by the Company or any of its Subsidiaries or (b) any
violation or alleged violation of any Environmental Law, which liability,
alleged liability or potential liability is required to be disclosed in the
Registration Statement, other than as disclosed therein, or which
liability, alleged liability or potential liability, singly or in the
aggregate, would cause a Material Adverse Change.
(jj) Periodic Review of Costs of Environmental Compliance. The
Company has established and will comply with policies requiring that prior
to originating any commercial mortgage or foreclosing or taking a deed in
lieu with respect to any property, the Company shall conduct Phase I
environmental site assessment and a review of the effect of Environmental
Laws on such property and the operations conducted thereon, in the course
of which it shall identify and evaluate associated costs and liabilities
(including, without limitation, any capital or operating expenditures
required for clean-up or compliance with Environmental Laws or any permit,
license or approval, any related constraints on operating activities and
any potential liabilities to third parties).
(kk) ERISA Compliance. The Company and its Subsidiaries and any
"employee benefit plan" (as defined under the Employee Retirement Income
Security Act of 1974, as amended, and the regulations and published
interpretations thereunder (collectively, "ERISA")) established or
maintained by the Company, its Subsidiaries or their "ERISA Affiliates" (as
defined below) are in compliance in all material respects with ERISA.
"ERISA Affiliate" means, with respect to the Company or a Subsidiary, any
member of any group of organizations described in Sections 414(b),(c),(m)
or (o) of the Internal Revenue Code of 1986, as amended, and the
regulations and published interpretations thereunder of which the Company
or such Subsidiary is a member. No "reportable event" (as defined under
ERISA) has occurred or is reasonably expected to occur with respect to any
"employee benefit plan" established or maintained by the Company, its
Subsidiaries or any of their ERISA Affiliates. Neither the Company nor any
Subsidiary has ever maintained any "employee pension benefit plan" or any
"employee welfare benefit plan," as such terms are defined in ERISA.
Neither the Company nor any Subsidiary has any obligation to make any
payment to or with respect to any former employee of the Company or any
subsidiary pursuant to any retiree medical benefit or other welfare plan.
No "employee benefit plan" established or maintained by the Company, its
Subsidiaries or any of their ERISA Affiliates, if such "employee benefit
plan" were terminated, would have any "amount of unfunded benefit
liabilities" (as defined under ERISA). Neither the Company, its
Subsidiaries nor any of their ERISA Affiliates has incurred or reasonably
expects to incur any liability under (i) Title IV of ERISA with respect to
termination of, or withdrawal from, any "employee benefit plan" or (ii)
Sections 412, 4971, 4975 or 4980B of the Tax Code. Each "employee benefit
plan" established or maintained by the Company, its Subsidiaries or any of
their ERISA Affiliates that is intended to be qualified under Section
401(a) of the Tax Code is so qualified and nothing has occurred, whether by
action or failure to act, which would cause the loss of such qualification.
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<PAGE> 15
(ll) Material Compliance with All Other Applicable Laws. The Company
and each Subsidiary is conducting business in compliance with all other
applicable state, federal and foreign laws, rules and regulations, except
where failure to be in compliance, if the subject of an unfavorable
decision, ruling or finding, could not singly or in the aggregate
reasonably be expected to result in a Material Adverse Change. The
description of the laws and regulations affecting the Company and the
Subsidiaries' investment operations in the Prospectus is a true and
accurate description thereof in all material respects and does not omit any
information relating to such laws and regulations reasonably likely to be
material to an investor in the Units.
Any certificate signed by an officer of the Company and delivered to the
Representative or to counsel for the Underwriters, shall be deemed to be a
representation and warranty by such the Company to each Underwriter as to the
matters set forth therein.
SECTION 2. PURCHASE, SALE AND DELIVERY OF THE UNITS.
(a) The Firm Units. The Company agrees to issue and sell to the
several Underwriters the Firm Units upon the terms herein set forth. On the
basis of the representations, warranties and agreements herein contained, and
upon the terms but subject to the conditions herein set forth, the Underwriters
agree, severally and not jointly, to purchase from the Company the respective
number of Firm Units set forth opposite their names on Schedule 1. The
purchase price per Firm Unit to be paid by the several Underwriters to the
Company shall be $[___] per Firm Unit.
(b) The First Closing Date. Delivery of the Firm Units to be
purchased by the Underwriters and payment therefor shall be made at the offices
of Stifel, Nicolaus & Company, Incorporated, 500 North Broadway, Suite 1500,
St. Louis, Missouri 63102 (or such other place as may be agreed to by the
Company and the Representative) at 9:00 a.m. New York time, on [___], 1998, or
such other time and date not later than 1:30 p.m. New York time, on [___],
1998, as the Representative shall designate by notice to the Company (the time
and date of such closing are called the "First Closing Date"). The Company
hereby acknowledges that circumstances under which the Representative may
provide notice to postpone the First Closing Date as originally scheduled
include, but are in no way limited to, any determination by the Company or the
Representative to recirculate to the public copies of an amended or
supplemented Prospectus or a delay as contemplated by the provisions of Section
10.
(c) The Optional Units; the Second Closing Date. In addition, on the
basis of the representations, warranties and agreements herein contained, and
upon the terms but subject to the conditions herein set forth, the Company
hereby grants an option to the several Underwriters to purchase, severally and
not jointly, up to an aggregate of 750,000 Optional Units from the Company at
the purchase price per Optional Unit to be paid by the Underwriters for the
Firm Units. The option granted hereunder is for use by the Underwriters solely
in covering any over-allotments in connection with the sale and distribution
of the Firm Units. The option granted hereunder may be exercised at any time
(but not more than once) upon notice by the
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<PAGE> 16
Representative to the Company, which notice may be given at any time within 30
days from the date of this Agreement. Such notice shall set forth (i) the
aggregate number of Optional Units as to which the Underwriters are exercising
the option, and (ii) the time and date on which such securities will be
delivered (which time and date may be simultaneous with, but not earlier than,
the First Closing Date; and in such case the term "First Closing Date" shall
refer to the time and date of delivery of the Firm Units and the Optional
Units). Such time and date of delivery, if subsequent to the First Closing
Date, is called the "Second Closing Date" and shall be determined by the
Representative and, unless the Company otherwise consents, shall not be earlier
than three nor later than five full business days after delivery of such notice
of exercise. If any Optional Units are to be purchased, each Underwriter
agrees, severally and not jointly, to purchase the number of Optional Units
(subject to such adjustments to eliminate fractional Units as the
Representative may determine) that bears the same proportion to the total
number of Optional Units to be purchased as the number of Firm Units set forth
on Schedule 1 opposite the name of such Underwriter bears to the total number
of Firm Units. The Representative may cancel the option at any time prior to
its expiration by giving written notice of such cancellation to the Company.
(d) Public Offering of the Units. The Representative hereby advises
the Company that the Underwriters intend to offer for sale to the public, as
described in the Prospectus, their respective portions of the Units as soon
after this Agreement has been executed and the Registration Statement has been
declared effective as the Representative, in its sole judgment, determines is
advisable and practicable.
(e) Payment for the Units. Payment for the Units shall be made at
the First Closing Date (and, if applicable, at the Second Closing Date) by wire
transfer of immediately available funds to the order of the Company or to such
account as the Company may designate.
It is understood that the Representative has been authorized, for its
own account and the accounts of the several Underwriters, to accept delivery of
and receipt for, and make payment of the purchase price for, the Firm Units and
any Optional Units the Underwriters have agreed to purchase. Stifel, Nicolaus
& Company, Incorporated, individually and not as the Representative of the
Underwriters, may (but shall not be obligated to) make payment for any Units to
be purchased by any Underwriter whose funds shall not have been received by the
Representative by the First Closing Date or the Second Closing Date, as the
case may be, for the account of such Underwriter, but any such payment shall
not relieve such Underwriter from any of its obligations under this Agreement.
(f) Delivery of the Units.
(i) The Company shall deliver, or cause to be delivered, to the
Representative for the accounts of the several Underwriters certificates
for the Firm Units at the First Closing Date, against the irrevocable
release of a wire transfer of immediately available funds for the amount of
the purchase price therefor. The Company shall also deliver, or cause to
be delivered, to the Representative for the accounts of the several
Underwriters, certificates for the Optional
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<PAGE> 17
Units the Underwriters have agreed to purchase at the First Closing Date or
the Second Closing Date, as the case may be, against the irrevocable
release of a wire transfer of immediately available funds for the amount of
the purchase price therefor. The certificates for the Units shall be in
definitive form and registered in such names and denominations as the
Representative shall have requested at least two full business days prior
to the First Closing Date (or the Second Closing Date, as the case may be)
and shall be made available for inspection on the business day preceding
the First Closing Date (or the Second Closing Date, as the case may be) at
a location in [New York City] as the Representative may designate.
(ii) Notwithstanding the terms of the preceding subsection 2(f)(i) or
elsewhere in this Agreement that contemplate physical certificates for the
Units, if the Company and the Representative so agree, the Units may be
issued without certificates and constructive delivery of such
uncertificated Units to the Underwriters may be accomplished through the
FAST system of The Depository Trust Company by the Company causing the
transfer agent and registrar of the Units, on the applicable Closing Date,
to issue one or more Depository Trust Company book entry positions,
representing in the aggregate the number of Units to be delivered to the
Representative on such Closing Date, to such account or accounts as shall
be specified by the Representative in an instruction letter or other
communication to the Company or such transfer agent.
(g) Time of the Essence. Time shall be of the essence, and delivery
at the time and in the manner specified in this Agreement is a further
condition to the obligations of the Underwriters.
(h) Delivery of Prospectus to the Underwriters. Not later than 12:00
p.m. on the second business day following the date the Units are released by
the Underwriters for sale to the public, the Company shall deliver or cause to
be delivered copies of the Prospectus in such quantities and at such places as
the Representative shall request.
SECTION 3. ADDITIONAL COVENANTS OF THE COMPANY.
The Company further covenants and agrees with each Underwriter as follows:
(a) Representative's Review of Proposed Amendments and Supplements.
During such period beginning on the date hereof and ending on the later of
the First Closing Date or such date, as in the opinion of counsel for the
Underwriters, the Prospectus is no longer required by law to be delivered
in connection with sales by an Underwriter or dealer (the "Prospectus
Delivery Period"), prior to amending or supplementing the Registration
Statement (including any registration statement filed under Rule 462(b)
under the Securities Act) or the Prospectus, the Company shall furnish to
the Representative for review a copy of each such proposed amendment or
supplement, and the Company shall not file any such proposed amendment or
supplement to which the Representative reasonably objects.
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(b) Securities Act Compliance. After the date of this Agreement, the
Company shall promptly advise the Representative in writing (i) of the
receipt of any comments of, or requests for additional or supplemental
information from, the Commission, (ii) of the time and date of any filing
of any post-effective amendment to the Registration Statement or any
amendment or supplement to any preliminary prospectus or the Prospectus,
(iii) of the time and date that any post-effective amendment to the
Registration Statement becomes effective and (iv) of the issuance by the
Commission of any stop order suspending the effectiveness of the
Registration Statement or any post-effective amendment thereto or of any
order preventing or suspending the use of any preliminary prospectus or the
Prospectus, or of any proceedings to remove, suspend or terminate from
listing or quotation the Shares, Warrants, Representative's Warrants or
Units from any securities exchange upon which they are listed for trading
or included or designated for quotation, or of the threatening or
initiation of any proceedings for any of such purposes. If the Commission
shall enter any such stop order at any time, the Company will use its best
efforts to obtain the lifting of such order at the earliest possible
moment. Additionally, the Company agrees that it shall comply with the
provisions of Rules 424(b), 430A and 434, as applicable, under the
Securities Act and will use its reasonable efforts to confirm that any
filings made by the Company under such Rule 424(b) were received in a
timely manner by the Commission.
(c) Amendments and Supplements to the Prospectus and Other Securities
Act Matters. (i) During the Prospectus Delivery Period, the Company shall
advise the Underwriters promptly of the happening of any event known to it
which, in the judgment of the Company, would require the making of any
change in the Prospectus then being used so that the Prospectus would not
include an untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary to make the statements
therein, in light of the circumstances under which they were made or when
the Prospectus is delivered to a purchaser, not misleading. (ii) If,
during the Prospectus Delivery Period, any event shall occur or condition
exist as a result of which it is necessary, in the opinion of the
Representative or counsel to the Underwriters, to amend or supplement the
Prospectus in order to make the statements therein, in the light of the
circumstances under which they were made or when the Prospectus is
delivered to a purchaser, not misleading, or if in the opinion of the
Representative or counsel for the Underwriters it is otherwise necessary to
amend or supplement the Prospectus to comply with law, the Company agrees
promptly to prepare (subject to Section 3(a) hereof), file with the
Commission and furnish at its own expense to the Underwriters and to
dealers, amendments or supplements to the Prospectus so that the statements
in the Prospectus as so amended or supplemented will not, in the light of
the circumstances when the Prospectus is delivered to a purchaser, be
misleading or so that the Prospectus, as amended or supplemented, will
comply with law.
(d) Copies of any Amendments and Supplements to the Prospectus. The
Company agrees to furnish the Representative, without charge, during the
Prospectus Delivery Period, as many copies of the Prospectus and any
amendments and supplements thereto as the Representative may reasonably
request.
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(e) Press Releases. The Company agrees that, if at any time during
the ninety (90) day period after the Registration Statement becomes
effective, any rumor, publication or event relating to or affecting any of
the Company or the Subsidiaries shall occur as a result of which in the
Representative's opinion the market price of the Units has been or is
likely materially to be affected (regardless of whether such rumor,
publication or event necessitates a supplement or amendment to the
Prospectus), the Company will, upon the request of the Representative,
promptly prepare, consult with the Representative concerning the content
of, and disseminate a press release or other public statement, reasonably
satisfactory to the Representative, responding to or commenting on such
rumor, publication or event.
(f) Blue Sky Compliance. The Company shall cooperate with the
Representative and counsel for the Underwriters to qualify or register the
Shares, Warrants, Representative's Warrants and Units for sale under (or
obtain exemptions from the application of) the Blue Sky or state or foreign
securities laws of those jurisdictions designated by the Representative,
shall comply with such laws and shall continue such qualifications,
registrations and exemptions in effect so long as required for the
distribution of the Shares, Warrants, Representative's Warrants and Units;
provided, however, that the Company shall not be required to qualify as a
foreign corporation or to take any action that would subject it to general
service of process in any such jurisdiction where it is not presently
qualified or where it would be subject to taxation as a foreign
corporation. The Company will advise the Representative promptly of the
suspension of the qualification or registration of (or any such exemption
relating to) the Shares, Warrants, Representative's Warrants or Units for
offering, sale or trading in any jurisdiction or any initiation or threat
of any proceeding for any such purpose, and in the event of the issuance of
any order suspending such qualification, registration or exemption, the
Company shall use its best efforts to obtain the withdrawal thereof at the
earliest possible moment.
(g) Uncertificated Shares. In the event that any portion of the
Shares is issued without certificates pursuant to section 2-210 of the
Maryland General Corporation Law (the "MGCL") and as may be permitted under
Section 2(f) above, at the time of issuance of such Shares and at the time
of every subsequent transfer of such Shares the Company shall send, or
cause to be sent, to the shareholder a written statement of the information
required on certificates by section 2-211 of the MGCL, and shall otherwise
maintain full compliance with sections 2-210 and 2-211 of the MGCL.
(h) Consummation of Formation Transactions. The Company shall, and
shall cause the Subsidiaries it controls to, complete the Formation
Transactions as described in the Prospectus.
(i) Use of Proceeds. The Company shall apply the net proceeds from
the sale of the Units sold by it in the manner described under the caption
"Use of Proceeds" in the Prospectus. The Company will not use the proceeds
of the sale of the Units in such a manner as to require the Company or any
Subsidiary to be registered under the Investment Company Act.
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(j) Transfer Agent. The Company shall engage and maintain, at its
expense, a transfer agent and registrar for the Units.
(k) Continuing listing on the American Stock Exchange. The Company
will use its reasonable best efforts to continue the listing of the Shares,
Warrants, Representative's Warrants and Units on the American Stock
Exchange and will continue to comply in all material respects with all of
the rules and regulations thereof applicable to the Company and the trading
of such securities.
(l) Earnings Statement. As soon as practicable, the Company will
make generally available to its security holders and to the Representative
an earnings statement (which need not be audited) covering the twelve-month
period ending on the final day of the Company's first quarter that ends at
least one year after "the effective date of the Registration Statement" (as
defined in Rule 158(c) under the Securities Act) that satisfies the
provisions of Section 11(a) of the Securities Act.
(m) Periodic Reporting Obligations. During the Prospectus Delivery
Period the Company shall file, on a timely basis, with the Commission and
the American Stock Exchange all reports and documents required to be filed
under the Exchange Act. Additionally, the Company shall file with the
Commission all reports on Form SR as may be required under Rule 463 under
the Securities Act.
(n) Agreement Not To Offer or Sell Additional Securities. The
Company will not, will cause each of the Subsidiaries not to, and will
cause each of their directors, officers and beneficial owners of greater
than five percent (5%) of their respective capital stock to enter into
agreements (the "Lock-Up Agreements") substantially in the form of Exhibit
B to the effect that each of them will not, without the prior written
consent of Stifel, Nicolaus & Company, Incorporated (which consent may be
withheld at the sole discretion of Stifel, Nicolaus & Company,
Incorporated), during the period of 180 days following the date of the
Prospectus, directly or indirectly, sell, offer, contract or grant any
option to sell, pledge, transfer or establish an open "put equivalent
position" within the meaning of Rule 16a-1(h) under the Exchange Act, or
otherwise dispose of or transfer, or announce the offering of, or file any
registration statement under the Securities Act in respect of, any shares
of Common Stock, Shares, Warrants or Units, options or warrants to acquire
shares of the Common Stock, Shares, Warrants or Units or securities
exchangeable or exercisable for or convertible into shares of Common Stock,
Shares, Warrants or Units (other than as contemplated by this Agreement
with respect to the Units and other than a registration statement on Form
S-8 with respect to any stock option plan, stock bonus or other stock plan
or arrangement described in the Prospectus); provided, however, that
pursuant to any stock option, stock bonus or other stock plan or
arrangement described in the Prospectus, the Company may issue shares of
its Common Stock or options to purchase its Common Stock, or Common Stock
upon exercise of options, but only if the holders of such shares, options,
or shares issued upon exercise of such options, agree in writing not to
sell, offer, dispose of or otherwise transfer any such shares or options
during such 180 day period without the prior written consent of Stifel,
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Nicolaus & Company, Incorporated (which consent may be withheld at the sole
discretion of Stifel, Nicolaus & Company, Incorporated).
(o) Future Reports to the Representative. During the period of three
years hereafter the Company will furnish to the Representative care of
Stifel, Nicolaus & Company, Incorporated, 500 North Broadway, Suite 1500
St. Louis, Missouri 63102, Attention: Mr. Rick E. Maples, and to O'Melveny
& Myers LLP at the address set forth in Section 13: (i) as soon as
practicable after the end of each fiscal year, copies of the Annual Report
of the Company containing the balance sheet of the Company as of the close
of such fiscal year and statements of income, shareholders' equity and cash
flows for the year then ended and the opinion thereon of the Company's
independent public or certified public accountants; (ii) as soon as
practicable after the filing thereof, copies of each proxy statement,
Annual Report on Form 10-K, Quarterly Report on Form 10-Q, Current Report
on Form 8-K or other report filed by the Company with the Commission, the
NASD or any securities exchange; and (iii) as soon as available, copies of
any report or communication of the Company mailed generally to holders of
its capital stock.
(p) REIT Status. The Company shall operate so as to qualify as a
REIT in accordance with the requirements of Sections 856-860 of the Tax
Code, and shall elect to be taxed as a REIT beginning with its taxable year
ending December 31, 1998. The Company shall thereafter not revoke such
REIT election and shall not conduct its business and operations in a manner
that would cause it to fail to qualify as a REIT. The Company will use its
best efforts to comply with the representations made as support for the
opinion letter rendered by the Company's tax counsel under the REIT
provisions of the Tax Code, the form of which opinion is filed as Exhibit
8.1 to the Registration Statement.
(q) Accounting and Tax Advice. The Company will engage and retain a
nationally recognized accounting firm as its qualified accountants and such
tax experts at such accounting firm with experience in advising REITs as
are reasonably acceptable to the Representative for a period of not less
than two years beginning on the First Closing Date to assist the Company in
developing appropriate accounting systems and testing procedures and to
conduct quarterly compliance reviews designed to determine compliance with
the REIT provisions of the Tax Code and the maintenance of Company's exempt
status under the Investment Company Act. Any written reports of such
compliance reviews shall be made available to the Representative.
(r) Commodities Exchange Act. The Company has not and will not, and
has not permitted and will not permit any of its Subsidiaries to, invest in
futures contracts, options on futures contracts or options on commodities
unless such entities were or are exempt from the registration requirements
of the Commodity Exchange Act, as amended, or otherwise complied or will
comply with the Commodity Exchange Act, as amended, when the applicable
investment was or is made.
(s) Investment Advisors Act. The Company will not, and will not
permit any of the Subsidiaries to, engage in any activity which would cause
or require such entity to register as
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an investment advisor under the Investment Advisors Act of 1940. Without
limiting the generality of the foregoing, the Company will not, and will
not permit any Subsidiary to, (i) render investment advice to more than
fifteen clients, (ii) hold itself out generally to the public as an
investment advisor, or (iii) act as an investment advisor to any investment
company that is registered under the Investment Company Act.
(t) SEC Compliance Program and Insider Trading Compliance Policy.
Promptly after the First Closing Date, the Company shall adopt and
implement (i) a compliance program, reasonably acceptable to counsel for
the Underwriters, to ensure compliance with the reporting requirements
under the Exchange Act and the securities laws generally and (ii) an
insider trading compliance policy, reasonably acceptable to counsel for the
Underwriters, to govern their employees' and directors' trading in
securities of the Company and all Company affiliates in accordance with
federal law and all applicable state blue sky and Canadian laws.
(u) Material Increases in Management Compensation. The Company shall
not authorize, approve or permit any material increase in the compensation
of any executive officer or director employed by the Company or any
affiliate of the Company without the prior written consent of a majority of
the directors of the Company who are not officers, employees or affiliates
of the Company or any of its Subsidiaries (the "Independent Directors").
(v) Affiliated Transactions. The Company shall not engage in
transactions with affiliates of the Company or with affiliates of any
entities owned or controlled by any employee, officer or director of the
Company except to the extent that such transactions meet the following
criteria: (i) the transactions are in the ordinary course of business, (ii)
the compensation therefor is fair and reasonable, and (iii) the overall
terms and conditions thereof are not less favorable to the Company than the
probable overall market-rate terms and conditions of a similar transaction
with an unaffiliated Person. Prior to entering into such transaction, such
transaction shall be approved by a majority of the Independent Directors.
Notwithstanding the foregoing, the Company shall have the right to engage
in transactions with a wholly-owned Subsidiary.
(w) Unrelated Lines of Business. The Company shall not engage in any
lines of business beyond the scope of business described in the
Registration Statement.
(x) Key Man Insurance. The Company shall maintain, for a period of
not less than five (5) years from the First Closing Date, Key Man Life
Insurance insuring each of Messrs. Mott and Fry, and the Company shall use
commercially reasonable efforts to maintain, for a period of not less than
five (5) years from the First Closing Date, Key Man Life Insurance insuring
Mr. McMurray (if available at a commercially reasonable cost), in each case
with a company with a Best's Rating of not less than B+, VII, in the amount
of not less than Five Million Dollars ($5,000,000) with the Company named
as beneficiary thereunder.
(y) Capital Allocation Guidelines, Hedge Policies and Underwriting
Guidelines. The Company has adopted hedging policies to address the risk
of interest rate fluctuations. Within
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forty-five (45) days after the First Closing Date management of the Company
shall submit to the Company's Board of Directors capital allocation
guidelines and underwriting guidelines for its review and approval. The
Company shall not amend the Company's hedging policy, underwriting
guidelines or capital allocation guidelines, without the prior written
approval of a majority of the Independent Directors.
The Representative, on behalf of the several Underwriters, may, in their
sole discretion, waive in writing the performance by the Company of any one or
more of the foregoing covenants or extend the time for their performance.
SECTION 4. PAYMENT OF EXPENSES. Whether or not the transactions
contemplated herein are consummated or this Agreement becomes effective or is
terminated, the Company agrees to pay all costs, fees and expenses incurred in
connection with the performance of its obligations hereunder and in connection
with the transactions contemplated hereby, including without limitation (i) all
expenses incident to the issuance and delivery of the Shares, Warrants,
Representative's Warrants and Units (including all printing and engraving
costs), (ii) all fees and expenses of the registrar and transfer agent, (iii)
all necessary issue, transfer and other stamp taxes in connection with the
issuance and sale of the Shares, Warrants, Representative's Warrants and Units
to the Underwriters, (iv) all fees and expenses of the Company's counsel,
independent public or certified pubic accountants and other advisors, (v) all
costs and expenses incurred in connection with the preparation, printing,
filing, shipping and distribution of the Registration Statement (including
financial statements, exhibits, schedules, consents and certificates of
experts), each preliminary prospectus and the Prospectus, and all amendments
and supplements thereto, and this Agreement, (vi) all filing fees, attorneys'
fees and expenses incurred by the Company or the Underwriters in connection
with investigating the qualification of, or qualifying or registering (or
obtaining exemptions from the qualification or registration of) all or any part
of the Shares, Warrants, Representative's Warrants and Units for offer and sale
under the Blue Sky laws or foreign securities laws, and, if requested by the
Representative, preparing and printing a "Blue Sky Survey" or memorandum, and
any supplements thereto, advising the Underwriters of such qualifications,
registrations and exemptions, (vii) the filing fees incident to, and the
reasonable fees and expenses of counsel for the Underwriters in connection
with, the NASD's review and approval of the Underwriters' participation in the
offering and distribution of the Units, (viii) the fees and expenses associated
with listing the Shares, Warrants, Representative's Warrants and Units on the
American Stock Exchange, and (ix) all other fees, costs and expenses referred
to in Part II of the Registration Statement. Except as provided in this
Section 4, Section 6, Section 8 and Section 9 hereof, the Underwriters shall
pay their own expenses, including the fees and disbursements of their counsel.
SECTION 5. CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITERS. The
obligations of the several Underwriters to purchase and pay for the Units as
provided herein on the First Closing Date and, with respect to the Optional
Units, the Second Closing Date, shall be subject to the accuracy of the
representations and warranties on the part of the Company set forth in Section
1 hereof as of the date hereof and as of the First Closing Date as though then
made and, with respect to the Optional Units, as of the Second Closing Date as
though then made, to the timely
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<PAGE> 24
performance by the Company of its covenants and other obligations hereunder,
and to each of the following additional conditions:
(a) Accountants' Comfort Letter. On the date hereof, the
Representative shall have received from KPMG Peat Marwick LLP, independent
public or certified public accountants for the Company, a letter dated the
date hereof addressed to the Underwriters, in form and substance
satisfactory to the Representative, containing statements and information
of the type ordinarily included in accountant's "comfort letters" to
underwriters, delivered according to Statement of Auditing Standards No. 72
(or any successor bulletin), with respect to the audited and unaudited
financial statements and certain financial information contained in the
Registration Statement and the Prospectus (and the Representative shall
have received such additional conformed copies of such accountants' letter
as Representative's counsel shall reasonably request).
(b) Compliance with Registration Requirements; No Material
Misstatements or Omissions; No Stop Order; No Objection from NASD. For the
period from and after effectiveness of this Agreement and prior to the
First Closing Date and, with respect to the Optional Units, the Second
Closing Date:
(i) the Company shall have filed the Prospectus with the
Commission (including the information required by Rule 430A under the
Securities Act) in the manner and within the time period required by
Rule 424(b) under the Securities Act; or the Company shall have filed
a post-effective amendment to the Registration Statement containing
the information required by such Rule 430A, and such post-effective
amendment shall have become effective; or, if the Company elected to
rely upon Rule 434 under the Securities Act and obtained the
Representative's consent thereto, the Company shall have filed a Term
Sheet with the Commission in the manner and within the time period
required by such Rule 424(b);
(ii) no stop order suspending the effectiveness of the
Registration Statement, any Rule 462(b) Registration Statement, or any
post-effective amendment to the Registration Statement, shall be in
effect and no proceedings for such purpose shall have been instituted
or threatened by the Commission;
(iii) you shall not in good faith have advised the Company
that the Registration Statement, or any amendment thereto, contains an
untrue statement of fact that in the reasonable opinion of you or your
counsel is material or omits to state a fact that in the reasonable
opinion of you or your counsel is material and is required to be
stated therein or is necessary to make the statements therein, in the
light of the circumstances under which they were made, not misleading,
or that the Prospectus, or any amendment or supplement thereto,
contains an untrue statement of fact that in the reasonable opinion of
you or your counsel is material or omits to state a fact that in the
reasonable opinion of you or your counsel is material and is required
to be stated therein or is necessary to make the statements therein,
in the light of the circumstances under which they were made, not
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<PAGE> 25
misleading and which statement or omission has not been or is not
being corrected to your satisfaction; and
(iv) the NASD shall have raised no objection to the fairness and
reasonableness of the underwriting terms and arrangements.
(c) No Material Adverse Change or Ratings Agency Change. For the
period from and after the date of this Agreement and prior to the First
Closing Date and, with respect to the Optional Units, the Second Closing
Date, in the judgment of the Representative there shall not have occurred
any Material Adverse Change.
(d) Opinion of Counsel for the Company. On each of the First Closing
Date and the Second Closing Date, the Representative shall have received
the favorable opinion of Jeffers, Wilson, Shaff & Falk LLP, counsel for the
Company, dated as of such Closing Date, the form of which is attached as
Exhibit A, which opinion may rely, as to matters of Maryland corporate law,
on the opinion of [name of Maryland counsel], a copy of which shall be
attached to such opinion (and the Representative shall have received such
number of additional conformed copies of such counsel's legal opinions as
the Representative shall reasonably request).
(e) Opinion of Counsel for the Underwriters. On each of the First
Closing Date and the Second Closing Date, the Representative shall have
received the favorable opinion of O'Melveny & Myers LLP, counsel for the
Underwriters, dated as of such Closing Date, with respect to such matters
as the Representative shall have reasonably requested.
(f) Officers' Certificates. On each of the First Closing Date and
the Second Closing Date, the Representative shall have received a written
certificate executed on behalf of the Company by its Chief Executive
Officer or President and its Chief Financial Officer or Chief Accounting
Officer dated as of such Closing Date and certifying as to such matters as
the Representative shall have reasonably requested, including, without
limitation, the matters set forth in subsections (b) and (c) of this
Section 5, and further to the effect that:
(i) for the period from and after the date of this Agreement
and prior to such Closing Date, there has not occurred any Material
Adverse Change;
(ii) the representations, warranties and covenants of the
Company set forth in Section 1 of this Agreement are true and correct
with the same force and effect as though expressly made on and as of
such Closing Date; and
(iii) the Company has complied with all the agreements and
satisfied all the conditions on its part to be performed or satisfied
at or prior to such Closing Date under this Agreement and all
Formation Agreements.
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(g) Bring-down Comfort Letter. On each of the First Closing Date and
the Second Closing Date, the Representative shall have received from KPMG
Peat Marwick LLP, independent public or certified public accountants for
the Company, a letter dated as of such Closing Date, in form and substance
satisfactory to the Representative, to the effect that they reaffirm the
statements made in the letter furnished by them pursuant to subsection (a)
of this Section 5, except that the specified date referred to therein for
the carrying out of procedures shall be no more than three business days
prior to the First Closing Date or Second Closing Date, as the case may be
(and the Representative shall have received such number of additional
conformed copies of such accountants' letter as the Representative shall
reasonably request).
(h) Lock-Up Agreements. On the date hereof, the Company shall have
furnished to the Representative the Lock-Up Agreements (referred to in
Section 3(n)) and each such agreement shall be in full force and effect on
each Closing Date.
(i) Written Consents. On or before the First Closing Date, the
Company shall have furnished to the Representative copies of the Written
Consents (referred to in Section 1(q)).
(j) Additional Documents. On or before each of the First Closing
Date and the Second Closing Date, the Representative and counsel for the
Underwriters shall have received such additional certificates, information,
documents and opinions as they may reasonably require for the purposes of
enabling them to pass upon the issuance and sale of the Units as
contemplated herein, or in order to evidence the accuracy of any of the
representations and warranties, or the satisfaction of any of the
conditions or agreements, herein contained.
(k) American Stock Exchange Listing. The Shares, Warrants
Representative's Warrants and Units shall have been approved for listing on
the American Stock Exchange, subject only to official notice of issuance.
(l) Consummation of Formation Transactions. The Formation
Transactions to be consummated on or prior to the First Closing Date as set
forth in the Prospectus shall have been consummated.
(m) Representative's Warrants. On or before the First Closing Date,
the Company shall have executed and delivered to the Representative the
Warrant Agreement pursuant to which the Company shall issue to the
Representative (for its own account and not as Representative of the
Underwriters) warrants (the "Representative's Warrants") to purchase up to
150,000 shares (172,500 shares if all of the Optional Units are purchased)
of Common Stock at an exercise price per share equal to the initial public
offering price of the Units and upon the terms and conditions set forth in
the Warrant Agreement, the form of which is filed as Exhibit 4.2 to the
Registration Statement. On the First Closing Date and Second Closing Date,
respectively, the Company shall have delivered to the Representative, duly
executed certificates representing the Representative's Warrants
countersigned by the Warrant Agent in accordance with the Warrant Agreement
representing warrants to purchase 150,000 shares of Common Stock on the
First Closing Date and 22,500 shares of Common Stock on the
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Second Closing Date (assuming full exercise of the over-allotment option),
such certificates to be in such denominations and registered in such names
as may be designated by the Representative.
If any condition specified in this Section 5 is not satisfied when and as
required to be satisfied, this Agreement may be terminated by the
Representative by notice to the Company at any time on or prior to the First
Closing Date and, with respect to the Optional Units, at any time prior to the
Second Closing Date, which termination shall be without liability on the part
of any party to any other party, except that Section 4, Section 6, Section 8
and Section 9 shall at all times be effective and shall survive such
termination.
SECTION 6. REIMBURSEMENT OF UNDERWRITERS' EXPENSES. If this
Agreement is terminated by the Representative pursuant to Section 5, Section 7,
Section 10 or Section 11, or if the sale to the Underwriters of the Units on
the First Closing Date is not consummated because of any refusal, inability or
failure on the part of the Company to perform any agreement herein or to comply
with any provision hereof, the Company agrees to reimburse the Representative
and the other Underwriters (or such Underwriters as have terminated this
Agreement with respect to themselves), severally, upon demand for all
out-of-pocket expenses that shall have been reasonably incurred by the
Representative and the Underwriters in connection with the proposed purchase
and the offering and sale of the Units, including but not limited to fees and
disbursements of counsel, printing expenses, travel expenses, postage,
facsimile and telephone charges.
SECTION 7. EFFECTIVENESS OF THIS AGREEMENT.
This Agreement shall not become effective until the later of (i) the
execution of this Agreement by the parties hereto and (ii) notification by the
Commission to the Company and the Representative of the effectiveness of the
Registration Statement under the Securities Act.
Prior to such effectiveness, this Agreement may be terminated by any
party by notice to each of the other parties hereto, and any such termination
shall be without liability on the part (a) of the Company to any Underwriter,
except that the Company shall be obligated to reimburse the expenses of the
Representative and the Underwriters pursuant to Sections 4 and 6 hereof, (b) of
any Underwriter to the Company, or (c) of any party hereto to any other party
except that the provisions of Section 8 and Section 9 shall at all times be
effective and shall survive such termination.
SECTION 8. INDEMNIFICATION.
(a) Indemnification of the Underwriters by the Company. The Company
agrees to indemnify and hold harmless each Underwriter, its officers and
employees, and each person, if any, who controls any Underwriter within the
meaning of the Securities Act and the
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Exchange Act against any loss, claim, damage, liability or expense, as
incurred, to which such Underwriter or such controlling person may become
subject, under the Securities Act, the Exchange Act or other federal, state
or Canadian statutory law or regulation, or at common law or otherwise
(including in settlement of any litigation, if such settlement is effected
with the written consent of the Company, insofar as such loss, claim,
damage, liability or expense (or actions in respect thereof as contemplated
below) arises out of or is based (i) upon any untrue statement or alleged
untrue statement of a material fact contained in the Registration
Statement, or any amendment thereto, including any information deemed to be
a part thereof pursuant to Rule 430A or Rule 434 under the Securities Act,
or the omission or alleged omission therefrom of a material fact required
to be stated therein or necessary to make the statements therein not
misleading; or (ii) upon any untrue statement or alleged untrue statement
of a material fact contained in any preliminary prospectus or the
Prospectus (or any amendment or supplement thereto), or the omission or
alleged omission therefrom of a material fact necessary in order to make
the statements therein, in the light of the circumstances under which they
were made, not misleading; or (iii) in whole or in part upon any inaccuracy
in the representations and warranties of the Company contained herein; or
(iv) in whole or in part upon any failure of the Company to perform its
obligations hereunder or under law; or (v) any act or failure to act or any
alleged act or failure to act by any Underwriter in connection with, or
relating in any manner to, the Units or the offering contemplated hereby,
and which is included as part of or referred to in any loss, claim, damage,
liability or action arising out of or based upon any matter covered by
clause (i) or (ii) above, provided that the Company shall not be liable
under this clause (v) to the extent that a court of competent jurisdiction
shall have determined by a final judgment that such loss, claim, damage,
liability or action resulted directly from any such acts or failures to act
undertaken or omitted to be taken by such Underwriter through its gross
negligence or willful misconduct; and to reimburse each Underwriter and
each such controlling person for any and all expenses (including the fees
and disbursements of counsel chosen by the Representative) as such expenses
are reasonably incurred by such Underwriter or such controlling person in
connection with investigating, defending, settling, compromising or paying
any such loss, claim, damage, liability, expense or action; provided,
however, that the foregoing indemnity agreement shall not apply to any
loss, claim, damage, liability or expense to the extent, but only to the
extent, arising out of or based upon any untrue statement or alleged untrue
statement or omission or alleged omission made in reliance upon and in
conformity with written information furnished to the Company by the
Representative expressly for use in the Registration Statement, any
preliminary prospectus or the Prospectus (or any amendment or supplement
thereto); and provided, further, that with respect to any preliminary
prospectus, the foregoing indemnity agreement shall not inure to the
benefit of any Underwriter from whom the person asserting any loss, claim,
damage, liability or expense purchased Units, or any person controlling
such Underwriter, if copies of the Prospectus were timely delivered to the
Underwriter pursuant to Section 2 and a copy of the Prospectus (as then
amended or supplemented if the Company shall have furnished any amendments
or supplements thereto) was not sent or given by or on behalf of such
Underwriter to such person, if required by law so to have been delivered,
at or prior to the written confirmation of the sale of the Units to such
person, and if the Prospectus (as so amended or supplemented) would have
cured the defect giving rise to such loss, claim,
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damage, liability or expense. The indemnity agreement set forth in this
Section 8(a) shall be in addition to any liabilities that the Company may
otherwise have.
(b) Indemnification of the Company, its Directors and Officers. Each
Underwriter agrees, severally and not jointly, to indemnify and hold
harmless the Company, each of its directors, each of its officers who
signed the Registration Statement, and each person, if any, who controls
the Company, within the meaning of the Securities Act or the Exchange Act,
against any loss, claim, damage, liability or expense, as incurred, to
which the Company, any such director or officer, or any such controlling
person may become subject, under the Securities Act, the Exchange Act, or
other federal or state statutory law or regulation, or at common law or
otherwise (including in settlement of any litigation, if such settlement is
effected with the written consent of such Underwriter), insofar as such
loss, claim, damage, liability or expense (or actions in respect thereof as
contemplated below) arises out of or is based upon any untrue or alleged
untrue statement of a material fact contained in the Registration
Statement, any preliminary prospectus or the Prospectus (or any amendment
or supplement thereto), or arises out of or is based upon the omission or
alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein not misleading, in each
case to the extent, but only to the extent, that such untrue statement or
alleged untrue statement or omission or alleged omission was made in the
Registration Statement, any preliminary prospectus, the Prospectus (or any
amendment or supplement thereto), in reliance upon and in conformity with
written information furnished to the Company by the Representative
expressly for use therein; and to reimburse the Company, any such director
or officer, or any such controlling person for any legal and other expense
reasonably incurred by the Company, any such director or officer, or any
such controlling person in connection with investigating, defending,
settling, compromising or paying any such loss, claim, damage, liability,
expense or action. The Company hereby acknowledges that the only
information that the Underwriters have furnished to the Company expressly
for use in the Registration Statement, any preliminary prospectus or the
Prospectus (or any amendment or supplement thereto) are the statements
referred to in Schedule 3; and the Underwriters confirm that such
statements are correct. The indemnity agreement set forth in this Section
8(b) shall be in addition to any liabilities that each Underwriter may
otherwise have.
(c) Notifications and Other Indemnification Procedures. Promptly
after receipt by an indemnified party under this Section 8 of notice of the
commencement of any action, such indemnified party will, if a claim in
respect thereof is to be made against an indemnifying party under this
Section 8, notify the indemnifying party in writing of the commencement
thereof, but the omission so to notify the indemnifying party will not
relieve it from any liability which it may have to any indemnified party
for contribution or otherwise than under the indemnity agreement contained
in this Section 8 or to the extent it is not prejudiced as a proximate
result of such failure. In case any such action is brought against any
indemnified party and such indemnified party seeks or intends to seek
indemnity from an indemnifying party, the indemnifying party will be
entitled to participate in, and, to the extent that it shall elect, jointly
with all other indemnifying parties similarly notified, by written notice
delivered to the indemnified party promptly after receiving the aforesaid
notice from such indemnified party,
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to assume the defense thereof with counsel reasonably satisfactory to such
indemnified party; provided, however, if the defendants in any such action
include both the indemnified party and the indemnifying party and the
indemnified party shall have reasonably concluded that a conflict may arise
between the positions of the indemnifying party and the indemnified party
in conducting the defense of any such action or that there may be legal
defenses available to it and/or other indemnified parties which are
different from or additional to those available to the indemnifying party,
the indemnified party or parties shall have the right to select separate
counsel to assume such legal defenses and to otherwise participate in the
defense of such action on behalf of such indemnified party or parties.
Upon receipt of notice from the indemnifying party to such indemnified
party of such indemnifying party's election so to assume the defense of
such action and approval by the indemnified party of counsel, the
indemnifying party will not be liable to such indemnified party under this
Section 8 for any legal or other expenses subsequently incurred by such
indemnified party in connection with the defense thereof unless (i) the
indemnified party shall have employed separate counsel in accordance with
the proviso to the next preceding sentence (it being understood, however,
that the indemnifying party shall not be liable for the expenses of more
than one separate counsel (together with local counsel), approved by the
indemnifying party (Stifel, Nicolaus & Company, Incorporated, in the case
of Section 8(b) and Section 9), representing the indemnified parties who
are parties to such action) or (ii) the indemnifying party shall not have
employed counsel satisfactory to the indemnified party to represent the
indemnified party within a reasonable time after notice of commencement of
the action, in each of which cases the fees and expenses of counsel shall
be at the expense of the indemnifying party.
(d) Settlements. The indemnifying party under this Section 8 shall
not be liable for any settlement of any proceeding effected without its
written consent, but if settled with such consent or if there be a final
judgment for the plaintiff, the indemnifying party agrees to indemnify the
indemnified party against any loss, claim, damage, liability or expense by
reason of such settlement or judgment. Notwithstanding the foregoing
sentence, if at any time an indemnified party shall have requested an
indemnifying party to reimburse the indemnified party for fees and expenses
of counsel as contemplated by Section 8(c) hereof, the indemnifying party
agrees that it shall be liable for any settlement of any proceeding
effected without its written consent if (i) such settlement is entered into
more than 30 days after receipt by such indemnifying party of the aforesaid
request and (ii) such indemnifying party shall not have reimbursed the
indemnified party in accordance with such request prior to the date of such
settlement. No indemnifying party shall, without the prior written consent
of the indemnified party, effect any settlement, compromise or consent to
the entry of judgment in any pending or threatened action, suit or
proceeding in respect of which any indemnified party is or could have been
a party and indemnity was or could have been sought hereunder by such
indemnified party, unless such settlement, compromise or consent includes
an unconditional release of such indemnified party from all liability on
claims that are the subject matter of such action, suit or proceeding.
SECTION 9. CONTRIBUTION.
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If the indemnification provided for in Section 8 is for any reason
held to be unavailable to or otherwise insufficient to hold harmless an
indemnified party in respect of any losses, claims, damages, liabilities or
expenses referred to therein, then each indemnifying party shall contribute
to the aggregate amount paid or payable by such indemnified party, as
incurred, as a result of any losses, claims, damages, liabilities or
expenses referred to therein (i) in such proportion as is appropriate to
reflect the relative benefits received by the Company, on the one hand, and
the Underwriters, on the other hand, from the offering of the Units
pursuant to this Agreement or (ii) if the allocation provided by clause (i)
above is not permitted by applicable law, in such proportion as is
appropriate to reflect not only the relative benefits referred to in clause
(i) above but also the relative fault of the Company, on the one hand, and
the Underwriters, on the other hand, in connection with the statements or
omissions or inaccuracies in the representations and warranties herein
which resulted in such losses, claims, damages, liabilities or expenses, as
well as any other relevant equitable considerations. The relative benefits
received by the Company, on the one hand, and the Underwriters, on the
other hand, in connection with the offering of the Units pursuant to this
Agreement shall be deemed to be in the same respective proportions as the
total net proceeds from the offering of the Units pursuant to this
Agreement (before deducting expenses) received by the Company, and the
total underwriting discount received by the Underwriters, in each case as
set forth on the front cover page of the Prospectus (or, if Rule 434 under
the Securities Act is used, the corresponding location on the Term Sheet)
bear to the aggregate initial public offering price of the Units as set
forth on such cover. The relative fault of the Company, on the one hand,
and the Underwriters, on the other hand, shall be determined by reference
to, among other things, whether any such untrue or alleged untrue statement
of a material fact or omission or alleged omission to state a material fact
or any such inaccurate or alleged inaccurate representation or warranty
relates to information supplied by the Company, on the one hand, or the
Underwriters, on the other hand, and the parties' relative intent,
knowledge, access to information and opportunity to correct or prevent such
statement or omission.
The amount paid or payable by a party as a result of the losses,
claims, damages, liabilities and expenses referred to above shall be deemed
to include, subject to the limitations set forth in Section 8(c), any legal
or other fees or expenses reasonably incurred by such party in connection
with investigating or defending any action or claim. The provisions set
forth in Section 8(c) with respect to notice of commencement of any action
shall apply if a claim for contribution is to be made under this Section 9;
provided, however, that no additional notice shall be required with respect
to any action for which notice has been given under Section 8(c) for
purposes of indemnification.
The Company and the Underwriters agree that it would not be just
and equitable if contribution pursuant to this Section 9 were determined by
pro rata allocation (even if for such purpose the Underwriters were treated
as one entity) or by any other method of allocation which does not take
account of the equitable considerations referred to in this Section 9.
Notwithstanding the provisions of this Section 9, no Underwriter shall
be required to contribute any amount in excess of the underwriting commissions
received by such Underwriter
30
<PAGE> 32
in connection with the Units underwritten by it and distributed to the public.
No person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Securities Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation. The Underwriters'
obligations to contribute pursuant to this Section 9 are several, and not
joint, in proportion to their respective underwriting commitments as set forth
opposite their names in Schedule 1. For purposes of this Section 9, each
officer and employee of an Underwriter and each person, if any, who controls an
Underwriter within the meaning of the Securities Act and the Exchange Act shall
have the same rights to contribution as such Underwriter; and each director of
the Company, each officer of the Company who signed the Registration Statement,
and each person, if any, who controls the Company within the meaning of the
Securities Act and the Exchange Act shall have the same rights to contribution
as the Company.
SECTION 10. DEFAULT OF ONE OR MORE OF THE SEVERAL UNDERWRITERS. If,
on the First Closing Date or the Second Closing Date, as the case may be, any
one or more of the several Underwriters shall fail or refuse to purchase Units
that it or they have agreed to purchase hereunder on such date, and the
aggregate number of Units which such defaulting Underwriter or Underwriters
agreed but failed or refused to purchase does not exceed 10% of the aggregate
number of the Units to be purchased on such date, the other Underwriters shall
be obligated, severally, in the proportions that the number of Firm Units set
forth opposite their respective names on Schedule 1 bears to the aggregate
number of Firm Units set forth opposite the names of all such non-defaulting
Underwriters, or in such other proportions as may be specified by the
Representative with the consent of the non-defaulting Underwriters, to purchase
the Units which such defaulting Underwriter or Underwriters agreed but failed
or refused to purchase on such date. If, on the First Closing Date or the
Second Closing Date, as the case may be, any one or more of the Underwriters
shall fail or refuse to purchase Units and the aggregate number of Units with
respect to which such default occurs exceeds 10% of the aggregate number of
Units to be purchased on such date, and arrangements satisfactory to the
Representative and the Company for the purchase of such Units are not made
within 48 hours after such default, this Agreement shall terminate without
liability of any party to any other party except that the provisions of Section
4, Section 6, Section 8 and Section 9 shall at all times be effective and shall
survive such termination. In any such case either the Representative or the
Company shall have the right to postpone the First Closing Date or the Second
Closing Date, as the case may be, but in no event for longer than seven days in
order that the required changes, if any, to the Registration Statement and the
Prospectus or any other documents or arrangements may be effected.
As used in this Agreement, the term "Underwriter" shall be deemed to
include any person substituted for a defaulting Underwriter under this Section
10. Any action taken under this Section 10 shall not relieve any defaulting
Underwriter from liability in respect of any default of such Underwriter under
this Agreement.
SECTION 11. TERMINATION OF THIS AGREEMENT. Prior to the First
Closing Date this Agreement may be terminated by the Representative by notice
given to the Company if at any time
31
<PAGE> 33
(i) trading or quotation in any of the Company's securities shall have been
suspended or limited by the Commission or by the American Stock Exchange, or
trading in securities generally on any of the American Stock Exchange, Nasdaq
Stock Market or the New York Stock Exchange shall have been suspended or
limited, or minimum or maximum prices shall have been generally established on
any of such stock exchanges by the Commission or the NASD; (ii) a general
banking moratorium shall have been declared by any of federal, Maryland or New
York authorities; (iii) there shall have occurred any outbreak or escalation of
national or international hostilities or any crisis or calamity, or any change
in the United States or international financial markets, or any substantial
change or development involving a prospective substantial change in United
States' or international political, financial or economic conditions, in each
case which in the judgment of the Representative is material and adverse and
makes it impracticable to market the Units in the manner and on the terms
described in the Prospectus or to enforce contracts for the sale of securities;
(iv) in the judgment of the Representative there shall have occurred any
Material Adverse Change; or (v) the Company or its Subsidiaries shall have
sustained a loss by strike, fire, flood, earthquake, accident or other calamity
of such character as in the judgment of the Representative may interfere
materially with the conduct of the business and operations of such entity
regardless of whether or not such loss shall have been insured. Any
termination pursuant to this Section 11 shall be without liability on the part
of (a) the Company to any Underwriter, except that the Company shall be
obligated to reimburse the expenses of the Representative and the Underwriters
pursuant to Sections 4 and 6 hereof, (b) any Underwriter to the Company, or (c)
of any party hereto to any other party except that the provisions of Section 8
and Section 9 shall at all times be effective and shall survive such
termination.
SECTION 12. REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY. The
respective indemnities, agreements, representations, warranties and other
statements of the Company and their officers and of the several Underwriters
set forth in or made pursuant to this Agreement will remain in full force and
effect, regardless of any investigation made by or on behalf of any Underwriter
or the Company or any of its or their partners, officers or directors,
affiliates or any controlling person, as the case may be, and will survive
delivery of and payment for the Units sold hereunder and any termination of
this Agreement.
SECTION 13. NOTICES. All communications hereunder shall be in
writing and shall be mailed, hand delivered or telecopied and confirmed to the
parties hereto as follows:
(a) Underwriters. If to the Representative:
Stifel, Nicolaus & Company, Incorporated
500 North Broadway, Suite 1500
St. Louis, Missouri 63102
Facsimile: (314) 342-2775
Attention: Mr. Rick E. Maples
32
<PAGE> 34
with a copy to:
O'Melveny & Myers LLP
Embarcadero Center West
275 Battery Street, Suite 2600
San Francisco, California 94111-3305
Facsimile: (415) 984-8701
Attention: Peter T. Healy, Esq.
(b) Company. If to the Company:
RealTrust Asset Corporation
2855 E. Cottonwood Parkway, Suite 500
Salt Lake City, Utah 84121
Facsimile: (801) 365-3125
Attention: Mr. John D. Fry
with a copy to:
Jeffers, Wilson, Shaff & Falk LLP
18881 Von Karman Avenue, Suite 1400
Irvine, California 92612
Facsimile: (714) 660-7799
Attention: Christopher A. Wilson, Esq.
Any party hereto may change the address for receipt of communications by giving
written notice to the others.
SECTION 14. SUCCESSORS. This Agreement will inure to the benefit of
and be binding upon the parties hereto, including any substitute Underwriters
pursuant to Section 10 hereof, and to the benefit of the employees, officers
and directors and controlling persons referred to in Section 8 and Section 9,
and in each case their respective successors, and no other person will have any
right or obligation hereunder. The term "successors" shall not include any
purchaser of the Units as such from any of the Underwriters merely by reason of
such purchase.
SECTION 15. PARTIAL UNENFORCEABILITY. The invalidity or
unenforceability of any Section, paragraph or provision of this Agreement shall
not affect the validity or enforceability of any other Section, paragraph or
provision hereof. If any Section, paragraph or provision of this Agreement is
for any reason determined to be invalid or unenforceable, there shall be deemed
to be made such minor changes (and only such minor changes) as are necessary to
make it valid and enforceable.
33
<PAGE> 35
SECTION 16. (a) GOVERNING LAW PROVISIONS. THIS AGREEMENT SHALL BE
GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF
NEW YORK APPLICABLE TO AGREEMENTS MADE AND TO BE PERFORMED IN SUCH STATE.
(b) Consent to Jurisdiction. Any legal suit, action or proceeding
arising out of or based upon this Agreement or the transactions contemplated
hereby ("Related Proceedings") may be instituted in the federal courts of the
United States of America located in the City and County of New York or the
courts of the State of New York in each case located in the City and County of
New York (collectively, the "Specified Courts"), and each party irrevocably
submits to the exclusive jurisdiction (except for proceedings instituted in
regard to the enforcement of a judgment of any such court (a "Related
Judgment"), as to which such jurisdiction is non-exclusive) of such courts in
any such suit, action or proceeding. Service of any process, summons, notice
or document by mail to such party's address set forth above shall be effective
service of process for any suit, action or other proceeding brought in any such
court. The parties irrevocably and unconditionally waive any objection to the
laying of venue of any suit, action or other proceeding in the Specified Courts
and irrevocably and unconditionally waive and agree not to plead or claim in
any such court that any such suit, action or other proceeding brought in any
such court has been brought in an inconvenient forum.
(c) Waiver of Immunity. With respect to any Related Proceeding, each
party irrevocably waives, to the fullest extent permitted by applicable law,
all immunity (whether on the basis of sovereignty or otherwise) from
jurisdiction, service of process, attachment (both before and after judgment)
and execution to which it might otherwise be entitled in the Specified Courts,
and with respect to any Related Judgment, each party waives any such immunity
in the Specified Courts or any other court of competent jurisdiction, and will
not raise or claim or cause to be pleaded any such immunity at or in respect of
any such Related Proceeding or Related Judgment, including, without limitation,
any immunity pursuant to the United States Foreign Sovereign Immunities Act of
1976, as amended.
SECTION 17. LEAD MANAGER. Any action required or permitted to be
taken by the Underwriters under this Agreement may be taken by them jointly or
by Stifel, Nicolaus & Company, Incorporated.
SECTION 18. GENERAL PROVISIONS. This Agreement constitutes the
entire agreement of the parties to this Agreement and supersedes all prior
written or oral and all contemporaneous oral agreements, understandings and
negotiations with respect to the subject matter hereof. This Agreement may be
executed in two or more counterparts, each one of which shall be an original,
with the same effect as if the signatures thereto and hereto were upon the same
instrument. This Agreement may not be amended or modified unless in writing by
all of the parties hereto, and no
34
<PAGE> 36
condition herein (express or implied) may be waived unless waived in writing by
each party whom the condition is meant to benefit. The Table of Contents and
the Section headings herein are for the convenience of the parties only and
shall not affect the construction or interpretation of this Agreement. In this
Agreement unless the context otherwise requires, (i) singular words shall
connote the plural number as well as the singular and vice versa, and the
masculine shall include the feminine and the neuter, and (ii) all references to
particular articles, sections, subsections, clauses or exhibits are references
to articles, sections, subsections, clauses or exhibits of this Agreement.
Each of the parties hereto acknowledges that it is a sophisticated
business person who was adequately represented by counsel during negotiations
regarding the provisions hereof, including, without limitation, the
indemnification provisions of Section 8 and the contribution provisions of
Section 9, and is fully informed regarding said provisions. Each of the
parties hereto further acknowledges that the provisions of Sections 8 and 9
hereto fairly allocate the risks in light of the ability of the parties to
investigate the Company, its affairs and its business in order to assure that
adequate disclosure has been made in the Registration Statement, any
preliminary prospectus and the Prospectus (and any amendments and supplements
thereto), as required by the Securities Act and the Exchange Act.
[signature page follows]
35
<PAGE> 37
If the foregoing is in accordance with your understanding of our
agreement, kindly sign and return to the Company the enclosed copies hereof,
whereupon this instrument, along with all counterparts hereof, shall become a
binding agreement in accordance with its terms.
Very truly yours,
REALTRUST ASSET CORPORATION, the Company
By:
------------------------------------
Mr. John D. Fry
Chief Executive Officer
The foregoing Underwriting Agreement is hereby confirmed and
accepted by the Representative in St. Louis, Missouri, as of the date first
above written.
STIFEL, NICOLAUS & COMPANY, INCORPORATED
Acting on their own behalf and as Representative
of the several Underwriters named in Schedule 1.
By: STIFEL, NICOLAUS & COMPANY, INCORPORATED
By:
-------------------------------------
[name]
[title]
S-1
<PAGE> 38
SCHEDULE 1
UNDERWRITERS
<TABLE>
<CAPTION>
Number of Firm Units
to be Purchased
<S> <C>
Stifel, Nicolaus & Company, Incorporated . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
-----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 000,000
===========
</TABLE>
Schedule 1 -1
<PAGE> 39
SCHEDULE 2
CERTAIN FORMATION DOCUMENTS
[To be completed by Company Counsel]
Schedule 2 -1
<PAGE> 40
SCHEDULE 3
INFORMATION RELATING TO ANY UNDERWRITER FURNISHED
BY THE REPRESENTATIVE FOR INCLUSION IN
THE REGISTRATION STATEMENT OR THE PROSPECTUS
The following information contained on the inside front cover of the
Prospectus:
1. the paragraph concerning stabilization by the Underwriters.
The following information contained under the caption "Underwriting":
1. the allocation of Firm Units among the Underwriters in the table
following the first paragraph; and
2. the amounts of the selling concession and reallowance set forth in the
second paragraph.
Schedule 3 -1
<PAGE> 41
SCHEDULE 4
CERTAIN EXISTING INSTRUMENTS
[To be completed by Company Counsel]
Schedule 4 -1
<PAGE> 42
SCHEDULE 5
LEGAL PROCEEDINGS
[To be completed by Company Counsel]
Schedule 5 -1
<PAGE> 43
EXHIBIT A
FORM OF OPINION OF COUNSEL FOR THE COMPANY
(TO BE DELIVERED PURSUANT TO SECTION 5(d))
The opinion of counsel for the Company (the "Opinion") shall be
addressed to Stifel, Nicolaus & Company, Incorporated, as representative of the
several underwriters listed in Schedule 1 to the Underwriting Agreement, shall
be dated as of the First Closing Date or the Second Closing Date, as
applicable, and shall expressly authorize O'Melveny & Myers LLP, as counsel for
the Underwriters, to rely upon the Opinion in connection with such firm's
opinion to be rendered pursuant to Section 5(e) of the Underwriting Agreement.
In rendering this Opinion, counsel for the Company may rely (1)
as to matters involving the application of laws of any jurisdiction other than
the General Corporation Law of the State of Delaware, the law of the State of
New York or the federal law of the United States, to the extent they deem
proper and specified in such opinion, upon the opinion of [Maryland counsel]
(which opinion shall be dated the First Closing Date or the Second Closing
Date, as the case may be, shall be delivered to the Representative, shall be
satisfactory in form and substance to the Representative, and shall expressly
state that the Underwriters and O'Melveny & Myers LLP, as counsel for the
Underwriters, may rely on such opinion); provided, however, that counsel to the
Company shall further state that they believe that they and the Underwriters
and counsel for the Underwriters are justified in relying upon such opinion of
other counsel, and (2) as to matters of fact, to the extent they deem proper,
on certificates of public officials and responsible officers of the Company
(counsel to the Company shall include any such representation certificate of
the Company as an exhibit to the Opinion ).
All capitalized terms used herein without definitions shall have
the meaning given such terms in the Underwriting Agreement to which this
Exhibit A is attached (the "Underwriting Agreement").
* * * *
(a) The Company has been duly organized and is validly existing as a
corporation in good standing under the laws of the State of Maryland.
(b) The Company is duly qualified as a foreign corporation to
transact business and is in good standing in each jurisdiction in which such
qualification is required, whether by reason of the ownership or leasing of
property or the conduct of business, except for
A-1
<PAGE> 44
such jurisdictions where the failure to so qualify or to be in good standing
would not, individually or in the aggregate, result in a Material Adverse
Change.
(c) The Company has all requisite corporate power and authority (i)
to own, lease and operate its properties and to conduct its business as
described in the Prospectus both currently and after giving effect to the
Formation Transactions, (ii) to enter into, to issue, sell and deliver the
Shares, Warrants, Representative's Warrants and Units to the Underwriters
pursuant to, and otherwise to perform its obligations under, the Underwriting
Agreement and the Warrant Agreement, (iii) to enter into and each Formation
Agreement to which it is a party, to perform its obligations thereunder and
otherwise to consummate the transactions contemplated thereby, and (iv) to
issue sell and deliver the Representative's Warrants.
(d) Each Subsidiary is a corporation, limited partnership or limited
liability company, as the case may be, duly organized or formed, as the case
may be, validly existing and in good standing under the laws of its
jurisdiction of its incorporation or formation.
(e) Each Subsidiary is duly qualified as a foreign corporation to
transact business and is in good standing in each jurisdiction in which such
qualification is required, whether by reason of the ownership or leasing of
property or the conduct of business, except for such jurisdictions where the
failure to so qualify or to be in good standing would not, individually or in
the aggregate, result in a Material Adverse Change.
(f) Each Subsidiary has all requisite power and authority (i) to own,
lease and operate its properties and to conduct its business as described in
the Prospectus both currently and after giving effect to the Formation
Transactions and (ii) to enter into each Formation Agreement to which it is a
party, to perform its obligations thereunder and otherwise to consummate the
transactions contemplated thereby.
(g) To such counsel's knowledge, the Company does not own or control,
directly or indirectly, any corporation, association or other entity other than
the Subsidiaries listed in Exhibit 21 to the Registration Statement.
(h) The authorized, issued and outstanding capital stock of the
Company is as set forth in the Prospectus under the caption "Capitalization."
The issued and outstanding shares of Common Stock have been, the Shares,
Warrants, Representative's Warrants and Units, upon issuance and delivery
against payment therefor in the manner described in the Underwriting Agreement
or the Warrant Agreement, as applicable, will be duly authorized and validly
issued, fully paid and nonassessable, and were not or, upon issuance, will not
be, issued (i) in violation of or subject to any preemptive rights, or other
rights to subscribe for or purchase any securities of the Company arising from
the charter or bylaws of the Company, the Maryland General Corporation Law or,
to the best knowledge of such
A-2
<PAGE> 45
counsel, otherwise or (ii) in violation of any federal or state securities
laws. The terms and provisions of the Shares, Warrants, Representative's
Warrants and Units conform in all material respects to the descriptions thereof
contained in the Prospectus.
(i) Except as disclosed in the Prospectus, no stockholder of
the Company or any other person has any preemptive right, right of first
refusal or other similar right to subscribe for or purchase securities of the
Company arising by operation of the charter or bylaws of the Company, the
Maryland General Corporation Law or, to the best knowledge of such counsel,
otherwise. Except as disclosed in the Prospectus, to the best knowledge of
such counsel, there are no persons with registration or other similar rights to
have any equity or debt securities registered for sale under the Registration
Statement or included in the offering contemplated by the Underwriting
Agreement, except for such rights as have been duly waived.
(j) The forms of certificates used to evidence the Shares,
Warrants, Representative's Warrants and Units are in due and proper form and
comply with all applicable requirements of the charter and bylaws of the
Company and the Maryland General Corporation Law.
(k) The Company has reserved for issuance a sufficient number of
shares of Common Stock to permit the issuance of all shares of Common Stock
issuable upon the exercise of the Warrants and the Representative's Warrants in
accordance with the terms of the Warrant Agreement. The shares of Common Stock
to be issued upon the exercise of the Warrants and the Representative's
Warrants have been duly authorized for issuance and sale pursuant to the
Warrant Agreement and, when issued and delivered by the Company pursuant to
such agreement, will be validly issued, fully paid and nonassessable. No
further approval or authority of the shareholders or the Board of Directors of
the Company is required for the issuance and sale of the shares of Common Stock
pursuant to the terms of the Warrant Agreement.
(l) The description of the Company's dividend reinvestment
plan, stock option, stock bonus and other stock plans or arrangements, and the
options or other rights granted and exercised thereunder, set forth in the
Prospectus accurately and fairly presents the information required to be shown
with respect to such plans, arrangements, options and rights.
(m) All of the issued and outstanding capital stock, membership
interests or other equity interests of each Subsidiary (i) has been duly
authorized and validly issued and is fully paid and non-assessable, (ii) except
as otherwise disclosed in the Prospectus, is owned by the Company, directly or
through Subsidiaries, in the respective amounts set forth in the Prospectus
free and clear of any security interest, mortgage, pledge, lien, encumbrance
or, to the best knowledge of such counsel, any pending or threatened claim, and
(iii) has been issued in compliance with all state and federal securities laws.
A-3
<PAGE> 46
(n) Each of the Underwriting Agreement, the Warrant Agreement and
each Formation Agreement to which the Company is a party (collectively, the
"Company Agreements") has been duly authorized, executed and delivered by, and
is a valid and binding agreement of, the Company, enforceable in accordance
with its terms, except as the enforcement thereof may be limited by bankruptcy,
insolvency, reorganization, moratorium or other similar laws related to or
affecting creditors' rights generally or by general equitable principles and,
with respect to the Underwriting Agreement, except as rights to indemnification
thereunder may be limited by applicable law.
(o) Each Formation Agreement to which any Subsidiary of the Company
is a party has been (i) duly authorized by all requisite partnership, corporate
or other action, (ii) duly executed and delivered by such Subsidiary and (iii)
constitutes a valid and binding agreement of such Subsidiary and, to such
Counsel's knowledge, each of the other parties thereto, and is enforceable in
accordance with its terms, except as the enforcement thereof may be limited by
bankruptcy, insolvency, reorganization, moratorium or other similar laws
relating to or affecting the rights and remedies of creditors or by general
equitable principles.
(p) The execution, delivery and performance of each of the Formation
Agreements by the Company and the Subsidiaries and the consummation of the
transactions contemplated thereby will not (i) result in any violation of the
provisions of the charter, bylaws, partnership agreement or other similar
organization document of the Company or any of the Subsidiaries; (ii) result in
a breach of, or constitute, either immediately or upon notice or the passage of
time or both, a Default or a Debt Repayment Triggering Event under, or result
in the creation or imposition of any lien, charge or encumbrance upon any
property or assets of the Company or any Subsidiary pursuant to any Existing
Instrument; (iii) require the consent of any other party to any Existing
Instrument, or, to such counsel's knowledge, any other agreement or
relationship by which any of the foregoing entities is bound except for such
consents which have been obtained in writing by such entity and except for such
consents as the failure of which to obtain would not, individually or in the
aggregate, result in a Material Adverse Change and (iv) result in any violation
of any law, administrative regulation or administrative or court decree
applicable to the Company or any of the Subsidiaries.
(q) Each of the Registration Statement and the Rule 462(b)
Registration Statement, if any, has been declared effective by the Commission
under the Securities Act. To the best knowledge of such counsel, no stop order
suspending the effectiveness of either of the Registration Statement or the
Rule 462(b) Registration Statement, if any, has been issued under the
Securities Act and no proceedings for such purpose have been instituted or are
pending or are contemplated or threatened by the Commission. Any required
filing of the Prospectus and any supplement thereto pursuant to Rule 424(b)
under the Securities Act has been made in the manner and within the time period
required by such Rule 424(b).
A-4
<PAGE> 47
(r) The Registration Statement, including any Rule 462(b)
Registration Statement, the Prospectus, and each amendment or supplement to the
Registration Statement and the Prospectus, as of their respective effective or
issue dates (other than the financial statements and supporting schedules
included therein or in exhibits to the Registration Statement, as to which no
opinion need be rendered) comply as to form in all material respects with the
applicable requirements of the Securities Act.
(s) The Shares, Warrants, Representative's Warrants and Units have
been approved for listing on the American Stock Exchange, subject only to
official notice of issuance.
(t) The statements (i) in the Prospectus under the captions "Risk
Factors," "Description of Capital Stock," "Management's Discussion and Analysis
of Financial Condition and Results of Operations," "Business," "Certain
Transactions," "Shares Eligible for Future Sale," "Federal Income Tax
Considerations," and "Underwriting" and (ii) in Item 33 (Recent Sales of
Unregistered Securities) and Item 34 (Indemnification of Directors and
Officers) of the Registration Statement, insofar as such statements constitute
matters of law, summaries of legal matters, the Company's charter or bylaw
provisions, documents or legal proceedings, or legal conclusions, have been
reviewed by such counsel and fairly present and summarize, in all material
respects, the matters referred to therein.
(u) To the best knowledge of such counsel, there are no Existing
Instruments required to be described or referred to in the Registration
Statement or to be filed as exhibits thereto other than those described or
referred to therein or filed as exhibits thereto; and the descriptions thereof
and references thereto are correct in all material respects.
(v) No consent, approval, authorization or other order of, or
registration or filing with, any court or other governmental authority or
agency, is required for the execution, delivery and performance of the
Formation Documents or the consummation of the transactions contemplated
thereby and by the Prospectus by the Company and the Subsidiaries, except, in
the case of the Company, as required under the Securities Act, applicable state
securities or blue sky laws and from the NASD.
(w) To the best knowledge of such counsel, neither the Company nor
any Subsidiary (i) is in violation of its charter or bylaws, partnership
agreement, partnership certificate or other organization document, as
applicable, or any law, administrative regulation or administrative or court
decree applicable to such entity or (ii) is in Default in the performance or
observance of any obligation, agreement, covenant or condition contained in any
material agreement, except in the case of clause (ii) for such Defaults as
would not, individually or in the aggregate, result in a Material Adverse
Change.
(x) The consummation of the Formation Transactions constitutes
neither a "roll-up transaction," as such term is defined in Item 901(c) of
Regulation S-K of the Securities
A-5
<PAGE> 48
Act, nor a "limited partnership roll-up transaction," as such term is defined
in Rule 2810(a)(10) of the Conduct Rules of the NASD.
(y) The Company is organized in conformity with the requirements for
qualification as a real estate investment trust ("REIT") under Sections 856
through 860 of the Tax Code; and the Company's proposed method of operation is
sufficient to enable it to meet the requirements for qualification and taxation
as a REIT under the Tax Code beginning with its taxable year ending December
31, 1998. To the best of such counsel's knowledge, there is no event or
condition which would cause or is likely to cause the Company to fail to
qualify as a REIT at any time after the First Closing Date.
(z) The descriptions of the law and the legal conclusions contained
in the Prospectus under the caption "Federal Income Tax Considerations" are
correct in all material respects, and the discussion thereunder fairly
summarizes the federal income tax considerations that are likely to be material
to a holder of the Units.
(aa) The descriptions of the law and the legal conclusions contained
in the Prospectus under the caption "Federal Income Tax Considerations -- ERISA
Investors" are correct in all material respects, and the discussion thereunder
fairly summarizes the considerations that are likely to be material to a
fiduciary of a Plan (as described in the Prospectus).
(bb) Each of the Company and the Manger is not and, after receipt of
payment for the Units, use of the proceeds of the offering as described in the
Prospectus and consummation of the Formation Transactions, will not be an
"investment company" within the meaning of Investment Company Act of 1940 or
otherwise subject to regulation under the Investment Company Act of 1940.
(cc) The proposed methods of operations of the Company and the
Subsidiaries, as described in the Prospectus, will not cause or require any
such entity to register as an investment advisor under the Investment Advisors
Act of 1940.
(dd) The legal opinion of [Maryland counsel] dated the date of this
Opinion and delivered to the Representative is satisfactory in form to such
counsel, and such counsel believes the Underwriters and counsel for the
Underwriters are justified in relying on it.
In addition, such counsel shall state that they have participated
in conferences with officers and other representatives of the Company,
representatives of the independent public or certified public accountants for
the Company and with representatives of the Underwriters at which the contents
of the Registration Statement and the Prospectus, and any supplements or
amendments thereto, and related matters were discussed and, although such
counsel is not passing upon and does not assume any responsibility for the
accuracy, completeness or fairness of the statements contained in the
Registration Statement or the
A-6
<PAGE> 49
Prospectus (other than as specified above), and any supplements or amendments
thereto, on the basis of the foregoing, nothing has come to their attention
which would lead them to believe that either the Registration Statement or any
amendments thereto, at the time the Registration Statement or such amendments
became effective, contained an untrue statement of a material fact or omitted
to state a material fact required to be stated therein or necessary to make the
statements therein not misleading or that the Prospectus, as of its date or at
the First Closing Date or the Second Closing Date, as the case may be,
contained an untrue statement of a material fact or omitted to state a material
fact necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading (it being understood
that such counsel need express no belief as to the financial statements or
schedules or other financial or statistical data derived therefrom, included in
the Registration Statement or the Prospectus or any amendments or supplements
thereto).
A-7
<PAGE> 50
EXHIBIT B
FORM OF DIRECTORS' AND OFFICERS' LOCK-UP AGREEMENT
(TO BE DELIVERED PURSUANT TO SECTION 5(h))
[Pricing Date]
STIFEL, NICOLAUS & COMPANY, INCORPORATED
As Representative of the several Underwriters
c/o STIFEL, NICOLAUS & COMPANY, INCORPORATED
500 North Broadway, Suite 1500
St. Louis, Missouri 63102
Re: RealTrust Asset Corporation (the "Company")
Ladies & Gentlemen:
The undersigned is an owner of record or beneficially of, or may
acquire, certain shares of Common Stock of the Company ("Common Stock") or
securities convertible into or exchangeable or exercisable for Common Stock.
The Company proposes to carry out a public offering of Common Stock (the
"Offering") for which you will act as the Representative of the underwriters.
The undersigned recognizes that the Offering will be of benefit to the
undersigned and will benefit the Company by, among other things, raising
additional capital for its operations. The undersigned acknowledges that you
and the other underwriters are relying on the representations and agreements of
the undersigned contained in this letter in carrying out the Offering and in
entering into underwriting arrangements with the Company with respect to the
Offering.
In consideration of the foregoing, the undersigned hereby agrees
that the undersigned will not, without the prior written consent of Stifel,
Nicolaus & Company, Incorporated (which consent may be withheld in its sole
discretion), directly or indirectly, sell, offer, contract or grant any option
to sell (including without limitation any short sale), pledge, transfer,
establish an open "put equivalent position" within the meaning of Rule 16a-1(h)
under the Securities Exchange Act of 1934, or otherwise dispose of any shares
of Common Stock, the Shares, Warrants or Units, options or warrants to acquire
shares of Common Stock, the Shares, Warrants or Units, or securities
exchangeable or exercisable for or convertible into shares of Common Stock, the
Shares, Warrants or Units currently or hereafter owned either of record or
beneficially (as defined in Rule 13d-3 under Securities Exchange Act of 1934,
as amended) by the undersigned, or publicly announce the undersigned's
intention to do any of the foregoing, for a period commencing on the date
hereof and continuing through the close of trading on the date 180 days after
B-1
<PAGE> 51
the date of the Prospectus. The undersigned also agrees and consents to the
entry of stop transfer instructions with the Company's transfer agent and
registrar against the transfer of shares of Common Stock, the Shares, Warrants
or Units or securities convertible into or exchangeable or exercisable for
Common Stock, the Shares, Warrants and Units held by the undersigned except in
compliance with the foregoing restrictions.
With respect to the Offering only, the undersigned waives any
registration rights relating to registration under the Securities Act of any
Common Stock, the Shares, Warrants and Units owned either of record or
beneficially by the undersigned, including any rights to receive notice of the
Offering.
This agreement is irrevocable and will be binding on the
undersigned and the respective successors, heirs, personal representative, and
assigns of the undersigned.
----------------------------------------
(printed name of Holder)
----------------------------------------
(signature)
----------------------------------------
(printed name of person signing)
----------------------------------------
(indicate capacity of person signing if
signing as custodian, trustee, or on
behalf of an entity)
B-2
<PAGE> 52
TABLE OF CONTENTS
[to be updated]
<TABLE>
<S> <C>
Section 1. Representations and Warranties of the Company . . . . . . . . . . . . . . . . . . . . . . . . 3
(a) Compliance with Registration Requirements . . . . . . . . . . . . . . . . . . . . . . . . 3
(b) Offering Materials Furnished to Underwriters . . . . . . . . . . . . . . . . . . . . . . . 4
(c) Distribution of Offering Material By the Company . . . . . . . . . . . . . . . . . . . . . 4
(d) The Underwriting Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
(e) Warrant Agreement and Formation Agreements . . . . . . . . . . . . . . . . . . . . . . . . 4
(f) Authorization of the Shares, Warrants, Representative's Warrants and Units . . . . . . . . 4
(g) No Applicable Registration or Other Similar Rights . . . . . . . . . . . . . . . . . . . . 5
(h) No Material Adverse Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
(i) Independent Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
(j) Preparation of the Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . 5
(k) Incorporation and Good Standing of the Company and its Subsidiaries . . . . . . . . . . . 6
(l) Capitalization and Other Capital Stock Matters . . . . . . . . . . . . . . . . . . . . . . 6
(m) Stock Exchange Listing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
(n) No Current Material Defaults . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
(o) Authorization and Non-Contravention of Existing Instruments . . . . . . . . . . . . . . . 7
(p) No Further Authorizations or Approvals Required . . . . . . . . . . . . . . . . . . . . . 8
(q) Formation Transactions Otherwise Exempt from Registration . . . . . . . . . . . . . . . . 8
(r) No Material Actions or Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
(s) Intellectual Property Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
(t) All Necessary Permits, Licenses, etc. . . . . . . . . . . . . . . . . . . . . . . . . . . 9
(u) Title to Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
(v) Tax Law Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
(w) REIT Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
(x) Company Not an "Investment Company". . . . . . . . . . . . . . . . . . . . . . . . . . . 10
(y) Company Not a "Broker" or "Dealer." . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
(z) Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
(aa) No Price Stabilization or Manipulation . . . . . . . . . . . . . . . . . . . . . . . . . . 11
(bb) No Broker or Finder Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
(cc) Related Party Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
(dd) Material Contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
(ee) No Unlawful Contributions or Other Payments . . . . . . . . . . . . . . . . . . . . . . . 11
(ff) Company's Accounting System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
(hh) Compliance with Environmental Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
No Material or Undisclosed Environmental Liability. . . . . . . . . . . . . . . . . . . . . . . 13
(jj) Periodic Review of Costs of Environmental Compliance . . . . . . . . . . . . . . . . . . . 13
(kk) ERISA Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
</TABLE>
i
<PAGE> 53
<TABLE>
<S> <C>
(ll) Material Compliance with All Other Applicable Laws . . . . . . . . . . . . . . . . . . . . 14
Section 2. PURCHASE, SALE AND DELIVERY OF THE UNITS . . . . . . . . . . . . . . . . . . . . . . . . . . 14
(a) The Firm Units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
(b) The First Closing Date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
(c) The Optional Units; the Second Closing Date . . . . . . . . . . . . . . . . . . . . . . . 15
(d) Public Offering of the Units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
(e) Payment for the Units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
(f) Delivery of the Units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
(g) Time of the Essence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
(h) Delivery of Prospectus to the Underwriters . . . . . . . . . . . . . . . . . . . . . . . . 16
Section 3. Additional Covenants of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
(a) Representative's Review of Proposed Amendments and Supplements . . . . . . . . . . . . . . 16
(b) Securities Act Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
(c) Amendments and Supplements to the Prospectus and Other Securities Act Matters . . . . . . 17
(d) Copies of any Amendments and Supplements to the Prospectus . . . . . . . . . . . . . . . . 18
(e) Press Releases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
(f) Blue Sky Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
(g) Uncertificated Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
(h) Consummation of Formation Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . 19
(i) Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
(j) Transfer Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
(k) Continuing listing on the American Stock Exchange . . . . . . . . . . . . . . . . . . . . 19
(l) Earnings Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
(m) Periodic Reporting Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
(n) Agreement Not To Offer or Sell Additional Securities . . . . . . . . . . . . . . . . . . . 19
(o) Future Reports to the Representative . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
(p) REIT Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
(q) Accounting and Tax Advice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
(r) Commodities Exchange Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
(s) Investment Advisors Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
(t) SEC Compliance Program and Insider Trading Compliance Policy . . . . . . . . . . . . . . . 21
Section 4. PAYMENT OF EXPENSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Section 5. Conditions of the Obligations of the Underwriters . . . . . . . . . . . . . . . . . . . . . . 23
(a) Accountants' Comfort Letter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
(b) Compliance with Registration Requirements; No Material Misstatements or Omissions; No Stop
Order; No Objection from NASD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
(c) No Material Adverse Change or Ratings Agency Change . . . . . . . . . . . . . . . . . . . 24
(d) Opinion of Counsel for the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
</TABLE>
ii
<PAGE> 54
<TABLE>
<S> <C>
(e) Opinion of Counsel for the Underwriters . . . . . . . . . . . . . . . . . . . . . . . . . 24
(f) Officers' Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
(g) Bring-down Comfort Letter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
(i) Written Consents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
(j) Additional Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
(k) American Stock Exchange Listing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
(l) Consummation of Formation Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . 25
(m) Representative's Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Section 6. Reimbursement of Underwriters' Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Section 7. Effectiveness of this Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Section 8. Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
(a) Indemnification of the Underwriters by the Company . . . . . . . . . . . . . . . . . . . . 27
(b) Indemnification of the Company, its Directors and Officers . . . . . . . . . . . . . . . . 28
(c) Notifications and Other Indemnification Procedures . . . . . . . . . . . . . . . . . . . . 29
(d) Settlements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Section 9. Contribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Section 10. Default of One or More of the Several Underwriters . . . . . . . . . . . . . . . . . . . . . 31
SECTION 11. TERMINATION OF THIS AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Section 12. Representations and Indemnities to Survive Delivery . . . . . . . . . . . . . . . . . . . . 32
Section 13. NOTICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Section 14. Successors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 15. Partial Unenforceability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 16. (a) Governing Law Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
(b) Consent to Jurisdiction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
(c) Waiver of Immunity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Section 17. Lead Manager . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Section 18. General Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
</TABLE>
iii
<PAGE> 1
EXHIBIT 3.1
AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
REALTRUST ASSET CORPORATION
REALTRUST ASSET CORPORATION, a Maryland corporation, having its
principal office in Baltimore, Maryland (hereinafter referred to as the
"Corporation"), hereby certifies to the State Department of Assessments and
Taxation of Maryland that:
FIRST: The Corporation desires to amend and restate its charter as currently in
effect and as hereinafter amended:
ARTICLE I
INCORPORATOR
The undersigned, Christopher A. Wilson, whose address is c/o Jeffers,
Wilson, Shaff & Falk, LLP, 18881 Von Karman Avenue, Irvine, California 92612,
being at least 18 years of age, does hereby form a corporation under the general
laws of the State of Maryland.
ARTICLE II
NAME
The name of the corporation (which is hereinafter called the
"Corporation") is:
RealTrust Asset Corporation
ARTICLE III
PURPOSES
The purpose for which the Corporation is formed is to transact any or
all lawful business, not required to be specifically stated in the Charter, for
which corporations may be incorporated under the MGCL.
<PAGE> 2
ARTICLE IV
PRINCIPAL OFFICE AND RESIDENT AGENT
A. The present address of the principal office of the Corporation in
this State is:
The Corporation Trust Incorporated
300 E. Lombard Street
Baltimore, Maryland 21202
B. The name and address of the resident agent of the Corporation are:
The Corporation Trust Incorporated
300 E. Lombard Street
Baltimore, Maryland 21202
Said resident agent is a Maryland corporation.
ARTICLE V
CAPITAL STOCK
A. The total number of shares of Capital Stock of all classes which the
Corporation has authority to issue is One Hundred Million (100,000,000) shares
of Capital Stock, par value one-tenth of a cent ($0.001) per share, amounting in
aggregate par value to One Hundred Thousand Dollars ($100,000.00). All of such
shares are initially classified as "Common Stock." The Board of Directors may
classify and reclassify any unissued shares of Capital Stock, whether now or
hereafter authorized, by setting or changing in any one or more respects the
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications or terms or conditions of redemption
of such shares of Capital Stock. All persons who acquire shares of Capital Stock
or securities exercisable for or convertible into shares of Capital Stock shall
acquire such shares subject to the provisions of the Charter (including Article
X) and Bylaws of the Corporation.
B. The following is a description of the preferences, conversion and
other rights, voting powers, restrictions, limitations as to dividends,
qualifications and terms and conditions of redemption of the Common Stock of the
Corporation:
(1) Each share of Common Stock shall have one vote, and, except
as otherwise provided in respect of any class of Capital Stock hereafter
classified or reclassified, the exclusive voting power for all purposes shall be
vested in the holders of the Common Stock.
(2) Subject to the provisions of law and any preferences of any
class of Capital Stock hereafter classified or reclassified, dividends,
including dividends payable in
<PAGE> 3
shares of the Corporation's Capital Stock, may be paid on the Common Stock of
the Corporation at such time and in such amounts as the Board of Directors may
deem advisable.
(3) In the event of any liquidation, dissolution or winding up of
the Corporation, whether voluntary or involuntary, the holders of the Common
Stock shall be entitled, after payment or provision for payment of the debts and
other liabilities of the Corporation and the amount to which the holders of any
class of Capital Stock hereafter classified or reclassified having a preference
on distributions in the liquidation, dissolution or winding up of the
Corporation shall be entitled, together with the holders of any other class of
Capital Stock hereafter classified or reclassified not having a preference on
distributions in the liquidation, dissolution or winding up of the Corporation,
to share ratably in the remaining net assets of the Corporation.
C. Subject to the foregoing, the power of the Board of Directors to
classify and reclassify any of the shares of Capital Stock shall include,
without limitation, subject to the provisions of the Charter, authority to
classify or reclassify any unissued shares of such Capital Stock into a class or
classes of preferred stock, preference stock, special stock, or other stock, and
to divide and classify shares of any class into one or more series of such
class, by determining, fixing or altering one or more of the following:
(1) The distinctive designation of such class or series and the
number of shares to constitute such class or series; provided that, unless
otherwise prohibited by the terms of such or any other class or series, the
number of shares of any class or series may be decreased by the Board of
Directors in connection with any classification or reclassification of unissued
shares and the number of shares of such class or series may be increased by the
Board of Directors in connection with any such classification or
reclassification, and any shares of any class or series which have been
redeemed, purchased, otherwise acquired or converted into shares of Common Stock
or any other class or series shall become part of the authorized Capital Stock
and be subject to classification and reclassification as provided in this
subparagraph.
(2) Whether or not and, if so, the rates, amounts and times at
which, and the conditions under which, dividends shall be payable on shares of
such class or series, whether any such dividends shall rank senior or junior to
or on a parity with the dividends payable on any other class or series of
Capital Stock, and the status of any such dividends as cumulative, cumulative to
a limited extent or noncumulative and as participating or nonparticipating.
(3) Whether or not shares of such class or series shall have
voting rights in addition to any voting rights provided by law and, if so, the
terms of such voting rights.
(4) Whether or not shares of such class or series shall have
conversion or exchange privileges and, if so, the terms and conditions thereof,
including provision for adjustment of the conversion or exchange rate in such
events or at such times as the Board of Directors shall determine.
(5) Whether or not shares of such class or series shall be
subject to redemption and, if so, the terms and conditions of such redemption,
including the date or dates
<PAGE> 4
upon or after which they shall be redeemable and the amount per share payable in
case of redemption, which amount may vary under different conditions and at
different redemption dates; and whether or not there shall be any sinking fund
or purchase account in respect thereof, and if so, the terms thereof.
(6) The rights of the holders of shares of such class or series
upon the liquidation, dissolution or winding up of the affairs of, or upon any
distribution of the assets of, the Corporation, which rights may vary depending
upon whether such liquidation, dissolution or winding up is voluntary or
involuntary and, if voluntary, may vary at different dates, and whether such
rights shall rank senior or junior to or on a parity with such rights of any
other class or series of Capital Stock.
(7) Whether or not there shall be any limitations applicable,
while shares of such class or series are outstanding, upon the payment of
dividends or making of distributions on, or the acquisition of, or the use of
moneys for purchase or redemption of, any Capital Stock of the Corporation, or
upon any other action of the Corporation, including action under this
subparagraph, and, if so, the terms and conditions thereof.
(8) Any other preferences, rights, restrictions, including
restrictions on transferability, and qualifications of shares of such class or
series, not inconsistent with law and the Charter.
D. For the purposes hereof and of any Articles Supplementary hereto
providing for the classification or reclassification of any shares of Capital
Stock or of any other Charter document of the Corporation (unless otherwise
provided in any such Articles or document), any class or series of Capital Stock
of the Corporation shall be deemed to rank:
(1) prior to another class or series either as to dividends or
upon liquidation, if the holders of such class or series shall be entitled to
the receipt of dividends or of amounts distributable on liquidation, dissolution
or winding up, as the case may be, in preference or priority to holders of such
other class or series;
(2) on a parity with another class or series either as to
dividends or upon liquidation, whether or not the dividend rates, dividend
payment dates or redemption or liquidation price per share thereof be different
from those of such others, if the holders of such class or series of stock shall
be entitled to receipt of dividends or amounts distributable upon liquidation,
dissolution or winding up, as the case may be, in proportion to their respective
dividend rates or redemption or liquidation prices, without preference or
priority over the holders of such other class or series; and
(3) junior to another class or series either as to dividends or
upon liquidation, if the rights of the holders of such class or series shall be
subject or subordinate to the rights of the holders of such other class or
series in respect of the receipt of dividends or the amounts distributable upon
liquidation, dissolution or winding up, as the case may be.
ARTICLE VI
<PAGE> 5
DIRECTORS
A. The number of directors of the Corporation initially shall be five
(5), which number may be increased or decreased from time to time by a vote of
60% of the entire Board of Directors of the Corporation, but shall never be less
than the minimum number permitted by the General Laws of the State of Maryland
now or hereafter in force.
B. The directors shall be divided into three classes as follows: (1) the
term of office of Class I shall be until the 1999 annual meeting of stockholders
and until their successors shall be elected and have qualified and thereafter
shall be for three years and until their successors shall be elected and have
qualified; (2) the term of office of Class II shall be until the 2000 annual
meeting of stockholders and until their successors shall be elected and have
qualified and thereafter shall be for three years and until their successors
shall be elected and have qualified; and (3) the term of office of Class III
shall be until the 2001 annual meeting of stockholders and until their
successors shall be elected and have qualified and thereafter shall be for three
years and until their successors shall be elected and have qualified. If the
number of directors is changed, any increase or decrease shall be apportioned
among the classes so as to maintain the number of directors in each class as
nearly equal as possible. A director elected by stockholders shall hold office
until the annual meeting for the year in which his or her term expires and until
his or her successor shall be elected and shall qualify, subject, however, to
prior death, resignation, retirement, disqualification or removal from office.
C. The names of the directors and the Class in which they will serve are
as follows:
<TABLE>
<CAPTION>
Director Class
-------- -----
<S> <C>
John D. Fry III
Carter E. Jones II
Terry L. Mott II
Jeff K. Thredgold I
Daniel W. Campbell I
</TABLE>
D. Subject to the rights of the holders of any class of preferred stock
then outstanding, newly created directorships resulting from any increase in the
authorized number of directors or any vacancies on the Board of Directors
resulting from death, resignation, retirement, disqualification, removal from
office, or other cause shall be filled by the required vote of the stockholders
or the directors then in office. A director so chosen by the stockholders shall
hold office for the balance of the term then remaining. A director so chosen by
the remaining directors shall hold office until the next annual meeting of
stockholders, at which time the stockholders shall elect a director to hold
office for the balance of the term then remaining. No decrease in the number of
directors constituting the Board of Directors shall affect the tenure of office
of any director.
<PAGE> 6
E. Whenever the holders of any one or more series of preferred stock of
the Corporation shall have the right, voting separately as a class, to elect one
or more directors of the Corporation, the Board of Directors shall consist of
such directors so elected in addition to the number of directors fixed as
provided in paragraph A of this Article VI or in the Bylaws. Notwithstanding the
foregoing, and except as otherwise may be required by law, whenever the holders
of any one or more series of preferred stock of the Corporation shall have the
right, voting separately as a class, to elect one or more directors of the
Corporation, the terms of the director or directors elected by such holders
shall expire at the next succeeding annual meeting of stockholders.
F. Subject to the rights of the holders of any class separately entitled
to elect one or more directors, any director, or the entire Board of Directors,
may be removed from office at any time, but only for cause and then only by the
affirmative vote of the holders of at least a majority of the combined voting
power of all classes of shares of capital stock entitled to vote in the election
for directors voting together as a single class.
ARTICLE VII
PREEMPTIVE RIGHTS
No holder of any Capital Stock or any other securities of the
Corporation, whether now or hereafter authorized, shall have a preemptive right
to subscribe for or purchase any Capital Stock or any other securities of the
Corporation other than such, if any, as the Board of Directors, in its sole
discretion, may determine and at such price or prices and upon such other terms
as the Board of Directors, in its sole discretion, may determine and at such
price or prices and upon such other terms as the Board of Directors, in its sole
discretion, may fix; and any Capital Stock or other securities which the Board
of Directors may determine to offer for subscription may, as the Board of
Directors in its sole discretion shall determine, be offered to the holders of
any class, series or type of Capital Stock or other securities at the time
outstanding to the exclusion of the holders of any or all other classes, series
or types of Capital Stock or other securities at the time outstanding.
<PAGE> 7
ARTICLE VIII
INDEMNIFICATION
The Corporation shall indemnify (A) its directors and officers, whether
serving the Corporation or at its request any other entity, to the full extent
required or permitted by the General Laws of the State of Maryland now or
hereafter in force, including the advance of expenses under the procedures and
to the full extent permitted by law and (B) other employees and agents to such
extent as shall be authorized by the Board of Directors or the Corporation's
Bylaws and be permitted by law. The foregoing rights of indemnification shall
not be exclusive of any other rights to which those seeking indemnification may
be entitled. The Board of Directors may take such action as is necessary to
carry out these indemnification provisions and is expressly empowered to adopt,
approve and amend from time to time such Bylaws, resolutions or contracts
implementing such provisions or such further indemnification arrangements as may
be permitted by law. No amendment of the Charter of the Corporation or repeal of
any of its provisions shall limit or eliminate the right to indemnification
provided hereunder with respect to acts or omissions occurring prior to such
amendment or repeal.
ARTICLE IX
PERSONAL LIABILITY
To the fullest extent permitted by Maryland statutory or decisional law,
as amended or interpreted, no director or officer of this Corporation shall be
personally liable to the Corporation or its stockholders for money damages. No
amendment of the Charter of the Corporation or repeal of any of its provisions
shall limit or eliminate the benefits provided to directors and officers under
this provision with respect to any act or omission which occurred prior to such
amendment or repeal.
ARTICLE X
RESTRICTION ON TRANSFER, ACQUISITION
AND REDEMPTION OF SHARES
Section 10.1 Definitions. For the purpose of this Article X, the
following terms shall have the following meanings:
Aggregate Stock Ownership Limit. The term "Aggregate Stock
Ownership Limit" shall mean not more than 9.8 percent in value of the aggregate
of the outstanding shares of Capital Stock. The value of the outstanding shares
of Capital Stock shall be determined by the Board of Directors of the
Corporation in good faith, which determination shall be conclusive for all
purposes hereof.
<PAGE> 8
AMEX. The term "AMEX" shall mean the American Stock Exchange.
Beneficial Ownership. The term "Beneficial Ownership" shall mean
ownership of Capital Stock by a Person, whether the interest in the shares of
Capital Stock is held directly or indirectly (including by a nominee), and shall
include interests that would be treated as owned through the application of
Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code. The
terms "Beneficial Owner," Beneficially Owns" and "Beneficially Owned" shall have
the correlative meanings.
Business Day. The term "Business Day" shall mean any day, other
than a Saturday or Sunday, that is neither a legal holiday nor a day on which
banking institutions in New York City are authorized or required by law,
regulation or executive order to close.
Charitable Beneficiary. The term "Charitable Beneficiary" shall
mean one or more beneficiaries of the Trust as determined pursuant to Section
10.3.6, provided that each such organization must be described in Section
501(c)(3) of the Code and contributions to each such organization must be
eligible for deduction under each Sections 170(b)(1)(A) (without regard to
clauses (vii) or (viii) thereof), 2055 and 2522 of the Code, provided selecting
such beneficiary or beneficiaries would not violate Section 10.2.1(a) hereof.
Code. The term "Code" shall mean the Internal Revenue Code of
1986, as amended from time to time.
Common Stock Ownership Limit. The term "Common Stock Ownership
Limit" shall mean not more than 9.8 percent (in value or in number of shares,
whichever is more restrictive) of the aggregate of the outstanding shares of
Common Stock of the Corporation. The number and value of outstanding shares of
Common Stock of the Corporation shall be determined by the Board of Directors of
the Corporation in good faith, which determination shall be conclusive for all
purposes hereof.
Constructive Ownership. The term "Constructive Ownership" shall
mean ownership of Capital Stock by a Person, whether the interest in the shares
of Capital Stock is held directly or indirectly (including by a nominee), and
shall include interests that would be treated as owned through the application
of Section 318(a) of the Code, as modified by Section 856(d)(5) of the Code. The
terms "Constructive Owner," "Constructively Owns" and "Constructively Owned"
shall have the correlative meanings.
Excepted Holder. The term "Excepted Holder" shall mean a
stockholder of the Corporation for whom an Excepted Holder Limit is created by
the Charter or by the Board of Directors pursuant to Section 10.2.7.
Excepted Holder Limit. The term "Excepted Holder Limit" shall
mean, provided that the affected Excepted Holder agrees to comply with the
requirements established by the Board of Directors pursuant to Section 10.2.7,
and subject to adjustment pursuant to Section 10.2.8, the percentage limit
established by the Board of Directors pursuant to Section 10.2.7.
<PAGE> 9
Initial Date. The term "Initial Date" shall mean the date upon
which the Corporation shall close its initial issuance of shares of Capital
Stock to investors for an aggregate amount of gross proceeds of at least $30
million.
Market Price. The term "Market Price" on any date shall mean,
with respect to any class or series of outstanding shares of Capital Stock, the
Closing Price for such Capital Stock on such date. The "Closing Price" on any
date shall mean the last sale price for such Capital Stock, regular way, or, in
case no such sale takes place on such day, the average of the closing bid and
asked prices, regular way, for such Capital Stock, in either case as reported in
the principal consolidated transaction reporting system with respect to
securities listed or admitted to trading on the NYSE or the AMEX, or, if such
Capital Stock is not listed or admitted to trading on the NYSE or the AMEX, as
reported on the principal consolidated transaction reporting system with respect
to securities listed on the principal national securities exchange on which such
Capital Stock is listed or admitted to trading or, if such Capital Stock is not
listed or admitted to trading on any national securities exchange, the last
quoted price, or, if not so quoted, the average of the high bid and low asked
prices in the over-the-counter market, as reported by the National Association
of Securities Dealers, Inc. Automated Quotation System, or, if such system is no
longer in use, the principal other automated quotation system that may then be
in use or, if such Capital Stock is not quoted by any such organization, the
average of the closing bid and asked prices as furnished by a professional
market maker making a market in such Capital Stock selected by the Board of
Directors of the Corporation or, in the event that no trading price is available
for such Capital Stock, the fair market value of the Capital Stock, as
determined in good faith by the Board of Directors of the Corporation.
NYSE. The term "NYSE" shall mean the New York Stock Exchange.
Person. The term "Person" shall mean an individual, corporation,
joint venture, limited liability company, unincorporated organization,
partnership, estate, state or political subdivision thereof, government agency,
trust (including a trust qualified under Sections 401(a) or 501(c)(17) of the
Code), a portion of a trust permanently set aside for or to be used exclusively
for the purposes described in Section 642(c) of the Code, association, private
foundation within the meaning of Section 509(a) of the Code, joint stock company
or other entity, but does not include an Underwriter participating in an
offering of Common Stock, Preferred Stock, and/or convertible securities of the
Corporation, provided that the ownership of such Common Stock, Preferred Stock
and/or convertible securities by such Underwriter would not result in the
Corporation being "closely held" within the meaning of Section 856(h) of the
Code and would not otherwise result in the Corporation's failure to qualify as a
REIT.
Prohibited Owner. The term "Prohibited Owner" shall mean, with
respect to any purported Transfer, any Person who, but for the provisions of
Section 10.2.1, would Beneficially Own or Constructively Own shares of Capital
Stock, and if appropriate in the context, shall also mean any Person who would
have been the record owner of the shares that
<PAGE> 10
the Prohibited Owner would have so owned.
REIT. The term "REIT" shall mean a real estate investment trust
within the meaning of Section 856 of the Code.
Restriction Termination Date. The term "Restriction Termination
Date" shall mean the first day after the Initial Date on which the Corporation
determines that it is no longer in the best interests of the Corporation to
attempt to, or continue to, qualify as a REIT or that compliance with the
restrictions and limitations on Beneficial Ownership, Constructive Ownership and
Transfers of shares of Capital Stock set forth herein is no longer required in
order for the Corporation to qualify as a REIT.
Transfer. The term "Transfer" shall mean any issuance, sale,
transfer, gift, assignment, devise or other disposition, as well as any other
event that causes any Person to acquire Beneficial Ownership or Constructive
Ownership, or any agreement to take any such actions or cause any such events,
of Capital Stock or the right to vote or receive dividends on Capital Stock,
including (a) the granting or exercise of any option or warrant (or any
disposition of any option or warrant), (b) any disposition of any securities or
rights convertible into or exchangeable for Capital Stock or any interest in
Capital Stock or any exercise of any such conversion or exchange right and (c)
Transfers of interests in other entities that result in changes in Beneficial or
Constructive Ownership of Capital Stock; in each case, whether voluntary or
involuntary, whether owned of record, Constructively Owned or Beneficially Owned
and whether by operation of law or otherwise. The terms "Transferring" and
"Transferred" shall have the correlative meanings.
Trust. The term "Trust" shall mean any trust provided for in
Section 10.3.1.
Trustee. The term "Trustee" shall mean the Person unaffiliated
with the Corporation, a Prohibited Owner and any Charitable Beneficiary, that is
appointed by the Corporation to serve as trustee of the Trust, and any successor
or trustee appointed by the Trustee.
Underwriter. The term "Underwriter" shall mean a securities firm
or other similar entity only in its capacity as a party of an underwriting
agreement with the Corporation entered into with the intent of such firm or
other entity acquiring securities of the Corporation for resale.
<PAGE> 11
Section 10.2 Capital Stock.
Section 10.2.1 Ownership Limitations. Subject to Section 10.2.10,
during the period commencing on the Initial Date and prior to the Restriction
Termination Date:
(a) Basic Restrictions.
(i) (1) No Person, other than an Excepted Holder,
shall Beneficially Own or Constructively Own shares of Capital Stock in excess
of the Aggregate Stock Ownership Limit, (2) no Person, other than an Excepted
Holder, shall Beneficially Own or Constructively Own shares of Common Stock in
excess of the Common Stock Ownership Limit, and (3) no Excepted Holder shall
Beneficially Own or Constructively Own shares of Capital Stock in excess of the
Excepted Holder Limit for such Excepted Holder.
(ii) No Person shall Beneficially Own or
Constructively Own shares of Capital Stock to the extent that such Beneficial or
Constructive Ownership of Capital Stock would result in the Corporation being
"closely held" within the meaning of Section 856(h) of the Code (without regard
to whether the ownership interest is held during the last half of a taxable
year), or otherwise failing to qualify as a REIT (including, but not limited to,
Beneficial Ownership or Constructive Ownership that would result in the
Corporation owning (actually or Constructively) an interest in a tenant that is
described in Section 856(d)(2)(B) of the Code if the income derived by the
Corporation from such tenant would cause the Corporation to fail to satisfy any
of the gross income requirements of Section 856(c) of the Code).
(iii) Any Transfer of shares of Capital Stock that,
if effective, would result in any person Beneficially Owning or Constructively
Owning any shares of Capital Stock in violation of Section 10.2.1(a) or Section
10.2.1(a)(ii) shall be null and void ab initio, and the purported transferee or
purported owner shall acquire no rights to, or economic interest in, any Capital
Stock held in violation of these restrictions.
(iv) Notwithstanding any other provisions contained
herein, any Transfer of shares of Capital Stock (whether or not such Transfer is
the result of a transaction entered into through the facilities of the NYSE, the
AMEX or any other national securities exchange or automated inter-dealer
quotation system) that, if effective, would result in the Capital Stock being
beneficially owned by less than 100 Persons (determined under the principles of
Section 856(a)(5) of the Code) shall be null and void ab initio, and the
intended transferee shall acquire no rights in such shares of Capital Stock.
(b) Transfer in Trust. If, notwithstanding the other
provisions contained in this Article X, there is a purported Transfer, change in
capital structure or other event such that any person would Beneficially Own or
Constructively Own Shares of Capital Stock in violation of Section 10.2.1(a)(i)
or Section 10.2.1(a)(ii), or if effective, any Transfer of shares of Capital
Stock occurs which, if effective, would result in any Person Beneficially Owning
or Constructively Owning shares of Capital Stock in violation of Section
10.2.1(a)(i)
<PAGE> 12
or (ii),
(i) then that number of shares of the Capital Stock
to Beneficial or Constructive Ownership of which otherwise would cause such
Person to violate Section 10.2.1(a)(i) or (ii) (rounded to the nearest whole
shares) shall be automatically transferred to a Trust for the benefit of a
Charitable Beneficiary, as described in Section 10.3, effective on the close of
business on the Business Day prior to the date of such Transfer or other event,
and such Person shall acquire no rights in such shares; and
(ii) upon the transfer of a share of Capital Stock
to the Trust described in clause (i) of this subsection 10.2.1(b), such share
shall have such voting, dividend, liquidation and other rights, and shall be
subject to such terms and limitations, as set forth in Section 10.3 of this
Article X.
Section 10.2.2 Remedies for Breach. If the Board of Directors of
the Corporation or any duly authorized committee thereof shall at any time
determine in good faith that a Transfer or other event has taken place that
results in a violation of Section 10.2.1 or that a Person intends to acquire or
has attempted to acquire Beneficial or Constructive Ownership of any shares of
Capital Stock in violation of Section 10.2.1 (whether or not such violation is
intended), the Board of Directors or a committee thereof shall take such action
as it deems advisable to refuse to give effect to or to prevent such Transfer or
other event, including, without limitation, causing the Corporation to redeem
shares, refusing to give effect to such Transfer on the books of the Corporation
or instituting proceedings to enjoin such Transfer or other event; provided,
however, that any Transfers or attempted Transfers or other events in violation
of Section 10.2.1 shall be null and void and shall automatically result in the
transfer to the Trust described above, and, where applicable, such Transfer (or
other event) shall be void ab initio as provided above irrespective of any
action (or non-action) by the Board of Directors or a committee thereof.
Section 10.2.3 Notice of Restricted Transfer. Any Person who
acquires or attempts or intends to acquire Beneficial Ownership or Constructive
Ownership of shares of Capital Stock that will or may violate Section 10.2.1(a),
or any Person who would have owned shares of Capital Stock that resulted in a
transfer to the Trust pursuant to the provisions of Section 10.2.1(b) shall
immediately give written notice to the Corporation of such event, or in the case
of such proposed or attempted transaction, give at least 15 days prior written
notice, and shall provide to the Corporation such other information as the
Corporation may request in order to determine the effect, if any, of such
Transfer on the Corporation's status as a REIT.
<PAGE> 13
Section 10.2.4 Owners Required to Provide Information. From the
Initial Date and prior to the Restriction Termination Date:
(a) every owner of more than five percent (or such lower
percentage as required by the Code or the Treasury Regulations promulgated
thereunder) of the outstanding shares of Capital Stock, within 30 days after the
end of each taxable year, shall give written notice to the Corporation stating
the name and address of such owner, the number of shares of Capital Stock
Beneficially Owned and a description of the manner in which such shares are
held. Each such owner shall provide to the Corporation such additional
information as the Corporation may request in order to determine the effect, if
any, of such Beneficial Ownership on the Corporation's status as a REIT and
ensure compliance with the Aggregate Stock Ownership Limit.
(b) each Person who is a Beneficial or Constructive Owner
of Capital Stock and each Person (including the stockholder of record) who is
holding Capital Stock for a Beneficial or Constructive Owner shall provide to
the Corporation such information as the Corporation may request, in good faith,
in order to determine the Corporation's status as a REIT and to comply with
requirements of any taxing authority or governmental authority or to determine
such compliance.
Section 10.2.5 Remedies Not Limited. Nothing contained in this
Section 10.2 shall limit the authority of the Board of Directors of the
Corporation to take such other action as it deems necessary or advisable to
protect the Corporation and the interests of its stockholders in preserving the
Corporation's status as a REIT and to ensure compliance with Section 10.2.1(a).
Section 10.2.6 Ambiguity. In the case of an ambiguity in the
application of any of the provisions of this Section 10.2, Section 10.3, or any
definition contained in Section 10.1, the Board of Directors of the Corporation
shall have the power to determine the application of the provisions of this
Section 10.2 or Section 10.3 with respect to any situation based on the facts
known to it. In the event Section 10.2 or 10.3 requires an action by the Board
of Directors and the Charter fails to provide specific guidance with respect to
such action, the Board of Directors shall have the power to determine the action
to be taken so long as such action is not contrary to the provisions of Sections
10.1, 10.2 or 10.3.
Section 10.2.7 Exceptions.
(a) Subject to Section 10.2.1(a)(ii), the Board of
Directors of the Corporation, in its sole discretion, may exempt a Person from
the Aggregate Stock Ownership Limit and the Common Stock Ownership Limit, as the
case may be, and may establish or increase an Excepted Holder Limit for such
Person, if:
(i) the Board of Directors obtains such
representations and undertakings from such Person as are reasonably necessary to
ascertain that no individual's Beneficial or Constructive Ownership of such
shares of Capital Stock will violate Section 10.2.1(a)(ii); and
<PAGE> 14
(ii) such Person agrees that any violation or
attempted violation of such representations or undertakings (or other action
which is contrary to the restrictions contained in Sections 10.2.1 through
10.2.6) will result in such shares of Capital Stock being automatically
transferred to a Trust in accordance with Sections 10.2.1(b) and 11.3.
(b) Prior to granting any exception pursuant to Section
10.2.7(a), the Board of Directors of the Corporation may require a ruling from
the Internal Revenue Service, or an opinion of counsel, in either case in form
and substance satisfactory to the Board of Directors in its sole discretion, as
it may deem necessary or advisable in order to determine or ensure the
Corporation's status as a REIT. Notwithstanding the receipt of any ruling or
opinion, the Board of Directors may impose such conditions or restrictions as it
deems appropriate in connection with granting such exception.
(c) The Board of Directors may only reduce the Excepted
Holder Limit for an Excepted Holder: (1) with the written consent of such
Excepted Holder at any time, or (2) pursuant to the terms and conditions of the
agreements and understandings entered into with such Excepted Holder in
connection with the establishment of the Excepted Holder Limit for that Excepted
Holder. No Excepted Holder Limit shall be reduced to a percentage that is less
than the Common Stock Ownership Limit.
Section 10.2.8 Increase in Aggregate Stock Ownership and Common
Stock Ownership Limits. The Board of Directors may from time to time increase or
decrease the Common Stock Ownership Limit and the Aggregate Stock Ownership
Limit; provided, however, that:
(a) Any decrease may be made only prospectively as to
subsequent holders (other than a decrease as a result of a retroactive change in
existing law, in which case such decrease shall be effective immediately);
(b) Neither ownership limitation may be increased if,
after giving effect to such increase, five Persons could Beneficially Own or
Constructively Own, in the aggregate, more than 50.0% in value of the shares of
Capital Stock then outstanding; and
(c) Prior to the modification of either of the ownership
limitations, the Board of Directors of the Corporation may require such opinions
of counsel, affidavits, undertakings or agreements as it may deem necessary or
advisable in order to determine or ensure the Corporation's status as a REIT.
Section 10.2.9 Legend. Each certificate for shares of Capital
Stock or securities exercisable or exchangeable for or convertible into shares
of Capital Stock shall bear the following legend:
"The securities represented by this certificate are subject to
<PAGE> 15
restrictions on Beneficial and Constructive Ownership and
Transfer for the purpose of the Corporation's maintenance of its
status as a Real Estate Investment Trust under the Internal
Revenue Code of 1986, as amended (the "Code"). Subject to certain
further restrictions and except as expressly provided in the
Corporation's Articles of Incorporation, (i) no Person may
Beneficially or Constructively Own shares of the Capital Stock of
the Corporation in excess of 9.8 percent (in value or number of
shares) of the total outstanding shares of any class of Capital
Stock of the Corporation unless such Person is an Excepted Holder
(in which case the Excepted Holder Limit shall be applicable);
(ii) no Person may Beneficially or Constructively Own Capital
Stock that would result in the Corporation being "closely held"
under Section 856(h) of the Code or otherwise cause the
Corporation to fail to qualify as a REIT; and (iii) no Person may
Transfer shares of Capital Stock if such Transfer would result in
the Capital Stock of the Corporation being owned by fewer than
100 Persons. Any Person who Beneficially or Constructively Owns
or attempts to Beneficially or Constructively Own shares of
Capital Stock which causes or will cause a Person to Beneficially
or Constructively Own shares of Capital Stock in excess or in
violation of the above limitations must immediately notify the
Corporation. Attempted transfers of ownership in violation of
these restrictions shall be null and void ab initio. In addition,
if any of the restrictions on transfer or ownership are violated,
the shares of Capital Stock represented hereby may be
automatically transferred to a Trustee of a Trust for the benefit
of one or more Charitable Beneficiaries. In addition, upon the
occurrence of certain events, attempted Transfers in violation of
the restrictions described above may be void ab initio. All
capitalized terms in this legend have the meanings defined in the
Articles of Incorporation of the Corporation, as the same may be
amended from time to time, a copy of which, including the
restrictions on transfer and ownership, will be furnished to each
holder of Capital Stock of the Corporation on request and without
charge."
Section 10.2.10 Settlements Permitted. Nothing contained in this
Article X or in any provision hereof shall preclude the settlement of any
transaction entered into through the facilities of the NYSE, the AMEX or any
other national securities exchange or automated inter-dealer quotation system.
Although settlement of any transaction is permitted, any transferee in such
transaction shall be subject to all the provisions and limitations set forth in
this Article X.
Section 10.3 Transfer of Capital Stock in Trust.
<PAGE> 16
Section 10.3.1 Ownership in Trust. Upon any purported Transfer or
other event described in Section 10.2.1(b) that would result in a transfer of
shares of Capital Stock to a Trust, such shares of Capital Stock shall be deemed
to have been transferred to the Trustee as trustee of a Trust for the exclusive
benefit of one or more Charitable Beneficiaries. Such transfer to the Trustee
shall be deemed to be effective as of the close of business on the Business Day
prior to the purported Transfer or other event that results in the transfer to
the Trust pursuant to Section 10.2.1(b). The Trustee shall be appointed by the
Corporation and shall be a Person unaffiliated with the Corporation, any
Prohibited Owner and any Charitable Beneficiary. Each Charitable Beneficiary
shall be designated by the Trustee as provided in Section 10.3.6.
Section 10.3.2 Status of Shares Held by the Trustee. Shares of
Capital Stock held by the Trustee shall be issued and outstanding shares of
Capital Stock of the Company. The Prohibited Owner shall have no rights in the
shares held by the Trustee. The Prohibited Owner shall not benefit economically
from ownership of any shares held in trust by the Trustee, shall have no rights
to dividends and shall not possess any rights to vote or other rights
attributable to the shares held in the Trust.
Section 10.3.3 Dividend and Voting Rights. The Trustee shall have
all voting rights and rights to dividends or other distributions with respect to
shares of Capital Stock held in the Trust, which rights shall be exercised for
the exclusive benefit of the Charitable Beneficiary. Any dividend or other
distribution paid prior to the discovery by the Corporation that the shares of
Capital Stock have been transferred to the Trustee shall be paid with respect to
such shares of Capital Stock to the Trustee upon demand and any dividend or
other distribution authorized but unpaid shall be paid when due to the Trustee.
Any dividends or distributions so paid over to the Trustee shall be held in
trust for the Charitable Beneficiary. The Prohibited Owner shall have no voting
rights with respect to shares held in the Trust and, subject to Maryland law,
effective as of the date that the shares of Capital Stock have been transferred
to the Trustee, the Trustee shall have the authority (at the Trustee's sole
discretion) (i) to rescind as void any vote cast by a Prohibited Owner prior to
the discovery by the Corporation that the shares of Capital Stock have been
transferred to the Trustee and (ii) to recast such vote in accordance with the
desires of the Trustee acting for the benefit of the Charitable Beneficiary.
Notwithstanding the provisions of this Article X, until the Corporation has
received notification that shares of Capital Stock have been transferred into a
Trust, the Corporation shall be entitled to rely on its share transfer and other
stockholder records for purposes of preparing lists of stockholders entitled to
vote at meetings, determining the validity and authority of proxies and
otherwise conducting votes of stockholders.
Section 10.3.4 Sale of Shares by Trustee. Within 20 days of
receiving notice from the Corporation that shares of Capital Stock have been
transferred to the Trust, the Trustee of the Trust shall sell the shares held in
the Trust to a person, designated by the Trustee, whose ownership of the shares
will not violate the ownership limitations set forth in Section 10.2.1(a). Upon
such sale, the interest of the Charitable Beneficiary in the shares sold shall
terminate and the Trustee shall distribute the net proceeds of the sale to the
Prohibited Owner and to the Charitable Beneficiary as provided in this Section
10.3.4. The Prohibited
<PAGE> 17
Owner shall receive the lesser of (1) the price paid by the Prohibited Owner for
the shares or, if the Prohibited Owner did not give value for the shares in
connection with the event causing the shares to be held in the Trust (e.g., in
the case of a gift, devise or other such transaction), the Market Price of the
shares on the day of the event causing the shares to be held in the Trust and
(2) the price per share received by the Trustee from the sale or other
disposition of the shares held in the Trust. Any net sales proceeds in excess of
the amount payable to the Prohibited Owner shall be immediately paid to the
Charitable Beneficiary. If, prior to the discovery by the Corporation that
shares of Capital Stock have been transferred to the Trustee, such shares are
sold by a Prohibited Owner, then (i) such shares shall be deemed to have been
sold on behalf of the Trust and (ii) to the extent that the Prohibited Owner
received an amount for such shares that exceeds the amount that such Prohibited
Owner was entitled to receive pursuant to this Section 10.3.4, such excess shall
be paid to the Trustee upon demand.
Section 10.3.5 Purchase Right in Stock Transferred to the
Trustee. Shares of Capital Stock transferred to the Trustee shall be deemed to
have been offered for sale to the Corporation, or its designee, at a price per
share equal to the lesser of (i) the price per share in the transaction that
resulted in such transfer to the Trust (or, in the case of a devise or gift, the
Market Price at the time of such devise or gift) and (ii) the Market Price on
the date the Corporation, or its designee, accepts such offer. The Corporation
shall have the right to accept such offer until the Trustee has sold the shares
held in the Trust pursuant to Section 10.3.4. Upon such sale to the Corporation,
the interest of the Charitable Beneficiary in the shares sold shall terminate
and the Trustee shall distribute the net proceeds of the sale to the Prohibited
Owner.
Section 10.3.6 Designation of Charitable Beneficiaries. The
Trustee shall designate one or more nonprofit organizations to be the Charitable
Beneficiary of the interest in the Trust such that (i) the shares of Capital
Stock held in the Trust would not violate the restrictions set forth in Section
10.2.1(a) in the hands of such Charitable Beneficiary and (ii) each such
organization must be a Charitable Beneficiary as defined in this Article X.
ARTICLE XI
DIRECTOR DISCRETION
With respect to any proposed merger, acquisition, business combination
or other similar transaction or proposal, a director of the Corporation, in
determining what is in the best interests of the Corporation, shall consider the
interest of the stockholders of the Corporation and, in his or her discretion,
may consider (i) the interests of the Corporation's employees, suppliers,
creditors and customers, (ii) the economy of the nation, (iii) community and
societal interests and (iv) the long-term as well as short-term interests of the
Corporation and its stockholders, including the possibility that these interests
may be best served by the continued independence of the Corporation. Pursuant to
this provision, the Board of Directors may consider numerous judgmental or
subjective factors affecting a proposal, including certain nonfinancial matters,
and on the basis of these considerations may oppose a business
<PAGE> 18
combination or other transaction which, as an exclusively financial matter,
might be attractive to some, or a majority, of the Corporation's stockholders.
ARTICLE XII
MAJORITY VOTE
Notwithstanding any provision of law requiring the authorization of any
action by a greater proportion than a majority of the total number of shares of
all classes of Capital Stock or of the total number of shares of any class of
Capital Stock, such action shall be valid and effective if authorized by the
affirmative vote of the holders of a majority of the total number of shares of
all classes outstanding and entitled to vote thereon, except as otherwise
provided in the Charter.
ARTICLE XIII
SHARE ISSUANCE
The Board of Directors is hereby empowered to authorize the issuance
from time to time of shares of its Capital Stock of any class, whether now or
hereafter authorized, or securities exercisable or exchangeable for or
convertible into shares of its Capital Stock of any class or classes, whether
now or hereafter authorized, for such consideration as may be deemed advisable
by the Board of Directors and without any action by the stockholders.
ARTICLE XIV
CHARTER AMENDMENTS
The Corporation reserves the right to amend, alter, change or repeal any
provision contained in the Charter, including any amendments changing the terms
or contract rights, as expressly set forth in the Charter, of any of its
outstanding stock by classification, reclassification or otherwise, by a
majority of the directors' adopting a resolution setting forth the proposed
change, declaring its advisability, and either calling a special meeting of the
stockholders entitled to vote on the proposed change, or directing the proposed
change to be considered at the next annual stockholders meeting. Unless
otherwise provided herein, the proposed change will be effective only if it is
adopted upon the affirmative vote of the holders of not less than a majority of
the aggregate votes entitled to be cast thereon (considered for this purpose as
a single class); provided, however, that any amendment to, repeal of or adoption
of any provision inconsistent with Article VI or this Article XIV will be
effective only if it is also advised by at least two-thirds of the Board of
Directors and adopted upon the affirmative vote of the holders of not less than
two-thirds of the aggregate votes entitled to be cast thereon (considered for
this purpose as a single class).
<PAGE> 19
ARTICLE XV
DIRECTORS' POWERS
The enumeration and definition of particular powers of the Board of
Directors included in the foregoing Articles shall in no way be limited or
restricted by reference to or inference from the terms of any other Article of
the Charter of the Corporation, or construed as or deemed by inference or
otherwise in any manner to exclude or limit any powers conferred upon the Board
of Directors under the General Laws of the State of Maryland now or hereafter in
force.
The Board of Directors of the Corporation shall, consistent with
applicable law, have power in its sole discretion to determine from time to time
in accordance with sound accounting practice or other reasonable valuation
methods what constitutes annual or other net profits, earnings, surplus, or net
assets in excess of capital; to fix and vary from time to time the amount to be
reserved as working capital, or determine that retained earnings or surplus
shall remain in the hands of the Corporation; to set apart out of funds of the
Corporation such reserve or reserves in such amount or amounts and for such
proper purpose or purposes as it shall determine and to abolish any such reserve
or any part thereof; to distribute and pay distributions or dividends in Capital
Stock, cash or other securities or property, out of surplus or any other funds
or amounts legally available therefor, at such times and to the stockholders of
record on such dates as it may, from time to time, determine; and to determine
whether and to what extent and at what times and places and under what
conditions and regulations the books, accounts and documents of the Corporation,
or any of them, shall be open to the inspection of stockholders, except as
otherwise provided by statute or by the Bylaws, and, except as so provided, no
stockholder shall have any right to inspect any book, account or document of the
Corporation unless authorized to do so by resolution of the Board of Directors.
For any stockholder proposal to be presented in connection with an
annual meeting of stockholders of the Corporation, including any proposal
relating to the nomination of a director to be elected to the Board of Directors
of the Corporation, the stockholders must have given timely written notice
thereof in writing to the Secretary of the Corporation in the manner and
containing the information required by the Bylaws. Stockholder proposals to be
presented in connection with a special meeting of stockholders will be presented
by the Corporation only to the extent required by Section 2-502 of the MGCL and
the Bylaws.
<PAGE> 20
ARTICLE XVI
TITLE 3 ELECTION
This Corporation hereby expressly elects not to be governed by the
provisions of Subtitle 6 and Subtitle 7 of Title 3 of the MGCL.
ARTICLE XVII
DURATION
The duration of the Corporation shall be perpetual.
ARTICLE XVIII
DEFINITIONS
The following terms shall have the meanings provided below when used in
the Charter:
Board of Directors. The term "Board of Directors" shall mean the
board of directors of the Corporation, as it may be constituted from time to
time.
Bylaws. The term "Bylaws" shall mean the Corporation's bylaws
adopted by the Board of Directors, as they may be amended from time to time.
Capital Stock. The term "Capital Stock" shall mean all classes or
series of stock of the Corporation, including, without limitation, Common Stock
and Preferred Stock.
Charter. The term "Charter" shall mean the charter of the
Corporation, as that term is defined in the MGCL.
Corporation. The term "Corporation" shall mean the corporation
formed by these Articles of Incorporation, as they may be amended from time to
time.
MGCL. The term "MGCL" shall mean the Maryland General Corporation
Law, as amended from time to time.
SECOND: The amendment to and restatement of the Charter of the Corporation as
hereinabove set forth has been duly approved by the Board of Directors and
approved by the stockholders of the Corporation as required by law.
THIRD: The provisions set forth herein are all of the provisions currently in
effect.
<PAGE> 21
FOURTH: The undersigned President acknowledges these Articles of Amendment and
Restatement to be the corporate act of the Corporation and as to all matters or
facts required to be verified under oath, the undersigned Chief Executive
Officer acknowledges that to the best of his knowledge, information and belief,
these matters and facts are true in all material respects and that this
statement is made under the penalties for perjury.
IN WITNESS WHEREOF, the Corporation has caused these Articles to be
signed in its name and on its behalf by its Chief Executive Officer and attested
by its Secretary on this _____ day of June, 1998.
REALTRUST ASSET CORPORATION
By: By:
----------------------------- ---------------------------------
Kent G. Bills, John D. Fry,
Secretary Chief Executive Officer
<PAGE> 1
EXHIBIT 4.4
NO. ______________
CMG FUNDING CORP.
1996 STOCK OPTION PLAN
STOCK OPTION AGREEMENT
This Agreement confirms the terms of your stock options granted to you
by CMG Funding Corp., a Delaware corporation (the "Company") under its 1996
Stock Option Plan (the "Plan").
1. Grant of Rights. You have been granted stock options which consist of either
or both of incentive stock options ("ISOs") or non-statutory stock options
("NSOs")) (the "Option", or "Options") in any combination, as reflected in the
attached schedule ("Annex A"). The Company will amend Annex A from time to time
to reflect changes to the amounts, the vesting dates, the exercise prices and
the expiration dates of the Options. The most recent amendment of Annex A will
replace any prior schedules.
2. Stock Options.
(a) An "Option" is the right to purchase a specified number of shares
(the "Underlying Shares") of the Company's Common Stock during a defined period
of time at a specified price. The Option will be characterized as either an ISO
or an NSO for tax purposes as follows:
(i) ISO.
A. An "ISO" is an option granted to an individual for any
reason connected with his or her employment by a corporation, as more fully
described in Section 422(b) of the Code. The principal benefit of an ISO is that
the recipient is not taxed on the receipt or exercise of the ISO; any tax is
imposed as capital gain when the employee sells the stock received on the
exercise of a qualifying ISO. Only actual Employees of the Company may receive
ISOs (officers are generally deemed employees for this purpose.)
B. If you do not exercise an ISO for at least two years
from the date of the grant, you will not be taxed upon the exercise of the ISO,
but will be taxed only on the sale of the Stock. If you exercise the ISO within
two years from the date of the grant, the gain between the exercise price and
the fair market value of the Stock on the date of exercise will be taxed as
ordinary income.
C. The sale of the Stock for an amount greater than the
exercise price of the ISO will be taxable to you as either ordinary income or
long term capital gain, depending on the amount of time that has passed since
the date the Option was exercised. If you sell your Stock less than 12 months
from the date of exercise of the Option, any gain on the sale will be taxed at
ordinary
-1-
<PAGE> 2
income tax rates of up to 39.6% (plus any applicable state income
taxes). If you sell your stock more than 12 months, but fewer than 18 months
from the date of exercise of the Option, any gain on the sale over your basis
will be taxed as long term capital gain at a maximum rate of 28% (plus any
applicable state income taxes). If you sell your stock more than 18 months from
the date of exercise of the Option, any gain on the sale over your basis will be
taxed as long term capital gain at a maximum rate of 20% (plus any applicable
state income taxes).
D. The excess, if any, of the fair market value of the
shares of the Stock on the date of exercise over the Exercise Price will be
treated as a tax preference item for federal income tax purposes and, depending
upon your own personal income tax situation, you may be subject to the
alternative minimum tax in the year of exercise.
E. You must notify the Company of the early exercise of
the Option or disposition of the Underlying Shares acquired within thirty (30)
days.
(ii) NSO.
A. An "NSO" is any option other than an ISO, including an
Option initially granted as an ISO but with respect to which not all of the
statutory requirements have been met. If the Option is an NSO, you may be
subject to regular federal and state income tax liability upon the exercise of
the Option. You will be treated as having received compensation income (taxable
at ordinary income tax rates) equal to the excess, if any, of (A) the fair
market value of the Stock at the close of trading on the business day before the
date of exercise over (B) the Exercise Price.
B. If you sell the Underlying Shares on the same day that
you exercise them, fair market value will be the actual price per share at which
you sell the Underlying Shares. In all other cases, the fair market value will
be the price per share at the close of trading on the business day before the
date of exercise.
C. If you are an Employee of the Company, the Company may
be required to withhold from your compensation or collect from you and pay to
the applicable taxing authorities an amount equal to a percentage of this
compensation income at the time of exercise. If you sell your Stock less than 12
months from the date of exercise of the Option, any gain on the sale will be
taxed at ordinary income tax rates of up to 39.6% (plus any applicable state
income taxes). If you sell your stock more than 12 months, but fewer than 18
months from the date of exercise of the Option, any gain on the sale will be
taxed as long term capital gain at a maximum rate of 28% (plus any applicable
state income taxes). If you sell your stock more than 18 months from the date of
exercise of the Option, any gain on the sale will be taxed as long term capital
gain at a maximum rate of 20% (plus any applicable state income taxes).
D. Upon the sale of the Stock, any appreciation in the
value of the Stock from date the Option was exercised is taxable to you as
either ordinary income or long term capital gain, depending on the amount of
time that has passed since the date the Option was exercised.
-2-
<PAGE> 3
(b) This is only is a brief summary of some of the federal and state
income tax consequences relating to the exercise of a stock option and the
disposition of the Underlying Shares.
THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. YOU SHOULD
CONSULT A TAX ADVISER BEFORE EXERCISING THE OPTION OR DISPOSING OF THE
UNDERLYING SHARES SO THAT YOU WILL FULLY UNDERSTAND THE TAX
CONSEQUENCES BASED ON YOUR PARTICULAR SITUATION.
(c) If you decide to exercise your Options to purchase the Underlying
Shares, the exercise price will be the price per share shown on Annex A.
(d) You may exercise your Options in whole or in part at any time after
six (6) months from the date the Option was granted, as reflected on Annex A.
The minimum exercise amount is at least one hundred (100) shares at a time. You
may exercise your Options by giving the Company written notice of the number of
Shares that you wish to exercise. Payment of the Purchase Price may be made in
any manner permitted under the Plan (including payment to the Company out of the
settlement from the sale of the Shares or, at the Company's discretion, by a
loan or extension of credit from the Company to you evidenced by a full recourse
promissory note). The Shares will be issued only upon the Company's receipt of
the full exercise price.
(e) Your Option will terminate if not exercised within ten (10) years
from the date of the grant. In addition, you may not exercise your Option if:
(i) your Employment is terminated for cause; (ii) three (3) months has passed
since the date of your Termination of Employment by reason of Retirement or
other than for cause; or (iii) one (1) year has passed since the date of your
Termination of Employment by reason of death or Disability.
(f) For purposes of this Agreement the term "Termination of Employment"
means the earlier of (i) the date when your service in fact terminates or (ii)
the date when you give or receive written notice that your service is to
terminate. Termination for cause includes termination resulting from the
conviction of a felony, misappropriation of assets of the Company, continued or
repeated insobriety, continued or repeated absence from service during the usual
working hours of your position for reason other than disability or sickness, or
refusal to carry out the reasonable directions of the Company's executive
officers or of the Board. Termination of Employment includes the termination of
the recipient's engagement as independent contractor or director.
(g) You will not have any rights as a shareholder with respect to any of
the Underlying Shares of the Options until after both of the following: (i) you
have exercised your Options as described above and (ii) the Company has issued
and delivered to you a certificate representing the Underlying Shares. You will
not be entitled to receive dividends or other rights for which the record date
is prior to the date such stock certificates are issued.
(h) You may sell the Underlying Shares you receive upon exercise of your
Options immediately, unless legal counsel to the Company determines that the
sale would violate federal or state securities laws.
-3-
<PAGE> 4
(i) For purposes of this Agreement, fair market value will be the price
per Share at the close of business on the Business Day preceding the exercise of
the Right, unless the Shares are not currently traded on an exchange, in which
case fair market value will be determined as provided in the Plan.
3. Effect of a Reorganization.
Any Options awarded to you under this Agreement shall be proportionately
adjusted in the event of a stock split or recapitalization. Upon the occurrence
of a Change in Control (as defined in the Plan), dissolution, or liquidation of
the Company, all outstanding Options shall automatically become fully vested and
exercisable and you will have fifteen days in which to exercise your Options
before they terminate (unless, with respect to a Change in Control, the Options
are being assumed by the successor company).
4. Notices.
You should address any notice to the Company in care of Mr. Steven K.
Passey, Chief Financial Officer. The Company will address any notice to you at
the address then currently on file with the Company. Notice shall be deemed
given when mailed in a correctly stamped and addressed envelope.
5. Miscellaneous.
(a) The Company has provided you with a copy of the Plan. The Company
assumes that you have read and understood the Plan prior to entering into this
Agreement. The terms and definitions of the Plan are incorporated into this
Agreement. The terms of the Plan will control if there is any conflict between
the terms of this Agreement and the Plan.
(b) The Company's Stock Option Committee has the power to interpret the
Plan and this Agreement and all actions taken and all interpretations and
determinations made by the Committee
are final and binding.
(c) This Agreement and the Plan constitute the entire agreement between
the Company and you, and supersedes any prior agreements, relating to the
Options.
(d) This agreement may be exercised in two or more counterparts,
including electronically transmitted counterparts, all of which shall constitute
one and the same agreement.
(e) This Agreement shall be governed by and construed under the laws of
the State of Maryland.
6. Signatures
-4-
<PAGE> 5
By signing on the line indicated below, you indicate your willingness to
abide by and be bound by the terms of this Agreement and the Plan.
CMG FUNDING CORP.,
A Delaware corporation
Date: By:
--------------------- ----------------------------------
John Fry, President
RECIPIENT OF GRANT
Date: Name:
-------------------- --------------------------------
Address:
-----------------------------
--------------------------------------
--------------------------------------
Tax ID No.:
--------------------------
Signature:
---------------------------
-8-
<PAGE> 1
EXHIBIT 4.6
NO. ___________
REAL TRUST ASSET CORPORATION
1998 STOCK OPTION PLAN
STOCK OPTION AND RIGHTS AGREEMENT
This Agreement confirms the terms of your stock options, dividend
equivalent rights, stock appreciation rights, restricted stock, deferred stock
and/or performance shares, granted to you by Real Trust Asset Corporation, a
Maryland corporation (the "Company") under its 1998 Stock Option and Plan (the
"Plan").
1. Grant of Rights. You have been granted one or more of the following:
(a) stock options (either incentive stock options ("ISOs") or
non-statutory stock options ("NOS")) (the "Option" or "Options");
(b) dividend equivalent rights ("DERs");
(c) stock appreciation rights ("SARs"); or,
(d) restricted stock, deferred stock or performance shares awards
(collectively, AShare Awards@).
(Options, DERs, SARs and Share Awards are referred to collectively as the
"Rights"), in any combination, as reflected in the attached schedule ("Annex
A"). The Company will amend Annex A from time to time to reflect changes to the
amounts, the vesting dates, the exercise prices and the expiration dates of the
Rights. The most recent amendment of Annex A will replace any prior schedules.
2. Stock Options.
(a) An "Option" is the right to purchase a specified number of shares
(the "Underlying Shares") of the Company's Common Stock during a defined period
of time at a specified price. The Option will be characterized as either an ISO
or an NSO for tax purposes as follows:
(I ISO.
A. An "ISO" is an option granted to an individual for any
reason connected with his or her employment by a corporation, as more fully
described in Section 422(b) of the Code. The principal benefit of an ISO is that
the recipient is not taxed on the receipt or exercise of the ISO; any tax is
imposed as capital gain when the employee sells the stock received on the
exercise of a qualifying ISO. Only actual Employees of the Company may receive
ISOs (officers are generally deemed employees for this purpose.)
<PAGE> 2
B. If you do not exercise an ISO for at least two years
from the date of the grant, you will not be taxed upon the exercise of the ISO,
but will be taxed only on the sale of the Stock. If you exercise the ISO within
two years from the date of the grant, the gain between the exercise price and
the fair market value of the Stock on the date of exercise will be taxed as
ordinary income.
C. The sale of the Stock for an amount greater than the
exercise price of the ISO will be taxable to you as either ordinary income or
long term capital gain, depending on the amount of time that has passed since
the date the Option was exercised. If you sell your Stock less than 12 months
from the date of exercise of the Option, any gain on the sale will be taxed at
ordinary income tax rates of up to 39.6% (plus any applicable state income
taxes). If you sell your stock more than 12 months, but fewer than 18 months
from the date of exercise of the Option, any gain on the sale over your basis
will be taxed as long term capital gain at a maximum rate of 28% (plus any
applicable state income taxes). If you sell your stock more than 18 months from
the date of exercise of the Option, any gain on the sale over your basis will be
taxed as long term capital gain at a maximum rate of 20% (plus any applicable
state income taxes).
D. The excess, if any, of the fair market value of the
shares of the Stock on the date of exercise over the Exercise Price will be
treated as a tax preference item for federal income tax purposes and, depending
upon your own personal income tax situation, you may be subject to the
alternative minimum tax in the year of exercise.
E. You must notify the Company of the early exercise of
the Option or disposition of the Underlying Shares acquired within thirty (30)
days.
(ii) NSO.
A. An "NSO" is any option other than an ISO, including an
Option initially granted as an ISO but with respect to which not all of the
statutory requirements have been met. If the Option is an NSO, you may be
subject to regular federal and state income tax liability upon the exercise of
the Option. You will be treated as having received compensation income (taxable
at ordinary income tax rates) equal to the excess, if any, of (A) the fair
market value of the Stock at the close of trading on the business day before the
date of exercise over (B) the Exercise Price.
B. If you sell the Underlying Shares on the same day that
you exercise them, fair market value will be the actual price per share at which
you sell the Underlying Shares. In all other cases, the fair market value will
be the price per share at the close of trading on the business day before the
date of exercise.
C. If you are an Employee of the Company, the Company may
be required to withhold from your compensation or collect from you and pay to
the applicable taxing authorities an amount equal to a percentage of this
compensation income at the time of exercise. If you sell your Stock less than 12
months from the date of exercise of the Option, any
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<PAGE> 3
gain on the sale will be taxed at ordinary income tax rates of up to 39.6% (plus
any applicable state income taxes). If you sell your stock more than 12 months,
but fewer than 18 months from the date of exercise of the Option, any gain on
the sale will be taxed as long term capital gain at a maximum rate of 28% (plus
any applicable state income taxes). If you sell your stock more than 18 months
from the date of exercise of the Option, any gain on the sale will be taxed as
long term capital gain at a maximum rate of 20% (plus any applicable state
income taxes).
D. Upon the sale of the Stock, any appreciation in the
value of the Stock from date the Option was exercised is taxable to you as
either ordinary income or long term capital gain, depending on the amount of
time that has passed since the date the Option was exercised.
(b) This is only is a brief summary of some of the federal and state
income tax consequences relating to the exercise of a stock option and the
disposition of the Underlying Shares. THE TAX LAWS AND REGULATIONS ARE SUBJECT
TO CHANGE. YOU SHOULD CONSULT A TAX ADVISER BEFORE EXERCISING THE OPTION OR
DISPOSING OF THE UNDERLYING SHARES SO THAT YOU WILL FULLY UNDERSTAND THE TAX
CONSEQUENCES BASED ON YOUR PARTICULAR SITUATION.
(c) If you decide to exercise your Options to purchase the Underlying
Shares, the exercise price will be the price per share shown on Annex A.
(d) You may exercise your Options as they vest. For each annual period
over a five-year period that the Company delivers a total return (stock price
appreciation, warrant value appreciation and dividends) to investors in the
Company=s initial public offering equal to or exceeding 20%, one-third of the
Options will vest until all granted Options shall have vested. Alternatively, if
at any time prior to the end of the five-year period the total return to
investors equals or exceeds 100%, all of the Options shall vest. Such automatic
grants of Options vest 25% on the anniversary date in the year following the
date of the grant and 25% on each anniversary date thereafter. The minimum
exercise amount is at least one hundred (100) shares at a time. You may exercise
your Options by giving the Company written notice of the number of Shares that
you wish to exercise. Payment of the Purchase Price may be made in any manner
permitted under the Plan (including payment to the Company out of the settlement
from the sale of the Shares or, at the Company's discretion, by a loan or
extension of credit from the Company to you evidenced by a full recourse
promissory note). The Shares will be issued only upon the Company's receipt of
the full exercise price.
(e) Your Option will terminate if not exercised within ten (10) years
from the date of the grant. In addition, you may not exercise your Option if:
(i) three (3) months has passed since the date of your Termination of Employment
by reason of Retirement or termination by the Company; or (ii) one (1) year has
passed since the date of your Termination of Employment by reason of death or
Disability.
(f) You will not have any rights as a shareholder with respect to any of
the Underlying Shares of the Options until after both of the following: (i) you
have exercised your Options as described above and (ii) the Company has issued
and delivered to you a certificate representing the
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<PAGE> 4
Underlying Shares. You will not be entitled to receive dividends or other rights
for which the record date is prior to the date such stock certificates are
issued.
(g) You may sell the Underlying Shares you receive upon exercise of your
Options immediately, unless legal counsel to the Company determines that the
sale would violate federal or state securities laws.
(h) For purposes of this Agreement, fair market value will be the price
per Share at the close of business on the Business Day preceding the exercise of
the Right, unless the Shares are not currently traded on an exchange, in which
case fair market value will be determined as provided in the Plan.
3. Description of other Rights.
The following is a summary description of the other various Rights that
you may have been granted:
(a) DERs. A "DER" is a right to receive either (i) cash or (ii) accrued
rights, in an amount equal to the dividend distributions paid on a share of
common stock. There are no tax consequences to you on the receipt of the DER.
Any cash paid to you will be taxable as compensation income. You must make your
election to receive cash or accrued rights prior to the first DER distribution
and may change it at anytime prospectively by giving notice to the Company. You
will begin to receive cash payments equal to the dividends paid on a Share or to
accrue accrued rights on your DER as of the next dividend distribution following
the date of issuance of the DER.
(b) SARs. An "SAR" is an unfunded deferred obligation of the Company to
pay the recipient of the SAR upon exercise an amount of cash equal to the
excess, if any, of (i) the fair market value of a share at the time of exercise
of the SAR over (ii) the fair market value at the time that the SAR was issued
(or such other stated value as set forth on Annex A). There are no tax
consequences to you upon the grant of an SAR. When you exercise your SAR and
receive cash, you will have ordinary compensation income. If you are an
Employee, your employer may be required to withhold from your compensation or
collect from you and pay to the applicable taxing authorities an amount equal to
a percentage of this compensation income.
(c) Share Awards. The Company may grant Share Awards in the form of
Restricted Stock, Deferred Stock and/or Performance Shares. All such Share
Awards are subject to certain ownership restrictions during specified time
periods (the ARestricted Period@). With respect to the Restricted Stock and
Performance Share Awards, you will generally have all the voting rights of a
stockholder of the Company, including the right to receive dividends, during the
Restricted Period. With respect to the Deferred Stock Awards, you will generally
not have the voting rights of a stockholder of the Company during the Restricted
Period, but will be entitled to dividends during such period.
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<PAGE> 5
(d) The Rights described in this Section vest immediately with the
exception of Related Stock Appreciation Rights (as defined in the Plan) which
vest after six months, unless otherwise stated in Annex A (DERs granted with the
issuance of convertible preferred stock are generally not effective until and
unless the preferred stock is converted into common stock.)
(e) The Rights will terminate if either (i) three (3) months has passed
since the date of your Termination of Employment by reason of Retirement or by
the Company; or (ii) One (1) year has passed since the date of your Termination
of Employment by reason of death or Disability. In the case of Share Awards, any
Termination of Employment during the Restricted Period will result in the
forfeiture of your shares in exchange for the amount, if any, paid to the
Company for such shares plus simple interest on such amount at the rate of 8%
per year.
4. Transferability.
Unless the Company otherwise consents in writing, the Rights (i) shall
be non-assignable and non-transferable, either voluntarily or by operation of
law, except pursuant to a qualified domestic relations order or by will or by
operation of the laws of descent and distribution, (ii) shall not be pledged or
hypothecated in any way, and (iii) shall be exercisable during your lifetime
only by you. Except as otherwise provided in this Agreement, any attempted sale,
transfer, pledge or assignment of any type, whether voluntary or involuntary,
with respect to all or any part of the Rights, shall be null and void and, at
the Company's option, shall cause all of your Rights to terminate. Any transfer,
other than those described in clauses (i), (ii), (iii) above, even if consented
to by the Company, may cause your Options not to be ISOs.
5. Effect of a Reorganization.
Any Rights awarded to you under this Agreement shall be proportionately
adjusted in the event of a stock split or recapitalization. Upon the occurrence
of a Change in Control (as defined in the Plan), dissolution, or liquidation of
the Company, all outstanding Rights shall automatically become fully vested and
exercisable and you will have fifteen days in which to exercise your Rights
before they terminate (unless, with respect to a change in control, the Rights
are being assumed by the successor company).
4. Notices.
You should address any notice to the Company in care of Mr. Steven K.
Passey, Chief Financial Officer. The Company will address any notice to you at
the address then currently on file with the Company. Notice shall be deemed
given when mailed in a correctly stamped and addressed envelope.
5. Miscellaneous.
(a) The Company has provided you with a copy of the Plan. The Company
assumes that
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<PAGE> 6
you have read and understood the Plan prior to entering into this Agreement. The
terms and definitions of the Plan are incorporated into this Agreement. The
terms of the Plan will control if there is any conflict between the terms of
this Agreement and the Plan.
(b) The Company's Stock Option Committee has the power to interpret the
Plan and this Agreement and all actions taken and all interpretations and
determinations made by the Committee are final and binding.
(c) This Agreement and the Plan constitute the entire agreement between
the Company and you, and supersedes any prior agreements, relating to the
Options.
(d) This agreement may be exercised in two or more counterparts,
including electronically transmitted counterparts, all of which shall constitute
one and the same agreement.
(e) This Agreement shall be governed by and construed under the laws of
the State of Maryland.
6. Signatures
By signing on the line indicated below, you indicate your willingness to
abide by and be bound by the terms of this Agreement and the Plan.
REAL TRUST ASSET CORPORATION.,
A Maryland corporation
Date: By:
-------------------- ----------------------------------
John Fry, President
RECIPIENT OF GRANT
Date: Name:
-------------------- --------------------------------
Address:
-----------------------------
--------------------------------------
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Tax ID No.:
--------------------------
Signature:
---------------------------
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<PAGE> 1
EXHIBIT 4.7
FORM OF
REGISTRATION RIGHTS AGREEMENT
This Registration Rights Agreement (the "Agreement") is made and
entered into this _ day of ________, ____, among [name of Company], a Delaware
corporation (the "Company"), and [name of Founders].
In consideration of the foregoing, the parties hereto agree as
follows:
1. Definitions.
As used in this Agreement, the following capitalized defined
terms shall have the following meanings:
"1933 Act" shall mean the Securities Act of 1933, as amended from
time to time.
"1934 Act" shall mean the Securities Exchange Act of 1934, as
amended from time to time.
"Company" shall have the meaning set forth in the preamble and
shall also include the Company's successors.
"Depository" shall mean The Depository Trust Company, or any
other depositary appointed by the Company, provided, however, that such
depositary must have an address in the Borough of Manhattan, in the City of New
York.
"Holder" shall mean [name of Founders], for so long as it owns
any Registrable Securities, and each of its successors, assigns and direct and
indirect transferees who become registered owners of Registrable Securities.
"Majority Holders" shall mean the Holders of a majority of the
Registrable Securities; provided that whenever the consent or approval of
Holders of a specified percentage of Registrable Securities is required
hereunder, Registrable Securities held by the Company and other obligors on the
Securities or any Affiliate of the Company shall be disregarded in determining
whether such consent or approval was given by the Holders of such required
percentage amount.
"Person" shall mean an individual, partnership (general or
limited), corporation, limited liability company, trust or unincorporated
organization, or a government or agency or political subdivision thereof.
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<PAGE> 2
"Prospectus" shall mean the prospectus included in a Registration
Statement, including any preliminary prospectus, and any such prospectus as
amended or supplemented by any prospectus supplement, including any such
prospectus supplement with respect to the terms of the offering of any portion
of the Registrable Securities covered by a Shelf Registration Statement, and by
all other amendments and supplements to a prospectus, including post-effective
amendments, and in each case including all material incorporated by reference
therein.
"Registrable Securities" shall mean the Securities; provided,
however, that Securities shall cease to be Registrable Securities when (i) a
Registration Statement with respect to such Securities shall have been declared
effective under the 1933 Act and such Securities shall have been disposed of
pursuant to such Registration Statement, (ii) such Securities have been sold to
the public pursuant to Rule 144 (or any similar provision then in force, but not
Rule 144A) under the 1933 Act, or (iii) such Securities shall have ceased to be
outstanding.
"Registration Expenses" shall mean any and all expenses incident
to performance of or compliance by the Company with this Agreement, including
without limitation: (i) all SEC, stock exchange or National Association of
Securities Dealers, Inc. (the "NASD") registration and filing fees, including,
if applicable, the fees and expenses of any "qualified independent underwriter"
(and its counsel) that is required to be retained by any holder of Registrable
Securities in accordance with the rules and regulations of the NASD, (ii) all
fees and expenses incurred in connection with compliance with state securities
or blue sky laws and compliance with the rules of the NASD (including reasonable
fees and disbursements of counsel for any underwriters or Holders in connection
with blue sky qualification of any of the Registrable Securities and any filings
with the NASD), (iii) all expenses of any Persons in preparing or assisting in
preparing, word processing, printing and distributing any Registration
Statement, any Prospectus, any amendments or supplements thereto, any
underwriting agreements, securities sales agreements and other documents
relating to the performance of and compliance with this Agreement, (iv) all fees
and expenses incurred in connection with the listing, if any, of any of the
Registrable Securities on any securities exchange or exchanges, (v) the fees and
disbursements of counsel for the Company and of the independent public
accountants of the Company, including the expenses of any special audits or
"cold comfort" letters required by or incident to such performance and
compliance, (vi) the reasonable fees and disbursements of [name of law firm],
special counsel representing the Holders of Registrable Securities and (x) any
fees and disbursements of the underwriters customarily required to be paid by
issuers or sellers of securities and the fees and expenses of any special
experts retained by the Company in connection with any Registration Statement,
but excluding underwriting discounts and commissions and transfer taxes, if any,
relating to the sale or disposition of Registrable Securities by a Holder.
"Registration Statement" shall mean any registration statement of
the Company which covers any of the Registrable Securities pursuant to the
provisions of this Agreement,
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<PAGE> 3
and all amendments and supplements to any such Registration Statement, including
post-effective amendments, in each case including the Prospectus contained
therein, all exhibits thereto and all material incorporated by reference
therein.
"SEC" shall mean the Securities and Exchange Commission or any
successor agency or government body performing the functions currently performed
by the United States Securities and Exchange Commission.
"Shelf Registration" shall mean a registration effected pursuant
to Section 2.2 hereof.
"Shelf Registration Statement" shall mean a "shelf" registration
statement of the Company pursuant to the provisions of Section 2.2 of this
Agreement which covers all of the Registrable Securities on an appropriate form
under Rule 415 under the 1933 Act, or any similar rule that may be adopted by
the SEC, and all amendments and supplements to such registration statement,
including post-effective amendments, in each case including the Prospectus
contained therein, all exhibits thereto and all material incorporated by
reference therein.
2. Registration Under the 1933 Act.
2.2 Shelf Registration. (i) [Describe conditions precedent to the
Company's requirement to file a shelf registration statement]:
(a) As promptly as practicable, file with the SEC, and thereafter
shall use its best efforts to cause to be declared effective as promptly
as practicable but no later than 120 days after the original issue of
the Registrable Securities, a Shelf Registration Statement relating to
the offer and sale of the Registrable Securities by the Holders from
time to time in accordance with the methods of distribution elected by
the Majority Holders participating in the Shelf Registration and set
forth in such Shelf Registration Statement.
(b) Use its best efforts to keep the Shelf Registration Statement
continuously effective in order to permit the Prospectus forming part
thereof to be usable by Holders for a period of two years from the date
the Shelf Registration Statement is declared effective by the SEC, or
for such shorter period that will terminate when all Registrable
Securities covered by the Shelf Registration Statement have been sold
pursuant to the Shelf Registration Statement or cease to be outstanding
or otherwise to be Registrable Securities (the "Effectiveness Period");
provided, however, that the Effectiveness Period in respect of the Shelf
Registration Statement shall be extended to the extent required to
permit dealers to comply with the applicable prospectus delivery
requirements of Rule 174 under the 1933 Act and as otherwise provided
herein.
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<PAGE> 4
(c) Notwithstanding any other provisions hereof, use its best
efforts to ensure that (i) any Shelf Registration Statement and any
amendment thereto and any Prospectus forming part thereof and any
supplement thereto complies in all material respects with the 1933 Act
and the rules and regulations thereunder, (ii) any Shelf Registration
Statement and any amendment thereto does not, when it becomes effective,
contain an untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading and (iii) any Prospectus forming part
of any Shelf Registration Statement, and any supplement to such
Prospectus (as amended or supplemented from time to time), does not
include an untrue statement of a material fact or omit to state a
material fact necessary in order to make the statements, in light of the
circumstances under which they were made, not misleading.
The Company shall not permit any securities other than
Registrable Securities to be included in the Shelf Registration Statement. The
Company further agrees, if necessary, to supplement or amend the Shelf
Registration Statement, as required by Section 3(b) below, and to furnish to the
Holders of Registrable Securities copies of any such supplement or amendment
promptly after its being used or filed with the SEC.
2.3 Expenses. The Company shall pay all Registration Expenses in
connection with the registration pursuant to Section 2.2. Each Holder shall pay
all underwriting discounts and commissions and transfer taxes, if any, relating
to the sale or disposition of such Holder's Registrable Securities pursuant to
the Shelf Registration Statement.
2.4 Effectiveness. (a) The Company will be deemed not have used
its best efforts to cause the Shelf Registration Statement to become, or to
remain, effective during the requisite period if the Company voluntarily takes
any action that would, or omits to take any action which omission would, result
in any such Registration Statement not being declared effective or in the
Holders of Registrable Securities covered thereby not being able to offer and
sell such Registrable Securities during that period as and to the Latent
contemplated hereby, unless such action is required by applicable law.
(b) A Shelf Registration Statement pursuant to Section 2.2 hereof
will not be deemed to have become effective unless it has been declared
effective by the SEC; provided, however, that if, after it has been declared
effective, the offering of Registrable Securities pursuant to a Shelf
Registration Statement is interfered with by any stop order, injunction or other
order or requirement of the SEC or any other governmental agency or court, such
Registration Statement will be deemed not to have become effective during the
period of such interference, until the offering of Registrable Securities
pursuant to such Registration Statement may legally resume.
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<PAGE> 5
3. Registration Procedures.
In connection with the obligations of the Company with respect to
Registration Statements pursuant to Sections 2.2 hereof, the Company shall:
(a) prepare and file with the SEC a Registration Statement,
within the relevant time period specified in Section 2, on the appropriate form
under the 1933 Act, which form (i) shall be selected by the Company, (ii) shall
be available for the sale of the Registrable Securities by the selling Holders
thereof, (iii) shall comply as to form in all material respects with the
requirements of the applicable form and include or incorporate by reference all
financial statements required by the SEC to be filed therewith or incorporated
by reference therein, and (iv) shall comply in all respects with the
requirements of Regulation S-K under the 1933 Act, and use its best efforts to
cause such Registration Statement to become effective and remain effective in
accordance with Section 2 hereof;
(b) prepare and file with the SEC such amendments and
post-effective amendments to each Registration Statement as may be necessary
under applicable law to keep such Registration Statement effective for the
applicable period; and cause each Prospectus to be supplemented by any required
prospectus supplement, and as so supplemented to be filed pursuant to Rule 424
(or any similar provision then in force) under the 1933 Act and comply with the
provisions of the 1933 Act, the 1934 Act and the rules and regulations
thereunder applicable to them with respect to the disposition of all securities
covered by each Registration Statement during the applicable period in
accordance with the intended method or methods of distribution by the selling
Holders thereof;
(c) (i) notify each Holder of Registrable Securities, at least
five business days prior to filing, that a Shelf Registration Statement with
respect to the Registrable Securities is being filed and advising such Holders
that the distribution of Registrable Securities will be made in accordance with
the method selected by the Majority Holders participating in the Shelf
Registration; (ii) furnish to each Holder of Registrable Securities and to each
underwriter of an underwritten offering of Registrable Securities, if any,
without charge, as many copies of each Prospectus, including each preliminary
Prospectus, and any amendment or supplement thereto and such other documents as
such Holder or underwriter may reasonably request, including financial
statements and schedules and, if the Holder so requests, all exhibits in order
to facilitate the public sale or other disposition of the Registrable
Securities; and (iii) hereby consent to the use of the Prospectus or any
amendment or supplement thereto by each of the selling Holders of Registrable
Securities in connection with the offering and sale of the Registrable
Securities covered by the Prospectus or any amendment or supplement thereto;
(d) use its best efforts to register or qualify the Registrable
Securities under all applicable state securities or "blue sky" laws of such
jurisdictions as any Holder of Registrable Securities covered by a Registration
Statement and each underwriter of an
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<PAGE> 6
underwritten offering of Registrable Securities shall reasonably request by the
time the applicable Registration Statement is declared effective by the SEC, and
do any and all other acts and things which may be reasonably necessary or
advisable to enable each such Holder and underwriter to consummate the
disposition in each such jurisdiction of such Registrable Securities owned by
such Holder; provided, however, that the Company shall not be required to (i)
qualify as a foreign corporation or as a dealer in securities in any
jurisdiction where it would not otherwise be required to qualify but for this
Section 3(d), or (ii) take any action which would subject it to general service
of process or taxation in any such jurisdiction where it is not then so subject;
(e) notify promptly each Holder of Registrable Securities under a
Shelf Registration who has notified the Company that it is utilizing the Shelf
Registration Statement as provided in paragraph (f) below and, if requested by
such Holder confirm such advice in writing promptly (i) when a Registration
Statement has become effective and when any post-effective amendments and
supplements thereto become effective, (ii) of any request by the SEC or any
state securities authority for post-effective amendments and supplements to a
Registration Statement and Prospectus or for additional information after the
Registration Statement has become effective, (iii) of the issuance by the SEC or
securities authority of any stop order suspending the effectiveness of a
Registration Statement or the initiation of any proceedings for that purpose,
(iv) in the Base of a Shelf Registration, if, between the effective date of a
Registration Statement and the closing of any sale of Registrable Securities
covered thereby, the representations and warranties of the Company contained in
any underwriting agreement, securities sales agreement or other similar
agreement, if any, relating to the offering cease to be true and correct in all
material respects, (v) of the happening of any event or the discovery of any
facts during the period a Shelf Registration Statement is effective which makes
any statement made in such Registration Statement or the related Prospectus
untrue in any material respect or which requires the making of any changes in
such Registration Statement or Prospectus in order to make the statements
therein not misleading, (vi) of the receipt by the Company of any notification
with respect to the suspension of the qualification of the Registrable
Securities for sale in any jurisdiction or the initiation or threatening of any
proceeding for such purpose and (vii) of any determination by the Company that a
post effective amendment to such Registration Statement would be appropriate;
(f) in the case of a Shelf Registration, furnish counsel for the
Holders of Registrable Securities copies of any comment letters received from
the SEC or any other request by the SEC or any state securities authority for
amendments or supplements to a Registration Statement and Prospectus or for
additional information;
(g) make every reasonable effort to obtain the withdrawal of any
order suspending the effectiveness of a Registration Statement at the earliest
possible moment;
(h) in the case of a Shelf Registration, furnish to each Holder
of Registrable Securities, and each underwriter, if any, without charge, at
least one conformed copy of each
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<PAGE> 7
Registration Statement and any post-effective amendment thereto, including
financial statements and schedules (without documents incorporated therein by
reference and all exhibits thereto, unless requested);
(i) in the case of a Shelf Registration, cooperate with the
selling Holders of Registrable Securities to facilitate the timely preparation
and delivery of certificates representing Registrable Securities to be sold and
not bearing any restrictive legends; and enable such Registrable Securities to
be in such denominations and registered in such names as the selling Holders or
the underwriters, if any, may reasonably request at least three business days
prior to the closing of any sale of Registrable Securities;
(j) in the case of a Shelf Registration, upon the occurrence of
any event or the discovery of any facts, each as contemplated by Sections
3(e)(v) and 3(e)(vi) hereof, as promptly as practicable after the occurrence of
such an event, use its best efforts to prepare a supplement or post-effective
amendment to the Registration Statement or the related Prospectus or any
document incorporated therein by reference or file any other required document
so that, as thereafter delivered to the purchasers of the Registrable
Securities, such Prospectus will not contain at the time of such delivery any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements therein, in light of the circumstances under which they
were made, not misleading or will remain so qualified. At such time as such
public disclosure is otherwise made or the Company determines that such
disclosure is not necessary, in each case to correct any misstatement of a
material fact or to include any omitted material fact, the Company agrees
promptly to notify each Holder of such determination and to furnish each Holder
such number of copies of the. Prospectus as amended or supplemented, as such
Holder may reasonably request;
(k) in the case of a Shelf Registration, a reasonable time prior
to the filing of any Registration Statement, any Prospectus, any amendment to a
Registration Statement or amendment or supplement to a Prospectus or any
document which is to be incorporated by reference into a Registration Statement
or a Prospectus after initial filing of a Registration Statement, provide copies
of such document to counsel on behalf of such Holders; and make representatives
of the Company as shall be reasonably requested by the Holders of Registrable
Securities, or counsel on behalf of such Holders, available for discussion of
such document;
(l) obtain a CUSIP number for all Registrable Securities not
later than the effective date of a Registration Statement in a form eligible for
deposit with the Depositary;
(m) in the case of a Shelf Registration, enter into agreements
(including underwriting agreements) and take all other customary and appropriate
actions in order to expedite or facilitate the disposition of such Registrable
Securities and in such connection whether or not an underwriting agreement is
entered into and whether or not the registration is an underwritten
registration:
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<PAGE> 8
(i) make such representations and warranties to the
Holders of such Registrable Securities and the underwriters, if
any, in form, substance and scope as are customarily made by
issuers to underwriters in similar underwritten offerings as may
be reasonably requested by them;
(ii) obtain opinions of counsel to the Company and updates
thereof (which counsel and opinions (in form, scope and
substance) shall be reasonably satisfactory to the managing
underwriters, if any, and the holders of a majority in principal
amount of the Registrable Securities being sold) addressed to
each selling Holder and the underwriters, if any, covering the
matters customarily covered in opinions requested in sales of
securities or underwritten offerings and such other matters as
may be reasonably requested by such Holders and underwriters;
(iii) obtain "cold comfort" letters and updates thereof
from the Company's independent certified public accountants (and,
if necessary, any other independent certified public accountants
of any subsidiary of the Company or of any business acquired by
the Company for which financial statements are, or are required
to be, included in the Registration Statement) addressed to the
underwriters, if any, and use reasonable efforts to have such
letter addressed to the selling Holders of Registrable Securities
(to the extent consistent with Statement on Auditing Standards
No. 72 of the American Institute of Certified Public Accounts),
such letters to be in customary form and covering matters of the
type customarily covered in "cold comfort" letters to
underwriters in connection with similar underwritten offerings;
(iv) enter into a securities sales agreement with the
Holders and an agent of the Holders providing for, among other
things, the appointment of such agent for the selling Holders for
the purpose of soliciting purchases of Registrable Securities,
which agreement shall be in form, substance and scope customary
for similar offerings;
(v) if an underwriting agreement is entered into, cause
the same to set forth indemnification provisions and procedures
substantially equivalent to the indemnification provisions and
procedures set forth in Section 4 hereof with respect to the
underwriters and all other parties to be indemnified pursuant to
said Section or, at the request of any underwriters, in the form
customarily provided to such underwriters in similar types of
transactions; and
(vi) deliver such documents and certificates as may be
reasonably requested and as are customarily delivered in similar
offerings to the Holders of a majority in principal amount of the
Registrable Securities being sold and the managing underwriters,
if any.
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<PAGE> 9
The above shall be done at (i) the effectiveness of such Registration Statement
(and each post-effective amendment thereto) and (ii) each closing under any
underwriting or similar agreement as and to the extent required thereunder;
(n) in the case of a Shelf Registration, make available for
inspection by representatives of the Holders of the Registrable Securities, any
underwriters participating in any disposition pursuant to a Shelf Registration
Statement and any counsel or accountant retained by any of the foregoing, all
financial and other records, pertinent corporate documents and properties of the
Company reasonably requested by any such persons, and cause the respective
officers, directors, employees, and any other agents of the Company to supply
all information reasonably requested by any such representative, underwriter,
special counsel or accountant in connection with a Registration Statement, and
make such representatives of the Company available for discussion of such
documents as shall be reasonably requested by the Holders;
(o) in the case of a Shelf Registration, a reasonable time prior
to filing any Shelf Registration Statement, any Prospectus forming a part
thereof, any amendment to such Shelf Registration Statement or amendment or
supplement to such Prospectus, provide copies of such document to the Holders of
Registrable Securities, to counsel for the Holders and to the underwriter or
underwriters of an underwritten offering of Registrable Securities, if any, make
such changes in any such document prior to the filing thereof as the counsel to
the Holders or the underwriter or underwriters reasonably request and not file
any such document in a form to which the Majority Holders, on behalf of the
Holders of Registrable Securities, counsel for the Holders of Registrable
Securities or any underwriter shall not have previously been advised and
furnished a copy of or to which the Majority Holders, the counsel on behalf of
the Holders of Registrable Securities, counsel to the Holders of Registrable
Securities or any underwriter shall reasonably object, and make the
representatives of the Company available for discussion of such document as
shall be reasonably requested by the Holders of Registrable Securities, counsel
on behalf of such Holders, counsel for the Holders of Registrable Securities or
any underwriter.
(p) in the case of a Shelf Registration, use its best efforts to
cause all Registrable Securities to be listed on any securities exchange on
which similar debt securities issued by the Company are then listed if requested
by the Majority Holders, or if requested by the underwriter or underwriters of
an underwritten offering of Registrable Securities, if any;
(q) in the case of a Shelf Registration, use its best efforts to
cause the Registrable Securities to be rated by the appropriate rating agencies,
if so requested by the Majority Holders, or if requested by the underwriter or
underwriters of an underwritten offering of Registrable Securities, if any;
(r) otherwise comply with all applicable rules and regulations of
the SEC and make available to its security holders, as soon as reasonably
practicable, an earnings statement
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<PAGE> 10
covering at least 12 months which shall satisfy the provisions of Section 11(a)
of the 1933 Act and Rule 158 thereunder;
(s) cooperate and assist in any filings required to be made with
the NASD and, in the case of a Shelf Registration, in the performance of any due
diligence investigation by any underwriter and its counsel (including any
"qualified independent underwriter" that is required to be retained in
accordance with the rules and regulations of the NASD); and
In the case of a Shelf Registration Statement, the Company may
(as a condition to such Holder's participation in the Shelf Registration)
require each Holder of Registrable Securities to furnish to the Company such
information regarding the Holder and the proposed distribution by such Holder of
such Registrable Securities as the Company may from time to time reasonably
request in writing.
In the case of a Shelf Registration Statement, each Holder agrees
that, upon receipt of any notice from the Company of the happening of any event
or the discovery of any facts, each of the kind described in Section 3(e)(v)
hereof, such Holder will forthwith discontinue disposition of Registrable
Securities pursuant to a Registration Statement until such Holder's receipt of
the copies of the supplemented or amended Prospectus contemplated by Section
3(k) hereof, and? if so directed by the Company, such Holder will deliver to the
Company (at its expense) all copies in such Holder's possession, other than
permanent file copies then in such Holder's possession, of the Prospectus
covering such Registrable Securities current at the time of receipt of such
notice.
In the event that the Company fails to file any Shelf
Registration Statement and maintain the effectiveness of any Shelf Registration
Statement as provided herein, the Company shall not file any Registration
Statement with respect to any securities (within the meaning of Section 2(1) of
the 1933 Act) of the Company other than Registrable Securities.
If any of the Registrable Securities covered by any Shelf
Registration Statement are to be sold in an underwritten offering, the
underwriter or underwriters and manager or managers that will manage such
offering will be selected by the Majority Holders of such Registrable Securities
included in such offering and shall be acceptable to the Company. No Holder of
Registrable Securities may participate in any underwritten registration
hereunder unless such Holder (a) agrees to sell such Holder's Registrable
Securities on the basis provided in any underwriting arrangements approved by
the persons entitled hereunder to approve such arrangements and (b) completes
and executes all questionnaires, powers of attorney, indemnities, underwriting
agreements and other documents required under the terms of such underwriting
arrangements.
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4. Indemnification; Contribution.
(a) The Company agrees to indemnify and hold harmless each
Holder, each Person who participates as an underwriter (any such Person being an
"Underwriter") and each Person, if any, who controls any Holder or Underwriter
within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act
as follows:
(i) against any and all loss, liability, claim, damage and
expense whatsoever, as incurred, arising out of any untrue statement or
alleged untrue statement of a material fact contained in any
Registration Statement (or any amendment or supplement thereto) pursuant
to which Registrable Securities were registered under the 1933 Act,
including all documents incorporated therein by reference, or the
omission or alleged omission therefrom of a material fact required to be
stated therein or necessary to make the statements therein not
misleading, or arising out of any untrue statement or alleged untrue
statement of a material fact contained in any Prospectus (or any
amendment or supplement thereto) or the omission or alleged omission
therefrom of a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made,
not misleading;
(ii) against any and all loss, liability, claim, damage
and expense whatsoever, as incurred, to the extent of the aggregate
amount paid in settlement of any litigation, or any investigation or
proceeding by any governmental agency or body, commenced or threatened,
or of any claim whatsoever based upon any such untrue statement or
omission, or any such alleged untrue statement or omission; provided
that (subject to Section 4(d) below) any such settlement is effected
with the written consent of the Company; and
(iii) against any and all expense whatsoever, as incurred
(including the fees and disbursements of counsel chosen by any
indemnified party), reasonably incurred in investigating, preparing or
defending against any litigation, or any investigation or proceeding by
any governmental agency or body, commenced or threatened, or any claim
whatsoever based upon any such untrue statement or omission, or any such
alleged untrue statement or omission, to the extent that any such
expense is not paid under subparagraph (i) or (ii) above;
provided, however, that this indemnity agreement shall not apply to any loss,
liability, claim, damage or expense to the extent arising out of any untrue
statement or omission or alleged untrue statement or omission made in reliance
upon and in conformity with written information furnished to the Company by the
Holder or Underwriter expressly for use in a Registration Statement (or any
amendment thereto) or any Prospectus (or any amendment or supplement thereto).
11
<PAGE> 12
(b) Each Holder severally, but not jointly, agrees to indemnify
and hold harmless the Company, each Underwriter and the other selling Holders,
and each of their respective directors and officers, and each Person, if any,
who controls the Company, any Underwriter or any other selling Holder within the
meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act, against any
and all loss, liability, claim, damage and expense described in the indemnity
contained in Section 4(a) hereof, as incurred, but only with respect to untrue
statements or omissions, or alleged untrue statements or omissions, made in the
Shelf Registration Statement (or any amendment thereto) or any Prospectus
included therein (or any amendment or supplement thereto) in reliance upon and
in conformity with written information with respect to such Holder furnished to
the Company by such Holder expressly for use in the Shelf Registration Statement
(or any amendment thereto) or such Prospectus (or any amendment or supplement
thereto); provided, however, that no such Holder shall be liable for any claims
hereunder in excess of the amount of net proceeds received by such Holder from
the sale of Registrable Securities pursuant to such Shelf Registration
Statement.
(c) Each indemnified party shall give notice as promptly as
reasonably practicable to each indemnifying party of any action or proceeding
commenced against it in respect of which indemnity may be sought hereunder, but
failure so to notify an indemnifying party shall not relieve such indemnifying
party from any liability hereunder to the extent it is not materially prejudiced
as a result thereof and in any event shall not relieve it from any liability
which it may have otherwise than on account of this indemnity agreement. An
indemnifying party may participate at its own expense in the defense of such
action; provided, however, that counsel to the indemnifying party shall not
(except with the consent of the indemnified party) also be counsel to the
indemnified party. In no event shall the indemnifying party or parties be liable
for the fees and expenses of more than one counsel (in addition to any local
counsel) separate from their own counsel for all indemnified parties in
connection with any one action or Separate but similar or related actions in the
same jurisdiction arising out of the same general allegations or circumstances.
No indemnifying party shall, without the prior written consent of the
indemnified parties, settle or compromise or consent to the entry of any
judgment with respect to any litigation, or any investigation or proceeding by
any governmental agency or body, commenced or threatened, or any claim
whatsoever in respect of which indemnification or contribution could be sought
under this Section 4 (whether or not the indemnified parties are actual or
potential parties thereto), unless such settlement, compromise or consent (i)
includes an unconditional release of each indemnified party from all liability
arising out of such litigation, investigation, proceeding or claim and (ii) does
not include a statement as to or an admission of fault, culpability or a failure
to act by or on behalf of any indemnified party.
(d) If at any time an indemnified party shall have requested an
indemnifying party to reimburse the indemnified party for fees and expenses of
counsel, such indemnifying party agrees that it shall be liable for any
settlement of the nature contemplated by Section 4(a)(ii) effected without its
written consent if (i) such settlement is entered into more than 45
12
<PAGE> 13
days after receipt by such indemnifying party of the aforesaid request, (ii)
such indemnifying party shall have received notice of the terms of such
settlement at least 30 days prior to such settlement being entered into and
(iii) such indemnifying party shall not have reimbursed such indemnified party
in accordance with such request prior to the date of such settlement.
(e) If the indemnification provided for in this Section 4 is for
any reason unavailable to or insufficient to hold harmless an indemnified party
in respect of any losses, liabilities, claims, damages or expenses referred to
therein, then each indemnifying party shall contribute to the aggregate amount
of such losses, liabilities, claims, damages and expenses incurred by such
indemnified party, as incurred, in such proportion as is appropriate to reflect
the relative fault of the Company on the one hand and the Holders on the other
hand in connection with the statements or omissions which resulted in such
losses, liabilities, claims, damages or expenses, as well as any other relevant
equitable considerations.
The relative fault of the Company on the one hand and the Holders
on the other hand shall be determined by reference to, among other things,
whether any such untrue or alleged untrue statement of a material fact or
omission or alleged omission to state a material fact relates to information
supplied by the Company, the Holders and the parties' relative intent,
knowledge, access to information and opportunity to correct or prevent such
statement or omission.
The Company and the Holders agree that it would not be just and
equitable if contribution pursuant to this Section 4 were determined by pro rata
allocation or by any other method of allocation which does not take account of
the equitable considerations referred to above in this Section 4. The aggregate
amount of losses, liabilities, claims, damages and expenses incurred by an
indemnified party and referred to above in this Section 4 shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in investigating, preparing or defending against any litigation, or any
investigation or proceeding by any governmental agency or body, commenced or
threatened, or any claim whatsoever based upon any such untrue or alleged untrue
statement or omission or alleged omission.
No Person guilty of fraudulent misrepresentation (within the
meaning of Section ll(f) of the 1933 Act) shall be entitled to contribution from
any Person who was not guilty of such fraudulent misrepresentation. it.
For purposes of this Section 4, each Person, if any, who controls
a Holder within the meaning of Section 15 of the 1933 Act or Section 20 of the
1934 Act shall have the same rights to contribution as such Holder, and each
director of the Company, and each Person, if any, who controls the Company
within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act
shall have the same rights to contribution as the Company.
13
<PAGE> 14
5. Miscellaneous.
5.1 Rule 144 and Rule 144A. For so long as the Company is subject
to the reporting requirements of Section 13 or 15 of the 1934 Act, the Company
covenants that it will file the reports required to be filed by it under the
1933 Act and Section 13(a) or 15(d) of the 1934 Act and the rules and
regulations adopted by the SEC thereunder. If the Company ceases to be so
required to file such reports, the Company covenants that it will upon the
request of any Holder of Registrable Securities (a) make publicly available such
information as is necessary to permit sales pursuant to Rule 144 under the 1933
Act, (b) deliver such information to a prospective purchaser as is necessary to
permit sales pursuant to Rule 144A under the 1933 Act and it will take such
further action as any Holder of Registrable Securities may reasonably request,
and (c) take such further action that is reasonable in the circumstances, in
each case, to the extent required from time to time to enable such Holder to
sell its Registrable Securities without registration under the 1933 Act within
the limitation of the exemptions provided by (i) Rule 144A under the 193'3 Act,
as such Rule may be amended from time to time, (ii) Rule 144A under the 1933
Act, as such Rule may be amended from time to time, or (iii) any similar rules
or regulations hereafter adopted by the SEC. Upon the request of any Holder of
Registrable Securities, the Company will deliver to such Holder a written
statement as to whether it has complied with such requirements.
5.2 No Inconsistent Agreements. The Company has not entered into
and the Company will not after the date of this Agreement enter into any
agreement which is inconsistent with the rights granted to the Holders of
Registrable Securities in this Agreement or otherwise conflicts with the
provisions hereof. The rights granted to the Holders hereunder do not and will
not for the term of this Agreement in any way conflict with the rights granted
to the holders of the Company's other issued and outstanding securities under
any such agreements.
5.3 Amendments and Waivers. The provisions of this Agreement,
including the provisions of this sentence, may not be amended, modified or
supplemented, and waivers or consents to departures from the provisions hereof
may not be given unless the Company has obtained the written consent of Holders
of at least a majority in aggregate principal amount of the outstanding
Registrable Securities affected by such amendment, modification, supplement,
waiver or departure.
5.4 Notices. All notices and other communications provided for or
permitted hereunder shall be made in writing by hand delivery, registered
first-class mail, telex, telecopier, or any courier guaranteeing overnight
delivery (a) if to a Holder, at the most current address given by such Holder to
the Company by means of a notice given in accordance with the provisions of this
Section 5.4, which address initially is the address set forth [S-11 filed on
_____________]; and (b) if to the Company, initially at the Company's address
set forth in the [S-11], and thereafter at such other address of which notice is
given in accordance with the provisions of this Section 5.4.
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<PAGE> 15
All such notices and communications shall be deemed to have been
duly given: at the time delivered by hand, if personally delivered; two business
days after being deposited in the mail, postage prepaid, if mailed; when
answered back, if telexed; when receipt is acknowledged, if telecopied; and on
the next business day if timely delivered to an air courier guaranteeing
overnight delivery.
5.5 Successor and Assigns. This Agreement shall inure to the
benefit of and be binding upon the successors, assigns and transferees of each
of the parties, including, without limitation and without the need for an
express assignment, subsequent Holders; provided that nothing herein shall be
deemed to permit any assignment, transfer or other disposition of Registrable
Securities in violation of the Securities Act. If any transferee of any Holder
shall acquire Registrable Securities, in any manner, whether by operation of law
or otherwise, such Registrable Securities shall be held subject to all of the
terms of this Agreement, and by taking and holding such Registrable Securities
such person shall be conclusively deemed to have agreed to be bound by and to
perform all of the terms and provisions of this Agreement, including the
restrictions on resale set forth in this Agreement and such person shall be
entitled to receive the benefits hereof.
5.7. Specific Enforcement. Without limiting the remedies
available to the the Holders, the Company acknowledges that any failure by the
Company to comply with its obligations under Sections 2.1 through 2.4 hereof may
result in material irreparable injury to the Holders for which there is no
adequate remedy at law, that it would not be possible to measure damages for
such injuries precisely and that, in the event of any such failure, any Holder
may obtain such relief as may be required to specifically enforce the Company's
obligations under Sections 2.1 through 2.4 hereof.
5.8. Restriction on Resales. Until the expiration of two years
after the original issuance of the Securities, the Company will not, and will
cause their "affiliates" (as such term is defined in Rule 144(a)(1) under the
1933 Act) not to, resell any Securities which are "restricted securities" (as
such term is defined under Rule 144(a)(3) under the 1933 Act) that have been
reacquired by any of them and shall immediately upon any purchase of any such
Securities submit such Securities for cancellation.
5.9 Counterparts. This Agreement may be executed in any number of
counterparts and by the parties hereto in separate counterparts, each of which
when so executed shall be deemed to be an original and all of which taken
together shall constitute one and the same agreement.
5.10 Headings. The headings in this Agreement are for convenience
of reference only and shall not limit or otherwise affect the meaning hereof.
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<PAGE> 16
5.11 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND
CONSTRUED IN ACCORDANCE WITH THE LAW OF THE STATE OF NEW YORK WITHOUT REGARD TO
THE PRINCIPLES OF CONFLICT OF LAWS THEREOF.
5.12 Severability. In the event that any one or more of the
provisions contained herein, or the application thereof in any circumstance, is
held invalid, illegal or unenforceable, the validity, legality and
enforceability of any such provision in every other respect and of the remaining
provisions contained herein shall not be affected or impaired thereby.
IN WITNESS WHEREOF, the parties have executed this Agreement as
of the date first written above.
[NAME OF COMPANY]
By: ____________________________________
Name:
Title:
[HOLDERS]
By: ____________________________________
16
<PAGE> 1
EXHIBIT 5.1
JEFFERS, WILSON, SHAFF & FALK, LLP
ATTORNEYS AT LAW
18881 VON KARMAN AVENUE
SUITE 1400
IRVINE, CALIFORNIA 92612
TELEPHONE: (949) 660-7700
FACSIMILE: (949) 660-7799
June 11, 1998
RealTrust Asset Corporation
2855 East Cottonwood Parkway, Suite 500
Salt Lake City, Utah 84121
Re: Registration Statement on Form S-11
Gentlemen:
We have acted as counsel to RealTrust Asset Corporation (the "Company"),
a Maryland corporation, in connection with the Registration Statement on Form
S-11 (No. 333-48653), filed with the Securities and Exchange Commission on March
25, 1998, as amended (the "Registration Statement"), covering 5,750,000 of the
Company's Units, each consisting of one share of Common Stock, par value $.001,
and one Stock Purchase Warrant (the "Units").
In acting as counsel for the Company and arriving at the opinions as
expressed below, we have examined and relied upon originals or copies, certified
or otherwise identified to our satisfaction, of such records of the Company,
agreements and other instruments, certificates of officers and representatives
of the Company, certificates of public officials and other documents as we have
deemed necessary or appropriate as a basis for the opinions expressed herein.
In connection with our examination we have assumed the genuineness of
all signatures, the authenticity of all documents tendered to us as originals,
the legal capacity of natural persons and the conformity to original documents
of all documents submitted to us as certified or photostated copies.
Based on the foregoing, and subject to the qualifications and
limitations set forth herein, it is our opinion that upon payment therefor and
delivery of stock certificates representing such shares, the shares of Common
Stock included in the Units have been duly authorized and when issued, delivered
and paid for, will be validly issued, fully paid and non-assessable.
We express no opinion with respect to laws other than those of the State
of California, the Maryland General Corporation Code and the federal laws of the
United States of America, and we assume no responsibility as to the
applicability thereof, or the effect thereon, of the laws of any other
jurisdiction.
We hereby consent to the filing of this opinion as Exhibit 5.1 to the
Registration Statement and to its use as part of the Registration Statement.
Very truly yours,
JEFFERS, WILSON, SHAFF & FALK, LLP
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
RealTrust Asset Corporation
We consent to the use of our reports included herein and to the reference to our
firm under the headings "Experts" and "Selected Financial Data of Real Trust
Asset Corporation and CMG Funding Corp." in the prospectus.
KPMG PEAT MARWICK LLP
Salt Lake City, Utah
June 12, 1998
