As filed with the Securities and Exchange Commission on March 22, 1999
Registration No. 333-67343
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
AMENDMENT NO. 2
to
FORM S-11
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
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FBR ASSET INVESTMENT CORPORATION (MARYLAND)
(Exact Name of Registrant as Specified in its Governing Instruments)
Potomac Tower, 1001 Nineteenth Street North
Arlington, Virginia 22209
(703) 469-1000
(Address, Including Zip Code, and Telephone Number, including
Area Code, of Registrant's Principal Executive Offices)
---------------
Robert S. Smith, Esq.
FBR Asset Investment Corporation
Potomac Tower, 1001 Nineteenth Street North
Arlington, Virginia 22209
(703) 469-1000
(703) 312-9756 (Telecopy)
(Name, Address, Including Zip Code, and Telephone
Number, Including Area Code, of Agent for Service)
---------------
COPY TO:
Randolph F. Totten, Esq.
Hunton & Williams
Riverfront Plaza, East Tower
951 E. Byrd Street
Richmond, Virginia 23219-4074
(804) 788-8200
(804) 788-8218 (Telecopy)
---------------
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 that specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act, or until the Registration Statement shall become effective
on such date as the Commission, acting pursuant to said Section 8(a), may
determine.
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<PAGE>
FBR Asset Investment Corporation
____________ Shares
Common Stock
FBR Asset Investment Corporation is a real estate investment trust that invests
in mortgages, mortgage-backed securities and other real estate-related assets,
both directly and indirectly through investments in other companies. The selling
shareholders identified in this prospectus are offering and selling up to ______
shares of FBR Asset's common stock. FBR Asset will not receive any proceeds from
the sale of those shares.
No public market currently exists for FBR Asset's common stock; the stock is not
listed on any securities exchange. The selling shareholders may offer their
shares of common stock in public or private transactions in the over-the-counter
markets, on or off any stock exchange on which the shares may be listed at the
time of sale, at prevailing market prices, or at privately negotiated prices.
The selling shareholders may engage brokers or dealers who may receive
commissions or discounts from the selling shareholders.
You should consider the risk factors discussed on pages 4-16 before investing in
FBR Asset, which include:
o Significant Conflicts of Interest;
o Sensitivity to Fluctuations in Interest Rates, Mortgage Prepayments,
and Borrower Defaults;
o Leverage;
o Riskiness of Interest Rate Hedging;
o Sensitivity to Declines in Market Value of Investments;
o Management's Limited Experience Operating a REIT; and
o Limited Operating History.
================================================================================
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
================================================================================
This prospectus is dated ____________, 1999.
<PAGE>
===================================================
This prospectus incorporates by reference exhibits
to the registration statement that we have filed
with the SEC. You may request copies of those
exhibits, free of charge, by calling or writing
Ms. Elaine Clancy at FBR Asset Investment
Corporation, Potomac Tower, 1001 Nineteenth Street
North, Arlington, Virginia 22209, (703) 469-1000.
===================================================
Table of Contents
SUMMARY........................................1
FBR Asset....................................1
FBR Asset's Business.........................1
FBR & FBR Management.........................2
Summary Financial Information................3
RISKS OF INVESTING IN FBR ASSET................4
Conflicts with FBR may result in
decisions that do not reflect FBR
Asset's best interests.......................4
FBR Asset's limited operating history
does not indicate future results.............5
FBR Management's limited experience in
managing a REIT may affect FBR Asset's
performance..................................6
Declines in market values of FBR
Asset's assets may adversely affect
credit availability and periodic
reported results.............................6
FBR Asset is heavily dependent upon FBR
Management...................................6
Management Agreement requires FBR Asset
to pay fee upon termination of FBR
Management...................................7
Use of leverage could adversely affect
FBR Asset's operations.......................7
FBR Asset's real estate-related
investments may incur losses.................7
Changes in interest rates could
negatively affect the value of FBR
Asset's mortgage loans and
mortgage-backed securities................8
Use of leverage can amplify declines
in market value resulting from
interest rate increases...................8
Prepayment rates could negatively
affect the value of FBR Asset's
mortgage-backed securities................9
Hedging against interest rate
exposure may adversely affect FBR
Asset's earnings..........................9
Multifamily and commercial real
estate may lose value and fail to
operate profitably.......................10
Investing in subordinated interests
exposes FBR Asset to increased
credit risk..............................10
Competition in the purchase, sale
and financing of mortgage assets may
limit the profitability of companies
in which FBR Asset invests...............10
Increased losses on uninsured
mortgage loans can reduce the value
of FBR Asset's equity investments........11
Prepayment sensitivity of
investments in interest-only
securities...............................11
Indirect nature of investments exposes
FBR Asset to additional risks...............12
Returns on equity investments not
directly linked to returns on
investee companies' assets...............12
Obstacles to success may remain
hidden if due diligence is
inadequate...............................12
Dependence on management of other
entities.................................13
Limited liquidity of equity security
investments..............................13
Volatility of prices.....................13
Disposition value of investments are
dependent upon general and specific
market conditions........................13
Tax requirements may restrict FBR
Asset's operations..........................14
Loss of Investment Company Act
exemption would adversely affect FBR
Asset.......................................15
Ownership limitation may restrict
change of control or business
combination opportunities...................15
Board of Directors may change policies
without shareholder consent.................16
Shares are not listed on a securities
exchange....................................16
ORGANIZATION & RELATIONSHIPS..................17
FBR & FBR MANAGEMENT..........................18
Related Party Transactions..................18
FBR Management's Executive Officers.........21
The Management Agreement....................21
FBR ASSET'S BUSINESS..........................26
Operating Policies & Strategies.............26
Current Investments.........................27
Whole-Pool Mortgage-Backed Securities....28
Real Estate..............................35
Commercial Mortgage Loans & CMBS.........36
Loans....................................38
Real Estate-Related Businesses...........38
Summary of Current Investments & Cash
and Cash Equivalents........................39
i
<PAGE>
Dividends & Distribution Policy.............41
SELECTED FINANCIAL DATA.......................43
MANAGEMENT'S DISCUSSION & ANALYSIS............44
Overview....................................44
Results of Operations.......................44
Net Income...............................44
Interest and Dividend Income.............46
Interest Expense.........................46
Dividends Declared and Distributions
in Excess of Earnings....................46
Changes in Financial Condition..............47
Securities Available for Sale............47
Repurchase Agreements....................47
Contractual Commitments..................48
Capital Resources and Liquidity..........48
Shareholders'Equity......................49
Year 2000 Compliance........................50
Market Conditions...........................51
Equity Market Conditions.................52
REIT and Real Estate Market Conditions...52
Interest Rate Environment................53
Market Risk..............................55
Developments Since December 31, 1998........57
FBR ASSET'S DIRECTORS & OFFICERS..............58
The Board of Directors......................58
The Directors...............................60
Executive Officers Who Are Not Directors....62
Time Required of Directors & Executive
Officers....................................63
Executive Compensation & Other Benefits.....63
FBR ASSET'S CAPITAL STOCK.....................66
General.....................................66
Common Stock................................66
Preferred Stock.............................66
Restrictions on Ownership and Transfer......67
Transfer Agent & Registrar..................69
Reports to Shareholders.....................69
FBR Asset's Charter and Bylaws..............70
ANTI-TAKEOVER EFFECT OF MARYLAND LAWS.........71
COMMON STOCK AVAILABLE FOR FUTURE SALE........73
PRINCIPAL SHAREHOLDERS........................74
FEDERAL INCOME TAX CONSEQUENCES OF FBR
ASSET'S STATUS AS A REIT......................75
Taxation of FBR Asset.......................75
Requirements for Qualification..............77
Recordkeeping Requirements..................85
Failure to Qualify..........................86
Taxation of Taxable U.S. Shareholders.......86
Taxation of U.S. Shareholders on the
Disposition of the Common Stock.............88
Capital Gains and Losses....................88
Information Reporting Requirements and
Backup Withholding..........................88
Taxation of Tax-Exempt Shareholders.........89
Taxation of Non-U.S. Shareholders...........90
Other Tax Consequences......................92
ERISA CONSIDERATIONS..........................93
SELLING SHAREHOLDERS..........................95
USE OF PROCEEDS...............................95
PLAN OF DISTRIBUTION..........................96
OTHER MATTERS.................................98
Legal.......................................98
Independent Accountants.....................98
Additional Information......................98
Index to Financial Statements...................F-1
===================================================
Neither FBR Asset nor the selling shareholders have
authorized anyone to give you any information other
than that which is included in this document.
Neither FBR Asset nor the selling shareholders have
authorized anyone to make any representations to
you other than those that are included in this
document. If anyone gives you additional
information, or makes additional representations,
you must not rely on them at all.
This prospectus is not an offer to sell or the
solicitation of an offer to buy any securities
other than those to which it relates, nor is it an
offer or solicitation of any person in any
jurisdiction to whom it would be unlawful to make
such an offer or solicitation.
The delivery of this prospectus at any time does
not imply that the information herein is correct as
of any time after ______________, 1999.
===================================================
ii
<PAGE>
Summary
This summary highlights only a few of the facts that you will need to make an
informed decision about investing in FBR Asset. We encourage you to read this
entire prospectus, and the other documents to which it refers, very carefully.
References to "we," "us," and "our" indicate the management of FBR Asset.
FBR Asset
FBR Asset is a Maryland corporation that recently succeeded, by merger, to all
of the assets and liabilities of a Virginia corporation also named FBR Asset
Investment Corporation. We formed the Maryland corporation in November 1998 for
the purpose of moving the Virginia corporation's state of incorporation to
Maryland. The merger effected no changes in the company's business, and we have
operated the company in substantially the same manner since we formed the
Virginia corporation in November 1997.
FBR Asset's Business
FBR Asset invests in:
o whole-pool mortgage-backed securities guaranteed by Fannie Mae, Freddie
Mac, or Ginnie Mae;
o residential and commercial real property;
o residential and commercial mortgage loans;
o residential and commercial mortgage-backed securities;
o direct loans to real estate-related companies; and
o other real estate-related assets.
FBR Asset invests in some of these assets directly by buying the assets and
invests in others by buying equity interests in, or making loans to, REITs and
other companies engaged in real estate-related businesses. In the future, FBR
Asset may enter into joint ventures or partnerships that will also invest in
these assets.
FBR Asset expects to generate income primarily from the net earnings derived
from its investments. FBR Asset also seeks to generate growth in earnings and
dividends per share by:
o increasing the income generated from new assets at a rate faster than
the rate of increases in operating expenses;
o increasing the size of its balance sheet when opportunities in the
market for its targeted investments are likely to allow growth in
earnings per share;
o continually reviewing the mix of its investments in an effort to
improve and enhance returns; and
o using leverage to create greater equity returns for shareholders.
1
<PAGE>
We can give no assurance, however, that FBR Asset will be able to achieve these
results. For a detailed discussion of the factors that may limit our ability to
achieve these results, see "Risks of Investing in FBR Asset," which begins on
page 4.
FBR Asset has elected to be taxed as a REIT under the federal tax laws and
intends to continue operating as a REIT. Accordingly, FBR Asset will not incur
federal income tax on its earnings to the extent that it distributes those
earnings to its shareholders, and as long as the asset, income, stock ownership
and minimum distribution tests of the federal tax laws are met. FBR Asset will,
however, be subject to tax at normal corporate rates on net income or capital
gains not distributed to shareholders.
FBR Asset intends to continue operating its business so as not to become
regulated as an investment company under the Investment Company Act of 1940.
For more information about FBR Asset's business, see "FBR Asset's Business" on
page 26.
FBR & FBR Management
Friedman, Billings, Ramsey Investment Management, Inc. manages FBR Asset's
day-to-day operations, subject to the direction and oversight of FBR Asset's
Board of Directors. FBR Management is a wholly-owned subsidiary of Friedman,
Billings, Ramsey Group, Inc., an investment banking firm that focuses on
research, underwriting, brokerage, and asset management activities in various
sectors, including real estate, financial services, specialty finance,
technology, insurance, and consumer products. FBR Group, together with its other
subsidiaries ("FBR"), has presented FBR Asset with opportunities to invest in
other companies, including REITs, that invest in or manage real estate and
companies that provide services to real estate owners and operators.
FBR Management has engaged BlackRock Financial Management, Inc., a subsidiary of
PNC Bank Corp., to sub-manage FBR Asset's mortgage portfolio. Through BlackRock,
FBR Asset has access to market expertise and risk management systems that allow
FBR Asset actively to monitor and manage its mortgage portfolio's exposure to
interest and prepayment risks. FBR Management has retained BlackRock to assist
it in assessing credit risk, risk of capital loss, the availability and cost of
financing, and yield spread movements on FBR Asset's mortgage assets.
For more information about FBR, FBR Management, and BlackRock, see "FBR & FBR
Management" on page 18.
2
<PAGE>
Summary Financial Information
The summary financial data set forth below should be read in conjunction with
"Management's Discussion & Analysis" and the Financial Statements and Notes
thereto included elsewhere in this prospectus. The selected balance sheet data
as of December 31, 1997 and 1998, and the statement of operations data for the
period from December 15, 1997 (Inception) to December 31, 1997, and for the year
ended December 31, 1998, has been derived from the audited financial statements
included elsewhere in this prospectus. The results for the year ended December
31, 1998, are not necessarily indicative of the results to be expected for any
future period.
<TABLE>
<CAPTION>
December 15, 1997
(Inception) For the
through Year Ended
December 31, 1997 December 31, 1998
------------------- -------------------
<S> <C> <C>
Statement of Operations Data
Interest income..................................... $ 18,040 $ 13,656,097
Dividend income..................................... 434,717 4,271,405
Net realized losses................................. - (8,369,807)
Net income ......................................... 646,921 1,588,235
Basic and diluted income per share.................. $ 0.06 $ 0.16
Dividends declared per share(1)..................... $ 0.05 $ 1.16
<CAPTION>
As of As of
December 31, 1997 December 31, 1998
------------------- -------------------
<S> <C> <C>
Selected Balance Sheet Data
Mortgage-backed securities, at fair value........... $ - $161,418,739
Cash and cash equivalents........................... 163,223,199 41,144,326
Investments in equity securities, at fair value..... 23,318,750 70,983,050
Total assets........................................ 190,538,402 295,930,620
Total liabilities................................... 771,573 145,026,041
Accumulated other comprehensive income(2)........... - (9,800,530)
Shareholders' equity................................ 189,766,829 150,904,579
Book value per share................................ $ 18.57 $ 17.66
</TABLE>
(1) Dividends declared are based upon FBR Asset's taxable income. Net realized
losses are not included in FBR Asset's ordinary taxable income.
(2) As of December 31, 1998, accumulated other comprehensive income includes
unrealized net gain on mortgage-backed securities of $713,499 and
unrealized net loss on investments in equity securities of $10,514,029.
3
<PAGE>
Risks of Investing in FBR Asset
Investing in FBR Asset involves various risks, including the risk that you might
lose your entire investment. The results of FBR Asset's operations depend upon
many factors, including the availability of opportunities to acquire assets, the
level and volatility of interest rates, the cost and availability of short-and
long-term credit, financial market conditions, and general economic conditions.
FBR Asset will strive to attain its objectives through, among other things, FBR
Management's research and portfolio management skills. There is no guarantee,
however, that FBR Asset will perform successfully, meet its objectives, or
achieve positive returns.
Some of the information in this prospectus contains forward-looking statements.
Those statements can be identified by the use of words like "may," "will,"
"expect," "anticipate," "estimate," or other similar words. The forward-looking
statements discuss our future expectations and contain our projections of
operation results or financial condition. When considering those statements, you
should keep in mind the risk factors discussed below and other cautionary
statements contained in this prospectus. Those factors could cause our actual
results to differ materially from our expectations or projections.
The following risks are interrelated, and you should treat them as a whole.
Conflicts with FBR may result in decisions that do not reflect FBR Asset's
best interests.
FBR Asset is subject to various conflicts of interest arising from its
relationship with FBR. These conflicts include the following:
o FBR Asset acquires indirect interests in real estate, commercial
mortgage loans and commercial mortgage-backed securities by investing
in companies whose securities have been underwritten or placed by FBR.
At December 31, 1998, the total market value of FBR Asset's investments
in securities underwritten or placed by FBR had declined 19.2% since
FBR Asset acquired the securities. At March 12, 1999, the total market
value of those same investments had declined further, for a total
decline of 21.18% since FBR Asset acquired the securities. FBR and its
employees are paid substantial fees for underwriting and placement
agent services, and to the extent that the success of a new offering
depends upon a significant investment by FBR Asset, FBR Management will
have a conflict of interest in recommending that investment to FBR
Asset. In those instances, FBR Asset's shareholders will rely on the
investment decision of FBR Asset's independent directors, who will in
part rely on information provided by FBR Management.
o FBR manages other funds that are authorized to invest in assets similar
to those in which FBR Asset invests. In particular, FBR manages mutual
and private equity funds, and may in the future manage other funds,
that invest in private equity securities and in REITs and other real
estate-related securities. There may be investment opportunities that
are favorable to each of FBR Asset and the other funds managed by FBR.
In that case, FBR will allocate investment opportunities among funds
based upon primary investment objectives, applicable investment
restrictions, and any other factors that FBR deems appropriate and fair
under the circumstances.
4
<PAGE>
o BlackRock, the mortgage portfolio manager, currently manages funds and
accounts, and may in the future manage other funds or accounts, that
have investment objectives similar to those of FBR Asset. There may be
investment opportunities that are favorable to each of FBR Asset and
the other funds or accounts managed by BlackRock. While there are no
contractual requirements for BlackRock to allocate specific investment
opportunities to FBR Asset. BlackRock will allocate investment
opportunities to its accounts in a manner that is reasonably fair to
each account over time. In allocating opportunities, BlackRock may
consider any factors that it deems appropriate under the circumstances.
o The incentive portion of the management fee, which is based on FBR
Asset's income, may create an incentive for FBR Management to recommend
investments that have greater potential for income or appreciation, but
that are generally more speculative than if the management fee did not
include a performance component.
o A majority of the Board, and each of FBR Asset's executive officers,
also serve as executive officers or employees of FBR and devote
substantial time to FBR. These persons will devote such time and
attention to FBR Asset's business as they, in their discretion, deem
necessary, but conflicts may arise in allocating management time,
services or functions between FBR Asset and FBR. The failure by these
people to devote adequate time to FBR Asset could result in FBR Asset
failing to take advantage of investment opportunities or failing to
take other actions that might be in the company's best interests.
o FBR may provide a broad range of financial services to enterprises in
which FBR Asset has invested or with which it otherwise does business.
For these services, FBR will be paid fees or will otherwise receive
compensation and thus might have an incentive to recommend an
investment to FBR Asset when it might not otherwise do so.
o Because of its relationship with FBR, FBR Asset may obtain confidential
information about the companies in which it has invested. If FBR Asset
does possess confidential information about other companies, it may be
restricted in its ability to dispose of, increase the amount of, or
otherwise take action with respect to its investment in those
companies.
FBR Asset's limited operating history does not indicate future results.
FBR Asset was organized in November 1997 and has a limited operating history.
Because of this limited history, investors should be especially cautious before
drawing conclusions about the company's future. FBR Asset's past performance,
particularly given its short operating history, is not necessarily indicative of
future results.
5
<PAGE>
FBR Management's limited experience in managing a REIT may affect FBR Asset's
performance.
Before November 1997, none of FBR Asset's or FBR Management's officers had ever
managed a REIT. FBR Management has no experience in managing a REIT other than
its experience with FBR Asset. There can be no assurance that the limited past
experience of FBR Management will enable it successfully to manage FBR Asset's
business.
Declines in market values of FBR Asset's assets may adversely affect credit
availability and periodic reported results.
FBR Asset's assets are primarily real estate and mortgage assets, including
indirect holdings through investments in other companies. These assets are
classified for accounting purposes as "available-for-sale." Changes in the
market values of these assets are directly charged or credited to FBR Asset's
shareholders' equity. As a result, a general decline in trading market values
may reduce the book value of FBR Asset's assets even though there may have been
no change in the inherent value of those assets.
A decline in the market value of FBR Asset's assets may adversely affect FBR
Asset in instances where FBR Asset has borrowed money based on the market value
of those assets. At December 31, 1998, FBR Asset had $128.6 million in
outstanding repurchase agreements that were based on the market value of
specific mortgage assets. The market value of those assets was $136.3 million
when FBR Asset entered into the repurchase agreements and as of March 12, 1999,
was $130.7 million. If the market value of those assets declines, the lender may
require FBR Asset to post additional collateral to support the loan. If FBR
Asset is unable to post the additional collateral, it may have to sell the
assets at a time when it would not otherwise choose to do so. As of December 31,
1998, no lenders had required FBR Asset to post additional collateral. As of
March 12, 1999, however, lenders had required FBR Asset to post additional
collateral in the aggregate amount of $8.5 million.
FBR Asset is heavily dependent upon FBR Management.
FBR Asset can gain access to good investment opportunities only to the extent
that they become known to FBR Management. Gaining access to opportunities is a
highly competitive business. FBR, FBR Management, and FBR Asset compete with
other companies that have greater capital, more long-standing relationships,
broader product offerings, and other advantages. Competitors include, but are
not limited to, Merrill Lynch, Morgan Stanley Dean Witter, GE Capital, Ocwen
Asset Investment Corp., Imperial Credit Commercial Mortgage Investment
Corporation, and General Motors Acceptance Corporation.
FBR Asset is heavily dependent for the selection, structuring, and monitoring of
its investments on the diligence and skill of FBR Management's officers and
employees, primarily those named under "FBR Asset's Directors & Officers." FBR
Asset does not have employment agreements with its senior officers or require
FBR Management to employ specific personnel or dedicate employees solely to FBR
Asset. FBR Management in turn is dependent on the efforts of senior management
personnel. Although FBR Asset believes that FBR Management could find
replacements for its key executives, the loss of their services could have an
adverse effect on the operations of FBR Management and FBR Asset.
6
<PAGE>
Management Agreement requires FBR Asset to pay fee upon termination of FBR
Management.
Either FBR Asset or FBR Management may terminate the Management Agreement
without cause after December 17, 1999. The Management Agreement requires FBR
Asset to pay FBR Management a substantial termination fee in the event that FBR
Asset terminates the agreement, except in the case of a termination for cause.
The termination fee would equal twelve months of base and incentive fees, as
further explained under "FBR & FBR Management --The Management Agreement." For
example, if FBR Asset had terminated the Management Agreement in January 1999,
the termination fee would have been $1.52 million, the amount of the base fee
expensed in 1998. Because no incentive fee was earned in 1998, no additional
termination fee would have been due. Payment of a termination fee could have an
adverse effect on FBR Asset's financial condition, cash flows, and results of
operations and could reduce the amount of funds available for distribution to
shareholders. In the event of termination, if it does not have sufficient cash
to pay the termination fee, FBR Asset may have to sell assets even though it
would not otherwise choose to do so.
Use of leverage could adversely affect FBR Asset's operations.
At December 31, 1998, FBR Asset's outstanding indebtedness for borrowed money
was 0.85 times the amount of its equity based on book values. The Board has the
authority to increase or decrease the company's debt-to-equity ratio at any time
and has not placed any limits on the amount FBR Asset may borrow. During 1998,
FBR Asset's debt-to-equity ratio ranged from 0.10 to 1 to 1.2 to 1. If FBR Asset
borrows more funds, the possibility that it would be unable to meet its debt
obligations as they come due would increase.
Of FBR Asset's $161.4 million mortgage-backed securities at December 31, 1998,
$128.6 million were financed with repurchase agreements. As of December 31,
1998, FBR Asset's portfolio of mortgage-backed securities was leveraged at a 4
to 1 ratio, based on book values. Financing assets through repurchase agreements
exposes FBR Asset to the risk that margin calls will be made and that FBR Asset
will not be able to meet those margin calls. Between December 31, 1998, and
March 12, 1998, FBR Asset had margin calls requiring it to post additional in
the amount of $8.5 million. Although FBR Asset was able to meet these margin
calls, there can be no assurance that it will meet future margin calls.
FBR Asset's real estate-related investments may incur losses.
FBR Asset invests in real estate-related assets and in other entities, such as
REITs, that themselves invest in real estate-related assets. Investments in real
estate-related assets are subject to a variety of general, regional and local
economic risks, as well as the following:
7
<PAGE>
Changes in interest rates could negatively affect the value of FBR Asset's
mortgage loans and mortgage-backed securities.
FBR Asset has invested indirectly in mortgage loans by purchasing
mortgage-backed securities. Some of the companies in which FBR Asset has
invested also own mortgage loans and mortgage-backed securities. At December 31,
1998, all of the mortgage-backed securities held directly by FBR Asset were
backed by pools of fixed-rate, residential mortgage loans. An investment in
fixed-rate mortgage loans or mortgage-backed securities will decline in value if
long-term interest rates increase. For example, assume FBR Asset or a REIT in
which FBR Asset invests owns mortgage loans or mortgage-backed securities with
fixed rates of 8%. If the prevailing market rates were to increase to 9%, then
the market value of the mortgage loans or mortgage-backed securities would
decline. Although Fannie Mae, Freddie Mac or Ginnie Mae may guarantee payments
on the mortgage-backed securities owned directly by FBR Asset, those guarantees
do not protect FBR Asset from declines in market value caused by changes in
interest rates.
A significant risk associated with FBR Asset's current portfolio of
mortgage-backed securities is the risk that both long-term and short-term
interest rates will increase significantly. If long-term rates were to increase
significantly, the market value of FBR Asset's mortgage-backed securities would
decline and the weighted average life of the investment would increase. FBR
Asset could realize a loss if the securities were sold. At the same time, an
increase in short-term interest rates would increase the amount of interest owed
on FBR Asset's repurchase agreement borrowings. The swap agreement to which FBR
Asset is a party would ameliorate a portion of the risk associated with an
increase in short-term interest rates, but only to the extent of the $50 million
swap agreement and only until June 2001.
Use of leverage can amplify declines in market value resulting from interest
rate increases.
FBR Asset and several of the REITs in which FBR Asset has invested borrow funds
to finance mortgage loan investments, which can worsen the effect of a decline
in value resulting from an interest rate increase. For example, assume FBR Asset
or a REIT in which FBR Asset has invested borrows $90 million to acquire $100
million of 8% mortgage certificates for $100 million. If prevailing interest
rates increase from 8% to 9%, the value of the mortgage loans may decline to a
level below the amount required to be maintained under the terms of the
borrowing. If the mortgage assets were then sold, FBR Asset or the REIT that
owned the mortgage assets would have to find funds from another source to repay
the borrowing.
Market values of mortgage loans and mortgage-backed securities may decline
without any general increase in interest rates for any number of reasons, as was
the case with commercial mortgage loans in the wake of the bankruptcy filing in
September 1998 by CRIIMI Mae, Inc., a mortgage REIT.
Prepayment rates could negatively affect the value of FBR Asset's
mortgage-backed securities.
In the case of residential mortgage loans, there are seldom any restrictions on
borrowers' abilities to prepay their loan. As a consequence, homeowners tend to
prepay mortgage loans faster when interest rates decline and when owners of the
8
<PAGE>
loans, such as FBR Asset or the REITs in which FBR Asset has invested, do not
want them to be prepaid. Consequently, owners of the loans would have to
reinvest the money received from the prepayments at the lower prevailing
interest rates. Correspondingly, homeowners tend not to prepay mortgage loans
when interest rates increase and when owners of the loans want them to be
prepaid. Consequently, owners of the loans would be unable to reinvest money
that would have otherwise been received from prepayments at the higher
prevailing interest rates. During 1998, FBR Asset acquired $226.6 million face
amount of residential mortgage-backed securities. Principal prepayments on the
mortgage-backed securities averaged $2.6 million per month for the periods that
FBR Asset owned the securities.
Although Fannie Mae, Freddie Mac or Ginnie Mae may guarantee payments on the
mortgage-backed securities owned directly by FBR Asset, those guarantees do not
protect investors against prepayment risks.
Hedging against interest rate exposure may adversely affect FBR Asset's
earnings.
During 1998, FBR Asset entered into two $50 million notional amount
interest rate swap agreements to limit the adverse effects of rising interest
rates on its short-term repurchase agreements. In the future, FBR Asset may
enter into other interest rate swap agreements, FBR Asset's hedging activity
varies in scope based on the level and volatility of interest rates and
principal prepayments, the type of mortgage-backed securities held, and other
changing market conditions.
The companies in which FBR Asset has invested also enter into interest rate
hedging transactions to protect themselves from the effect of changes in
interest rates. Interest rate hedging may fail to protect or adversely affect a
company because, among other things:
o interest rate hedging can be expensive, particularly during periods of
rising and volatile interest rates;
o available interest rate hedging may not correspond directly with the
interest rate risk for which protection is sought;
o the duration of the hedge may not match the duration of the related
liability;
o the amount of income that a REIT may earn from hedging transactions to
offset interest rate losses is limited by federal tax provisions
governing REITs;
o the party owing money in the hedging transaction may default on its
obligation to pay; and
o the credit quality of the party owing money on the hedge may be
downgraded to such an extent that it impairs FBR Asset's ability to
sell or assign its side of the hedging transaction.
In October 1998, FBR Asset sold mortgage assets, repaid certain outstanding
repurchase agreements, and terminated a related hedge transaction, resulting in
a $1.9 million recorded loss in the fourth quarter of 1998. Similarly, Chastain
Capital Corporation, a REIT of which FBR Asset owns 9.15%, declared in its 1998
third quarter report, a loss of $13.5 million resulting from its termination of
an interest rate hedge.
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Multifamily and commercial real estate may lose value and fail to operate
profitably.
Seven of the companies in which FBR Asset has invested own multifamily and
commercial real estate. In the future, FBR Asset may invest in other companies
that invest in multifamily and commercial real estate or may itself invest in
these assets. These investments and other similar investments are dependent on
the ability of the real estate to generate income. Investing in real estate is
subject to many risks. Among these are:
o property managers may not have the ability to attract tenants willing
to pay rents that sustain the property and to maintain and operate the
properties on a profitable basis;
o the value of real estate may be significantly affected by general,
regional and local economic conditions, and other factors beyond the
investor's control;
o the value of real estate may be significantly affected by unknown or
undetected environmental problems; and
o the value of real estate may be significantly affected by changes in
zoning or land use regulations or other applicable laws.
Investing in subordinated interests exposes FBR Asset to increased credit
risk.
Although FBR Asset does not directly own "subordinated interests," some of the
companies in which FBR Asset invests do. In the future, FBR Asset may invest in
other companies that invest in subordinated interests or may itself invest in
those interests. Subordinated interests are classes of commercial
mortgage-backed securities and mortgage loans that are subject to the senior
claim of mortgage-backed debt securities. Losses on the underlying mortgage
loans may be significant to the owner of a subordinated interest in because the
investments are leveraged. For example, assume a REIT acquires a $10 million
principal amount subordinated interest in a $100 million pool of mortgage loans
that is subject to $90 million of senior mortgage-backed securities. If
thereafter there are $7 million of losses on the $100 million of loans the
entire loss will be allocated to the owner of the subordinated interest. In
essence, a 7% loss on the loans would translate into a 70% loss of principal for
the owner of the subordinated interest.
Competition in the purchase, sale and financing of mortgage assets may limit
the profitability of companies in which FBR Asset invests.
FBR Asset owns interests in commercial mortgage-backed securities and
subordinated interests through its equity ownership of mortgage REITs. Mortgage
REITs derive their net income, in large part, from their ability to acquire
mortgage assets that have yields above borrowing costs. In 1997 and 1998,
increased competition for subordinated interests developed as new mortgage REITs
entered the market. These mortgage REITs raised funds through public offerings
and sought to invest those funds on a long-term basis. The amount of funds
available for investment, however, exceeded the amount of available investments,
which resulted in significant competition for assets. This competition resulted
in higher prices for subordinated interests, lowering the yields and narrowing
the spread of those yields over borrowing costs. Competitors for the acquisition
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of mortgage assets include newer mortgage REITs, such as Imperial Credit
Commercial Mortgage Investment Corporation, Anthracite Capital, Inc., AMRESCO
Capital Trust, and potentially FBR Asset and other REIT and non-REIT investors,
such as Lennar Corporation and Capital Trust.
Increased losses on uninsured mortgage loans can reduce the value of FBR
Asset's equity investments
Although the majority of FBR Asset's investments in mortgage loans are insured,
several of the companies in which FBR Asset has invested own uninsured mortgage
loans. In the future, FBR Asset may increase its own investments in uninsured
mortgage loans.
Owners of uninsured mortgage loans are subject to the risk that borrowers will
not pay principal or interest on their mortgage loans as it becomes due.
Borrowers become unable to pay their mortgage loans for a wide variety of
reasons, including general, regional, local and personal economics and declines
in business activity or real estate values. Generally, if a borrower defaults,
the owner of the mortgage loan will incur a loss to the extent the value of the
property securing the mortgage loan is less than the amount of the mortgage
loan. Defaults on mortgage loans often coincide with declines in real estate
values, which can create greater losses than anticipated. Increased exposure to
losses on uninsured mortgage loans can reduce the value of FBR Asset's equity
investments. For example, because of increased delinquencies on its uninsured
mortgage loans, Imperial Credit Commercial Mortgage Investment Corporation, a
REIT of which FBR Asset owns 3.2%, revised its estimates of potential losses.
For this reason, and because it wrote down its interest-only securities to their
fair market value based primarily upon prepayments on the underlying mortgage
loans, Imperial Credit reflected a non-cash charge of $6.4 million in its
financial statements for the third quarter of 1998.
Prepayment sensitivity of investments in interest-only securities Although FBR
Asset has no direct investments in interest-only securities, the companies in
which FBR Asset invests may own these types of securities. In the future, FBR
Asset may invest in other companies that invest in interest-only securities or
may invest in those securities itself. Interest-only securities are
mortgage-backed securities that entitle the holder to receive only interest on
the outstanding principal amount of the underlying mortgage loans, and no
principal. The value of these interest-only securities can be adversely affected
if the underlying mortgage loans are prepaid faster than anticipated and the
interest stream therefor decreases. For example, an interest-only security with
an initial notional amount of $100 million may entitle a holder to interest
equal to 1% on the outstanding notional amount. The holder may anticipate that
10% of the loans will prepay at the end of each year; however the actual
experience is that 20% of the loans prepay at the end of each year. In that
case, the anticipated and actual cash paid to the holder would be:
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Year Anticipated Actual
---- ----------- ----------
1 $1,000,000 $1,000,000
2 900,000 800,000
3 800,000 600,000
4 700,000 400,000
5 600,000 200,000
6 500,000 --
7 400,000 --
8 300,000 --
9 200,000 --
10 100,000 --
---- ---------- ----------
Total $5,500,000 $3,000,000
========== ==========
Some interest-only securities pay interest based on a floating rate that varies
inversely with, and at a multiple of, a specified floating interest rate index,
such as LIBOR. The yield on these securities is sensitive not only to
prepayments, but also to changes in the related index. For example, a security
might bear interest at a rate equal to forty percent minus the product of five
and LIBOR, or 40% - (5 X LIBOR). An increase in LIBOR by only 1%, from 6% to 7%,
would cause the interest rate on the investment to decline from 10% to 5%.
Indirect nature of investments exposes FBR Asset to additional risks.
Approximately 36% of FBR Asset's investments, as of December 31, 1998, were
investments in equity securities issued by REITs and other business entities
that own real estate, commercial mortgage loans and commercial mortgage-backed
securities. In addition to the risks described above, obtaining interests in
real estate and mortgage related assets indirectly by investing in other
enterprises carries the following risks:
Returns on equity investments not directly linked to returns on invested
companies' assets.
FBR Asset holds interests in assets through its equity ownership of other
companies. As an equity holder, FBR Asset's return on its investment is not
directly linked to returns on any company's assets but will depend upon the
payment of dividends and changes in the price of the equity securities.
Furthermore, as a common shareholder, FBR Asset's claims to the assets of the
companies in which it invests are junior to those of other creditors and senior
stockholders.
Obstacles to success may remain hidden if due diligence is inadequate
Before making an investment in another REIT or business entity, FBR Asset will
assess the strength and skills of the entity's management and other factors that
FBR Asset believes will determine the success of its investment. In making its
assessment and otherwise conducting its customary due diligence, FBR Asset will
rely on the resources available to FBR Management and, in some cases, an
investigation by third parties. Because there may be little or no publicly
available information, this process is particularly important and subjective
with respect to newly-organized entities that have new and to-be-acquired assets
and a management that may not be familiar with the business and operations of
the new or expanded enterprise. Against this background, FBR Asset can give no
assurance that the due diligence processes of FBR Management will uncover all
relevant facts or that any investment will be successful.
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Dependence on management of other entities
FBR Asset does not control the management, investment decisions, or operations
of the enterprises in which it has invested. Management of those enterprises may
decide to change the nature of their assets, or management may otherwise change
in a manner that is not satisfactory to FBR Asset. FBR Asset has no ability to
affect these management decisions, and as noted below, FBR Asset may have only
limited ability to dispose of its investments.
Limited liquidity of equity security investments
The equity securities of a new entity in which FBR Asset invests are likely to
be restricted as to resale and may otherwise be highly illiquid. FBR Asset
expects that there will be restrictions on its ability to resell the securities
of any newly public company that it acquires for one year after it acquires
those securities. Thereafter, a public market sale may be subject to volume
limitations or dependent upon securing a registration statement for a secondary
offering of the securities. As of March 12, 1999, 35.0% of the equity securities
held by FBR Asset were restricted in this manner.
The securities of newly public entities may trade less frequently and in smaller
volume than securities of companies that are more widely held and have more
established trading patterns. Thus, sales of these securities may cause their
values to fluctuate more sharply. Furthermore, and because of its affiliation
with FBR, FBR Asset's ability to invest in companies may be constrained by
applicable securities laws and the National Association of Securities Dealers,
Inc. This is so because Friedman, Billings, Ramsey & Co., Inc., another
subsidiary of FBR Group, is a registered broker-dealer and its investment and
trading activities are regulated by the SEC and NASD. For example, the NASD's
prohibition on "free-riding and withholding" may limit the number of shares FBR
Asset can acquire in a "hot issue" public offering that is underwritten by FBR &
Co.
Volatility of prices
Prices of the equity securities of new entities in which FBR Asset invests are
likely to be volatile, particularly when FBR Asset decides to sell those
securities. FBR Asset makes investments in significant amounts, and resales of
significant amounts of securities might adversely affect the market and the
sales price for the securities.
Disposition value of investments are dependent upon general and specific
market conditions.
Even if FBR Asset makes an appropriate investment decision based on the
intrinsic value of an enterprise, FBR Asset has no assurance that the trading
market value of the investment will not decline, perhaps materially, as a result
of general market conditions. For example, an increase in interest rates, a
general decline in the stock markets, or other market conditions adverse to
companies of the type in which FBR Asset has invested could result in a decline
in the value of the securities.
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At December 31, 1998, the total market value of FBR Asset's investments in
equity securities had declined 19.2%. At March 12, 1999, the total market value
of those same investments had declined 21.18%. See "Summary of Current
Investments & Cash and Cash Equivalents" on page 39. FBR Asset believes that
much of the decline in value of these investments is attributable to market
turmoil during the third and fourth quarters of 1998. See "Management's
Discussion & Analysis--Market Conditions" on page 50.
Tax requirements may restrict FBR Asset's operations.
FBR Asset has operated and intends to continue operating in a manner so as to
qualify as a REIT for federal income tax purposes. Qualifying as a REIT requires
FBR Asset to meet certain tests regarding the nature of its assets and its
income on an ongoing basis. Some of FBR Asset's investments are in equity
securities of REITs, which are qualifying assets and produce qualifying income
for purposes of those REIT qualification tests. The failure of the REITs in
which FBR Asset invests to maintain their REIT status, however, could jeopardize
FBR Asset's own REIT status.
In order to qualify as a REIT, FBR Asset also must distribute to its
shareholders, each calendar year, at least 95% of its taxable income, other than
any net capital gain. To the extent that FBR Asset meets the 95% distribution
requirement, but distributes less than 100% of its taxable income, it will be
required to pay income tax on its undistributed income. In addition, FBR Asset
will incur a 4% nondeductible excise tax if the actual amount it pays out to its
shareholders in a calendar year is less than a minimum amount specified under
the federal tax laws. See "Federal Income Tax Consequences of FBR Asset's Status
as a REIT--Requirements for Qualification--Distribution Requirements." FBR Asset
has distributed and intends to continue distributing all of its taxable income
to its shareholders on an annual basis so that it will satisfy the 95% test and
avoid both corporate income tax and the 4% excise tax.
FBR Asset's taxable income may differ substantially from its net income as
determined based on generally accepted accounting principles because, for
example, FBR Asset may deduct losses in determining its GAAP income but not its
taxable income. For example, FBR Asset's net income was $0.16 per share in
1998, but it was required to distribute $1.155 per share in order to satisfy the
95% distribution requirement.
FBR Asset may invest in assets that generate taxable income in excess of
economic income or in advance of the corresponding cash flow from the assets
("phantom income") or that cause FBR Asset's shareholders to suffer adverse tax
consequences. Although some types of phantom income are excluded in determining
the 95% distribution requirement, FBR Asset will incur corporate income tax and
the 4% excise tax with respect to phantom income items if it does not distribute
those items on an annual basis. As a result of the foregoing, FBR Asset may have
less cash than is necessary to distribute all of its taxable income each year.
Consequently, FBR Asset may have to incur debt or liquidate assets at rates or
times that it regards as unfavorable in order to distribute all of its taxable
income and thereby avoid corporate income and excise tax. See "Federal Income
Tax Consequences of FBR Asset's Status as a REIT."
If FBR Asset fails to qualify as a REIT in any year, FBR Asset would be required
to pay federal income tax on its taxable income. FBR Asset might need to borrow
money or sell assets in order to pay that tax. FBR Asset's payment of income tax
would decrease the amount of its income available for distribution to
shareholders. Furthermore, FBR Asset no longer would be required to distribute
substantially all of its taxable income to its shareholders. Unless its failure
to qualify as a REIT is excused under federal tax laws, FBR Asset could not
re-elect REIT status until the fifth calendar year following the year in which
it fails to qualify.
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Loss of Investment Company Act exemption would adversely affect FBR Asset.
FBR Asset believes that it is not, and intends to continue operating so as not
to become, regulated as an investment company under the Investment Company Act
because it is "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate."
Specifically, FBR Asset has invested, and intends to continue investing, at
least 55% of its assets in mortgage loans or mortgage-backed securities that
represent the entire ownership in a pool of mortgage loans and at least an
additional 25% of its assets in mortgages, mortgage-backed securities,
securities of REITs, and other real estate-related assets.
If FBR Asset fails to qualify for that exemption, it could be required to
restructure its activities. For example, if the market value of FBR Asset's
investments in equity securities were to increase by an amount that resulted in
less than 55% of the company's assets being invested in mortgage loans or
mortgage-backed securities, FBR Asset might have to sell equity securities in
order to qualify for its exemption under the Investment Company Act. The sale
could occur under adverse market conditions.
Ownership limitation may restrict change of control or business combination
opportunities.
In order for FBR Asset to qualify as a REIT, no more than 50% in value of its
outstanding capital stock may be owned, directly or indirectly, by five or fewer
individuals during the last half of any calendar year. "Individuals" include
natural persons, private foundations, some employee benefit plans and trusts,
and some charitable trusts. In order to preserve FBR Asset's REIT status, FBR
Asset's Charter generally prohibits:
o shareholders, other than FBR and some mutual funds and pension plans,
from directly or indirectly owning more than 9.9% of the outstanding
common stock or preferred stock of any series,
o FBR from directly or indirectly owning more than 20% of the outstanding
common stock or preferred stock of any series, and
o some mutual funds and pension plans from directly or indirectly owning
more than 15% of the outstanding common stock or preferred stock of any
series.
FBR Asset's Board has exempted FBR from the 20% limit applicable to it. The
exemption permits FBR to own up to 30% of the outstanding common stock or
preferred stock of any series. These ownership limitations could have the effect
of discouraging a takeover or other transaction in which holders of some, or a
majority, of FBR Asset's common stock might receive a premium for their shares
over the then prevailing market price or which holders might believe to be
otherwise in their best interests. See "FBR Asset's Capital Stock--Restrictions
on Ownership and Transfer" and "Federal Income Tax Consequences of FBR Asset's
Status as a REIT--Requirements for Qualification."
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Board of Directors may change policies without shareholder consent.
FBR Asset's major policies, including its investment policy and other policies
with respect to acquisitions, financing, growth, operations, debt and
distributions, are determined by its Board of Directors. The Board may amend or
revise these and other policies, or approve transactions that deviate from these
policies, from time to time without a vote of the common shareholders. The
effect of those changes may be positive or negative. FBR Asset's Charter also
authorizes the Board of Directors to issue up to 50,000,000 shares of preferred
stock and to establish the preferences and rights of any shares of preferred
stock issued. Although FBR Asset has no current intention to issue any series of
preferred stock, the issuance of preferred stock could increase the investment
risk associated with common stock ownership, delay or prevent a change in
control of FBR Asset, or otherwise change the nature of an investment in FBR
Asset's common stock.
Shares are not listed on a securities exchange.
FBR Asset's shares are not listed on any national securities exchange, and FBR
Asset does not currently qualify for listing on any national securities
exchange. FBR Asset intends to apply for listing on a national securities
exchange when it meets the qualifications. There can be no assurance, however,
that it will ever meet those qualifications. Listing shares on a national
securities exchange generally increases the shares' liquidity.
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Organization & Relationships
[graphic omitted]
17
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FBR & FBR Management
FBR is a full-service investment banking firm that makes a market in more than
400 securities and provides research coverage on more than 400 publicly traded
companies.
As of December 31, 1998, FBR, including FBR Management, which is a registered
investment adviser under the Investment Advisers Act of 1940, managed more than
$688.8 million of net assets. Of those assets, more than $224.4 million were
managed in separately managed accounts, including FBR Asset's account. FBR's
investment management services include more traditional management services for
individual accounts and investment funds. These funds include four open-end
mutual funds, an offshore fund whose capital is maintained outside the United
States, proprietary investment partnerships, and private equity and venture
capital funds. Two of FBR's mutual funds seek capital appreciation through
investments in financial services companies. The third fund invests in the
equity securities of small cap companies that FBR believes to be undervalued,
and the fourth invests in REITs and other real estate-related securities.
FBR Group, the parent company of FBR Management, completed an initial public
offering in December 1997, and its stock is listed on the New York Stock
Exchange. FBR Group's management and employees own a majority of its outstanding
stock. On December 29, 1997, PNC Bank Corp. purchased 4.9% of FBR Group's
outstanding shares of common stock. PNC is the majority owner of BlackRock, the
sub-manager of FBR Asset's mortgage portfolio, and also owns less than 5% of
Anthracite, one of the companies in which FBR Asset has invested. Pursuant to a
non-binding memorandum of understanding entered into between FBR and PNC in
October 1997, FBR and PNC have established a strategic business relationship
with respect to selected capital markets and related activities. The
understanding provides a framework pursuant to which FBR and PNC work together
on an arms-length basis to refer potential business to each other. FBR and PNC
have also agreed to work together to provide enhanced derivatives, asset
securitization, bridge lending, and other bank financing products to FBR's
clients.
Related Party Transactions
Because of its extensive involvement in real estate securities, FBR may have
material direct and indirect interests in, or relationships with, companies in
which FBR Asset also has an interest. FBR's interests may conflict with FBR
Asset's interests. For example, FBR Asset may purchase equity securities of a
company whose securities have been or will be underwritten by FBR or of a
company on which FBR provides ongoing research or in whose securities FBR makes
a market. Any such purchase of securities by FBR Asset creates a conflict
because it may indirectly benefit FBR and its directors, officers, and owners.
FBR Asset has made the following investments in companies with which FBR has a
relationship:
FBR was the lead underwriter in October 1997 of an initial public offering by
Imperial Credit Commercial Mortgage Investment Corporation of 30 million shares
of common stock at a public offering price of $15 per share. The underwriting
discount was 7%. Beginning in December 1997, FBR Asset has purchased in
open-market transactions 900,000 shares of Imperial Credit common stock at an
average price per share of $14.50. As of March 12, 1999, shares of Imperial
Credit were selling for $9.37 per share.
Since 1994, FBR has provided underwriting and other investment banking services
to Prime Group Inc. and its affiliates. Between January 1, 1997, and September
30, 1998, FBR acted as lead underwriter or co-manager, or provided advisory
services to affiliates
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of Prime Group Inc., in connection with $507.5 million of capital raising and
$936 million of merger transactions. FBR Asset has acquired 123,500 shares of
Prime Retail, Inc. in open-market transactions at an average price per share of
$9.73. As of March 12, 1999, shares of Prime Retail were selling for $8.19 per
share.
FBR was the co-managing underwriter in November 1997 of an initial public
offering by Prime Group Realty Trust, an affiliate of Prime Group, Inc. of
12,380,000 common shares at a public offering price of $20.00 per share. FBR was
the co-managing underwriter in May 1998 of an offering by Prime Group Realty of
4,000,000 preferred shares at an offering price of $25.00 per share. On February
5, 1999, FBR Asset loaned Prime Group Realty $7 million. The loan is secured by
real property and is due and payable on August 5, 1999. The loan bears interest
at a rate of 15% per annum.
On December 23, 1997, FBR Asset entered into an interim financing and security
agreement with Prime Capital Holdings, Inc., an affiliate of Prime Group Inc.,
for up to $20 million. As of December 31, 1998, approximately $12.5 million,
which includes approximately $1 million of accrued interest, had been drawn
against this loan. The note accrues interest at a rate between 12% and 15% per
annum depending upon the funding period and interest is payable monthly on the
twenty-fifth day of each month. The agreement originally called for the
repayment of principal on May 31, 1998. Prime has used the proceeds of the loan
to fund commercial first mortgages and mezzanine loans. In order to give Prime
sufficient time to negotiate a sale of those loans in one or more sale or
securitization transactions, FBR Asset has extended the maturity date on the
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$12,500,000 outstanding until June 30, 1999, and Prime has agreed to pay 1% of
the aggregate advance balance in consideration for that extension. In accordance
with the extension agreement, and subject to the claims of some of Prime's
senior lenders, Prime is required to repay FBR Asset from the proceeds of any
sale of the loans.
In connection with the organization of Building One Services Corporation, FBR
Asset agreed to acquire 500,000 shares of Building One for $10,000,000 ($20 per
share). FBR Asset also agreed not to sell the shares purchased until after
November 25, 1998. At the time of the acquisition, FBR Asset was a wholly-owned
subsidiary of FBR. FBR was the lead underwriter of a $480 million initial public
offering by Building One that closed in December 1997. The public offering price
was $20 per share and the underwriting discount was 7%. W. Russell Ramsey, one
of FBR Asset's directors and executive officers, is a director of Building One.
FBR offered its shares in the tender offer of Building One which commenced on
February 19, 1999 and expires March 24, 1999. As of March 12, 1999, shares of
Building One were selling for $16.87 per share.
FBR was the lead underwriter in January 1998 of an initial public offering by
Resource Asset Investment Trust of 2,833,334 shares at a public offering price
of $15 per share. The underwriting discount was 7%. Beginning in February 1998,
FBR Asset has purchased in open-market transactions 344,575 shares of Resource
common stock at an average price per share of $15.36. As of March 12, 1999,
shares of Resource were selling for $11.37 per share.
FBR was the lead underwriter in February 1998 of an initial public offering by
Capital Automotive REIT of 20 million shares at a public offering price of $15
per share. The underwriting discount was 7%. In a privately negotiated
transaction that closed at the same time, FBR Asset purchased from Capital
Automotive 1,792,115 shares for $25 million ($13.95 per share). At the time of
purchase, FBR Asset agreed to not sell the shares purchased until after February
12, 1999. William R. Swanson, one of FBR Asset's executive officers, is a
director of Capital Automotive. As of March 12, 1999, shares of Capital
Automotive were selling for $12.50 per share.
FBR was the lead underwriter in March 1998 of an initial public offering by
Anthracite Capital, Inc. of 20 million shares at a public offering price of $15
per share. The underwriting discount was 7%. In a privately negotiated
transaction that closed at the same time, FBR Asset purchased from Anthracite
716,846 shares for $10 million ($13.95 per share). At the time of purchase, FBR
Asset agreed to not sell the shares purchased until after March 24, 1999. In
September and October 1998, FBR Asset purchased an additional 865,000 shares of
Anthracite in open-market transactions for $8.3 million, or an average price per
share of $9.64. As of March 12, 1999, shares of Anthracite were selling for
$6.87 per share.
FBR was the lead underwriter in April 1998 of an initial public offering by
Chastain Capital Corporation of 7,380,000 shares at a public offering price of
$15 per share. The underwriting discount was 7%. In a privately negotiated
transaction that closed at the same time, FBR Asset purchased from Chastain
700,000 shares for $9,765,000 ($13.95 per share). At the time of purchase, FBR
Asset agreed to not sell the shares purchased until after April 15, 1999. As of
March 12, 1999, shares of Chastain were selling for $5.62 per share.
In June 1998, FBR entered into an agreement with Kennedy-Wilson Inc. to
underwrite an offering of common shares of Kennedy-Wilson to obtain capital for
the expansion of its business. At the same time, FBR Asset loaned Kennedy-Wilson
$10 million that was due and payable in December 1998. In December 1998,
Kennedy-Wilson paid $2,500,000 principal on the loan, and the term of the
$7,500,000 balance was extended to June 3, 1999. The loan bears interest at 17%
per annum and entitles FBR Asset to five-year warrants to acquire 131,096 shares
of Kennedy-Wilson stock at a price of $7.5526 per share. FBR Asset agreed to
extend the maturity of the Kennedy-Wilson loan to allow Kennedy-Wilson to fund
additional acquisitions. FBR Asset expects to be repaid from the proceeds of an
equity or debt offering by Kennedy-Wilson or from lines of credit available to
Kennedy-Wilson. As of March 12, 1999, shares of Kennedy-Wilson were selling for
$9.56 per share.
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On June 30, 1998, FBR Asset purchased 520,000 shares of East-West Bancorp, Inc.
common stock from selling shareholders for a purchase price of $5.2 million ($10
per share) in a $237.8 million private transaction. FBR acted as placement agent
in the transaction and for its services received a private placement fee equal
to 7%. As of March 12, 1999, shares of East-West Bancorp were selling for $9.62
per share.
FRBR was the lead underwriter in May 1997 of an initial public offering by
Brookdale Living Communities, Inc. of 4,500,000 common shares at a public
offering price of $11.50 per share. FBR was the lead underriter in December 1997
of a secondary offering by Brookdale of 2,000,000 common shares at a share price
of $16.69 and was the lead underwriter in November 1998 of a secondary offering
by Brookdale of 2,000,000 common shares at a share price of $16.50. On January
25, 1999, FBR Asset loanded Brookdale $5 million in subordinated debt that is
due and payable on April 26, 1999. The loan bears interest at 13% per annum.
FBR Management's Executive Officers
The following table sets forth some information about the executive officers of
FBR Management. FBR Management's executive officers are also directors of FBR
Asset. No executive officer is related by blood, marriage, or adoption to any
other director or executive officer of FBR Asset or FBR.
<TABLE>
<CAPTION>
Name Age Position(s) Held
- ---- --- ----------------
<S> <C> <C>
Emanuel J. Friedman 52 Chairman & Chief Executive Officer
Eric F. Billings 46 Vice Chairman & Chief Operating Officer
W. Russell Ramsey 39 President & Secretary
</TABLE>
For biographical information on Messrs. Friedman, Billings and
Ramsey, see "FBR Asset's Directors & Officers--The Board of
Directors."
The Management Agreement
FBR Asset and FBR Management entered into a Management Agreement on December 17,
1997. The following section summarizes the Management Agreement. This section
does not completely describe the Management Agreement, and you should not rely
on it as if it did. You may obtain a complete copy of the Management Agreement
by following the document request procedures set forth in the "Additional
Information" section of this document.
FBR Management's Responsibilities
FBR Management has only the authority that FBR Asset's Board of Directors
delegates to it. FBR Management is at all times subject to the Board's
supervision. Generally, FBR Management performs the services necessary to keep
FBR Asset running on a day-to-day basis. These services include:
Investment Services
o representing FBR Asset in connection with
o the purchase and sale of assets,
o commitments to purchase and sell assets, and
o the maintenance and administration of FBR Asset's asset portfolio;
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<PAGE>
o engaging in hedging activities on FBR Asset's behalf, consistent with
FBR Asset's status as a REIT;
o upon request by and in accordance with the directions of the Board of
Directors, investing or reinvesting any of FBR Asset's money;
o acting as liaison between FBR Asset and banking, mortgage banking,
investment banking and other parties with respect to the purchase,
financing and disposition of assets;
Advisory Services
o consulting with FBR Asset on the formulation of investment criteria and
guidelines;
o furnishing reports and collecting information relating to FBR Asset's
assets, interest rates, and general economic conditions;
o furnishing reports regarding FBR Asset's activities and the services
performed for FBR Asset by FBR Management;
o monitoring and providing the Board of Directors with price information
and other data obtained from nationally recognized dealers that
maintain markets in assets identified by the Board, and providing data
and advice to the Board of Directors in connection with the
identification of such dealers;
o counseling FBR Asset in connection with policy decisions to be made by
the Board of Directors;
o counseling FBR Asset regarding the maintenance of its status as a REIT
and monitoring compliance with the various REIT qualification tests;
o counseling FBR Asset regarding the maintenance of its exemption from
the Investment Company Act and monitoring compliance with the various
requirements for that status;
Administrative Services
o providing executive and administrative personnel, office space, and
office services required in rendering services to FBR Asset;
o administering FBR Asset's day-to-day operations and performing and
supervising the performance of such other necessary administrative
functions as may be agreed upon by FBR Management and the Board of
Directors, including
o the collection of revenues,
o the payment of FBR Asset's debts and obligations,
o the maintenance of appropriate computer services to perform such
administrative functions, and
o other customary functions related to portfolio management;
o communicating on behalf of FBR Asset with holders of FBR Asset's
securities as required to satisfy the reporting and other requirements
of any governmental bodies or agencies or trading markets and to
maintain effective relations those holders; and
22
<PAGE>
o to the extent not otherwise subject to an agreement executed by FBR
Asset, designating servicers for mortgage loans sold to FBR Asset and
arranging for the monitoring and administering of those services.
FBR Management has engaged BlackRock to advise it on the management of FBR
Asset's mortgage portfolio and may enter into subcontracts with other parties,
including FBR, to provide other services to FBR Asset.
The Management Fee
Base Management Fee
FBR Management is entitled to receive a quarterly base management fee equal to
the sum of:
o 0.25% per annum of the average book value of FBR Asset's mortgage
assets during each calendar quarter, and
o 0.75% per annum of the average book value of the remainder of FBR
Asset's invested assets during each calendar quarter. Book value
includes FBR Asset's proportionate share of the assets of all of its
direct and indirect subsidiaries, before reserves for depreciation or
bad debts or other similar noncash reserves. The Board of Directors may
adjust the base management fee in the future if necessary to align the
fee more closely with the actual costs of services and, by agreement
with FBR Management, may reduce the base management fee to the extent
FBR Asset incurs costs internally.
For the period December 17, 1997 through December 31, 1998, the base management
fee was $1,579,348.
Incentive Compensation
FBR Management is also entitled to receive incentive compensation based on FBR
Asset's performance. For each calendar quarter beginning with the quarter ended
March 31, 1999, FBR Management will be entitled to receive 25% of the "Incentive
Calculation Amount" for the 12 month period ending with the end of that calendar
quarter.
The "Incentive Calculation Amount" for any 12 month period means an amount equal
to the product of
(A) 25% of the dollar amount by which
(1) (a) Funds from Operations (before the incentive fee) of FBR Asset
per share of common stock, based on the weighted average number of
shares outstanding, (b) plus gains or minus losses from debt
restructuring and sales of property per share, based on the weighted
average number of shares outstanding, exceed
(2) an amount equal to (a) the weighted average of the price per share
at the initial offering price ($20) and the price per share at any
secondary offerings by FBR Asset multiplied by (b) the Ten-Year U.S.
Treasury Rate plus five percent per annum multiplied by
23
<PAGE>
(B) the weighted average number of common shares outstanding during the
applicable period.
"Funds from Operations" as defined by the National Association of Real Estate
Investment Trusts means net income computed in accordance with generally
accepted accounting principles, excluding gains or losses from debt
restructuring and sales of property, plus depreciation and amortization on real
estate assets, and after adjustments for unconsolidated partnerships and joint
ventures. Funds from Operations does not represent cash generated from operating
activities in accordance with generally accepted accounting principles and
should not be considered as an alternative to net income as an indication of FBR
Asset's performance or to cash flows as a measure of liquidity or ability to
make distributions.
As used in calculating FBR Management's compensation, the term "Ten-Year U.S.
Treasury Rate" means the arithmetic average of the weekly average yield to
maturity for actively traded current coupon U.S. Treasury fixed-rate securities,
adjusted to constant maturities of ten years, published by the Federal Reserve
Board during a quarter. The Ten-Year U.S. Treasury Rate for the quarter ended
December 31, 1998, was 4.67%.
No incentive compensation had been earned by FBR Management as of December 31,
1998.
Options Owned by FBR Management
FBR Management received options to acquire 1,021,900 shares of FBR Asset's stock
at an option price of $20 per share. In connection with the execution of the
sub-management agreement, FBR Management assigned options to acquire 51,095
shares to BlackRock. In connection with the establishment of FBR Asset's stock
incentive plan, FBR Management has agreed to rescind options to acquire 155,000
shares, which when completed, will leave FBR Management with options to acquire
815,805 shares. FBR Management also intends to assign certain of these options
to FBR's officers and employees. The options held by FBR Management and
BlackRock are exercisable in whole or in part at any time before December 17,
2007.
Expenses
Because FBR Management's employees will perform due diligence tasks that
purchasers of real estate typically hire outside consultants to perform, FBR
Management will be reimbursed for FBR Management's out of pocket costs in
performing due diligence on assets purchased or considered for purchase by FBR
Asset. Moreover, FBR Management tracks the time its employees spend in
performing such due diligence tasks and is entitled to reimbursement for the
allocated portion of the salary and benefits of such employees. However, (1) the
amount of due diligence costs for which FBR Management receives reimbursement
with respect to any asset may not exceed an arm's length due diligence fee for
such asset, and (2) FBR Management is not entitled to reimbursement for any due
diligence or employee time costs associated with investments in securities being
underwritten or placed by FBR.
Limits of Responsibility
Under the Management Agreement, FBR Management does not assume any
responsibility other than to render the services called for and is not
responsible for any action of the Board of Directors in following or declining
to follow its advice or
24
<PAGE>
recommendations. FBR Asset has agreed to indemnify FBR Management, FBR, and
their directors and officers with respect to all expenses, losses, damages,
liabilities, demands, charges, and claims arising from acts not constituting bad
faith, willful misconduct, gross negligence, or reckless disregard of duties,
performed in good faith in accordance with and pursuant to the Management
Agreement.
The Management Agreement does not limit or restrict the right of FBR Management
or any of its officers, directors, employees, or FBR from engaging in any
business or rendering services of any kind to any other person, including the
purchase of, or the rendering of advice to others who purchase REIT or other
securities or other real estate-related assets that meet FBR Asset's policies
and criteria.
Term of Management Agreement
The Management Agreement has an initial term expiring on December 17, 1999. FBR
Asset may terminate the Management Agreement without cause at any time after
December 17, 1999, upon 60 days written notice by a majority vote of FBR Asset's
independent directors or by a vote of the holders of a majority of the
outstanding common shares. If terminated, FBR Management will be entitled to all
fees accrued through the date of termination and, as a termination fee, will be
entitled to an amount equal to the sum of the base management fee and incentive
management fee earned during the twelve months preceding the final day of the
calendar quarter last ending prior to the date of termination. In addition, FBR
Asset has the right to terminate the Management Agreement without paying a
termination fee if FBR Management violates any material provision of the
Management Agreement and fails to cure the violation.
25
<PAGE>
FBR Asset's Business
Operating Policies & Strategies
FBR Asset relies upon the professionals employed by FBR to evaluate
opportunities for investment. Since its inception in 1989, FBR has sought to
identify rapidly changing industries and industries that are not fully
understood or appropriately valued by the market. Real estate is one of the
sectors on which FBR currently focuses. FBR has specialized in underwriting
offerings of REIT securities, particularly REITs that invest in mortgage loans
and mortgage-backed securities. From 1993 to 1998, FBR served as managing
underwriter in the public issuance of $5.3 billion of REIT and real estate
equity securities, consisting of $2.2 billion of mortgage and hybrid REITs and
$3.1 billion of equity REITs and real estate operating companies.
FBR Asset believes that there is a global trend towards the securitization of
real estate and real estate-related assets and that this trend is represented by
the increased formation of non-traditional REITs. FBR Asset also believes that
there is a global trend towards the consolidation of real estate owners and
operators and companies that provide services to real estate owners and
operators. FBR Asset expects these trends to provide it with significant
opportunities for investing in real estate-related assets. FBR Asset also
anticipates that, notwithstanding the recent decline in the mortgage REIT
market, additional REITs or real estate-related companies will be organized in
the future and that through investments in those companies, FBR Asset can
diversify and expand its investments in the real estate market.
FBR Asset has relied on BlackRock to manage its investments in mortgage-backed
securities and has used its affiliation with FBR to generate a flow of
investment opportunities in REITs and other real-estate related businesses.
FBR Asset's goal, subject to maintaining its REIT qualification, is to acquire
assets that it believes will generate the highest returns on capital invested.
To determine which assets are likely to provide those returns, FBR Asset
considers:
o the amount and nature of anticipated cash flows from the asset;
o the risks of investing in the asset;
o FBR Asset's ability to pledge the asset to secure collateralized
borrowings;
o the capital requirements for purchasing and financing the asset;
o the potential for appreciation and depreciation of the asset's value;
and
o the cost of financing, hedging and managing the asset.
FBR Asset is an opportunistic investor and does not have or expect to adopt
guidelines dictating specific investment restrictions or operating restrictions.
Among other things, FBR Asset may, without the consent of its stockholders:
o borrow any amount of money as FBR Asset has already done;
o issue preferred stock that has liquidation and dividend preferences
over the outstanding common stock;
26
<PAGE>
o make loans to other companies as FBR Asset has already done;
o invest in securities of other issuers as FBR Asset has already done;
o sell existing investments and make additional investments;
o offer securities in exchange for property; and
o repurchase or otherwise reacquire FBR Asset's shares as FBR Asset has
already done.
Likewise, as to specific investments, FBR Asset may invest directly or
indirectly in any type of mortgage, real estate or real estate-related assets,
as well as in other assets, subject to the policy that FBR Asset maintain its
qualification as a REIT and its exemption from registration as an investment
company.
FBR Asset expects that investment opportunities will change. Based on the recent
past, FBR Asset anticipates that REITs will continue to have difficulty
accessing the public capital markets. In this environment, FBR Asset will seek
what it considers to be attractive opportunities to invest on a privately
negotiated basis. For example, FBR Asset believes there will be opportunities to
enter into joint ventures with other REIT and non-REIT investors seeking to
complete planned acquisitions, to provide mezzanine loans with equity features,
and to provide private equity financing. If an adequate amount of what FBR Asset
considers to be appropriate investments becomes available, FBR Asset intends to
borrow funds to make additional investments.
Current Investments
FBR Asset currently invests directly in whole-pool mortgage-backed securities,
commercial loans, and equity securities of real estate-related businesses, and
indirectly in commercial and residential real estate, commercial mortgage loans,
and commercial mortgage-backed securities. As to FBR Asset's indirect
investments, FBR Asset holds interests in these assets through its equity
ownership of other companies. As an equity holder, FBR Asset's return on its
investment is not directly linked to returns on any company's assets, but will
depend upon the authorization and payment of dividends and changes in the price
of its equity securities. Furthermore, as a common stockholder, FBR Asset's
claims to the assets of the companies in which it invests are subordinated to
those of creditors and other senior stockholders.
Based upon the information provided on form 10-Q for the quarter ended
September 30, 1998, by the companies in which FBR Asset holds equity securities,
FBR Asset believes that at December 31, 1998, approximately 67% of FBR Asset's
assets were invested in residential mortgage-backed securities, approximately
11% were invested in commercial real estate, approximately 5% were invested in
commercial mortgage loans, approximately 3% were invested in commercial
mortgage-backed securities, approximately 8% were loans made to other companies,
and approximately 6% did not fit into the identified categories.
Whole-Pool Mortgage-Backed Securities
FBR Asset currently invests, and intends to continue investing at least 55% of
its assets in whole-pool mortgage-backed securities. These securities represent
the entire ownership interest in pools of mortgage loans made by lenders such as
savings and loan
27
<PAGE>
institutions, mortgage bankers, and commercial banks. Various government,
government-related and private organizations assemble the pools of loans for
sale to investors, such as FBR Asset.
At December 31, 1998, FBR Asset owned mortgage-backed securities guaranteed by
Freddie Mac, Fannie Mae, or Ginnie Mae, which had a market value of $161.4
million, and had borrowed $128.6 million to finance its investment in those
securities. Anthracite Capital, Inc., one of the companies in which FBR Asset
has invested, also owns similar securities.
Mortgage-backed securities differ from other forms of traditional debt
securities, which normally provide for periodic payments of interest in fixed
amounts with principal payments at maturity or on specified call dates. Instead,
mortgage-backed securities provide for a monthly payment that consists of both
interest and principal. In effect, these payments are a "pass-through" of the
monthly interest and principal payments made by borrowers on their mortgage
loans, net of any fees paid to the issuer or guarantor of the securities.
The investment characteristics of pass-through mortgage-backed securities differ
from those of traditional fixed-income securities. The major differences include
the payment of interest and principal on the mortgage-backed securities, as
described above, and the possibility that principal may be prepaid on the
mortgage-backed securities at any time due to prepayments on the underlying
mortgage loans. These differences can result in significantly greater price and
yield volatility than is the case with traditional fixed-income securities.
Mortgage prepayments are affected by factors including the level of interest
rates, general economic conditions, the location and age of the mortgage, and
other social and demographic conditions. Generally prepayments on pass-through
mortgage-backed securities increase during periods of falling mortgage interest
rates and decrease during periods of rising mortgage interest rates.
Reinvestment of prepayments may occur at higher or lower interest rates than the
original investment, thus affecting the yield on FBR Asset's investments.
As of December 31, 1998, FBR Asset owned thirty-three fixed rate, residential
mortgage-backed securities that represented the entire ownership interest in
pools of single-family mortgage loans. In connection with these investments, FBR
Asset entered into an interest rate swap and two repurchase agreements. The
mortgage-backed securities, the swap, and the repurchase agreements are
summarized on the following table:
28
<PAGE>
<TABLE>
<CAPTION>
Expected
Original Nominal Weighted Relevant
Issue Date Principal Market Value at Yield verage Life Expected Prepayment
Descriptive of Face Amount Amount December 31, 1998 at at 12/31/1998 Duration Assumption
Title(1) Securities (in thousands) (in thousands) (in thousands) 12/31/1998 (years) (years) (% PAM)(2)
<S> <C> <C> <C> <C> <C> <C> <C>
Freddie Mac <C>
FGOLD 15 yr. 5/1/98 $ 75,019 $ 79,334 6.08% 4.3 2.05 303
$ 76,121
Fannie Mae
FNMA 15 yr. 5/1/98 $ 21,887 $ 23,381 6.06% 4.4 2.05 303
22,188
Freddie Mac
FGOLD 15 yr. 9/1/95 $ 4,304 $ 7,496 6.02% 2.8 0.85 382
4,400
Freddie Mac
FGOLD 15 yr. 7/1/93 $ 3,952 $ 11,850 6.39% 2.3 1.61 337
4,077
Fannie Mae
30 yr. 4/1/98 $ 13,348 $ 16,291 6.20% 3.6 2.23 266
13,841
Fannie Mae
30 yr. 4/1/98 $ 13,151 $ 16,868 6.88% 3.0 1.65 310
13,813
Ginnie Mae
30 yr. 11/1/89 $ 16,294 $ 45,874 6.02% 3.7 0.83 354
Freddie Mac 17,192
FGOLD 15 yr. 9/1/98 $ 10,004 $ 10,083 5.99% 5.8 3.92 155
-------- -------- 9,787 ----- --- ---- ---
--------
Mortgage
Portfolio
Total $157,959 $211,177 6.19% 4.1 1.33 299
======== ======== $161,419 ===== === ==== ===
Repurchase ========
Agreement
Liability 12/10/98 $ 16,405 5.08%
Repurchase
Agreement
Liability 12/15/98 $112,145 5.08%
Repurchase
Agreement
Total $128,550
========
Interest Rate
Swap Agreement 6/1/98 $ 50,000(3) 4 2.07
======== =====
</TABLE>
(1) All of the mortgage-backed securities are backed by pools of fixed-rate
mortgages and are principal and interest paying instruments.
(2) Prepayment assumptions express the relationship between the assumption for
a specific pass-through security and a prepayment assumption model ("PAM").
For example, a prepayment assumption of 100% PAM for a 30-year mortgage
assumes a prepayment rate increase of 0.2% per month for the first 30
months, and level off at 6% for the remainder of the term. "50% PAM" means
that the prepayment rate is half of "100% PAM" for that month. "300% PAM"
means that the prepayment rate is three times "100% PAM" for that month. We
can give no assurance that actual prepayments will not be materially
different from the prepayment rates assumed in the PAM. For more
information on the risk of prepayments with respect to mortgage
investments, see "Prepayment rates could negatively affect the
value of FBR Asset's mortgage-backed securities" on page 9.
(3) Notional amount.
(4) Under the interest rate swap agreement, FBR Asset receives quarterly
payments of interest based on three-month LIBOR and remits semi-annual
payments at a fixed rate of approximately 5.9% based in each case on the
$50 million notional amount.
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<PAGE>
As the table above shows, the average yield on FBR Asset's mortgage backed
securities at December 31, 1998, was approximately 6.19%. The yield is based on
the anticipated life of the securities. If the actual life of the security is
reduced below its anticipated life, the yield would be reduced. The actual life
of the mortgage-backed securities is reduced if the mortgage loans underlying
the securities are prepaid faster than anticipated at the time the securities
were acquired. The table that follows outlines the recent prepayment experience
of mortgage-backed securities owned by FBR Asset in terms of PAM. See footnote 2
to the table on page 29 for a more detailed discussion of PAM. For each category
of securities in which FBR Asset owns only one pool of mortgage loans, the
prepayment history is for that specific pool. For each category of securities in
which FBR Asset holds multiple pools of mortgage loans, we have presented the
prepayment history of a representative pool. Several securities were recently
issued and thus have little prepayment history.
<TABLE>
<CAPTION>
Period from Period from
December 1998 to February 1998 to
Face Amount February 1999 February 1999
Mortgage-Backed Securities (in thousands) (% PAM) (% PAM)
- ---------------------------------- -------------------- ------------------- ------------------
<S> <C> <C>
Freddie Mac FGOLD 15yr. 6.5% $ 75,019 236 N/A
Fannie Mae 15yr. 6.5% 21,887 224 N/A
Freddie Mac FGOLD 15yr. 7.0% 4,304 937 438
Freddie Mac FGOLD 30yr. 8.0% 3,952 345 288
Fannie Mae 30yr. 7.5% 13,318 484 N/A
Fannie Mae 30yr. 9.0% 13,151 466 N/A
Ginnie Mae 30yr. 7.95% 16,294 326 407
Freddie Mac FGOLD 15yr. 5.5% 10,004 168 N/A
---------
Total $157,959
========
</TABLE>
Freddie Mac Certificates
The Federal Home Loan Mortgage Corporation, better known as "Freddie Mac," is a
privately owned government-sponsored enterprise created pursuant to Title III of
the Emergency Home Finance Act of 1970. Freddie Mac's principal activities
currently consist of the purchase of mortgage loans or participation interests
in mortgage loans and the resale of the loans and participations in the form of
guaranteed mortgage-backed securities. Freddie Mac guarantees to holders of
Freddie Mac certificates, such as FBR Asset, the timely payment of interest at
the applicable pass-through rate and ultimate collection of all principal on the
holder's pro rata share of the unpaid principal balance of the underlying
mortgage loans, but does not guarantee the timely payment of scheduled principal
on the underlying mortgage loans. The obligations of Freddie Mac under its
guarantees are solely those of Freddie Mac and are not backed by the full faith
and credit of the United States. If Freddie Mac were unable to satisfy its
obligations, distributions to FBR Asset would consist solely of payments and
other recoveries on the underlying mortgage loans, and accordingly, monthly
distributions to FBR Asset would be adversely affected by delinquent payments
and defaults on those mortgage loans.
Fannie Mae Certificates
The Federal National Mortgage Association, better known as "Fannie Mae," is a
privately owned, federally chartered corporation organized and existing under
the Federal National Mortgage Association Charter Act. Fannie Mae provides funds
to the
30
<PAGE>
mortgage market primarily by purchasing home mortgage loans from local lenders,
thereby replenishing their funds for additional lending. Fannie Mae guarantees
to registered holders of Fannie Mae certificates, such as FBR Asset, that it
will distribute amounts representing scheduled principal and interest (at the
rate provided by the Fannie Mae certificate) on the mortgage loans in the pool
underlying the Fannie Mae certificate, whether or not received, and the full
principal amount of any mortgage loan foreclosed or otherwise finally
liquidated, whether or not the principal amount is actually received. The
obligations of Fannie Mae under its guarantees are solely those of Fannie Mae
and are not backed by the full faith and credit of the United States. If Fannie
Mae were unable to satisfy its obligations, distributions to FBR Asset would
consist solely of payments and other recoveries on the underlying mortgage
loans, and accordingly, monthly distributions to FBR Asset would be adversely
affected by delinquent payments and defaults on the mortgage loans.
Ginnie Mae Certificates
The Government National Mortgage Association, better known as "Ginnie Mae," is a
wholly owned corporate instrumentality of the United States within the
Department of Housing and Urban Development. Title III of the National Housing
Act of 1934 authorizes Ginnie Mae to guarantee the timely payment of principal
and interest on certificates that represent an interest in a pool of mortgages
insured by the Federal Housing Administration under the Housing Act or partially
guaranteed by the Veteran's Administration under the Servicemen's Readjustment
Act of 1944 and other loans eligible for inclusion in mortgage pools underlying
Ginnie Mae certificates. Section 306(g) of the Housing Act provides that "the
full faith and credit of the United States is pledged to the payment of all
amounts that may be required to be paid under any guaranty under this
subsection." An opinion, dated December 12, 1969, of an Assistant Attorney
General of the United States provides that guarantees under section 306(g) of
Ginnie Mae certificates of the type that may be purchased by FBR Asset are
authorized to be made by Ginnie Mae and "would constitute general obligations of
the United States backed by its full faith and credit."
Single-Family and Multifamily Privately-Issued Certificates
Although FBR Asset does not single-family or multifamily privately-issued
certificates, some of the companies in which it invests may own these
certificates. FBR Asset may in the future invest in other companies that invest
in these assets or may invest in them itself.
Single-family and multifamily privately-issued certificates are pass-through
certificates that are not issued or guaranteed by one of the agencies described
above and that are backed by a pool of single-family or multifamily mortgage
loans. Single-family and multifamily privately-issued certificates are issued by
originators of, investors in, and other owners of mortgage loans, including
savings and loan associations, savings banks, commercial banks, mortgage banks,
investment banks and special purpose "conduit" subsidiaries of those
institutions.
While agency certificates are backed by the express obligation or guarantee of
one of the agencies, as described above, single-family and multifamily
privately-issued certificates are generally covered by one or more forms of
private credit enhancements. Those credit enhancements provide an extra layer of
loss coverage in the event that losses are incurred
31
<PAGE>
upon foreclosure sales or other liquidations of underlying mortgaged properties
in amounts that exceed the equity holder's equity interest in the property and
result in realized losses. Forms of credit enhancements include, but are not
limited to, limited issuer guarantees, reserve funds, private mortgage guaranty
pool insurance, over-collateralization, and subordination.
Borrowed Funds
FBR Asset may reduce the amount of equity capital it has invested in mortgages
or other assets by funding a portion of those investments with long-term
borrowings, warehouse lines of credit, or other borrowing arrangements.
Borrowing funds creates interest expense that can exceed the revenue FBR Asset
earns from its financed assets. To the extent that revenue derived from those
assets exceeds the interest expense, FBR Asset's net income will be greater than
if FBR Asset had not borrowed funds. Conversely, if the revenue from those
assets does not sufficiently cover the expense, FBR Asset's net income will be
less than if FBR Asset had not borrowed funds.
FBR Asset has borrowed, and intends to continue borrowing funds by entering into
repurchase agreements. Under these agreements, FBR Asset sells assets to a third
party with the commitment to repurchase the same assets at a fixed price on an
agreed date. The repurchase price reflects the purchase price plus an agreed
upon market rate of interest. FBR Asset accounts for repurchase agreements as
loans, secured by the underlying assets, that FBR Asset owes to the third party.
FBR Asset intends to use the proceeds from borrowings to invest in mortgages or
other assets and to repeat this process of borrowing and investing, while
continually monitoring its use of leverage. Based on book values, the
debt-to-equity ratio as of December 31, 1998, on FBR Asset's mortgage-backed
securities portfolio was 4 to 1. Traditionally, lenders have permitted
repurchase agreement borrowings against agency mortgage-backed securities at a
debt-to-equity ratio of up to 19 to 1. FBR Asset does not currently intend to
increase this leverage ratio, although its Charter and Bylaws do not impose any
specific limits on permissible leverage.
What follows are two examples of how FBR Asset might use borrowings to increase
the yield on a hypothetical mortgage-backed security:
--------------------------------------------------------------------------
Example 1 Example 2
--------- ---------
1. Amount invested in
mortgage-backed security.......... $10,000,000 $10,000,000
2. Annual interest rate on
mortgage-backed security.......... 7.25% 7.25%
3. Income from mortgage-backed
security (1 x 2)*................ $ 725,000 $ 725,000
4. Amount borrowed to finance
investment in mortgage-backed
security.......................... $8,000,000 $5,000,000
5. Interest rate on amount borrowed.. 5.50% 5.50%
6. Interest expense (4 x 5)*......... $ 440,000 $ 275,000
7. Equity capital invested (1 - 4)*.. $2,000,000 $5,000,000
--------------------------------------------------------------------------
32
<PAGE>
--------------------------------------------------------------------------
Example 1 Example 2
--------- ---------
8. Management fee (0.25% x
$10,000,000)...................... $ 25,000 $ 25,000
9. Hedging expense (4 x 1%)*......... $ 80,000 $ 50,000
10. Total expenses (6 + 8 + 9)*....... $ 545,000 $ 350,000
11. Net income on mortgage-backed
security (3-10)*.................. $ 180,000 $ 375,000
12. Return on equity capital
invested (11 / 7)*................ 9.00% 7.50%
--------------------------------------------------------------------------
* The numbers in parentheses, unless otherwise specified, refer to the
paragraph numbers on the far left.
In example 1 above, FBR Asset uses borrowed funds to increase the initial yield
on its investment from 7.25% to 9.0%. In example 2 above, FBR Asset borrows less
funds and increases its yield only from 7.25% to 7.50%. FBR Asset plans to
complete these types of transactions by arranging loans in which it pledges its
assets as collateral to secure its repayment obligations. Some of those loans
may be margin loans in which a decline in the pledged assets' market value could
trigger an early repayment of FBR Asset's obligations. If FBR Asset repays loans
early, then the return on equity would be reduced. As reflected above, if FBR
Asset were required to increase the amount of equity capital it invests by $3
million in order to prepay $3 million of the loan, then the return on equity
would be reduced from 9.00% to 7.50%.
Hedging & Interest Rate Management
FBR Asset acquires derivative financial instruments to hedge all or a portion of
the interest rate risk associated with its borrowings. FBR Asset does not intend
to acquire derivative instruments for speculative purposes. FBR Asset's hedging
activities may include entering into interest rate swaps and caps and options to
purchase swaps and caps. Under the tax laws applicable to REITs, FBR Asset
generally will be able to enter into swap or cap agreements, options, futures
contracts, forward rate agreements, or similar financial instruments to hedge
indebtedness that FBR Asset may incur, or plans to incur, to acquire or carry
real estate assets. The applicable tax provisions, however, may limit FBR
Asset's ability to enter into other types of hedging transactions. If so, FBR
Asset may conduct some or all of its hedging activities through a to-be-formed
subsidiary that is fully subject to income tax.
FBR Asset engages in a variety of interest rate management techniques that are
intended to match the effective maturity of, and the interest received on, its
assets with the effective maturity of, and the interest owed on, its
liabilities. FBR Asset generally will be able to use those techniques directly,
instead of through a corporate subsidiary that is fully subject to corporate
income taxation. FBR Asset, however, cannot give any assurances that it can
successfully implement its investment and leverage strategies. FBR Asset's
interest rate management techniques may include:
o puts and calls on securities or indices of securities;
o Eurodollar futures contracts and options on such contracts;
33
<PAGE>
o interest rate swaps, which are the exchange of fixed-rate payments for
floating-rate payments; or
o other similar transactions.
FBR Asset may also use these techniques to attempt to protect itself against
declines in the market value of its assets that result from general trends in
debt markets. The inability to match closely the maturities and interest rates,
or the inability to protect adequately against declines in the market values,
could result in losses with respect to FBR Asset's mortgage assets.
At December 31, 1998, FBR Asset owned $161.4 million of long-term fixed-rate
mortgage-backed securities and was indebted for $128.6 million under short-term
repurchase agreements. These agreements expire and are renewed on a regular
basis. At December 31, 1998, the repurchase agreements had remaining terms to
maturity of between 69 and 74 days. As of March 12, 1999, all of the repurchase
agreements held by FBR Asset had a stated maturity date of May 17, 1999. The
interest rate received by FBR Asset under the short-term borrowing arrangements
increases and decreases as short-term interest rates increase or decrease. The
interest rate on the mortgage-backed securities remains constant. If short-term
rates increased significantly above 6.19%, which is the average yield on FBR
Asset's mortgage portfolio as of December 31, 1998, the interest owed on the
borrowings would exceed the interest income payable to FBR Asset on its
mortgage-backed securities.
To limit the adverse effect of rising short-term interest rates under its
short-term repurchase agreements, FBR Asset entered into two interest rate swap
agreements pursuant to which FBR Asset paid a fixed interest rate on $100
million notional amount of borrowings and received a variable interest rate on
$100 million notional amount of borrowings. FBR Asset realized a $1.9 million
loss when it terminated one $50,000,000 agreement in October 1998. The remaining
$50,000,000 agreement matures on June 1, 2001.
Interest rate management techniques do not eliminate risk. For example, if both
long-term and short-term interest rates were to increase significantly, it can
be expected that:
o the weighted average life of the mortgage-backed securities would be
extended because prepayments of the underlying mortgage loans would
decrease; and
o the market value of the fixed rate mortgage-backed securities would
decline as long-term interest rates increased.
Yet, in this situation, the interest rate swap agreement would be ineffective
for periods after its June 1, 2001 termination date, and if FBR Asset sold the
fixed-rate mortgage-backed securities to pay down its short-term borrowings, it
would realize a loss because of the decline in their market value.
Real Estate
FBR Asset seeks to invest in real property to generate income and to provide the
company with the potential for capital appreciation in the value of property
owned. Although FBR Asset does not currently own any direct interests in real
property, it does own interests in real property through its equity investments
in Capital Automotive REIT, and to a lesser extent through its equity
investments in Prime Retail, Resource,
34
<PAGE>
and Imperial Credit. Through its relationship with FBR, FBR Asset was able to
acquire the stock of Capital Automotive before Capital Automotive offered its
stock to the public. FBR Asset purchased shares of Prime Retail, Resource and
Imperial Credit in open-market transactions.
Capital Automotive REIT invests in the real property and improvements used by
operators of multi-site, multi-franchised motor vehicle dealerships and motor
vehicle-related businesses located in major metropolitan areas of the United
States. Capital Automotive is a self-administered and self-managed Maryland REIT
that primarily acquires real property and simultaneously leases back this
property to automobile dealers. These transactions generally have the following
characteristics:
o Capital Automotive's interest in the property acquired generally
includes the land, buildings and improvements, related easements and
rights and fixtures, but not any personal property, furniture or
equipment.
o The leases generally range from 8 to 11 years and may be extended for
one or two terms of 10 years at the option of the lessee.
o The leases typically require the lessee to pay substantially all
expenses associated with the operation of the real property, such as
real estate taxes and other governmental charges, insurance, utilities,
service, maintenance and, therefore are on a "triple-net" basis.
o Upon expiration or termination of the lease, the lease generally
provides that additions, repairs, renovations and improvements become
the property of Capital Automotive.
o The leases also typically require the lessee to operate the property
only for the same purpose for which it was used on the date Capital
Automotive purchased it, unless Capital Automotive consents to a
different use.
These types of "sale-leaseback" transactions generally enable Capital Automotive
to eliminate brokerage, re-leasing and similar costs and the risk of high lessee
turnover due to the general, historic long-term operation of automobile
dealerships.
Prime Retail invests in factory outlet centers. Prime is a self-administered and
self-managed REIT that develops, acquires, owns and operates factory outlet
centers in the United States. Resource invests in commercial office buildings
and land. Resource is a Maryland REIT whose principal business activity is to
provide specialized commercial mortgage loans to those who do not meet the
traditional underwriting standards of other lenders, but Resource also owns real
estate.
In the future, FBR Asset may invest in other companies that own real property.
In addition, FBR Asset may purchase real property directly or through joint
ventures that purchase real property directly.
Commercial Mortgage Loans & CMBS
FBR Asset invests in commercial mortgage loans and commercial mortgage-backed
securities, commonly known as "CMBS." Currently, FBR Asset owns interests in
commercial loans and CMBS indirectly through its investments in Anthracite
Capital, Inc., Chastain Capital Corporation, Imperial Credit Commercial Mortgage
Investment Corporation, Prime Capital, Resource Asset Investment Trust and
East-West Bancorp.
35
<PAGE>
FBR acted as lead underwriter or placement agent for each of these companies.
Through its relationship with FBR, FBR Asset was able to acquire stock in
Anthracite and Chastain before or while the companies offered their stock to the
public or, in the case of East-West Bancorp, when FBR placed the stock with
private investors.
In the future, FBR Asset may invest in other companies that originate or acquire
commercial mortgage loans or CMBS. In addition, FBR Asset may purchase
commercial mortgage loans and CMBS directly.
Commercial mortgage loans are loans secured by senior or subordinate liens on
commercial or multifamily real estate. The characteristics of the commercial
mortgage loans held by companies in which FBR Asset invests vary widely. Some of
those companies' commercial mortgage loan holdings are performing loans that can
be securitized. Imperial Credit, for example, invests primarily in performing
multifamily and commercial term loans. Chastain originates commercial mortgage
loans and targets the major metropolitan markets in the United States. East-West
Bancorp originates commercial mortgage loans to borrowers who have ties to the
Asia Pacific region. Prime Capital originates first and mezzanine commercial
loans.
Some of the companies in which FBR Asset invests also own commercial mortgage
loans that are not intended to be securitized. For example, Resource originates
wraparound loans, in which a borrower grants Resource a junior lien mortgage
with a principal amount equal to the principal amount owed under any existing
loans plus an additional amount that Resource actually advances to the borrower.
The borrower makes all loan payments to Resource, which in turn pays the prior
lenders principal and interest on the prior loans. Because the loans made by
Resource are subordinated and include an obligation by Resource to make payments
on prior loans, these loans involve different and carry more significant risk
than traditional first mortgage loans originated by institutional lenders and
thus are generally not suitable for securitization. Anthracite and Chastain own
other commercial loans that generally are not securitized because they involve a
higher degree of credit risk, they have a shorter term, or because they cannot
be grouped together easily. These loans include mezzanine loans, which are loans
subject to a prior lien on the property, bridge loans, which are short-term
loans that are intended to provide interim financing before a property is sold
or the loan refinanced, and loans made to facilitate construction of new
commercial properties.
FBR Asset, or the companies in which it invests, may invest in commercial
mortgage loans with borrowers who are delinquent in payments on the loans. A
lender can purchase this kind of loan at a price less than the amount owed on
the loan, which enables the lender to work out a forbearance plan or other
restructuring. If an agreement cannot be made, the lender ultimately may
foreclose on the loan, acquiring ownership of the commercial property.
In addition to investing in commercial mortgage loans, some of the companies in
which FBR Asset invests own CMBS. FBR Asset currently owns interests in CMBS
through its equity ownership of Anthracite, Imperial Credit and Chastain.
Imperial Credit issues CMBS secured by its commercial term loans and retains an
equity interest in those loans with characteristics similar to a Subordinated
CMBS. Chastain plans to create CMBS and retain similar equity interests.
36
<PAGE>
CMBS typically are divided into two or more classes, sometimes called
"tranches." Generally the most senior class or classes would be rated investment
grade, which increases the marketability of the class. The junior, or
subordinated, classes typically would include a non-investment grade rated class
and an unrated, higher-yielding credit support class. The market for
non-investment grade CMBS is limited, and holders of CMBS have incurred, and
might in the future incur, significant losses if required to sell them as a
result of margin calls or otherwise.
Each class of CMBS generally is issued with a stated principal amount and a
specific fixed or variable interest rate. The principal of and interest on the
underlying mortgage loans may be allocated to the classes of CMBS in many ways,
and the credit quality of a particular class results primarily from the order
and timing of the receipt of payments on the underlying mortgage loans. For
example, subordinated classes of CMBS provide credit protection to the more
senior classes because the subordinated classes absorb all losses from loan
defaults and foreclosures before any losses are allocated to the more senior
classes. Typically, prepayments on mortgage loans are paid to the more senior
classes of CMBS for a period of time or until the senior classes are paid in
full. In some instances, subordinated classes of CMBS are not entitled to
receive any scheduled payments of principal until the more senior classes are
paid in full or until a specified time.
Some classes of CMBS are not entitled to payments of principal, or are entitled
to only nominal principal payments. These classes are known as interest-only
securities or IOs. IOs are sensitive to prepayments on the underlying mortgage
loans, and IO classes of CMBS are sensitive to losses resulting from defaults on
the underlying mortgage loans. In November 1998, Imperial Credit reported a
non-cash charge of $6.4 million, or $0.20 per share, primarily because of a
write down of its IOs to estimated fair market value. According to Imperial
Credit's management, the write down was necessary because the company revised
its estimates of anticipated prepayments and losses on the underlying loans.
To the extent that FBR Asset holds interests in commercial mortgage loans and
CMBS through its investments in other companies, FBR Asset must rely on the
management of those other companies to make decisions with respect to the
commercial mortgage loans and CMBS. In general, FBR Asset will have no ability
to control those decisions. Moreover, the management of those other companies
are not required to inform FBR Asset of their decisions, although to the extent
the companies are reporting companies under the Securities Exchange Age of 1934,
they must file reports of material events with the SEC.
Loans
FBR Asset directly invests in real estate-based loans. Investments in 1998 were
loans to Prime Capital and Kennedy-Wilson aggregating $20 million. Since
December 31, 1998, FBR Asset has invested $12 million in loans to Brookdale
Living Communities and Prime Group Realty Trust. Each of these loans provides
debt financing for capital needs not covered by traditional secured and senior
loans and available equity. FBR Asset anticipates that there will be a continued
demand for this type of loan and that it will make additional similar real
estate based loans in the future.
37
<PAGE>
Real Estate-Related Businesses
The tax rules limit FBR Asset's ability to expand its investments beyond its
core direct and indirect investments in mortgage loans, mortgage-backed
securities and real estate. Subject to those limits, however, FBR Asset invests
in businesses that provide services to real estate owners and operators.
For example, FBR Asset owns common stock in Building One Services Corporation.
Building One intends to become a national single-source provider of facilities
services. Building One currently derives most of its income from providing
janitorial maintenance management services and electrical and mechanical
installation and maintenance services. Building One actively seeks to expand its
business by acquiring or merging with other facilities service providers.
FBR Management believes that additional opportunities may arise in the future
for FBR Asset to invest in businesses that provide services to real estate
owners and operators. In many cases, FBR Management believes that these
investments may provide higher returns than mortgage and real estate assets.
Accordingly, subject to the tax restrictions that apply, FBR Asset may invest in
real estate-related businesses in the future.
38
<PAGE>
Summary of Current Investments & Cash and Cash Equivalents
The following table summarizes FBR Asset's investments as of December 31, 1998.
For each investment in common stock, the first column shows the number of shares
of common stock that FBR Asset owns in each entity and the second column shows
the percentage ownership that FBR Asset's investment in each company represents.
The third column shows the amount FBR Asset paid for its investment, and the
fourth column shows the market value of the investment as of December 31, 1998.
The final column shows the percentage increase or decrease in the value of FBR
Asset's investments from the dates of purchase, which vary for each investment
to December 31, 1998. The percentages in this last column have not been
annualized or adjusted to reflect the length of time FBR Asset has held the
investment.
<TABLE>
<CAPTION>
As of December 31, 1998 As of March 12, 1999
-------------------------------------- ------------------------------------
Amount Percentage Amount Percentage
Shares Percent of Market Increase of Market Increase
Owned Ownership Investment Value (Decrease) Investment Value (Decrease)
------ --------- ---------- ------ ---------- ---------- ------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-Backed Securities N/A N/A $160,705,239 $161,418,739 0.44% $154,537,310 $154,627,948 0.06%
------------ ------------ ------------ ------------
Equity Investments(1)
Anthracite Capital, Inc.
(AHR)(2) 1,581,846 7.40% 18,334,496 12,358,172 -32.60% 18,334.495 10,875,191 -40.66%
Capital Automotive REIT
(CARS)(2) 1,792,115 7.23% 25,000,000 26,657,711 6.63% 25,000,000 22,401,438 -10.39%
Chastain Capital Group
(CHAS)(2) 700,000 9.15% 9,765,000 3,150,000 -67.74% 3,150,000 3,937,500 25.00%
Imperial Credit Commercial
Mortgage Inv. Corp.
(ICMI)(2) 900,000 3.2% 13,050,230 8,437,500 -35.35% 13,050,230 8,437,500 -35.35%
Prime Retail, Inc.
(PRT)(2) 123,500 0.29% 1,201,317 1,211,844 0.88% 1,201,317 1,011,156 -15.83%
Resource Asset Investment
Trust (RAS)(2) 344,575 5.59% 5,292,516 3,790,325 -28.38% 5,292,516 3,919,541 -25.94%
Building One Services
Corporation (BOSS)(2) 500,000 1.13% 10,000,000 10,437,500 4.38% 10,000,000 8,437,500 -15.63%
East-West Bancorp, Inc.
(EWBC)(2) 520,000 2.19% 5,200,000 4,940,000 -5.00% 5,200,000 5,005,000 -3.75%
------------ ------------ ------ ------------ ------------ ------
Total Equity Investments $ 87,843,559 $ 70,983,052 19.20% $ 81,228,559 $ 64,024,826 -21.18%
============ ============ ====== ============ ============ ======
Promissory Notes
Prime Capital Holdings,
Inc.(2) N/A N/A 12,504,334(3) 12,504,334 N/A 12,556,024(3) 12,556,024
Prime Realty Group 7,000,000 7,000,000
Kennedy-Wilson, Inc.
(KWIC) N/A N/A 7,525,479 N/A 7,584,176 7,584,176
Brookdale Living
Communities - - 5,000,000 5,000,000
------------ ------------ ------------ ------------
Total Promissory Notes $20,029,813 $ 20,029,813 $ 32,140,201 $ 32,240,201
============ ============ ============ ============
Cash and Cash Equivalents N/A N/A $ 41,144,326 $ 41,144,326 17,779,786 17,779,786 N/A
============ ============ ============ ============
Total Investments & Cash
and Cash Equivalents $309,722,937 $293,575,930 -5.21% $285,685,857 $268,572,760 -5.99%
============ ============ ====== ============ ============ ======
</TABLE>
(1) The symbols in parentheses next to the company names are the symbols of
those companies on Nasdaq or a national securities exchange. Each of these
companies is a reporting company under the Securities Exchange Act of 1934
and information is available about these companies from the SEC's website,
www.sec.gov.
(2) FBR has underwritten or privately placed the securities of these companies
or their affiliates. See "FBR & FBR Management-Related Party Transactions"
on page 18. FBR Asset has realized a permanent loss on its investment in
Chastain as of December 31, 1998, equal to $6,615,000.
(3) Includes principal of $11,557,442 and accrued interest receivable of
$946,092 as of December 31, 1998. At March 12, 1999 includes $51,690 of
accrued interest.
39
<PAGE>
The following table shows, for calendar year 1998, FBR Asset's investments and
cash and cash equivalents, including, with respect to its investments, the
weighted average cost of each investment based on the number of days from
January 1, 1998, to December 31, 1998, on which FBR Asset held each investment,
and the gross income from each investment for the year ended December 31, 1998.
Weighted Gross
Average Cost Income
------------ ------
Mortgage-Backed Securities $169,564,932 $ 7,101,326
------------ -----------
Equity Investments
Anthracite Capital, Inc. 10,356,129 739,613
Capital Automotive REIT 21,986,301 1,569,893
Chastain Capital Group 6,581,342 287,000
Imperial Credit Commercial Mortgage Inv. Corp. 13,050,230 1,062,000
Prime Retail, Inc. 374,166 36,433
Resource Asset Investment Trust 4,329,152 576,466
Building One Services Corporation 10,000,000 -
East-West Bancorp, Inc. 2,621,370 -
------------ -----------
Total Equity Investments & Dividends $ 69,298,690 $ 4,271,405
------------ -----------
Promissory Notes
Prime Capital Holdings, Inc. 7,947,365 1,248,707
Kennedy-Wilson Inc. 5,506,849 749,264
------------ -----------
Total Promissory Notes $ 13,454,214 $ 1,997,971
------------ -----------
Cash & Cash Equivalents 84,496,947 4,556,800
------------ -----------
Total Investments and
Cash & Cash Equivalents $336,814,783 $17,927,502
============ ===========
Dividends & Distribution Policy
To maintain its status as a REIT for federal income tax purposes, FBR Asset is
required to distribute substantially all its taxable income, which may differ
materially from its income calculated in accordance with generally accepted
accounting principles, to its shareholders each year. In order to satisfy this
requirement, FBR Asset intends to declare regular quarterly dividends and to
distribute any taxable income remaining at the end of a year with a first
quarter dividend in the following year.
The Board of Directors may change the dividend policy at any time. The Board of
Directors will declare dividends based on:
o the taxable income of FBR Asset;
o the financial condition of FBR Asset;
o the distributions required to maintain REIT status and to avoid
corporate income tax and the 4% excise tax; and
40
<PAGE>
o other factors that the Board of Directors considers relevant.
To date, FBR Asset has declared the following dividends:
For the Period Total Per Share
-------------- ----- ---------
12/15/97 - 12/31/97 $ 562,045(1) 0.055
01/01/97 - 03/31/98 2,083,165 0.200
04/01/98 - 06/30/98 3,072,669 0.295
07/01/98 - 09/30/98 3,379,798(2) 0.360
10/01/98 - 12/31/98(3) 2,563,058 0.300
----------- ------
$11,660,735 $1.210
=========== ======
(1) Includes $0.05 dividend declared in June 1998 and paid in July 1998 for
shareholders of record as of December 31, 1997.
(2) Dividend declared and paid in October 1998.
(3) Dividend paid in January 1999.
FBR Asset has paid substantially all of its dividends to date out of current or
accumulated earnings and profits; only 11% of those dividends are expected to be
a return of capital for 1998 federal income tax purposes. The level of quarterly
dividends is based on a number of factors and should not be deemed indicative of
taxable income for the quarter in which declared or future quarters or of income
calculated in accordance with generally accepted accounting principles.
Distributions to shareholders will generally be subject to tax as ordinary
income, although in appropriate circumstances a portion of a distribution may be
designated by FBR Asset as capital gain or may be determined to be a tax-free
return of capital. FBR Asset generally does not intend to declare more than a de
minimis amount of dividends that are a return of capital for tax purposes,
except in those instances where companies in which FBR Asset invests determine
that a portion of their dividends are a return of capital. FBR Asset will
furnish annually to each shareholder a statement setting forth distributions
paid during the preceding year and their characterization as ordinary income,
capital gain or return of capital. For a discussion of the federal income tax
treatment of distributions by FBR Asset, see "Federal Income Tax Consequences of
FBR Asset's Status as a REIT--Taxation of Taxable U.S. Shareholders."
41
<PAGE>
Selected Financial Data
The selected financial data set forth below should be read in conjunction with
"Management's Discussion & Analysis" and the Financial Statements and Notes
thereto included elsewhere in this prospectus. The selected balance sheet data
as of December 31, 1997 and 1998, and statement of operations data for the
period from December 15, 1994 (Inception) to December 31, 1997, and for the year
ended December 31, 1998, has been derived from the audited financial statements
included elsewhere in this prospectus. The results for the year ended December
31, 1998, are not necessarily indicative of the results to be expected for any
future period.
<TABLE>
<CAPTION>
December 15, 1997
(Inception) For the Year
through Ended
December 31, 1997 December 31, 1998
----------------- -----------------
<S> <C> <C>
Statement of Operations Data:
Interest income...................................... $ 18,040 $ 13,656,097
Dividend income...................................... 434,717 4,271,405
Other income......................................... 268,520 -
Interest expense..................................... - 5,359,633
Management Fee expense............................... 58,623 1,520,725
Other expense........................................ 15,733 1,089,102
Net realized losses.................................. - (8,369,807)
Net income .......................................... 646,921 1,588,235
Basic and diluted income per share................... $ 0.06 $ 0.16
Dividends declared per share(1)...................... $ 0.05 $ 1.16
Weighted average basic and diluted shares............ 10,218,999 10,044,483
<CAPTION>
As of As of
December 31, 1997 December 31, 1998
----------------- -----------------
<S> <C> <C>
Selected Balance Sheet Data:
Mortgage-backed securities, at fair value............ $ - $161,418,739
Cash and cash equivalents............................ 163,223,199 41,144,326
Investments in equity securities, at fair value...... 23,318,750 70,983,050
Total assets......................................... 190,538,402 295,930,620
Repurchase agreements................................ - 128,550,000
Total liabilities.................................... 771,573 145,026,041
Accumulated other comprehensive income(2)............ - (9,800,530)
Shareholders' equity................................. 189,766,829 150,904,579
Book value per share................................. $ 18.57 $ 17.66
Common shares outstanding(3)......................... 10,218,999 8,543,527
<CAPTION>
As of For the Year Ended
December 31, 1997 December 31, 1998
----------------- -----------------
<S> <C> <C>
Other Selected Data
Weighted Average daily borrowings for May 13,
1998 through year end(4)............................. - 144,793,891
Average equity ...................................... 189,766,829 182,750,145
</TABLE>
(1) Dividends are calculated and declared based on estimates of FBR Asset's
taxable income.
(2) As of December 31, 1998, accumulated other comprehensive income includes
net unrealized gain on mortgage-backed securities of $713,499 and
unrealized net losses on investments in equity securities of $10,514,029.
(3) Reflects 1,872,300 shares of treasury stock repurchased as of December 31,
1998.
(4) Repurchase agreements were entered into on May 13, 1998.
42
<PAGE>
Management's Discussion & Analysis
Overview
FBR Asset targets investments in real estate and real estate-related companies.
FBR Asset has invested, and intends to continue investing in, whole-pool
mortgage-backed securities that are guaranteed by Fannie Mae, Freddie Mac or
Ginnie Mae, mortgage loans, mortgage-backed securities, real property, and joint
ventures formed to own real property. FBR Asset invests in some of these assets
indirectly through its investments in and loans made to REITs and other
companies.
As of December 31, 1998, FBR Asset had:
o mortgage-backed securities totaling $161.4 million, which were financed
with repurchase agreements totaling $128.6 million;
o investments in equity securities of eight companies with an original
total cost basis of $87.8 million and a total market value of $71
million as of December 31, 1998; and
o loans to two companies totaling $20 million.
Results of Operations
FBR Asset's fiscal year commenced on January 1, 1998, and concluded on December
31, 1998. Operations from the date of inception, December 15, 1997 through
December 31, 1997, were not material.
Net Income
FBR Asset's sole sources of income since inception have been quarterly dividend
earnings on its REIT holdings and interest earnings on its mortgage-backed
securities, notes receivable, and cash and cash equivalents. Net income for the
year ended December 31, 1998, was $1.6 million, or $0.16 per share (basic and
diluted). FBR Asset's primary source of interest income to date has been its
investments in fixed-rate mortgage-backed securities. Interest income is
recorded based on contractual rates of interest and amortization of any premium
or discount associated with the original purchase. The amount of future
contractual interest income received may be adversely affected in the event of
prepayments or defaults on the underlying mortgage loans. Generally, as interest
rates fall, prepayment rates may increase significantly. Accordingly, FBR
Asset's interest income for any given period may not be indicative of that for
future interim or annual periods. FBR Asset began investing in mortgage-backed
securities in the second quarter of 1998. Interest income, including interest
earned on outstanding loans, cash and cash equivalents, for the year ended
December 31, 1998, was approximately $13.7 million.
For the year ended December 31, 1998, the estimated average yield on FBR Asset's
mortgage securities was 6.19%. For that same period the estimated average yield
on cash and cash equivalents was approximately 5.39%.
43
<PAGE>
In order to maintain its preferential tax status under the federal income tax
laws, a REIT must distribute at least 95% of its taxable income to shareholders.
REITs generally make distributions on a quarterly basis. FBR Asset has received
and expects to continue receiving quarterly distributions from its equity
investments in other REITs, except for Chastain, which suspended its quarterly
dividend for the fourth quarter of 1998. However, depending on the nature of the
underlying business of each REIT investment, quarterly distributions and annual
taxable income may vary. As a result, dividend distributions for any one
quarterly or annual period may not be indicative of receipts for future
quarterly or annual periods. Dividend income for the year ended December 31,
1998, was $4.3 million.
Interest expense of $5.4 million was attributable to FBR Asset's repurchase and
interest rate swap agreements accounted for 67.3% of FBR Asset's total expenses
for the year ended December 31, 1998. FBR Asset did not begin to leverage its
mortgage portfolio until May 1998. FBR Asset anticipates that its cost of
borrowed funds will continue to comprise the largest portion of its total
expenses in future periods. FBR Asset has borrowed funds under repurchase
agreements of which $128.6 million were outstanding as of December 31, 1998. As
of December 31, 1998, the weighted average borrowing rate on amounts outstanding
under repurchase agreements was 5.82%.
FBR Asset realized non-recurring expenses of $8.4 million, which were charged to
income as the result of two actions. First, FBR Asset determined that there had
been an other than temporary impairment to the value of its investment in
Chastain and charged earnings $6.6 million to reduce the carrying value of the
investment to the market value of the Chastain stock as of December 31, 1998.
Second, FBR Asset sold mortgage-backed securities in October 1998, and in
connection with the sale, repaid certain short-term repurchase agreements and
terminated an interest rate swap agreement. The swap agreement termination
charge of $1.9 million was also charged to earnings.
Management fees for the year ended December 31, 1998, were approximately $1.52
million. FBR Management receives a quarterly fee based on FBR Asset's average
invested assets. FBR Management has subcontracted with a mortgage portfolio
manager, BlackRock, to manage FBR Asset's mortgage portfolio. BlackRock receives
a fee based on the average gross asset value of FBR Asset's mortgage portfolio.
See Note 5 of Notes to Financial Statements. FBR Management is also entitled to
receive an annual incentive fee if Funds from Operations, as defined on page 22
of this prospectus, exceed certain thresholds. Through December 31, 1998, FBR
Asset's Funds from Operations did not exceed the threshold amounts.
In connection with the organization of FBR Asset, FBR Asset granted FBR
Management ten-year options to acquire 1,021,900 shares of FBR Asset common
stock at a purchase price of $20 per share. The value of the options at the date
of grant ($909,492) is being amortized over the two years ending December 31,
1999. $454,746 was charged to income for the year ended December 31, 1998; the
remaining $454,746 will be charged to income in 1999.
Professional fees consist primarily of legal and accounting fees. Professional
fees were approximately $440,185 for the year ended December 31, 1998. The legal
fees are attributable to the costs associated with the acquisition of assets and
FBR Asset's private placement of its equity securities. Accounting fees are
primarily attributable to the audits related to this filing.
44
<PAGE>
Interest and Dividend Income
The following tables set forth information regarding the total amount of income
from interest and dividend earning assets and the resultant average yields for
the year ended December 31, 1998. Information is based on daily average balances
during the period.
<TABLE>
<CAPTION>
Year Ended December 31, 1998
Weighted
Weighted Average
Interest/Dividend Average Annual
Income Balance Yield
----------------- ------------ -----------
<S> <C> <C> <C>
Mortgage securities available for sale(1) $ 7,101,326 $169,564,932 6.19%
Investment in equity securities(2 3) 6,269,376 82,752,904 7.90%
Cash and cash equivalents 4,556,800 84,496,947 5.39%
----------- ------------ ----
Total(3) $17,927,502 $336,814,783 6.41%
=========== ============ ====
</TABLE>
(1) Weighted average mortgage assets were held for 247 days.
(2) Includes accrued interest and amortized commitment fees on convertible
loans to Prime Capital and Kennedy-Wilson. Such amounts are included as
interest income in FBR Asset's statements of income included in its
financial statements.
(3) FBR Asset accrues dividend income based on declared dividends for the
periods presented.
Interest Expense
The following table sets forth information regarding the total amount of
interest expense from repurchase agreements, including the net amount payable
under the interest rate swap agreement and the resultant average yields.
Information is based on daily average balances during the reported periods.
Year ended December 31, 1998
Weighted Weighted
Interest Average Average
Expense Balance(1) Expense
------------ -------------- -----------
Repurchase agreements(2) $ 5,359,633 $144,793,891 5.82%
=========== ============ ====
(1) At December 31, 1998, FBR Asset had $128,550,000 outstanding under
repurchase agreements, with a weighted-average remaining maturity of 73
days.
(2) Repurchase Agreements were entered into on May 13, 1998.
Dividends Declared and Distributions in Excess of GAAP Net Income
Since its organization, FBR Asset has declared dividends for the year in the
amount of $11.1 million, or $1.155 per share, as reflected in Note 4 of Notes to
Financial Statements. These dividends covered FBR Asset's undistributed taxable
income for the period from January 1, 1998, through December 31, 1998, which
exceeded its net income calculation based on generally accepted accounting
principles. For federal income tax purposes, 89% per share of dividends paid in
1998 is expected to be ordinary income to FBR Asset's stockholders, and 11% per
share is expected to be a return of capital for 1998.
Changes in Financial Condition
Securities Available for Sale
At December 31, 1998, FBR Asset had mortgage-backed securities equal to $161.4
million. All of FBR Asset's mortgage-backed securities at December 31, 1998,
were agency pass-through securities that represent a 100% interest in the
45
<PAGE>
underlying conforming mortgage loans. Conforming loans comply with the
underwriting requirements for purchase by Fannie Mae, Freddie Mac, and Ginnie
Mae. These securities bear little risk of credit loss due to defaults because
they are guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac.
Premium balances associated with the purchase of mortgage-backed securities are
amortized as a decrease in interest income over the life of the security. At
December 31, 1998, FBR Asset had on its balance sheet a total of $2.7 million of
unamortized premium representing the difference between the remaining principal
value and the then current historical amortized cost of mortgage-backed
securities acquired.
Mortgage principal repayments received were $21.2 million for the year ended
December 31, 1998. Given FBR Asset's current portfolio composition, if mortgage
principal repayment rates increase over the life of the mortgage-backed
securities comprising the current portfolio, all other factors being equal, FBR
Asset's net interest income would decrease during the life of the
mortgage-backed securities, as FBR Asset would be required to amortize its net
premium balance into income over a shorter time period. Similarly, if mortgage
principal repayment rates decrease over the life of the mortgage-backed
securities, all other factors being equal, FBR Asset's net interest income would
increase during the life of the mortgage-backed securities, as FBR Asset would
be required to amortize its net premium balance over a longer time period.
At December 31, 1998, $10.5 million of net unrealized losses on equity
securities and $0.7 million of net unrealized gains on mortgage-backed
securities were included as accumulated other comprehensive income. See
"Stockholders' Equity" elsewhere in "Management's Discussion and Analysis" and
Note 3 of Notes to Financial Statements for further discussion.
Repurchase Agreements
On December 31, 1998, FBR Asset had $128.6 million outstanding under various
repurchase agreements with several financial institutions. To date, FBR Asset's
debt has consisted entirely of borrowings collateralized by a pledge of most of
FBR Asset's mortgage-backed securities. FBR Asset has obtained, and believes it
will be able to continue to obtain, short-term financing in amounts and at
interest rates consistent with FBR Asset's financing objectives. FBR Asset
limits its borrowings, and thus its potential asset growth, in order to maintain
unused borrowing capacity, and thereby increase the liquidity and strength of
its balance sheet. At December 31, 1998, the ratio of the company's indebtedness
for borrowed money to shareholders' equity was 0.85 to 1.
For the year ended December 31, 1998, the term to maturity of FBR Asset's
borrowings has been limited to 92 days with a weighted average remaining
maturity as of December 31, 1998, of 73 days and a weighted average cost of
funds on outstanding borrowings of 5.82%.
Contractual Commitments
During 1998, FBR Asset entered into two interest rate swap agreements to offset
the potential adverse effects of rising interest rates under some of its
short-term repurchase agreements, of which only one remains a commitment. That
agreement is with Salomon Brothers Holding Company Inc. Salomon Smith Barney
46
<PAGE>
Holdings, Inc., the parent company of Salomon Brothers Holding Inc., has a
long-term debt rating of "A" by S&P. Under the swap agreement with Salomon, FBR
Asset receives quarterly payments of interest based on three-month LIBOR and
remits semi-annual payments based on a fixed interest rate of approximately 5.9%
based upon the $50 million notional amount of the swap.
The swap became effective on June 1, 1998, and matures on June 1, 2001. At
December 31, 1998, the interest rate payable to FBR Asset by Salomon was 5.07%.
The timing of quarterly receipts under the swap approximates the timing of the
repricing dates for the repurchase agreements. The payments received under the
swap agreement have substantially offset the interest payments under the
repurchase agreeements. In some circumstances, FBR Asset may be required to
provide collateral to secure its obligations under the interest rate swap
agreement or may be entitled to receive collateral from the counterparty to the
swap agreement. At December 31, 1998, no collateral was required under the
interest rate swap agreement.
In October 1998, FBR Asset terminated an interest rate swap agreement with
Lehman Brothers. As a result of the termination, FBR Asset realized a loss of
$1.9 million that was recognized as a charge to income.
Capital Resources and Liquidity
Liquidity is a measurement of FBR Asset's ability to meet potential cash
requirements including ongoing commitments to repay borrowings, fund
investments, loan acquisition and lending activities, and for other general
business purposes. The primary sources of funds for liquidity consist of
repurchase agreements and maturities, distributions or principal payments on
mortgage-backed and equity securities, and proceeds from sales of those
securities. To date, proceeds from the issuance of common stock and repurchase
agreements have provided FBR Asset with sufficient funding for its investment
needs. Potential future sources of liquidity for FBR Asset include existing cash
balances, borrowing capacity through margin accounts, and future issuances of
common, preferred stock or debt. FBR Asset believes that its existing cash
balances, borrowing capacity through margin accounts and borrowing capacity
under collateralized repurchase agreements will be sufficient to meet its
investment objectives and fund operating expenses for at least the next twelve
months. There can be no assurance that FBR Asset will be able to generate
sufficient funds from future operations, or raise sufficient debt or equity on
acceptable terms, to take advantage of investment opportunities that become
available. Should FBR Asset's needs ever exceed these sources of liquidity,
management believes FBR Asset's mortgage-backed securities could be sold, in
most circumstances, to provide cash.
For the year ended December 31, 1998, FBR Asset's operating activities provided
net cash flows of $11.2 million. The primary source of operating cash flow was
interest on mortgage-backed securities and cash equivalents and dividends from
REIT investments. For the same period, FBR Asset's investing activities, which
were primarily purchases of mortgage-backed securities and equity investments,
resulted in net cash out-flows totaling $232.3 million. FBR Asset's financing
activities resulted in net cash in-flows of $99.0 million during the year ended
December 31, 1998. Cash flows from financing activities consisted primarily of
net proceeds from short-term repurchase agreements and proceeds from the
issuance of 196,828 shares of common stock in January 1998, offset partially by
funds used to repurchase FBR Asset's common stock and funds distributed to
shareholders.
47
<PAGE>
Shareholders' Equity
FBR Asset accounts for its investments in mortgaged backed securities and other
equity instruments in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." Under SFAS 115, FBR Asset has classified these investments
as "available-for-sale." Securities classified as available for sale are
reported at fair value, with temporary unrealized gains and losses excluded from
earnings and reported as a separate component of stockholders' equity as
accumulated other comprehensive income.
Also in accordance with SFAS 115, management must regularly evaluate whether
declines in the market value of its securities available-for-sale are other than
temporary. In performing this evaluation, FBR Asset looks to the financial
condition and business performance of each investment relative to that expected
at the time of purchase. FBR Asset also evaluates overall economic and
industry-specific conditions.
If FBR Asset determines that declines are other than temporary, it records a
charge against income for the difference between an investment's cost basis and
its estimated fair value. For the year ended December 31, 1998, FBR Asset
recorded a charge to reflect the decline in value of its investment in Chastain,
which FBR Asset determined is other than temporary. That determination resulted,
in substantial part, from Chastain's announcement that it was suspending its
dividend for the fourth quarter of 1998.
The value of the equity securities in FBR Asset's portfolio has declined from
$87.8 million as of the date the investments were made to $71 million as of
December 31, 1998. Declines have been recorded as accumulated other
comprehensive income in the statement of stockholders' equity, except that FBR
Asset has realized and charged to income a loss of $6.6 million on its
investment in Chastain. See Note 3 of Notes to Financial Statements.
With respect to each of FBR Asset's other equity investments, management
believes that, as of December 31, 1998, their decline in fair value was
temporary. That belief is based on several facts, including the following:
o None of the other REITs has suspended their dividends.
o Each of the equity securities has increased in fair value since the
worst of the liquidity crisis in September 1998.
o Each of the REIT securities owned has experienced pricing movements
similar to the Morgan Stanley REIT Index for the past six months. This
similar movement indicates that the entire industry has declined and
not just one specific company.
o The sharpest movements within the REIT sector track similar declines
and subsequent increases in the Dow Jones Index (serving as a leading
indicator by several weeks) and the Russell 2000 Index.
Based on these factors, FBR Asset believes that the declines are not persistent
declines in market value, but rather reflect general market and REIT sector
pricing movements, and are therefore temporary changes. Further, FBR Asset has
the intent and ability to hold each of its investments to allow for the
anticipated recovery in stock prices. There can be no assurances that other
charges will not be required in future periods.
48
<PAGE>
As a result of "mark-to-market" accounting treatment, the book value and book
value per share of FBR Asset are likely to fluctuate far more than those of
companies who do not make investments in marketable and non-marketable debt and
equity securities. As a result, comparisons with these companies may not be
meaningful.
FBR Asset's Board of Directors has authorized a program to repurchase up to
2,000,000 shares of FBR Asset's common stock. Through December 31, 1998, FBR
Asset had repurchased 1,872,300 shares of its common stock pursuant to the
program at an average price of $12.86 per share.
Year 2000 Compliance
FBR Asset's software and information systems are Year 2000 compliant. However,
FBR Asset places significant reliance on the technologies of FBR Management and
BlackRock. FBR Asset's reliance on FBR Management primarily relates to
information technology systems, more specifically, the general ledger
applications and to a lesser extent the brokerage and trading information
systems, including related hardware. These information systems are commercially
provided, widely-used hardware and software. FBR Management, together with FBR,
has contacted key external vendors in an effort to assess the systems' readiness
for the Year 2000. Due diligence that FBR has and is continuing to perform to
evaluate the readiness of key third party vendors includes point-to-point
testing with mission critical vendors, conducting interviews with key third
party vendor Year 2000 program offices, and analysis of compliance letters
received from third party vendors. To date, FBR has not encountered a vendor
that does not expect to be fully compliant by the end of 1999. In addition, FBR
intends to continue monitoring the progress of its third party vendors through
the following activities: performing additional point-to-point testing when
third party vendors provide this capability, reviewing status updates whenever
provided by third party vendors, and reviewing results from the Securities
Industries Association when made available.
Both FBR Management and FBR are currently in the process of finalizing their own
internal testing, remediation and validation of all vendor supported critical
systems, including those related to FBR Asset. FBR Management and FBR are also
currently finalizing their contingency planning for Year 2000 and have
represented that those plans will be completed no later than March of 1999, with
an implementation target of the third quarter of 1999. FBR Management and FBR
have represented to FBR Asset that the total cost to complete their Year 2000
compliance efforts is estimated to be less than $150,000.
FBR Asset also places significant reliance on certain technologies of BlackRock.
Management has inquired of BlackRock and has been provided information regarding
the status of BlackRock's Year 2000 readiness. BlackRock has identified its
critical technology areas and systems with Year 2000 exposure. Those systems and
the areas identified by BlackRock that may affect FBR Asset include BlackRock's
internally developed trading and analytical systems, the accounting and
reporting systems for fixed income securities including mortgage-backed
investments, and relationships with daily market pricing and data providers,
asset custodians and clearing brokers. BlackRock has indicated that it has
49
<PAGE>
completed all testing, remediation, and validation of its internal systems.
Furthermore, BlackRock expects to complete upgrades to Year 2000 compliant
versions of all major systems reliant on third party software and that to date,
it has received responses regarding compliance with or plans to address
compliance from over 90% of its business partners and service providers. These
responses, which in most cases were in writing, generally indicate the
responding party's year 2000 readiness and plans. There is no assurance,
however, that either BlackRock's internal systems or the external systems it
uses will work properly on or after January 1, 2000.
BlackRock is currently in the process of developing and finalizing contingency
plans related to this issue. BlackRock expects that such plans are expected to
be completed by April of 1999 and fully implemented by the middle of 1999.
BlackRock has estimated that the aggregate cost of its Year 2000 compliance
efforts will not exceed $500,000.
FBR Asset is currently evaluating its contingency plan alternatives,
particularly with respect to its reliance on the information systems provided by
BlackRock and FBR Management. FBR Asset expects to complete such plans not later
than July of 1999.
There can be no assurance that the systems on which FBR Asset currently relies
will be operationally effective by the end of 1999. If those systems are not
Year 2000 compliant, their failure could have a material adverse effect on FBR
Asset's operations. Furthermore, the failure of banking and securities systems
in general--although an unlikely occurrence and one totally beyond our
control--could have a material adverse effect on FBR Asset's operations. In the
worst case, FBR Asset could be required to establish its ownership of assets and
its entitlement to interest and dividend payments on those assets. FBR Asset
maintains trade tickets and other written documentation that it believes would
be adequate to establish its ownership of those assets.
Market Conditions
The ability of FBR Asset to make investments is dependent upon a number of
factors, including the overall health of the equity and debt capital markets,
the condition of the U.S. and foreign real estate markets, the ability of other
REITs and real estate owners and operators to access equity and debt through the
capital markets, the availability of credit to finance the acquisition of
assets, and the interest rates that FBR Asset pays to finance its purchases.
Equity Market Conditions
1998 was a volatile year in the U.S. equity and debt markets. The Standard &
Poor's 500 Index, or "S&P 500," is a capitalization-weighted index of 500 stocks
designed to measure changes in the aggregate market value of 500 stocks that
represent all major industries. The S&P 500 began the year at 975.0 and ended
the year at 1,229.2, an increase of 26.1%. However, from July 15, 1998, to
October 21, 1998, the S&P 500 dropped approximately 200 points, a decrease equal
to 17.0%.
FBR Asset has investments in REIT securities and small-cap stock securities.
While the S&P 500 was up in 1998, indices that track composite prices for
small-cap and REIT stocks reflect a different performance. A key index that
tracks small-cap stocks is the Russell 2000 Index. The Russell 2000 is comprised
of the smallest 2000 companies in the Russell 3000 Index, which represents 98%
of the investable securities in the U.S. equity market. The Russell 2000 began
50
<PAGE>
1998 at 436.5 and ended the year at 422.0, a decrease of 3.32%. Similar to the
mid-year drop in the S&P 500, the Russell 2000 dropped from a 1998 high on April
21, 1998, of 491.4 to a low on October 10, 1998, of 310.3, a decline of 36.9%.
The Morgan Stanley REIT Index is a total return index that tracks the most
actively traded real estate investment trusts and is designed to be a measure of
real estate equity performance. The Morgan Stanley REIT Index began the year at
363.2 and ended the year at 302.4, a decrease of 16.7%.
Some of the factors that FBR Asset believes have influenced the fluctuations of
the equity markets include statements from the Chairman of the Federal Reserve
Board, Alan Greenspan, that the prices of stocks reflected an "irrational
exuberance" relative to historical price earnings ratios, a declaration from the
Russian government that it did not intend to continue current payments on its
outstanding debt obligations, general turmoil in Asia, particularly Asian
financial institutions, and currency devaluation in Brazil.
The debt markets were also affected by the factors influencing the equity
markets. In response to concerns about a potential recession in the U.S. and
events such as the Russian bond default, the Federal Reserve cut the federal
funds rate, the rate it charges on overnight borrowings by banks, on three
separate occasions in 1998. General uneasiness about the health of international
economies prompted investors to sell their investments in the debt of other
countries and invest the sales proceeds in U.S. Treasuries. As a result, prices
for U.S. Treasuries increased and yields decreased.
REIT and Real Estate Market Conditions
Through December 31, 1998, FBR Asset invested $87.8 million in equity securities
of eight companies, including six REITs and two companies that operate real
estate-related businesses. The value of FBR Asset's equity investments is
subject to factors that affect the stock prices of companies in which it has
invested. FBR Asset and the companies in which it has invested are affected by
changes in interest rates, the condition of the REIT equity and debt markets,
the availability of credit to REITs through commercial mortgage-backed
securities issuance and lending from financial institutions, and the underlying
leasing, occupancy and development trends affecting the fundamental operations
of real property.
REIT Equity Market
REITs, such as FBR Asset, are required to distribute to their shareholders at
least 95% of their taxable income each year. As a result, REITs have limited
ability to retain earnings for growth and must access the capital markets on a
continual basis to finance growth plans. During the period from 1995 to
mid-1998, the prices of REIT stocks steadily increased, driven by investor
expectations that REITs would use the proceeds from equity financings to acquire
additional properties that would generate accretive earnings. However, FBR Asset
believes that as more REITs raised more money and prices for property
acquisitions increased, there were fewer opportunities available for REITs to
acquire properties that were accretive to earnings. As a result, in mid-1998,
investors began to adjust their growth expectations for REITs, which caused REIT
stock prices to decline. In addition, just as the global financial crises caused
investors to sell investments in foreign debt issuances and invest in U.S.
Treasuries, FBR Asset believes that investors began selling REIT securities to
invest in larger, more well-capitalized stocks such as those included in the S&P
500. See "Equity Market Conditions" for a more detailed discussion of the
factors that FBR Asset believes to have influenced the equity markets.
51
<PAGE>
FBR Asset's ability to fund its growth and find attractive investments is, in
part, dependent upon the market conditions for REITs. In 1998, there were
sixteen REIT initial public offerings, which raised a total of $2.1 billion. Of
the sixteen REIT initial public offerings, seven were mortgage REITs, which
raised $848 million. Of the seven mortgage REIT initial public offerings, FBR
Asset invested $33.3 million in contemporaneous private placements by three. Of
the nine equity REIT initial public offerings, FBR Asset invested $25 million in
a contemporaneous private placement by one.
The market for initial public offerings and secondary common stock offerings of
REIT securities was robust during the first and second quarters of 1998.
However, because of factors affecting the debt and equity markets, the market
for REIT offerings essentially closed during the third and fourth quarters. The
table below summarizes public common equity raised by REITs from January 1, 1998
to December 31, 1998.
<TABLE>
<CAPTION>
IPO Secondary
------------------------------------------ --------------------------------------------
($ In Millions)
Market Market
Mortgage Equity Value Mortgage Equity Value
REITs REITs Total 12/31/98 REITs REITs Total 12/31/98
-------- ------ ----- -------- -------- ------ ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
First Quarter $522.3 $ 657.4 $1,179.7 -30.35% $ 71.6 $4,198.3 $4,269.9 -18.80%
Second Quarter 325.7 557.3 883.0 -37.50% 44.1 2,395.5 2,439.6 -14.13%
Third Quarter 12.0 12.0 -37.50% - 100.9 100.9 -4.49%
Fourth Quarter - - - - - 211.0 211.0 1.56%
------ -------- -------- ------ ------ -------- -------- ------
Total Year-to-Date $848.0 $1,226.7 $2,074.7 -33.61% $115.7 $6,905.7 $7,021.9 -16.36%
====== ======== ======== ====== ====== ======== ======== ======
</TABLE>
Source: CommScan Equidesk, Inc.
FBR Asset's investments in REITs have experienced declines similar to the
declines in market value reflected above. See "Summary of Current Investments &
Cash and Cash Equivalents." Historically, FBR Asset has invested in REITs and
companies that propose to elect REIT status. There has been no significant
strengthening in the market for REIT stocks since December 31, 1998. For so long
as the market for public offerings of REIT stocks remains weak, FBR Asset will
have to find other investment opportunities.
Real Estate Market
Despite the fluctuations of the REIT equity markets, FBR Asset believes the
underlying fundamentals in real estate have continued to improve. Overall
vacancy rates in many major U.S. real estate markets have decreased from highs
reached in the late 1980s and early 1990s to levels that historically would have
resulted in substantial increases in speculative development. However, FBR Asset
believes that REIT investors and reports by analysts who follow REITs have
effectively restrained new speculative development activity by reducing the
availability of financing for development and by analyzing and questioning the
need for new developments.
FBR Asset believes that sectors of the commercial real estate market such as
central business district office buildings, industrial warehouse facilities that
serve as national distribution centers, luxury and full service hotels,
apartments in areas where development is constrained by lack of land or
development restrictions, and assisted living facilities with strong operators
are still attractive to institutional investors.
52
<PAGE>
FBR Asset has invested in the equity securities of Prime Retail, which invests
in factory outlet malls, and East-West Bancorp, which invests in multifamily
housing. In addition, FBR Asset has made loans to Kennedy-Wilson, Prime Capital,
Prime Group and Brookdale, as described below.
Real Estate-Based Lending Market
One of the most important factors associated with an investment in real estate
is the availability of debt to finance a significant portion of the investment.
In recent years, traditional lending sources such as banks and insurance
companies have been supplemented by capital market financing through lending
conduits. These conduits make loans and finance the loans by the sale of
securities backed by and payable from the payments on the loans. The growth of
these commercial mortgage-backed securities, or CMBS, has been significant.
The mortgage loans that can be most efficiently securitized are traditional
first mortgage loans underwritten to traditional institutional lending
standards. The CMBS that can be most easily placed at attractively low interest
rates are those that have been rated in one of the investment grade categories
by a recognized rating agency.
FBR Asset has calculated its investment in real based lending investments in
real estate based loans that are not easily securitized and, to a lesser extent,
in CMBS that is not investment grade rated. FBR Asset has made indirect
investments in commercial mortgage REITs whose business plans contemplated them
retaining subordinated mortgage loans that they originate or acquire and
securitize. The market value of those mortgage REITs has declined significantly
since the time FBR Asset made those investments, attributable in fact to the
filing in October of 1998 by CRIIMI MAE, the largest commercial mortgage REIT,
for protection under Chapter 11 of the bankruptcy code. The filing by CRIIMI MAE
and general market conditions resulted in a tightening of credit available to
mortgage REITs. This in turn made it more difficult for mortgage REITs and other
conduit lenders to originate loans and finance growth.
FBR Asset has made direct investments in real estate based loans. Investments in
1998 were loans to Prime Capital and Kennedy-Wilson aggregating $20 million.
Since December 31, 1998 has invested $12 million in loans to Brookdale Living
Communities and Prime Group Realty Trust. Each of these loans provides debt
financing for capital needs not covered by traditional secured and senior loans
and available equity. FBR Asset anticipates that there will be a continued
demand for this type of loan and that it will make additional similar real
estate based loans in the future.
Interest Rate Environment
FBR Asset's earnings depend, in part, on the relationship between long-term
interest rates and short-term interest rates. FBR Asset's direct investments in
mortgage-backed securities bear interest at fixed rates determined by reference
to the yields of medium- or long-term U.S. Treasury securities or at adjustable
rates determined by reference to the yields on various short-term instruments.
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<PAGE>
From January 1, 1998, to December 31, 1998, interest rates on U.S. Treasury
securities have declined, in part, as a reaction to global financial
uncertainties. U.S. and international investors have reduced their exposure to
foreign government and corporate bonds and increased their investments in U.S.
Treasury securities. This has resulted in higher prices for Treasury securities
and lower yields. As a result, the yield curve has inverted such that
short-term, non-Treasury borrowing rates exceed long-term Treasury rates.
FBR Asset has invested in fixed-rate long-term mortgage backed securities and
financed a significant portion of that investment with short term borrowings at
short-term borrowing rates. As a general matter, FBR Asset's mortgage backed
securities portfolio performs better where the spread between short-term
interest rates and long-term interest rates increases and less well as it
decreases. The following table summarizes the relationship in 1998 between LIBOR
and the 10-year U.S. Treasury yield. FBR Asset's borrowings typically bear
interest rates that have historically moved in close relationship to LIBOR. FBR
Asset's incentive management fee is based on the ten-year U.S. Treasury.
<TABLE>
<CAPTION>
Yield
-----------------------------------------------------------------------------------------
High Low Average
-------------------------- ---------------------------- ------------------------
10-Year Net 10-Year Net 10-Year Net
Treasury LIBOR Spread Treasury LIBOR Spread Treasury LIBOR Spread
-------- ----- ------ -------- ----- ------ -------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
First Quarter 5.78% 5.72% 0.06% 5.30% 5.59% -0.29% 5.58% 5.65% -0.07%
Second Quarter 5.81% 5.69% 0.12% 5.35% 5.64% -0.29% 5.59% 5.66% -0.07%
Third Quarter 5.52% 5.66% -0.14% 4.42% 5.34% -0.92% 5.20% 5.62% -0.42%
Fourth Quarter 4.94% 5.63% -0.69% 4.44% 5.03% -0.59% 4.70% 5.36% -0.66%
------ ----- ----- ------ ------ ----- ------ ----- -----
1998 Average 5.51% 5.68% -0.16% 4.88% 5.40% -0.52% 5.27% 5.57% -0.31%
====== ===== ===== ====== ====== ===== ====== ===== =====
1998
Increase/(Decrease) -0.84% -0.09% -0.86% -0.56% -0.88% -0.29%
1998 Percentage
Increase/(Decreases) -14.53% -1.57% -16.23% -10.02% -15.77% -5.13%
</TABLE>
Source: Bloomberg
As the table indicates, as of December 31, 1998, the average yield on the
ten-year U.S. Treasury security had decreased 15.8% during 1998, from 5.58% to
4.70%, and LIBOR decreased 5.1% from 5.65% to 5.36% during the same period.
For the year ended December 31, 1998: the weighted average annual yield on
mortgage-backed securities owned by FBR Asset was 6.19%; the annual management
fee associated with that investment was 0.25; and the weighted average interest
rate on FBR Asset's repurchase agreement borrowings was 5.82%. The net interest
rate spread was 0.12%.
54
<PAGE>
The decline in the yields of U.S. Treasury securities have caused an increase in
the spreads in the CMBS market. Increasing spreads, in turn, have caused
declines in CMBS values. As a result, many lenders who financed CMBS assets with
repurchase agreements have required borrowers to meet margin calls resulting
from the declining value of the CMBS assets. Unlike CMBS, the mortgage-backed
securities held directly by FBR Asset are insured by Ginnie Mae, Fannie Mae or
Freddie Mac and are not leveraged to the fullest extent possible. There can be
no assurance that FBR Asset can obtain additional leverage, that margin calls
will not be made, or that replacement financing will be available if lenders
rescind their repurchase agreements.
For the mortgage REITs in which FBR Asset has invested, the inversion of the
yield curve, coupled with the higher yields commanded by investors in CMBS, made
it less profitable or unprofitable to acquire and finance commercial mortgage
loan portfolios priced at a spread fixed to corresponding U.S.
Treasury rates.
Market Risk
Market risk generally represents the risk of loss that can result from a change
in the prices of equity securities in the equity market, a change in the value
of financial instruments as a result of changes in interest rates, a change in
the volatility of interest rates or, a change in the credit rating of an issuer.
FBR Asset is exposed to the following market risks, as a result of its
investments in mortgage-backed securities and equity investments. None of these
investments are held for trading purposes.
Interest Rate Risk
FBR Asset is subject to interest rate risk as a result of its investments in
mortgage-backed securities and its financing with repurchase agreements, all of
which are interest rate sensitive financial instruments. FBR Asset is exposed to
interest rate risk that fluctuates based on changes in the level or volatility
of interest rates and mortgage prepayments and in the shape and slope of the
yield curve. FBR Asset attempts to hedge a portion of its exposure to interest
rate risk primarily through the use of interest rate swaps.
FBR Asset's primary risk is related to changes in both short and long term
interest rates, which affect the company in several ways. As interest rates
increase, the market value of the mortgage-backed securities may be expected to
decline, prepayment rates may be expected to go down and durations may be
expected to extend. An increase in interest rates is beneficial to the market
value of FBR Asset's swap position as the cash flows from the floating rate
portion increase under this scenario. The reverse is true for mortgage-backed
securities and the swap if interest rates decline.
The fair value of interest rate swap agreements that qualify as hedges is not
recorded for accounting purposes. The differential between amounts paid and
received under the swap agreements is recorded as an adjustment to the interest
expense incurred under the repurchase agreements. In the event of early
termination of a swap agreement, a gain or loss is recorded and the company
receives or makes a payment based on the fair value of the swap agreement.
The table that follows shows the expected instantaneous change in market value
for FBR Asset's current mortgage-backed securities and interest rate swaps under
several interest rate "shocks." Each rate shift assumes that interest rates
change uniformly across the yield curve. The portfolio may be expected to
benefit less from a decline in interest rates than it will be adversely affected
by a similiar scale increase.
55
<PAGE>
<TABLE>
<CAPTION>
Value at Value at
12/31/98 12/31/98
with 100 with 100
basis point basis point
increase in decrease in
Value at interest Percent interest Percent
12/31/98* rates Change rates Change
------------- ------------- -------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Assets
Mortgage securities 161,418,739 157,134,949 -2.65% 163,478,100 1.28%
Other 134,511,881 134,511,881 - 134,511,881 -
------------- ------------- ------------
Total Assets 295,930,620 291,646,830 -1.45% 297,989,981 0.70%
============= ============= ============
Liabilities
Interest rate swap 0 -1,039,000 1,069,000
Other 145,026,041 145,026,041 145,026,041
------------- ------------- ------------
Total Liabilities 145,026,041 143,987,041 -0.72% 146,095,041 0.74%
============= ============= ============
Shareholders' Equity
Common stock 104,158 104,158 - 104,158 -
Paid-in-capital 194,097,193 194,097,193 - 194,097,193 -
Accumulated -9,800,530 -13,045,320 - -8,810,169 -
comprehensive income
Retained earnings -9,425,579 -9,425,579 - -9,425,579 -
(deficit)
Treasury stock -24,070,663 -24,070,663 - -24,070,663 -
------------- ------------- ------------
Total Shareholders' 150,904,579 147,659,789 - 151,894,940 -
Equity ============= ============= ============
Total Liabilities and
Shareholders' Equity 295,930,620 291,646,830 -1.45% 297,989,981 0.70%
</TABLE>
*Includes Accrued Interest
The value of FBR Asset's investments in other companies is also likely to be
affected by significant changes in interest rates. First, many of the companies
are exposed to risks similar to those identified above as being applicable to
FBR Asset's direct investments. Second, the REITs in which FBR Asset has
invested tend to trade on a yield basis. As interest rates increase, the yield
required by investors in REITs, thrifts and other financial institutions
increases with the result that market values decline. Finally, changes in
interest rates often affect market prices of equity securities generally.
Because, as each of the companies in which FBR Assets invests has its own
interest rate risk management process, it is not feasible for us to quantify the
potential impact that interest rate changes would have on the stock price or the
future dividend payments by any of the companies in which FBR Asset has
invested.
Equity Price Risk
FBR Asset is exposed to equity price risk as a result of its investments in
equity securities of REITs and other real estate related companies. Equity price
risk changes as the volatility of equity prices changes or the values of
corresponding equity indices change.
While it is impossible to project with any exactitude what factors may affect
the prices of equity sectors and how much that might be, the table below
illustrates the impact a ten percent increase and a ten percent decrease in the
price of the equities held by FBR Asset would have on the value of the total
assets and the book value of FBR Asset as of December 31, 1998.
<TABLE>
<CAPTION>
Value at Value at
December 31, December 31,
Value at 1998 with 10% 1998 with 10%
December 31, increase in Percent decrease in Percent
1998 price Change price Change
-------------- -------------- ------- -------------- --------
<S> <C> <C> <C> <C> <C>
Assets
Equity securities $ 70,983,050 $ 78,081,355 10.00% $ 63,884,745 (10.00%)
Other 224,947,570 224,947,570 - 224,947,570 -
------------ ------------ ------------
Total Assets $295,930,620 $303,028,925 2.40% $288,832,315 (2.40%)
============ ============ ============
Liabilities 145,026,041 145,026,041 - 145,026,041 -
Shareholders' Equity
Common stock 104,158 104,158 - 104,158 -
Paid-in-capital 194,097,193 194,097,193 - 194,097,193 -
Accumulated
comprehensive income (9,800,530) (2,702,225) 72.43% (16,898,835) (72.43%)
Retained earnings
(deficit) (9,425,579) (9,425,579) - (9,425,579) -
Treasury stock (24,070,663) (24,070,663) - (24,070,663) -
------------ ------------ ------------
Total Shareholders' Equity $150,904,579 $158,002,884 4.70% $143,806,274 (4.70%)
Total Liabilities and
Shareholders'
Equity $295,930,620 $303,028,925 2.40% $288,832,315 (2.40%)
============ ============ ============
Book value per share $17.66 $18.49 4.70% $16.83 (4.70%)
</TABLE>
56
<PAGE>
Except to the extent that FBR Asset sells its equity investments, an increase or
decrease in the market value of those assets will not directly affect FBR
Asset's earnings, although an increase or decrease in interest rates would
affect the market value of the assets owned by the companies in which FBR Asset
invests. Consequently, if those companies' earnings are affected by changes in
the market value of their assets, that could in turn impact their ability to pay
dividends, which could in turn affect FBR Asset's earnings. If FBR Asset had
sold all of its equity investments on December 31, 1998, the company would have
incurred a loss of approximately $10.25 million and that loss would have been
directly charged to earnings.
Developments Since December 31, 1998
On January 14, 1999, FBR Asset repurchased 107,000 shares under its authorized
buyback program at $13.70 per share. As of February 12, 1999, there were
8,436,527 shares outstanding.
On January 25, 1999, FBR Asset loaned Brookdale Living Communities, Inc. $5
million in subordinated debt that is due and payable on April 26, 1999. The loan
bears interest at a rate of 13% per annum. See "FBR & FBR Management--Related
Party Transactions."
On February 5, 1999, FBR Asset made a secured loan to Prime Group Realty Trust
in the amount of $7 million. The loan is due and payable on August 5, 1999, and
bears interest at a rate of 15% per annum. See "FBR & FBR Management--Related
Party Transactions."
As of March 12, 1999, the market value of the equity securities owned by FBR
Asset on December 31, 1998, had declined from $71 million to $64 million.
57
<PAGE>
FBR Asset's Directors & Officers
FBR Asset's principal executive offices are located in Arlington, Virginia, at
Potomac Tower, 1001 Nineteenth Street North. The phone number is (703) 469-1000.
The Board of Directors
Composition of the Board
FBR Asset's Board consists of five members. All directors are elected at each
annual meeting of FBR Asset's shareholders for a term of one year. Directors
hold office until their successors are elected and qualified. Two of FBR Asset's
five directors are independent directors. The remaining three directors are
Affiliates of FBR Management.
An "independent director" is a person who has not, in the past two years:
o owned a material interest in FBR Management or any of its Affiliates;
o been employed by FBR Management or any of its Affiliates;
o been an officer or director of FBR Management or any of its Affiliates;
or
o performed any material services for FBR Management or any of its
Affiliates.
For purposes of determining who may be classified as an independent director:
o FBR Asset is not considered an Affiliate of FBR Management;
o an "interest" is deemed material if it:
o exceeds 5% of a person's outstanding voting securities, or
o 5% of a person's net worth on a fair market value basis; and
o "services" are deemed material if the gross revenue derived from them
exceeds 5% of a person's:
o annual gross revenue from all sources in either of the past two
years; or
o net worth on a fair market value basis.
No person will be disqualified from serving as an independent director solely
because (a) that person maintains a discretionary brokerage account with FBR
Management or its Affiliates or (b) FBR Management or the Affiliates perform
other services for such person, whether material or not.
An "Affiliate" of FBR Management is any person, including a corporation or other
entity, that:
o FBR Management directly or indirectly controls;
o directly or indirectly controls FBR Management;
o is under common control with FBR Management;
o is an officer of, partner in, or director of FBR Management, or serves
in a similar capacity with respect to FBR Management; or
58
<PAGE>
o directly or indirectly, beneficially owns, controls or holds, with the
power to vote, more than 10% of any class of FBR Management's equity
securities.
Affiliates of FBR Management also include those persons, including corporations
and other entities:
o for which FBR Management serves as an officer, partner, or director, or
serves in some similar capacity; or
o of which FBR Management beneficially owns, controls or holds, with the
power to vote, directly or indirectly, more than 10% of a class of that
person's equity securities.
FBR Asset's Charter requires that, except in the case of a vacancy, at least 30%
of the members of the Board of Directors will be independent directors. With a
view toward protecting the interests of FBR Asset's shareholders in transactions
involving conflicts with FBR Management, a majority of the independent directors
must approve:
o any transaction in which FBR Asset seeks to acquire securities that are
being underwritten or placed by FBR; and
o any transaction involving FBR Asset in which FBR has a material
financial interest, as determined by all of the directors in their role
as fiduciaries, including but not limited to, any decisions concerning
the termination or renewal of the Management Agreement.
In making their decisions, the independent directors will consider information
provided by FBR Management and such other information as they deem appropriate
to determine whether such transactions will be in FBR Asset's best interests.
The independent directors will not otherwise participate in FBR Asset's daily
operations and will have no ability to cause the company to take action or
refrain from taking action against the wishes of the inside directors. The
independent directors will, however, review transactions engaged in by FBR Asset
on a quarterly basis and will review FBR Asset's investment policies annually.
Investors should be aware that, in conducting these reviews, the independent
directors will rely primarily on information provided to them by FBR Management.
Executive Committee
The executive committee consists of Messrs. Friedman, Billings, and Ramsey. Mr.
Billings serves as the chairman of the executive committee. When the Board is
not in session, the executive committee exercises all of the Board's authority,
provided, however, that unless otherwise authorized by FBR Asset's Bylaws, the
executive committee does not have the authority to elect directors, declare
dividends or distributions on stock, recommend to shareholders any action that
requires shareholder approval, amend or repeal FBR Asset's Bylaws, approve any
merger or share exchange that does not require shareholder approval, authorize
the issuance of stock, or approve transactions that require the approval of the
independent directors.
59
<PAGE>
Audit Committee
The audit committee consists solely of FBR Asset's independent directors,
Messrs. Harlan and Hayes. The audit committee meets with management to consider
the adequacy of the internal controls and the objectivity of financial
reporting. The audit committee also meets with the independent auditors and with
appropriate financial personnel of FBR Asset regarding these matters. The audit
committee recommends to the Board the appointment of independent auditors,
subject to ratification by the shareholders at the annual meeting. The
independent auditors periodically meet alone with the audit committee and have
unrestricted access to the audit committee.
Contracts Committee
The contracts committee consists solely of FBR Asset's independent directors,
Messrs. Harlan and Hayes. The contracts committee assists the Board in reviewing
any contract that FBR Asset may propose to enter into with FBR Management or its
Affiliates, including without limitation, the Management Agreement, and monitors
on an ongoing basis the performance of FBR Management or any of its Affiliates
pursuant to any such contract.
Nominating Committee
The nominating committee consists solely of FBR Asset's independent directors,
Messrs. Harlan and Hayes. The nominating committee assists the Board in
establishing processes for director nominations, including the criteria for
selecting nominees, and identifies and recommends nominees for election to the
Board.
The Directors
FBR Asset's directors are as follows:
The Independent Directors
Name Age Position(s) Held
- ---- --- ----------------
Stephen D. Harlan 65 Director
Webb Hayes 50 Director
Directors Affiliated with FBR Management
Name Age Position(s) Held
- ---- --- ----------------
Emanuel J. Friedman 52 Chairman of the Board
Eric F. Billings 46 Vice Chairman & Chief
Executive Officer
W. Russell Ramsey 38 President & Secretary
60
<PAGE>
Stephen D. Harlan is Chairman of H.G. Smithy Company, a specialized real estate
firm that provides mortgage banking, finance, investment, advisory, and property
management services to commercial real estate investors. Before joining H.G.
Smithy in 1993, Mr. Harlan was Vice Chairman of KPMG Peat Marwick, where he also
served on KPMG's International Council, Board of Directors, and Management
Committee. In June 1995, President Clinton appointed Mr. Harlan to the District
of Columbia Financial Responsibility and Management Assistance Authority, for
which he previously served as Vice Chairman. Mr. Harlan chairs the Finance
Committee, and is a member of the Board of Directors of MedStar Health, Inc. He
(i) serves on the Board of Directors of the Mary and Daniel Loughran Foundation,
Inc., (ii) is a member of the Senior Council of the Greater Washington Board of
Trade, (iii) is a Trustee and member of the Executive Committee of the Carnegie
Endowment for International Peace, and (iv) is the Chairman of the Board of the
Counsel for Court Excellence.
Webb Hayes is a Director and Vice Chairman of United Bank of Virginia, a
subsidiary of United Bankshares. Mr. Hayes was Executive Vice President of
George Mason Bankshares, Inc., and President and CEO of George Mason Bank, N.A.
until its merger with United Bankshares in 1998. Previously, Mr. Hayes was
Chairman and CEO of Palmer National Bankcorp. and Palmer National Bank until its
merger with George Mason Bankshares in 1996. Mr. Hayes serves as a Director of
CERBCO, Inc., and Insituform East, Inc., both public companies headquartered in
Landover, Maryland. He also serves on the Executive Committee of the American
Bankers Association Government Relations Council and served as a Director of the
Federal Reserve Bank of Richmond from 1991-1995. Mr. Hayes received a B.A. from
the University of North Carolina and an executive management degree from
Columbia University School of Business.
Emanuel J. Friedman is Chairman and Chief Executive Officer of FBR Group. He has
continuously served as Chairman and Chief Executive Officer of FBR Group since
co-founding FBR in 1989. As of December 31, 1998, Mr. Friedman owned 21.4% of
the outstanding common stock of FBR Group. Mr. Friedman is involved in FBR's
investment banking, research, brokerage, and asset management activities. He
also manages private investment funds sponsored by FBR Management. Mr. Friedman
founded the Friedman, Billings, Ramsey Foundation, a charitable foundation, in
1993 and currently serves as one of its directors. Mr. Friedman entered the
securities industry in 1973, when he joined Legg Mason Wood Walker & Co., Inc.,
and from 1985 until 1989, he was Senior Vice President in the institutional
sales group at Johnston, Lemon & Co., Incorporated, a Washington, DC brokerage
firm.
Eric F. Billings is Vice Chairman and Chief Operating Officer of FBR Group. He
has continuously served as Vice Chairman and Chief Operating Officer of FBR
Group since co-founding FBR in 1989. As of December 31, 1998, Mr. Billings owned
17.7% of the outstanding common stock of FBR Group. Mr. Billings is involved in
FBR's investment banking, research, brokerage, and asset management activities.
He also manages private investment funds sponsored by FBR Management and is a
director and executive officer of the FBR Family of Funds. Mr. Billings entered
the securities industry in 1982, when he joined Legg Mason Wood Walker & Co.,
Inc., and from 1984 until 1989, he was Senior Vice President in the
institutional sales group at Johnston, Lemon & Co., Incorporated, a Washington,
DC brokerage firm.
61
<PAGE>
W. Russell Ramsey is President of FBR Group. He has continuously served as
President of FBR Group since co-founding FBR in 1989. As of December 31, 1998,
Mr. Ramsey owned 11.9% of the outstanding common stock of FBR Group. Mr. Ramsey
is involved in FBR's investment banking, research, brokerage, and asset
management activities. Before co-founding FBR, Mr. Ramsey served as Vice
President in the institutional sales group at Johnston, Lemon & Co.,
Incorporated, a Washington, DC brokerage firm. Mr. Ramsey is also a director of
Building One Services Corporation, one of the companies in which FBR Asset has
invested.
Executive Officers Who Are Not Directors
All of FBR Asset's executive officers are Affiliates of FBR Management. All
officers serve at the discretion of FBR Asset's Board of Directors.
<TABLE>
<CAPTION>
Name Age Position(s) Held
- ---- --- ----------------
<S> <C> <C>
William R. Swanson 50 Executive Vice President & Chief Operating Officer
Elaine M. Clancy 33 Senior Vice President & Chief Financial Officer
George Abraham 34 Senior Vice President
Robert Smith 39 Senior Vice President & General Counsel
Kurt R. Harrington 46 Treasurer
John M. Blassingame, Jr. 35 Controller
</TABLE>
William R. Swanson is a Managing Director of FBR & Co.'s real estate investment
banking group. Mr. Swanson joined FBR Group in February, 1994. Before that, Mr.
Swanson served as president of H.G. Smithy Company, Inc., a specialized real
estate firm that provides mortgage banking, finance, investment, advisory, and
property management services to commercial real estate investors. Before working
at H.G. Smithy, Mr. Swanson served as a managing director at LaSalle Partners,
Ltd. While with LaSalle Partners, Mr. Swanson managed and directed the firm's
acquisition and development activities for the southeastern region of the United
States. Mr. Swanson received a Bachelor of Science in accounting from the
University of Illinois at Urbana-Champaign and is a Certified Public Accountant.
Mr. Swanson is also a director of Capital Automotive REIT, one of the companies
in which FBR Asset has invested.
Elaine M. Clancy is a Senior Vice President of FBR & Co.'s real estate
investment banking group. Ms. Clancy joined FBR in 1994. Prior to joining FBR &
Co., Ms. Clancy was a Manager of Finance for Combined Properties, Inc., a real
estate firm in Washington, DC, which owns shopping centers. Before Combined
Properties, Ms. Clancy was a financial analyst with La Salle Partners. Ms.
Clancy received a Masters in Management from the J.L. Kellogg Graduate School of
Management at Northwestern University and a Bachelor of Business Administration
from James Madison University.
George Abraham is a Managing Director of FBR Management. Mr. Abraham is
responsible for marketing, administration, and investor relations for several of
FBR Management's private investment partnerships. He joined FBR at its inception
in 1989 and has been involved in its investment management business since 1992.
Mr. Abraham received his Masters of Business Administration in Marketing from
Southeastern University and a Bachelor of Engineering from B.I.E.T. in India.
62
<PAGE>
Robert S. Smith is Executive Vice President and General Counsel of FBR Group and
FBR Management. Before joining FBR in January 1997, Mr. Smith was a partner in
the law firm of McGuire, Woods, Battle & Boothe, LLP, where he had been in
practice since 1986, and represented FBR from its inception in 1989. Mr. Smith
formerly practiced as a lawyer in the United Kingdom from 1982-1985. Mr. Smith
received his Masters in Law from the University of Virginia and his diploma in
legal practice and a Bachelor of Laws from the University of Edinburgh.
Kurt R. Harrington joined FBR Group in March 1997, as Vice President,
Finance/Treasurer. From September 1996 to March 1997, Mr. Harrington was a
consultant to the venture capital industry. For the five years before then, Mr.
Harrington was Chief Financial Officer of Jupiter National, Inc., a
publicly-traded venture capital company, and in that capacity, served as a
director of a number of companies, including Viasoft, Inc., a publicly-held
software company from January 1994 to October 1995. Mr. Harrington is a
Certified Public Accountant.
John M. Blassingame, Jr., joined FBR Group in February 1998, as a Senior
Accountant. From 1993 to 1998, Mr. Blassingame was a Senior Accountant at
Capital Real Estate Investment where he supervised a REIT portfolio consisting
of approximately 5,000 apartment units, with approximately $50 million in yearly
gross revenues. From 1988 to 1993, Mr. Blassingame was a Senior Public Fund
Accountant at Oxford Realty Services Corp., where he supervised the SEC filings
for Oxford Residential Properties. Mr. Blassingame received a Bachelor of
Business Administration in Accounting from The University of the District of
Columbia.
Time Required of Directors & Executive Officers
FBR Asset requires its directors and executive officers to devote only so much
of their time to FBR Asset's affairs as is necessary or required for the
effective conduct and operation of FBR Asset's business. Because FBR Management
assumes principal responsibility for managing FBR Asset's affairs, FBR Asset
does not expect its officers, in their capacities as officers, to devote
substantial portions of their time to FBR Asset. However, in their capacities as
officers or employees of FBR Management or its Affiliates, they will devote such
portion of their time to FBR Asset's affairs as is required to perform FBR
Management's duties under the Management Agreement.
Executive Compensation & Other Benefits
Directors' Fees
Each independent director receives an annual director's fee of $20,000. After
the Board's first four meetings, each independent director will receive $1,000
for each additional Board meeting that he personally attends. Directors who are
Affiliates of FBR Management will not receive separate compensation from FBR
Asset. FBR Asset will, however, reimburse all directors, including affiliated
directors, for the costs and expenses of attending all Board meetings.
63
<PAGE>
Salaries
FBR Asset has not paid, and does not expect to pay, any cash compensation to
those executive officers who are also executive officers or employees of FBR
Management or any of its Affiliates. That policy may change, however, if at any
time, FBR Management ceases to conduct FBR Asset's day-to-day operations.
Indemnification
FBR Asset's Charter requires FBR Asset to indemnify its directors and officers
to the fullest extent permitted by Maryland law. FBR Asset also may indemnify
its employees and agents, to whatever extent authorized by the directors. If a
director, officer, employee or agent becomes a party to a proceeding because of
his or her position in FBR Asset, Maryland law permits the company to indemnify
that person against judgments, penalties, settlements and reasonable expenses
incurred in connection with that proceeding. However, FBR Asset may not
indemnify the person if:
o the person acted or failed to act in a material matter that led to the
proceeding, and the action or failure to act was in bad faith or the
result of active and deliberate dishonesty;
o the person received an improper personal benefit in money, property or
services; or
o in the case of criminal proceedings, the person had reasonable cause to
believe that the act or failure to act was criminal.
The SEC has expressed the opinion that public policy would prevent FBR Asset
from indemnifying its directors, officers, or any persons controlling FBR Asset
from liability under the Securities Act of 1933.
FBR Asset's Charter also limits, to the fullest extent permitted by Maryland
law, any director's or officer's personal liability for money damages. Under
current Maryland law, this means that a director or officer would owe money
damages only:
o if he or she actually received an improper personal benefit; or
o if a final decision is made that he or she acted in an active and
deliberately dishonest manner.
Stock Options
FBR Asset has adopted a stock option plan that provides for the grant of both
tax-qualified incentive stock options and non-qualified incentive stock options.
FBR Asset's Board, or a committee appointed by the Board, administers the stock
incentive plan, which is designed to promote the success and enhance the value
of FBR Asset by linking the interests of those who provide services to FBR Asset
with the interests of FBR Asset's shareholders, and by providing those persons
with an incentive for outstanding performance. The stock incentive plan is
further intended to provide flexibility to FBR Asset in its ability to motivate,
attract and retain persons upon whose judgment, interest, and special efforts
FBR Asset's successful operation is largely dependent.
Officers, employees, and directors of FBR Asset and FBR, as well as other
persons who provide services to FBR Asset, are eligible to participate in the
stock incentive plan. The Board determines which officers, employees, and
service providers will participate in the plan and sets the terms of these
persons' awards.
64
<PAGE>
The stock incentive plan provides that the total number of shares of common
stock available for issuance under the plan may not exceed 155,000 shares. The
terms of options granted under the stock incentive plan may not exceed 10 years.
Unless otherwise determined by the Board, options will generally vest ratably on
each of the first five anniversaries after the grant date. Unless otherwise
determined by the Board, options will have a fair market value exercise price,
which in any event may not be less than $20. A participant exercising an option
may pay the exercise price in full in cash, or, if approved by the Board, with
previously acquired shares of common stock or a combination thereof. The Board,
in its discretion, may allow cashless exercises of options.
FBR Asset's Board may at any time terminate, amend, or modify the stock
incentive plan; provided that no termination, amendment, or modification may
impair the rights of award holders, and no amendment may be made without
shareholders' approval to the extent such approval is required by law or stock
exchange rules.
On March __, 1999, FBR Asset's Board granted options to acquire an aggregate of
155,000 shares of the company's common stock to persons it deemed to be key
personnel. Information about the grants is set forth in the following table:
<TABLE>
<CAPTION>
Number Percent of Total
of Shares Options Granted Present Value
Underlying To Individuals Exercise of Expiration Of Grant At
Name Option In Fiscal Year Base price Date Date of Grant
---- ------ -------------- ---------- ---- -------------
<S> <C> <C> <C> <C> <C>
Stephen D. Harlan 15,000
Webb Hayes 15,000
William R. Swanson 100,000
Elaine M. Clancy 25,000
</TABLE>
Related Party Transactions
FBR Asset has made investments in companies with which FBR has a relationship.
See "FBR & FBR Management--Related Party Transactions."
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FBR Asset's Capital Stock
The following summary discusses the material terms of FBR Asset's capital stock.
This summary does not purport to be a complete description of FBR Asset's
capital stock, and you should not rely on it as if it were. We have filed
complete copies of FBR Asset's Charter and Bylaws with the SEC as exhibits to
our registration statement and are incorporating the full text of those
documents by reference. You may obtain complete copies of the Charter and Bylaws
by following the document request procedures set forth in the "Additional
Information" section. We encourage you to read each of those documents in its
entirety.
General
FBR Asset's Charter provides that FBR Asset may issue up to 250,000,000 shares
of capital stock, consisting of 200,000,000 shares of common stock, $.01 par
value per share, and 50,000,000 shares of preferred stock, $.01 par value per
share. No preferred stock is issued or outstanding.
Common Stock
All of FBR Asset's outstanding common shares are duly authorized, fully paid,
and nonassessable. Subject to the preferential rights of any other shares or
series of shares of capital stock, FBR Asset's common shareholders are entitled:
(a) to receive dividends if and when authorized and declared by the Board out
of assets legally available therefor and
(b) to share ratably in the assets legally available for distribution to
shareholders in the event of liquidation, dissolution, winding-up, after
payment of, or adequate provision for, all known debts and liabilities of
the company.
The holders of FBR Asset's common stock are entitled to one vote for each share
on all matters submitted to a vote of common shareholders. FBR Asset does not
permit cumulative voting, and accordingly, the holders of a majority of the
company's outstanding shares have the power to elect all directors to be elected
in any given year.
Preferred Stock
FBR Asset may issue preferred stock, in one or more series, as authorized by the
Board. Because the Board has the power to establish the preferences and rights
of any class or series of preferred stock, it may afford the holders of that
stock preferences, powers and rights, voting or otherwise, senior to the rights
of common shareholders. The Board can also authorize the issuance of preferred
stock with terms and conditions that would have the effect of discouraging
takeovers or other transactions that holders of some, or even a majority, of
common shares might believe to be in their best interests or in which holders of
some, or a majority, of common shares might receive a premium for their shares
over the then prevailing market price. FBR Asset has no current plans to issue
any preferred stock.
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Restrictions on Ownership and Transfer
For FBR Asset to qualify as a REIT under the federal tax laws, it must meet two
requirements concerning the ownership of its outstanding shares of capital
stock. Specifically, no more than 50% in value of FBR Asset's outstanding
capital stock may be owned, directly or indirectly, by five or fewer individuals
during the last half of a calendar year. For this purpose, individuals include
natural persons, private foundations, some employee benefit plans and trusts,
and some charitable trusts. In addition, FBR Asset must have at least 100
beneficial owners of its shares of stock during at least 335 days of a taxable
year of 12 months or during a proportionate part of a shorter taxable year. See
"Federal Income Tax Consequences of FBR Asset's Status as a REIT--Requirements
for Qualification."
To ensure that FBR Asset meets the stock ownership requirements, subject to the
exemptions described below, FBR Asset's Charter restricts the ownership and
transfer of FBR Asset's outstanding stock. Specifically, the Charter prohibits
any person from owning, or being deemed to own by virtue of the attribution
provisions of the federal tax laws, more than 9.9% of the number of outstanding
shares of common stock or preferred stock of any series. However, under FBR
Asset's Charter, FBR may own up to 20% of the outstanding common stock and the
preferred stock of any series, and certain mutual funds and pension trusts may
own up to 15% of the outstanding common stock and the preferred stock of any
series. FBR Asset's Board of Directors has exempted FBR from the 20% limit
applicable to FBR. The exemption allows FBR to own up to 30% of FBR Asset's
common stock.
In order to prevent FBR Asset from incurring an entity-level tax if and when it
accrues phantom taxable income from REMIC residual interests, FBR Asset's
Charter, subject to the exemptions described below, also contains provisions
designed to prevent a "disqualified organization," as defined in "Federal Income
Tax Consequences of FBR Asset's Status as a REIT--Taxation of FBR Asset," from
owning FBR Asset's shares.
Subject to the exemptions described below, shares of common stock or preferred
stock the purported transfer of which would:
o result in any person owning, directly or indirectly, common stock or
preferred stock in excess of the limits described above;
o result in FBR Asset's capital stock being beneficially owned by fewer
than 100 persons, determined without reference to any rules of
attribution;
o result in FBR Asset being "closely held" within the meaning of the
federal tax laws;
o cause FBR Asset to own, actually or constructively, 10% or more of the
ownership interests in a tenant of its real property, within the
meaning of the federal tax laws; or
o cause any common stock or preferred stock to be owned by a
"disqualified organization," as defined in "Federal Income Tax
Consequences of FBR Asset's Status as a REIT--Taxation of FBR Asset;"
will be transferred automatically to a trust effective on the day before the
purported transfer of the common stock or preferred stock.
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The record holder of the shares of common stock or preferred stock that are
transferred to a trust will be required to submit the stock to FBR Asset for
registration in the name of the trust. FBR Asset will designate a trustee of the
trust that is not affiliated with FBR Asset. The beneficiary of the trust will
be one or more charitable organizations that are named by FBR Asset.
Shares in the trust will remain issued and outstanding shares and will be
entitled to the same rights and privileges as all other shares of the same class
or series. The trustee will receive all dividends and distributions on the
shares and will hold those dividends or distributions in trust for the benefit
of the beneficiary. The trustee will vote all shares in the trust. The trustee
will designate a permitted transferee of the shares, provided that the permitted
transferee purchases the shares for valuable consideration and acquires the
shares without the acquisition resulting in a transfer to another trust.
The owner of shares in the trust will be required to repay to the trustee the
amount of any dividends or distributions received by the owner (1) that are
attributable to shares in the trust and (2) the record date of which was on or
after the date that the shares were transferred to the trust. The owner
generally will receive from the trustee the lesser of (a) the price per share
the owner paid for the shares in the trust, or in the case of a gift or devise,
the market price per share on the date of the transfer, or (b) the price per
share received by the trustee from the sale of the shares in the trust. Any
amounts received by the trustee in excess of the amounts to be paid to the owner
will be distributed to the beneficiary of the trust.
Shares in the trust will be deemed to have been offered for sale to FBR Asset,
or its designee, at a price per share equal to the lesser of (a) the price per
share in the transaction that created the trust, or in the case of a gift or
devise, the market price per share on the date of the transfer, or (b) the
market price per share on the date that FBR Asset, or its designee, accepts the
offer. FBR Asset will have the right to accept the offer for a period of ninety
days after the later of (1) the date of the purported transfer that resulted in
the trust or (2) the date FBR Asset determines in good faith that a prohibited
transfer has occurred.
For these purposes, the "market price" on any date means the average of the
"closing price" of FBR Asset's stock for the five previous consecutive trading
days ending on such date. The "closing price" on any date means:
o the last sale price for the stock, as reported on the New York Stock
Exchange, NASDAQ, or other principal national securities exchange on
which the stock is listed; or
o if no sale takes place on the day, the average of the closing bid and
asked prices for the stock, as reported on the New York Stock Exchange,
NASDAQ, or other principal national securities exchange on which the
stock is listed; or
o if the stock is not listed on any exchange, the average of the closing
bid and asked prices as furnished by a professional market maker making
a market in FBR Asset's stock selected by FBR Asset's Board of
Directors; or
o in the event that no trading price is available for the stock, the fair
market value of the stock, as determined in good faith by FBR Asset's
Board of Directors.
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Any person who acquires or attempts to acquire common stock or preferred stock
in violation of the restrictions set forth in FBR Asset's Charter, or any person
who owned common stock or preferred stock that was transferred to a trust, will
be required (1) to give immediately written notice to FBR Asset of that event
and (2) to provide to FBR Asset any other information as it may request in order
to determine the effect, if any, of the transfer on FBR Asset's status as a
REIT.
The ownership limits generally will not apply to the acquisition of common stock
or preferred stock by an underwriter that participates in a public offering of
that stock. In addition, FBR Asset's Board of Directors, upon receipt of a
ruling from the IRS or an opinion of counsel that FBR Asset will not jeopardize
its REIT status by granting the exemption and upon such other conditions as the
Board of Directors may direct, may exempt a person from the ownership
limitations or the restrictions on transfer set forth in the Charter. As
discussed above, FBR Asset's Board of Directors has exempted FBR from the 20%
ownership limit applicable to FBR.
The foregoing restrictions will not be removed until:
o the restrictions are no longer required in order to qualify as a REIT,
and the Board of Directors determines that it is no longer in the best
interests of FBR Asset to retain the restrictions; or
o the Board of Directors determines that it is no longer in the best
interests of FBR Asset to attempt to qualify, or to continue to
qualify, as a REIT, and there is an affirmative vote of 80% of the
members of the Board of Directors, or in the absence of an 80% vote,
there is an affirmative vote of at least two-thirds of the holders of
FBR Asset's outstanding shares of common stock.
All certificates representing FBR Asset's common or preferred stock will bear a
legend referring to the restrictions described above.
All persons who own, directly or indirectly, more than 5%, or any lower
percentage as set forth in the federal tax laws, of FBR Asset's outstanding
common stock and preferred stock must, within 30 days after January 1 of each
year, provide to FBR Asset a written statement or affidavit stating the name and
address of the direct or indirect owner, the number of shares owned directly or
indirectly, and a description of how the shares are held. In addition, each
direct or indirect shareholder must provide to FBR Asset any additional
information that FBR Asset requests in order to determine the effect, if any, of
such ownership on FBR Asset's status as a REIT and to ensure compliance with the
restrictions on ownership and transfer set forth in FBR Asset's Charter.
Transfer Agent & Registrar
American Stock Transfer & Trust Company serves as the transfer agent and
registrar for FBR Asset's common stock.
Reports to Shareholders
FBR Asset furnishes its shareholders with annual reports containing audited
financial statements certified by independent public accountants and such other
periodic reports as it determines to furnish or as is required by law.
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FBR Asset's Charter and Bylaws
Notice of Shareholder Proposals
FBR Asset's Bylaws govern shareholder proposals. To advance a proposal, a
shareholder must give written notice of the proposal to the company's Secretary.
The Secretary must receive the notice at least 90 days before the annual
meeting. The notice must:
o describe briefly the proposal with supporting reasoning,
o contain the shareholder's name and address,
o state the number of each class of shares the shareholder beneficially
owns, and
o disclose any material interest the shareholder has in the proposed
business.
Charter Amendments
FBR Asset's Charter provides that a majority of outstanding shares of common
stock must approve an amendment to the Charter. However, as discussed in
previous sections, the voting requirements are greater for amending those
provisions addressing the number and composition of the Board of Directors and
the restrictions pertaining to stock ownership and transfer.
Amendments to Bylaws
Except as set forth below, FBR Asset's Bylaws may be amended by
majority vote of FBR Asset's Board or its shareholders. The
provisions addressing:
o the number, tenure and qualifications of directors,
o changes in the numbers of directors,
o the removal of directors,
o the quorum requirement for director votes, and
o the majority approval for certain transactions involving FBR Management
require the vote of 80% of the Board of Directors, or two-thirds of the
outstanding shares.
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Anti-Takeover Effect of Maryland Laws
Maryland Business Combination Statute
The Maryland General Corporation Law establishes special requirements for
"business combinations" between a Maryland corporation and "interested
shareholders" unless exemptions are applicable. An interested shareholder is any
person who beneficially owns ten percent or more of the voting power of a
company's then-outstanding voting stock. Among other things, the law prohibits
for a period of five years a merger and other similar transactions between FBR
Asset and an interested shareholder unless the Board of Directors approved the
transaction prior to the party becoming an interested shareholder. The five year
period runs from the most recent date on which the interested shareholder became
an interested shareholder. The law also requires a super-majority shareholder
vote for such transactions after the end of the five year period. This means
that the transaction must be approved by at least:
o 80% of the votes entitled to be cast by holders of outstanding voting
shares, and
o 66% of the votes entitled to be cast by holders of outstanding voting
shares other than shares held by the interested shareholder with whom
the business combination is to be effected.
The business combination statute could have the effect of discouraging offers to
acquire FBR Asset and of increasing the difficulty of consummating any such
offers, even if the acquisition would be in FBR Asset's shareholders' best
interests.
Maryland Control Share Acquisition Statute
Maryland law 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 shareholder vote. Two-thirds of the shares eligible to vote must
vote in favor of granting the "control shares" voting rights. "Control shares"
are shares of stock that, taken together with all other shares of stock the
acquiror previously acquired, would entitle the acquiror to exercise at least
20% of the voting power in electing directors. Control shares do not include
shares of stock the acquiring person is entitled to vote as a result of having
previously obtained shareholder approval. A "control share acquisition" means
the acquisition of control shares, subject to certain exceptions.
If a person who has made, or proposes to make, a control share acquisition
satisfies certain conditions, including agreeing to pay expenses, he may compel
the Board of Directors to call a special meeting of shareholders to be held
within 50 days to consider the voting rights of the shares. If such a person
makes no request for a meeting, we have the option to present the question at
any shareholders' meeting.
If voting rights are not approved at a meeting of shareholders, then FBR Asset
may redeem any or all of the control shares (except those for which voting
rights have previously been approved) for fair value. FBR Asset will determine
the fair value of the shares, without regard to voting rights, as of the date of
either:
o the last control share acquisition, or
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o any meeting where shareholders considered and did not approve voting
rights of the control shares.
If voting rights for control shares are approved at a shareholders' meeting and
the acquiror becomes entitled to vote a majority of the shares of stock entitled
to vote, all other shareholders may exercise appraisal rights. This means that
you would be able to redeem your stock back to the company for fair value. Under
Maryland law, the fair value may not be less than the highest price per share
paid in the control share acquisition. Furthermore, certain limitations
otherwise applicable to the exercise of dissenters' rights would not apply in
the context of a control share acquisition.
The control share acquisition statute would not apply to shares acquired in a
merger, consolidation or share exchange if FBR Asset were a party to the
transaction.
The control share acquisition statute could have the effect of discouraging
offers to acquire FBR Asset and of increasing the difficulty of consummating any
such offers, even if the acquisition would be in FBR Asset's shareholders' best
interests.
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Common Stock Available For Future Sale
At December 31, 1998, FBR Asset had outstanding 9,065,427 shares of common
stock, including 521,900 shares reserved for issuance upon exercise of
outstanding options. Of the outstanding shares, _________ shares of common stock
sold in this offering, will be freely tradable without restriction or further
registration under the federal securities laws, unless the shares are purchased
by "affiliates" of the company as that term is defined in Rule 144 under the
Securities Act of 1933. The remaining _________ shares have not been registered
with the SEC; accordingly, they cannot be sold except as permitted by Rule 144.
In general, under Rule 144, a person who beneficially owned shares for at least
one year may sell within any three-month period a number of shares that does not
exceed 1% of the shares of FBR Asset's common stock outstanding shares or the
average weekly trading volume in common stock during the four weeks preceding
the date on which notice of the sale is filed with the SEC. A person who is not
an affiliate of FBR Asset at any time during the three months before a sale and
who has beneficially owned shares for at least two years would be entitled to
sell such shares under Rule 144, without regard to the volume limitation
described above.
FBR Asset may issue additional shares at any time without shareholder consent.
No prediction can be made as to the effect, if any, that future sales of shares,
or the availability of shares for future sale, will have on the market price
prevailing from time to time. Sales of substantial amounts of common stock, or
the perception that such sales could occur, may adversely affect prevailing
market prices of the common stock.
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Principal Shareholders
The following table sets forth some information as of March 12, 1999, relating
to the beneficial ownership of FBR Asset's common stock by (a) all persons known
by FBR Asset to beneficially own more than 5% of the company's outstanding
shares, (b) each director and named executive officer of FBR Asset, and (c) all
directors and executive officers of FBR Asset as a group:
Principal Shareholders
<TABLE>
<CAPTION>
Name and Address of Number of Shares
Beneficial Owner Beneficially Owned Percent(3)
---------------- ------------------ ----------
<S> <C> <C>
Friedman Billings, Ramsey Group, Inc.(1)
1001 Nineteenth Street North
Arlington, VA 22209 2,159,891(2) 22.84%
Boston Partners Asset Management
One Financial Center
43rd Floor 830,200 8.78%
Boston, MA 02111
Franklin Mutual
51 John F. Kennedy Parkway
Short Hills, NJ 07078 750,000 7.93%
Keefe Managers
375 Park Avenue
New York, NY 10021 695,000 7.35%
======= ====
Oppenheimer Funds
Two World Trade Center
New York, NY 10048 543,500 5.75%
======= ====
Angelo Gordon
245 Park Avenue, 26th Floor
New York, NY 10167 525,000 5.55%
Loews Corp.
667 Madison Avenue
New York, NY 10021 500,000 5.29%
Management Shareholders
Stephen D. Harlan 15,000(2) (4)
Webb Hayes 15,000(2) (4)
Emanuel J. Friedman 0(6) 0%
Eric F. Billings 1.48%
139,700(5)(6)
W. Russell Ramsey 0(6) 0%
William R. Swanson 160,000(2) 1.69%
Elaine M. Clancy 27,500(2) (4)
George Abraham 1,250 (4)
Robert Smith 1,000 (4)
Kurt R. Harrington 750 (4)
John M. Blassingame 0 0%
------- ----
All directors and officers of FBR Asset 360,200 3.81%
======= ====
</TABLE>
(1) Held through wholly-owned subsidiaries.
(2) Includes shares as to which options are held.
(3) Assumes exercise of all options.
(4) Less than 1%.
(5) Includes 92,800 shares held by FBR Weston, LP, as to which Mr. Billings may
be deemed to have shared voting and dispositive power. Mr. Billings
disclaims beneficial ownership of all shares held by Weston in excess of
his pecuniary interest.
(6) Does not include shares identified above for Friedman, Billings, Ramsey
Group, Inc., of which Messrs. Friedman, Billings, and Ramsey are principal
shareholders.
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Federal Income Tax Consequences of FBR Asset's Status as a REIT
This section summarizes the federal income tax issues that you, as a
shareholder, may consider relevant. Hunton & Williams, our counsel, has reviewed
this section and has given us an opinion that this section correctly describes
the relevant law and fairly summarizes the federal income tax issues that may be
material to FBR Asset and its shareholders. Because this section is a summary,
it does not address all of the tax issues that may be important to you. In
addition, this section does not address all of the tax issues that may be
important to shareholders that are subject to special treatment under the
federal income tax laws, such as insurance companies, tax-exempt organizations,
financial institutions or broker-dealers, and non-U.S. individuals and foreign
corporations.
The statements in this section and the opinion of Hunton & Williams are based on
the current federal income tax laws governing qualification as a REIT. We cannot
assure you that new laws, interpretations thereof, or court decisions, any of
which may take effect retroactively, will not cause any statement in this
section to become inaccurate.
We urge you to consult your own tax advisor regarding the specific tax
consequences to you of investing in the common stock and of FBR Asset's election
to be taxed as a REIT. Specifically, you should consult your own tax advisor
regarding the federal, state, local, foreign, and other tax consequences of your
investment, and regarding potential changes in applicable tax laws.
Taxation of FBR Asset
FBR Asset elected to be taxed as a REIT under the federal income tax laws
commencing with its short taxable year ended December 31, 1997. FBR Asset has
operated in a manner intended to qualify as a REIT since its formation in
November 1997, and FBR Asset intends to continue to so operate. This section
discusses the laws governing the federal income tax treatment of a REIT and its
shareholders, which laws are highly technical and complex.
Hunton & Williams has given us an opinion that FBR Asset qualified to be taxed
as a REIT under the federal income tax laws beginning with its taxable year
ended December 31, 1997, and FBR Asset's organization and current and proposed
method of operation will enable it to continue to qualify as a REIT. You should
be aware that the opinion is based on current law and is not binding upon the
IRS or any court. In addition, Hunton & Williams' opinion is based on some
assumptions and on our factual representations, all of which are described in
the opinion.
FBR Asset's qualification as a REIT depends on its ability to meet on a
continuing basis certain qualification tests set forth in the federal tax laws.
Those qualification tests involve:
o the percentage of income that FBR Asset earns from specified sources;
o the percentage of its assets that falls within certain categories;
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o the diversity of its share ownership; and
o the percentage of its earnings that it distributes.
We describe the REIT qualification tests in more detail below. Hunton & Williams
will not review FBR Asset's compliance with those tests on a continuing basis.
Accordingly, neither we nor Hunton & Williams can assure you that FBR Asset will
satisfy those tests in the future. For a discussion of the tax treatment of FBR
Asset and its shareholders if FBR Asset fails to qualify as a REIT, see
"--Failure to Qualify."
If FBR Asset qualifies as a REIT, it generally will not be subject to federal
income tax on the taxable income that it distributes to its shareholders. The
benefit of that tax treatment is that it avoids the "double taxation," or
taxation at both the corporate and shareholder levels, that generally results
from owning stock in a corporation. However, FBR Asset will be subject to
federal tax in the following circumstances:
o First, FBR Asset will pay federal income tax on taxable income,
including net capital gain, that it does not distribute to its
shareholders during, or within a specified time period after, the
calendar year in which the income is earned.
o Second, FBR Asset may be subject to the "alternative minimum tax" on
any items of tax preference that it does not distribute or allocate to
its shareholders.
o Third, FBR Asset will pay income tax at the highest corporate rate on
(1) net income from the sale or other disposition of property acquired
through foreclosure that it holds primarily for sale to customers in
the ordinary course of business and (2) other non-qualifying income
from property acquired through foreclosure.
o Fourth, FBR Asset will pay a 100% tax on net income from sales or other
dispositions of property, other than foreclosure property, that it
holds primarily for sale to customers in the ordinary course of
business.
o Fifth, if FBR Asset fails to satisfy the 75% gross income test or the
95% gross income test, as described below under "--Requirements for
Qualification--Income Tests," and nonetheless continues to qualify as a
REIT because it meets certain other requirements, it will pay a 100%
tax on (1) the gross income attributable to the greater of the amounts
by which it fails the 75% and 95% gross income tests, multiplied by (2)
a fraction intended to reflect its profitability.
o Sixth, if FBR Asset fails to distribute during a calendar year at least
the sum of (1) 85% of its REIT ordinary income for that year, (2) 95%
of its REIT capital gain net income for that year, and (3) any
undistributed taxable income from prior periods, it will pay a 4%
excise tax on the excess of the required distribution over the amount
it actually distributed.
o Seventh, FBR Asset may elect to retain and pay income tax on its net
long-term capital gain.
o Eighth, if FBR Asset acquires any asset from a C corporation, or a
corporation generally subject to full corporate-level tax, in a merger
or other transaction in which it acquires a basis in the asset that is
determined by reference to the C corporation's basis in the asset, it
will pay tax at the highest regular corporate rate applicable if it
recognizes gain on the sale or disposition of such asset during the
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10-year period after it acquires the asset. The amount of gain on which
it will pay tax is the lesser of (1) the amount of gain that it
recognizes at the time of the sale or disposition and (2) the amount of
gain that it would have recognized if it had sold the asset at the time
it acquired the asset. The rule described in this paragraph will apply
assuming that FBR Asset makes an election under IRS Notice 88-19 upon
its acquisition of an asset from a C corporation.
o Ninth, FBR Asset will pay tax at the highest corporate rate on the
portion of any excess inclusion, or phantom taxable income, that it
derives from REMIC residual interests equal to the percentage of its
stock held by "disqualified organizations." A "disqualified
organization" includes the United States, any state or political
subdivision thereof, any foreign government, any international
organization, any agency or instrumentality of any of the foregoing,
any other tax-exempt organization, other than a farmer's cooperative
described in section 521 of the Code, that is exempt both from income
taxation and from taxation under the unrelated business taxable income
provisions of the Code, or any rural electrical or telephone
cooperative. For this reason, FBR Asset's Charter prohibits
disqualified organizations from owning stock of FBR Asset.
o Tenth, FBR Asset may be subject to tax at the highest corporate rate on
the portion of its allocable share of any Excess Inclusion that a REIT
in which it owns an equity interest derives from REMIC residual
interests, equal to the percentage of its stock that is held by
disqualified organizations. For this reason, FBR Asset's Charter
prohibits disqualified organizations from owning the stock of FBR
Asset.
Requirements for Qualification
A REIT is a corporation, trust, or association that meets the following
requirements:
1. it is managed by one or more trustees or directors;
2. its beneficial ownership is evidenced by transferable shares, or by
transferable certificates of beneficial interest;
3. it would be taxable as a domestic corporation, but for the REIT
provisions of the federal income tax laws;
4. it is neither a financial institution nor an insurance company subject
to certain provisions of the federal income tax laws;
5. at least 100 persons are beneficial owners of its shares or ownership
certificates;
6. not more than 50% in value of its outstanding shares or ownership
certificates is owned, directly or indirectly, by five or fewer
individuals, including specified entities, during the last half of any
taxable year;
7. it elects to be a REIT, or has made a REIT election for a previous
taxable year, and satisfies all relevant filing and other
administrative requirements established by the IRS that must be met to
elect and maintain REIT status;
8. it uses a calendar year for federal income tax purposes and complies
with the record keeping requirements of the federal income tax laws;
and
9. it meets other qualification tests, described below, regarding the
nature of its income and assets.
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FBR Asset must meet requirements 1 through 4 during its entire taxable year and
must meet requirement 5 during at least 335 days of a taxable year of 12 months,
or during a proportionate part of a taxable year of less than 12 months.
Requirements 5 and 6 apply to FBR Asset beginning with its 1998 taxable year. If
FBR Asset complies with all the requirements for ascertaining the ownership of
its outstanding shares in a taxable year and has no reason to know that it
violated requirement 6 above, it will be deemed to have satisfied that
requirement for that taxable year. For purposes of determining share ownership
under requirement 6, an "individual" generally includes a supplemental
unemployment compensation benefits plan, a private foundation, or a portion of a
trust permanently set aside or used exclusively for charitable purposes. An
"individual," however, generally does not include a trust that is a qualified
employee pension or profit sharing trust under the federal income tax laws, and
beneficiaries of such a trust will be treated as holding shares of FBR Asset in
proportion to their actuarial interests in the trust for purposes of requirement
6.
FBR Asset has issued sufficient common stock with sufficient diversity of
ownership to satisfy requirements 5 and 6 set forth above. In addition, FBR
Asset's Charter restricts the ownership and transfer of the common stock so that
FBR Asset should continue to satisfy requirements 5 and 6. The provisions of the
Charter restricting the ownership and transfer of the common stock are described
in "FBR Asset's Capital Stock--Restrictions on Ownership and Transfer."
FBR Asset currently does not have corporate subsidiaries, but may have corporate
subsidiaries in the future. A corporation that is a "qualified REIT subsidiary"
is not treated as a corporation separate from its parent REIT. All assets,
liabilities, and items of income, deduction, and credit of a qualified REIT
subsidiary are treated as assets, liabilities, and items of income, deduction,
and credit of the REIT. A qualified REIT subsidiary is a corporation, all of the
capital stock of which is owned by the REIT.
In the case of a REIT that is a partner in a partnership, the REIT is treated as
owning its proportionate share of the assets of the partnership and as earning
its allocable share of the gross income of the partnership for purposes of the
applicable REIT qualification tests. FBR Asset is not currently a partner in any
partnership, but it may become a partner in the future.
Income Tests
FBR Asset must satisfy two gross income tests annually to maintain its
qualification as a REIT. First, at least 75% of its gross income for each
taxable year must consist of defined types of income that it derives, directly
or indirectly, from investments relating to real property or mortgages on real
property or temporary investment income. Qualifying income for purposes of that
75% gross income test includes:
o "rents from real property";
o interest on debt secured by mortgages on real property or on interests
in real property; and
o dividends or other distributions on and gain from the sale of shares in
other REITs.
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Second, at least 95% of its gross income for each taxable year must consist of
income that is qualifying income for purposes of the 75% gross income test
described above, dividends, other types of interest, gain from the sale or
disposition of stock or securities, or any combination of the foregoing. Gross
income from FBR Asset's sale of property that it holds primarily for sale to
customers in the ordinary course of business is excluded from both income tests.
The following paragraphs discuss the specific application of the income tests to
FBR Asset.
Interest on debt secured by mortgages on real property or on interests in real
property generally is qualifying income for purposes of the 75% gross income
test. However, if the highest principal amount of a loan outstanding during a
taxable year exceeds the fair market value of the real property securing the
loan as of the date FBR Asset acquired the loan, a portion of the interest
income from such loan will not be qualifying income for purposes of the 75%
gross income test, but will be qualifying income for purposes of the 95% gross
income test. The portion of the interest income that will not be qualifying
income for purposes of the 75% gross income test will be equal to the portion of
the principal amount of the loan that is not secured by real property.
Interest and Rents
The term "interest," as defined for purposes of both gross income tests,
generally excludes any amount that is based in whole or in part on the income or
profits of any person, but includes the following:
o an amount that is based on a fixed percentage or percentages of
receipts or sales; and
o an amount that is based on the income or profits of a debtor, as long
as the debtor derives substantially all of its income from the related
property from leasing such property, and only to the extent that the
amounts received by the debtor would be qualifying income if received
directly by a REIT.
If a loan contains a provision that entitles a REIT to a percentage of the
borrower's gain upon the sale of the secured property or a percentage of the
appreciation in the property's value as of a specific date, income attributable
to that loan provision will be treated as gain from the sale of the secured
property, which generally is qualifying income for purposes of both gross income
tests.
We believe that the interest and original issue discount income that FBR Asset
receives from mortgage-backed securities and other mortgage-related assets
generally is qualifying income for purposes of both gross income tests. However,
the loan amount of a mortgage loan owned by FBR Asset may exceed the value of
the real property securing the loan. In that case, a portion of the income from
the loan will be qualifying income for purposes of the 95% gross income test,
but not the 75% gross income test. It also is possible that, in some instances,
the interest income from a mortgage loan may be based in part on the borrower's
profits or net income. That scenario generally will cause the income from the
loan to be non-qualifying income for purposes of both gross income tests.
We believe that FBR Asset's income from stock in other REITs is qualifying
income for purposes of both gross income tests. However, if a REIT in which FBR
Asset owns stock fails to qualify as a REIT in any year, FBR Asset's income from
such REIT will be
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qualifying income for purposes of the 95% gross income test, but not the 75%
gross income test. We believe that FBR Asset's income from stock in real
estate-related companies that are C corporations is qualifying income for
purposes of the 95% gross income test, but not the 75% gross income test. In
addition to stock, FBR Asset may own debt securities issued by other REITs or C
corporations. Interest income from such debt securities will be qualifying
income for purposes of the 95% gross income test. Such interest income will not
be qualifying income for purposes of the 75% gross income test unless such debt
securities are secured by mortgages on real property or on interests in real
property.
FBR Asset currently does not own any real property, but it may acquire real
property or an interest therein in the future. To the extent that FBR Asset
acquires real property or an interest therein, any rent that FBR Asset receives
from the tenants of such real property will qualify as "rents from real
property," which is qualifying income for purposes of both gross income tests,
only if the following conditions are met:
o First, the rent must not be based, in whole or in part, on the income
or profits of any person, but may be based on a fixed percentage or
percentages of receipts or sales.
Second, neither FBR Asset nor a direct or indirect owner of 10% or more
of its stock may own, actually or constructively, 10% or more of a
tenant from whom it receives rent.
o Third, all of the rent received under a lease of real property will not
qualify as rents from real property unless the rent attributable to the
personal property leased in connection with such lease is no more than
15% of the total rent received under the lease.
o Finally, FBR Asset generally must not operate or manage its real
property or furnish or render services to its tenants, other than
through an independent contractor who is adequately compensated and
from whom FBR Asset does not derive revenue. However, FBR Asset may
provide services directly to its tenants, if the services are usually
or customarily rendered in connection with the rental of space for
occupancy only and are not considered to be provided for the tenants'
convenience. In addition, FBR Asset may provide a minimal amount of
services that are not customarily rendered to the tenants of a
property, other than through an independent contractor, as long as its
income from the services does not exceed 1% of its income from the
related property.
We have represented that we will manage FBR Asset's mortgage assets so that
substantially all of the income from those assets will be qualifying income for
purposes of both gross income tests. Furthermore, we have represented that we
will manage any real property that FBR Asset acquires so that the rent it
receives from such property qualifies as rents from real property. In summary,
we believe that FBR Asset will be able to satisfy both gross income tests on a
continuing basis. However, FBR Asset may receive income not described above that
is not qualifying income for purposes of the gross income tests. We will monitor
the amount of non-qualifying income that its assets produce and we will manage
its portfolio to comply at all times with the gross income tests.
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Hedging Transactions
From time to time, FBR Asset may enter into hedging transactions with respect to
one or more of its assets or liabilities. Its hedging activities may include
entering into interest rate swaps, caps, and floors, or options to purchase
those items, and futures and forward contracts. To the extent that FBR Asset
enters into an interest rate swap or cap contract, option, futures contract,
forward rate agreement, or any similar financial instrument to hedge its
indebtedness incurred to acquire or carry assets that are qualifying real
estate-related assets under the federal income tax laws, any periodic income or
gain from the disposition of such contract should be qualifying income for
purposes of the 95% gross income test, but not the 75% gross income test. To the
extent that FBR Asset hedges with other types of financial instruments, or in
other situations, it is not entirely clear how the income from those
transactions will be treated for purposes of the gross income tests. We intend
to structure any hedging transactions in a manner that does not jeopardize FBR
Asset's status as a REIT.
Failure to Satisfy Income Tests
If FBR Asset fails to satisfy one or both of the gross income tests for any
taxable year, it nevertheless may qualify as a REIT for such year if it
qualifies for relief under federal income tax laws. Those relief provisions
generally will be available if:
o FBR Asset's failure to meet such tests is due to reasonable cause and
not due to willful neglect;
o we attach a schedule of the sources of its income to its tax return,
and
o any incorrect information on the schedule was not due to fraud with
intent to evade tax.
We cannot predict, however, whether in all circumstances FBR Asset would qualify
for the relief provisions. In addition, as discussed above in "--Taxation of FBR
Asset," even if the relief provisions apply, FBR Asset would incur a 100% tax on
the gross income attributable to the greater of the amounts by which it fails
the 75% and 95% gross income tests, multiplied by a fraction intended to reflect
its profitability.
Foreclosure Property Rules
REITs generally will incur tax at the maximum corporate rate on any net income
from any real property, or an interest in real property, acquired through
foreclosure and any personal property incident to such real property that meets
the following requirements:
o a REIT acquires the property when the REIT bids in such property at
foreclosure, or otherwise reduces such property to ownership or
possession by agreement or process of law, after a default or imminent
default on a lease of such property or on a debt owed to the REIT that
such property secured;
o the REIT acquired the related loan when default was not imminent or
anticipated; and
o the REIT elects to treat the property as foreclosure property.
However, that tax does not apply to income that would be qualifying income for
purposes of the 75% gross income test.
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We do not anticipate that FBR Asset will receive any income from property
acquired through foreclosure that is not qualifying income for purposes of the
75% gross income test, but if it does receive any such income, we will make an
election to treat the related property as foreclosure property.
If property is not eligible for the election to be treated as foreclosure
property because the REIT acquired the related loan when default was imminent or
anticipated, income the REIT receives with respect to that property may not be
qualifying income for purposes of the 75% or 95% gross income test. We
anticipate that any income FBR Asset receives with respect to property that is
not eligible for a foreclosure property election will be qualifying income for
purposes of both gross income tests.
Prohibited Transaction Rules
A REIT will incur a 100% tax on the net income derived from any sale or other
disposition of property, other than foreclosure property, that the REIT holds
primarily for sale to customers in the ordinary course of a trade or business.
We believe that none of FBR Asset's assets is held for sale to customers and
that a sale of any such asset would not be in the ordinary course of its
business. Whether a REIT holds an asset "primarily for sale to customers in the
ordinary course of a trade or business" depends, however, on the facts and
circumstances in effect from time to time, including those related to a
particular asset. Nevertheless, we will attempt to comply with the terms of
safe-harbor provisions in the federal income tax laws prescribing when an asset
sale will not be characterized as a sale to customers in the ordinary course of
business. We cannot provide assurance, however, that we can comply with such
safe-harbor provisions or that FBR Asset will avoid owning property that may be
characterized as property that it holds primarily for sale to customers in the
ordinary course of a trade or business.
Asset Tests
To maintain its qualification as a REIT, FBR Asset also must satisfy two asset
tests at the close of each quarter of each taxable year. First, at least 75% of
the value of its total assets must consist of:
o cash or cash items, including certain receivables;
o government securities;
o investments in stock or debt instruments during the one-year period
following FBR Asset's receipt of new capital that it raises through
equity offerings or offerings of debt with at least a five-year term;
o stock in other REITs;
o interests in real property, including leaseholds and options to acquire
real property and leaseholds;
o interests in mortgages on real property; or
o regular or residual interests in a real estate mortgage investment
conduit, or "REMIC." However, if less than 95% of the assets of a REMIC
consists of assets that are qualifying real estate-related assets under
the federal income tax laws, determined as if FBR Asset held such
assets, FBR Asset will be treated as holding directly its proportionate
share of the assets of such REMIC.
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To the extent that the fair market value of the real property securing a loan
equals or exceeds the outstanding principal balance of the loan, the loan will
be a qualifying asset for purposes of the 75% asset test described above.
However, if the outstanding principal balance of a loan exceeds the fair market
value of the real property securing the loan, the portion of such loan in excess
of the value of the associated real property likely will not be a qualifying
asset for purposes of the 75% asset test described above.
The second asset test has two components:
o First, of FBR Asset's investments not included in the 75% asset class,
the value of its interest in any one issuer's securities may not exceed
5% of the value of its total assets (the "5% asset test").
o Second, FBR Asset may not own more than 10% of any one issuer's
outstanding voting securities.
For purposes of both components of the second asset test, "securities" does not
include FBR Asset's stock in other REITs or in any qualified REIT subsidiary or
its interest in any partnership.
The Clinton Administration's budget proposal for fiscal year 2000 would allow
FBR Asset to own up to 100% of the stock in two types of taxable REIT
subsidiaries: (1) qualified business subsidiaries, which could perform
activities unrelated to FBR Asset's tenants, such as third-party management,
development, and other independent business activities, as well as provide
"customary" services to FBR Asset's tenants, and (2) qualified independent
contractor subsidiaries, which could both perform activities that a qualified
business subsidiary could perform and provide "non-customary" services to FBR
Asset's tenants. FBR Asset would be subject to restrictions on its stock
ownership of those taxable subsidiaries. The taxable REIT subsidiary provision
would be effective after the date of enactment.
We believe that FBR Asset's stock in other REITs is a qualifying asset for
purposes of the 75% asset test. However, if a REIT in which it owns stock fails
to qualify as a REIT in any year, the stock in such REIT will not be a
qualifying asset for purposes of the 75% asset test. Instead, FBR Asset would be
subject to both components of the second asset test described above with respect
to its investment in such disqualified REIT. We believe that FBR Asset satisfies
both components of the second asset test with respect to its stock in real
estate-related companies that are C corporations. To the extent that FBR Asset
owns debt securities issued by other REITs or C corporations which debt
securities are not secured by mortgages on real property, such securities will
not be qualifying assets for purposes of the 75% asset test. Instead, FBR Asset
would be subject to both components of the second asset test with respect to
such debt securities.
We also believe that FBR Asset's mortgage loans and mortgage-backed securities
are qualifying assets for purposes of the 75% asset test. However, if the
outstanding principal balance of a mortgage loan exceeds the fair market value
of the real property securing the loan, a portion of such loan will not be a
qualifying real estate-related asset under the federal income tax laws. The
non-qualifying portion of that mortgage loan will be equal to the portion of the
loan amount that exceeds the value of the associated real property. We will
monitor the status of FBR Asset's assets for purposes of the various asset tests
and we will manage its portfolio to comply at all times with such tests.
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If FBR Asset should fail to satisfy the asset tests at the end of a calendar
quarter, it would not lose its REIT status if (1) it satisfied the asset tests
at the close of the preceding calendar quarter and (2) the discrepancy between
the value of its assets and the asset test requirements arose from changes in
the market values of its assets and was not wholly or partly caused by the
acquisition of one or more non-qualifying assets. If FBR Asset did not satisfy
the condition described in clause (2) of the preceding sentence, it still could
avoid disqualification as a REIT by eliminating any discrepancy within 30 days
after the close of the calendar quarter in which the discrepancy arose.
Distribution Requirements
Each taxable year, FBR Asset must distribute dividends, other than capital gain
dividends and deemed distributions of retained capital gain, to its shareholders
in an aggregate amount at least equal to:
o the sum of (1) 95% of its "REIT taxable income" (computed without
regard to the dividends paid deduction and its net capital gain or
loss) and (2) 95% of its after-tax net income, if any, from foreclosure
property; minus
o the sum of certain items of non-cash income.
FBR Asset must pay such distributions in the taxable year to which they relate,
or in the following taxable year if it declares the distribution before it
timely files its federal income tax return for such year and pays the
distribution on or before the first regular dividend payment date after such
declaration.
FBR Asset will pay federal income tax on taxable income, which includes net
capital gain, that it does not distribute to shareholders. Furthermore, if it
fails to distribute during a calendar year, or by the end of January following
such calendar year, in the case of distributions with declaration and record
dates falling in the last three months of the calendar year, at least the sum
of:
o 85% of its REIT ordinary income for such year;
o 95% of its REIT capital gain income for such year; and
o any undistributed taxable income from prior periods;
it will incur a 4% nondeductible excise tax on the excess of such required
distribution over the amounts it actually distributed. FBR Asset may elect to
retain and pay income tax on the net long-term capital gain it receives in a
taxable year. See "--Taxation of Taxable U.S. Shareholders." If it so elects, it
will be treated as having distributed any such retained amount for purposes of
the 4% excise tax described above. FBR Asset has made, and intends to continue
to make, timely distributions sufficient to satisfy the annual distribution
requirements.
It is possible that, from time to time, FBR Asset may experience timing
differences between (1) the actual receipt of income and actual payment of
deductible expenses and (2) the inclusion of that income and deduction of such
expenses in arriving at its REIT taxable income. Possible examples include:
o Because FBR Asset may deduct capital losses only to the extent of its
capital gains, it may have taxable income that exceeds its economic
income.
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o FBR Asset will recognize taxable income in advance of the related cash
flow if any of its subordinated mortgage-backed securities or mortgage
loans are deemed to have original issue discount. FBR Asset generally
must accrue original issue discount based on a constant yield method
that takes into account projected prepayments but that defers credit
losses until they are actually incurred.
o FBR Asset may be required to recognize the amount of any payment
projected to be made pursuant to a provision in a mortgage loan that
entitles FBR Asset to share in the gain from the sale of or the
appreciation in the property over the term of the related loan using
the constant yield method, even though FBR Asset may not receive the
related cash until the maturity of the loan.
o FBR Asset may recognize taxable market discount income when it receives
the proceeds from the disposition of, or principal payments on, loans
that have a stated redemption price at maturity that is greater than
FBR Asset's tax basis in those loans, although such proceeds often will
be used to make non-deductible principal payments on related
borrowings.
o FBR Asset may recognize taxable income without receiving a
corresponding cash distribution if it forecloses on or makes a
significant modification to a loan, to the extent that the fair market
value of the underlying property or the principal amount of the
modified loan, as applicable, exceeds FBR Asset's basis in the original
loan.
o Although several types of non-cash income are excluded in determining
the annual distribution requirement, FBR Asset will incur corporate
income tax and the 4% excise tax with respect to those non-cash income
items if it does not distribute those items on a current basis.
o FBR Asset may recognize phantom taxable income from any residual
interests in REMICs or retained ownership interests in mortgage loans
subject to collateralized mortgage obligation debt that it owns.
As a result of the foregoing, FBR Asset may have less cash than is necessary to
distribute all of its taxable income and thereby avoid corporate income tax and
the excise tax imposed on undistributed income. In such a situation, it may need
to borrow funds or issue preferred stock or additional common stock.
Under some circumstances, FBR Asset may be able to correct a failure to meet the
distribution requirement for a year by paying deficiency dividends to its
shareholders in a later year. FBR Asset may include such deficiency dividends in
its deduction for dividends paid for the earlier year. Although FBR Asset may be
able to avoid income tax on amounts distributed as deficiency dividends, it will
be required to pay interest to the Internal Revenue Service based upon the
amount of any deduction it takes for deficiency dividends.
Recordkeeping Requirements
FBR Asset must maintain certain records in order to qualify as a REIT. In
addition, to avoid a monetary penalty, it must request on an annual basis
information from its shareholders designed to disclose the actual ownership of
its outstanding stock. FBR Asset has complied, and FBR Asset intends to continue
to comply, with such requirements.
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Failure to Qualify
If FBR Asset failed to qualify as a REIT in any taxable year, and no relief
provision applied, it would be subject to federal income tax and any applicable
alternative minimum tax on its taxable income at regular corporate rates. In
calculating its taxable income in a year in which it failed to qualify as a
REIT, FBR Asset would not be able to deduct amounts paid out to shareholders. In
fact, FBR Asset would not be required to distribute any amounts to shareholders
in such year. In such event, to the extent of its current and accumulated
earnings and profits, all distributions to shareholders would be taxable as
ordinary income. Subject to certain limitations of the federal income tax laws,
corporate shareholders might be eligible for the dividends received deduction.
Unless FBR Asset qualified for relief under specific statutory provisions, it
also would be disqualified from taxation as a REIT for the four taxable years
following the year during which it ceased to qualify as a REIT. We cannot
predict whether in all circumstances FBR Asset would qualify for such statutory
relief.
Taxation of Taxable U.S. Shareholders
As long as FBR Asset qualifies as a REIT, a taxable "U.S. shareholder" must take
into account distributions that are made out of FBR Asset's current or
accumulated earnings and profits and that FBR Asset does not designate as
capital gain dividends or retained long-term capital gain as ordinary income. A
U.S. shareholder will not qualify for the dividends received deduction generally
available to corporations. As used herein, the term "U.S. shareholder" means a
holder of common stock that for U.S. federal income tax purposes is:
o a citizen or resident of the United States;
o a corporation, partnership, or other entity created or organized in or
under the laws of the United States or of an political subdivision
thereof;
o an estate whose income from sources without the United States is
includible in gross income for U.S. federal income tax purposes
regardless of its connection with the conduct of a trade or business
within the United States; or
o any trust with respect to which (1) a U.S. court is able to exercise
primary supervision over the administration of such trust and (2) one
or more U.S. persons have the authority to control all substantial
decisions of the trust.
A U.S. shareholder generally will recognize distributions that FBR Asset
designates as capital gain dividends as long-term capital gain without regard to
the period for which the U.S. shareholder has held its common stock. Subject to
certain limitations, FBR Asset will designate its capital gain dividends as
either 20% or 25% rate distributions. A corporate U.S. shareholder, however, may
be required to treat up to 20% of certain capital gain dividends as ordinary
income.
FBR Asset may elect to retain and pay income tax on the net long-term capital
gain that it receives in a taxable year. In that case, a U.S. shareholder would
be taxed on its proportionate share of FBR Asset's undistributed long-term
capital gain. The U.S. shareholder would receive a credit or refund for its
proportionate share of the tax FBR Asset paid. The U.S. shareholder would
increase the basis in its stock by the amount of its proportionate share of FBR
Asset's undistributed long-term capital gain, minus its share of the tax FBR
Asset paid.
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If a distribution exceeds FBR Asset's current and accumulated earnings and
profits but does not exceed the adjusted basis of a U.S. shareholder's common
stock, the U.S. shareholder will not incur tax on the distribution. Instead,
such distribution will reduce the adjusted basis of the common stock. A U.S.
shareholder will recognize a distribution that exceeds both FBR Asset's current
and accumulated earnings and profits and the U.S. shareholder's adjusted basis
in its common stock as long-term capital gain if the common stock has been held
for more than one year, or short-term capital gain if the common stock has been
held for one year or less, assuming the common stock is a capital asset in the
hands of the U.S. shareholder. In addition, if FBR Asset declares a distribution
in October, November, or December of any year that is payable to a U.S.
shareholder of record on a specified date in any such month, such distribution
shall be treated as both paid by FBR Asset and received by the U.S. shareholder
on December 31 of such year, provided that FBR Asset actually pays the
distribution during January of the following calendar year. We will notify U.S.
shareholders after the close of FBR Asset's taxable year as to the portions of
the distributions attributable to that year that constitute ordinary income or
capital gain dividends.
FBR Asset's investments may cause it to recognize taxable income in excess of
its economic income and to experience an offsetting excess of economic income
over its taxable income in later years. As a result, U.S. shareholders may from
time to time be required to pay federal income tax on distributions that
economically represent a return of capital, rather than a dividend. Such
distributions would be offset in later years by distributions representing
economic income that would be treated as returns of capital for federal income
tax purposes. Accordingly, if FBR Asset receives phantom income, its U.S.
shareholders may incur federal income tax with respect to such income before
they realize such income in an economic sense. Taking into account the time
value of money, such an acceleration of federal income tax liabilities would
cause shareholders to receive an after-tax rate of return on an investment in
the common stock that would be less than the after-tax rate of return on an
investment with an identical before-tax rate of return that did not generate
phantom income. We will consider the potential effects of phantom income on FBR
Asset's taxable U.S. shareholders in managing FBR Asset's investments.
Although FBR Asset does not currently own REMIC residual interests or retained
ownership interests in mortgage loans subject to collateralized mortgage
obligation debt, FBR Asset could acquire assets of that type in the future. If
FBR Asset does so, its U.S. Shareholders may suffer the following adverse tax
consequences:
o Those types of assets may produce significant amounts of phantom
income; and
o Those types of assets may cause a portion of the dividends received by
U.S. shareholders to be treated as excess inclusion, a type of income
that generally cannot be offset by tax losses and is not subject to any
exemptions from federal income tax.
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Taxation of U.S. Shareholders on the Disposition of the Common Stock
In general, a U.S. shareholder who is not a dealer in securities must treat any
gain or loss realized upon a taxable disposition of the common stock as
long-term capital gain or loss if the U.S. shareholder has held the common stock
for more than one year and otherwise as short-term capital gain or loss.
However, a U.S. shareholder generally must treat any loss upon a sale or
exchange of common stock held by such shareholder for six months or less as a
long-term capital loss to the extent of capital gain dividends and other
distributions from FBR Asset that such U.S. shareholder treats as long-term
capital gain. All or a portion of any loss a U.S. shareholder realizes upon a
taxable disposition of the common stock may be disallowed if the U.S.
shareholder purchases other shares of common stock within 30 days before or
after the disposition.
Capital Gains and Losses
A taxpayer generally must hold a capital asset for more than one year for gain
or loss derived from its sale or exchange to be treated as long-term capital
gain or loss. The highest marginal individual income tax rate is 39.6%. The
maximum tax rate on long-term capital gain applicable to non-corporate taxpayers
is 20% for sales and exchanges of assets held for more than one year. The
maximum tax rate on long-term capital gain from the sale or exchange of
depreciable real property that is treated as "section 1250 property" under the
federal income tax laws is 25% to the extent that such gain would have been
treated as ordinary income if the property were personal property that is
treated as "section 1245 property" under the federal income tax laws. With
respect to distributions that FBR Asset designates as capital gain dividends and
any retained capital gain that it is deemed to distribute, FBR Asset generally
may designate whether such a distribution is taxable to its non-corporate
shareholders at a 20% or 25% rate. Thus, the tax rate differential between
capital gain and ordinary income for non-corporate taxpayers may be significant.
In addition, the characterization of income as capital gain or ordinary income
may affect the deductibility of capital losses. A non-corporate taxpayer may
deduct capital losses not offset by capital gains against its ordinary income
only up to a maximum annual amount of $3,000. A non-corporate taxpayer may carry
forward unused capital losses indefinitely. A corporate taxpayer must pay tax on
its net capital gain at ordinary corporate rates. A corporate taxpayer can
deduct capital losses only to the extent of capital gains, with unused losses
being carried back three years and forward five years.
Information Reporting Requirements and Backup Withholding
FBR Asset will report to its shareholders and to the Internal Revenue Service
the amount of distributions it pays during each calendar year, and the amount of
tax it withholds, if any. Under the backup withholding rules, a shareholder may
be subject to backup withholding at the rate of 31% with respect to
distributions unless such holder either:
o is a corporation or comes within another exempt category and, when
required, demonstrates this fact; or
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<PAGE>
o provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with the
applicable requirements of the backup withholding rules.
A shareholder who does not provide FBR Asset with its correct taxpayer
identification number also may be subject to penalties imposed by the Internal
Revenue Service. Any amount paid as backup withholding will be creditable
against the shareholder's income tax liability. In addition, FBR Asset may be
required to withhold a portion of capital gain distributions to any shareholders
who fail to certify their non-foreign status to FBR Asset. The Treasury
Department has issued final regulations regarding the backup withholding rules
as applied to non-U.S. shareholders. Those regulations alter the current system
of backup withholding compliance and are effective for distributions made after
December 31, 1999. See "--Taxation of Non-U.S. Shareholders."
Taxation of Tax-Exempt Shareholders
Tax-exempt entities, including qualified employee pension and profit sharing
trusts and individual retirement accounts and annuities, generally are exempt
from federal income taxation. However, they are subject to taxation on their
unrelated business taxable income. While many investments in real estate
generate unrelated business taxable income, the Internal Revenue Service has
issued a published ruling that dividend distributions from a REIT to an exempt
employee pension trust do not constitute unrelated business taxable income,
provided that the exempt employee pension trust does not otherwise use the
shares of the REIT in an unrelated trade or business of the pension trust. Based
on that ruling, amounts that FBR Asset distributes to tax-exempt shareholders
generally should not constitute unrelated business taxable income. However, if a
tax-exempt shareholder were to finance its acquisition of the common stock with
debt, a portion of the income that it receives from FBR Asset would constitute
unrelated business taxable income pursuant to the "debt-financed property"
rules. Furthermore, social clubs, voluntary employee benefit associations,
supplemental unemployment benefit trusts, and qualified group legal services
plans that are exempt from taxation under special provisions of the federal
income tax laws are subject to different unrelated business taxable income
rules, which generally will require them to characterize distributions that they
receive from FBR Asset as unrelated business taxable income. Finally, in certain
circumstances, a qualified employee pension or profit sharing trust that owns
more than 10% of FBR Asset's stock is required to treat a percentage of the
dividends that it receives from FBR Asset as unrelated business taxable income.
The percentage of its dividends that the tax-exempt trust must treat as
unrelated business taxable income is equal to the gross income FBR Asset derives
from an unrelated trade or business, determined as if it were a pension trust,
divided by its total gross income for the year in which it pays the dividends.
The unrelated business taxable income rule applies to a pension trust holding
more than 10% of FBR Asset's stock only if:
o the percentage of its dividends that the tax-exempt trust must treat as
unrelated business taxable income is at least 5%;
o FBR Asset qualifies as a REIT by reason of the modification of the rule
requiring that no more than 50% of FBR Asset's shares be owned by five
or fewer individuals that allows the beneficiaries of the pension trust
to be treated as holding FBR Asset's stock in proportion to their
actuarial interests in the pension trust; and
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<PAGE>
o either (1) one pension trust owns more than 25% of the value of FBR
Asset's stock or (2) a group of pension trusts individually holding
more than 10% of the value of FBR Asset's stock collectively owns more
than 50% of the value of FBR Asset's stock.
Although FBR Asset does not currently own REMIC residual interests or retained
ownership interests in mortgage loans subject to collateralized mortgage
obligation debt, FBR Asset could acquire assets of that type in the future. If
FBR Asset does so, tax-exempt shareholders may be required to treat a portion of
their dividends as unrelated business taxable income. Tax-exempt shareholders
also may suffer those adverse tax consequences if FBR Asset acquires stock in
other REITs that own REMIC residual interests or mortgage loans subject to
collateralized mortgage debt.
Taxation of Non-U.S. Shareholders
The rules governing U.S. federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships, and other foreign
shareholders are complex. This section is only a summary of such rules. We urge
those non-U.S. shareholders to consult their own tax advisors to determine the
impact of federal, state, and local income tax laws on ownership of the common
stock, including any reporting requirements.
A non-U.S. shareholder that receives a distribution that is not attributable to
gain from FBR Asset's sale or exchange of U.S. real property interests (as
defined below) and that FBR Asset does not designate as a capital gain dividend
or retained capital gain will recognize ordinary income to the extent that FBR
Asset pays such distribution out of its current or accumulated earnings and
profits. A withholding tax equal to 30% of the gross amount of the distribution
ordinarily will apply to such distribution unless an applicable tax treaty
reduces or eliminates the tax. However, if a distribution is treated as
effectively connected with the non-U.S. shareholder's conduct of a U.S. trade or
business, the non-U.S. shareholder generally will be subject to federal income
tax on the distribution at graduated rates, in the same manner as U.S.
shareholders are taxed with respect to such distributions. A non-U.S.
corporation also may be subject to the 30% branch profits tax . FBR Asset plans
to withhold U.S. income tax at the rate of 30% on the gross amount of any such
distribution paid to a non-U.S. shareholder unless either:
o a lower treaty rate applies and the non-U.S. shareholder files the
required form evidencing eligibility for that reduced rate with FBR
Asset; or
o the non-U.S. shareholder files an IRS Form 4224 with FBR Asset claiming
that the distribution is effectively connected income.
The U.S. Treasury Department has issued final regulations that modify the manner
in which FBR Asset will comply with the withholding requirements. Those
regulations are effective for distributions made after December 31, 1999.
Although FBR Asset does not currently own REMIC residual interests or retained
ownership interests in mortgage loans subject to collateralized mortgage
obligation debt, FBR Asset may acquire assets of that type in the future. If FBR
Asset does so, or invests
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<PAGE>
in the stock of a REIT that owns assets of that type, a portion of the dividends
that are paid by FBR Asset to non-U.S shareholders may be subject to 30%
withholding tax, regardless of any reduced rate that otherwise would apply under
a tax treaty.
A non-U.S. shareholder will not incur tax on a distribution that exceeds FBR
Asset's current and accumulated earnings and profits but does not exceed the
adjusted basis of its common stock. Instead, such a distribution will reduce the
adjusted basis of such common stock. A non-U.S. shareholder will be subject to
tax on a distribution that exceeds both FBR Asset's current and accumulated
earnings and profits and the adjusted basis of its common stock, if the non-U.S.
shareholder otherwise would be subject to tax on gain from the sale or
disposition of its common stock, as described below. Because FBR Asset generally
cannot determine at the time it makes a distribution whether or not the
distribution will exceed its current and accumulated earnings and profits, it
normally will withhold tax on the entire amount of any distribution at the same
rate as it would withhold on a dividend. However, a non-U.S. shareholder may
obtain a refund of amounts that FBR Asset withholds if it later determines that
a distribution in fact exceeded its current and accumulated earnings and
profits.
FBR Asset must withhold 10% of any distribution that exceeds its current and
accumulated earnings and profits. Consequently, although it intends to withhold
at a rate of 30% on the entire amount of any distribution, to the extent that it
does not do so, it will withhold at a rate of 10% on any portion of a
distribution not subject to withholding at a rate of 30%.
For any year in which FBR Asset qualifies as a REIT, a non-U.S. shareholder will
incur tax on distributions that are attributable to gain from its sale or
exchange of "U.S. real property interests" under special provisions of the
federal income tax laws. The term "U.S. real property interests" includes
certain interests in real property and stock in corporations at least 50% of
whose assets consists of interests in real property, but excludes mortgage loans
and mortgage-backed securities. Under those rules, a non-U.S. shareholder is
taxed on distributions attributable to gain from sales of U.S. real property
interests as if such gain were effectively connected with a U.S. business of the
non-U.S. shareholder. A non-U.S. shareholder thus would be taxed on such a
distribution at the normal capital gain rates applicable to U.S. shareholders
and also might be subject to the alternative minimum tax. A nonresident alien
individual also might be subject to special alternative minimum tax. A non-U.S.
corporate shareholder not entitled to treaty relief or exemption also may be
subject to the 30% branch profits tax on such a distribution. FBR Asset must
withhold 35% of any distribution that it could designate as a capital gain
dividend. A non-U.S. shareholder may receive a credit against its tax liability
for the amount FBR Asset withholds.
A non-U.S. shareholder generally will not incur tax under the provisions
applicable to distributions that are attributable to gain from the sale of U.S.
real property interests on gain from the sale of its common stock as long as at
all times non-U.S. persons hold, directly or indirectly, less than 50% in value
of FBR Asset's stock. We cannot assure you that that test will be met. However,
a non-U.S. shareholder that owned, actually or constructively, 5% or less of the
common stock at all times during a specified testing period will not incur tax
under the provisions applicable to distributions that are attributable to gain
from the sale of U.S. real property interests if FBR Asset's common stock is
"regularly traded" on an established securities market. If the gain on the sale
of
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<PAGE>
the common stock were taxed under those provisions, a non-U.S. shareholder would
be taxed in the same manner as U.S. shareholders with respect to such gain,
subject to applicable alternative minimum tax, a special alternative minimum tax
in the case of nonresident alien individuals, and the possible application of
the 30% branch profits tax in the case of non-U.S. corporations. Furthermore, a
non-U.S. shareholder will incur tax on gain not subject to the provisions
applicable to distributions that are attributable to gain from the sale of U.S.
real property interests if either:
o the gain is effectively connected with the non-U.S. shareholder's U.S.
trade or business, in which case the non-U.S. shareholder will be
subject to the same treatment as U.S. shareholders with respect to such
gain; or
o the non-U.S. shareholder is a nonresident alien individual who was
present in the United States for 183 days or more during the taxable
year, in which case the non-U.S. shareholder will incur a 30% tax on
his capital gains.
Other Tax Consequences
FBR Asset and/or you may be subject to state and local tax in various states and
localities, including those states and localities in which FBR Asset or you
transact business, own property, or reside. The state and local tax treatment in
such jurisdictions may differ from the federal income tax treatment described
above. Consequently, you should consult your own tax advisor regarding the
effect of state and local tax laws upon an investment in the common stock.
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<PAGE>
ERISA Considerations
This section discusses only issues relevant under the "plan asset regulations"
(as defined below) and, as a result, does not address all of the issues that may
be important to you under of the Employee Retirement Income Security Act of 1974
("ERISA") and the prohibited transaction provisions of the federal income tax
laws. The discussion contained in this section is based on current federal law
and interpretations thereof. We cannot assure you that new laws or
interpretations thereof, which may take effect retroactively, will not cause any
statement in this section to become inaccurate.
This section is a summary of materially relevant law and is not a substitute for
careful planning with a professional.
A fiduciary deciding whether to buy common stock on behalf of an employee
benefit plan, a tax-qualified retirement plan, or an individual retirement
account should consult its own legal advisor regarding the specific
considerations arising under ERISA, the prohibited transaction provisions of the
federal income tax laws, and state law with respect to an investment in the
common stock by such plan or individual retirement account. A fiduciary also
should consider the entire discussion under the heading "Federal Income Tax
Consequences of FBR Asset's Status as a REIT," because the discussion in that
section is relevant to a plan or individual retirement account's decision to
purchase common stock.
Department of Labor Regulations defining plan assets (the "plan asset
regulations") generally provide that when an ERISA investor acquires an equity
interest in an entity, the ERISA investor's assets include both the equity
interest and an undivided interest in each of the underlying assets of the
issuer of such equity interest, unless one or more exceptions specified in the
plan asset regulations are satisfied. An "ERISA investor" includes:
o a pension, profit sharing, or other employee benefit plan subject to
Title I of ERISA;
o a qualified retirement plan not subject to Title I of ERISA because it
is a governmental or church plan or because it does not cover common
law employees; and
o an individual retirement account or an individual retirement annuity.
One exception under the plan asset regulations provides that an ERISA investor's
assets will not include any of the underlying assets of an entity if at all
times ERISA investors own less than 25% of the value of each class of equity
interests in the entity (the "insignificant participation exception"). Another
exception provides that an ERISA Investor's assets will not include the
underlying assets of an entity if the class of equity interests in which the
ERISA investor invests meets the following requirements and, as a result, is
"publicly-offered":
o it is held by 100 or more investors who are independent of the issuer
and each other;
o it is freely transferable; and
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<PAGE>
o it is part of a class of securities registered under Section 12(b) or
12(g) of the Securities Exchange Act of 1934.
The plan asset regulations list restrictions on transfer that ordinarily will
not prevent securities from being "freely transferable." Such restrictions
include any restriction on or prohibition against a transfer that would result
in the termination or reclassification of an entity for federal or state tax
purposes.
FBR Asset's Charter provides that before the date that either (1) the common
stock is "publicly offered" or (2) FBR Asset qualifies for another exception to
the plan asset regulations (other than the insignificant participation
exception), FBR Asset must satisfy the insignificant participation exception.
FBR Asset's common stock is held by 100 or more shareholders who are independent
of FBR Asset and each other. In addition, we believe that the restrictions on
transfer of the common stock imposed under FBR Asset's Charter do not prevent
the common stock from being "freely transferable." Furthermore, FBR Asset will
register its common stock under Section 12(g) of the Securities Exchange Act at
the same time that this registration statement becomes effective under the
Securities Act. Accordingly, the common stock should be "publicly offered"
securities, and FBR Asset's assets should not be deemed to be "plan assets" of
any ERISA investor that owns common stock. As a result, the requirement
described above that FBR Asset satisfy the insignificant participation exception
no longer applies. However, if at any time FBR Asset fails to qualify for an
exception from the plan asset regulations, the assets of an ERISA investor that
invests in the common stock will include an undivided interest in FBR Asset's
assets. In such event, FBR Asset's assets, transactions involving its assets,
and the persons with authority or control over and that provide services with
respect to its assets would be subject to the fiduciary responsibility
provisions of Title I of ERISA and the prohibited transaction provisions of the
federal income tax laws.
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Selling Shareholders
The following table sets forth the name of each selling shareholder, the
aggregate number of shares of common stock beneficially owned by each selling
shareholder as of ____________, 1999, the aggregate number of shares that each
selling shareholder may offer pursuant to this prospectus, and the aggregate
number of shares of common stock that will be beneficially owned by each selling
shareholder after completion of this offering. All of the shares offered by
selling shareholders are issued and outstanding as of the date of this
prospectus. To FBR Asset's knowledge, none of the selling shareholders has had
within the past three years any material relationship with FBR Asset or any of
its affiliates.
<TABLE>
<CAPTION>
Shares to be
Shares Offered for Shares
Beneficially the Selling Beneficially
Owned Before the Shareholder's Owned After
Selling Shareholder Offering Account the Offering
------------------- -------- ------- ------------
<S> <C> <C> <C>
</TABLE>
Use of Proceeds
The shares of common stock offered hereby are being registered for the account
of the selling shareholders identified in this prospectus. All net proceeds from
the sale of the common stock will go to the shareholders who offer and sell
their shares. Accordingly, we will not receive any part of the proceeds from the
sale of these shares.
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<PAGE>
Plan of Distribution
The selling shareholders may offer their shares of common stock directly or
through pledgees, donees, transferees or other successors in interest in one or
more of the following transactions:
o in the over-the-counter market;
o on any stock exchange on which shares of the common stock may be listed
at the time of sale;
o in negotiated transactions; or
o in a combination of any of the above transactions.
The selling shareholders may offer their shares of common stock at any of the
following prices:
o fixed prices that may be changed;
o market prices prevailing at the time of sale;
o prices related to prevailing market prices; or
o at negotiated prices.
The selling shareholders may sell their shares of common stock by one or more of
the following methods, without limitation:
o a block trade in which the broker-dealer so engaged will attempt to
sell the shares as agent, but may position and resell a portion of the
block as principal to facilitate the transaction;
o a broker or dealer may purchase as principal and resell for its own
account pursuant to this prospectus;
o ordinary brokerage transactions and transactions in which the broker
solicits purchasers; or
o face-to-face transactions between the selling shareholders and
purchasers without a broker-dealer.
In effecting sales, brokers or dealers engaged by selling shareholders may
arrange for other brokers or dealers to participate. The selling shareholders
may give such brokers or dealers commissions or discounts in amounts to be
negotiated immediately prior to the sale. Such brokers or dealers and any other
participating brokers or dealers may be deemed to be "underwriters" within the
meaning of Section 2(11) of the Securities Act of 1933 in connection with such
sales.
In addition, any securities covered by this prospectus that qualify for sale
pursuant to Rule 144 might be sold under Rule 144 rather than pursuant to this
prospectus. The selling shareholders and any broker-dealers acting in connection
with the sale of shares of common stock hereunder may be deemed to be
"underwriters" within the meaning of Section 2(11) of the Securities Act, and
any commissions received by them and any profit realized by them on the resale
of shares of common stock as principals may be deemed underwriting compensation
under the Securities Act.
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If and when a selling shareholder notifies us that he or she has entered into a
material arrangement with a broker-dealer for the sale of shares of common stock
through a block trade, special offering or secondary distribution, or a purchase
by a broker or dealer, we will file a supplemental prospectus, if required,
pursuant to Rule 424(c) under the Securities Act, disclosing (1) the name of the
selling shareholder and of the participating broker-dealer(s); (2) the number of
shares of common stock involved; (3) the price at which such shares of common
stock were sold; (4) the commissions paid or discounts or concessions allowed to
such broker-dealer(s), where applicable; (5) that such broker-dealer(s) did not
conduct any investigation to verify the information set out or incorporated by
reference in this prospectus; and (6) other facts material to the transaction.
Each selling shareholder reserves the sole right to accept and, together with
any agent of the selling shareholder, to reject in whole or in part any proposed
purchase of the shares of common stock. The selling shareholder will pay any
sales commissions or other seller's compensation applicable to such
transactions.
We have not registered or qualified offers and sales of shares of the common
stock under the laws of any country, other than the United States. To comply
with certain states' securities laws, if applicable, the selling shareholders
will offer and sell their shares of common stock in such jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
states the selling shareholders may not offer or sell shares of common stock
unless we have registered or qualified such shares for sale in such states or we
have complied with an available exemption from registration or qualification.
Under applicable rules and regulations under the Securities Exchange Act of
1934, any person engaged in a distribution of shares of the common stock may not
simultaneously engage in market-making activities with respect to such shares of
common stock for a period of two to nine business days prior to the commencement
of such distribution. In addition, the selling shareholders and any other person
participating in a distribution will be subject to applicable provisions of the
Exchange Act and the rules and regulations under the Exchange Act, including
Rules 10b-2, 10b-6 and 10b-7. Such provisions may limit the timing of purchases
and sales of any of the shares of common stock by the selling shareholders or
any such other person. This may affect the marketability of the common stock and
the brokers' and dealers' ability to engage in market-marking activities with
respect to the common stock.
We will pay substantially all of the expenses incident to the registration of
the shares of common stock, estimated to be approximately ____________.
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Other Matters
Legal
We have based the description of federal income tax consequences in "Federal
Income Tax Consequences of FBR Asset's Status as a REIT" upon the opinion of
Hunton & Williams, Richmond, Virginia.
Independent Accountants
The audited financial statements included in this prospectus have been audited
by Arthur Andersen LLP, independent public accountants, to the extent and for
the periods stated in their reports and are included herein in reliance upon the
authority of Arthur Andersen as experts in giving those reports.
Additional Information
From FBR Asset
You can obtain complete copies of the documents to which we refer in this
prospectus, free of charge, by writing or calling:
Elaine Clancy, Chief Financial Officer
FBR Asset Investment Corporation
1001 Nineteenth Street North
Arlington, Virginia 22209
(703) 469-1000 phone
(703) 312-9602 fax
From the SEC
This prospectus is part of a Registration Statement that we have filed with the
SEC. You can read and copy that Registration Statement, and the exhibits
attached to it, at the SEC's public reference rooms in Washington, DC, New York,
New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for more
information about the public reference rooms.
After the offering, we will file annual, quarterly and special reports, proxy
statements and other information with the SEC. You will be able to read and copy
those documents at the SEC's public reference rooms too.
You can also obtain copies of all documents that we file with the SEC on the
SEC's website (http://www.sec.gov).
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Index to Financial Statements
Page
----
Report of Independent Public Accountants...............................F-2
Financial Statements:
Statements of Financial Condition
as of December 31, 1997 and 1998...............................F-3
Statements of Income for the Period from
December 15, 1997 (Inception),
through December 31, 1997,
and the Year Ended December 31, 1998...........................F-4
Statements of Changes in Shareholders'
Equity for the Period from
December 15, 1997 (Inception),
through December 31, 1997,
and the Year Ended December 31, 1998...........................F-5
Statements of Cash Flows for the Period from
December 15, 1997 (Inception),
through December 31, 1997,
and the Year Ended December 31, 1998...........................F-6
Notes to Financial Statements..........................................F-7
F-1
<PAGE>
Report of Independent Public Accountants
To FBR Asset Investment Corporation:
We have audited the accompanying statements of financial condition of FBR Asset
Investment Corporation (the "Company", a Virginia corporation) as of December
31, 1997 and 1998, and the related statements of income, changes in
shareholders' equity and cash flows for the period from December 15, 1997
(inception) through December 31, 1997, and the year ended December 31, 1998.
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 FBR Asset Investment
Corporation as of December 31, 1997 and 1998, and the results of its operations
and its cash flows for the period from December 15, 1997 (inception), through
December 31, 1997, and the year ended December 31, 1998, in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
Washington, D.C.
February 12, 1999
F-2
<PAGE>
<TABLE>
<CAPTION>
FBR Asset Investment Corporation
Statements of Financial Condition as of December 31, 1997 and 1998*
============================================================================================================
As of December 31
-----------------------------------
1997 1998
---- ----
<S> <C> <C>
Assets
Mortgage-backed securities, at fair value $ - $161,418,739
Cash and cash equivalents 163,223,199 41,144,326
Investments in equity securities, at fair value 23,318,750 70,983,050
Notes receivable 3,000,000 19,082,921
Due from affiliate 545,827 -
Dividends receivable 434,717 870,477
Prepaid expenses - 454,746
Organization costs, net of accumulated
amortization of $3,733 and $5,329, respectively 7,909 6,313
Interest receivable 8,000 1,970,048
============ ============
Total assets $190,538,402 $295,930,620
============ ============
Liabilities and Shareholders' Equity
Liabilities:
Repurchase agreements $ - $128,550,000
Interest payable - 310,096
Dividends payable 510,950 2,563,058
Management fees payable 58,623 1,275,514
Accounts payable and accrued expenses 12,000 224,933
Due to custodian-mortgage securities - 11,929,614
Deferred revenue 190,000 172,826
------------ ------------
Total liabilities 771,573 145,026,041
------------ ------------
Shareholders' equity:
Preferred stock, par value $.01 per share,
50,000,000 shares authorized - -
Common stock, par value $.01 per share, 200,000,000
shares authorized, 10,218,999, and 10,415,827
shares issued as of December 31, 1997 and 1998, 102,190 104,158
respectively
Additional paid-in capital 189,528,668 194,097,193
Accumulated other comprehensive income - (9,800,530)
Retained earnings (deficit) 135,971 (9,425,579)
Treasury stock, at cost, 1,872,300 shares - (24,070,663)
------------ ------------
Total shareholders' equity 189,766,829 150,904,579
============ ============
Total liabilities and shareholders' equity $190,538,402 $295,930,620
============ ============
============================================================================================================
</TABLE>
*The accompanying notes are an integral part of these statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
FBR Asset Investment Corporation
Statements of Income for the Period from December 15, 1997 (Inception)
through December 31, 1997, and the Year Ended December 31, 1998*
============================================================================================================
December 15, 1997
(Inception)
through Year Ended December
December 31, 1997 31, 1998
-------------------- -------------------
<S> <C> <C>
Income:
Interest $ 18,040 $ 13,656,097
Dividends 434,717 4,271,405
Other income 268,520 -
---------- -----------
Total Income 721,277 17,927,502
---------- -----------
Expenses:
Interest expense - 5,359,633
Management fee expense 58,623 1,520,725
Professional fees 12,000 440,185
Insurance - 52,769
Amortization of stock options issued to manager - 454,746
Amortization of organization costs 3,733 1,596
Other - 139,806
---------- -----------
Total expenses 74,356 7,969,460
---------- ----------
Realized gain on sale of mortgage securities - 176,048
Realized loss on equity investment - (6,615,000)
Realized loss on interest rate hedge - (1,930,855)
---------- -----------
Net income $ 646,921 $ 1,588,235
========== ===========
Basic and diluted earnings per share $ 0.06 $ 0.16
========== ===========
Weighted-average common and equivalent shares 10,218,999 10,044,483
========== ===========
============================================================================================================
</TABLE>
*The accompanying notes are an integral part of these statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
FBR Asset Investment Corporation
Statements of Changes in Shareholders' Equity for the Period from December 15, 1997
(Inception) through December 31, 1997, and the Year Ended December 31, 1998*
====================================================================================================================================
Accumulated
Additional Retained Other
Common Paid in Earnings Treasury Comprehensive Comprehensive
Stock Capital (Deficit) Stock Income Total Income
----- ------- --------- ----- ------ ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 15, 1997 $ - $ - $ - $ - $ - $ - $ -
Issuance of common stock 102,190 189,528,668 - - - 189,630,858 -
Net income - - 646,921 - - 646,921
646,921
-----------
Comprehensive income - - - - - - $ 646,921
===========
Dividends - - (510,950) - - (510,950)
-------- ------------ ------------ ------------ ----------- ------------
Balance, December 31, 1997 102,190 189,528,668 135,971 - - 189,766,829
-------- ------------ ------------ ------------ ----------- ------------
Issuance of common stock 1,968 3,659,033 - - - 3,661,001
Stock options issued to
manager - 909,492 - - - 909,492
Repurchase of common stock - - - (24,070,663) - (24,070,663)
Net income - - 1,588,235 - - 1,588,235 $ 1,588,235
Other comprehensive
income--
Change in unrealized
loss on available-
for-sale securities - - - - (9,800,530) (9,800,530) (9,800,530)
-----------
Comprehensive income - - - - - - $(8,212,295)
===========
Dividends - - (11,149,785) - - (11,149,785)
-------- ------------ ------------ ------------ ----------- ------------
Balance, December 31, 1998 $104,158 $194,097,193 $ (9,425,579) $(24,070,663) $(9,800,530) $150,904,579
======== ============ ============ ============ =========== ============
====================================================================================================================================
</TABLE>
*The accompanying notes are an integral part of these statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
FBR Asset Investment Corporation
Statements of Cash Flows for the Period from December 15, 1997 (Inception)
through December 31, 1997, and the Year Ended December 31, 1998*
====================================================================================================================================
December 15, 1997
(Inception)
through Year Ended
December 31, 1997 December 31, 1998
----------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 646,921 $ 1,588,235
Adjustments to reconcile net income to net cash (used
in) provided by operating activities--
Realized loss on equity securities - 6,615,000
Realized gain on sale of mortgage-backed securities - (176,048)
Unrealized gain on equity investments (268,520) -
Amortization 3,733 456,342
Premium amortization on mortgage-backed securities - 777,179
Changes in operating assets and liabilities:
Due from affiliate (545,827) 545,827
Dividends receivable (434,717) (435,760)
Interest receivable (8,000) (1,962,048)
Organization costs (11,642) -
Management fees payable 58,623 1,216,891
Accounts payable and accrued expenses 12,000 212,933
Interest payable - 310,096
Due to custodian - 2,041,230
Deferred revenue 190,000 (17,174)
------------ -------------
Net cash (used in) provided by operating activities (357,429) 11,172,703
------------ -------------
Cash flows from investing activities:
Investments in equity securities and notes receivable, net of
repayments on notes receivable (26,050,230) (80,876,250)
Purchase of mortgage-backed securities - (221,156,241)
Proceeds from sale of mortgage-backed securities - 48,533,267
Receipt of principal payments - 21,204,987
------------ -------------
Net cash used in investing activities (26,050,230) (232,294,237)
------------ -------------
Cash flows from financing activities:
Repurchase of common stock - (24,070,663)
Proceeds from issuance of common stock 189,630,858 3,661,001
Proceeds from repurchase agreements - 128,550,000
Dividends paid - (9,097,677)
------------ -------------
Net cash provided by financing activities 189,630,858 99,042,661
------------ -------------
Net increase (decrease) in cash and cash equivalents 163,223,199 (122,078,873)
Cash and cash equivalents, beginning of the period - 163,223,199
------------ -------------
Cash and cash equivalents, end of the period $163,223,199 $ 41,144,326
============ =============
====================================================================================================================================
</TABLE>
*The accompanying notes are an integral part of these statements.
F-6
<PAGE>
Notes to Financial Statements
Note 1 Organization and Nature of Operations
FBR Asset Investment Corporation ("FBR Asset" or the "Company") was incorporated
in Virginia on November 10, 1997. FBR Asset commenced operations on December 15,
1997, upon the closing of a private placement of equity capital (the "Private
Placement") (see Note 4).
FBR Asset is organized as a real estate investment trust ("REIT") whose primary
purpose is to invest in mortgage loans and mortgage-backed securities issued or
guaranteed by instrumentalities of the U.S. Government or by private issuers
that are secured by real estate (together the "Mortgage Assets"). FBR Asset also
acquires indirect interests in those and other types of real estate-related
assets by investing in public and private real estate companies, subject to the
limitations imposed by the various REIT qualification requirements. Funds not
immediately allocated will generally be temporarily invested in readily
marketable, interest-bearing securities. To create yields commensurate with its
investment objectives, FBR Asset leverages its assets and mortgage loan
portfolio primarily with collateralized borrowings. FBR Asset uses derivative
financial instruments to hedge a portion of the interest rate risk associated
with its borrowings.
Note 2 Summary of Significant Accounting Policies
Investments in Mortgage backed Securities
FBR Asset invests primarily in mortgage pass-through certificates that represent
a 100 percent interest in the underlying conforming mortgage loans and are
guaranteed by the Government National Mortgage Association ("Ginnie Mae"), the
Federal Home Loan Mortgage Corporation ("Freddie Mac"), and the Federal National
Mortgage Association ("Fannie Mae").
Mortgage-backed security transactions are recorded on the date the securities
are purchased or sold. Any amounts payable for unsettled trades are recorded as
"due to custodian--mortgage securities" in FBR Asset's Statement of Financial
Condition.
FBR Asset accounts for its investments in mortgage-backed securities in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," which
requires FBR Asset to classify its investments as either trading,
available-for-sale or held to maturity. FBR Asset does not hold its
mortgage-backed securities for trading purposes, but may not hold such
investments to maturity, and has classified these investments as
available-for-sale. Securities classified as available for sale are reported at
fair value, with temporary unrealized gains and losses excluded from earnings
and reported as a separate component of shareholders' equity. Realized gains and
losses on mortgage-backed securities transactions are determined on the specific
identification basis.
F-7
<PAGE>
Unrealized losses on mortgage-backed securities that are determined to be other
than temporary are recognized in income. Management regularly reviews its
investment portfolio for other than temporary impairment. There were no such
adjustments for mortgage-backed investments.
The fair value of FBR Asset's mortgage-backed securities are based on market
prices provided by certain dealers who make markets in these financial
instruments. The fair values reported reflect estimates and may not necessarily
be indicative of the amounts FBR Asset could realize in a current market
exchange.
Income from investments in mortgage-backed securities is recognized using the
effective interest method, using the expected yield over the life of the
investment. Income includes contractual interest accrued and the amortization or
accretion of any premium or discount recorded upon purchase. Changes in
anticipated yields result primarily from the changes in actual and projected
cash flows and estimated prepayments. Changes in the yield that result from
changes in the anticipated cash flows and prepayments are recognized over the
remaining life of the investment with recognition of a cumulative catch-up at
the date of change from the date of original investment.
During 1998, FBR Asset received proceeds of $48.5 million from the sale of
mortgage-backed securities. The Company recorded $176,048 in realized gains
related to this sale.
The following table summarizes FBR Asset's mortgage-backed securities as of
December 31, 1998:
<TABLE>
<CAPTION>
===============================================================================================
Total Mortgage
Freddie Mac Fannie Mae Ginnie Mae Assets
----------- ---------- ---------- --------------
<S> <C> <C> <C> <C>
Mortgage-backed securities,
available for sale-principal $93,278,879 $48,386,870 $16,294,168 $157,959,917
Unamortized premium 512,080 1,415,625 780,216 2,707,921
---------- ---------- ---------- -----------
Amortized cost 93,790,959 49,802,495 17,074,384 160,667,838
Gross unrealized gains 682,949 196,615 135,862 1,015,426
Gross unrealized losses (89,511) (156,584) (18,430) (264,525)
---------- ---------- ---------- -----------
Estimated fair value $94,384,397 $49,842,526 $17,191,816 $161,418,739
=========== =========== =========== ============
===============================================================================================
</TABLE>
Repurchase Agreements
FBR Asset has entered into short-term repurchase agreements to finance a
significant portion of its mortgage-backed investments. The repurchase
agreements are secured by FBR Asset's mortgage-backed securities and bear
interest at rates that have historically related closely to LIBOR for a
corresponding period. As of December 31, 1998, FBR Asset had $128.6 million
outstanding under repurchase agreements with a borrowing rate of 5.08% as of the
end of the period and a weighted-average remaining maturity of 73 days. At
December 31, 1998, mortgage-backed securities pledged had an estimated fair
value of $136.2 million. At December 31, 1998, the repurchase agreements had
remaining maturities of between 69 and 74 days.
F-8
<PAGE>
Interest Rate Swaps
During 1998, FBR Asset entered into two interest rate swap agreements to offset
the potential adverse effects of rising interest rates under certain short-term
repurchase agreements. The interest rate swap agreements are structured such
that FBR Asset receives payments based on a variable interest rate and makes
payments based on a fixed interest rate. The variable interest rate on which
payments are received is calculated based on the three-month LIBOR. The
Company's repurchase agreements, which generally have maturities of 60 to 90
days, carry interest rates that correspond to LIBOR rates for those same
periods. The swap agreements effectively fix the Company's borrowing cost and
are not held for speculative or trading purposes. As a result of these factors,
the Company has accounted for these agreements as hedges.
The fair value of interest rate agreements that qualify as hedges are not
recorded. The differential between amounts paid and received under the interest
rate swap agreements is recorded as an adjustment to the interest expense
incurred under the repurchase agreements. In the event of early termination of
an interest rate agreement, a gain or loss is recorded and the Company receives
or makes a payment based on the fair value of the interest rate agreement on the
date of termination.
In October 1998, in connection with the sale of mortgage assets and repayment of
certain repurchase agreements, the Company terminated one of its swap
agreements. The Company realized a loss of $1.9 million upon termination. The
remaining interest rate agreement has a notional amount of $50 million, a fair
value of $(910,535) and matures on June 1, 2001.
Investments in Equity Securities
Investments in securities that are listed on a national securities exchange (or
reported on the Nasdaq National Market) are stated at the last reported sale
price on the day of valuation. Listed securities for which no sale was reported
are stated at the mean between the closing "bid" and "asked" price on the day of
valuation. Other securities for which quotations are not readily available are
valued at fair value as determined by FBR Asset's investment adviser, Friedman,
Billings, Ramsey Investment Management, Inc. ("FBR Management"). FBR Management
may use methods of valuing securities other than those described above if it
believes the alternative method is preferable in determining the fair value of
such securities.
At December 31, 1997, FBR Asset classified its only three equity portfolio
investments as trading securities in accordance with SFAS No. 115. In January
1998, consistent with the intention to have the Company operate as a REIT,
management reevaluated its investment objectives for these investments and
concluded that these investments were being held for long-term yield, capital
appreciation, and cash flow. Accordingly, management reclassified such
investments as available for sale. The transfer of these securities between
categories was accounted for at fair value, and there was no change to FBR
Asset's net assets as a result of this change in classification.
Realized gains and losses are recorded on the date of the transaction using the
specific identification method. The difference between the purchase price and
market price (or fair value) of investments in securities is reported as an
unrealized gain or loss and a component of comprehensive income.
F-9
<PAGE>
Management regularly reviews any declines in the market value of its equity
investments for declines and impairments that are other than temporary. Such
declines are recorded in operations when determined. In 1998, management
recorded a charge to operations for $6.6 million associated with an other than
temporary decline in the value of its investment in Chastain Capital, Inc.
Notes Receivable
On December 23, 1997, FBR Asset entered into an Interim Financing and Security
Agreement with Prime Holding, LLC ("Prime"). The agreement allows for up to a
$20 million bridge loan to Prime. The note accrues interest at an annualized
rate of 12-15% depending upon the funding period. All amounts due under the
bridge loan are due on June 30, 1999. As of December 31, 1998, $11.5 million had
been drawn against the bridge loan. From inception through December 31, 1998,
$1.0 million in interest income has been recorded by FBR Asset. Prime is a
Delaware limited liability company formed in August 1997 and is an early stage
mortgage origination company.
On February 5, 1999, FBR Asset funded an additional $7 million against the Prime
bridge loan.
On June 3, 1998, FBR Asset entered into a promissory note agreement with
Kennedy-Wilson, Inc. for $10 million. The note accrued interest at a rate of 12
percent per annum, which was payable monthly. The agreement called for the
repayment of the advanced principal amount upon the earlier of, the closing of a
public offering of common stock by Kennedy-Wilson, or December 3, 1998. On
November 30, 1998, Kennedy-Wilson paid the note down to $7,500,000, and FBR
Asset and Kennedy-Wilson entered into an amended promissory note agreement
increasing the interest rate to 17% and extending the repayment date to June 3,
1999. Kennedy-Wilson is a U.S. real estate marketing and investment firm
specializing in innovative marketing programs for various types of properties
and financial instruments. From inception through December 31, 1998, interest
income of $0.7 million has been recorded on this note.
On January 25, 1999, the Company loaned Brookdale Living Community, Inc. $5
million in subordinated debt. The debt bears interest at 13 percent per annum
and is due on April 26, 1999.
Credit Risk
FBR Asset has limited its exposure to credit losses on its mortgage-backed
portfolio of mortgage-backed securities by purchasing securities only from
Freddie Mac, Fannie Mae, or Ginnie Mae. The payment of principal and interest on
the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by
those respective agencies and the payment of principal and interest on the
Ginnie Mae mortgage-backed securities is backed by the full-faith-and-credit of
the U.S. Government. At December 31, 1998, all of FBR Asset's mortgage-backed
securities have an implied "AAA" rating.
Cash and Cash Equivalents
All investments with original maturities of less than three months are cash
equivalents. As of December 31, 1998, cash and cash equivalents consisted of
$14.4 million of cash deposited in two commercial banks, and $26.7 million in
two separate domestic money market funds. The money market fund invests
primarily in obligations of the U.S. Government. The carrying amount of cash
equivalents approximates their fair value.
F-10
<PAGE>
New Accounting Pronouncements
During the period, FBR Asset adopted SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 requires the reporting of comprehensive income in addition
to net income from operations. Comprehensive income is a financial reporting
methodology that includes certain financial information that historically has
not been recognized in the calculation of net income. FBR Asset's only component
of other comprehensive income is the net unrealized loss on investments
classified as available for sale in accordance with SFAS No. 115.
In June 1998, the Financial Accounting Standards Board issued Statement on
Financial Accounting Standards No. 133 (SFAs No. 133) "Accounting for Derivative
Instruments and Hedging Activities." This statement is effective for all fiscal
years beginning after June 15, 1999, and generally requires that an entity
recognize derivative financial instruments as assets or liabilities and measure
them at fair value. Management is currently evaluating the impact of adopting
the requirements of SFAS 133.
Net Earnings Per Share
FBR Asset has adopted SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires
the presentation of basic and diluted earnings per share. SFAS No. 128 specifies
that basic earnings per share excludes potential dilution and is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. Diluted earnings per share reflects
the dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock or resulted in the issuance
of common stock that would share in earnings. The potentially dilutive
securities did not impact the computation of earnings per share for any period
presented.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
Income Taxes
FBR Asset has elected to be taxed as a REIT under the Internal Revenue Code. To
qualify for tax treatment as a REIT, FBR asset must meet certain income and
asset tests and distribution requirements. FBR Asset generally will not be
subject to federal income tax at the corporate level to the extent that it
distributes at least 95 percent of its taxable income to its shareholders and
complies with certain other requirements. Failure to meet these requirements
could have a material adverse impact on FBR Asset's results or financial
condition. Furthermore, because FBR Asset's investments include stock in other
REITs, failure of those other REITs to maintain their REIT status could
jepardize FBR Asset's qualification as a REIT. No provision has been made for
income taxes in the accompanying financial statements, as FBR Asset believes it
has met the prescribed distribution and other requirements.
Reclassifications
Certain amounts in the financial statements as of December 31, 1997, have been
reclassified to conform with 1998 presentation.
F-11
<PAGE>
Note 3 Stockholders' Equity
On December 15, 1997, FBR Asset completed a private placement of equity capital.
FBR Asset received net proceeds of $189.7 million from the issuance of
10,218,999 shares of common stock.
On January 15, 1998, FBR purchased 196,828 shares of FBR Asset for $3.7 million
pursuant to a stock option awarded in connection with the private placement
offering.
FBR Asset has paid the following dividends:
Declaration Date Payable Date Dividend
---------------- ------------ --------
December 31, 1997 January 22, 1998 $.055(1)
April 6, 1998 April 22, 1998 $.200
June 24, 1998 July 14, 1998 $.295
October 13, 1998 October 20, 1998 $.360
December 31, 1998 January 15, 1999 $.300
(1) Includes $0.05 divided declared in June 1998 and paid in July 1998 to
shareholders of record as of December 31, 1997.
In September 1998, the Board of Directors authorized the repurchase of up to
2,000,000 shares of FBR Asset's common stock. Through December 31, 1998, FBR
Asset had repurchased 1,872,300 shares for a cost of $24 million, or $12.86
average cost per share. In January 1999, the Company repurchased an additional
107,000 shares of its common stock at $13.70 per share.
FBR Asset has outstanding, as of December 31, 1998, 1,021,900 options to
purchase common stock. These options, which were issued in a single grant, have
a term of ten years, and have an exercise price of $20 per share.
Note 4 Management and Performance Fees
FBR Asset has entered into a management agreement with Friedman, Billings,
Ramsey Investment Management, Inc. ("FBR Management"), for an initial term
expiring on December 15, 1999. FBR Management will perform portfolio management
services on behalf of FBR Asset. Such services shall include, but are not
limited to, consulting with FBR Asset on purchase and sale opportunities,
collection of information and submission of reports pertaining to FBR Asset's
assets, interest rates, and general economic conditions, and periodic review and
evaluation of the performance of FBR Asset's portfolio of assets.
FBR Management is entitled to a quarterly "base" management fee equal to the sum
of (1) 0.25 percent per annum (adjusted to reflect a quarterly period) of the
average invested mortgage assets of FBR Asset during each calendar quarter and,
(2) 0.75 percent per annum (adjusted to reflect a quarterly period) of the
remainder of the average invested assets of FBR Asset during each calendar
quarter. FBR Management also received 1,021,900 options to purchase FBR Asset's
common stock at $20 per share. The estimated value of these options is $909,492,
based on a discounted Black-Scholes valuation, and is being amortized over the
initial term of the Management Agreement. FBR Management assigned options to
F-12
<PAGE>
acquire 51,045 shares to Blackrock in connection with the execution of the
sub-management agreement. The Company anticipates that FBR Management will
rescind options to purchase 155,000 shares in connection with the establishment
of FBR Asset's stock incentive plan.
FBR Management is also entitled to receive incentive compensation based on the
performance of FBR Asset. On December 31, 1998, and each subsequent year
thereafter, FBR Management is entitled to an incentive fee calculated as: funds
from operations (as defined), plus net realized gains or losses from asset
sales, less the threshold amount (all computed on a weighted average share
outstanding basis), multiplied by 25 percent. The threshold amount is calculated
as the weighted average per share price of all equity offerings of FBR Asset,
multiplied by a rate equal to the ten-year U.S. Treasury rate plus five percent
per annum.
FBR Management has engaged BlackRock Financial Management, Inc. ("BlackRock") to
manage FBR Asset's mortgage asset investment program (the "Mortgage Portfolio")
as a sub-adviser. BlackRock is a majority owned subsidiary of PNC Bank
Corporation who is a 4.9 percent owner of FBR Management's parent company. As
compensation for rendering services, BlackRock will be entitled to share the
management fees of FBR Management, calculated based on the average gross asset
value managed by BlackRock, with a minimum annual fee of $100,000, payable
quarterly. The agreement may be terminated by either party with thirty days
advance notice.
Note 5 Related Parties
As of December 31, 1998, a wholly-owned subsidiary of Friedman, Billings, Ramsey
Group, Inc. ("FBR Group") owns 1,344,086 shares or 15.73% of the outstanding
common stock of FBR Asset. FBR Group is the parent company of FBR Management and
FBR & Co.
Note 6 Equity Investments
As of December 31, 1997, the Company's equity investments had an aggregate cost
basis of $23 million, a fair value of $23.3 million and unrealized gains of $0.3
million. As of December 31, 1998, the Company's equity investments had an
aggregate cost basis of $81.2 million, fair value of $71.0 million, unrealized
losses of $12.6 million, realized losses of $6.6 million, and unrealized gains
of $2 million.
F-13
<PAGE>
<TABLE>
<CAPTION>
Amount of Market Value at
Equity Investments Investment December 31, 1998
- ----------------------------- --------------- ---------------------
<S> <C> <C>
Anthracite Capital, Inc. 18,334,496 12,358,172
Capital Automotive REIT 25,000,000 26,657,711
Chastain Capital Group 3,150,000 3,150,000
Imperial Credit Commercial Mortgage Inv. Corp. 13,050,230 8,437,500
Prime Retail, Inc. 1,201,317 1,211,844
Resource Asset Investment Trust 5,292,516 3,790,325
Building One Services Corporation 10,000,000 10,437,500
East-West Bank 5,200,000 4,940,000
---------- ----------
Total 81,228,559 70,983,052
========== ==========
</TABLE>
Imperial Credit Commercial Corporation ("ICMI")
FBR Asset purchased 900,000 shares of ICMI common stock in December 1997. ICMI
is a Maryland corporation that has elected REIT status. It invests primarily in
performing multifamily and commercial term loans and interests in commercial and
residential mortgage-backed securities. ICMI also invests in various classes of
non-investment grade mortgage-backed securities. ICMI's common stock is publicly
traded.
Building One Services Corporation ("BOSS")
FBR Asset purchased 500,000 shares of BOSS (formerly Consolidated Capital
Corporation) common stock in December 1997. BOSS is a Delaware corporation that
was founded in February 1997 to build consolidated enterprises through the
acquisition and integration of multiple businesses in one or more fragmented
industries. BOSS has undertaken to consolidate facilities management companies
and may select companies in this or related industries in which to make future
investments. BOSS's common stock is publicly traded.
Capital Automotive REIT ("CARs")
On February 13, 1998, FBR Asset acquired 1,792,115 shares of common stock in
CARs in a private transaction, concurrent with CARs's initial public stock
offering at a price of $13.95 per share. CARs is a self-administered and
self-managed Maryland REIT formed to invest in the real property and
improvements used by operators of multisite, multifranchised motor vehicle
dealerships and motor vehicle related businesses located in major metropolitan
areas throughout the United States. CARs primarily acquires real property and
simultaneously leases back this property for use by dealers. CARs's common stock
is publicly traded.
Resource Asset Investment Trust ("RAS")
On February 19, 1998, FBR Asset acquired 300,000 shares of common stock in RAS,
a Maryland REIT, for a cost of $4,599,000 or $15.33 per share. RAS's principal
business activity is the acquisition and/or financing of loans secured by
mortgages on real property (or interests in such loans) in situations that,
generally, do not conform to the underwriting standards of institution lenders
or sources that provide financing through securitization. RAS believes that its
anticipated financing activity provides it with an underserved niche market in
the real estate industry. RAS's common stock is publicly traded.
F-14
<PAGE>
On June 24th and 25th, 1998, FBR Asset acquired an additional 44,575 shares of
RAS for a cost of $693,516 or $15.55 average cost per share.
Anthracite Capital, Inc. ("AHR")
On March 27, 1998, FBR Asset purchased 716,846 shares of common stock in AHR, a
Maryland REIT, for a cost of approximately $10 million or $13.95 per share. AHR
was organized in November 1997 to invest in a diversified portfolio of
multifamily, commercial and residential mortgage loans, mortgage-backed
securities, and other real estate related assets in the United States and
non-U.S. markets. AHR seeks to achieve strong investment returns by maximizing
the spread of investment income earned on its real estate assets over the cost
of financing and hedging these assets and/or liabilities. AHR's common stock is
publicly traded.
During September and October, 1998, FBR Asset purchased an additional 865,000
shares of AHR for $8,334,496 or $9.64 average cost per share.
Chastain Capital, Inc. ("CHAS")
On April 29, 1998, FBR Asset purchased 700,000 shares of common stock in CHAS, a
Georgia REIT, for a cost of $9,765,000 or $13.95 per share. CHAS was organized
in December 1997 to invest in commercial and multifamily mortgage and real
estate related assets located in major metropolitan markets throughout the
United States. CHAS emphasizes, in particular, origination of commercial
mortgage loans for the purpose of securitizing and the retainage of subordinated
interests in these loans.
In 1998, FBR Asset recorded a charge to operations in the amount of $6,615,000
to reflect management's determination that the decline in the market value of
the stock was more than temporary.
East-West Bancorp ("EWB")
On June 30, 1998, FBR Asset purchased, through a private placement offering,
520,000 shares of EWB, a Southern California commercial bank, for a cost of
$5,200,000 or $10.00 per share. EWB's strategy is to become the premier
commercial bank in California serving the unique personal and business banking
needs of customers engaged in business and having family ties with or origins
from the Asia Pacific region, with experienced personnel having the language
capability and cultural sensitivity appropriate for the region.
Prime Retail, Inc. ("PRT")
In September 1998, FBR Asset purchased an aggregate of 122,300 shares of PRT,
for a total of $1,191,832, or $9.74 average cost per share. On October 18, 1998,
FBR Asset purchased an additional 1,200 shares of PRT's common stock for $9,485
or $7.90 per share. PRT is a Maryland REIT that is engaged primarily in the
ownership, development, construction, acquisition, leasing, marketing and
management of factory outlet centers. PRT's common stock is publicly traded.
F-15
<PAGE>
===================================================
We have not authorized any dealer, salesperson
or any other person to give any information or make
any representations in connection with this
offering other than those contained in this
prospectus, and, if given or made, such information
or representations must not be relied upon as
having been authorized by the company or the
selling stockholders. This prospectus does not
constitute an offer to sell or a solicitation of an
offer to buy any security other than the shares
offered by this prospectus nor does it constitute
an offer to sell or a solicitation of an offer or
to buy the shares offered hereby in any
jurisdiction in which such offer or solicitation is
not authorized or in which the person making such
offer or solicitation is not qualified to do so, or
to any person to whom it is unlawful to make such
offer or solicitation. Neither the delivery of this
prospectus nor any sale made hereunder shall, under
any circumstances, create any implication that the
information herein is correct as of any time
subsequent to the date hereof or that there has not
been a change in the affairs of the company since
the date hereof.
-----------------
SUMMARY TABLE OF CONTENTS
Page
----
Summary...........................................1
Risks of Investing in FBR Asset...................4
Organization & Relationships.....................17
FBR & FBR Management.............................18
FBR Asset's Business.............................26
Selected Financial Data..........................43
Management's Discussion & Analysis...............44
FBR Asset's Directors & Officers.................58
FBR Asset's Capital Stock........................66
Anti-Takeover Effect of Maryland Laws............71
Common Stock Available For Future Sale...........73
Principal Shareholders...........................74
Federal Income Tax Consequences of FBR
Asset's Status as a REIT.........................75
ERISA Considerations.............................93
Selling Shareholders.............................95
Use of Proceeds..................................95
Plan of Distribution.............................96
Other Matters....................................98
Until __________, 1999, all dealers effecting
transactions in the registered securities, whether
or not participating in this distribution, may be
required to deliver a prospectus.
===================================================
===================================================
________ Shares
FBR Asset Investment
Corporation
Common Stock
--------------------
PROSPECTUS
--------------------
___________, 1999
===================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 31. Other Expenses of Issuance and Distribution.
The following table sets forth the costs and expense, other than underwriting
discounts and commissions, payable by the Registrant in connection with the sale
of common stock being registered.
All amounts are estimates.
Amount To Be Paid
-----------------
SEC registration fee $45,888
Printing and mailing expenses $______*
Legal fees and expenses $______*
Accounting fees and expenses $______*
Transfer agent and custodian fees $______*
Miscellaneous $______*
Total $______*
========
- --------------------
*To be included by amendment
Item 32. Sales to Special Parties.
There are none, except to the extent that shares may be acquired pursuant to the
exercise of options as described under "FBR & FBR Management--The Management
Agreement--Options Owned by FBR Management" and "FBR Asset's Directors &
Officers--Executive Compensation & Other Benefits--Stock Options."
Item 33. Recent Sales of Unregistered Securities.
On November 19, 1998, the Registrant was formed and one share was issued to
Elaine M. Clancy for consideration of $20 in cash.
On __________, 1999, FBR Asset Investment Corporation, a Virginia corporation,
was merged into the Registrant. As part of that merger, _______ shares of the
Registrant's common stock were issued to shareholders of the Virginia
corporation in exchange for their shares in the Virginia corporation, on a
one-for-one basis. The transaction was exempt from registration under the
Securities Act of 1933 pursuant to Rule 145(a)(2).
Item 34. Indemnification of Officers and Directors.
The Maryland General Corporation Law permits a Maryland corporation to include
in its Charter a provision limiting the liability of its directors and officers
to the corporation and its stockholders for money damages except for liability
resulting from (a) actual receipt of an improper benefit or profit in money,
property or services or (b) active and deliberate dishonesty established by a
final judgment as being material to the cause of action. The Charter of the
Registrant contains such a provision that eliminates such liability to the
maximum extent permitted by Maryland law.
II-1
<PAGE>
The Charter of the Registrant authorizes it, to the maximum extent permitted by
Maryland law, to obligate itself to indemnify and to pay or reimburse reasonable
expenses in advance of final disposition of a proceeding to (a) any or former
director or officer or (b) any individual who, while a director of the
Registrant and at the request of the Registrant, serves or has served another
corporation, real estate investment trust, partnership, joint venture, trust,
employee benefit plan or any other enterprise as a director, officer, partner or
trustee of such corporation, real estate investment trust, partnership, joint
venture, trust, employee benefit plan or other enterprise from and against any
claim or liability to which such person may become subject or which such person
may incur by reason or his status as a present or former director or officer of
the Registrant. The Bylaws of the Registrant obligate it, to the maximum extent
permitted by Maryland law, to indemnify and to pay or reimburse reasonable
expenses in advance of final disposition of a proceeding to (a) any present or
former director or officer who is a made a party to the proceeding by reason of
his service in that capacity or (b) any individual who, while a director of the
Registrant and at the request of the Registrant serves or has served another
corporation, real estate investment trust, partnership, joint venture, trust,
employee benefit plan or any other enterprise as a director, officer, partner or
trustee of such corporation, real estate investment trust, partnership, joint
venture, trust, employee benefit plan or other enterprise who is made a party to
the proceeding by reason of his service in that capacity. The Charter and Bylaws
also permit the Registrant to indemnify and advance expenses to any person who
served a predecessor of the Registrant in any of the capacities described above
and to any employee or agent of the Registrant or a predecessor of the
Registrant. The Maryland General Corporation Law requires a corporation (unless
its Charter provides otherwise, which the Registrant's Charter does not) to
indemnify a director or officer who has been successful, on the merits or
otherwise, in the defense of any proceeding to which he is made a party by
reason of his service in that capacity.
The Maryland General Corporation Law permits a corporation to indemnify its
present and former directors and officers, among others, against judgments,
penalties, fines, settlements and reasonable expenses actually incurred by them
in connection with any proceeding to which they may be made a party by reason of
their service in those or other capacities unless it is established that (a) the
act or omission of the director or officer was material to the matter giving
rise to the proceeding and (i) was committed in bad faith or (ii) was 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, under the
Maryland General Corporation Law, a Maryland corporation may not indemnify for
an adverse judgment in a suit by or in the right of the corporation or for a
judgment of liability on the basis that personal benefit was improperly
received, unless in either case a court orders indemnification and then only for
expenses. In addition, the Maryland General Corporation Law permits a
corporation to advance reasonable expenses to a director or officer upon the
corporation's receipt of (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 corporation and (b) a written undertaking by or on his
behalf to repay the amount paid or reimbursed by the corporation if it shall
ultimately be determined that the standard of conduct was not met.
Item 35. Treatment of Proceeds from Stock Being Registered.
Not applicable.
II-2
<PAGE>
Item 36. Financial Statements and Exhibits.
(a) Financial Statements included in the prospectus.
(b) Exhibits
3.1 Amended and Restated Charter of
Registrant*
3.2 Amended and Restated Bylaws of
Registrant*
4 Form of stock certificate*
5 Form of opinion of Hunton & Williams
8 Form of opinion of Hunton & Williams
with respect to tax matters
10.1 Management Agreement, dated December
17, 1997, by and between FBR Asset
Investment Corporation and Friedman,
Billings, Ramsey Investment Management,
Inc.*
10.2 License Agreement, dated December 17, 1997, by and
between FBR Asset Investment Corporation and
Friedman, Billings, Ramsey Group, Inc.*
10.3 Stock Option Agreement, dated December
17, 1997, by and between FBR Asset
Investment Corporation and Friedman,
Billings, Ramsey Investment Management,
Inc.*
10.4 Sub-management Agreement, dated as of December 17,
1997, by and between Friedman, Billings, Ramsey
Investment Management, Inc., and BlackRock Financial
Management, Inc.*
10.5 Assignment Agreement, dated as of December 17, 1998,
by and between Friedman, Billings, Ramsey Investment
Management, Inc., and BlackRock Financial Management,
Inc.*
10.6 Stock Incentive Plan of Registrant**
10.7 Form of Interest Rate Swap Agreement**
10.8 Form of Repurchase Agreement
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Hunton & Williams (included
in Exhibit 5)
25 Power of Attorney of Officers and
Directors of Registrant (included on
signature pages of the Registration
Statement)
27.1 Financial Data Schedule*
* Previously filed.
** To be filed by amendment.
II-3
<PAGE>
Item 37. Undertakings.
(a) The undersigned Registrant hereby undertakes as
follows:
1. To file, during any period in which offers or sales are
being made, a post-effective amendment to this registration statement:
(i) To include any prospectus required by section
10(a)(3) of the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events
arising after the effective date of the
registration statement (or the most recent
post-effective amendment thereof) which,
individually or in the aggregate, represent a
fundamental change in the information set forth in
the registration statement. Notwithstanding the
foregoing, any increase or decrease in volume of
securities offered(if the total dollar value of
securities offered would not exceed that which was
registered) and any deviation from the low or high
end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the
Commission pursuant to Rule 242(b) if, in the
aggregate, the changes in volume and price
represent no more than 20 percent change in the
maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the
effective registration statement.
(iii) To include any material information with respect to
the plan of distribution not previously disclosed
in the registration statement or any material
change to such information in the registration
statement.
2. That, for the purpose of determining any liability under
the Securities Act of 1933, each such post-effective amendment shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time will
be deemed to be the initial bona fide offering thereof;
3. To remove from registration by means of a post-effective
amendment any of the securities being registered which remain unsold at
the termination of the offering; and
4. Insofar as indemnification for liabilities arising under
the Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification
is against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the
Registrant in the successful defense of any action, suit or proceeding)
is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of
such issue.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form S-11 and has duly caused this
registration statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Arlington, Commonwealth of Virginia,
on March 22, 1999.
FBR ASSET INVESTMENT CORPORATION (Maryland)
(Registrant)
By: /s/ Elaine M. Clancy
-------------------------------
Chief Financial Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities indicated on November 13, 1998. Each of the directors and/or officers
of FBR Asset Investment Corporation (Maryland) whose signature appears below
hereby appoints Eric F. Billings and Elaine M. Clancy, and both of them
severally, as his attorney-in-fact to sign in his name and behalf, in any and
all capacities stated below and to file with the Commission, any and all
amendments, including post-effective amendments to this registration statement,
making such changes in the registration statement as appropriate, and generally
to do all such things in their behalf in their capacities as officers and
directors to enable FBR Asset Investment Corporation to comply with the
provisions of the Securities Act of 1933, and all requirements of the Securities
and Exchange Commission.
Signature Title
--------- -----
/s/ Emanuel J. Friedman Chairman of the Board of Directors
----------------------------
Emanuel J. Friedman
/s/ Eric F. Billings Vice Chairman, Chief Executive Officer
---------------------------- and Director (Principal Executive Officer)
Eric F. Billings
/s/ W. Russell Ramsey President, Secretary and Director
----------------------------
W. Russell Ramsey
/s/ Elaine M. Clancy Chief Financial Officer
---------------------------- (Principal Financial Officer)
Elaine M. Clancy
/s/ Stephen D. Harlan Director
----------------------------
Stephen D. Harlan
/s/ Webb Hayes Director
----------------------------
Webb Hayes
<PAGE>
EXHIBIT INDEX
Exhibit Number Exhibit
-------------- -------
3.1 Amended and Restated Charter of Registrant*
3.2 Amended and Restated Bylaws of Registrant*
4 Form of stock certificate*
5 Form of opinion of Hunton & Williams
8 Form of opinion of Hunton & Williams with respect to tax
matters
10.1 Management Agreement, dated December 17, 1997, by and
between FBR Asset Investment Corporation and Friedman,
Billings, Ramsey Investment Management, Inc.*
10.2 License Agreement, dated December 17, 1997, by and
between FBR Asset Investment Corporation and Friedman,
Billings, Ramsey Group, Inc.*
10.3 Stock Option Agreement, dated December 17, 1997, by and
between FBR Asset Investment Corporation and Friedman,
Billings, Ramsey Investment Management, Inc.*
10.4 Sub-management Agreement, dated as of December 17, 1997,
by and between Friedman, Billings, Ramsey Investment
Management, Inc., and BlackRock Financial Management,
Inc.*
10.5 Assignment Agreement, dated as of December 17, 1998, by
and between Friedman, Billings, Ramsey Investment
Management, Inc., and BlackRock Financial Management,
Inc.*
10.6 Stock Incentive Plan of Registrant**
10.7 Form of Interest Rate Swap Agreement**
10.8 Form of Repurchase Agreement
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Hunton & Williams (included in Exhibit 5)
25 Power of Attorney of Officers and Directors of Registrant
(included on signature pages of the Registration
Statement)
27.1 Financial Data Schedule*
* Previously filed.
** To be filed by amendment.
Exhibit 5
FORM OF OPINION
February __, 1999
FBR Asset Investment Corporation
Potomac Tower
1001 Nineteenth Street North
Arlington, Virginia 22209
Registration Statement on Form S-11
-----------------------------------
Ladies and Gentlemen:
We have acted as counsel to FBR Asset Investment Corporation, a
Maryland corporation (the "Company"), in connection with the preparation of a
Form S-11 registration statement (No. 333-67343) (the "Registration Statement")
filed with the Securities and Exchange Commission (the "Commission") with
respect to the offer and sale from time to time of up to __________ shares (the
"Secondary Shares") of the Company's common stock, par value $.01 per share, by
certain selling shareholders named in the Registration Statement. You have
requested our opinion regarding certain Corporate Matters.
Giving this opinion, we have examined the Charter and By Laws of the
Company, the Plan of Merger, the proceedings of the Board of Directors of the
Company or a committee thereof relating to the issuance of the Shares, a
Certificate of the Secretary of the Company dated the date hereof, and such
other statutes, certificates, instruments, and documents relating to the Company
and matters of law as we have deemed necessary to the issuance of this opinion.
In such examination, we have assumed, without independent investigation, the
genuineness of all signatures, the legal capacity of all individuals who have
executed any of the aforesaid documents, the authenticity of all documents
submitted to us as originals, the conformity with originals of all documents
submitted to us as copies (and the authenticity of the originals of such
copies), no substantial change in the final documents of documents submitted to
us as drafts, and that all public records reviewed are accurate and complete. As
to factual matters, we have relied on the Certificate of the Secretary and have
not independently verified the matters stated therein.
Based upon the foregoing and having regard for such legal
considerations as we deem relevant, we are of the opinion and so advise you that
the Secondary Shares in accordance with the terms set forth in the Plan of
Merger, the Secondary Shares have been duly and validly authorized and are
validly issued, fully paid, and non-assessable.
<PAGE>
FBR Asset Investment Corporation
February __, 1999
Page 2
The opinion expressed is for the use of the Company in connection with
the Registration Statement. This opinion is limited to the matters set forth
herein, and no other opinion should be inferred beyond the matters expressly
stated.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to us under the heading "Legal
Matters" in the prospectus included in the Registration Statement.
Very truly yours,
Exhibit 8
FORM OF TAX OPINION
March __, 1999
FBR Asset Investment Corporation (Maryland)
1001 Nineteenth Street North
Arlington, VA 22209
FBR Asset Investment Corporation (Maryland)
-------------------------------------------
Qualification as
----------------
Real Estate Investment Trust
----------------------------
Ladies and Gentlemen:
We have acted as counsel to FBR Asset Investment Corporation
(Maryland), a Maryland corporation (the "Company"), in connection with the
preparation of a Form S-11 registration statement (the "Registration Statement")
filed with the Securities and Exchange Commission ("SEC") on February __, 1999
(No. 333-67343), as amended through the date hereof, with respect to the offer
and sale from time to time of up to __________ shares (the "Secondary Shares")
of the common stock, par value $0.01 per share, of the Company by certain
selling shareholders named in the Registration Statement. You have requested our
opinion regarding certain U.S. federal income tax matters.
In giving this opinion letter, we have examined the following:
1. the Restated and Amended Articles of Incorporation of FBR Asset Investment
Corporation, a Virginia corporation merged into the Company on ________ __, 1999
("FBR Asset Virginia"), as duly filed with the State Corporation Commission of
the State of Virginia on December 16, 1997;
2. the Bylaws of FBR Asset Virginia;
<PAGE>
FBR Asset Investment Corporation (Maryland)
March __, 1999
Page 2
3. the Company's Articles of Incorporation and Restated and Amended Articles of
Incorporation, as duly filed with the Department of Assessments and Taxation of
the State of Maryland on ________ __, 1998 and _________ __, 1999, respectively;
4. the Company's Amended and Restated Bylaws;
5. the Registration Statement, including the prospectus contained as part
thereof (the "Prospectus"); and
6. such other documents as we have deemed necessary or appropriate for purposes
of this opinion.
In connection with the opinions rendered below, we have
assumed, with your consent, that:
1. each of the documents referred to above has been duly authorized, executed,
and delivered; is authentic, if an original, or is accurate, if a copy; and has
not been amended;
2. during its taxable year ending December 31, 1999 and future taxable years,
the Company will operate in a manner that will make the factual representations
contained in a certificate, dated March __, 1999 and executed by a duly
appointed officer of the Company (the "Officer's Certificate"), true for such
years;
3. the Company will not make any amendments to its organizational documents
after the date of this opinion that would affect its qualification as a real
estate investment trust (a "REIT") for any taxable year; and
4. no action will be taken by the Company after the date hereof that would have
the effect of altering the facts upon which the opinions set forth below are
based.
In connection with the opinions rendered below, we also have
relied upon the correctness of the factual representations contained in the
Officer's Certificate. Where such factual representations involve terms defined
in the Internal Revenue Code of 1986, as amended (the "Code"), the Treasury
regulations thereunder (the "Regulations"), published rulings of the Internal
Revenue Service (the "Service"), or other relevant authority, we have
<PAGE>
FBR Asset Investment Corporation (Maryland)
March __, 1999
Page 3
explained such terms to the Company's representatives and are satisfied that the
Company's representatives understand such terms and are capable of making such
factual representations.
Based on the documents and assumptions set forth above, the
representations set forth in the Officer's Certificate, and the discussion in
the Prospectus under the caption "Federal Income Tax Consequences of FBR Asset's
Status as a REIT" (which is incorporated herein by reference), we are of the
opinion that:
(a) the Company qualified to be taxed as a REIT pursuant to sections
856 through 860 of the Code for its taxable years ended December 31,
1997 and December 31, 1998, and the Company's organization and current
and proposed method of operation will enable it to continue to meet the
requirements for qualification and taxation as a REIT under the Code
for its taxable year ending December 31, 1999 and in the future; and
(b) the descriptions of the law and the legal conclusions contained in
the Memorandum under the caption "Federal Income Tax Consequences of
FBR Asset's Status as a REIT" 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
Secondary Shares.
We will not review on a continuing basis the Company's
compliance with the documents or assumptions set forth above, or the factual
representations set forth in the Officer's Certificate. Accordingly, no
assurance can be given that the actual results of the Company's operations for
any given taxable year will satisfy the requirements for qualification and
taxation as a REIT.
The foregoing opinions are based on current provisions of the
Code and the Regulations, published administrative interpretations thereof, and
published court decisions. The Service has not issued Regulations or
administrative interpretations with respect to various provisions of the Code
relating to REIT qualification. No assurance can be given that the law will not
change in a way that will prevent the Company from qualifying as a REIT.
We hereby consent to the filing of this opinion as an exhibit
to the Registration Statement. We also consent to the references to Hunton &
Williams under
<PAGE>
FBR Asset Investment Corporation (Maryland)
March __, 1999
Page 4
the captions "Federal Income Tax Consequences of FBR Asset's Status as a REIT"
and "Legal Matters" in the Prospectus. In giving this consent, we do not admit
that we are in the category of persons whose consent is required by Section 7 of
the Securities Act of 1933, as amended, or the rules and regulations promulgated
thereunder by the SEC. The foregoing opinions are limited to the U.S. federal
income tax matters addressed herein, and no other opinions are rendered with
respect to other federal tax matters or to any issues arising under the tax laws
of any other country, or any state or locality. We undertake no obligation to
update the opinions expressed herein after the date of this letter. This opinion
letter is solely for the information and use of the addressee and the purchasers
of Secondary Shares pursuant to the Prospectus, and it may not be distributed,
relied upon for any purpose by any other person, quoted in whole or in part or
otherwise reproduced in any document, or filed with any governmental agency
without our express written consent.
Very truly yours,
THE
BOND
MARKET
ASSOCIATION
Master Repurchase
Agreement
- --------------------------------------------------------------------------------
September 1996 Version
Dated as of
- --------------------------------------------------------------------------------
Between:
- --------------------------------------------------------------------------------
and
- --------------------------------------------------------------------------------
1. Applicability
From time to time the parties hereto may enter into transactions in
which one party ("Seller") agrees to transfer to the other ("Buyer")
securities or other assets ("Securities") against the transfer of funds
by Buyer, with a simultaneous agreement by Buyer to transfer to Seller
such Securities at a date certain or on demand, against the transfer of
funds by Seller. Each such transaction shall be referred to herein as a
"Transaction" and, unless otherwise agreed in writing, shall be
governed by this Agreement, including any supplemental terms or
conditions contained in Annex I hereto and in any other annexes
identified herein or therein as applicable hereunder.
2. Definitions
(a) "Act of Insolvency", with respect to any party, (i) the
commencement by such party as debtor of any case or proceeding
under any bankruptcy, insolvency, reorganization, liquidation,
moratorium, dissolution, delinquency or similar law, or such
party seeking the appointment or election of a receiver,
conservator, trustee, custodian or similar official for such
party or any substantial part of its property, or the
convening of any meeting of creditors for purposes of
commencing any such case or proceeding or seeking such an
appointment or election, (ii) the commencement of any such
case or proceeding against such party, or another seeking such
an appointment or election, or the filing against a party of
an application for a protective decree under the provisions of
the Securities Investor Protection Act of 1970, which (A) is
consented to or not timely contested by such party, (B)
results in the entry of an order for relief, such an
appointment or election, the issuance of such a protective
decree or the entry of an order having a similar effect, or
(C) is not dismissed within 15 days, (iii) the making by such
party of a general assignment for the benefit of creditors, or
<PAGE>
(iv) the admission in writing by such party of such party's
inability to pay such party's debts as they become due;
(b) "Additional Purchased Securities", Securities provided by
Seller to Buyer pursuant to Paragraph 4(a) hereof;
(c) "Buyer's Margin Amount", with respect to any Transaction as of
any date, the amount obtained by application of the Buyer's
Margin Percentage to the Repurchase Price for such Transaction
as of such date;
(d) "Buyer's Margin Percentage", with respect to any Transaction
as of any date, a percentage (which may be equal to the
Seller's Margin Percentage) agreed to by Buyer and Seller or,
in the absence of any such agreement, the percentage obtained
by dividing the Market Value of the Purchased Securities on
the Purchase Date by the Purchase Price on the Purchase Date
for such Transaction;
(e) "Confirmation", the meaning specified in Paragraph 3 (b)
hereof;
(f) "Income", with respect to any Security at any time, any
principal thereof and all interest, dividends or other
distributions thereon;
(g) "Margin Deficit", the meaning specified in Paragraph 4 (a)
hereof (h) "Margin Excess", the meaning specified in Paragraph
4 (b) hereof;
(i) "Margin Notice Deadline", the time agreed to by the parties in
the relevant Confirmation, Annex I hereto or otherwise as the
deadline for giving notice requiring same-day satisfaction of
margin maintenance obligations as provided in Paragraph 4
hereof (or, in the absence of any such agreement, the deadline
for such purposes established in accordance with market
practice);
(j) "Market Value", with respect to any Securities as of any date,
the price for such Securities on such date obtained from a
generally recognized source agreed to by the parties or the
most recent closing bid quotation from such a source, plus
accrued Income to the extent not included therein (other than
any Income credited or transferred to, or applied to the
obligations of, Seller pursuant to Paragraph 5 hereof) as of
such date (unless contrary to market practice for such
Securities);
(k) "Price Differential", with respect to any Transaction as of
any date, the aggregate amount obtained by daily application
of the Pricing Rate for such Transaction to the Purchase Price
for such Transaction on a 360 day per year basis for the
actual number of days during the period commencing on (and
including) the Purchase Date for such Transaction and ending
on (but excluding) the date of determination (reduced by any
amount of such Price Differential previously paid by Seller to
Buyer with respect to such Transaction);
2 o September 1996 o Master Repurchase Agreement
<PAGE>
(l) "Pricing Rate", the per annum percentage rate for
determination of the Price Differential;
(m) "Prime Rate", the prime rate of U.S. commercial banks as
published in The Wall Street Journal (or, if more than one
such rate is published, the average of such rates);
(n) "Purchase Date", the date on which Purchased Securities are to
be transferred by Seller to Buyer;
(o) "Purchase Price", (i) on the Purchase Date, the price at which
Purchased Securities are transferred by Seller to Buyer, and
(ii) thereafter, except where Buyer and Seller agree
otherwise, such price increased by the amount of any cash
transferred by Buyer to Seller pursuant to Paragraph 4 (b)
hereof and decreased by the amount of any cash transferred by
Seller to Buyer pursuant to Paragraph 4 (a) hereof or applied
to reduce Seller's obligations under clause (ii) of Paragraph
5 hereof;
(p) "Purchased Securities", the Securities transferred by Seller
to Buyer in a Transaction hereunder, and any Securities
substituted therefor in accordance with Paragraph 9 hereof.
The term "Purchased Securities" with respect to any
Transaction at any time also shall include Additional
Purchased Securities delivered pursuant to Paragraph 4 (a)
hereof and shall exclude Securities returned pursuant to
Paragraph 4 (b) hereof;
(q) "Repurchase Date", the date on which Seller is to repurchase
the Purchased Securities from Buyer, including any date
determined by application of the provisions of Paragraph 3(c)
or 11 hereof;
(r) "Repurchase Price", the price at which Purchased Securities
are to be transferred from Buyer to Seller upon termination of
a Transaction, which will be determined in each case
(including Transactions terminable upon demand) as the sum of
the Purchase Price and the Price Differential as of the date
of such determination;
(s) "Seller's Margin Amount", with respect to any Transaction as
of any date, the amount obtained by application of the
Seller's Margin Percentage to the Repurchase Price for such
Transaction as of such date;
(t) "Seller's Margin Percentage", with respect to any Transaction
as of any date, a percentage (which may be equal to the
Buyer's Margin Percentage) agreed to by Buyer and Seller or,
in the absence of any such agreement, the percentage obtained
by dividing the Market Value of the Purchased Securities on
the Purchase Date by the Purchase Price on the Purchase Date
for such Transaction.
3. Initiation; Confirmation; Termination
(a) An agreement to enter into a Transaction may be made orally or
in writing at the initiation of either Buyer or Seller. On the
Purchase Date for the Transaction, the
September 1996 o Master Repurchase Agreement o 3
<PAGE>
Purchased Securities shall be transferred to Buyer or its
agent against the transfer of the Purchase Price to an account
of Seller.
(b) Upon agreeing to enter into a Transaction hereunder, Buyer or
Seller (or both), as shall be agreed, shall promptly deliver
to the other party a written confirmation of each Transaction
(a "Confirmation"). The Confirmation shall describe the
Purchased Securities (including CUSIP number, if any),
identify Buyer and Seller and set forth (i) the Purchase Date,
(ii) the Purchase Price, (iii) the Repurchase Date, unless the
Transaction is to be terminable on demand, (iv) the Pricing
Rate or Repurchase Price applicable to the Transaction, and
(v) any additional terms or conditions of the Transaction not
inconsistent with this Agreement. The Confirmation, together
with this Agreement, shall constitute conclusive evidence of
the terms agreed between Buyer and Seller with respect to the
Transaction to which the Confirmation relates, unless with
respect to the Confirmation specific objection is made
promptly after receipt thereof. In the event of any conflict
between the terms of such Confirmation and this Agreement,
this Agreement shall prevail.
(c) In the case of Transactions terminable upon demand, such
demand shall be made by Buyer or Seller, no later than such
time as is customary in accordance with market practice, by
telephone or otherwise on or prior to the business day on
which such termination will be effective. On the date
specified in such demand, or on the date fixed for termination
in the case of Transactions having a fixed term, termination
of the Transaction will be effected by transfer to Seller or
its agent of the Purchased Securities and any Income in
respect thereof received by Buyer (and not previously credited
or transferred to, or applied to the obligations of, Seller
pursuant to Paragraph 5 hereof) against the transfer of the
Repurchase Price to an account of Buyer.
4. Margin Maintenance
(a) If at any time the aggregate Market Value of all Purchased
Securities subject to all Transactions in which a particular
party hereto is acting as Buyer is less than the aggregate
Buyer's Margin Amount for all such Transactions (a "Margin
Deficit"), then Buyer may by notice to Seller require Seller
in such Transactions, at Seller's option, to transfer to Buyer
cash or additional Securities reasonably acceptable to Buyer
("Additional Purchased Securities"), so that the cash and
aggregate Market Value of the Purchased Securities, including
any such Additional Purchased Securities, will thereupon equal
or exceed such aggregate Buyer's Margin Amount (decreased by
the amount of any Margin Deficit as of such date arising from
any Transactions in which such Buyer is acting as Seller).
(b) If at any time the aggregate Market Value of all Purchased
Securities subject to all Transactions in which a particular
party hereto is acting as Seller exceeds the aggregate
Seller's Margin Amount for all such Transactions at such time
(a "Margin Excess"), then Seller may by notice to Buyer
require Buyer in such Transactions, at Buyer's option, to
transfer cash or Purchased Securities to Seller, so that the
4 o September 1996 o Master Repurchase Agreement
<PAGE>
aggregate Market Value of the Purchased Securities, after
deduction of any such cash or any Purchased Securities so
transferred, will thereupon not exceed such aggregate Seller's
Margin Amount (increased by the amount of any Margin Excess as
of such date arising from any Transactions in which such
Seller is acting as Buyer).
(c) If any notice is given by Buyer or Seller under subparagraph
(a) or (b) of this Paragraph at or before the Margin Notice
Deadline on any business day, the party receiving such notice
shall transfer cash or Additional Purchased Securities as
provided in such subparagraph no later than the close of
business in the relevant market on such day. If any such
notice is given after the Margin Notice Deadline, the party
receiving such notice shall transfer such cash or Securities
no later than the close of business in the relevant market on
the next business day following such notice.
(d) Any cash transferred pursuant to this Paragraph shall be
attributed to such Transactions as shall be agreed upon by
Buyer and Seller.
(e) Seller and Buyer may agree, with respect to any or all
Transactions hereunder, that the respective rights of Buyer or
Seller (or both) under subparagraphs (a) and (b) of this
Paragraph may be exercised only where a Margin Deficit or
Margin Excess, as the case may be, exceeds a specified dollar
amount or a specified percentage of the Repurchase Prices for
such Transactions (which amount or percentage shall be agreed
to by Buyer and Seller prior to entering into any such
Transactions).
(f) Seller and Buyer may agree, with respect to any or all
Transactions hereunder, that the respective rights of Buyer
and Seller under subparagraphs (a) and (b) of this Paragraph
to require the elimination of a Margin Deficit or a Margin
Excess, as the case may be, may be exercised whenever such a
Margin Deficit or Margin Excess exists with respect to any
single Transaction hereunder (calculated without regard to any
other Transaction outstanding under this Agreement).
5. Income Payments
Seller shall be entitled to receive an amount equal to all Income paid
or distributed on or in respect of the Securities that is not otherwise
received by Seller, to the full extent it would be so entitled if the
Securities had not been sold to Buyer. Buyer shall, as the parties may
agree with respect to any Transaction (or, in the absence of any such
agreement, as Buyer shall reasonably determine in its discretion), on
the date such Income is paid or distributed either (i) transfer to or
credit to the account of Seller such Income with respect to any
Purchased Securities subject to such Transaction or (ii) with respect
to Income paid in cash, apply the Income payment or payments to reduce
the amount, if any, to be transferred to Buyer by Seller upon
termination of such Transaction. Buyer shall not be obligated to take
any action pursuant to the preceding sentence (A) to the extent that
such action would result in the creation of a Margin Deficit, unless
prior thereto or simultaneously therewith Seller transfers to Buyer
cash or Additional Purchased Securities sufficient to eliminate such
Margin Deficit, or
September 1996 o Master Repurchase Agreement o 5
<PAGE>
(B) if an Event of Default with respect to Seller has occurred and is
then continuing at the time such Income is paid or distributed.
6. Security Interest
Although the parties intend that all Transactions hereunder be sales
and purchases and not loans, in the event any such Transactions are
deemed to be loans, Seller shall be deemed to have pledged to Buyer as
security for the performance by Seller of its obligations under each
such Transaction, and shall be deemed to have granted to Buyer a
security interest in, all of the Purchased Securities with respect to
all Transactions hereunder and all Income thereon and other proceeds
thereof.
7. Payment and Transfer
Unless otherwise mutually agreed, all transfers of funds hereunder
shall be in immediately available funds. All Securities transferred by
one party hereto to the other party (i) shall be in suitable form for
transfer or shall be accompanied by duly executed instruments of
transfer or assignment in blank and such other documentation as the
party receiving possession may reasonably request, (ii) shall be
transferred on the book-entry system of a Federal Reserve Bank, or
(iii) shall be transferred by any other method mutually acceptable to
Seller and Buyer.
8. Segregation of Purchased Securities
To the extent required by applicable law, all Purchased Securities in
the possession of Seller shall be segregated from other securities in
its possession and shall be identified as subject to this Agreement.
Segregation may be accomplished by appropriate identification on the
books and records of the holder, including a financial or securities
intermediary or a clearing corporation. All of Seller's interest in the
Purchased Securities shall pass to Buyer on the Purchase Date and,
unless otherwise agreed by Buyer and Seller, nothing in this Agreement
shall preclude Buyer from engaging in repurchase transactions with the
Purchased Securities or otherwise selling, transferring, pledging or
hypothecating the Purchased Securities, but no such transaction shall
relieve Buyer of its obligations to transfer Purchased Securities to
Seller pursuant to Paragraph 3, 4 or 11 hereof, or of Buyer's
obligation to credit or pay Income to, or apply Income to the
obligations of, Seller pursuant to Paragraph 5 hereof.
6 o September 1996 o Master Repurchase Agreement
<PAGE>
- --------------------------------------------------------------------------------
Required Disclosure for Transactions in Which the Seller
Retains Custody of the Purchased Securities
Seller is not permitted to substitute other securities for those subject to this
Agreement and therefore must keep Buyer's securities segregated at all times,
unless in this Agreement Buyer grants Seller the right to substitute other
securities. If Buyer grants the right to substitute, this means that Buyer's
securities will likely be commingled with Seller's own securities during the
trading day. Buyer is advised that, during any trading day that Buyer's
securities are commingled with Seller's securities, they [will]* [may]** be
subject to liens granted by Seller to [its clearing bank] * [third parties] **
and may be used by Seller for deliveries on other securities transactions.
Whenever the securities are commingled, Seller's ability to resegregate
substitute securities for Buyer will be subject to Seller's ability to satisfy
[the clearing]* [any]** lien or to obtain substitute securities.
* Language to be used under 17 C.ER. B403.4(e) if Seller is a government
securities broker or dealer other than a financial institution.
** Language to be used under 17 C.ER. B403.5(d) if Seller is a financial
institution.
- --------------------------------------------------------------------------------
9. Substitution
(a) Seller may, subject to agreement with and acceptance by Buyer,
substitute other Securities for any Purchased Securities. Such
substitution shall be made by transfer to Buyer of such other
Securities and transfer to Seller of such Purchased
Securities. After substitution, the substituted Securities
shall be deemed to be Purchased Securities.
(b) In Transactions in which Seller retains custody of Purchased
Securities, the parties expressly agree that Buyer shall be
deemed, for purposes of subparagraph (a) of this Paragraph, to
have agreed to and accepted in this Agreement substitution by
Seller of other Securities for Purchased Securities; provided,
however, that such other Securities shall have a Market Value
at least equal to the Market Value of the Purchased Securities
for which they are substituted.
10. Representations
Each of Buyer and Seller represents and warrants to the other that (i)
it is duly authorized to execute and deliver this Agreement, to enter
into Transactions contemplated hereunder and to perform its obligations
hereunder and has taken all necessary action to authorize such
execution, delivery and performance, (ii) it will engage in such
Transactions as principal (or, if agreed in writing, in the form of an
annex hereto or otherwise, in advance of any Transaction by the other
party hereto, as agent for a disclosed principal), (iii) the person
signing this Agreement on its behalf is duly authorized to do so on its
behalf (or on behalf of any such disclosed principal), (iv) it has
obtained all authorizations of any governmental body required in
connection with this Agreement and the Transactions hereunder and such
authorizations are in full force and effect and (v) the execution,
delivery and performance of this
September 1996 o Master Repurchase Agreement o 7
<PAGE>
Agreement and the Transactions hereunder will not violate any law,
ordinance, charter, bylaw or rule applicable to it or any agreement by
which it is bound or by which any of its assets are affected. On the
Purchase Date for any Transaction Buyer and Seller shall each be deemed
to repeat all the foregoing representations made by it.
11. Events of Default
In the event that (i) Seller fails to transfer or Buyer fails to
purchase Purchased Securities upon the applicable Purchase Date, (ii)
Seller fails to repurchase or Buyer fails to transfer Purchased
Securities upon the applicable Repurchase Date, (iii) Seller or Buyer
fails to comply with Paragraph 4 hereof, (iv) Buyer fails, after one
business day's notice, to comply with Paragraph 5 hereof, (v) an Act of
Insolvency occurs with respect to Seller or Buyer, (vi) any
representation made by Seller or Buyer shall have been incorrect or
untrue in any material respect when made or repeated or deemed to have
been made or repeated, or (vii) Seller or Buyer shall admit to the
other its inability to, or its intention not to, perform any of its
obligations hereunder (each an "Event of Default"):
(a) The nondefaulting party may, at its option (which option shall
be deemed to have been exercised immediately upon the
occurrence of an Act of Insolvency), declare an Event of
Default to have occurred hereunder and, upon the exercise or
deemed exercise of such option, the Repurchase Date for each
Transaction hereunder shall, if it has not already occurred,
be deemed immediately to occur (except that, in the event that
the Purchase Date for any Transaction has not yet occurred as
of the date of such exercise or deemed exercise, such
Transaction shall be deemed immediately canceled). The
nondefaulting party shall (except upon the occurrence of an
Act of Insolvency) give notice to the defaulting party of the
exercise of such option as promptly as practicable.
(b) In all Transactions in which the defaulting party is acting as
Seller, if the nondefaulting party exercises or is deemed to
have exercised the option referred to in subparagraph (a) of
this Paragraph, (i) the defaulting party's obligations in such
Transactions to repurchase all Purchased Securities, at the
Repurchase Price therefor on the Repurchase Date determined in
accordance with subparagraph (a) of this Paragraph, shall
thereupon become immediately due and payable, (ii) all Income
paid after such exercise or deemed exercise shall be retained
by the nondefaulting party and applied to the aggregate unpaid
Repurchase Prices and any other amounts owing by the
defaulting party hereunder, and (iii) the defaulting party
shall immediately deliver to the nondefaulting party any
Purchased Securities subject to such Transactions then in the
defaulting party's possession or control.
(c) In all Transactions in which the defaulting party is acting as
Buyer, upon tender by the nondefaulting party of payment of
the aggregate Repurchase Prices for all such Transactions, all
right, title and interest in and entitlement to all Purchased
Securities subject to such Transactions shall be deemed
transferred to the nondefaulting party,
8 o September 1996 o Master Repurchase Agreement
<PAGE>
and the defaulting party shall deliver all such Purchased
Securities to the nondefaulting party.
(d) If the nondefaulting party exercises or is deemed to have
exercised the option referred to in subparagraph (a) of this
Paragraph, the nondefaulting party, without prior notice to
the defaulting party, may:
(i) as to Transactions in which the defaulting party is
acting as Seller, (A) immediately sell, in a
recognized market (or otherwise in a commercially
reasonable manner) at such price or prices as the
nondefaulting party may reasonably deem satisfactory,
any or all Purchased Securities subject to such
Transactions and apply the proceeds thereof to the
aggregate unpaid Repurchase Prices and any other
amounts owing by the defaulting party hereunder or
(B) in its sole discretion elect, in lieu of selling
all or a portion of such Purchased Securities, to
give the defaulting party credit for such Purchased
Securities in an amount equal to the price therefor
on such date, obtained from a generally recognized
source or the most recent closing bid quotation from
such a source, against the aggregate unpaid
Repurchase Prices and any other amounts owing by the
defaulting party hereunder; and
(ii) as to Transactions in which the defaulting party is
acting as Buyer, (A) immediately purchase, in a
recognized market (or otherwise in a commercially
reasonable manner) at such price or prices as the
nondefaulting party may reasonably deem satisfactory,
securities ("Replacement Securities") of the same
class and amount as any Purchased Securities that are
not delivered by the defaulting party to the
nondefaulting party as required hereunder or (B) in
its sole discretion elect, in lieu of purchasing
Replacement Securities, to be deemed to have
purchased Replacement Securities at the price
therefor on such date, obtained from a generally
recognized source or the most recent closing offer
quotation from such a source.
Unless otherwise provided in Annex I, the parties acknowledge and agree
that (1) the Securities subject to any Transaction hereunder are
instruments traded in a recognized market, (2) in the absence of a
generally recognized source for prices or bid or offer quotations for
any Security, the nondefaulting party may establish the source therefor
in its sole discretion and (3) all prices, bids and offers shall be
determined together with accrued Income (except to the extent contrary
to market practice with respect to the relevant Securities).
September 1996 o Master Repurchase Agreement o 9
<PAGE>
(e) As to Transactions in which the defaulting party is acting as
Buyer, the defaulting party shall be liable to the
nondefaulting party for any excess of the price paid (or
deemed paid) by the nondefaulting party for Replacement
Securities over the Repurchase Price for the Purchased
Securities replaced thereby and for any amounts payable by the
defaulting party under Paragraph 5 hereof or otherwise
hereunder.
(f) For purposes of this Paragraph 11, the Repurchase Price for
each Transaction hereunder in respect of which the defaulting
party is acting as Buyer shall not increase above the amount
of such Repurchase Price for such Transaction determined as of
the date of the exercise or deemed exercise by the
nondefaulting party of the option referred to in subparagraph
(a) of this Paragraph.
(g) The defaulting party shall be liable to the nondefaulting
party for (i) the amount of all reasonable legal or other
expenses incurred by the nondefaulting party in connection
with or as a result of an Event of Default, (ii) damages in an
amount equal to the cost (including all fees, expenses and
commissions) of entering into replacement transactions and
entering into or terminating hedge transactions in connection
with or as a result of an Event of Default, and (iii) any
other loss, damage, cost or expense directly arising or
resulting from the occurrence of an Event of Default in
respect of a Transaction.
(h) To the extent permitted by applicable law, the defaulting
party shall be liable to the non-defaulting party for interest
on any amounts owing by the defaulting party hereunder, from
the date the defaulting party becomes liable for such amounts
hereunder until such amounts are (i) paid in full by the
defaulting party or (ii) satisfied in full by the exercise of
the nondefaulting party's rights hereunder. Interest on any
sum payable by the defaulting party to the nondefaulting party
under this Paragraph 11 (h) shall be at a rate equal to the
greater of the Pricing Rate for the relevant Transaction or
the Prime Rate.
(i) The nondefaulting party shall have, in addition to its rights
hereunder, any rights otherwise available to it under any
other agreement or applicable law.
12. Single Agreement
Buyer and Seller acknowledge that, and have entered hereinto and will
enter into each Transaction hereunder in consideration of and in
reliance upon the fact that, all Transactions hereunder constitute a
single business and contractual relationship and have been made in
consideration of each other. Accordingly, each of Buyer and Seller
agrees (i) to perform all of its obligations in respect of each
Transaction hereunder, and that a default in the performance of any
such obligations shall constitute a default by it in respect of all
Transactions hereunder, (ii) that each of them shall be entitled to set
off claims and apply property held by them in respect of any
Transaction against obligations owing to them in respect of any other
Transactions hereunder and (iii) that payments, deliveries and other
transfers made by either of them in respect of any Transaction shall be
deemed to have been made in consideration of payments, deliveries and
other transfers in respect of any other Transactions hereunder, and
10 o September 1996 o Master Repurchase Agreement
<PAGE>
the obligations to make any such payments, deliveries and other
transfers may be applied against each other and netted.
13. Notices and Other Communications
Any and all notices, statements, demands or other communications
hereunder may be given by a party to the other by mail, facsimile,
telegraph, messenger or otherwise to the address specified in Annex II
hereto, or so sent to such party at any other place specified in a
notice of change of address hereafter received by the other. All
notices, demands and requests hereunder may be made orally, to be
confirmed promptly in writing, or by other communication as specified
in the preceding sentence.
14. Entire Agreement; Severability
This Agreement shall supersede any existing agreements between the
parties containing general terms and conditions for repurchase
transactions. Each provision and agreement herein shall be treated as
separate and independent from any other provision or agreement herein
and shall be enforceable notwithstanding the unenforceability of any
such other provision or agreement.
15. Non-assignability; Termination
(a) The rights and obligations of the parties under this Agreement
and under any Transaction shall not be assigned by either
party without the prior written consent of the other party,
and any such assignment without the prior written consent of
the other party shall be null and void. Subject to the
foregoing, this Agreement and any Transactions shall be
binding upon and shall inure to the benefit of the parties and
their respective successors and assigns. This Agreement may be
terminated by either party upon giving written notice to the
other, except that this Agreement shall, notwithstanding such
notice, remain applicable to any Transactions then
outstanding.
(b) Subparagraph (a) of this Paragraph 15 shall not preclude a
party from assigning, charging or otherwise dealing with all
or any part of its interest in any sum payable to it under
Paragraph 11 hereof.
16. Governing Law
This Agreement shall be governed by the laws of the State of New York
without giving effect to the conflict of law principles thereof.
17. No Waivers, Etc.
No express or implied waiver of any Event of Default by either party
shall constitute a waiver of any other Event of Default and no exercise
of any remedy hereunder by any party shall constitute a waiver of its
right to exercise any other remedy hereunder. No
September 1996 o Master Repurchase Agreement o 11
<PAGE>
modification or waiver of any provision of this Agreement and no
consent by any party to a departure herefrom shall be effective unless
and until such shall be in writing and duly executed by both of the
parties hereto. Without limitation on any of the foregoing, the failure
to give a notice pursuant to Paragraph 4 (a) or 4 (b) hereof will not
constitute a waiver of any right to do so at a later date.
18. Use of Employee Plan Assets
(a) If assets of an employee benefit plan subject to any provision
of the Employee Retirement Income Security Act of 1974
("ERISA") are intended to be used by either party hereto (the
"Plan Party") in a Transaction, the Plan Party shall so notify
the other party prior to the Transaction. The Plan Party shall
represent in writing to the other party that the Transaction
does not constitute a prohibited transaction under ERISA or is
otherwise exempt therefrom, and the other party may proceed in
reliance thereon but shall not be required so to proceed.
(b) Subject to the last sentence of subparagraph (a) of this
Paragraph, any such Transaction shall proceed only if Seller
furnishes or has furnished to Buyer its most recent available
audited statement of its financial condition and its most
recent subsequent unaudited statement of its financial
condition.
(c) By entering into a Transaction pursuant to this Paragraph,
Seller shall be deemed (i) to represent to Buyer that since
the date of Seller's latest such financial statements, there
has been no material adverse change in Seller's financial
condition which Seller has not disclosed to Buyer, and (ii) to
agree to provide Buyer with future audited and unaudited
statements of its financial condition as they are issued, so
long as it is a Seller in any outstanding Transaction
involving a Plan Party.
19. Intent
(a) The parties recognize that each Transaction is a "repurchase
agreement" as that term is defined in Section 101 of Title 11
of the United States Code, as amended (except insofar as the
type of Securities subject to such Transaction or the term of
such Transaction would render such definition inapplicable),
and a "securities contract" as that term is defined in Section
741 of Title 11 of the United States Code, as amended (except
insofar as the type of assets subject to such Transaction
would render such definition inapplicable).
(b) It is understood that either party's right to liquidate
Securities delivered to it in connection with Transactions
hereunder or to exercise any other remedies pursuant to
Paragraph 11 hereof is a contractual right to liquidate such
Transaction as described in Sections 555 and 559 of Title 11
of the United States Code, as amended.
(c) The parties agree and acknowledge that if a party hereto is an
"insured depository institution," as such term is defined in
the Federal Deposit Insurance Act, as amended ("FDIA"), then
each Transaction hereunder is a "qualified financial
12 o September 1996 o Master Repurchase Agreement
<PAGE>
contract," as that term is defined in FDIA and any rules,
orders or policy statements thereunder (except insofar as the
type of assets subject to such Transaction would render such
definition inapplicable).
(d) It is understood that this Agreement constitutes a "netting
contract" as defined in and subject to Title IV of the Federal
Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") and each payment entitlement and payment obligation
under any Transaction hereunder shall constitute a "covered
contractual payment entitlement" or "covered contractual
payment obligation", respectively, as defined in and subject
to FDICIA (except insofar as one or both of the parties is not
a "financial institution" as that term is defined in FDICIA).
20. Disclosure Relating to Certain Federal Protections
The parties acknowledge that they have been advised that:
(a) in the case of Transactions in which one of the parties is a
broker or dealer registered with the Securities and Exchange
Commission ("SEC") under Section 15 of the Securities Exchange
Act of 1934 (" 1934 Act"), the Securities Investor Protection
Corporation has the position that the provisions of the
Securities Investor Protection Act of 1970 ("SIPA") do not
protect the other party with respect to any Transaction
hereunder;
(b) in the case of Transactions in which one of the parties is a
government securities broker or a government securities dealer
registered with the SEC under Section 15C of the 1934 Act,
SIPA will not provide protection to the other party with
respect to any Transaction hereunder; and
(c) in the case of Transactions in which one of the parties is a
financial institution, funds held by the financial institution
pursuant to a Transaction hereunder are not a deposit and
therefore are not insured by the Federal Deposit Insurance
Corporation or the National Credit Union Share Insurance Fund,
as applicable.
[Name of Party] [Name of Party]
By: By:
------------------------- -------------------------
Title: Title:
------------------------- -------------------------
Date: Date:
------------------------- -------------------------
September 1996 o Master Repurchase Agreement o 13
<PAGE>
Annex I
Supplemental Terms and Conditions
This Annex I forms a part of the Master Repurchase Agreement dated as of
________, 19__ (the "Agreement") between _______________ and ____________.
Capitalized terms used but not defined in this Annex I shall have the meanings
ascribed to them in the Agreement.
1. Other Applicable Annexes. In addition to this Annex I and Annex II, the
following Annexes and any Schedules thereto shall form a part of this
Agreement and shall be applicable thereunder:
[Annex III (International Transactions)]
[Annex IV (Party Acting as Agent)]
[Annex V (Margin for Forward Transactions)]
[Annex VI (Buy/Sell Back Transactions)]
[Annex VII (Transactions Involving Registered Investment Companies)]
14 o September 1996 o Master Repurchase Agreement
<PAGE>
Annex II
Names and Addresses for Communications Between Parties
September 1996 o Master Repurchase Agreement o 15
<PAGE>
Annex III
International Transactions
This Annex III (including any Schedules hereto) forms a part of the Master
Repurchase Agreement dated as of _________________ 19__, (the "Agreement")
between ______________ and _______________. Capitalized terms used but not
defined in this Annex III shall have the meanings ascribed to them in the
Agreement.
1. Definitions. For purposes of the Agreement and this Annex III:
(a) The following terms shall have the following meanings:
"Base Currency", United States dollars or such other currency
as Buyer and Seller may agree in the Confirmation with respect
to any International Transaction or otherwise in writing;
"Business Day" or "business day":
(i) in relation to any International Transaction which
(A) involves an International Security and (B) is to
be settled through CEDEL, or Euroclear, a day on
which CEDEL or, as the case may be, Euroclear is open
to settle business in the currency in which the
Purchase Price and the Repurchase Price are
denominated;
(ii) in relation to any International Transaction which
(A) involves an International Security and (B) is to
be settled through a settlement system other than
CEDEL or Euroclear, a day on which that settlement
system is open to settle such International
Transaction;
(iii) in relation to any International Transaction which
involves a delivery of Securities not falling within
(i) or (ii) above, a day on which banks are open for
business in the place where delivery of the relevant
Securities is to be effected; and
(iv) in relation to any International Transaction which
involves an obligation to make a payment not falling
within (i) or (ii) above, a day other than a
16 o September 1996 o Master Repurchase Agreement
<PAGE>
Saturday or Sunday on which banks are open for
business in the principal financial center of the
country of which the currency in which the payment is
denominated is the official currency and, if
different, in the place where any account designated
by the parties for the making or receipt of the
payment is situated (or, in the case of ECU, a day on
which ECU clearing operates);
"CEDEL", CEDEL Bank, societe anonyme;
"Contractual Currency", the currency in which tile
International Securities subject to any International
Transaction are denominated or such other currency as may be
specified in the Confirmation with respect to any
International Transaction;
"Euroclear", Morgan Guaranty Trust Company of New York,
Brussels Branch, as operator of the Euroclear System;
"International Security", any Security that (i) is denominated
in a currency other than United States dollars or (ii) is
capable of being cleared through a clearing facility outside
the United States or (iii) is issued by an issuer organized
under the laws of a jurisdiction other than the United States
(or any political subdivision thereof);
"International Transaction", any Transaction involving (i) an
International Security or (ii) a party organized under the
laws of a jurisdiction other than the United States (or any
political subdivision thereof) or having its principal place
of business outside the United States or (iii) a branch or
office outside the United States designated in Annex I by a
party organized under the laws of the United States (or any
political subdivision thereof) as an office through which that
party may act;
"LIBOR", in relation to any sum in any currency, the offered
rate for deposits for such sum in such currency for a period
of three months which appears on the Reuters Screen LIBO page
as of 11:00 A.M., London time, on the date on which it is to
be determined (or, if more than one such rate appears, the
arithmetic mean of such rates);
"Spot Rate", where an amount in one currency is to be
converted into a second currency on any date, the spot rate of
exchange of a comparable amount quoted by a major money-center
bank in the New York interbank market, as agreed by Buyer and
Seller, for the sale by such bank of such second currency
against a purchase by it of such first currency.
(b) Notwithstanding Paragraph 2 of the Agreement, the term "Prime
Rate" shall mean, with respect to any International
Transaction, LIBOR plus a spread, as may be specified in the
Confirmation with respect to any International Transaction or
otherwise in writing.
September 1996 o Master Repurchase Agreement o 17
<PAGE>
2. Manner of Transfer. All transfers of International Securities (i) shall
be in suitable form for transfer and accompanied by duly executed
instruments of transfer or assignment in blank (where required for
transfer) and such other documentation as the transferee may reasonably
request, or (ii) shall be transferred through the book-entry system of
Euroclear or CEDEL, or (iii) shall be transferred through any other
agreed securities clearing system or (iv) shall be transferred by any
other method mutually acceptable to Seller and Buyer.
3. Contractual Currency.
(a) Unless otherwise mutually agreed, all funds transferred in
respect of the Purchase Price or the Repurchase Price in any
International Transaction shall be in the Contractual
Currency.
(b) Notwithstanding subparagraph (a) of this Paragraph 3, the
payee of any payment may, at its option, accept tender thereof
in any other currency; provided, however, that, to the extent
permitted by applicable law, the obligation of the payor to
make such payment will be discharged only to the extent of the
amount of the Contractual Currency that such payee may,
consistent with normal banking procedures, purchase with such
other currency (after deduction of any premium and costs of
exchange) for delivery within the customary delivery period
for spot transactions in respect of the relevant currency.
(c) If for any reason the amount in the Contractual Currency so
received, including amounts received after conversion of any
recovery under any judgment or order expressed in a currency
other than the Contractual Currency, falls short of the amount
in the Contractual Currency due in respect of the Agreement,
the party required to make payment shall (unless an Event of
Default has occurred and such party is the nondefaulting
party) as a separate and independent obligation (which shall
not merge with any judgment or any payment or any partial
payment or enforcement of payment) and to the extent permitted
by applicable law, immediately pay such additional amount in
the Contractual Currency as may be necessary to compensate for
the shortfall.
(d) If for any reason the amount of the Contractual Currency
received by one party hereto exceeds the amount in the
Contractual Currency due such party in respect of the
Agreement, then (unless an Event of Default has occurred and
such party is the nondefaulting party) the party receiving the
payment shall refund promptly the amount of such excess.
4. Notices. Any and all notices, statements, demands or other
communications with respect to International Transactions shall be
given in accordance with Paragraph 13 of the Agreement and shall be in
the English language.
18 o September 1996 o Master Repurchase Agreement
<PAGE>
5. Taxes.
(a) Transfer taxes, stamp taxes and all similar costs with respect
to the transfer of Securities shall be paid by Seller.
(b) (i) Unless otherwise agreed, all money payable by one
party (the "Payor") to the other (the "Payee") in
respect of any International Transaction shall be
paid free and clear of, and without holding or
deduction for, any taxes or duties of whatsoever
nature imposed, levied, collected, withheld or
assessed by any authority having power to tax (a
"Tax"), unless the withholding or deduction of such
Tax is required by law. In that event, unless
otherwise agreed, Payor shall pay such additional
amounts as will result in the net amounts receivable
by Payee (after taking account of such withholding or
deduction) being equal to such amounts as would have
been received by Payee had no such Tax been required
to be withheld or deducted; provided that for
purposes of Paragraphs 5 and 6 the term "Tax" shall
not include any Tax that would not have been imposed
but for the existence of any present or former
connection between Payee and the jurisdiction
imposing such Tax other than the mere receipt of
payment from Payor or the performance of Payee's
obligations under an International Transaction. The
parties acknowledge and agree, for the avoidance of
doubt, that the amount of Income required to be
transferred, credited or applied by Buyer for the
benefit of Seller under Paragraph 5 of the Agreement
shall be determined without taking into account any
Tax required to be withheld or deducted from such
Income, unless otherwise agreed.
(ii) In the case of any Tax required to be withheld or
deducted from any money payable to a party hereto
acting as Payee by the other party hereto acting as
Payor, Payee agrees to deliver to Payor (of, if
applicable, to the authority imposing the Tax) any
certificate or document reasonably required by Payor
that would entitle Payee to an exemption from, or
reduction in the rate of, withholding or deduction of
Tax from money payable by Payor to Payee.
(iii) Each party hereto agrees to notify the other party of
any circumstance known or reasonably known to it
(other than a Change of Tax Law, as defined in
Paragraph 6 hereof) that causes a certificate or
document provided by it pursuant to subparagraph (b)
(ii) of this Paragraph to fail to be true.
(iv) Notwithstanding subparagraph (b) (i) of this
Paragraph, no additional amounts shall be payable by
Payor to Payee in respect of an International
Transaction to the extent that such additional
amounts are payable as a result of a failure by Payee
to comply with its obligations under subparagraph (b)
(ii) or (b) (iii) of this Paragraph with respect to
such International Transaction.
September 1996 o Master Repurchase Agreement o 19
<PAGE>
6. Tax Event.
(a) This Paragraph 6 shall apply if either party notifies the
other, with respect to a Tax required to be collected by
withholding or deduction, that
(i) any action taken by a taxing authority or brought in
a court of competent jurisdiction after the date an
International Transaction is entered into, regardless
of whether such action is taken or brought with
respect to a party to the Agreement; or
(ii) a change in the fiscal or regulatory regime after the
date an International Transaction is entered into,
(each, a "Change of Tax Law") has or will, in the notifying
party's reasonable opinion, have a material adverse effect on
such party in the context of an International Transaction.
(b) If so requested by the other party, the notifying party will
furnish the other party with an opinion of a suitably
qualified adviser that an event referred to in subparagraph
(a) (i) or (a) (ii) of this Paragraph 6 has occurred and
affects the notifying party.
(c) Where this Paragraph 6 applies, the party giving the notice
referred to in subparagraph (a) above may, subject to
subparagraph (d) below, terminate the International
Transaction effective from a date specified in the notice, not
being earlier (unless so agreed by the other party) than 30
days after the date of such notice, by nominating such date as
the Repurchase Date.
(d) If the party receiving the notice referred to in subparagraph
(a) of this Paragraph 6 so elects, it may override such notice
by giving a counter-notice to the other party. If a
counter-notice is given, the party which gives such
counter-notice will be deemed to have agreed to indemnify the
other party against the adverse effect referred to in
subparagraph (a) of this Paragraph 6 so far as it relates to
the relevant International Transaction and the original
Repurchase Date will continue to apply.
(e) Where an International Transaction is terminated as described
in this Paragraph 6, the party which has given the notice to
terminate shall indemnify the other party against any
reasonable legal and other professional expenses incurred by
the other party by reason of the termination, but the other
party may not claim any sum constituting consequential loss or
damage in respect of a termination in accordance with this
Paragraph 6.
20 o September 1996 o Master Repurchase Agreement
<PAGE>
(f) This Paragraph 6 is without prejudice to Paragraph 5 of this
Annex III; but an obligation to pay additional amounts
pursuant to Paragraph 5 of this Annex III may, where
appropriate, be a circumstance which causes this Paragraph 6
to apply.
7. Margin. In the calculation of "Margin Deficit" and "Margin Excess"
pursuant to Paragraph 4 of the Agreement, all sums not denominated in
the Base Currency shall be deemed to be converted into the Base
Currency at the Spot Rate on the date of such calculation.
8. Events of Default.
(a) In addition to the Events of Default set forth in Paragraph 11
of the Agreement, it shall be an additional "Event of Default"
if either party fails, after one business day's notice, to
perform any covenant or obligation required to be performed by
it under this Annex III, including, without limitation, the
payment of taxes or additional amounts as required by
Paragraph 5 of this Annex III.
(b) In addition to the other rights of a nondefaulting party under
Paragraph 11 of the Agreement, following an Event of Default,
the nondefaulting party may, at any time at its option, effect
the conversion of any currency into a different currency of
its choice at the Spot Rate on the date of the exercise of
such option and offset obligations of the defaulting party
denominated in different currencies against each other.
September 1996 o Master Repurchase Agreement o 21
<PAGE>
Schedule III.A
International Transactions Relating to [Relevant Country]
This Schedule III.A forms a part of Annex III to the Master Repurchase Agreement
dated as of ____________________,19__ (the "Agreement")
between__________________________ and__________________________. Capitalized
terms used but not defined in this Schedule III.A shall have the meanings
ascribed to them in Annex III.
[Insert provisions applicable to relevant country.]
22 o September 1996 o Master Repurchase Agreement
<PAGE>
Annex IV
Party Acting as Agent
This Annex IV forms a part of the Master Repurchase Agreement dated as of
___________________________, 19__ (the "Agreement") between __________________
and __________________. This Annex IV sets forth the terms and conditions
governing all transactions in which a party selling securities or buying
securities, as the case may be ("Agent"), in a Transaction is acting as agent
for one or more third parties (each, a "Principal"). Capitalized terms used but
not defined in this Annex IV shall have the meanings ascribed to them in the
Agreement.
1. Additional Representations. In addition to the representations set
forth in Paragraph 10 of the Agreement, Agent hereby makes the
following representations, which shall continue during the term of any
Transaction: Principal has duly authorized Agent to execute and deliver
the Agreement on its behalf, has the power to so authorize Agent and to
enter into the Transactions contemplated by the Agreement and to
perform the obligations of Seller or Buyer, as the case may be, under
such Transactions, and has taken all necessary action to authorize such
execution and delivery by Agent and such performance by it.
2. Identification of Principals. Agent agrees (a) to provide the other
party, prior to the date on which the parties agree to enter into any
Transaction under the Agreement, with a written list of Principals for
which it intends to act as Agent (which list may be amended in writing
from time to time with the consent of the other party), and (b) to
provide the other party, before the close of business on the next
business day after orally agreeing to enter into a Transaction, with
notice of the specific Principal or Principals for whom it is acting in
connection with such Transaction. If (i) Agent fails to identify such
Principal or Principals prior to the close of business on such next
business day or (ii) the other party shall determine in its sole
discretion that any Principal or Principals identified by Agent are not
acceptable to it, the other party may reject and rescind any
Transaction with such Principal or Principals, return to Agent any
Purchased Securities or portion of the Purchase Price, as the case may
be, previously transferred to the other party and refuse any further
performance under such Transaction, and Agent shall immediately return
to the other party any portion of the Purchase Price or Purchased
Securities, as the case may be, previously transferred to Agent in
connection with such Transaction; provided, however, that (A) the other
party shall promptly (and in any event within one business day) notify
Agent of its determination to reject and rescind such Transaction and
(B) to the extent that any performance was rendered by any party under
any Transaction rejected by the other party, such party shall remain
entitled to any Price Differential or other amounts that would have
been payable to it with respect to such performance if such Transaction
had not been rejected. The other party acknowledges that Agent shall
not have any obligation to provide it with confidential information
regarding the financial status of its Principals; Agent agrees,
however, that it
September 1996 o Master Repurchase Agreement o 23
<PAGE>
will assist the other party in obtaining from Agent's Principals such
information regarding the financial status of such Principals as the
other party may reasonably request.
3. Limitation of Agent's Liability. The parties expressly acknowledge that
if the representations of Agent under the Agreement, including this
Annex IV, are true and correct in all material respects during the term
of any Transaction and Agent otherwise complies with the provisions of
this Annex IV, then (a) Agent's obligations under the Agreement shall
not include a guarantee of performance by its Principal or Principals
and (b) the other party's remedies shall not include a right of setoff
in respect of rights or obligations, if any, of Agent arising in other
transactions in which Agent is acting as principal.
4. Multiple Principals.
(a) In the event that Agent proposes to act for more than one
Principal hereunder, Agent and the other party shall elect
whether (i) to treat Transactions under the Agreement as
transactions entered into on behalf of separate Principals or
(ii) to aggregate such Transactions as if they were
transactions by a single Principal. Failure to make such an
election in writing shall be deemed an election to treat
Transactions under the Agreement as transactions on behalf of
separate Principals,
(b) In the event that Agent and the other party elect (or are
deemed to elect) to treat Transactions under the Agreement as
transactions on behalf of separate Principals, the parties
agree that (i) Agent will provide the other party, together
with the notice described in Paragraph 2 (b) of this Annex IV,
notice specifying the portion of each Transaction allocable to
the account of each of the Principals for which it is acting
(to the extent that any such Transaction is allocable to the
account of more than one Principal); (ii) the portion of any
individual Transaction allocable to each Principal shall be
deemed a separate Transaction under the Agreement; (iii) the
margin maintenance obligations of Buyer and Seller under
Paragraph 4 of the Agreement shall be determined on a
Transaction-by-Transaction basis (unless the parties agree to
determine such obligations on a Principal-by-Principal basis);
and (iv) Buyer's and Seller's remedies under the Agreement
upon the occurrence of an Event of Default shall be determined
as if Agent had entered into a separate Agreement with the
other party on behalf of each of its Principals.
(c) In the event that Agent and the other party elect to treat
Transactions under the Agreement as if they were transactions
by a single Principal, the parties agree that (i) Agent's
notice under Paragraph 2(b) of this Annex IV need only
identify the names of its Principals but not the portion of
each Transaction allocable to each Principal's account; (ii)
the margin maintenance obligations of Buyer and Seller under
Paragraph 4 of the Agreement shall, subject to any greater
requirement imposed by applicable law, be determined on an
aggregate basis for all Transactions entered into by Agent on
behalf of any Principal; and (iii) Buyer's and Seller's
remedies upon the occurrence of an Event of Default shall be
determined as if all Principals were a single Seller or Buyer,
as the case may be.
24 o September 1996 o Master Repurchase Agreement
<PAGE>
(d) Notwithstanding any other provision of the Agreement
(including, without limitation, this Annex IV), the parties
agree that any Transactions by Agent on behalf of an employee
benefit plan under ERISA shall be treated as Transactions on
behalf of separate Principals in accordance with Paragraph 4
(b) of this Annex IV (and all margin maintenance obligations
of the parties shall be determined on a
Transaction-by-Transaction basis).
5. Interpretation of Terms. All references to "Seller" or "Buyer", as the
case may be, in the Agreement shall, subject to the provisions of this
Annex IV (including, among other provisions, the limitations on Agent's
liability in Paragraph 3 of this Annex IV), be construed to reflect
that (i) each Principal shall have, in connection with any Transaction
or Transactions entered into by Agent on its behalf, the rights,
responsibilities, privileges and obligations of a "Seller" or "Buyer",
as the case may be, directly entering into such Transaction or
Transactions with the other party under the Agreement, and (ii) Agent's
Principal or Principals have designated Agent as their sole agent for
performance of Seller's obligations to Buyer or Buyer's obligations to
Seller, as the case may be, and for receipt of performance by Buyer of
its obligations to Seller or Seller of its obligations to Buyer, as the
case may be, in connection with any Transaction or Transactions under
the Agreement (including, among other things, as Agent for each
Principal in connection with transfers of Securities, cash or other
property and as agent for giving and receiving all notices under the
Agreement). Both Agent and its Principal or Principals shall be deemed
"parties" to the Agreement and all references to a "party" or "either
party" in the Agreement shall be deemed revised accordingly (and any
Act of Insolvency with respect to Agent or any other Event of Default
by Agent under Paragraph 11 of the Agreement shall be deemed an Event
of Default by Seller or Buyer, as the case may be).
September 1996 o Master Repurchase Agreement o 25
<PAGE>
Annex V
Margin for Forward Transactions
This Annex V forms a part of the Master Repurchase Agreement dated as of
_____________________________ ,19___ (the "Agreement") between ________________
and ________________________. Capitalized terms used but not defined in this
Annex V shall have the meanings ascribed to them in the Agreement.
1. Definitions. For purposes of the Agreement and this Annex V, the
following terms shall have the following meanings:
"Forward Exposure", the amount of loss a party would incur upon
canceling a Forward Transaction and entering into a replacement
transaction, determined in accordance with market practice or as
otherwise agreed by the parties;
"Forward Transaction", any Transaction agreed to by the parties as to
which the Purchase Date has not yet occurred;
"Net Forward Exposure", the aggregate amount of a party's Forward
Exposure to the other party under all Forward Transactions hereunder
reduced by the aggregate amount of any Forward Exposure of the other
party to such party under all Forward Transactions hereunder;
"Net Unsecured Forward Exposure", a party's Net Forward Exposure
reduced by the Market Value of any Forward Collateral transferred to
such party (and not returned) pursuant to Paragraph 2 of this Annex V.
2. Margin Maintenance.
(a) If at any time a party (the "In-the-Money Party") shall have a
Net Unsecured Forward Exposure to the other party (the
"Out-of-the-Money Party") under one or more Forward
Transactions, the In-the-Money Party may by notice to the
Out-of-the-Money Party require the Out-of-the-Money Party to
transfer to the In-the-Money Party Securities or cash
reasonably acceptable to the In-the-Money-Party (together with
any Income thereon and proceeds thereof, "Forward Collateral")
having a Market Value sufficient to eliminate such Net
Unsecured Forward Exposure. The Out-of-the-Money Party may by
notice to the In-the-Money Party require the In-the-Money
Party to transfer to the Out-of-the-Money Party Forward
Collateral having a Market Value that exceeds the In-the-Money
Party's Net Forward Exposure ("Excess Forward Collateral
Amount"). The rights of the parties under this subparagraph
shall be in addition to their rights under subparagraphs (a)
and (b) of Paragraph 4 and any other provisions of the
Agreement.
26 o September 1996 o Master Repurchase Agreement
<PAGE>
(b) The parties may agree, with respect to any or all Forward
Transactions hereunder, that the respective rights of the
parties under subparagraph (a) of this Paragraph may be
exercised only where a Net Unsecured Forward Exposure or
Excess Forward Collateral Amount, as the case may be, exceeds
a specified dollar amount or other specified threshold for
such Forward Transactions (which amount or threshold shall be
agreed to by the parties prior to entering into any such
Forward Transactions).
(c) The parties may agree, with respect to any or all Forward
Transactions hereunder, that the respective rights of the
parties under subparagraph (a) of this Paragraph to require
the elimination of a Net Unsecured Forward Exposure or Excess
Forward Collateral Amount, as the case may be, may be
exercised whenever such a Net Unsecured Forward Exposure or
Excess Forward Collateral Amount exists with respect to any
single Forward Transaction hereunder (calculated without
regard to any other Forward Transaction outstanding
hereunder).
(d) The parties may agree, with respect to any or all Forward
Transactions hereunder, that (i) one party shall transfer to
the other party Forward Collateral having a Market Value equal
to a specified dollar amount or other specified threshold no
later than the Margin Notice Deadline on the day such Forward
Transaction is entered into by the parties or (ii) one party
shall not be required to make any transfer otherwise required
to be made under this Paragraph if, after giving effect to
such transfer, the Market Value of the Forward Collateral held
by such party would be less than a specified dollar amount or
other specified threshold (which amount or threshold shall be
agreed to by the parties prior to entering into any such
Forward Transactions).
(e) If any notice is given by a party to the other under
subparagraph (a) of this Paragraph at or before the Margin
Notice Deadline on any business day, the party receiving such
notice shall transfer Forward Collateral as provided in such
subparagraph no later than the close of business in the
relevant market on such business day. If any such notice is
given after the Margin Notice Deadline, the party receiving
such notice shall transfer such Forward Collateral no later
than the close of business in the relevant market on the next
business day.
(f) Upon the occurrence of the Purchase Date for any Forward
Transaction and the performance by the parties of their
respective obligations to transfer cash and Securities on such
date, any Forward Collateral in respect of such Forward
Transaction, together with any Income thereon and proceeds
thereof, shall be transferred by the party holding such
Forward Collateral to the other party; provided, however, that
neither party shall be required to transfer such Forward
Collateral to the other if such transfer would result in the
creation of a Net Unsecured Forward Exposure of the
transferor.
(g) The Pledgor (as defined below) of Forward Collateral may,
subject to agreement with and acceptance by the Pledgee (as
defined below) thereof, substitute other Securities reasonably
acceptable to the Pledgee for any Securities Forward
Collateral. Such
September 1996 o Master Repurchase Agreement o 27
<PAGE>
substitution shall be made by transfer to the Pledgee of such
other Securities and transfer to the Pledgor of such
Securities Forward Collateral. After substitution, the
substituted Securities shall constitute Forward Collateral.
3. Security Interest.
(a) In addition to the rights granted to the parties under
Paragraph 6 of the Agreement, each party ("Pledgor") hereby
pledges to the other party ("Pledgee") as security for the
performance of its obligations hereunder, and grants Pledgee,
a security interest in and right of setoff against, any
Forward Collateral and any other cash, Securities or property,
and all proceeds of any of the foregoing, transferred by or on
behalf of Pledgor to Pledgee or due from Pledgee to Pledgor in
connection with the Agreement and the Forward Transactions
hereunder.
(b) Unless otherwise agreed by the parties, a party to whom
Forward Collateral has been transferred shall have the right
to engage in repurchase transactions with Forward Collateral
or otherwise sell, transfer, pledge or hypothecate Forward
Collateral, including in respect of loans or other extensions
of credit to such party that may be in amounts greater than
the Forward Collateral such party is entitled to as security
for obligations hereunder, and that may extend for periods of
time longer than the periods during which such party is
entitled to Forward Collateral as security for obligations
hereunder; provided, however, that no such transaction shall
relieve such party of its obligations to transfer Forward
Collateral pursuant to Paragraph 2 or 4 of this Annex V or
Paragraph 11 of the Agreement.
4. Events of Default.
(a) In addition to the Events of Default set forth in Paragraph 11
of the Agreement, it shall be an additional "Event of Default"
if either party fails, after one business day's notice, to
perform any covenant or obligation required to be performed by
it under Paragraph 2 or any other provision of this Annex.
(b) In addition to the other rights of a nondefaulting party under
Paragraphs 11 and 12 of the Agreement, if the nondefaulting
party exercised or is deemed to have exercised the option
referred to in Paragraph 11 (a) of the Agreement:
(i) The nondefaulting party, without prior notice to the
defaulting party, may (A) immediately sell, in a
recognized market (or otherwise in a commercially
reasonable manner) at such price or prices as the
nondefaulting party may reasonably deem satisfactory,
any or all Forward Collateral subject to any or all
Forward Transactions hereunder and apply the proceeds
thereof to any amounts owing by the defaulting party
hereunder or (B) in its sole discretion elect, in
lieu of selling all or a portion of such Forward
Collateral, to give the defaulting party credit for
such Forward Collateral in an amount equal to the
price therefor on such date, obtained from a
generally recognized source or the most recent
closing bid quotation from such a source, against any
amounts owing by the defaulting party hereunder.
28 o September 1996 o Master Repurchase Agreement
<PAGE>
(ii) Any Forward Collateral held by the defaulting party,
together with any Income thereon and proceeds
thereof, shall be immediately transferred by the
defaulting party to the nondefaulting party. The
nondefaulting party may, at its option (which option
shall be deemed to have been exercised immediately
upon the occurrence of an Act of Insolvency), and
without prior notice to the defaulting party, (i)
immediately purchase, in a recognized market (or
otherwise in a commercially reasonable manner) at
such price or prices as the nondefaulting party may
reasonably deem satisfactory, securities
("Replacement Securities") of the same class and
amount as any Securities Forward Collateral that is
not delivered by the defaulting party to the
nondefaulting party as required hereunder or (ii) in
its sole discretion elect, in lieu of purchasing
Replacement Securities, to be deemed to have
purchased Replacement Securities at the price
therefor on such date, obtained from a generally
recognized source or the most recent dosing offer
quotation from such a source, whereupon the
defaulting party shall be liable for the price of
such Replacement Securities together with the amount
of any cash Forward Collateral not delivered by the
defaulting party to the nondefaulting party as
required hereunder.
Unless otherwise provided in Annex I, the parties acknowledge
and agree that (1) the Forward Collateral subject to any
Forward Transaction hereunder are instruments traded in a
recognized market, (2) in the absence of a generally
recognized source for prices or bid quotations for any Forward
Collateral, the nondefaulting party may establish the source
therefor in its sole discretion and (3) all prices and bids
shall be determined together with accrued Income (except to
the extent contrary to market practice with respect to the
relevant Forward Collateral).
5. No Waivers, Etc. Without limitation of the provisions of Paragraph 17
of the Agreement, the failure to give a notice pursuant to subparagraph
(a), (b), (c) or (d) of Paragraph 2 of this Annex V will not constitute
a waiver of any right to do so at a later date.
September 1996 o Master Repurchase Agreement o 29
<PAGE>
Annex VI
Buy/Sell Back Transactions
This Annex VI forms a part of the Master Repurchase Agreement dated as of
________________ , 19___ (the "Agreement") between __________________________
and __________________. Capitalized terms used but not defined in this Annex VI
shall have the meanings ascribed to them in the Agreement.
1. In the event of any conflict between the terms of this Annex VI and any
other term of the Agreement, the terms of this Annex VI shall prevail.
2. Each Transaction shall be identified at the time it is entered into and
in the relevant Confirmation as either a Repurchase Transaction or a
Buy/Sell Back Transaction.
3. In the case of a Buy/Sell Back Transaction, the Confirmation delivered
in accordance with Paragraph 3 of the Agreement may consist of a single
document in respect of both of the transfers of funds against
Securities which together form the Buy/Sell Back Transaction or
separate Confirmations may be delivered in respect of each such
transfer.
4. Definitions. The following definitions shall apply to Buy/Sell Back
Transactions:
(a) "Accrued Interest", with respect to any Purchased Securities
subject to a Buy/Sell Back Transaction, unpaid Income that has
accrued during the period from (and including) the issue date
or the last Income payment date (whichever is later) in
respect of such Purchased Securities to (but excluding) the
date of calculation. For these purposes unpaid Income shall be
deemed to accrue on a dally basis from (and including) the
issue date or the last Income payment date (as the case may
be) to (but excluding) the next Income payment date or the
maturity date (whichever is earlier);
(b) "Sell Back Differential", with respect to any Buy/Sell Back
Transaction as of any date, the aggregate amount obtained by
daily application of the Pricing Rate for such Buy/Sell Back
Transaction to the Purchase Price for such Buy/Sell Back
Transaction on a 360 day per year basis (unless otherwise
agreed by the parties for the Transaction) for the actual
number of days during the period commencing on (and including)
the Purchase Date for such Buy/Sell Back Transaction and
ending on (but excluding) the date of determination;
(c) "Sell Back Price", with respect to any Buy/Sell Back
Transaction:
(i) in relation to the date originally specified by the
parties as the Repurchase Date pursuant to Paragraph
2 (q) of the Agreement, the price agreed by the
Parties in relation to such Buy/Sell Back
Transaction, and
30 o September 1996 o Master Repurchase Agreement
<PAGE>
(ii) in any other case (including for the purposes of the
application of Paragraph 4 or Paragraph 11 of the
Agreement), the product of the formula (P + D) - (IR
+ C), where -
P = the Purchase Price
D = the Sell Back Differential
IR = the amount of any Income in respect of the Purchased
Securities paid by the issuer on any date falling between
the Purchase Date and the Repurchase Date
C = the aggregate amount obtained by daily application of
the Pricing Rate for such Buy/Sell Back Transaction to
any such Income from (and including) the date of payment
by the issuer to (but excluding) the date of calculation.
5. When entering into a Buy/Sell Back Transaction the parties shall also
agree on the Sell Back Price and the Pricing Rate to apply in relation
to such Buy/Sell Back Transaction on the scheduled Repurchase Date. The
parties shall record the Pricing Rate in at least one Confirmation
applicable to such Buy/Sell Back Transaction.
6. Termination of a Buy/Sell Back Transaction shall be effected on the
Repurchase Date by transfer to Seller or its agent of Purchased
Securities against the payment by Seller of (i) in a case where the
Repurchase Date is the date originally agreed to by the parties
pursuant to Paragraph 2(q) of the Agreement, the Sell Back Price
referred to in Paragraph 4(c)(i) of this Annex; and (ii) in any other
case, the Sell Back Price referred to in Paragraph 4(c)(ii) of this
Annex.
7. For the avoidance of doubt, the parties acknowledge and agree that the
Purchase Price and the Sell Back Price in Buy/Sell Back transactions
shall include Accrued Interest (except to the extent contrary to market
practice with respect to the Securities subject to such Buy/Sell Back
Transaction, in which event (i) an amount equal to the Purchase Price
plus Accrued Interest to the Purchase Date shall be paid to Seller on
the Purchase Date and shall be used, in lieu of the Purchase Price, for
calculating the Sell Back Differential, (ii) an amount equal to the
Sell Back Price plus the amount of Accrued Interest to the Repurchase
Date shall be paid to Buyer on the Repurchase Date, and (iii) the
formula in Paragraph 4(c)(ii) of this Annex VI shall be replaced by the
formula "(P+AI+D) - (IR+C)", where "AI" equals Accrued Interest to the
Purchase Date).
8. Unless the parties agree in Annex I to the Agreement that a Buy/Sell
Back Transaction is not to be repriced, they shall at the time of
repricing agree on the Purchase Price, the Sell Back Price and the
Pricing Rate applicable to such Transaction.
September 1996 o Master Repurchase Agreement o 31
<PAGE>
9. Paragraph 5 of the Agreement shall not apply to Buy/Sell Back
Transactions. Seller agrees, on the date such Income is received, to
pay to Buyer any Income received by Seller in respect of Purchased
Securities that is paid by the issuer on any date falling between the
Purchase Date and the Repurchase Date.
10. References to "Repurchase Price" throughout the Agreement shall be
construed as references to "Repurchase Price or the Sell Back Price, as
the case may be."
11. In 11 of the Agreement, references to the "Repurchase Prices" shall be
construed as references to "Repurchase Prices and Sell Back Prices."
32 o September 1996 o Master Repurchase Agreement
<PAGE>
Annex VII
Transactions Involving Registered Investment Companies
This Annex VII (including any Schedules hereto) forms a part of the Master
Repurchase Agreement dated as of _________________ ,19__ (the "Agreement")
between _______________________________ ("Counterparty") and each investment
company identified on Schedule VII.A hereto (as such schedule may be amended
from time to time) acting on behalf of its respective series or portfolios
identified on such Schedule VII.A, or in the case of those investment companies
for which no separate series or portfolios are identified on such Schedule
VII.A, acting for and on behalf of itself (each such series, portfolio or
investment company, as the case may be, hereinafter referred to as a "Fund"). In
the event of any conflict between the terms of this Annex VII and any other term
of the Agreement, the terms of this Annex VII shall prevail. Capitalized terms
used but not defined in this Annex VII shall have the meanings ascribed to them
in the Agreement.
1. Multiple Funds. For any Transaction in which a Fund is acting as Buyer
(or Seller, as the case may be), each reference in the Agreement and
this Annex VII to Buyer (or Seller, as the case may be) shall be deemed
a reference solely to the particular Fund to which such Transaction
relates, as identified to Seller (or Buyer, as the case may be) by the
Fund and as may be specified in the Confirmation therefor. In no
circumstances shall the rights, obligations or remedies of either party
with respect to a particular Fund constitute a right, obligation or
remedy applicable to any other Fund. Specifically, and without
otherwise limiting the scope of this Paragraph: (a) the margin
maintenance obligations of Buyer and Seller specified in Paragraph 4 or
any other provisions of the Agreement and the single agreement
provisions of Paragraph 12 of the Agreement shall be applied based
solely upon Transactions entered into by a particular Fund, (b) Buyer's
and Seller's remedies under the Agreement upon the occurrence of an
Event of Default shall be determined as if each Fund had entered into a
separate Agreement with Counterparty, and (c) Seller and Buyer shall
have no right to set off claims related to Transactions entered into by
a particular Fund against claims related to Transactions entered into
by any other Fund.
2. Margin Percentage. For any Transaction in which a Fund is acting as
Buyer, the Buyer's Margin Percentage shall always be equal to at least
___%, or such other percentage as the parties hereto may from time to
time mutually determine; provided, that in no event shall such
percentage be less than 100%. For any Transaction in which a Fund is
acting as Seller, the Buyer's Margin Percentage shall be such
percentage as the parties hereto may from time to time mutually
determine; provided, that in no event shall such percentage be less
than 100%.
3. Confirmations. Unless otherwise agreed, Counterparty shall promptly
issue a Confirmation to the Fund pursuant to Paragraph 3 of the
Agreement. Upon the transfer of substituted or Additional Purchased
Securities by either party, Counterparty shall promptly provide notice
to the Fund confirming such transfer.
September 1996 o Master Repurchase Agreement o 33
<PAGE>
4. Financial Condition. Each party represents that it has delivered the
following financial information to the other party to the Agreement: in
the case of a party that is a registered broker-dealer, its most recent
statements required to be furnished to customers by Rule 17a-5(c) under
the 1934 Act; in the case of a party that is a Fund, its most recent
audited or unaudited financial statements required to be furnished to
its shareholders by Rule 30d-1 under the Investment Company Act of
1940; in the case of any other party, its most recent audited or
unaudited statements of financial condition or other comparable
information concerning its financial condition.
Each party represents that the financial statements or information so
delivered fairly reflect its financial condition and, if applicable,
its net capital ratio, on the date as of which such financial
statements or information were prepared. Each party agrees that it will
make available and deliver to the other party, promptly upon request,
all such financial statements that subsequently are required to be
delivered to its customers or shareholders pursuant to Rule 17a-5(c) or
Rule 30d-l, as the case may be, or, in the case of a party that is
neither a registered broker-dealer nor a Fund, all such financial
information that subsequently becomes available to the public.
Each Fund acknowledges and agrees that it has made an independent
evaluation of the creditworthiness of the other party that is required
pursuant to the Investment Company Act of 1940 or the regulations
thereunder. Each Fund agrees that its agreement to enter into each
Transaction hereunder shall constitute an acknowledgment and agreement
that it has made such an evaluation.
5. Segregation of Purchased Securities. Unless otherwise agreed by the
parties, any transfer of Purchased Securities to a Fund shall be
effected by delivery or other transfer (in the manner agreed upon
pursuant to Paragraph 7 of the Agreement) to the custodian or
subcustodian designated for such Fund in Schedule VII.A hereto
("Custodian") for credit to the Fund's custodial account with such
Custodian. If the party effecting such transfer is the Fund's
Custodian, such party shall, unless otherwise directed by the Fund, (a)
transfer and maintain such Purchased Securities to and in the Fund's
custodial account with such party and (b) so indicate in a notice to
the Fund.
34 o September 1996 o Master Repurchase Agreement
<PAGE>
Schedule VII.A
Supplemental Terms and Conditions of Transactions
Involving Registered Investment Companies
This Schedule VII.A forms a part of Annex VII to the Master Repurchase Agreement
dated as of __________________, 19 ___ (the "Agreement") between
_____________________ and ________________________.
Capitalized terms used but not defined in this Schedule VII.A shall have the
meanings ascribed to them in Annex VII.
1. This Agreement is entered into by or on behalf of the following Funds, and
unless otherwise indicated by the appropriate Fund in connection with a
Transaction, the following Custodians are designated to receive transfers
of Purchased Securities on behalf of such Funds for credit to the
appropriate Fund's custodial account:
Name of Fund Custodian
------------ ---------
[ ]. Limitation of Liability. If the Fund is organized as a business trust (or a
series thereof), the parties agree as follows: [insert appropriate language
limiting liability of trustees, officers and others].
THE
BOND
MARKET
ASSOCIATION
40 Broad Street
New York, NY 10004-2373
Telephone 212.440.9400
Fax 212.440.5260
www. bondmarkets.com
September 1996 o Master Repurchase Agreement o 35
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our reports
(and to all references to our Firm) included in or made a part of this
Registration Statement.
/s/ Arthur Andersen LLP
Washington, D.C.
March 22, 1999
