sv11za
As filed with the Securities and Exchange
Commission on July 11, 2011
Registration
No. 333-173890
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Amendment No. 2
to
Form S-11
FOR REGISTRATION UNDER THE
SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
ORCHID ISLAND CAPITAL,
INC.
(Exact name of registrant as
specified in its governing instruments)
3305 Flamingo Drive, Vero Beach, Florida 32963
(772) 231-1400
(Address, including zip
code, and telephone number, including area code, of
registrants principal executive offices)
Robert E. Cauley
Chairman and Chief Executive Officer
Orchid Island Capital, Inc.
3305 Flamingo Drive, Vero Beach, Florida 32963
(772) 231-1400
(Name, address, including
zip code and telephone number, including area code, of agent for
service)
copies to:
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S. Gregory Cope
Hunton & Williams LLP
Riverfront Plaza, East Tower
951 East Byrd Street
Richmond, VA 23219
(804) 788-8388
(804) 343-4833
(facsimile)
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Bonnie A. Barsamian
Valerie Ford Jacob
Fried, Frank, Harris, Shriver & Jacobson LLP
One New York Plaza
New York, New York 10004
(212) 859-8226
(212) 859-4000 (facsimile)
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Approximate date of commencement of proposed sale to the
public: As soon as practicable after the
effective date of this Registration Statement.
If any of the Securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to
Rule 415 under the Securities Act, check the following
box. o
If this Form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act,
check the following box and list the Securities Act registration
statement number of the earlier effective registration statement
for the same
offering. o
If this Form is a post-effective amendment filed pursuant to
Rule 462(c) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o
If this Form is a post-effective amendment filed pursuant to
Rule 462(d) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o
If delivery of the prospectus is expected to be made pursuant to
Rule 434, check the following
box. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in Rule
12b-2 of the
Exchange Act. (Check one):
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Large accelerated
filer o
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Accelerated
filer o
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Non-accelerated
filer þ
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Smaller reporting
company o
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(Do not check if a smaller
reporting company)
The Registrant hereby amends this Registration Statement on
such date or dates as may be necessary to delay its effective
date until the Registrant shall file a further amendment which
specifically states that this Registration Statement shall
thereafter become effective in accordance with Section 8(a)
of the Securities Act of 1933 or until the Registration
Statement shall become effective on such date as the Commission,
acting pursuant to said Section 8(a), may determine.
The
information in this prospectus is not complete and may be
changed. We may not sell these securities until the registration
statement filed with the Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these
securities and it is not soliciting an offer to buy these
securities in any jurisdiction where the offer or sale is not
permitted.
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Subject to Completion, dated
July 11, 2011
PROSPECTUS
7,500,000 Shares
Common Stock
Orchid Island Capital, Inc., a Maryland corporation, invests in
residential mortgage-backed securities the principal and
interest payments of which are guaranteed by a
U.S. Government agency or a U.S. Government-sponsored
entity. We will be externally managed and advised by Bimini
Advisors, Inc., or our Manager, a wholly-owned subsidiary of
Bimini Capital Management, Inc., or Bimini. Bimini is an
existing real estate investment trust for U.S. federal
income tax purposes, or REIT, incorporated in Maryland whose
common stock is traded on the OTC Bulletin Board under the
symbol BMNM.
This is our initial public offering. We are offering
7,500,000 shares of our common stock. We currently expect
the initial public offering price of our common stock to be
between $10.00 and $12.00 per share. Prior to this offering,
there has been no public market for our common stock. We have
applied to have our common stock listed on the New York
Stock Exchange, or the NYSE, under the symbol ORC.
Concurrently with this offering, we intend to sell in a separate
private placement to Bimini warrants to purchase an aggregate of
4,500,000 shares of our common stock. The aggregate
purchase price of such warrants will be $2,475,000. Each warrant
will be exercisable into one share of our common stock at an
exercise price of 110% of the price per share of the common
stock sold in this offering, subject to certain adjustments. See
Description of Securities Warrants. The
warrants will become exercisable upon the completion of this
offering and will expire at the close of business
on ,
2018.
We are organized and intend to conduct our operations to qualify
as a REIT. To assist us in qualifying as a REIT, among other
purposes, ownership of our stock by any person is generally
limited to 9.8% in value or number of shares, whichever is more
restrictive, of any class or series of our stock, except that
Bimini may own up to 44% of our common stock so long as Bimini
continues to qualify as a REIT. Our charter also contains
various other restrictions on the ownership and transfer of our
common stock, see Description of Securities
Restrictions on Ownership and Transfer.
Investing in our
common stock involves risks. See Risk Factors
beginning on page 25 of this prospectus.
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Per Share
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Total
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Price to the public
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$
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$
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Underwriting discounts and
commissions(1)
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$
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$
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Proceeds to us (before
expenses)(2)
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$
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$
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(1)
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Upon the completion of this
offering, the underwriters will be entitled to receive
$ per share from us for the shares
sold in this offering. Our Manager will pay the underwriters the
remaining $ per share for the
shares sold in this offering on a deferred basis after the
completion of this offering.
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(2)
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Our obligation to pay for the
expenses of this offering will be capped at 1.0% of the total
gross proceeds from this offering. Our Manager will pay any
offering expenses incurred above this 1.0% cap.
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We have granted the underwriters the option to purchase
1,125,000 additional shares of common stock on the same terms
and conditions set forth above within 30 days after the
date of this prospectus.
Neither the Securities and Exchange Commission nor any state
securities commission has approved or disapproved of these
securities or passed on the adequacy or accuracy of this
prospectus. Any representation to the contrary is a criminal
offense.
Barclays Capital, on behalf of the underwriters, expects to
deliver the shares on or
about ,
2011.
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Barclays
Capital |
JMP Securities |
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Cantor Fitzgerald & Co.
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Oppenheimer & Co.
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Lazard Capital
Markets
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Sterne Agee
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Prospectus
dated ,
2011
TABLE OF
CONTENTS
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Page
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1
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23
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25
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54
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55
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56
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57
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58
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60
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72
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76
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77
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91
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100
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109
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112
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117
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118
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123
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124
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148
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150
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157
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157
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158
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F-1
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You should rely only on the information contained in this
prospectus and any free writing prospectus that we authorize to
be delivered to you. We have not, and the underwriters have not,
authorized any other person to provide you with any additional
or different information. If anyone provides you with
additional, different or inconsistent information, you should
not rely on it. We are not, and the underwriters are not, making
an offer to sell these securities in any jurisdiction where the
offer or sale is not permitted. You should assume that the
information appearing in this prospectus is accurate only as of
the date on the front cover of this prospectus or another date
specified herein. Our business, financial condition and
prospects may have changed since such dates.
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PROSPECTUS
SUMMARY
This section summarizes information contained elsewhere in
this prospectus. It is not complete and may not contain all of
the information that you may want to consider before making an
investment in our common stock. You should read this entire
prospectus carefully, including the section titled Risk
Factors and our financial statements and related notes,
before making an investment in our common stock. As used in this
prospectus, Orchid, Company,
we, our, and us refer to
Orchid Island Capital, Inc., except where the context otherwise
requires. References to our Manager refer to Bimini
Advisors, Inc., a wholly-owned subsidiary of Bimini Capital
Management, Inc. References to Bimini and
Bimini Capital refer to Bimini Capital Management,
Inc. Unless otherwise indicated, the information in this
prospectus assumes (i) the underwriters will not exercise
their option to purchase up to 1,125,000 additional shares of
our common stock, and (ii) that the shares of our common
stock to be sold in this offering will be sold at $11.00 per
share, which is the mid-point of the price range set forth on
the front cover of this prospectus. Unless otherwise indicated
or the context requires, all information in this prospectus
relating to the number of shares of common stock to be
outstanding after the completion of this offering reflects a
stock dividend of 7.0922 shares for each share of common stock
that we will effect immediately prior to the completion of this
offering. See Description of Securities
General.
Our
Company
Orchid Island Capital, Inc. is a specialty finance company that
invests in residential mortgage-backed securities, or RMBS. The
principal and interest payments of these RMBS are guaranteed by
the Federal National Mortgage Association, or Fannie Mae, the
Federal Home Loan Mortgage Corporation, or Freddie Mac, or the
Government National Mortgage Association, or Ginnie Mae, and are
backed by primarily single-family residential mortgage loans. We
refer to these types of RMBS as Agency RMBS. Our investment
strategy focuses on, and our portfolio consists of, two
categories of Agency RMBS: (i) traditional pass-through
Agency RMBS and (ii) structured Agency RMBS, such as
collateralized mortgage obligations, or CMOs, interest only
securities, or IOs, inverse interest only securities, or IIOs,
and principal only securities, or POs, among other types of
structured Agency RMBS.
Our business objective is to provide attractive risk-adjusted
total returns to our investors over the long term through a
combination of capital appreciation and the payment of regular
quarterly distributions. We intend to achieve this objective by
investing in and strategically allocating capital between the
two categories of Agency RMBS described above. We seek to
generate income from (i) the net interest margin, which is
the spread or difference between the interest income we earn on
our assets and the interest cost of our related borrowing and
hedging activities, on our leveraged pass-through Agency RMBS
portfolio and the leveraged portion of our structured Agency
RMBS portfolio, and (ii) the interest income we generate
from the unleveraged portion of our structured Agency RMBS
portfolio. We intend to fund our pass-through Agency RMBS and
certain of our structured Agency RMBS, such as fixed and
floating rate tranches of CMOs and POs, through short-term
borrowings structured as repurchase agreements. However, we do
not intend to employ leverage on the securities in our
structured Agency RMBS portfolio that have no principal balance,
such as IOs and IIOs. We do not intend to use leverage in these
instances because these securities contain structural leverage.
Pass-through Agency RMBS and structured Agency RMBS typically
exhibit materially different sensitivities to movements in
interest rates. Declines in the value of one portfolio may be
offset by appreciation in the other. The percentage of capital
that we allocate to our two Agency RMBS asset categories will
vary and will be actively managed in an effort to maintain the
level of income generated by the combined portfolios, the
stability of that income stream and the stability of the value
of the combined portfolios. We believe that this strategy will
enhance our liquidity, earnings, book value stability and asset
selection opportunities in various interest rate environments.
We were formed by Bimini in August 2010. We commenced operations
on November 24, 2010, and through March 31, 2011,
Bimini had contributed approximately $7.5 million in cash
to us. Bimini has agreed to contribute an additional $7.5
million in cash to us prior to the completion of this offering
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pursuant to a subscription agreement to purchase additional
shares of our common stock. Bimini is currently our sole
stockholder. Bimini has managed our portfolio since inception by
utilizing the same investment strategy that we expect our
Manager and its experienced RMBS investment team to continue to
employ after completion of this offering. As of March 31,
2011, our Agency RMBS portfolio had a fair value of
approximately $28.9 million and was comprised of
approximately 83.5%
pass-through
Agency RMBS and 16.5% structured Agency RMBS. Our net asset
value as of March 31, 2011 was approximately
$7.5 million.
We intend to qualify and will elect to be taxed as a REIT under
the Internal Revenue Code of 1986, as amended, or the Code,
commencing with our short taxable year ending December 31,
2011. We generally will not be subject to U.S. federal
income tax to the extent that we annually distribute all of our
REIT taxable income to our stockholders and qualify as a REIT.
Our
Manager
We are currently managed by Bimini. Upon completion of this
offering, we will be externally managed and advised by Bimini
Advisors, Inc., or our Manager, pursuant to the terms of a
management agreement. Our Manager is a newly-formed Maryland
corporation and wholly-owned subsidiary of Bimini. Our Manager
will be responsible for administering our business activities
and
day-to-day
operations, subject to the supervision and oversight of our
Board of Directors. Members of Biminis and our
Managers senior management team will also serve as our
executive officers. We will not have any employees.
Bimini is a mortgage REIT that has operated since 2003 and, as
of March 31, 2011, had approximately $117 million of
pass-through Agency RMBS and structured Agency RMBS. Bimini has
employed its investment strategy with its own portfolio since
the third quarter of 2008 and with our portfolio since our
inception. We expect that our Manager will continue to employ
this strategy after the completion of this offering. We were
formed and have been managed by Bimini as a vehicle through
which Bimini could employ its same investment strategy and
pursue growth and capital-raising opportunities. As a result of
the adverse impact of its legacy mortgage origination business,
Bimini has been unable to raise capital on attractive terms to
finance the growth of its own portfolio. Bimini may seek to
raise capital in the future if and when it is able to do so. For
additional information regarding Bimini, see
About Bimini.
Our Investment
and Capital Allocation Strategy
Our Investment
Strategy
Our business objective is to provide attractive risk-adjusted
total returns to our investors over the long term through a
combination of capital appreciation and the payment of regular
quarterly distributions. We intend to achieve this objective by
investing in and strategically allocating capital between
pass-through Agency RMBS and structured Agency RMBS. We seek to
generate income from (i) the net interest margin on our
leveraged pass-through Agency RMBS portfolio and the leveraged
portion of our structured Agency RMBS portfolio, and
(ii) the interest income we generate from the unleveraged
portion of our structured Agency RMBS portfolio. We also seek to
minimize the volatility of both the net asset value of, and
income from, our portfolio through a process which emphasizes
capital allocation, asset selection, liquidity and active
interest rate risk management.
We intend to fund our pass-through Agency RMBS and certain of
our structured Agency RMBS, such as fixed and floating rate
tranches of CMOs and POs, through repurchase agreements.
However, we do not intend to employ leverage on our structured
Agency RMBS that have no principal balance, such as IOs and
IIOs. We do not intend to use leverage in these instances
because the securities contain structural leverage.
2
Our target asset categories and the principal assets in which we
intend to invest are as follows:
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Asset Categories
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Principal Assets
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Pass-through Agency RMBS
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Residential Mortgage Pass-Through
Certificates. Residential mortgage
pass-through certificates are securities representing interests
in pools of mortgage loans secured by residential
real property where payments of both interest and principal,
plus pre-paid principal, on the securities are made monthly to
holders of the securities, in effect passing through
monthly payments made by the individual borrowers on the
mortgage loans that underlie the securities, net of fees paid to
the issuer/guarantor and servicers of the securities.
Pass-through certificates can be divided into various categories
based on the characteristics of the underlying mortgages, such
as the term or whether the interest rate is fixed or variable.
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The principal and interest payments of these Agency RMBS are
guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae and are
backed by primarily single-family residential mortgage loans. We
intend to invest in pass-through certificates with the three
following types of underlying loans:
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Fixed-Rate
Mortgages. Fixed-rate mortgages are mortgages
for which the borrower pays an interest rate that is constant
throughout the term of the loan.
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Adjustable-Rate Mortgages
(ARMs). ARMs are mortgages for which the
borrower pays an interest rate that varies over the term of the
loan.
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Hybrid ARMs. Hybrid ARMs
are mortgages that have a fixed-rate for the first few years of
the loan, often three, five or seven years, and thereafter reset
periodically like a traditional ARM.
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Structured Agency RMBS
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Collateralized Mortgage
Obligations. CMOs are securities that are
structured from residential mortgage pass-through certificates,
which receive monthly payments of principal and interest. CMOs
may be collateralized by whole mortgage loans, but are more
typically collateralized by portfolios of residential mortgage
pass-through securities issued directly by or under the auspices
of Fannie Mae, Freddie Mac or Ginnie Mae. CMOs divide the cash
flows which come from the underlying residential mortgage
pass-through certificates into different classes of securities
that may have different maturities and different weighted
average lives than the underlying residential mortgage
pass-through certificates.
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Interest Only Securities. IOs are
securities that are structured from residential mortgage
pass-through certificates, which receive monthly payments of
interest only. IOs represent the stream of interest payments on
a pool of mortgages, either fixed-rate mortgages or hybrid ARMs.
The value of IOs depends primarily on two factors, which are
prepayments and interest rates.
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Inverse Interest Only Securities. IIOs
are IOs that have interest rates that move in the opposite
direction of an interest rate index, such as LIBOR. The value of
IIOs depends primarily on three factors, which are prepayments,
LIBOR and term interest rates.
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Principal Only Securities. POs are securities
that are structured from residential mortgage pass-through
certificates, which receive monthly payments of principal only
and are, therefore, similar to zero coupon bonds. The value of
POs depends primarily on two factors, which are prepayments and
interest rates.
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Our investment strategy consists of the following components:
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investing in pass-through Agency RMBS and certain structured
Agency RMBS, such as fixed and floating rate tranches of CMOs
and POs, on a leveraged basis to increase returns on the capital
allocated to this portfolio;
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investing in certain structured Agency RMBS, such as IOs and
IIOs, on an unleveraged basis in order to (i) increase returns
due to the structural leverage contained in such securities,
(ii) enhance liquidity due to the fact that these
securities will be unencumbered and (iii) diversify
portfolio interest rate risk due to the different interest rate
sensitivity these securities have compared to pass-through
Agency RMBS;
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investing in Agency RMBS in order to minimize credit risk;
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investing in assets that will cause us to maintain our exclusion
from regulation as an investment company under the Investment
Company Act of 1940, as amended, or the Investment Company
Act; and
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investing in assets that will allow us to qualify and maintain
our qualification as a REIT.
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Our Manager will make investment decisions based on various
factors, including, but not limited to, relative value, expected
cash yield, supply and demand, costs of hedging, costs of
financing, liquidity requirements, expected future interest rate
volatility and the overall shape of the U.S. Treasury and
interest rate swap yield curves. We do not attribute any
particular quantitative significance to any of these factors,
and the weight we give to these factors depends on market
conditions and economic trends. We believe that this strategy,
combined with our Managers experienced RMBS investment
team, will enable us to provide attractive long-term returns to
our stockholders.
Capital
Allocation Strategy
The percentage of capital invested in our two asset categories
will vary and will be managed in an effort to maintain the level
of income generated by the combined portfolios, the stability of
that income stream and the stability of the value of the
combined portfolios. Typically, pass-through Agency RMBS and
structured Agency RMBS exhibit materially different
sensitivities to movements in interest rates. Declines in the
value of one portfolio may be offset by appreciation in the
other, although we cannot assure you that this will be the case.
Additionally, our Manager will seek to maintain adequate
liquidity as it allocates capital.
During periods of rising interest rates, refinancing
opportunities available to borrowers typically decrease because
borrowers are not able to refinance their current mortgage loans
with new mortgage loans at lower interest rates. In such
instances, securities that are highly sensitive to refinancing
activity, such as IOs and IIOs, typically increase in value. Our
capital allocation strategy allows us to redeploy our capital
into such securities when and if we believe interest rates will
be higher in the future, thereby allowing us to hold securities
the value of which we believe is likely to increase as interest
rates rise. Also, by being able to re-allocate capital into
structured Agency RMBS, such as IOs, during periods of rising
interest rates, we may be able to offset the likely decline in
the value of our pass-through Agency RMBS, which are negatively
impacted by rising interest rates.
Competitive
Strengths
We believe that our competitive strengths include:
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Ability to Successfully Allocate Capital between
Pass-Through and Structured Agency RMBS. We
seek to maximize our risk-adjusted returns by investing
exclusively in Agency RMBS, which has limited credit risk due to
the guarantee of principal and interest payments on such
securities by Fannie Mae, Freddie Mac or Ginnie Mae. Our Manager
will allocate capital between pass-through Agency RMBS and
structured Agency RMBS. The percentage of our capital we
allocate to our two asset categories will vary and will be
actively managed
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in an effort to maintain the level of income generated by the
combined portfolios, the stability of that income stream and the
stability of the value of the combined portfolios. We believe
this strategy will enhance our liquidity, earnings, book value
stability and asset selection opportunities in various interest
rate environments and provide us with a competitive advantage
over other REITs that invest in only pass-through Agency RMBS.
This is because, among other reasons, our investment and capital
allocation strategies allow us to move capital out of
pass-through Agency RMBS and into structured Agency RMBS in a
rising interest rate environment, which will protect our
portfolio from excess margin calls on our pass-through Agency
RMBS portfolio and reduced net interest margins, and allow us to
invest in securities, such as IOs, that have historically
performed well in a rising interest rate environment.
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Experienced RMBS Investment
Team. Robert Cauley, our Chief Executive
Officer and co-founder of Bimini, and Hunter Haas, our Chief
Investment Officer, have 19 and ten years of experience,
respectively, in analyzing, trading and investing in Agency
RMBS. Additionally, Messrs. Cauley and Haas each have over
seven years of experience managing Bimini, which is a
publicly-traded REIT that has invested in Agency RMBS since its
inception in 2003. Messrs. Cauley and Haas managed Bimini
through the recent housing market collapse and the related
adverse effects on the banking and financial system,
repositioning Biminis portfolio in response to adverse
market conditions. We believe this experience has enabled them
to recognize portfolio risk in advance, hedge such risk
accordingly and manage liquidity and borrowing risks during
adverse market conditions. We believe that
Messrs. Cauleys and Haass experience will
provide us with a competitive advantage over other management
teams that may not have experience managing a publicly-traded
mortgage REIT or managing a business similar to ours during
various interest rate and credit cycles, including the recent
housing market collapse.
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Clean Balance Sheet With an Implemented Investment
Strategy. As a recently-formed entity, we
intend to build on our existing investment portfolio. As of
March 31, 2011, our Agency RMBS portfolio had a fair value
of approximately $28.9 million and was comprised of
approximately 83.5% pass-through Agency RMBS and 16.5%
structured Agency RMBS. Our net asset value as of March 31,
2011 was approximately $7.5 million. Bimini has managed our
portfolio since inception by utilizing the same investment
strategy that we expect our Manager and its experienced RMBS
investment team to continue to employ after the completion of
this offering.
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Alignment of Interests. Upon completion
of this offering, Bimini will own 1,063,830 shares of our
common stock. Concurrently with this offering, we intend to sell
to Bimini warrants to purchase an aggregate of
4,500,000 shares of our common stock in a separate private
placement for an aggregate purchase price of $2,475,000. Upon
completion of this offering, Bimini will own common stock
representing approximately 12.42% of the outstanding shares of
our common stock (or 10.98% if the underwriters exercise their
option to purchase additional shares in full). Bimini has agreed
that, for a period of 365 days after the date of this
prospectus, it will not, without the prior written consent of
Barclays Capital Inc., dispose of or hedge any of (i) its
shares of our common stock, including any shares of our common
stock issuable upon the exercise of the warrants it intends to
purchase in the concurrent private placement, (ii) the
warrants that it intends to purchase in the concurrent private
placement or (iii) any shares of common stock that it may
acquire after the completion of this offering, subject to
certain exceptions and extensions. We believe that Biminis
ownership of our common stock will align our Managers
interests with our interests.
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5
Summary Risk
Factors
An investment in our common stock involves material risks. Each
prospective purchaser of our common stock should consider
carefully the matters discussed under Risk Factors
beginning on page 25 before investing in our common stock.
Some of the risks include:
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The federal conservatorship of Fannie Mae and Freddie Mac and
related efforts, along with any changes in laws and regulations
affecting the relationship between Fannie Mae and Freddie Mac
and the U.S. Government, may adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
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Continued adverse developments in the broader residential
mortgage market have adversely affected Bimini and may
materially adversely affect our business, financial condition
and results of operations and our ability to pay distributions
to our stockholders.
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Interest rate mismatches between our Agency RMBS and our
borrowings may reduce our net interest margin during periods of
changing interest rates, which could materially adversely affect
our business, financial condition and results of operations and
our ability to pay distributions to our stockholders.
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We have not established a minimum distribution payment level,
and we cannot assure you of our ability to make distributions to
our stockholders in the future.
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Mortgage loan modification programs and future legislative
action may adversely affect the value of, and the returns on,
our Agency RMBS, which could materially adversely affect our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders.
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Increased levels of prepayments on the mortgages underlying our
Agency RMBS might decrease net interest income or result in a
net loss, which could materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
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We invest in structured Agency RMBS, including CMOs,
IOs, IIOs and POs. Although structured Agency RMBS are
generally subject to the same risks as our pass-through Agency
RMBS, certain types of risks may be enhanced depending on the
type of structured Agency RMBS in which we invest.
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Our use of leverage could materially adversely affect our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders.
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Adverse market developments could cause our lenders to require
us to pledge additional assets as collateral. If our assets were
insufficient to meet these collateral requirements, we might be
compelled to liquidate particular assets at inopportune times
and at unfavorable prices, which could materially adversely
affect our business, financial condition and results of
operations and our ability to pay distributions to our
stockholders.
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Hedging against interest rate exposure may not completely
insulate us from interest rate risk and could materially
adversely affect our business, financial condition and results
of operations and our ability to pay distributions to our
stockholders.
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The management agreement was not negotiated on an
arms-length basis and the terms, including fees payable
and our inability to terminate, or our election not to renew,
the management agreement based on our Managers poor
performance without paying our Manager a significant termination
fee, may not be as favorable to us as if it were negotiated with
an unaffiliated third party.
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We are completely dependent upon our Manager and certain key
personnel of Bimini who provide services to us through the
management agreement, and we may not find suitable
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6
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replacements for our Manager and these personnel if the
management agreement is terminated or such key personnel are no
longer available to us.
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There are various conflicts of interest in our relationship with
our Manager and Bimini, which could result in decisions that are
not in the best interest of our stockholders, including possible
conflicts created by our Managers compensation whereby it
is entitled to receive a management fee that is not tied to the
performance of our portfolio and possible conflicts of duties
that may result from the fact that all of our Managers
officers are also employees of Bimini.
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Loss of our exemption from regulation under the Investment
Company Act would negatively affect the value of shares of our
common stock and our ability to pay distributions to our
stockholders.
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Our failure to qualify, or maintain our qualification, as a REIT
would subject us to U.S. federal income tax, which could
adversely affect the value of the shares of our common stock and
would substantially reduce the cash available for distribution
to our stockholders.
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Our
Portfolio
As of March 31, 2011, our portfolio consisted of Agency
RMBS with an aggregate fair value of approximately
$28.9 million, a weighted average coupon of 4.22% and a net
weighted average borrowing cost of 0.33%. The following table
summarizes our portfolio as of March 31, 2011:
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Weighted
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Percentage
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Weighted
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Average
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Weighted
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Weighted
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of
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Weighted
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Average
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Coupon
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Average
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Average
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Weighted
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Entire
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Average
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Maturity in
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Longest
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Reset in
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Lifetime
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Periodic
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Average
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Asset Category
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Fair Value
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Portfolio
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Coupon
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Months
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Maturity
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Months
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Cap
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Cap
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CPR(1)
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(In thousands)
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Pass-through Agency RMBS backed by:
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Adjustable-Rate Mortgages
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$
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7,721
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26.7
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%
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2.53
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%
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288
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April 2035
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5.03
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9.55
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%
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2.00
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%
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0.11
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%
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Fixed-Rate Mortgages
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16,418
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56.8
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%
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4.54
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%
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171
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November 2025
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N/A
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N/A
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N/A
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0.75
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%
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Hybrid Adjustable-Rate Mortgages
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Total/Weighted Average Whole-pool Mortgage Pass-through Agency
RMBS
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$
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24,139
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83.5
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%
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3.90
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%
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208
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April 2035
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5.03
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9.55
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%
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2.00
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%
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0.54
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%
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Structured Agency RMBS:
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CMOs
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IOs
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966
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3.3
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%
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4.50
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%
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163
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October 2024
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N/A
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N/A
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N/A
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N/A
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IIOs
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3,799
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13.2
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%
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6.22
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%
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297
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April 2037
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N/A
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N/A
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N/A
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19.73
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%
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POs
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Total/Weighted Average Structured Agency RMBS
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4,765
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16.5
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%
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5.87
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%
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270
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April 2037
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N/A
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N/A
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N/A
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19.73
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%
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Total/Weighted Average
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$
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28,904
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100
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%
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4.22
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%
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218
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April 2037
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5.03
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9.55
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%
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2.00
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%
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5.67
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%
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(1) |
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CPR refers to Constant Prepayment
Rate, which is a method of expressing the prepayment rate for a
mortgage pool that assumes that a constant fraction of the
remaining principal is prepaid each month or year. Specifically,
the constant prepayment rate in the chart above represents the
three month prepayment rate of the securities in the respective
asset category.
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Our Financing
Strategy
We intend to fund our pass-through Agency RMBS and certain of
our structured Agency RMBS, such as fixed and floating rate
tranches of CMOs and POs, through short-term repurchase
agreements. However, we do not intend to employ leverage on our
structured Agency RMBS that have
7
no principal balance, such as IOs and IIOs. We do not intend to
use leverage in these instances because the securities contain
structural leverage. Our borrowings currently consist of
short-term repurchase agreements. We may use other sources of
leverage, such as secured or unsecured debt or issuances of
preferred stock. We do not have a policy limiting the amount of
leverage we may incur. However, we generally expect that the
ratio of our total liabilities compared to our equity, which we
refer to as our leverage ratio, will be less than 12 to 1. Our
amount of leverage may vary depending on market conditions and
other factors that we deem relevant. As of March 31, 2011,
our portfolio leverage ratio was approximately 3.0 to 1. As of
March 31, 2011, we had entered into master repurchase
agreements with two counterparties and had funding in place with
one such counterparty, as described below. We have since entered
into master repurchase agreements with three additional
counterparties (for a total of five) and are currently
negotiating, and intend to enter into, additional master
repurchase agreements with additional counterparties after the
completion of this offering to attain additional lending
capacity and to diversify counterparty credit risk. However, we
cannot assure you that we will enter into such additional master
repurchase agreements on favorable terms, or at all.
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Net
|
|
Weighted Average
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Weighted
|
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Maturity of
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Percent of
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Average
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Repurchase
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Total
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Borrowing
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Agreements
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Amount
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Counterparty
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Balance
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Borrowings
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Cost
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in Days
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at
Risk(1)
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MF Global Inc.
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$
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22,530,842
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100
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%
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0.33
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%
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77
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$
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1,673,153
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(1) |
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Equal to the fair value of
securities sold, plus accrued interest income, minus the sum of
repurchase agreement liabilities and accrued interest expense.
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During the three months ended March 31, 2011, the average
balance of our repurchase agreement financing was $22,680,448.
Risk
Management
We invest in Agency RMBS to mitigate credit risk. Additionally,
our Agency RMBS are backed by a diversified base of mortgage
loans to mitigate geographic, loan originator and other types of
concentration risks.
Interest Rate
Risk Management
We believe that the risk of adverse interest rate movements
represents the most significant risk to our portfolio. This risk
arises because (i) the interest rate indices used to
calculate the interest rates on the mortgages underlying our
assets may be different from the interest rate indices used to
calculate the interest rates on the related borrowings, and
(ii) interest rate movements affecting our borrowings may
not be reasonably correlated with interest rate movements
affecting our assets. We attempt to mitigate our interest rate
risk by using the following techniques:
Agency RMBS Backed by ARMs. We seek to
minimize the differences between interest rate indices and
interest rate adjustment periods of our Agency RMBS backed by
ARMs and related borrowings. At the time of funding, we
typically align (i) the underlying interest rate index used
to calculate interest rates for our Agency RMBS backed by ARMs
and the related borrowings and (ii) the interest rate
adjustment periods for our Agency RMBS backed by ARMs and the
interest rate adjustment periods for our related borrowings. As
our borrowings mature or are renewed, we may adjust the index
used to calculate interest expense, the duration of the reset
periods and the maturities of our borrowings.
Agency RMBS Backed by Fixed-Rate
Mortgages. As interest rates rise, our
borrowing costs increase; however, the income on our Agency RMBS
backed by fixed-rate mortgages remains unchanged. Subject to
qualifying and maintaining our qualification as a REIT, we may
seek to limit increases to our borrowing costs through the use
of interest rate swap or cap agreements, options, put
8
or call agreements, futures contracts, forward rate agreements
or similar financial instruments to effectively convert our
floating-rate borrowings into fixed-rate borrowings.
Agency RMBS Backed by Hybrid
ARMs. During the fixed-rate period of our
Agency RMBS backed by hybrid ARMs, the security is similar to
Agency RMBS backed by fixed-rate mortgages. During this period,
subject to qualifying and maintaining our qualification as a
REIT, we may employ the same hedging strategy that we employ for
our Agency RMBS backed by fixed-rate mortgages. Once our Agency
RMBS backed by hybrid ARMs convert to floating rate securities,
we may employ the same hedging strategy as we employ for our
Agency RMBS backed by ARMs.
Additionally, our structured Agency RMBS generally exhibit
sensitivities to movements in interest rates different than our
pass-through Agency RMBS. To the extent they do so, our
structured Agency RMBS may protect us against declines in the
market value of our combined portfolio that result from adverse
interest rate movements, although we cannot assure you that this
will be the case.
Prepayment
Risk Management
The risk of mortgage prepayments is another significant risk to
our portfolio. When prevailing interest rates fall below the
coupon rate of a mortgage, mortgage prepayments are likely to
increase. Conversely, when prevailing interest rates increase
above the coupon rate of a mortgage, mortgage prepayments are
likely to decrease.
When prepayment rates increase, we may not be able to reinvest
the money received from prepayments at yields comparable to
those of the securities prepaid. Also, some ARMs and hybrid ARMs
which back our Agency RMBS may bear initial teaser
interest rates that are lower than their fully-indexed interest
rates. If these mortgages are prepaid during this
teaser period, we may lose the opportunity to
receive interest payments at the higher, fully-indexed rate over
the expected life of the security. Additionally, some of our
structured Agency RMBS, such as IOs and IIOs, may be negatively
affected by an increase in prepayment rates because their value
is wholly contingent on the underlying mortgage loans having an
outstanding principal balance.
A decrease in prepayment rates may also have an adverse effect
on our portfolio. For example, if we invest in POs, the purchase
price of such securities will be based, in part, on an assumed
level of prepayments on the underlying mortgage loan. Because
the returns on POs decrease the longer it takes the principal
payments on the underlying loans to be paid, a decrease in
prepayment rates could decrease our returns on these securities.
Prepayment risk also affects our hedging activities. When an
Agency RMBS backed by a fixed-rate mortgage or hybrid ARM is
acquired with borrowings, we may cap or fix our borrowing costs
for a period close to the anticipated average life of the
fixed-rate portion of the related Agency RMBS. If prepayment
rates are different than our projections, the term of the
related hedging instrument may not match the fixed-rate portion
of the security, which could cause us to incur losses.
Because our business may be adversely affected if prepayment
rates are different than our projections, we seek to invest in
Agency RMBS backed by mortgages with well-documented and
predictable prepayment histories. To protect against increases
in prepayment rates, we invest in Agency RMBS backed by
mortgages that we believe are less likely to be prepaid. For
example, we invest in Agency RMBS backed by mortgages
(i) with loan balances low enough such that a borrower
would likely have little incentive to refinance,
(ii) extended to borrowers with credit histories weak
enough to not be eligible to refinance their mortgage loans,
(iii) that are newly originated fixed-rate or hybrid ARMs
or (iv) that have interest rates low enough such that a
borrower would likely have little incentive to refinance. To
protect against decreases in prepayment rates, we may also
invest in Agency RMBS backed by mortgages with characteristics
opposite to those described above, which would typically be more
likely to be refinanced. We may also invest in certain types of
structured Agency RMBS as a means of mitigating our
portfolio-wide prepayment risks. For example, certain tranches
of
9
CMOs are less sensitive to increases in prepayment rates, and we
may invest in those tranches as a means of hedging against
increases in prepayment rates.
Liquidity
Management Strategy
Because of our use of leverage, we manage liquidity to meet our
lenders margin calls using the following measures:
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Maintaining cash balances or unencumbered assets well in excess
of anticipated margin calls; and
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Making margin calls on our lenders when we have an excess of
collateral pledged against our borrowings.
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We also attempt to minimize the number of margin calls we
receive by:
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Deploying capital from our leveraged Agency RMBS portfolio to
our unleveraged Agency RMBS portfolio;
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Investing in Agency RMBS backed by mortgages that we believe are
less likely to be prepaid to decrease the risk of excessive
margin calls when monthly prepayments are announced. Prepayments
are declared, and the market value of the related security
declines, before the receipt of the related cash flows.
Prepayment declarations give rise to a temporary collateral
deficiency and generally results in margin calls by lenders;
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Obtaining funding arrangements which defer or waive
prepayment-related margin requirements in exchange for payments
to the lender tied to the dollar amount of the collateral
deficiency and a pre-determined interest rate; and
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Reducing our overall amount of leverage.
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Our Management
Agreement
We are currently a party to a management agreement with Bimini.
Upon completion of this offering, we will terminate our
management agreement with Bimini and enter into a new management
agreement with our Manager that will govern the relationship
between us and our Manager and will describe the services to be
provided by our Manager and its compensation for those services.
Under the management agreement, our Manager, subject to the
supervision of our Board of Directors, will be required to
oversee our business affairs in conformity with our operating
policies and our investment guidelines that are proposed by the
investment committee of our Manager and approved by our Board of
Directors. Our Managers obligations and responsibilities
under the management agreement will include asset selection,
asset and liability management and investment portfolio risk
management.
The management agreement will have an initial term expiring
on ,
2014, and will automatically be renewed for one-year terms
thereafter unless terminated by us for cause or by us or our
Manager upon at least
180-days
notice prior to the end of the initial term or any automatic
renewal term.
10
The following table summarizes the fees that will be payable to
our Manager pursuant to the management agreement:
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Fee
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Summary Description
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Management Fee
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|
The management fee will be payable monthly in arrears in an
amount equal to 1/12th of (a) 1.50% of the first $250,000,000 of
our equity (as defined below), (b) 1.25% of our equity that is
greater than $250,000,000 and less than or equal to
$500,000,000, and (c) 1.00% of our equity that is greater than
$500,000,000.
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Equity equals our month-end stockholders
equity, adjusted to exclude the effect of any unrealized gains
or losses included in either retained earnings or other
comprehensive income (loss), as computed in accordance with
accounting principles generally accepted in the United States,
or GAAP.
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|
Under our existing management agreement with Bimini, which will
be terminated upon the completion of this offering and replaced
by a new management agreement with our Manager, we paid Bimini
aggregate management fees of $5,500 for the period beginning on
November 24, 2010 (date operations commenced) to
December 31, 2010, and we paid Bimini aggregate management
fees of $20,900 for the three months ended March 31, 2011.
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Stock-Based Compensation
|
|
Our Managers officers and employees will be eligible to
receive stock awards pursuant to our 2011 Equity Incentive Plan.
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Expense Reimbursement
|
|
We will reimburse any expenses directly related to our
operations incurred by our Manager, but excluding
personnel-related expenses of our Manager or of Bimini (other
than the compensation of our Chief Financial Officer), which
include services provided to us pursuant to the management
agreement. We will reimburse our Manager for our allocable share
of the compensation of our Chief Financial Officer based on our
percentage of the aggregate amount of our Managers assets
under management and Biminis assets. We will also
reimburse our pro rata portion of our Managers and
Biminis overhead expenses based on our percentage of the
aggregate amount of our Managers assets under management
and Biminis assets. Our obligation to pay for the expenses
incurred in connection with this offering will be capped at 1.0%
of the total gross proceeds from this offering (or approximately
$ , and approximately
$ if the underwriters exercise
their overallotment option). Our Manager will pay the expenses
incurred above this 1.0% cap.
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|
|
Under our existing management agreement with Bimini, which will
be terminated upon the completion of this offering and replaced
by a new management agreement with our Manager, we reimbursed
Bimini an aggregate of $7,200 in expenses for the period
beginning on November 24, 2010 (date operations commenced)
to December 31, 2010, and we reimbursed Bimini an aggregate
of $21,600 in expenses for the three months ended March 31,
2011.
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Termination Fee
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The termination fee, payable for non-renewal of the management
agreement without cause, will be equal to three times the sum of
the average annual management fee earned by our Manager during
the prior 24-month period immediately preceding the most
recently completed calendar quarter prior to the effective date
of termination.
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Assuming aggregate net proceeds from this offering (based on the
mid-point of the price range set forth on the cover of this
prospectus) and the concurrent private placement of warrants for
11
approximately $81.7 million and no additional increases or
decreases in our stockholders equity, we will pay our
Manager management fees equal to approximately $1.45 million
during the first 12 months after the completion of this offering
and the concurrent private placement.
Overhead Sharing
Agreement
Our Manager will enter into an overhead sharing agreement with
Bimini effective upon the closing of this offering. Pursuant to
this agreement, our Manager will be provided with access to,
among other things, Biminis portfolio management, asset
valuation, risk management and asset management services as well
as administration services addressing accounting, financial
reporting, legal, compliance, investor relations and information
technologies necessary for the performance of our Managers
duties in exchange for a reimbursement of the Managers
allocable cost for these services. The reimbursement paid by our
Manager pursuant to this agreement will not constitute an
expense under the management agreement.
Conflicts of
Interest; Equitable Allocation of Opportunities
Bimini invests solely in Agency RMBS and, because it is
internally-managed, does not pay a management fee. Additionally,
Bimini currently receives management fees from us and, as the
sole stockholder of our Manager, will indirectly receive the
management fees earned by our Manager through reimbursement
payments under the overhead sharing agreement and our
Managers payment of dividends to Bimini. Our Manager may
in the future manage other funds, accounts and investment
vehicles that have strategies that are similar to our strategy,
although our Manager currently does not manage any other funds,
accounts or investment vehicles. Our Manager and Bimini make
available to us opportunities to acquire assets that they
determine, in their reasonable and good faith judgment, based on
our objectives, policies and strategies, and other relevant
factors, are appropriate for us in accordance with their written
investment allocation procedures and policies, subject to the
exception that we might not be offered each such opportunity,
but will on an overall basis equitably participate with Bimini
and our Managers other accounts in all such opportunities
when considered together. Bimini and our Manager have agreed not
to sponsor another REIT that has substantially the same
investment strategy as Bimini or us prior to the earlier of
(i) the termination or expiration of the management
agreement or (ii) our Manager no longer being a subsidiary
or affiliate of Bimini.
Because many of our targeted assets are typically available only
in specified quantities and because many of our targeted assets
are also targeted assets for Bimini and may be targeted assets
for other accounts our Manager may manage in the future, neither
Bimini nor our Manager may be able to buy as much of any given
asset as required to satisfy the needs of Bimini, us and any
other account our Manager may manage in the future. In these
cases, our Managers and Biminis investment
allocation procedures and policies will typically allocate such
assets to multiple accounts in proportion to their needs and
available capital. The policies will permit departure from such
proportional allocation when (i) allocating purchases of
whole-pool Agency RMBS, because those securities cannot be
divided into multiple parts to be allocated among various
accounts, and (ii) such allocation would result in an
inefficiently small amount of the security being purchased for
an account. In these cases, the policy allows for a protocol of
allocating assets so that, on an overall basis, each account is
treated equitably. Specifically, our investment allocation
procedures and policies stipulate that we will base our
allocation of investment opportunities on the following factors:
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the primary investment strategy and the stage of portfolio
development of each account;
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the effect of the potential investment on the diversification of
each accounts portfolio by coupon, purchase price, size,
prepayment characteristics and leverage;
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the cash requirements of each account;
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the anticipated cash flow of each accounts
portfolio; and
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the amount of funds available to each account and the length of
time such funds have been available for investment.
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We intend for our independent directors to conduct quarterly
reviews with our Manager of its allocation decisions, if any,
and discuss with our Manager the portfolio needs of each account
for the next quarter and whether such needs will give rise to an
asset allocation conflict and, if so, the potential resolution
of such conflict.
Other policies that our Manager will apply to the management of
the Company include controls for cross transactions
(transactions between managed accounts (including us)),
principal transactions (transactions between Bimini or our
Manager and a managed account (including us)) and split price
executions. To date we have not entered into any cross
transactions but we have entered into one principal transaction
and have conducted split price executions. See Our Manager
and the Management Agreement Conflicts of Interest;
Equitable Allocation of Opportunities and Certain
Relationships and Related Transactions for a more detailed
description of these types of transactions, the principal
transaction we have entered into with Bimini and the policies of
Bimini and our Manager that govern these types of transactions.
We currently do not anticipate that we will enter into any cross
transactions or principal transactions after the completion of
this offering.
We are entirely dependent on our Manager for our
day-to-day
management and do not have any independent officers. Our
executive officers are also executive officers of Bimini and our
Manager, and none of them will devote his time to us
exclusively. We compete with Bimini and will compete with any
other account managed by our Manager or other RMBS investment
vehicles that may be sponsored by Bimini in the future for
access to these individuals.
John B. Van Heuvelen, one of our independent director
nominees, owns shares of common stock of Bimini.
Mr. Cauley, our Chief Executive Officer and Chairman of our
Board of Directors, also serves as Chief Executive Officer and
Chairman of the Board of Directors of Bimini and owns shares of
common stock of Bimini. Mr. Haas, our Chief Financial
Officer, Chief Investment Officer, Secretary and a member of our
Board of Directors, also serves as the Chief Financial Officer,
Chief Investment Officer and Treasurer of Bimini and owns shares
of common stock of Bimini. Accordingly,
Messrs. Van Heuvelen, Cauley and Haas may have a
conflict of interest with respect to actions by our Board of
Directors that relate to Bimini or our Manager.
Because our executive officers are also officers of our Manager,
the terms of our management agreement, including fees payable,
were not negotiated on an arms-length basis, and its terms
may not be as favorable to us as if it was negotiated with an
unaffiliated party.
The management fee we will pay to our Manager will be paid
regardless of our performance and it may not provide sufficient
incentive to our Manager to seek to achieve attractive
risk-adjusted returns for our investment portfolio.
Our Formation and
Structure
We were formed by Bimini as a Maryland corporation in August
2010. Concurrently with this offering, we intend to sell to
Bimini in a separate private placement warrants to purchase an
aggregate of 4,500,000 shares of our common stock. Upon
completion of this offering, Bimini will own approximately
12.42% of our outstanding common stock, or 10.98% if the
underwriters exercise their option to purchase additional shares
in full. The following chart illustrates our ownership structure
immediately after completion of this offering.
13
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(1) |
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Includes 1,063,830 shares of
our common stock issued to Bimini prior to completion of this
offering (after giving effect to the stock dividend that we will
effect prior to the completion of this offering). See
Description of Securities General.
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About
Bimini
Bimini is a mortgage REIT that has operated since 2003 and had
approximately $117 million of pass-through Agency RMBS and
structured Agency RMBS as of March 31, 2011. Bimini has
employed this strategy with its own portfolio since the third
quarter of 2008 and with our portfolio since our inception. The
following table shows Biminis returns on invested capital
since employing our investment strategy in the third quarter of
2008. The returns on Biminis invested capital provided
below are net of the interest paid pursuant to Biminis
repurchase agreements but does not give effect to the cost of
Biminis other long-term financing costs as described below.
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Quarterly
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Cumulative
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Return on
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Return on
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Invested
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Invested
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Three Months Ended
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Capital(1)
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Capital(1)(2)
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September 30, 2008
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2.5
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%
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2.5
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%
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December 31, 2008
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8.9
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%
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11.7
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%
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March 31, 2009
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13.2
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%
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26.4
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%
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June 30, 2009
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14.0
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%
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44.0
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%
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September 30, 2009
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10.7
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%
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59.4
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%
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December 31, 2009
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7.0
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%
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70.6
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%
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March 31, 2010
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(0.3
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)%
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70.1
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%
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June 30, 2010
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9.4
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%
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86.0
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%
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September 30, 2010
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3.0
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%
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91.6
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%
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December 31, 2010
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8.0
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%
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106.9
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%
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March 31, 2011
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6.2
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%
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119.7
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%
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Annualized Return on Invested
Capital(3)
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33.1
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%
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(1) |
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Returns on invested capital are
calculated by dividing (i) the sum of (A) net interest
income, before interest on junior subordinated notes (which
equals the difference between interest income and interest
expense), and (B) gains/losses on trading securities by
(ii) invested capital. Invested capital consists of the sum
of: (i) mortgage-backed securities pledged to
counterparties (less repurchase agreements and unsettled
security transactions), (ii) mortgage-backed
securities unpledged (which consists of structured
Agency RMBS and unpledged pass-through Agency RMBS less any
unsettled Agency RMBS), (iii) cash and cash equivalents and
(iv) restricted cash. The components of invested capital
and returns on invested capital are based entirely on
information contained in the SEC filings of Bimini Capital
Management, Inc., which are
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publicly available through the
SECs website at www.sec.gov. The information contained in
the SEC filings of Bimini Capital Management, Inc. do not
constitute a part of this prospectus or any amendment or
supplement thereto.
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(2) |
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Cumulative return on invested
capital represents the return on invested capital assuming the
reinvestment of all prior period returns beginning on
July 1, 2008. For example, the cumulative return on
invested capital as of December 31, 2008 was calculated as
follows: ((1+0.0252)*(1+0.0891))-1.
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(3) |
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Calculated by annualizing the total
cumulative return on invested capital for the periods presented
above.
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We believe that this method of calculating returns described
above provides a useful means to measure the performance of
Biminis portfolio because (i) it is based on actual
capital invested in Biminis portfolio (including cash and
cash equivalents and restricted cash that could be used to
satisfy margin calls) instead of overall stockholders
equity, which takes into account Biminis accumulated
deficit and other factors unrelated to the portfolio, and (ii)
it shows Biminis quarterly and cumulative returns on its
Agency RMBS portfolio taking into account the repurchase
agreement financing costs typical to manage this type of
portfolio, but without taking into account its entity-level
capital by excluding from the returns the effects of interest
due on Biminis junior subordinated debt, which is related
to Biminis trust preferred securities. Because of the
terms of its trust preferred securities (which include the
long-term nature of the underlying junior subordinated debt and
the fact that such debt is not held directly by outside
investors, but indirectly through preferred equity securities of
an intervening trust that holds such debt), Bimini characterizes
its trust preferred securities (and the related junior
subordinated debt) as a form of capital, rather than as a form
of financing for Biminis portfolio, when calculating
returns on invested capital.
Our results may differ from Biminis results and will
depend on a variety of factors, some of which are beyond our
control
and/or are
difficult to predict, including changes in interest rates,
changes in prepayment speeds and other changes in market
conditions and economic trends. In addition, Biminis
portfolio results above do not include other expenses necessary
to operate a public company and that we will incur following the
completion of this offering, including the management fee we
will pay to our Manager. Therefore, you should not assume that
Biminis portfolios performance will be indicative of
the performance of our portfolio or the Company.
In 2005, Bimini acquired Opteum Financial Services, LLC, or OFS,
an originator of residential mortgages. At the time OFS was
acquired, Bimini managed an Agency RMBS portfolio with a fair
value of approximately $3.5 billion. OFS operated in
46 states and originated residential mortgages through
three production channels. OFS did not have the capacity to
retain the mortgages it originated, and relied on the ability to
sell loans as they were originated as either whole loans or
through off-balance sheet securitizations. When the residential
housing market in the United States started to collapse in late
2006 and early 2007, the ability to successfully execute this
strategy was quickly impaired as whole loan prices plummeted and
the securitization markets closed. Biminis management
closed a majority of the mortgage origination operations in
early 2007, with the balance sold by June 30, 2007.
Additional losses were incurred after June 30, 2007 as the
remaining assets were sold or became impaired, and by
December 31, 2009, OFS had an accumulated deficit of
approximately $278 million. The losses generated by OFS
required Bimini to slowly liquidate its Agency RMBS portfolio as
capital was reduced and the operations of OFS drained
Biminis cash resources. On November 5, 2007, Bimini
was delisted by the NYSE. By December 31, 2008,
Biminis Agency RMBS portfolio was reduced to approximately
$172 million and, as a result of the reduced capital
remaining and the financial crisis, Bimini had limited access to
repurchase agreement funding. Bimini and its subsidiaries are
subject to a number of ongoing legal proceedings. Those
proceedings or any future proceedings may divert the time and
attention of our Manager and certain key personnel of our
Manager from us and our investment strategy. The diversion of
time of our Manager and certain key personnel of our Manager may
have a material adverse effect on our reputation, business
operations, financial condition and results of operations and
our ability to pay distributions to our stockholders. See
Risk Factors Legal proceedings involving Bimini
and certain of its subsidiaries have adversely affected Bimini,
may materially adversely affect Biminis ability to
effectively manage our business and could materially
15
adversely affect our reputation, business operations, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
Although our and Biminis Chief Executive Officer,
Mr. Cauley, and Chief Investment Officer and Chief
Financial Officer, Mr. Haas, both worked at Bimini during
the time it owned OFS (Mr. Cauley was the Chief Investment
Officer and Chief Financial Officer and Mr. Haas was the
Head of Research and Trading), their primary focus and
responsibilities were the management of Biminis securities
portfolio, not the management of OFS. In addition,
Mr. Cauley is the only director still serving on
Biminis board of directors that served when OFS was
acquired. Biminis current investment strategy was
implemented in the third quarter of 2008, the first full quarter
of operations after Mr. Cauley become the Chief Executive
Officer of Bimini and Mr. Haas became the Chief Investment
Officer and Chief Financial Officer of Bimini.
Messrs. Cauley and Haas were appointed to these respective
roles on April 14, 2008.
Tax
Structure
We will elect and intend to qualify to be taxed as a REIT
commencing with our short taxable year ending December 31,
2011. Our qualification as a REIT, and the maintenance of such
qualification, will depend upon our ability to meet, on a
continuing basis, various complex requirements under the Code
relating to, among other things, the sources of our gross
income, the composition and values of our assets, our
distribution levels and the concentration of ownership of our
capital stock. We believe that we will be organized in
conformity with the requirements for qualification and taxation
as a REIT under the Code, and we intend to operate in a manner
that will enable us to meet the requirements for qualification
and taxation as a REIT commencing with our short taxable year
ending December 31, 2011. In connection with this offering,
we will receive an opinion from Hunton & Williams LLP
to the effect that we will be organized in conformity with the
requirements for qualification and taxation as a REIT under the
Code, and that our intended method of operation will enable us
to meet the requirements for qualification and taxation as a
REIT.
As a REIT, we generally will not be subject to U.S. federal
income tax on the REIT taxable income that we currently
distribute to our stockholders, but taxable income generated by
any taxable REIT subsidiary, or TRS, that we may form or acquire
will be subject to federal, state and local income tax. Under
the Code, REITs are subject to numerous organizational and
operational requirements, including a requirement that they
distribute annually at least 90% of their REIT taxable income,
determined without regard to the deduction for dividends paid
and excluding any net capital gains. If we fail to qualify as a
REIT in any calendar year and do not qualify for certain
statutory relief provisions, our income would be subject to
U.S. federal income tax (and any applicable state and local
taxes), and we would likely be precluded from qualifying for
treatment as a REIT until the fifth calendar year following the
year in which we failed to qualify. Even if we qualify as a
REIT, we may still be subject to certain federal, state and
local taxes on our income and assets and to U.S. federal
income and excise taxes on our undistributed income.
Our Distribution
Policy
To qualify as a REIT, we must distribute annually to our
stockholders an amount at least equal to 90% of our REIT taxable
income, determined without regard to the deduction for dividends
paid and excluding any net capital gain. We will be subject to
income tax on our taxable income that is not distributed and to
an excise tax to the extent that certain percentages of our
taxable income are not distributed by specified dates. See
Material U.S. Federal Income Tax
Considerations. Income as computed for purposes of the
foregoing tax rules will not necessarily correspond to our
income as determined for financial reporting purposes. Our cash
available for distribution may be less than the amount required
to meet the distribution requirements for REITs under the Code,
and we may be required to borrow money, sell assets or make
taxable distributions of our capital stock or debt securities to
satisfy the distribution requirements. Additionally, we may pay
future distributions from the proceeds from this offering or
other securities offerings, and thus all or a portion of such
16
distributions may constitute a return of capital for
U.S. federal income tax purposes. We do not currently
intend to pay future distributions from the proceeds of this
offering.
Any distributions that we make on our common stock will be
authorized by and at the discretion of our Board of Directors
and declared by us based upon a variety of factors deemed
relevant by our directors, which may include among other things,
our actual results of operations, restrictions under applicable
law, our capital requirements and the REIT requirements of the
Code. We have not established a minimum payment distribution
level, and we cannot assure you of our ability to make
distributions to our stockholders in the future.
Distributions to stockholders generally will be taxable to our
stockholders as ordinary income, although a portion of such
distributions may be designated by us as long-term capital gain
or qualified dividend income or may constitute a return of
capital. We will furnish annually to each of our stockholders a
statement setting forth distributions paid during the preceding
year and their U.S. federal income tax treatment. For a
discussion of the U.S. federal income tax treatment of our
distributions, see Material U.S. Federal Income Tax
Considerations.
Restrictions on
Ownership and Transfer of Our Capital Stock
Due to limitations on the concentration of ownership of REIT
stock imposed by the Code, effective upon the completion of this
offering and subject to certain exceptions, our charter will
provide that no person may beneficially or constructively own
more than 9.8% in value or in number of shares, whichever is
more restrictive, of the outstanding shares of any class or
series of our capital stock, except that Bimini may own up to
44% of our common stock so long as Bimini continues to qualify
as a REIT. See Description of Securities
Restrictions on Ownership and Transfer.
Our charter will also prohibit any person from, among other
matters:
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beneficially or constructively owning or transferring shares of
our capital stock if such ownership or transfer would result in
our being closely held within the meaning of
Section 856(h) of the Code (without regard to whether the
ownership interest is held during the last half of a taxable
year) or otherwise cause us to fail to qualify as a
REIT; and
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transferring shares of our capital stock if such transfer would
result in our capital stock being owned by less than
100 persons.
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Our Board of Directors may, in its sole discretion, exempt
(prospectively or retroactively) a person from the 9.8%
ownership limit and other restrictions in our charter and may
establish or increase an excepted holder percentage limit for
such person if our Board of Directors obtains such
representations, covenants and undertakings as it deems
appropriate in order to conclude that granting the exemption
and/or
establishing or increasing the excepted holder percentage limit
will not cause us to lose our qualification as a REIT.
Our charter will also provide that any ownership or purported
transfer of our capital stock in violation of the foregoing
restrictions will result in the shares owned or transferred in
such violation being automatically transferred to a charitable
trust for the benefit of a charitable beneficiary and the
purported owner or transferee acquiring no rights in such
shares, except that any transfer that results in the violation
of the restriction relating to shares of our capital stock being
beneficially owned by fewer than 100 persons will be void
ab initio. Additionally, if the transfer to the trust is
ineffective for any reason to prevent a violation of the
restriction, the transfer that would have resulted in such
violation will be void ab initio.
Investment
Company Act Exemption
We operate our business so that we are exempt from registration
under the Investment Company Act. We rely on the exemption
provided by Section 3(c)(5)(C) of the Investment Company
Act. We monitor our portfolio periodically and prior to each
investment to confirm that we continue to qualify for the
exemption. To qualify for the exemption, we make investments so
that at least 55% of
17
the assets we own on an unconsolidated basis consist of
qualifying mortgages and other liens on and interests in real
estate, which we refer to as qualifying real estate assets, and
so that at least 80% of the assets we own on an unconsolidated
basis consist of real estate-related assets, including our
qualifying real estate assets.
We treat whole-pool pass-through Agency RMBS as qualifying real
estate assets based on no-action letters issued by the Staff of
the Securities and Exchange Commission, or the SEC. To the
extent that the SEC publishes new or different guidance with
respect to these matters, we may fail to qualify for this
exemption. Our Manager intends to manage our pass-through Agency
RMBS portfolio such that we will have sufficient whole-pool
pass-through Agency RMBS to ensure we retain our exemption from
registration under the Investment Company Act. At present, we
generally do not expect that our investments in structured
Agency RMBS will constitute qualifying real estate assets but
will constitute real estate-related assets for purposes of the
Investment Company Act.
Lock-Up
Agreements
We and each of our Manager, our directors and executive officers
will agree that, for a period of 180 days after the date of
this prospectus, without the prior written consent of Barclays
Capital Inc., we and they will not sell, dispose of or hedge any
shares of our common stock, subject to certain exceptions and
extensions in certain circumstances. Additionally, Bimini will
agree that, for a period of 365 days after the date of this
prospectus, it will not, without the prior written consent of
Barclays Capital Inc., dispose of or hedge any of (i) its
shares of our common stock, including any shares of our common
stock issuable upon the exercise of the warrants it intends to
purchase in the concurrent private placement, (ii) the
warrants that it intends to purchase in the concurrent private
placement or (iii) any shares of our common stock that it
may acquire after completion of this offering, subject to
certain exceptions and extensions.
Our Corporate
Information
Our offices are located at 3305 Flamingo Drive, Vero Beach,
Florida 32963, and the telephone number of our offices is
(772) 231-1400.
Our internet address is www.orchidislandcapital.com. Our
internet site and the information contained therein or connected
thereto do not constitute a part of this prospectus or any
amendment or supplement thereto.
18
The
Offering
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Common stock offered by us in this offering |
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7,500,000
shares(1) |
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Common stock to be outstanding after this offering |
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8,563,830
shares(1)(2)(3) |
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Common stock to be outstanding after this offering and the
concurrent private placement of warrants, on a fully-diluted
basis |
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13,063,830 shares(1)(2)(4) |
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Use of proceeds |
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We estimate that the net proceeds from this offering and the
concurrent private placement will be approximately
$81.7 million (or approximately $93.6 million if the
underwriters fully exercise their option to purchase additional
shares), after deducting the portion of the underwriting
discount and commissions payable by us of approximately
$2.5 million (or approximately $2.9 million if the
underwriters fully exercise their option to purchase additional
shares) and estimated offering expenses of approximately
$825,000 payable by us, in each case assuming the mid-point
of the price range set forth on the cover of the prospectus. Our
obligation to pay for the expenses of this offering will be
capped at 1.0% of the total gross proceeds from this offering. |
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Our Manager will (i) pay the underwriters
$ per share with respect to each
share of common stock sold in this offering on a deferred basis
after the completion of this offering and (ii) pay the offering
expenses related to this offering that exceed an amount equal to
1.0% of the total gross proceeds from this offering. |
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We intend to invest the net proceeds of this offering and the
concurrent private placement in (i) pass-through Agency
RMBS backed by hybrid ARMs, ARMs and fixed-rate mortgage loans
and (ii) structured Agency RMBS. Specifically, we intend to
invest the net proceeds of this offering as follows: |
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approximately 0% to 50% in pass-through Agency RMBS
backed by fixed-rate mortgage loans;
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approximately 0% to 50% in pass-through Agency RMBS
backed by ARMs;
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approximately 0% to 50% in pass-through Agency RMBS
backed by hybrid ARMs; and
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approximately 25% to 75% in structured Agency RMBS.
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We expect to borrow against the pass-through Agency RMBS and
certain of our structured Agency RMBS that we purchase with the
net proceeds of this offering and the concurrent private
placement through repurchase agreements and use the proceeds of
the borrowings to acquire additional pass-through Agency RMBS
and structured Agency RMBS in accordance with a similar targeted
allocation. We reserve the right to |
19
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change our targeted allocation depending on prevailing market
conditions, including, among others, the pricing and supply of
pass-through Agency RMBS and structured Agency RMBS, the
performance of our portfolio and the availability and terms of
financing. |
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Distribution Policy |
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To qualify as a REIT, U.S. federal income tax law generally
requires that we distribute annually at least 90% of our REIT
taxable income, determined without regard to the deduction for
dividends paid and excluding net capital gains, and that we pay
tax at regular corporate rates on any undistributed REIT taxable
income. We have not established a minimum distribution payment
level, and we cannot assure you of our ability to make
distributions to our stockholders in the future. In connection
with these requirements, we intend to make regular quarterly
distributions of all or substantially all of our net taxable
income to our stockholders. Any distributions we make will be
authorized by and at the discretion of our Board of Directors
and will depend upon a variety of factors deemed relevant by our
directors, which may include among other things, our actual
results of operations, restrictions under applicable law, our
capital requirements and the REIT requirements of the Code. For
more information, please see Distribution Policy and
Material U.S. Federal Income Tax Considerations. |
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Proposed New York Stock Exchange symbol |
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ORC |
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Ownership and transfer restrictions |
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To assist us in qualifying as a REIT, among other purposes, our
charter will generally limit beneficial and constructive
ownership by any person to no more than 9.8% in value or in
number of shares, whichever is more restrictive, of the
outstanding shares of any class or series of our capital stock,
except that Bimini may own up to 44% of our common stock so long
as Bimini continues to qualify as a REIT. In addition, our
charter will contain various other restrictions on the ownership
and transfer of our common stock. See Description of
Securities Restrictions on Ownership and
Transfer. |
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Risk factors |
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Investing in our common stock involves a high degree of risk.
See Risk Factors beginning on page 25. |
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(1) |
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Assumes the underwriters
option to purchase up to an additional 1,125,000 shares of our
common stock is not exercised.
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(2) |
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Includes
(i) 150,000 shares of common stock issued to Bimini
prior to completion of this offering (which will increase to
1,063,830 shares of common stock after giving effect to the
stock dividend that we will effect prior to the completion of
this offering as described in Description of
Securities General) and
(ii) 7,500,000 shares of common stock to be sold in
this offering. Excludes an aggregate of 4,000,000 shares of
common stock available for issuance pursuant to our 2011 Equity
Incentive Plan.
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(3) |
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Excludes shares issuable upon the
exercise of warrants.
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(4) |
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Assumes that all of the shares of
our common stock issuable upon exercise of the warrants we
intend to sell to Bimini in the concurrent private placement
have been issued and are outstanding upon the completion of this
offering.
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20
Summary Selected
Financial Data
The following table presents summary selected financial data as
of March 31, 2011, for the three months ended
March 31, 2011 and for the period beginning on
November 24, 2010 (date operations commenced) to
December 31, 2010. The statement of operations data for the
period beginning on November 24, 2010 (date operations
commenced) to December 31, 2010 has been derived from our
audited financial statements. The statement of operations and
balance sheet data as of March 31, 2011 and for the three
months ended March 31, 2011 has been derived from our
interim unaudited financial statements. These interim unaudited
financial statements have been prepared on substantially the
same basis as our audited financial statements and reflect all
adjustments which are, in the opinion of management, necessary
to provide a fair statement of our financial position as of
March 31, 2011 and the results of operations for the three
months ended March 31, 2011. All such adjustments are of a
normal recurring nature. These results are not necessarily
indicative of our results for the full fiscal year.
Because the information presented below is only a summary and
does not provide all of the information contained in our
historical financial statements, including the related notes,
you should read it in conjunction with the more detailed
information contained in our financial statements and related
notes and Managements Discussion and Analysis of
Financial Condition and Results of Operations included
elsewhere in this prospectus.
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Period from
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November 24, 2010
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|
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Three Months
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(Date Operations
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Ended
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Commenced) to
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March 31,
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December 31,
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2011
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|
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2010
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|
|
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(unaudited)
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|
|
|
|
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Statement of Operations Data:
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|
|
|
|
|
|
|
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Revenues:
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|
|
|
|
|
|
|
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Interest income
|
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$
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307,764
|
|
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$
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69,340
|
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Interest expense
|
|
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(18,942
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)
|
|
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(5,186
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)
|
|
|
|
|
|
|
|
|
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Net interest income
|
|
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288,822
|
|
|
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64,154
|
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Losses on trading
securities(1)
|
|
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(168,532
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)
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|
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(55,307
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)
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Gains on futures contracts
|
|
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10,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Net portfolio income
|
|
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131,165
|
|
|
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8,847
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Total expenses
|
|
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115,093
|
|
|
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39,001
|
|
|
|
|
|
|
|
|
|
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Net income (loss)
|
|
$
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16,072
|
|
|
$
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(30,154
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)
|
|
|
|
|
|
|
|
|
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Basic and diluted income (loss) per share of
common stock(2)
|
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$
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0.21
|
|
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$
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(0.68
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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As of
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|
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March 31, 2011
|
|
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(unaudited)
|
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Balance Sheet Data:
|
|
|
|
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Total mortgage-backed securities
|
|
$
|
28,903,656
|
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Total assets
|
|
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30,101,395
|
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Repurchase agreements
|
|
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22,530,842
|
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Total liabilities
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22,615,477
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Total stockholders equity
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|
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7,485,918
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Book value per share of our common
stock(2)
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$
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99.81
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(1) |
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Because all of our Agency RMBS have
been classified as held for trading securities, all
changes in the fair values of our Agency RMBS are reflected in
our statement of operations, as opposed to a component of other
comprehensive income in our statement of stockholders
equity if they were instead classified as available for
sale securities. See Managements Discussion
and Analysis of Financial Condition and Results of
Operations Critical Accounting Policies
Mortgage-Backed Securities.
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21
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(2) |
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On March 31, 2011 and
December 31, 2010, no shares of common stock were
outstanding; however, on March 31, 2011 and
December 31, 2010, 75,000 shares and
44,050 shares of our common stock had been subscribed for
by Bimini, respectively. On April 29, 2011, we issued
75,000 shares of our common stock to Bimini, which
consisted of the 44,050 shares subscribed for as of
December 31, 2010, 17,950 shares subscribed for on
March 28, 2011 and 13,000 shares subscribed for on
March 31, 2011.
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Core
Earnings
We classify our Agency RMBS as held for trading. We
do not intend to elect GAAP hedge accounting for any derivative
financial instruments that we may utilize. Securities held for
trading and hedging instruments, for which hedge accounting has
not been elected, are recorded at estimated fair value, with
changes in the fair value recorded as unrealized gains or losses
through the statement of operations. Many other publicly-traded
REITs that invest in Agency RMBS classify their Agency RMBS as
available for sale. Unrealized gains and losses in
the fair value of securities classified as available for sale
are recorded as a component of other comprehensive income in the
statement of stockholders equity. As a result, investors
may not be able to readily compare our results of operations to
those of many of our competitors. We believe that the
presentation of our Core Earnings is useful to investors because
it provides a means of comparing our results of operations to
those of our competitors. Core Earnings represents a non-GAAP
financial measure and is defined as net income (loss) excluding
unrealized gains (losses) on trading securities and hedging
instruments and net interest income (expense) on hedging
instruments. Management utilizes Core Earnings because it allows
management to: (i) isolate the net interest income plus
other expenses of the Company over time, free of all
mark-to-market
adjustments and net payments associated with our hedging
instruments and (ii) assess the effectiveness of our
funding and hedging strategies, our capital allocation decisions
and our asset allocation performance. Our funding and hedging
strategies, capital allocation and asset selection are integral
to our risk management strategy, and therefore critical to our
Managers management of our portfolio.
Our presentation of Core Earnings may not be comparable to
similarly-titled measures of other companies, who may use
different calculations. As a result, Core Earnings should not be
considered as a substitute for our GAAP net income (loss) as a
measure of our financial performance or any measure of our
liquidity under GAAP.
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For the Period
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Three Months
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|
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from November 24, 2010
|
|
|
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Ended
|
|
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(Date Operations
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|
|
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March 31,
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|
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Commenced) through
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|
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2011
|
|
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December 31, 2010
|
|
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Non-GAAP Reconciliation (unaudited):
|
|
|
|
|
|
|
|
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Net income (loss)
|
|
$
|
16,072
|
|
|
$
|
(30,154
|
)
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Unrealized (gains) losses on trading securities
|
|
|
168,532
|
|
|
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55,307
|
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Gains on futures contracts
|
|
|
(10,875
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)
|
|
|
|
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Net interest (income) expense on hedging instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Core Earnings
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|
$
|
173,729
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|
|
$
|
25,153
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22
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this prospectus that are
subject to risks and uncertainties. These forward-looking
statements include information about possible or assumed future
results of our business, financial condition, liquidity, results
of operations, plans and objectives. When we use the words
believe, expect, anticipate,
estimate, intend, should,
may, plans, projects,
will, or similar expressions, or the negative of
these words, we intend to identify forward-looking statements.
Statements regarding the following subjects are forward-looking
by their nature:
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our business and investment strategy;
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our ability to deploy effectively and timely the net proceeds of
this offering;
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our expected operating results;
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our ability to acquire investments on attractive terms;
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the effect of the U.S. Federal Reserves and the
U.S. Treasurys recent actions on the liquidity of the
capital markets;
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the federal conservatorship of Fannie Mae and Freddie Mac and
related efforts, along with any changes in laws and regulations
affecting the relationship between Fannie Mae and Freddie Mac
and the U.S. Government;
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mortgage loan modification programs and future legislative
action;
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our ability to access the capital markets;
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our ability to obtain future financing arrangements;
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our ability to successfully hedge the interest rate risk and
prepayment risk associated with our portfolio;
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the assumptions used to value the warrants we intend to sell to
Bimini in the concurrent private placement;
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our ability to make distributions to our stockholders in the
future;
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our understanding of our competition and our ability to compete
effectively;
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our ability to qualify and maintain our qualification as a REIT
for U.S. federal income tax purposes;
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our ability to maintain our exemption from registration under
the Investment Company Act;
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market trends;
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expected capital expenditures; and
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the impact of technology on our operations and business.
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The forward-looking statements are based on our beliefs,
assumptions and expectations of our future performance, taking
into account all information currently available to us. Although
we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements.
These beliefs, assumptions and expectations can change as a
result of many possible events or factors, not all of which are
known to us. If a change occurs, our business, financial
condition, liquidity and results of operations may vary
materially from those expressed in our forward-looking
statements. We are not obligated to update or revise any
forward-looking statements after the date of this prospectus,
whether as a result of new information, future events or
otherwise.
When considering forward-looking statements, you should keep in
mind the risks and other cautionary statements set forth in this
prospectus, including those contained in Risk
Factors. Readers
23
are cautioned not to place undue reliance on any of these
forward-looking statements, which reflect our views as of the
date of this prospectus. You should carefully consider these
risks when you make a decision concerning an investment in our
common stock, along with the following factors, among others,
that may cause actual results to vary from our forward-looking
statements:
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general volatility of the securities markets in which we invest
and the market price of our common stock;
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our limited operating history;
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|
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changes in our business or investment strategy;
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|
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changes in interest rate spreads or the yield curve;
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availability, terms and deployment of debt and equity capital;
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availability of qualified personnel;
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the degree and nature of our competition;
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increased prepayments of the mortgage loans underlying our
Agency RMBS;
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risks associated with our hedging activities;
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changes in governmental regulations, tax rates and similar
matters; and
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defaults on our investments.
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24
RISK
FACTORS
You should carefully consider the risks described below
before making an investment decision. Our business, financial
condition or results of operations could be harmed by any of
these risks. Similarly, these risks could cause the market price
of our common stock to decline and you might lose all or part of
your investment. Our forward-looking statements in this
prospectus are subject to the following risks and uncertainties.
Our actual results could differ materially from those
anticipated by our forward-looking statements as a result of the
risk factors below.
Risks Related to
Our Business
The federal
conservatorship of Fannie Mae and Freddie Mac and related
efforts, along with any changes in laws and regulations
affecting the relationship between Fannie Mae and Freddie Mac
and the U.S. Government, may adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
The payments we receive on the Agency RMBS in which we invest
are guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac. Ginnie
Mae is part of a U.S. Government agency and its guarantees
are backed by the full faith and credit of the United States.
Fannie Mae and Freddie Mac are U.S. Government sponsored
entities, or GSEs, but their guarantees are not backed by the
full faith and credit of the United States.
On September 7, 2008, in response to the deterioration in
the financial condition of Fannie Mae and Freddie Mac, the
Federal Housing Finance Authority, or FHFA, placed Fannie Mae
and Freddie Mac into conservatorship, which is a statutory
process pursuant to which the FHFA will operate Fannie Mae and
Freddie Mac as conservator in an effort to stabilize the
entities. The FHFA, together with the U.S. Treasury and the
U.S. Federal Reserve, also has undertaken actions designed
to boost investor confidence in Fannie Mae and Freddie Mac,
support the availability of mortgage financing and protect
taxpayers. In addition, the U.S. Treasury has taken steps
to capitalize and provide financing to Fannie Mae and Freddie
Mac and agreed to purchase direct obligations and Agency RMBS
issued or guaranteed by Fannie Mae or Freddie Mac.
Shortly after Fannie Mae and Freddie Mac were placed in federal
conservatorship, the Secretary of the U.S. Treasury, in
announcing the actions, noted that the guarantee structure of
Fannie Mae and Freddie Mac required examination and that changes
in the structures of the entities were necessary to reduce risk
to the financial system. In February 2011, the U.S. Treasury and
the Department of Housing and Urban Development released a White
Paper titled Reforming Americas Housing Finance
Market, or the Housing Report, in which they proposed to
reduce or eliminate the role of GSEs in mortgage financing. The
Housing Report calls for phasing in increased pricing of Fannie
Mae and Freddie Mac guarantees to help level the playing field
for the private sector to take back market share, reducing
conforming loan limits by allowing the temporary increase in
Fannie Maes and Freddie Macs conforming loan limits
to reset as scheduled on October 1, 2011 to the lower
levels set in the Housing and Economic Recovery Act of 2008 and
continuing to wind down Fannie Maes and Freddie Macs
investment portfolio at an annual rate of no less than 10% per
year. The future roles of Fannie Mae and Freddie Mac could be
significantly reduced and the nature of their guarantees could
be eliminated or considerably limited relative to historical
measurements.
If Fannie Mae or Freddie Mac were eliminated, or their
structures were to change radically, we may not be able to
acquire Agency RMBS from these companies, which would
drastically reduce the amount and type of Agency RMBS available
for investment, which would increase the price of these assets.
Additionally, the current credit support provided by the
U.S. Treasury to Fannie Mae and Freddie Mac, and any
additional credit support it may provide in the future, could
have the effect of lowering the interest rate we receive from
Agency RMBS, thereby tightening the spread between the interest
we earn on our portfolio and our financing costs. Additionally,
the U.S. Government could elect to stop providing credit
support of any kind to the mortgage market. If any of these
risks were to occur, our business, financial condition and
results of operations and our ability to pay distributions to
our stockholders could be materially adversely affected.
25
Continued
adverse developments in the broader residential mortgage market
have adversely affected Bimini and may materially adversely
affect our business, financial condition and results of
operations and our ability to pay distributions to our
stockholders.
The residential mortgage market in the United States has
experienced a variety of difficulties and changed economic
conditions, including defaults, credit losses and liquidity
concerns. In addition, certain commercial banks, investment
banks and insurance companies announced extensive losses from
exposure to the residential mortgage market. These losses
reduced financial industry capital, leading to reduced liquidity
for some institutions. These factors have impacted investor
perception of the risk associated with real estate-related
assets, including Agency RMBS. As a result, values for RMBS,
including some Agency RMBS and other AAA-rated RMBS assets, have
been negatively impacted. Further increased volatility and
deterioration in the broader residential mortgage and RMBS
markets may adversely affect the performance and market value of
the Agency RMBS in which we intend to invest.
In 2005, Bimini Capital acquired Opteum Financial Services, LLC,
or OFS, an originator of residential mortgage loans. At the time
OFS was acquired, Bimini managed an Agency RMBS portfolio with a
fair value of approximately $3.5 billion. OFS operated in
46 states and originated residential mortgages through
three production channels. OFS did not have the capacity to
retain the mortgages it originated, and relied on the ability to
sell loans as they were originated as either whole loans or
through off-balance sheet securitizations. When the residential
housing market in the United States started to collapse in late
2006 and early 2007, the ability to execute this strategy was
quickly impaired as whole loan prices plummeted and the
securitization markets closed. Biminis management closed a
majority of the mortgage origination operations in early 2007,
with the balance sold by June 30, 2007. Additional losses
were incurred after June 30, 2007 as the remaining assets
were sold or became impaired, and by December 31, 2009, OFS
had an accumulated deficit of approximately $278 million.
The losses generated by OFS required Bimini to slowly liquidate
its Agency RMBS portfolio as capital was reduced and the
operations of OFS drained cash resources. On November 5,
2007, Bimini was delisted by the NYSE. By December 31,
2008, Biminis Agency RMBS portfolio was reduced to
approximately $172 million and, as a result of the reduced
capital remaining and the financial crisis, Bimini had limited
access to repurchase agreement funding.
We will need to rely on our Agency RMBS as collateral for our
financings. Any decline in their value, or perceived market
uncertainty about their value, would likely make it difficult
for us to obtain financing on favorable terms or at all, or
maintain our compliance with terms of any financing arrangements
already in place. Additionally, our Agency RMBS are classified
for accounting purposes as held for trading and,
therefore, will be reported on our financial statements at fair
value, with unrealized gains and losses included in earnings. If
market conditions result in a decline in the value of our Agency
RMBS, our business, financial position and results of operations
and our ability to pay distributions to our stockholders could
be materially adversely affected.
Interest rate
mismatches between our Agency RMBS and our borrowings may reduce
our net interest margin during periods of changing interest
rates, which could materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
Our portfolio includes Agency RMBS backed by ARMs, hybrid ARMs
and fixed-rate mortgages, and the mix of these securities in the
portfolio may be increased or decreased over time. Additionally,
the interest rates on ARMs and hybrid ARMs may vary over time
based on changes in a short-term interest rate index, of which
there are many.
We finance our acquisitions of pass-through Agency RMBS with
short-term financing. During periods of rising short-term
interest rates, the income we earn on these securities will not
change (with respect to Agency RMBS backed by fixed-rate
mortgage loans) or will not increase at the same rate (with
respect to Agency RMBS backed by ARMs and hybrid ARMs) as our
related financing costs, which may reduce our net interest
margin or result in losses.
26
Interest rate fluctuations will also cause variances in the
yield curve, which illustrates the relationship between
short-term and longer-term interest rates. If short-term
interest rates rise disproportionately relative to longer-term
interest rates (a flattening of the yield curve) or exceed
long-term interest rates (an inversion of the yield curve), our
borrowing costs may increase more rapidly than the interest
income earned on the related Agency RMBS because the related
Agency RMBS may bear interest based on longer-term rates than
our borrowings. Consequently, a flattening or inversion of the
yield curve may reduce our net interest margin or result in
losses.
Additionally, to the extent cash flows from Agency RMBS are
reinvested in new Agency RMBS, the spread between the yields of
the new Agency RMBS and available borrowing rates may decline,
which could reduce our net interest margin or result in losses.
Any one of the foregoing risks could materially adversely affect
our business, financial condition and results of operations and
our ability to pay distributions to our stockholders.
Mortgage loan
modification programs and future legislative action may
adversely affect the value of, and the returns on, our Agency
RMBS, which could materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
During the second half of 2008, the U.S. Government
commenced programs designed to provide homeowners with
assistance in avoiding residential mortgage loan foreclosures.
The programs involve, among other things, the modification of
mortgage loans to reduce the principal amount of the loans or
the rate of interest payable on the loans, or to extend the
payment terms of the loans.
In addition, in February 2008, the U.S. Treasury announced
the Homeowner Affordability and Stability Plan, or HASP, which
is a multi-faceted plan intended to prevent residential mortgage
foreclosures by, among other things:
|
|
|
|
|
allowing certain homeowners whose homes are encumbered by Fannie
Mae or Freddie Mac conforming mortgages to refinance those
mortgages into lower interest rate mortgages with either Fannie
Mae or Freddie Mac;
|
|
|
|
creating the Homeowner Stability Initiative, which is intended
to utilize various incentives for banks and mortgage servicers
to modify residential mortgage loans with the goal of reducing
monthly mortgage principal and interest payments for certain
qualified homeowners; and
|
|
|
|
allowing judicial modifications of Fannie Mae and Freddie Mac
conforming residential mortgages loans during bankruptcy
proceedings.
|
It is likely that loan modifications would result in increased
prepayments on some Agency RMBS. These loan modification
programs, as well as legislative or regulatory actions,
including amendments to the bankruptcy laws that result in the
modification of outstanding mortgage loans, may adversely affect
the value of, and the returns on, the Agency RMBS in which we
invest, which could materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders. Furthermore, if Fannie
Mae and Freddie Mac were to modify or end their repurchase
programs or if the U.S. Government modified its loan
modification programs to modify non-delinquent mortgage loans,
our investment portfolio could be materially adversely affected.
We invest in
structured Agency RMBS, including CMOs, IOs, IIOs and POs.
Although structured Agency RMBS are generally subject to the
same risks as our pass-through Agency RMBS, certain types of
risks may be enhanced depending on the type of structured Agency
RMBS in which we invest.
The structured Agency RMBS in which we invest are
securitizations (i) issued by Fannie Mae, Freddie Mac or
Ginnie Mae, (ii) that are collateralized by Agency RMBS and
(iii) that are divided into various tranches that have
different characteristics (such as different maturities or
different coupon payments). These securities may carry greater
risk than an investment in pass-through Agency RMBS. For
example, certain types of structured Agency RMBS, such as
IOs, IIOs and POs, are more sensitive
27
to prepayment risks than pass-through Agency RMBS. If we were to
invest in structured Agency RMBS that were more sensitive to
prepayment risks relative to other types of structured Agency
RMBS or pass-through Agency RMBS, we may increase our
portfolio-wide prepayment risk.
Increased
levels of prepayments on the mortgages underlying our Agency
RMBS might decrease net interest income or result in a net loss,
which could materially adversely affect our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
Prepayment rates generally increase when interest rates fall and
decrease when interest rates rise. Prepayment rates also may be
affected by other factors, including, without limitation,
conditions in the housing and financial markets, general
economic conditions and the relative interest rates on ARMs,
hybrid ARMs and fixed-rate mortgage loans. With respect to
pass-through Agency RMBS,
faster-than-expected
prepayments could also materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders in various ways, including
the following:
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A portion of our pass-through Agency RMBS backed by ARMs and
hybrid ARMs may initially bear interest at rates that are lower
than their fully indexed rates, which are equivalent to the
applicable index rate plus a margin. If a pass-through Agency
RMBS backed by ARMs or hybrid ARMs is prepaid prior to or soon
after the time of adjustment to a fully-indexed rate, we will
have held that Agency RMBS while it was less profitable and lost
the opportunity to receive interest at the fully-indexed rate
over the remainder of its expected life.
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If we are unable to acquire new Agency RMBS to replace the
prepaid Agency RMBS, our returns on capital may be lower than if
we were able to quickly acquire new Agency RMBS.
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When we acquire structured Agency RMBS, we anticipate that the
underlying mortgages will prepay at a projected rate, generating
an expected yield. When the prepayment rates on the mortgages
underlying our structured Agency RMBS are higher than expected,
our returns on those securities may be materially adversely
affected. For example, the value of our IOs and IIOs are
extremely sensitive to prepayments because holders of these
securities do not have the right to receive any principal
payments on the underlying mortgages. Therefore, if the mortgage
loans underlying our IOs and IIOs are prepaid, such securities
would cease to have any value, which, in turn, could materially
adversely affect our business, financial condition and results
of operations and our ability to pay distributions to our
stockholders.
While we seek to minimize prepayment risk, we must balance
prepayment risk against other risks and the potential returns of
each investment. No strategy can completely insulate us from
prepayment or other such risks.
A decrease in
prepayment rates on the mortgages underlying our Agency RMBS
might decrease net interest income or result in a net loss,
which could materially adversely affect our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
Certain of our structured Agency RMBS may be adversely affected
by a decrease in prepayment rates. For example, because POs are
similar to zero-coupon bonds, our expected returns on such
securities will be contingent on our receiving the principal
payments of the underlying mortgage loans at expected intervals,
which assume a certain prepayment rate. If prepayment rates are
lower than expected, we will not receive principal payments as
quickly as we anticipated and, therefore, our expected returns
on these securities will be adversely affected, which, in turn,
could materially adversely affect our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
While we seek to minimize prepayment risk, we must balance
prepayment risk against other risks and the potential returns of
each investment. No strategy can completely insulate us from
prepayment or other such risks.
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The U.S.
Governments pressing for refinancing of certain loans may
affect prepayment rates for mortgage loans underlying our Agency
RMBS.
In addition to the increased pressure upon residential mortgage
loan investors and servicers to engage in loss mitigation
activities, the U.S. Government is pressing for refinancing
of certain loans, and this encouragement may affect prepayment
rates for mortgage loans underlying our Agency RMBS. To the
extent these and other economic stabilization or stimulus
efforts are successful in increasing prepayment speeds for
residential mortgage loans, such as those in Agency RMBS, our
income and operating results could be harmed, particularly in
connection with our IOs and IIOs, which, in turn, could
materially adversely affect our business, financial condition
and results of operations and our ability to pay distributions
to our stockholders.
Interest rate
caps on the ARMs and hybrid ARMs backing our Agency RMBS may
reduce our net interest margin during periods of rising interest
rates, which could materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
ARMs and hybrid ARMs are typically subject to periodic and
lifetime interest rate caps. Periodic interest rate caps limit
the amount an interest rate can increase during any given
period. Lifetime interest rate caps limit the amount an interest
rate can increase through the maturity of the loan. Our
borrowings typically are not subject to similar restrictions.
Accordingly, in a period of rapidly increasing interest rates,
our financing costs could increase without limitation while caps
could limit the interest we earn on the ARMs and hybrid ARMs
backing our Agency RMBS. This problem is magnified for ARMs and
hybrid ARMs that are not fully indexed because such periodic
interest rate caps prevent the coupon on the security from fully
reaching the specified rate in one reset. Further, some ARMs and
hybrid ARMs may be subject to periodic payment caps that result
in a portion of the interest being deferred and added to the
principal outstanding. As a result, we may receive less cash
income on Agency RMBS backed by ARMs and hybrid ARMs than
necessary to pay interest on our related borrowings. Interest
rate caps on Agency RMBS backed by ARMs and hybrid ARMs could
reduce our net interest margin if interest rates were to
increase beyond the level of the caps, which could materially
adversely affect our business, financial condition and results
of operations and our ability to pay distributions to our
stockholders.
We have a
limited operating history and may not be able to operate our
business successfully or generate sufficient revenue to make or
sustain distributions to our stockholders.
We commenced operations in November 2010 and have a limited
operating history. We cannot assure you that we will be able to
operate our business successfully or implement our operating
policies and strategies. The results of our operations depend on
several factors, including the availability of opportunities for
the acquisition of target assets, the level and volatility of
interest rates, the availability of adequate short and long-term
financing, conditions in the financial markets and economic
conditions. Our revenues will depend, in large part, on our
ability to acquire assets at favorable spreads over our
borrowing costs. If we are unable to acquire assets that
generate favorable spreads, our results of operations may be
materially adversely affected, which could materially adversely
affect our ability to make or sustain distributions to our
stockholders.
We rely on
analytical models and other data to analyze potential asset
acquisition and disposition opportunities and to manage our
portfolio. Such models and other data may be incorrect,
misleading or incomplete, which could cause us to purchase
assets that do not meet our expectations or to make asset
management decisions that are not in line with our
strategy.
We rely on analytical models, and information and data supplied
by third parties. These models and data may be used to value
assets or potential asset acquisitions and dispositions and also
in connection with our asset management activities. If our
models and data prove to be incorrect, misleading or incomplete,
any decisions made in reliance thereon could expose us to
potential risks.
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Our reliance on models and data may induce us to purchase
certain assets at prices that are too high, to sell certain
other assets at prices that are too low or to miss favorable
opportunities altogether. Similarly, any hedging activities that
are based on faulty models and data may prove to be unsuccessful.
Some models, such as prepayment models, may be predictive in
nature. The use of predictive models has inherent risks. For
example, such models may incorrectly forecast future behavior,
leading to potential losses. In addition, the predictive models
used by us may differ substantially from those models used by
other market participants, with the result that valuations based
on these predictive models may be substantially higher or lower
for certain assets than actual market prices. Furthermore,
because predictive models are usually constructed based on
historical data supplied by third parties, the success of
relying on such models may depend heavily on the accuracy and
reliability of the supplied historical data, and, in the case of
predicting performance in scenarios with little or no historical
precedent (such as extreme broad-based declines in home prices,
or deep economic recessions or depressions), such models must
employ greater degrees of extrapolation, and are therefore more
speculative and of more limited reliability.
All valuation models rely on correct market data input. If
incorrect market data is entered into even a well-founded
valuation model, the resulting valuations will be incorrect.
However, even if market data is inputted correctly, model
prices will often differ substantially from market prices,
especially for securities with complex characteristics or whose
values are particularly sensitive to various factors. If our
market data inputs are incorrect or our model prices differ
substantially from market prices, our business, financial
condition and results of operations and our ability to make
distributions to our stockholders could be materially adversely
affected.
Valuations of
some of our assets are inherently uncertain, may be based on
estimates, may fluctuate over short periods of time and may
differ from the values that would have been used if a ready
market for these assets existed. As a result, the values of some
of our assets are uncertain.
While in many cases our determination of the fair value of our
assets is based on valuations provided by third-party dealers
and pricing services, we can and do value assets based upon our
judgment and such valuations may differ from those provided by
third-party dealers and pricing services. Valuations of certain
assets are often difficult to obtain or are unreliable. In
general, dealers and pricing services heavily disclaim their
valuations. Additionally, dealers may claim to furnish
valuations only as an accommodation and without special
compensation, and so they may disclaim any and all liability for
any direct, incidental or consequential damages arising out of
any inaccuracy or incompleteness in valuations, including any
act of negligence or breach of any warranty. Depending on the
complexity and illiquidity of an asset, valuations of the same
asset can vary substantially from one dealer or pricing service
to another. The valuation process has been particularly
difficult recently because market events have made valuations of
certain assets more difficult and unpredictable and the
disparity of valuations provided by third-party dealers has
widened.
Our business, financial condition and results of operations and
our ability to make distributions to our stockholders could be
materially adversely affected if our fair value determinations
of these assets were materially higher than the values that
would exist if a ready market existed for these assets.
An increase in
interest rates may cause a decrease in the volume of newly
issued, or investor demand for, Agency RMBS, which could
materially adversely affect our ability to acquire assets that
satisfy our investment objectives and our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
Rising interest rates generally reduce the demand for consumer
credit, including mortgage loans, due to the higher cost of
borrowing. A reduction in the volume of mortgage loans may
affect the volume of Agency RMBS available to us, which could
affect our ability to acquire assets that satisfy our investment
objectives. Rising interest rates may also cause Agency RMBS
that were issued prior to
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an interest rate increase to provide yields that exceed
prevailing market interest rates. If rising interest rates cause
us to be unable to acquire a sufficient volume of Agency RMBS or
Agency RMBS with a yield that exceeds our borrowing costs, our
ability to satisfy our investment objectives and to generate
income and pay dividends, our business, financial condition and
results of operations and our ability to pay distributions to
our stockholders may be materially adversely affected.
Because the
assets that we acquire might experience periods of illiquidity,
we might be prevented from selling our Agency RMBS at favorable
times and prices, which could materially adversely affect our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders.
Agency RMBS generally experience periods of illiquidity. Such
conditions are more likely to occur for structured Agency RMBS
because such securities are generally traded in markets much
less liquid than the pass-through Agency RMBS market. As a
result, we may be unable to dispose of our Agency RMBS at
advantageous times and prices or in a timely manner. The lack of
liquidity might result from the absence of a willing buyer or an
established market for these assets, as well as legal or
contractual restrictions on resale. The illiquidity of Agency
RMBS could materially adversely affect our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
Our use of
leverage could materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
Under normal market conditions, we generally expect our leverage
ratio to be less than 12 to 1, although at times our borrowings
may be above or below this level. We incur this indebtedness by
borrowing against a substantial portion of the market value of
our pass-through Agency RMBS and a portion of our structured
Agency RMBS. Our total indebtedness, however, is not expressly
limited by our policies and will depend on our and our
prospective lenders estimates of the stability of our
portfolios cash flow. As a result, there is no limit on
the amount of leverage that we may incur. We face the risk that
we might not be able to meet our debt service obligations or a
lenders margin requirements from our income and, to the
extent we cannot, we might be forced to liquidate some of our
Agency RMBS at unfavorable prices. Our use of leverage could
materially adversely affect our business, financial condition
and results of operation and our ability to pay distributions to
our stockholders. For example:
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Our borrowings are secured by our pass-through Agency RMBS and a
portion of our structured Agency RMBS under repurchase
agreements. A decline in the market value of the pass-through
Agency RMBS or structured Agency RMBS used to secure these debt
obligations could limit our ability to borrow or result in
lenders requiring us to pledge additional collateral to secure
our borrowings. In that situation, we could be required to sell
Agency RMBS under adverse market conditions in order to obtain
the additional collateral required by the lender. If these sales
are made at prices lower than the carrying value of the Agency
RMBS, we would experience losses.
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To the extent we are compelled to liquidate qualifying real
estate assets to repay debts, our compliance with the REIT rules
regarding our assets and our sources of gross income could be
negatively affected, which could jeopardize our qualification as
a REIT. Losing our REIT qualification would cause us to be
subject to U.S. federal income tax (and any applicable
state and local taxes) on all of our income and would decrease
profitability and cash available for distributions to
stockholders.
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If we experience losses as a result of our use of leverage, such
losses could materially adversely affect our business, results
of operations and financial condition and our ability to make
distributions to our stockholders.
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We may incur
increased borrowing costs, which could materially adversely
affect our business, financial condition and results of
operations and our ability to pay distributions to our
stockholders.
Our borrowing costs under repurchase agreements are generally
adjustable and correspond to short-term interest rates, such as
LIBOR or a short-term U.S. Treasury index, plus or minus a
margin. The margins on these borrowings over or under short-term
interest rates may vary depending upon a number of factors,
including, without limitation:
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the movement of interest rates;
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the availability of financing in the market; and
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the value and liquidity of our Agency RMBS.
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All of our current borrowings are collateralized borrowings in
the form of repurchase agreements. If the interest rates on
these repurchase agreements increase, our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders could be materially adversely
affected.
Failure to
procure adequate repurchase agreement financing, or to renew or
replace existing repurchase agreement financing as it matures,
could materially adversely affect our business, financial
condition and results of operations and our ability to make
distributions to our stockholders.
We currently have master repurchase agreements with five
counterparties. We cannot assure you that any, or sufficient,
repurchase agreement financing will be available to us in the
future on terms that are acceptable to us. Any decline in the
value of Agency RMBS, or perceived market uncertainty about
their value, would make it more difficult for us to obtain
financing on favorable terms or at all, or maintain our
compliance with the terms of any financing arrangements already
in place. Additionally, our lenders may have owned or financed
RMBS that have declined in value and caused the lender to suffer
losses as a result of the recent downturn in the residential
mortgage market. If these conditions persist, these institutions
may be forced to exit the repurchase market, become insolvent or
further tighten lending standards or increase the amount of
equity capital, or haircuts, required to obtain financing, and
in such event, could make it more difficult for us to obtain
financing on favorable terms or at all. Additionally, we may be
unable to diversify the credit risk associated with our lenders.
In the event that we cannot obtain sufficient funding on
acceptable terms, our business, financial condition and results
of operations and our ability to pay distributions to our
stockholders may be materially adversely effected.
Furthermore, because we intend to rely primarily on short-term
borrowings, our ability to achieve our investment objective will
depend not only on our ability to borrow money in sufficient
amounts and on favorable terms, but also on our ability to renew
or replace on a continuous basis our maturing short-term
borrowings. If we are not able to renew or replace maturing
borrowings, we will have to sell some or all of our assets,
possibly under adverse market conditions. In addition, if the
regulatory capital requirements imposed on our lenders change,
they may be required to significantly increase the cost of the
financing that they provide to us. Our lenders also may revise
their eligibility requirements for the types of assets they are
willing to finance or the terms of such financings, based on,
among other factors, the regulatory environment and their
management of perceived risk.
Adverse market
developments could cause our lenders to require us to pledge
additional assets as collateral. If our assets were insufficient
to meet these collateral requirements, we might be compelled to
liquidate particular assets at inopportune times and at
unfavorable prices, which could materially adversely affect our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders.
Adverse market developments, including a sharp or prolonged rise
in interest rates, a change in prepayment rates or increasing
market concern about the value or liquidity of one or more types
of Agency RMBS, might reduce the market value of our portfolio,
which might cause our lenders to
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initiate margin calls. A margin call means that the lender
requires us to pledge additional collateral to re-establish the
ratio of the value of the collateral to the amount of the
borrowing. The specific collateral value to borrowing ratio that
would trigger a margin call is not set in the master repurchase
agreements and not determined until we engage in a repurchase
transaction under these agreements. Our fixed-rate Agency RMBS
generally are more susceptible to margin calls as increases in
interest rates tend to more negatively affect the market value
of fixed-rate securities. If we are unable to satisfy margin
calls, our lenders may foreclose on our collateral. The threat
or occurrence of a margin call could force us to sell either
directly or through a foreclosure our Agency RMBS under adverse
market conditions. Because of the significant leverage we expect
to have, we may incur substantial losses upon the threat or
occurrence of a margin call, which could materially adversely
affect our business, financial condition and results of
operations and our ability to pay distributions to our
stockholders. Additionally, the liquidation of collateral may
jeopardize our ability to qualify or maintain our qualification
as a REIT, as we must comply with requirements regarding our
assets and our sources of gross income. If we are compelled to
liquidate our Agency RMBS, we may be unable to comply with these
requirements, ultimately jeopardizing our ability to qualify or
maintain our qualification as a REIT. Our failure to qualify as
a REIT or maintain our qualification would cause us to be
subject to U.S. federal income tax (and any applicable
state and local taxes) on all of our income.
Our use of
repurchase agreements may give our lenders greater rights in the
event that either we or any of our lenders file for bankruptcy,
which may make it difficult for us to recover our collateral in
the event of a bankruptcy filing.
Our borrowings under repurchase agreements may qualify for
special treatment under the bankruptcy code, giving our lenders
the ability to avoid the automatic stay provisions of the
bankruptcy code and to take possession of and liquidate our
collateral under the repurchase agreements without delay if we
file for bankruptcy. Furthermore, the special treatment of
repurchase agreements under the bankruptcy code may make it
difficult for us to recover our pledged assets in the event that
any of our lenders files for bankruptcy. Thus, the use of
repurchase agreements exposes our pledged assets to risk in the
event of a bankruptcy filing by either our lenders or us. In
addition, if the lender is a broker or dealer subject to the
Securities Investor Protection Act of 1970, or an insured
depository institution subject to the Federal Deposit Insurance
Act, our ability to exercise our rights to recover our
investment under a repurchase agreement or to be compensated for
any damages resulting from the lenders insolvency may be
further limited by those statutes.
If we fail to
maintain our relationship with AVM, L.P. or if we do not
establish relationships with other repurchase agreement trading,
clearing and administrative service providers, our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders could be materially
adversely affected.
We have engaged AVM, L.P. to provide us with certain repurchase
agreement trading, clearing and administrative services. If we
are unable to maintain our relationship with AVM, L.P. or we are
unable to establish successful relationships with other
repurchase agreement trading, clearing and administrative
service providers, our business, financial condition and results
of operations and our ability to pay distributions to our
stockholders could be materially adversely affected.
If our lenders
default on their obligations to resell the Agency RMBS back to
us at the end of the repurchase transaction term, or if the
value of the Agency RMBS has declined by the end of the
repurchase transaction term or if we default on our obligations
under the repurchase transaction, we will lose money on these
transactions, which, in turn, may materially adversely affect
our business, financial condition and results of operations and
our ability to pay distributions to our
stockholders.
When we engage in a repurchase transaction, we initially sell
securities to the financial institution under one of our master
repurchase agreements in exchange for cash and our counterparty
is obligated to resell the securities to us at the end of the
term of the transaction, which is typically from 24 to
90 days, but which may have terms up to 364 days or
more. The cash we receive when we
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initially sell the securities is less than the value of those
securities, which is referred to as the haircut. Many financial
institutions from whom we may obtain repurchase agreement
financing have increased their haircuts in the past, and may do
so again in the future. As of March 31, 2011, our haircuts
were approximately 7.0% on average, which means that we will be
required to pledge Agency RMBS the value of which equals
approximately 107% of the principal amount of the borrowings. If
these haircuts are increased, we will be required to post
additional cash or securities as collateral for our Agency RMBS.
If our counterparty defaults on its obligation to resell the
securities to us, we would incur a loss on the transaction equal
to the amount of the haircut (assuming there was no change in
the value of the securities). We would also lose money on a
repurchase transaction if the value of the underlying securities
has declined as of the end of the transaction term, as we would
have to repurchase the securities for their initial value but
would receive securities worth less than that amount. Any losses
we incur on our repurchase transactions could materially
adversely affect our business, financial condition and results
of operations and our ability to pay distributions to our
stockholders.
If we default on one of our obligations under a repurchase
transaction, the counterparty can terminate the transaction and
cease entering into any other repurchase transactions with us.
In that case, we would likely need to establish a replacement
repurchase facility with another financial institution in order
to continue to leverage our portfolio and carry out our
investment strategy. There is no assurance we would be able to
establish a suitable replacement facility on acceptable terms or
at all.
Hedging
against interest rate exposure may not completely insulate us
from interest rate risk and could materially adversely affect
our business, financial condition and results of operations and
our ability to pay distributions to our
stockholders.
To the extent consistent with qualifying and maintaining our
qualification as a REIT, we may enter into interest rate cap or
swap agreements or pursue other hedging strategies, including
the purchase of puts, calls or other options and futures
contracts in order to hedge the interest rate risk of our
portfolio. In general, our hedging strategy depends on our view
of our entire portfolio consisting of assets, liabilities and
derivative instruments, in light of prevailing market
conditions. We could misjudge the condition of our investment
portfolio or the market. Our hedging activity will vary in scope
based on the level and volatility of interest rates and
principal prepayments, the type of Agency RMBS we hold and other
changing market conditions. Hedging may fail to protect or could
adversely affect us because, among other things:
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hedging can be expensive, particularly during periods of rising
and volatile interest rates;
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available interest rate hedging may not correspond directly with
the interest rate risk for which protection is sought;
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the duration of the hedge may not match the duration of the
related liability;
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certain types of hedges may expose us to risk of loss beyond the
fee paid to initiate the hedge;
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the amount of gross income that a REIT may earn from certain
hedging transactions is limited by federal income tax provisions
governing REITs;
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the credit quality of the counterparty on the hedge may be
downgraded to such an extent that it impairs our ability to sell
or assign our side of the hedging transaction; and
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the counterparty in the hedging transaction may default on its
obligation to pay.
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There are no perfect hedging strategies, and interest rate
hedging may fail to protect us from loss. Alternatively, we may
fail to properly assess a risk to our investment portfolio or
may fail to recognize a risk entirely, leaving us exposed to
losses without the benefit of any offsetting hedging activities.
The derivative financial instruments we select may not have the
effect of reducing our interest rate risk. The nature and timing
of hedging transactions may influence the effectiveness of these
strategies. Poorly designed strategies or improperly executed
transactions could actually increase our risk and losses. In
addition, hedging activities could result in losses if the event
against which we hedge does not occur.
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Because of the foregoing risks, our hedging activity could
materially adversely affect our business, financial condition
and results of operation and our ability to pay distributions to
our stockholders.
Our use of
certain hedging techniques may expose us to counterparty
risks.
If an interest rate swap counterparty cannot perform under the
terms of the interest rate swap, we may not receive payments due
under that swap, and thus, we may lose any unrealized gain
associated with the interest rate swap. The hedged liability
could cease to be hedged by the interest rate swap.
Additionally, we may also risk the loss of any collateral we
have pledged to secure our obligations under the interest rate
swap if the counterparty becomes insolvent or files for
bankruptcy. Similarly, if an interest rate cap counterparty
fails to perform under the terms of the interest rate cap
agreement, we may not receive payments due under that agreement
that would off-set our interest expense and then could incur a
loss for the then remaining fair market value of the interest
rate cap.
Hedging
instruments often are not traded on regulated exchanges,
guaranteed by an exchange or a clearing house, or regulated by
any U.S. or foreign governmental authorities and involve risks
and costs.
The cost of using hedging instruments increases as the period
covered by the instrument increases and during periods of rising
and volatile interest rates. We may increase our hedging
activity and thus increase our hedging costs during periods when
interest rates are volatile or rising and hedging costs have
increased.
In addition, hedging instruments involve risk since they often
are not traded on regulated exchanges, guaranteed by an exchange
or its clearing house, or regulated by any U.S. or foreign
governmental authorities. While the recently enacted Dodd-Frank
Wall Street Reform and Consumer Protection Act, or the
Dodd-Frank Act, among other current or proposed pieces of
legislation, may add regulatory oversight or reduce counterparty
risk among market participants, little of such oversight
currently exists. Consequently, there are no requirements with
respect to record keeping, financial responsibility or
segregation of customer funds and positions. Furthermore, the
enforceability of agreements underlying derivative transactions
may depend on compliance with applicable statutory and commodity
and other regulatory requirements and, depending on the identity
of the counterparty, applicable international requirements. The
business failure of a hedging counterparty with whom we enter
into a hedging transaction most likely will result in a default.
Default by a hedging counterparty may result in the loss of
unrealized profits and force us to cover our resale commitments,
if any, at the then current market price. In addition, we may
not always be able to dispose of or close out a hedging position
without the consent of the hedging counterparty, and we may not
be able to enter into an offsetting contract to cover our risk.
We cannot assure you that a liquid secondary market will exist
for hedging instruments purchased or sold, and we may be
required to maintain a position until exercise or expiration,
which could materially adversely affect our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
Our ability to
achieve our investment objectives will depend on our ability to
manage future growth effectively.
Our ability to achieve our investment objectives will depend on
our ability to grow, which will depend, in turn, on our
Managers ability to identify and invest in securities that
meet our investment criteria. Accomplishing this result on a
cost-effective basis largely will be a function of our
Managers structuring and implementation of the investment
process, its ability to provide competent, attentive and
efficient services to us and our access to financing on
acceptable terms. Our Manager has substantial responsibilities,
and, in order to grow, needs to hire, train, supervise and
manage new employees successfully. Any failure to manage our
future growth effectively could have a material adverse effect
on our business, financial condition and results of operations
and our ability to pay distributions to our stockholders.
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We may change
our investment strategy, investment guidelines and asset
allocation without notice or stockholder consent, which may
result in riskier investments. In addition, our charter will
provide that our Board of Directors may revoke or otherwise
terminate our REIT election, without the approval of our
stockholders.
Our Board of Directors has the authority to change our
investment strategy or asset allocation at any time without
notice to or consent from our stockholders. To the extent that
our investment strategy changes in the future, we may make
investments that are different from, and possibly riskier than,
the investments described in this prospectus. A change in our
investment strategy may increase our exposure to interest rate
and real estate market fluctuations. Furthermore, a change in
our asset allocation could result in our allocating assets in a
different manner than as described in this prospectus.
In addition, our charter will provide that our Board of
Directors may revoke or otherwise terminate our REIT election,
without the approval of our stockholders, if it determines that
it is no longer in our best interests to qualify as a REIT.
These changes could materially adversely affect our business,
financial condition, results of operations, the market value of
our common stock and our ability to make distributions to our
stockholders.
Competition
might prevent us from acquiring Agency RMBS at favorable yields,
which could materially adversely affect our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
We operate in a highly competitive market for investment
opportunities. Our net income largely depends on our ability to
acquire Agency RMBS at favorable spreads over our borrowing
costs. In acquiring Agency RMBS, we compete with a variety of
institutional investors, including other REITs, investment
banking firms, savings and loan associations, banks, insurance
companies, mutual funds, other lenders and other entities that
purchase Agency RMBS, many of which have greater financial,
technical, marketing and other resources than we do. Several
other REITs have recently raised, or are expected to raise,
significant amounts of capital, and may have investment
objectives that overlap with ours, which may create additional
competition for investment opportunities. Some competitors may
have a lower cost of funds and access to funding sources that
may not be available to us, such as funding from the
U.S. Government. Additionally, many of our competitors are
not subject to REIT tax compliance or required to maintain an
exemption from the Investment Company Act. In addition, some of
our competitors may have higher risk tolerances or different
risk assessments, which could allow them to consider a wider
variety of investments. Furthermore, competition for investments
in Agency RMBS may lead the price of such investments to
increase, which may further limit our ability to generate
desired returns. As a result, we may not be able to acquire
sufficient Agency RMBS at favorable spreads over our borrowing
costs, which would materially adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
The recent
actions of the U.S. Government for the purpose of stabilizing
the financial markets may adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
The U.S. Government, through the Federal Reserve, the
U.S. Treasury, the SEC, the Federal Housing Administration,
or FHA, the Federal Deposit Insurance Corporation, or FDIC, and
other governmental and regulatory bodies have taken or are
considering taking various actions to address the financial
crisis. For example, on July 21, 2010, President Obama
signed into law the Dodd-Frank Act. Many aspects of the
Dodd-Frank Act are subject to rulemaking and will take effect
over several years, making it difficult to anticipate the
overall financial impact on us and, more generally, the
financial services and mortgage industries. Additionally, we
cannot predict whether there will be additional proposed laws or
reforms that would affect us, whether or when such changes may
be adopted, how such changes may be interpreted and enforced or
how such changes may affect us. However, the costs of complying
with any additional laws or regulations could have a material
adverse
36
effect on our business, financial condition and results of
operations and our ability to pay distributions to our
stockholders.
In addition to the foregoing, the U.S. Congress
and/or
various state and local legislatures may enact additional
legislation or regulatory action designed to address the current
economic crisis or for other purposes that could have a material
adverse effect on our ability to execute our business
strategies. To the extent the market does not respond favorably
to these initiatives or they do not function as intended, our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders could be
materially adversely affected.
We will be
subject to the requirements of the Sarbanes-Oxley Act of
2002.
After becoming a public company, management will be required to
deliver a report that assesses the effectiveness of our internal
controls over financial reporting, pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act.
Section 404 of the Sarbanes-Oxley Act may require our
auditors to deliver an attestation report on the effectiveness
of our internal controls over financial reporting in conjunction
with their opinion on our audited financial statements as of
December 31 subsequent to the year in which this registration
statement becomes effective. Substantial work on our part is
required to implement appropriate processes, document the system
of internal control over key processes, assess their design,
remediate any deficiencies identified and test their operation.
This process is expected to be both costly and challenging. We
cannot give any assurances that material weaknesses will not be
identified in the future in connection with our compliance with
the provisions of Section 302 and 404 of the Sarbanes-Oxley
Act. The existence of any material weakness described above
would preclude a conclusion by management and our independent
auditors that we maintained effective internal control over
financial reporting. Our management may be required to devote
significant time and expense to remediate any material
weaknesses that may be discovered and may not be able to
remediate any material weakness in a timely manner. The
existence of any material weakness in our internal control over
financial reporting could also result in errors in our financial
statements that could require us to restate our financial
statements, cause us to fail to meet our reporting obligations
and cause investors to lose confidence in our reported financial
information, all of which could lead to a decline in the trading
price of our common stock.
Terrorist
attacks and other acts of violence or war may materially
adversely affect our business, financial condition and results
of operations and our ability to pay distributions to our
stockholders.
We cannot assure you that there will not be further terrorist
attacks against the United States or U.S. businesses. These
attacks or armed conflicts may directly impact the property
underlying our Agency RMBS or the securities markets in general.
Losses resulting from these types of events are uninsurable.
More generally, any of these events could cause consumer
confidence and spending to decrease or result in increased
volatility in the United States and worldwide financial markets
and economies. They also could result in economic uncertainty in
the United States or abroad. Adverse economic conditions could
harm the value of the property underlying our Agency RMBS or the
securities markets in general, which could materially adversely
affect our business, financial condition and results of
operations and our ability to pay distributions to our
stockholders.
We are highly
dependent on communications and information systems operated by
third parties, and systems failures could significantly disrupt
our business, which may, in turn, adversely affect our business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
Our business is highly dependent on communications and
information systems that allow us to monitor, value, buy, sell,
finance and hedge our investments. These systems are operated by
third parties and, as a result, we have limited ability to
ensure their continued operation. In the event of a systems
failure or interruption, we will have limited ability to affect
the timing and success of systems restoration. Any failure or
interruption of our systems could cause delays or other problems
in our
37
securities trading activities, including Agency RMBS trading
activities, which could have a material adverse effect on our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders.
If we issue
debt securities, our operations may be restricted and we will be
exposed to additional risk.
If we decide to issue debt securities in the future, it is
likely that such securities will be governed by an indenture or
other instrument containing covenants restricting our operating
flexibility. Additionally, any convertible or exchangeable
securities that we issue in the future may have rights,
preferences and privileges more favorable than those of our
common stock. We, and indirectly our stockholders, will bear the
cost of issuing and servicing such securities. Holders of debt
securities may be granted specific rights, including but not
limited to, the right to hold a perfected security interest in
certain of our assets, the right to accelerate payments due
under the indenture, rights to restrict dividend payments, and
rights to approve the sale of assets. Such additional
restrictive covenants and operating restrictions could have a
material adverse effect on our business, financial condition and
results of operations and our ability to pay distributions to
our stockholders.
Risks Related to
Conflicts of Interest in Our Relationship with Our Manager and
Bimini
The management
agreement was not negotiated on an arms-length basis and
the terms, including fees payable and our inability to
terminate, or our election not to renew, the management
agreement based on our Managers poor performance without
paying our Manager a significant termination fee, may not be as
favorable to us as if it were negotiated with an unaffiliated
third party.
The management agreement was negotiated between related parties,
and we did not have the benefit of arms-length
negotiations of the type normally conducted with an unaffiliated
third party. The terms of the management agreement, including
fees payable and our inability to terminate, or our election not
to renew, the management agreement based on our Managers
poor performance without paying our Manager a significant
termination fee, may not reflect the terms we may have received
if it was negotiated with an unrelated third party. In addition,
as a result of the relationship with our Manager, we may choose
not to enforce, or to enforce less vigorously, our rights under
the management agreement because of our desire to maintain our
ongoing relationship with our Manager.
We have no
employees and our Manager will be responsible for making all of
our investment decisions. None of our or our Managers
officers are required to devote any specific amount of time to
our business and each of them may provide their services to
Bimini which could result in conflicts of
interest.
Our Manager will be responsible for making all of our
investments. We do not have any employees, and we are completely
reliant on our Manager to provide us with investment advisory
services. Each of our and our Managers officers is an
employee of Bimini and none of them will devote their time to us
exclusively. Each of Messrs. Cauley and Haas, who will be
the initial members of our Managers investment committee,
is an officer of Bimini and has significant responsibilities to
Bimini. Due to the fact that each of our officers is responsible
for providing services to Bimini, they may not devote sufficient
time to the management of our business operations. At times when
there are turbulent conditions in the mortgage markets or
distress in the credit markets or other times when we will need
focused support and assistance from our executive officers and
our Manager, Bimini and its affiliates will likewise require
greater focus and attention from them. In such situations, we
may not receive the level of support and assistance that we
otherwise would likely have received if we were internally
managed or if such executives were not otherwise committed to
provide support to Bimini.
We expect our Board of Directors to adopt investment guidelines
that will require that any investment transaction between us and
Bimini or any affiliate of Bimini receives the prior approval of
a majority of our independent directors. See Our Manager
and the Management Agreement Conflicts of Interest;
Equitable Allocation of Opportunities. However, this
policy will not eliminate the conflicts
38
of interest that our officers will face in making investment
decisions on behalf of Bimini and us. Further, we do not have
any agreement or understanding with Bimini that would give us
any priority over Bimini or any of its affiliates. Accordingly,
we may compete for access to the benefits that we expect our
relationship with our Manager and Bimini to provide.
We are
completely dependent upon our Manager and certain key personnel
of Bimini who provide services to us through the management
agreement, and we may not find suitable replacements for our
Manager and these personnel if the management agreement is
terminated or such key personnel are no longer available to
us.
We are completely dependent on our Manager to conduct our
operations pursuant to the management agreement. Because we do
not have any employees or separate facilities, we are reliant on
our Manager to provide us with the personnel, services and
resources necessary to carry out our
day-to-day
operations. Our management agreement does not require our
Manager to dedicate specific personnel to our operations or a
specific amount of time to our business. Additionally, because
we will be affiliated with Bimini, we may be negatively impacted
by an event or factors, including ongoing and potential legal
proceedings against Bimini and its subsidiaries, that negatively
impacts or could negatively impact Biminis business or
financial condition.
After the initial term of the management agreement, which
expires
on ,
2014, or upon the expiration of any automatic renewal term, our
Manager may elect not to renew the management agreement without
cause, and without penalty, on
180-days
prior written notice to us. If we elect not to renew the
management agreement without cause, we would have to pay a
termination fee equal to three times the average annual
management fee earned by our Manager during the prior 24-month
period immediately preceding the most recently completed
calender quarter prior to the effective date of termination.
During the term of the management agreement and for two years
after its expiration or termination, we may not, without the
consent of our Manager, employ any employee of the Manager or
any of its affiliates or any person who has been employed by our
Manager or any of its affiliates at any time within the two year
period immediately preceding the date on which the person
commences employment with us. We do not have retention
agreements with any of our officers. We believe that the
successful implementation of our investment and financing
strategies depends to a significant extent upon the experience
of Biminis executive officers. None of these
individuals continued service is guaranteed. If the
management agreement is terminated or these individuals leave
Bimini, we may be unable to execute our business plan.
Legal
proceedings involving Bimini and certain of its subsidiaries
have adversely affected Bimini, may materially adversely affect
Biminis ability to effectively manage our business and
could materially adversely affect our reputation, business,
financial condition and results of operations and our ability to
pay distributions to our stockholders.
Bimini and its subsidiaries are currently subject to a number of
ongoing legal proceedings and could be subject to further legal
proceedings in the future. Bimini is vigorously defending itself
in these proceedings. Most of these legal proceedings arise out
of the mortgage-related operations of Biminis mortgage
origination subsidiary that discontinued operations in 2007. In
the past, Bimini and certain of its subsidiaries have been
subject to similar actions, including proceedings alleging
violations of the federal securities laws and for breach of duty
arising from the sale of certain mortgage-related securities,
which have now been satisfactorily resolved, but Bimini and its
subsidiaries could be subject to similar actions in the future.
Because all of our Managers officers are also officers of
Bimini, any legal proceedings or regulatory inquiries involving
Bimini and its subsidiaries, whether meritorious or not, may
divert the time and attention of our Manager and certain key
personnel of our Manager from us and our investment strategy and
may negatively affect Biminis business operations and
financial condition. In addition, due to our relationship with
Bimini and our Manager, such events could result in a material
adverse effect on our reputation, business, financial condition
and results of operations and our ability to pay distributions
to our stockholders. Furthermore, if these legal proceedings
were to result in a bankruptcy of Bimini or our Manager, we may
not terminate the management agreement with our
39
Manager until 30 days after we provide written notice of
termination to the Manager and could experience difficulty in
finding another manager or hiring personnel to conduct our
business. Alternatively, a bankruptcy court could prevent us
from exercising such termination right, regardless of the
provisions of the management agreement.
We, Bimini and
other accounts managed by our Manager may compete for
opportunities to acquire assets, which are allocated in
accordance with the Investment Allocation Agreement by and among
Bimini, our Manager and us.
Bimini and our Manager may, from time to time, simultaneously
seek to purchase the same or similar assets for us (through our
Manager) that it is seeking to purchase for Bimini and other
accounts that may be managed by our Manager in the future, and
our Manager has no duty to allocate such opportunities in a
manner that preferentially favors us. Bimini and our Manager
make available to us opportunities to acquire assets that they
determine, in their reasonable and good faith judgment, based on
our objectives, policies and strategies, and other relevant
factors, are appropriate for us in accordance with the
Investment Allocation Agreement.
Because many of our targeted assets are typically available only
in specified quantities and because many of our targeted assets
are also targeted assets for Bimini and may be targeted assets
for other accounts our Manager may manage in the future, neither
Bimini nor our Manager may be able to buy as much of any given
asset as required to satisfy the needs of Bimini, us and any
other account our Manager may manage in the future. In these
cases, the Investment Allocation Agreement will require the
allocation of such assets to multiple accounts in proportion to
their needs and available capital. The Investment Allocation
Agreement will permit departure from such proportional
allocation when (i) allocating purchases of whole-pool Agency
RMBS, because those securities cannot be divided into multiple
parts to be allocated among various accounts, and (ii) such
allocation would result in an inefficiently small amount of the
security being purchased for an account. In that case, the
Investment Allocation Agreement allows for a protocol of
allocating assets so that, on an overall basis, each account is
treated equitably.
There are
conflicts of interest in our relationships with our Manager and
Bimini, which could result in decisions that are not in the best
interests of our stockholders.
We are subject to conflicts of interest arising out of our
relationship with Bimini and our Manager. All of our executive
officers are employees of Bimini. As a result, our officers may
have conflicts between their duties to us and their duties to
Bimini or our Manager.
We may acquire or sell assets in which Bimini or its affiliates
have or may have an interest. Similarly, Bimini or its
affiliates may acquire or sell assets in which we have or may
have an interest. Although such acquisitions or dispositions may
present conflicts of interest, we nonetheless may pursue and
consummate such transactions. Additionally, we may engage in
transactions directly with Bimini or its affiliates, including
the purchase and sale of all or a portion of a portfolio asset.
For example, on March 31, 2011, we purchased Agency RMBS
from Bimini for a purchase price of approximately
$1.1 million.
Acquisitions made for entities with similar objectives may be
different from those made on our behalf. Bimini may have
economic interests in or other relationships with others in
whose obligations or securities we may acquire. In particular,
such persons may make
and/or hold
an investment in securities that we acquire that may be pari
passu, senior or junior in ranking to our interest in the
securities or in which partners, security holders, officers,
directors, agents or employees of such persons serve on the
board of directors or otherwise have ongoing relationships. Each
of such ownership and other relationships may result in
securities laws restrictions on transactions in such securities
and otherwise create conflicts of interest. In such instances,
our Manager may, in its sole discretion, make recommendations
and decisions regarding such securities for other entities that
may be the same as or different from those made to or for us
with respect to such securities and may take actions (or omit to
take actions) in the context of these other economic interests
or relationships the consequences of which may be adverse to our
interests.
40
The officers of Bimini and our Manager devote as much time to us
as Bimini and our Manager deem appropriate. However, these
officers may have conflicts in allocating their time and
services among us and Bimini and our Manager. During turbulent
conditions in the mortgage industry, distress in the credit
markets or other times when we will need focused support and
assistance from our Managers and Biminis employees,
Bimini and other entities for which our Manager may serve as a
manager in the future, will likewise require greater focus and
attention, placing our Managers and Biminis
resources in high demand. In such situations, we may not receive
the necessary support and assistance we require or would
otherwise receive if we were internally managed.
We, directly or through Bimini or our Manager, may obtain
confidential information about the companies or securities in
which we have invested or may invest. If we do possess
confidential information about such companies or securities,
there may be restrictions on our ability to dispose of, increase
the amount of, or otherwise take action with respect to the
securities of such companies. Our Managers management of
other accounts could create a conflict of interest to the extent
our Manager or Bimini is aware of material non-public
information concerning potential investment decisions. We have
implemented compliance procedures and practices designed to
ensure that investment decisions are not made while in
possession of material non-public information. We cannot assure
you, however, that these procedures and practices will be
effective. In addition, this conflict and these procedures and
practices may limit the freedom of our Manager to make
potentially profitable investments, which could have an adverse
effect on our operations. These limitations imposed by access to
confidential information could therefore materially adversely
affect our business, financial condition and results of
operations and our ability to make distributions to our
stockholders.
John B. Van Heuvelen, one of our independent director
nominees, owns shares of common stock of Bimini.
Mr. Cauley, our Chief Executive Officer and Chairman of our
Board of Directors, also serves as Chief Executive Officer and
Chairman of the Board of Directors of Bimini and owns shares of
common stock of Bimini. Mr. Haas, our Chief Financial
Officer, Chief Investment Officer, Secretary and a member of our
Board of Directors, also serves as the Chief Financial Officer,
Chief Investment Officer and Treasurer of Bimini and owns shares
of common stock of Bimini. Accordingly,
Messrs. Van Heuvelen, Cauley and Haas may have a
conflict of interest with respect to actions by our Board of
Directors that relate to Bimini or our Manager.
Bimini will own 12.42% of our outstanding shares of common stock
upon completion of this offering. In evaluating opportunities
for us and other management strategies, this may lead our
Manager to emphasize certain asset acquisition, disposition or
management objectives over others, such as balancing risk or
capital preservation objectives against return objectives. This
could increase the risks, or decrease the returns, of your
investment.
If we elect to
not renew the management agreement without cause, we would be
required to pay our Manager a substantial termination fee. These
and other provisions in our management agreement make
non-renewal of our management agreement difficult and
costly.
Electing not to renew the management agreement without cause
would be difficult and costly for us. With the consent of the
majority of our independent directors, we may elect not to renew
our management agreement after the initial term of the
management agreement, which expires
on ,
2014, or upon the expiration of any automatic renewal term, both
upon
180-days
prior written notice. If we elect to not renew the agreement
because of a decision by our Board of Directors that the
management fee is unfair, our Manager has the right to
renegotiate a mutually agreeable management fee. If we elect to
not renew the management agreement without cause, we are
required to pay our Manager a termination fee equal to three
times the average annual management fee earned by our Manager
during the prior
24-month
period immediately preceding the most recently completed
calendar quarter prior to the effective date of termination.
These provisions may increase the effective cost to us of
electing to not renew the management agreement, thereby
adversely affecting our inclination to end our relationship with
our Manager even if we believe our Managers performance is
unsatisfactory.
41
Our
Managers management fee is payable regardless of our
performance.
Our Manager is entitled to receive a management fee from us that
is based on the amount of our equity (as defined in the
management agreement), regardless of the performance of our
investment portfolio. See Prospectus Summary
Our Management Agreement. For example, we would pay our
Manager a management fee for a specific period even if we
experienced a net loss during the same period. Our
Managers entitlement to substantial nonperformance-based
compensation may reduce its incentive to devote sufficient time
and effort to seeking investments that provide attractive
risk-adjusted returns for our investment portfolio. This in turn
could materially adversely affect our business, financial
condition and results of operations and our ability to make
distributions to our stockholders.
Our Manager
will not be liable to us for any acts or omissions performed in
accordance with the management agreement, including with respect
to the performance of our investments.
Our Manager has not assumed any responsibility other than to
render the services called for under the management agreement in
good faith and is not responsible for any action of our Board of
Directors in following or declining to follow its advice or
recommendations, including as set forth in the investment
guidelines. Our Manager and its affiliates, and the directors,
officers, employees, members and stockholders of our Manager and
its affiliates, will not be liable to us, our Board of Directors
or our stockholders for any acts or omissions performed in
accordance with and pursuant to the management agreement, except
by reason of acts constituting bad faith, willful misconduct,
gross negligence or reckless disregard of their respective
duties under the management agreement. We have agreed to
indemnify our Manager and its affiliates, and the directors,
officers, employees, members and stockholders of our Manager and
its affiliates, with respect to all expenses, losses, damages,
liabilities, demands, charges and claims in respect of or
arising from any acts or omissions of our Manager, its
affiliates, and the directors, officers, employees, members and
stockholders of our Manager and its affiliates, performed in
good faith under the management agreement and not constituting
bad faith, willful misconduct, gross negligence, or reckless
disregard of their respective duties. Therefore, you will have
no recourse against our Manager with respect to the performance
of investments made in accordance with the management agreement.
Risks Related to
Our Common Stock
Investing in
our common stock may involve a high degree of
risk.
The investments we make in accordance with our investment
objectives may result in a high amount of risk when compared to
alternative investment options and volatility or loss of
principal. Our investments may be highly speculative and
aggressive, and therefore an investment in our common stock may
not be suitable for someone with a lower risk tolerance.
There may not
be an active market for our common stock, which may cause our
common stock to trade at a discount and make it difficult to
sell the common stock you purchase.
Prior to this offering, there has been no public market for our
common stock. The initial public offering price for our common
stock will be determined by negotiations between the
underwriters and us. The initial public offering price may not
correspond to the price at which our common stock will trade in
the public market subsequent to this offering and the price of
our shares available in the public market may not reflect our
actual financial performance.
We have applied to have our common stock approved for listing on
the NYSE under the symbol ORC. Trading on the NYSE
will not ensure that an actual market will develop for our
common stock. Accordingly, no assurance can be given as to:
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the likelihood that an actual market for our common stock will
develop;
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the liquidity of any such market;
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the ability of any holder to sell shares of our common stock; or
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the prices that may be obtained for our common stock.
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We have not
established a minimum distribution payment level, and we cannot
assure you of our ability to make distributions to our
stockholders in the future.
We intend to make quarterly distributions to our stockholders in
amounts such that we distribute all or substantially all of our
taxable income in each year, subject to certain adjustments. We
have not established a minimum distribution payment level, and
our ability to make distributions might be harmed by the risk
factors described in this prospectus. All distributions will be
made at the discretion of our Board of Directors out of funds
legally available therefor and will depend on our earnings, our
financial condition, qualifying and maintaining our
qualification as a REIT and such other factors as our Board of
Directors may deem relevant from time to time. We cannot assure
you that we will have the ability to make distributions to our
stockholders in the future. To the extent that we decide to pay
distributions from the proceeds from this offering or other
securities offerings, such distributions would generally be
considered a return of capital for U.S. federal income tax
purposes. A return of capital reduces the basis of a
stockholders investment in our common stock to the extent
of such basis and is treated as capital gain thereafter.
The issuance
of common stock issuable upon exercise of the warrants we intend
to sell to Bimini in the concurrent private placement may
substantially dilute your holdings and may, therefore, reduce
the value of our common stock.
We intend to sell to Bimini in a concurrent private placement
warrants to purchase 4,500,000 shares of our common stock. These
warrants likely will be exercised if the market price of our
common stock equals or exceeds the exercise price of the
warrants. The issuance of shares of our common stock to Bimini
pursuant to the exercise of its warrants may substantially
dilute your holdings as follows: (i) the issuance of shares
of common stock to Bimini may decrease our earnings per share,
(ii) the issuance of shares of common stock to Bimini may
decrease our book value per share, and (iii) the issuance
of shares of common stock to Bimini will dilute your voting
interests. These dilutive events could cause a significant
reduction in the value of our common stock.
Future
offerings of debt securities, which would be senior to our
common stock upon liquidation, or equity securities, which would
dilute our existing stockholders and may be senior to our common
stock for the purposes of distributions, may harm the value of
our common stock.
In the future, we may attempt to increase our capital resources
by making additional offerings of debt or equity securities,
including commercial paper, medium-term notes, senior or
subordinated notes and classes of preferred stock or common
stock, as well as warrants to purchase shares of common stock or
convertible preferred stock. Upon the liquidation of the
Company, holders of our debt securities and shares of preferred
stock and lenders with respect to other borrowings will receive
a distribution of our available assets prior to the holders of
our common stock. Additional equity offerings by us may dilute
the holdings of our existing stockholders or reduce the market
value of our common stock, or both. Our preferred stock, if
issued, would have a preference on distributions that could
limit our ability to make distributions to the holders of our
common stock. Because our decision to issue securities in any
future offering will depend on market conditions and other
factors beyond our control, we cannot predict or estimate the
amount, timing or nature of our future offerings. Our
stockholders are therefore subject to the risk of our future
securities offerings reducing the market price of our common
stock and diluting their common stock.
The market
value of our common stock may be volatile following this
offering.
The market value of shares of our common stock may be based
primarily upon current and future cash dividends, and the market
price of shares of our common stock will be influenced by the
dividends on those shares relative to market interest rates.
Rising interest rates may lead potential buyers of our common
stock to expect a higher dividend rate, which would adversely
affect the market price of shares of our common stock. As a
result, the market price of our common stock may be highly
volatile and subject to wide price fluctuations. In addition,
the trading volume in our common
43
stock may fluctuate and cause significant price variations to
occur. Some of the factors that could negatively affect the
share price or trading volume of our common stock include:
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actual or anticipated variations in our quarterly operating
results or distributions;
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changes in our earnings estimates or publication of research
reports about us or the real estate or specialty finance
industry;
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increases in market interest rates that lead purchasers of our
common stock to demand a higher dividend yield;
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the exercise of the warrants we intend to sell to Bimini in the
concurrent private placement;
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changes in market valuations of similar companies;
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adverse market reaction to any increased indebtedness we incur
in the future;
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a change in our Manager or additions or departures of key
management personnel;
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actions by institutional stockholders;
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speculation in the press or investment community; and
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general market and economic conditions.
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If the market price of our common stock declines significantly,
you may be unable to resell your shares at or above the offering
price. We cannot assure you that the market price of our common
stock will not fluctuate or decline significantly in the future.
Broad market
fluctuations could harm the market price of our common
stock.
The stock market has experienced extreme price and volume
fluctuations in the past that have affected the market price of
many companies in industries similar or related to ours and that
have been unrelated to these companies operating
performances. These broad market fluctuations could occur again
and could reduce the market price of our common stock.
Furthermore, our operating results and prospects may be below
the expectations of public market analysts and investors or may
be lower than those of companies with comparable market
capitalizations, which could harm the market price of our common
stock.
Shares of our
common stock eligible for future sale may harm our share
price.
We cannot predict the effect, if any, of future sales of shares
of our common stock, or the availability of shares for future
sales, on the market price of our common stock. Sales of
substantial amounts of these shares of our common stock, or the
perception that these sales could occur, may harm prevailing
market prices for our common stock. Prior to the completion of
this offering, Bimini will own 1,063,830 shares of our
common stock (after giving effect to the stock dividend we
intend to effect prior to the completion of this offering) and,
upon completion of this offering and the concurrent private
placement, we intend to sell to Bimini warrants to purchase
4,500,000 shares of our common stock. The 2011 Equity
Incentive Plan provides for grants up to an aggregate of 10% of
the issued and outstanding shares of our common stock (on a
fully diluted basis) at the time of the award, subject to a
maximum aggregate number of shares of common stock that may be
issued under the 2011 Equity Incentive Plan of
4,000,000 shares of common stock. Pursuant to the
registration rights agreement, upon the first anniversary of the
completion of this offering, we will grant to (i) Bimini
and its transferees demand registration rights to have its
shares of our common stock, including shares of our common stock
issuable upon the exercise of the warrants we intend to sell to
Bimini in the concurrent private placement, registered for
resale, provided that no holder may request more than two demand
registrations, and, (ii) solely Bimini, in certain
circumstances, the right to piggy-back these shares
in registration statements we might file in connection with any
future public offering, so long as Bimini holds these shares. If
Bimini sells a large number of our securities in the public
market, the sale could reduce the market price of our common
stock and could impede our ability to raise future capital.
44
You should not
rely on
lock-up
agreements in connection with this offering to limit the amount
of common stock sold into the market.
We and each of our Manager, our directors and executive officers
will agree that, for a period of 180 days after the date of
this prospectus, without the prior written consent of Barclays
Capital Inc., we and they will not sell, dispose of or hedge any
shares of our common stock, subject to certain exceptions and
extensions in certain circumstances. Bimini will agree that, for
a period of 365 days after the date of this prospectus, it
will not, without the prior written consent of Barclays Capital
Inc., dispose of or hedge any of (i) its shares of our common
stock, including any shares of our common stock issuable upon
the exercise of the warrants it intends to purchase in the
concurrent private placement, (ii) the warrants that it intends
to purchase in the concurrent private placement or (iii) any
shares of our common stock that it may acquire after completion
of this offering, subject to certain exceptions and extension in
certain circumstances.
There are no present agreements between Barclays Capital Inc.
and any of Bimini, our Manager, our directors, our executive
officers or us to release any of them or us from these
lock-up
agreements. However, we cannot predict the circumstances or
timing under which Barclays Capital Inc. may waive these
restrictions. These sales or a perception that these sales may
occur could reduce the market price of our common stock.
An increase in
market interest rates may cause a material decrease in the
market price of our common stock.
One of the factors that investors may consider in deciding
whether to buy or sell shares of our common stock is our
distribution rate as a percentage of our share price relative to
market interest rates. If the market price of our common stock
is based primarily on the earnings and return that we derive
from our investments and income with respect to our investments
and our related distributions to stockholders, and not from the
market value of the investments themselves, then interest rate
fluctuations and capital market conditions are likely to
adversely affect the market price of our common stock. For
instance, if market rates rise without an increase in our
distribution rate, the market price of our common stock could
decrease as potential investors may require a higher
distribution yield on our common stock or seek other securities
paying higher distributions or interest. In addition, rising
interest rates would result in increased interest expense on our
variable rate debt, thereby reducing cash flow and our ability
to service our indebtedness and pay distributions.
Risks Related to
Our Organization and Structure
Loss of our
exemption from regulation under the Investment Company Act would
negatively affect the value of shares of our common stock and
our ability to pay distributions to our
stockholders.
We have operated and intend to continue to operate our business
so as to be exempt from registration under the Investment
Company Act because we are primarily engaged in the
business of purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate. Specifically,
we invest and intend to continue to invest so that at least 55%
of the assets that we own on an unconsolidated basis consist of
qualifying mortgages and other liens and interests in real
estate, which are collectively referred to as qualifying
real estate assets, and so that at least 80% of the assets
we own on an unconsolidated basis consist of real estate related
assets (including our qualifying real estate assets). We treat
Fannie Mae, Freddie Mac and Ginnie Mae whole-pool residential
mortgage pass-through securities issued with respect to an
underlying pool of mortgage loans in which we hold all of the
certificates issued by the pool as qualifying real estate assets
based on no-action letters issued by the SEC. To the extent that
the SEC publishes new or different guidance with respect to
these matters, we may fail to qualify for this exemption.
If we fail to qualify for this exemption, we could be required
to restructure our activities in a manner that, or at a time
when, we would not otherwise choose to do so, which could
negatively affect the value of shares of our common stock and
our ability to distribute dividends. For example, if the market
value of our investments in CMOs or structured Agency RMBS,
neither of which are qualifying real estate
45
assets, were to increase by an amount that resulted in less
than 55% of our assets being invested in pass-through Agency
RMBS, we might have to sell CMOs or structured Agency RMBS in
order to maintain our exemption from the Investment Company Act.
The sale could occur during adverse market conditions, and we
could be forced to accept a price below that which we believe is
acceptable.
Alternatively, if we fail to qualify for this exemption, we may
have to register under the Investment Company Act and we could
become subject to substantial regulation with respect to our
capital structure (including our ability to use leverage),
management, operations, transactions with affiliated persons (as
defined in the Investment Company Act), portfolio composition,
including restrictions with respect to diversification and
industry concentration, and other matters.
We may be required at times to adopt less efficient methods of
financing certain of our securities, and we may be precluded
from acquiring certain types of higher yielding securities. The
net effect of these factors would be to lower our net interest
income. If we fail to qualify for an exemption from registration
as an investment company or an exclusion from the definition of
an investment company, our ability to use leverage would be
substantially reduced, and we would not be able to conduct our
business as described in this prospectus. Our business will be
materially and adversely affected if we fail to qualify for and
maintain an exemption from regulation pursuant to the Investment
Company Act.
Our ownership
limitations and certain other provisions of applicable law and
our charter and bylaws may restrict business combination
opportunities that would otherwise be favorable to our
stockholders.
Our charter and bylaws and Maryland law contain provisions that
may delay, defer or prevent a change in control or other
transaction that might involve a premium price for our common
stock or otherwise be in the best interests of our stockholders,
including business combination provisions, supermajority vote
and cause requirements for removal of directors, provisions that
vacancies on our Board of Directors may be filled only by the
remaining directors, for the full term of the directorship in
which the vacancy occurred, the power of our Board of Directors
to increase or decrease the aggregate number of authorized
shares of stock or the number of shares of any class or series
of stock, to cause us to issue additional shares of stock of any
class or series and to fix the terms of one or more classes or
series of stock without stockholder approval, the restrictions
on ownership and transfer of our stock and advance notice
requirements for director nominations and stockholder proposals.
Upon the closing of this offering, to assist us in qualifying as
a REIT, among other purposes, ownership of our stock by any
person will generally be limited to 9.8% in value or number of
shares, whichever is more restrictive, of any class or series of
our stock, except that Bimini may own up to 44% of our common
stock so long as Bimini continues to qualify as a REIT.
Additionally, our charter will prohibit beneficial or
constructive ownership of our stock that would otherwise result
in our failure to qualify as a REIT. The ownership rules in our
charter are complex and may cause the outstanding stock owned by
a group of related individuals or entities to be deemed to be
owned by one individual or entity. As a result, these ownership
rules could cause an individual or entity to unintentionally own
shares beneficially or constructively in excess of our ownership
limits. Any attempt to own or transfer shares of our common or
preferred stock in excess of our ownership limits without the
consent of our Board of Directors will result in such shares
being transferred to a charitable trust. These provisions may
inhibit market activity and the resulting opportunity for our
stockholders to receive a premium for their stock that might
otherwise exist if any person were to attempt to assemble a
block of shares of our stock in excess of the number of shares
permitted under our charter and which may be in the best
interests of our security holders.
Our Board of Directors may, without stockholder approval, amend
our charter to increase or decrease the aggregate number of our
shares or the number of shares of any class or series that we
have the authority to issue and to classify or reclassify any
unissued shares of common stock or preferred stock, and set the
preferences, rights and other terms of the classified or
reclassified shares. As a result, our Board of Directors may
take actions with respect to our common or preferred stock that
may have the effect of delaying or preventing a change in
control, including transactions at a premium over the market
price of our shares, even if stockholders believe that a change
in control is in their interest. These provisions, along with
the restrictions on ownership and transfer contained in our
46
charter and certain provisions of Maryland law described below,
could discourage unsolicited acquisition proposals or make it
more difficult for a third party to gain control of us, which
could adversely affect the market price of our securities. See
Certain Provisions of Maryland Law and of Our Charter and
Bylaws.
Our rights and
the rights of our stockholders to take action against our
directors and officers are limited, which could limit your
recourse in the event of actions not in your best
interests.
Our charter will limit the liability of our directors and
officers to us and our stockholders for money damages, except
for liability resulting from:
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actual receipt of an improper benefit or profit in money,
property or services; or
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a final judgment based upon a finding of active and deliberate
dishonesty by the director or officer that was material to the
cause of action adjudicated.
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We will enter into indemnification agreements with our directors
and executive officers that obligate us to indemnify them to the
maximum extent permitted by Maryland law. In addition, our
charter will authorize the Company to obligate itself to
indemnify our present and former directors and officers for
actions taken by them in those and other capacities to the
maximum extent permitted by Maryland law. Our bylaws will
require us, to the maximum extent permitted by Maryland law, to
indemnify each present and former director or officer in the
defense of any proceeding to which he or she is made, or
threatened to be made, a party by reason of his or her service
to us. In addition, we may be obligated to advance the defense
costs incurred by our directors and officers. As a result, we
and our stockholders may have more limited rights against our
directors and officers than might otherwise exist absent the
provisions in our charter, bylaws and indemnification agreements
or that might exist with other companies. See Certain
Provisions of Maryland Law and of our Charter and
Bylaws Limitation of Directors and
Officers Liability and Indemnification.
Certain
provisions of Maryland law could inhibit changes in
control.
Certain provisions of the Maryland General Corporation Law, or
the MGCL, may have the effect of inhibiting a third party from
making a proposal to acquire us or impeding a change of control
under circumstances that otherwise could provide our
stockholders with the opportunity to realize a premium over the
then-prevailing market price of our common stock, including:
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business combination provisions that, subject to
limitations, prohibit certain business combinations between us
and an interested stockholder (defined generally as
any person who beneficially owns 10% or more of the voting power
of our outstanding voting stock or an affiliate or associate of
ours who, at any time within the two-year period immediately
prior to the date in question, was the beneficial owner of 10%
or more of the voting power of our then outstanding stock) or an
affiliate of an interested stockholder for five years after the
most recent date on which the stockholder becomes an interested
stockholder, and thereafter require two supermajority
stockholder votes to approve any such combination; and
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control share provisions that provide that a holder
of control shares of the Company (defined as voting
shares of stock which, when aggregated with all other shares of
stock owned by the acquiror or in respect of which the acquiror
is able to exercise or direct the exercise of voting power
(except solely by virtue of a revocable proxy), entitle the
acquiror to exercise one of three increasing ranges of voting
power in electing directors) acquired in a control share
acquisition (defined as the direct or indirect acquisition
of ownership or control of control shares, subject
to certain exceptions) generally have no voting rights with
respect to the control shares except to the extent approved by
our stockholders by the affirmative vote of two-thirds of all
the votes entitled to be cast on the matter, excluding all
interested shares.
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We will elect to opt-out of these provisions of the MGCL, in the
case of the business combination provisions of the MGCL, by
resolution of our Board of Directors (provided that such
business combination is first approved by our Board of
Directors, including a majority of our directors who are not
affiliates or associates of such person), and in the case of the
control share provisions of the MGCL, pursuant to a provision in
our bylaws. However, our Board of Directors may by resolution
elect to repeal the foregoing opt-out from the business
combination provisions of the MGCL, and we may, by amendment to
our bylaws, opt in to the control share provisions of the MGCL
in the future.
We may be
subject to adverse legislative or regulatory changes that could
reduce the market price of our common stock.
At any time, laws or regulations, or the administrative
interpretations of those laws or regulations, that impact our
business and Maryland corporations may be amended. In addition,
the markets for RMBS and derivatives, including interest rate
swaps, have been the subject of intense scrutiny in recent
months. We cannot predict when or if any new law, regulation or
administrative interpretation, or any amendment to any existing
law, regulation or administrative interpretation, will be
adopted or promulgated or will become effective. Additionally,
revision to these laws, regulations or administrative
interpretations could cause us to change our investments. We
could be materially adversely affected by any such change to any
existing, or any new, law, regulation or administrative
interpretation, which could reduce the market price of our
common stock.
U.S. Federal
Income Tax Risks
Your
investment has various U.S. federal income tax
risks.
Although the provisions of the Code relevant to your investment
are generally described in Material U.S. Federal
Income Tax Considerations, we strongly urge you to consult
your own tax advisor concerning the effects of federal, state
and local income tax law on an investment in our common stock
and on your individual tax situation.
Our failure to
qualify or maintain our qualification as a REIT would subject us
to U.S. federal income tax, which could adversely affect the
value of the shares of our common stock and would substantially
reduce the cash available for distribution to our
stockholders.
We believe that we will be organized in conformity with the
requirements for qualification as a REIT under the Code, and we
intend to operate in a manner that will enable us to meet the
requirements for qualification and taxation as a REIT commencing
with our short taxable year ending December 31, 2011.
However, we cannot assure you that we will qualify and remain
qualified as a REIT. In connection with this offering, we will
receive an opinion from Hunton & Williams LLP that,
commencing with our short taxable year ending December 31,
2011, we will be organized in conformity with the requirements
for qualification and taxation as a REIT under the
U.S. federal income tax laws and our intended method of
operations will enable us to satisfy the requirements for
qualification and taxation as a REIT under the U.S. federal
income tax laws for our short taxable year ending
December 31, 2011 and subsequent taxable years. Investors
should be aware that Hunton & Williams LLPs
opinion is based upon customary assumptions, will be conditioned
upon certain representations made by us as to factual matters,
including representations regarding the nature of our assets and
the conduct of our business, is not binding upon the Internal
Revenue Service, or the IRS, or any court and speaks as of the
date issued. In addition, Hunton & Williams LLPs
opinion will be based on existing U.S. federal income tax
law governing qualification as a REIT, which is subject to
change either prospectively or retroactively. Moreover, our
qualification and taxation as a REIT will depend upon our
ability to meet on a continuing basis, through actual annual
operating results, certain qualification tests set forth in the
U.S. federal tax laws. Hunton & Williams LLP will
not review our compliance with those tests on a continuing
basis. Accordingly, given the complex nature of the rules
governing REITs, the ongoing importance of factual
determinations, including the potential tax treatment of
investments we make, and the possibility of future changes in
our circumstances, no assurance can be given that our actual
results of operations for any particular taxable year will
satisfy such requirements.
48
If we fail to qualify as a REIT in any calendar year, we would
be required to pay U.S. federal income tax (and any
applicable state and local tax), including any applicable
alternative minimum tax, on our taxable income at regular
corporate rates, and dividends paid to our stockholders would
not be deductible by us in computing our taxable income
(although such dividends received by certain non-corporate
U.S. taxpayers generally would be subject to a preferential
rate of taxation through December 31, 2012). Further, if we
fail to qualify as a REIT, we might need to borrow money or sell
assets in order to pay any resulting tax. Our payment of income
tax would decrease the amount of our income available for
distribution to our stockholders. Furthermore, if we fail to
maintain our qualification as a REIT, we no longer would be
required under U.S. federal tax laws to distribute
substantially all of our REIT taxable income to our
stockholders. Unless our failure to qualify as a REIT was
subject to relief under U.S. federal tax laws, we could not
re-elect to qualify as a REIT until the fifth calendar year
following the year in which we failed to qualify.
Complying with
REIT requirements may cause us to forego or liquidate otherwise
attractive investments.
To qualify as a REIT, we must continually satisfy various tests
regarding the sources of our income, the nature and
diversification of our assets, the amounts we distribute to our
stockholders and the ownership of our stock. In order to meet
these tests, we may be required to forego investments we might
otherwise make. Thus, compliance with the REIT requirements may
hinder our investment performance.
In particular, we must ensure that at the end of each calendar
quarter, at least 75% of the value of our total assets consists
of cash, cash items, government securities and qualified REIT
real estate assets, including Agency RMBS. The remainder of our
investment in securities (other than government securities and
qualified real estate assets) generally cannot include more than
10% of the outstanding voting securities of any one issuer or
more than 10% of the total value of the outstanding securities
of any one issuer. In addition, in general, no more than 5% of
the value of our total assets (other than government securities,
TRS securities, and qualified real estate assets) can consist of
the securities of any one issuer, and no more than 25% of the
value of our total assets can be represented by securities of
one or more TRSs. Generally, if we fail to comply with these
requirements at the end of any calendar quarter, we must correct
the failure within 30 days after the end of the calendar
quarter or qualify for certain statutory relief provisions to
avoid losing our REIT qualification and becoming subject to
U.S. federal income tax (and any applicable state and local
taxes) on all of our income. As a result, we may be required to
liquidate from our portfolio otherwise attractive investments or
contribute such investments to a TRS. These actions could have
the effect of reducing our income and amounts available for
distribution to our stockholders.
Failure to
make required distributions would subject us to tax, which would
reduce the cash available for distribution to our
stockholders.
To qualify as a REIT, we must distribute to our stockholders
each calendar year at least 90% of our REIT taxable income
(including certain items of non-cash income), determined without
regard to the deduction for dividends paid and excluding net
capital gain. To the extent that we satisfy the 90% distribution
requirement, but distribute less than 100% of our taxable
income, we will be subject to federal corporate income tax on
our undistributed income. In addition, we will incur a 4%
nondeductible excise tax on the amount, if any, by which our
distributions in any calendar year are less than the sum of:
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85% of our REIT ordinary income for that year;
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95% of our REIT capital gain net income for that year; and
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any undistributed taxable income from prior years.
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We intend to distribute our REIT taxable income to our
stockholders in a manner intended to satisfy the 90%
distribution requirement and to avoid both corporate income tax
and the 4%
49
nondeductible excise tax. However, there is no requirement that
TRSs distribute their after-tax net income to their parent REIT
or their stockholders.
Our taxable income may substantially exceed our net income as
determined based on GAAP, because, for example, realized capital
losses will be deducted in determining our GAAP net income, but
may not be deductible in computing our taxable income. In
addition, we may invest in assets that generate taxable income
in excess of economic income or in advance of the corresponding
cash flow from the assets. As a result of the foregoing, we may
generate less cash flow than taxable income in a particular
year. To the extent that we generate such non-cash taxable
income in a taxable year, we may incur corporate income tax and
the 4% nondeductible excise tax on that income if we do not
distribute such income to stockholders in that year. In that
event, we may be required to use cash reserves, incur debt, sell
assets, make taxable distributions of our stock or debt
securities or liquidate non-cash assets at rates or at times
that we regard as unfavorable to satisfy the distribution
requirement and to avoid corporate income tax and the 4%
nondeductible excise tax in that year.
Even if we
qualify as a REIT, we may face other tax liabilities that reduce
our cash flows.
Even if we qualify for taxation as a REIT, we may be subject to
certain federal, state and local taxes on our income and assets,
including taxes on any undistributed income, tax on income from
some activities conducted as a result of a foreclosure, and
state or local income, property and transfer taxes. In addition,
any TRSs we form will be subject to regular corporate federal,
state and local taxes. Any of these taxes would decrease cash
available for distributions to stockholders.
The failure of
Agency RMBS subject to a repurchase agreement to qualify as real
estate assets would adversely affect our ability to qualify as a
REIT.
We have entered and intend to continue to enter into repurchase
agreements under which we will nominally sell certain of our
Agency RMBS to a counterparty and simultaneously enter into an
agreement to repurchase the sold assets. We believe that for
U.S. federal income tax purposes these transactions will be
treated as secured debt and we will be treated as the owner of
the Agency RMBS that are the subject of any such agreement
notwithstanding that such agreement may transfer record
ownership of such assets to the counterparty during the term of
the agreement. It is possible, however, that the IRS could
successfully assert that we do not own the Agency RMBS during
the term of the repurchase agreement, in which case we could
fail to qualify as a REIT.
Our ability to
invest in and dispose of contracts for delayed delivery
transactions, or delayed delivery contracts, including to
be announced securities, could be limited by the
requirements necessary to qualify as a REIT, and we could fail
to qualify as a REIT as a result of these
investments.
We may purchase Agency RMBS through delayed delivery contracts,
including to-be-announced forward contracts, or
TBAs. We may recognize income or gains on the disposition of
delayed delivery contracts. For example, rather than take
delivery of the Agency RMBS subject to a TBA, we may dispose of
the TBA through a roll transaction in which we agree
to purchase similar securities in the future at a predetermined
price or otherwise, which may result in the recognition of
income or gains. The law is unclear regarding whether delayed
delivery contracts will be qualifying assets for the 75% asset
test and whether income and gains from dispositions of delayed
delivery contracts will be qualifying income for the 75% gross
income test.
Until we receive a favorable private letter ruling from the IRS
or we are advised by counsel that delayed delivery contracts
should be treated as qualifying assets for purposes of the 75%
asset test, we will limit our investment in delayed delivery
contracts and any non-qualifying assets to no more than 25% of
our total gross assets at the end of any calendar quarter and
will limit the delayed delivery contracts issued by any one
issuer to no more than 5% of our total gross assets at the end
of any calendar quarter. Further, until we receive a favorable
private letter ruling from the IRS or we are advised by counsel
that income and gains from the disposition of delayed delivery
contracts should be treated as qualifying income for purposes of
the 75% gross income test, we will limit our income and
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gains from dispositions of delayed delivery contracts and any
non-qualifying income to no more than 25% of our gross income
for each calendar year. Accordingly, our ability to purchase
Agency RMBS through delayed delivery contracts and to dispose of
delayed delivery contracts through roll transactions or
otherwise, could be limited.
Moreover, even if we are advised by counsel that delayed
delivery contracts should be treated as qualifying assets or
that income and gains from dispositions of delayed delivery
contracts should be treated as qualifying income, it is possible
that the IRS could successfully take the position that such
assets are not qualifying assets and such income is not
qualifying income. In that event, we could be subject to a
penalty tax or we could fail to qualify as a REIT if
(i) the value of our delayed delivery contracts together
with our non-qualifying assets for the 75% asset test, exceeded
25% of our total gross assets at the end of any calendar
quarter, (ii) the value of our delayed delivery contracts,
including TBAs, issued by any one issuer exceeds 5% of our total
assets at the end of any calendar quarter, or (iii) our
income and gains from the disposition of delayed delivery
contracts together with our non-qualifying income for the 75%
gross income test, exceeded 25% of our gross income for any
taxable year.
Complying with
REIT requirements may limit our ability to hedge
effectively.
The REIT provisions of the Code substantially limit our ability
to hedge. Our aggregate gross income from non-qualifying hedges,
fees, and certain other non-qualifying sources cannot exceed 5%
of our annual gross income. As a result, we might have to limit
our use of advantageous hedging techniques or implement those
hedges through a TRS. Any hedging income earned by a TRS would
be subject to federal, state and local income tax at regular
corporate rates. This could increase the cost of our hedging
activities or expose us to greater risks associated with changes
in interest rates than we would otherwise want to bear.
Our ownership
of and relationship with any TRSs that we form will be limited
and a failure to comply with the limits would jeopardize our
REIT status and may result in the application of a 100% excise
tax.
A REIT may own up to 100% of the stock of one or more TRSs. A
TRS may earn income that would not be qualifying income if
earned directly by the parent REIT. Both the subsidiary and the
REIT must jointly elect to treat the subsidiary as a TRS. A
corporation (other than a REIT) of which a TRS directly or
indirectly owns more than 35% of the voting power or value of
the stock will automatically be treated as a TRS. Overall, no
more than 25% of the value of a REITs total assets may
consist of stock or securities of one or more TRSs. A domestic
TRS will pay federal, state and local income tax at regular
corporate rates on any income that it earns. In addition, the
TRS rules limit the deductibility of interest paid or accrued by
a TRS to its parent REIT to assure that the TRS is subject to an
appropriate level of corporate taxation. The rules also impose a
100% excise tax on certain transactions between a TRS and its
parent REIT that are not conducted on an arms length
basis. Any domestic TRS that we may form will pay federal, state
and local income tax on its taxable income, and its after-tax
net income will be available for distribution to us but is not
required to be distributed to us unless necessary to maintain
our REIT qualification.
Dividends
payable by REITs do not qualify for the reduced tax rates
available for some dividends.
The maximum tax rate applicable to income from qualified
dividends payable to domestic stockholders taxed at
individual rates has been reduced by legislation to 15% through
the end of 2012. Dividends payable by REITs, however, generally
are not eligible for the reduced rates. Although this
legislation does not adversely affect the taxation of REITs or
dividends payable by REITs, the more favorable rates applicable
to regular corporate qualified dividends could cause investors
who are taxed at individual rates to perceive investments in
REITs to be relatively less attractive than investments in the
stocks of non-REIT corporations that pay dividends treated as
qualified dividend income, which could adversely affect the
value of the stock of REITs, including our common stock.
51
We may pay
taxable dividends in cash and our common stock, in which case
stockholders may sell shares of our common stock to pay tax on
such dividends, placing downward pressure on the market price of
our common stock.
We may distribute taxable dividends that are payable in cash and
common stock at the election of each stockholder. Under IRS
Revenue Procedure
2010-12, up
to 90% of any such taxable dividend paid with respect to our
2011 taxable year could be payable in shares of our common
stock. Taxable stockholders receiving such dividends will be
required to include the full amount of the dividend as ordinary
income to the extent of our current or accumulated earnings and
profits, as determined for U.S. federal income tax
purposes. As a result, stockholders may be required to pay
income tax with respect to such dividends in excess of the cash
dividends received. If a U.S. stockholder sells the common
stock that it receives as a dividend in order to pay this tax,
the sales proceeds may be less than the amount included in
income with respect to the dividend, depending on the market
price of our common stock at the time of the sale. Furthermore,
with respect to certain
non-U.S. stockholders,
the applicable withholding agent may be required to withhold
U.S. federal income tax with respect to such dividends,
including in respect of all or a portion of such dividend that
is payable in common stock. If we utilize Revenue Procedure
2010-12 and
a significant number of our stockholders determine to sell
shares of our common stock in order to pay taxes owed on
dividends, it may put downward pressure on the trading price of
our common stock. Further, although Revenue Procedure
2010-12
applies only to taxable dividends payable in cash and stock with
respect to our 2011 taxable year, it is unclear whether and to
what extent we will be able to pay taxable dividends payable in
cash and our stock in later years. Moreover, various tax aspects
of taxable cash/stock dividends are uncertain and have not yet
been addressed by the IRS. No assurance can be given that the
IRS will not impose additional requirements in the future with
respect to taxable cash/stock dividends, including on a
retroactive basis, or assert that the requirements for such
taxable cash/stock dividends have not been met. We currently do
not intend to pay taxable dividends payable in cash and our
stock.
Our ownership
limitations may restrict change of control or business
combination opportunities in which our stockholders might
receive a premium for their stock.
In order for us to qualify as a REIT for each taxable year after
2011, no more than 50% in value of our outstanding stock may be
owned, directly or indirectly, by five or fewer individuals
during the last half of any calendar year.
Individuals for this purpose include natural
persons, private foundations, some employee benefit plans and
trusts, and some charitable trusts. In order to assist us in
qualifying as a REIT, among other purposes, ownership of our
stock by any person is generally limited to 9.8% in value or
number of shares, whichever is more restrictive, of any class or
series of our stock, except that Bimini may own up to 44% of our
common stock so long as Bimini continues to qualify as a REIT.
These ownership limitations could have the effect of
discouraging a takeover or other transaction in which holders of
our common stock might receive a premium for their common stock
over the then-prevailing market price or which holders might
believe to be otherwise in their best interests.
We may be
subject to adverse legislative or regulatory tax changes that
could reduce the market price of our common stock.
At any time, the U.S. federal income tax laws or
regulations governing REITs or the administrative
interpretations of those laws or regulations may be amended. We
cannot predict when or if any new U.S. federal income tax
law, regulation or administrative interpretation, or any
amendment to any existing U.S. federal income tax law,
regulation or administrative interpretation, will be adopted,
promulgated or become effective and any such law, regulation or
interpretation may take effect retroactively. We and our
stockholders could be adversely affected by any such change in,
or any new, U.S. federal income tax law, regulation or
administrative interpretation.
52
Certain
financing activities may subject us to U.S. federal income tax
and could have negative tax consequences for our
stockholders.
We currently do not intend to enter into any transactions that
could result in our, or a portion of our assets, being treated
as a taxable mortgage pool for U.S. federal income tax
purposes. If we enter into such a transaction in the future, we
will be taxable at the highest corporate income tax rate on a
portion of the income arising from a taxable mortgage pool,
referred to as excess inclusion income, that is
allocable to the percentage of our stock held in record name by
disqualified organizations (generally tax-exempt entities that
are exempt from the tax on unrelated business taxable income,
such as state pension plans, charitable remainder trusts and
government entities). In that case, under our charter, we will
reduce distributions to such stockholders by the amount of tax
paid by us that is attributable to such stockholders
ownership.
If we were to realize excess inclusion income, IRS guidance
indicates that the excess inclusion income would be allocated
among our stockholders in proportion to our dividends paid.
Excess inclusion income cannot be offset by losses of our
stockholders. If the stockholder is a tax-exempt entity and not
a disqualified organization, then this income would be fully
taxable as unrelated business taxable income under
Section 512 of the Code. If the stockholder is a foreign
person, it would be subject to U.S. federal income tax at
the maximum tax rate and withholding will be required on this
income without reduction or exemption pursuant to any otherwise
applicable income tax treaty.
Our
recognition of phantom income may reduce a
stockholders after-tax return on an investment in our
common stock.
We may recognize taxable income in excess of our economic
income, known as phantom income, in the first years that we hold
certain investments, and experience an offsetting excess of
economic income over our taxable income in later years. As a
result, stockholders at times may be required to pay
U.S. federal income tax on distributions that economically
represent a return of capital rather than a dividend. These
distributions would be offset in later years by distributions
representing economic income that would be treated as returns of
capital for U.S. federal income tax purposes. Taking into
account the time value of money, this acceleration of
U.S. federal income tax liabilities may reduce a
stockholders after-tax return on his or her investment to
an amount less than the after-tax return on an investment with
an identical before-tax rate of return that did not generate
phantom income.
Liquidation of
our assets may jeopardize our REIT qualification.
To qualify and maintain our qualification as a REIT, we must
comply with requirements regarding our assets and our sources of
income. If we are compelled to liquidate our assets to repay
obligations to our lenders, we may be unable to comply with
these requirements, thereby jeopardizing our qualification as a
REIT, or we may be subject to a 100% tax on any resultant gain
if we sell assets that are treated as inventory or property held
primarily for sale to customers in the ordinary course of
business.
Our
qualification as a REIT and exemption from U.S. federal income
tax with respect to certain assets may be dependent on the
accuracy of legal opinions or advice rendered or given or
statements by the issuers of assets that we acquire, and the
inaccuracy of any such opinions, advice or statements may
adversely affect our REIT qualification and result in
significant corporate-level tax.
When purchasing securities, we may rely on opinions or advice of
counsel for the issuer of such securities, or statements made in
related offering documents, for purposes of determining whether
such securities represent debt or equity securities for
U.S. federal income tax purposes, the value of such
securities, and also to what extent those securities constitute
qualified real estate assets for purposes of the REIT asset
tests and produce income which qualifies under the 75% gross
income test. The inaccuracy of any such opinions, advice or
statements may adversely affect our REIT qualification and
result in significant corporate-level tax.
53
USE OF
PROCEEDS
We estimate that the net proceeds from this offering and the
concurrent private placement will be approximately
$81.7 million (or approximately $93.6 million if the
underwriters fully exercise their option to purchase additional
shares), after deducting the portion of the underwriting
discount and commissions payable by us of approximately
$2.5 million (or approximately $2.9 million if the
underwriters fully exercise their option to purchase additional
shares) and estimated offering expenses of approximately
$825,000 payable by us. A $1.00 increase (decrease) in the
assumed public offering price of $11.00 per share would
increase (decrease) the net proceeds that we will receive from
this offering and the concurrent private placement by
$7.2 million, assuming the number of shares offered by us,
as set forth on the front cover of this prospectus, remains the
same and after deducting the portion of the underwriting
discount and commissions payable by us and estimated offering
expenses payable by us.
Our obligation to pay for the expenses of this offering will be
capped at 1.0% of the total gross proceeds from this offering.
Our Manager will (i) pay the underwriters
$ per share with respect to
each share of common stock sold in this offering on a deferred
basis after the completion of this offering and (ii) pay
the offering expenses that exceed an amount equal to 1.0% of the
total gross proceeds from this offering.
We intend to invest the net proceeds of this offering and the
concurrent private placement in (i) pass-through Agency
RMBS backed by hybrid ARMs, ARMs and fixed-rate mortgage loans
and (ii) structured Agency RMBS. Specifically, we intend to
invest the net proceeds of this offering as follows:
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approximately 0% to 50% in pass-through Agency RMBS backed by
fixed-rate mortgage loans;
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approximately 0% to 50% in pass-through Agency RMBS backed by
ARMs;
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approximately 0% to 50% in pass-through Agency RMBS backed by
hybrid ARMs; and
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approximately 25% to 75% in structured Agency RMBS.
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We expect to fully invest the net proceeds of this offering and
the concurrent private placement in Agency RMBS within
approximately three months of closing the offering and, for our
pass-through Agency RMBS portfolio and a certain portion of our
structured Agency RMBS portfolio, to implement our leveraging
strategy within approximately three additional months. We then
expect to borrow against the pass-through Agency RMBS and a
portion of our structured Agency RMBS that we purchase with the
net proceeds of this offering through repurchase agreements and
use the proceeds of the borrowings to acquire additional
pass-through Agency RMBS and structured Agency RMBS in
accordance with a similar targeted allocation. We reserve the
right to change our targeted allocation depending on prevailing
market conditions, including, among others, the pricing and
supply of Agency RMBS and structured Agency RMBS, the
performance of our portfolio and the availability and terms of
financing.
Until these assets can be identified and obtained, we may
temporarily invest the balance of the proceeds of this offering
in interest-bearing short-term investment grade securities or
money market accounts consistent with our intention to qualify
and maintain our qualification as a REIT, or we may hold cash.
These investments are expected to provide a lower net return
than we hope to achieve from our intended investments.
54
DISTRIBUTION
POLICY
We intend to make regular quarterly cash distributions to our
stockholders, as more fully described below. To qualify as a
REIT, we must distribute annually to our stockholders an amount
at least equal to 90% of our REIT taxable income, determined
without regard to the deduction for dividends paid and excluding
any net capital gain. We will be subject to income tax on our
taxable income that is not distributed and to an excise tax to
the extent that certain percentages of our taxable income are
not distributed by specified dates. See Material
U.S. Federal Income Tax Considerations. Income as
computed for purposes of the foregoing tax rules will not
necessarily correspond to our income as determined for financial
reporting purposes.
Any distributions we make will be authorized by and at the
discretion of our Board of Directors based upon a variety of
factors deemed relevant by our directors, which may include:
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actual results of operations;
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our financial condition;
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our level of retained cash flows;
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our capital requirements;
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the timing of the investment of the net proceeds of this
offering and the concurrent private placement;
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any debt service requirements;
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our taxable income;
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the annual distribution requirements under the REIT provisions
of the Code;
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applicable provisions of Maryland law; and
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other factors that our Board of Directors may deem relevant.
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We have not established a minimum distribution payment level,
and we cannot assure you of our ability to make distributions to
our stockholders in the future.
Our charter will authorize us to issue preferred stock that
could have a preference over our common stock with respect to
distributions. We currently have no intention to issue any
preferred stock, but if we do, the distribution preference on
the preferred stock could limit our ability to make
distributions to the holders of our common stock.
Our ability to make distributions to our stockholders will
depend upon the performance of our investment portfolio, and, in
turn, upon our Managers management of our business. To the
extent that our cash available for distribution is less than the
amount required to be distributed under the REIT provisions of
the Code, we may consider various funding sources to cover any
shortfall, including selling certain of our assets, borrowing
funds or using a portion of the net proceeds we receive in this
offering and the concurrent private placement or future
offerings (and thus all or a portion of such distributions may
constitute a return of capital for U.S. federal income tax
purposes). We also may elect to pay all or a portion of any
distribution in the form of a taxable distribution of our stock
or debt securities. We do not currently intend to pay future
distributions from the proceeds of this offering. In addition,
our Board of Directors may change our distribution policy in the
future. See Risk Factors.
55
CAPITALIZATION
The following table sets forth our capitalization as of
March 31, 2011:
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On an as adjusted basis to give effect to (i) the sale of
7,500,000 shares of our common stock in this offering,
assuming a public offering price of $11.00 per share, which is
the mid-point of the price range set forth on the cover of this
prospectus, and after deducting the portion of the
underwriters discount payable by us and estimated offering
expenses payable by us, (ii) the issuance of
1,063,830 shares of our common stock sold to Bimini for
$15.0 million in cash (after giving effect to $7.5 million
investment to be made prior to completion of this offering and
the stock dividend of 7.0922 shares for each share of
common stock that we will effect prior to the completion of this
offering, or the Stock Dividend), (iii) the sale of
warrants to purchase 4,500,000 shares of our common stock in the
concurrent private placement for an aggregate purchase price of
$2,475,000 and (iv) the Stock Dividend.
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You should read this table together with Managements
Discussion and Analysis of Financial Conditions and Results of
Operations and our financial statements and related notes
included elsewhere in this prospectus.
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March 31, 2011
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Actual
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As
Adjusted(1)(2)
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STOCKHOLDERS EQUITY:
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Common stock, $0.01 par value; 1,000,000 shares
authorized; 75,000 shares subscribed, actual; 500,000,000
shares authorized, as adjusted; 8,563,830 shares issued and
outstanding, as adjusted
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$
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750
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$
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85,638
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Preferred stock, $0.01 par value; no shares authorized; no
shares outstanding, actual; 100,000,000 shares authorized and no
shares issued and outstanding, as adjusted
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Additional paid-in capital
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7,499,250
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96,589,362
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(Accumulated deficit) Retained earnings
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(14,082
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)
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(14,082
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)
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TOTAL STOCKHOLDERS EQUITY
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$
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7,485,918
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$
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96,660,918
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(1) |
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The number of shares of common
stock to be outstanding immediately after the closing of this
offering and the concurrent private placement includes
(i) 1,063,830 shares of our common stock that will be
held by Bimini upon completion of this offering, and
(ii) 7,500,000 shares of common stock to be sold in
this offering. Does not include 4,000,000 shares of common
stock reserved for issuance under our 2011 Equity Incentive Plan.
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(2) |
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Does not include the
underwriters option to purchase up to an additional
1,125,000 shares of common stock. Also does not include
4,500,000 shares of common stock issuable upon exercise of
the warrants issued to Bimini in the concurrent private
placement, however, as adjusted additional paid-in capital does
include the $2,475,000 aggregate purchase price of such
warrants. Each warrant will have an exercise price of 110% of
the price per share of the common stock sold in this offering,
will be immediately exercisable and will expire seven years from
the completion of the offering.
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56
DILUTION
Our net tangible book value as of March 31, 2011 was
approximately $7.5 million, or $99.81 per share of our
common stock subscribed. Net tangible book value per share
represents the amount of our total tangible assets minus our
total liabilities, divided by the aggregate shares of our common
stock outstanding (or subscribed for). After giving effect to
(i) the sale of 7,500,000 shares of our common stock
in this offering at an assumed initial public offering price of
$11.00 per share, which is the mid-point of the range set
forth on the cover page of this prospectus, and after deducting
the portion of the underwriting discounts and commissions
payable by us and estimated offering expenses payable by us and
(ii) the sale of warrants to purchase 4,500,000 shares
of our common stock in the concurrent private placement for an
aggregate purchase price of $2,475,000, our as adjusted net
tangible book value on March 31, 2011 would have been
approximately $96.7 million, or $11.29 per share. This
amount represents an immediate increase in net tangible book
value of $0.29 per share to new investors who purchase our
common stock in this offering at an assumed initial public
offering price of $11.00. The following table shows this
immediate per share dilution:
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Public offering price per share
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$
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11.00
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Net tangible book value per share subscribed for on
March 31, 2011, before giving effect to this offering and
the concurrent private placement
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$
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99.81
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As adjusted net tangible book value per share of common stock on
March 31, 2011, after giving effect to the additional
investment of $7.5 million in cash and the Stock Dividend
(1,063,830 shares outstanding, as adjusted)
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$
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14.09
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Decrease in net tangible book value per share attributable to
this offering and the concurrent private placement
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(2.80
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)
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As adjusted net tangible book value per share on March 31,
2011, after giving effect to this offering and the concurrent
private placement
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$
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11.29
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Accretion in as adjusted net tangible book value per share to
new investors
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$
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0.29
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The following table summarizes, on the as adjusted basis
described above as of March 31, 2011, the differences
between the average price per share paid by our existing
stockholder and by new investors purchasing shares of common
stock in this offering at an assumed initial public offering
price of $11.00 per share, which is the mid-point of the
range set forth on the front cover of this prospectus, before
deducting the portion of the underwriting discounts and
commissions payable by us and estimated offering expenses
payable by us in this offering:
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Shares
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Purchased(1)
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Total Consideration
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Average Price
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Number
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%
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Amount
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%
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Per
Share(2)
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Shares purchased by existing stockholder
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1,063,830
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12.42
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%
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$
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15,000,000
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15.38
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%
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$
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14.10
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New
investors(3)
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7,500,000
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87.58
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82,500,000
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84.62
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11.00
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Total(3)
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8,563,830
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100.00
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%
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$
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97,500,000
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100.00
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%
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(1) |
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Assumes no exercise of the
underwriters option to purchase an additional
1,125,000 shares of our common stock.
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(2) |
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The average price per share for
shares purchased by the existing stockholder gives effect to the
issuance of 913,830 shares of our common stock to Bimini
pursuant to the Stock Dividend on that will occur immediately
prior to the completion of this offering. The actual average
price per share for shares purchased by Bimini was $100.00.
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(3) |
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A $1.00 increase (decrease) in the
assumed initial public offering price of $11.00 per share, which
is the mid-point of the range set forth on the cover page of
this prospectus, would increase (decrease) total consideration
paid by new investors and total consideration paid by all
investors by $7.5 million, assuming the number of shares of
common stock offered by us, as set forth on the cover page of
this prospectus, remains the same and the underwriters do not
exercise their over-allotment option to purchase an additional
1,125,000 shares of our common stock, and after deducting
estimated offering expenses payable by us.
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If the underwriters fully exercise their option to purchase an
additional 1,125,000 shares of our common stock, the number
of shares of common stock held by the existing stockholder will
be reduced to 10.98% of the aggregate number of shares of common
stock outstanding after this offering, and the number of shares
of common stock held by new investors will be increased to
8,625,000, or 89.02% of the aggregate number of shares of common
stock outstanding after this offering.
57
SELECTED
FINANCIAL DATA
The following table presents selected financial data as of
March 31, 2011, for the three months ended March 31,
2011 and for the period beginning on November 24, 2010
(date operations commenced) to December 31, 2010. The
statement of operations data for the period beginning on
November 24, 2010 (date operations commenced) to
December 31, 2010 has been derived from our audited
financial statements. The statement of operations and balance
sheet data as of March 31, 2011 and for the three months
ended March 31, 2011 has been derived from our interim
unaudited financial statements. These interim unaudited
financial statements have been prepared on substantially the
same basis as our audited financial statements and reflect all
adjustments which are, in the opinion of management, necessary
to provide a fair statement of our financial position as of
March 31, 2011 and the results of operations for the three
months ended March 31, 2011. All such adjustments are of a
normal recurring nature. These results are not necessarily
indicative of our results for the full fiscal year.
Because the information presented below is only a summary and
does not provide all of the information contained in our
historical financial statements, including the related notes,
you should read it in conjunction with the more detailed
information contained in our financial statements and related
notes and Managements Discussion and Analysis of
Financial Condition and Results of Operations included
elsewhere in this prospectus.
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Period from
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November 24, 2010
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Three Months
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(Date Operations
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Ended
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Commenced) to
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March 31,
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December 31,
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2011
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2010
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(unaudited)
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Statement of Operations Data:
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Revenues:
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Interest income
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$
|
307,764
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$
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69,340
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Interest expense
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(18,942
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)
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|
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(5,186
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)
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Net interest income
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288,822
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64,154
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Losses on trading
securities(1)
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(168,532
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)
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(55,307
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)
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Gains on futures contracts
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10,875
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Net portfolio income
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131,165
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8,847
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Total expenses
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115,093
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39,001
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Net income (loss)
|
|
$
|
16,072
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$
|
(30,154
|
)
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|
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Basic and diluted income (loss) per share of common
stock(2)
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$
|
0.21
|
|
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$
|
(0.68
|
)
|
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|
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|
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|
|
|
|
|
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|
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As of
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March 31, 2011
|
|
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(unaudited)
|
|
Balance Sheet Data:
|
|
|
|
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Total mortgage-backed securities
|
|
$
|
28,903,656
|
|
Total assets
|
|
|
30,101,395
|
|
Repurchase agreements
|
|
|
22,530,842
|
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Total liabilities
|
|
|
22,615,477
|
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Total stockholders equity
|
|
|
7,485,918
|
|
Book value per share of our common
stock(2)
|
|
$
|
99.81
|
|
|
|
|
(1) |
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Because all of our Agency RMBS have
been classified as held for trading securities, all
changes in the fair values of our Agency RMBS are reflected in
our statement of operations, as opposed to a component of other
comprehensive income in our
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58
|
|
|
|
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statement of stockholders
equity if they were instead classified as available for
sale securities. See Managements Discussion
and Analysis of Financial Condition and Results of
Operations Critical Accounting Policies
Mortgage-Backed Securities.
|
|
(2) |
|
On March 31, 2011 and
December 31, 2010, no shares of common stock were
outstanding; however, on March 31, 2011 and December 31,
2010, 75,000 shares and 44,050 shares of our common stock
had been subscribed for by Bimini, respectively. On
April 29, 2011, we issued 75,000 shares of our common
stock to Bimini, which consisted of the 44,050 shares
subscribed for as of December 31, 2010, 17,950 shares
subscribed for on March 28, 2011 and 13,000 shares
subscribed for on March 31, 2011.
|
Core
Earnings
We classify our Agency RMBS as held for trading. We
do not intend to elect GAAP hedge accounting for any derivative
financial instruments that we may utilize. Securities held for
trading and hedging instruments, for which hedge accounting has
not been elected, are recorded at estimated fair value, with
changes in the fair value recorded as unrealized gains or losses
through the statement of operations. Many other publicly-traded
REITs that invest in Agency RMBS classify their Agency RMBS as
available for sale. Unrealized gains and losses in
the fair value of securities classified as available for sale
are recorded as a component of other comprehensive income in the
statement of stockholders equity. As a result, investors
may not be able to readily compare our results of operations to
those of many of our competitors. We believe that the
presentation of our Core Earnings is useful to investors because
it provides a means of comparing our results of operations to
those of our competitors. Core Earnings represents a non-GAAP
financial measure and is defined as net income (loss) excluding
unrealized gains (losses) on trading securities and hedging
instruments and net interest income (expense) on hedging
instruments. Management utilizes Core Earnings because it allows
management to: (i) isolate the net interest income plus
other expenses of the Company over time, free of all
mark-to-market
adjustments and net payments associated with our hedging
instruments and (ii) assess the effectiveness of our
funding and hedging strategies, our capital allocation decisions
and our asset allocation performance. Our funding and hedging
strategies, capital allocation and asset selection are integral
to our risk management strategy, and therefore critical to our
Managers management of our portfolio.
Our presentation of Core Earnings may not be comparable to
similarly-titled measures of other companies, who may use
different calculations. As a result, Core Earnings should not be
considered as a substitute for our GAAP net income (loss) as a
measure of our financial performance or any measure of our
liquidity under GAAP.
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|
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|
|
|
|
|
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|
|
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For the Period
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|
|
|
Three Months
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|
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from November 24, 2010
|
|
|
|
Ended
|
|
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(Date Operations
|
|
|
|
March 31,
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|
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Commenced) through
|
|
|
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2011
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|
|
December 31, 2010
|
|
|
Non-GAAP Reconciliation (unaudited):
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|
|
|
|
|
|
|
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Net income (loss)
|
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$
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16,072
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|
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$
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(30,154
|
)
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Unrealized (gains) losses on trading securities
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|
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168,532
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|
|
|
55,307
|
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Unrealized (gains) losses on hedging instruments
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|
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(10,875
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)
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|
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|
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Net interest (income) expense on hedging instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Core Earnings
|
|
$
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173,729
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|
|
$
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25,153
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|
|
|
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59
MANAGEMENTS
DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with
the sections of this prospectus entitled Risk
Factors, Special Note Regarding Forward-Looking
Statements, Business and our financial
statements and the related notes thereto included elsewhere in
this prospectus. This discussion contains forward-looking
statements reflecting current expectations that involve risks
and uncertainties. Actual results and the timing of events may
differ materially from those contained in these forward-looking
statements due to a number of factors, including those discussed
in the section entitled Risk Factors and elsewhere
in this prospectus.
Overview
Orchid Island Capital, Inc. is a specialty finance company that
invests in Agency RMBS. Our investment strategy focuses on, and
our portfolio consists of, two categories of Agency RMBS:
(i) traditional pass-through Agency RMBS and
(ii) structured Agency RMBS, such as CMOs, IOs, IIOs
and POs, among other types of structured Agency RMBS.
Our business objective is to provide attractive risk-adjusted
total returns over the long term through a combination of
capital appreciation and the payment of regular quarterly
distributions. We intend to achieve this objective by investing
in and strategically allocating capital between the two
categories of Agency RMBS described above. We seek to generate
income from (i) the net interest margin on our leveraged
pass-through Agency RMBS portfolio and the leveraged portion of
our structured Agency RMBS portfolio, and (ii) the interest
income we generate from the unleveraged portion of our
structured Agency RMBS portfolio. We intend to fund our
pass-through Agency RMBS and certain of our structured Agency
RMBS, such as fixed and floating rate tranches of CMOs and POs,
through short-term borrowings structured as repurchase
agreements. However, we do not intend to employ leverage on the
securities in our structured Agency RMBS portfolio that have no
principal balance, such as IOs and IIOs. We do not intend to use
leverage in these instances because the securities contain
structural leverage. Pass-through Agency RMBS and structured
Agency RMBS typically exhibit materially different sensitivities
to movements in interest rates. Declines in the value of one
portfolio may be offset by appreciation in the other. The
percentage of capital that we allocate to our two Agency RMBS
asset categories will vary and will be actively managed in an
effort to maintain the level of income generated by the combined
portfolios, the stability of that income stream and the
stability of the value of the combined portfolios. We believe
that this strategy will enhance our liquidity, earnings, book
value stability and asset selection opportunities in various
interest rate environments.
We were formed by Bimini in August 2010. We commenced operations
on November 24, 2010, and through March 31, 2011,
Bimini had contributed approximately $7.5 million in cash
to us. Bimini has agreed to contribute an additional $7.5
million in cash to us prior to the completion of this offering
pursuant to a subscription agreement to purchase additional
shares of our common stock. Bimini is currently our sole
stockholder. Bimini has managed our portfolio since inception by
utilizing the same investment strategy that we expect our
Manager and its experienced RMBS investment team to continue to
employ after completion of this offering. As of March 31,
2011, our Agency RMBS portfolio had a fair value of
approximately $28.9 million and was comprised of
approximately 83.5% pass-through Agency RMBS and 16.5%
structured Agency RMBS. Our net asset value as of March 31,
2011 was approximately $7.5 million.
We intend to qualify and will elect to be taxed as a REIT
commencing with our short taxable year ending December 31,
2011. We generally will not be subject to U.S. federal
income tax to the extent that we annually distribute all of our
REIT taxable income to our stockholders and qualify as a REIT.
60
Factors that
Affect our Results of Operations and Financial
Condition
A variety of industry and economic factors may impact our
results of operations and financial condition. These factors
include:
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interest rate trends;
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prepayment rates on mortgages underlying our Agency RMBS, and
credit trends insofar as they affect prepayment rates;
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the difference between Agency RMBS yields and our funding and
hedging costs;
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competition for investments in Agency RMBS;
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recent actions taken by the U.S. Federal Reserve and the
U.S. Treasury; and
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other market developments.
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In addition, a variety of factors relating to our business may
also impact our results of operations and financial condition.
These factors include:
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our degree of leverage;
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our access to funding and borrowing capacity;
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our borrowing costs;
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our hedging activities;
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the market value of our investments; and
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the requirements to qualify as a REIT and the requirements to
qualify for a registration exemption under the Investment
Company Act.
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We anticipate that, for any period during which changes in the
interest rates earned on our assets do not coincide with
interest rate changes on the corresponding liabilities, such
assets will reprice more slowly than the corresponding
liabilities. Consequently, changes in interest rates,
particularly short term interest rates, may significantly
influence our net income.
Our net income may be affected by a difference between actual
prepayment rates and our projections. Prepayments on loans and
securities may be influenced by changes in market interest rates
and homeowners ability and desire to refinance their
mortgages.
Outlook
Regulatory
Developments
In response to the credit market disruption and the
deteriorating financial conditions of Fannie Mae and Freddie
Mac, Congress and the U.S. Treasury undertook a series of
actions that culminated with putting Fannie Mae and Freddie Mac
in conservatorship in September 2008. The FHFA now operates
Fannie Mae and Freddie Mac as conservator, in an effort to
stabilize the entities. The FHFA also noted that during the
conservatorship period, it would work to enact new regulations
for minimum capital standards, prudent safety and soundness
standards and portfolio limits of Fannie Mae and Freddie Mac.
Although the U.S. Government has committed significant
resources to Fannie Mae and Freddie Mac, Agency RMBS guaranteed
by either Fannie Mae or Freddie Mac are not backed by the full
faith and credit of the United States. Moreover, the Secretary
of the U.S. Treasury noted that the guarantee structure of
Fannie Mae and Freddie Mac required examination and that changes
in the structures of the entities were necessary to reduce risk
to the financial system. Such changes may involve an explicit
U.S. Government backing of Fannie Mae and Freddie Mac
Agency RMBS or the express elimination of any implied
U.S. Government guarantee and, therefore, the creation of
credit risk with respect to Fannie
61
Mae and Freddie Mac Agency RMBS. Additionally, on
February 11, 2011, the U.S. Treasury issued a White
Paper titled Reforming Americas Housing Finance
Market that lays out, among other things, proposals to
limit or potentially wind down the role that Fannie Mae and
Freddie Mac play in the mortgage market. Accordingly, the effect
of the actions taken and to be taken by the U.S. Treasury
and FHFA remains uncertain. The November 2, 2010 national
elections in the United States created further uncertainty
because of material changes to the composition of both houses of
Congress. Given the public reaction to the substantial funds
made available to Fannie Mae and Freddie Mac, future funding for
both is likely to face increased scrutiny. New and recently
enacted laws, regulations and programs related to Fannie Mae and
Freddie Mac may adversely affect the pricing, supply, liquidity
and value of Agency RMBS and otherwise materially harm our
business and operations. See Risk Factors
Risks Related to Our Business The federal
conservatorship of Fannie Mae and Freddie Mac and related
efforts, along with changes in laws and regulations affecting
the relationship between Fannie Mae and Freddie Mac and the
U.S. Government, may materially adversely affect our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders.
On July 21, 2010, President Obama signed into law the
Dodd-Frank Act. The Dodd-Frank Act provides for new regulations
on financial institutions and creates new supervisory and
advisory bodies, including the new Consumer Financial Protection
Bureau. The Dodd-Frank Act tasks many agencies with issuing a
variety of new regulations, including rules related to mortgage
origination and servicing, securitization and derivatives.
Because a significant number of regulations under the Dodd-Frank
Act have either not yet been proposed or not yet been adopted in
final form, it is not possible for us to predict how the
Dodd-Frank Act will impact our business. See Risk
Factors Risks Related to Our Business
The recent actions of the U.S. Government for the purpose
of stabilizing the financial markets may adversely affect our
business, financial condition and results of operations and our
ability to pay distributions to our stockholders.
Agency
RMBS
Our Agency RMBS backed by hybrid ARMs pay a fixed interest rate
for a set period and then convert to a floating rate payment
structure. Our Agency RMBS backed by fixed-rate mortgage loans
pay a fixed rate for a term of either 15 or 30 years. The
market prices of Agency RMBS backed by fixed-rate mortgage loans
correlate more closely with movements in long-term interest
rates than Agency RMBS backed by ARMs or hybrid ARMs.
As 2010 drew to a close, the U.S. economy had not fully
recovered from the effects of the financial crisis. Unemployment
in the United States was 9.4% and gross domestic product growth
was still low. Moreover, inflation in the United States was at
or near the low end of the U.S. Federal Reserves
target range of 1% to 2%. On November 3, 2010, the
U.S. Federal Reserve instituted a second round of asset
purchases of up to $600 billion of U.S. Treasury
securities intended to further reduce long-term interest rates.
In addition, the U.S. Federal Reserve announced all
principal amortization of their $1.25 trillion Agency RMBS
portfolio purchased during 2009 and 2010 would be used to
purchase additional U.S. Treasury securities as well.
Partially as a result of the U.S. Federal Reserves
actions to stimulate the economy, long-term interest rates have
remained high relative to short-term interest rates, which has
resulted in the issuance of higher-yielding Agency RMBS.
Additionally, on March 21, 2011, the U.S. Treasury
announced that it will begin selling its portfolio of
approximately $142 billion of Agency RMBS at a rate of up
to $10 billion per month beginning in March 2011. These
sales will add additional supply to the Agency RMBS market,
which could lower prices on Agency RMBS and, therefore, increase
yields.
Assuming there is no change in inflation and inflation
expectations and the U.S. labor market recovery remains
tepid, we believe long-term interest rates will remain high
relative to short-term interest rates. However, recent signs of
strength in the U.S. economy and recent increases in energy
prices, to the extent such increases are not transitory, may
cause an increase in long-term interest rates which, in turn,
will decrease the value of certain Agency RMBS, possibly at an
accelerated rate.
62
Borrowing
Costs
We leverage our pass-through Agency RMBS portfolio and a portion
of our structured Agency RMBS with principal balances through
the use of short-term repurchase agreement transactions. The
interest rates on our debt most closely correlate with the
30-day LIBOR.
European inter-bank lending rates, specifically LIBOR, are
affected by the fiscal and budgetary problems of several
European countries. The European Union, International Monetary
Fund and member countries provide emergency funding mechanisms
to support those countries facing a crisis of investor
confidence and inability to raise new debt at acceptable levels
(such as Greece, Ireland, Portugal and Spain) and to head off
the expansion of the same to other nations. To the extent this
crisis persists or worsens, LIBOR may increase substantially and
thus increase our funding costs and depress our profitability
and potential dividends.
If the recent strength in the U.S. economy or inflation
pressures cause the U.S. Federal Reserve to raise the
Federal Funds Target Rate in the near future, LIBOR would almost
certainly increase, which would increase our borrowing costs.
Prepayment
Rates and Loan Modification Programs
Prepayment
Rates
Our portfolio is affected by movements in mortgage prepayment
rates in a number of ways. See Prospectus
Summary Risk Management Prepayment Risk
Management, for a discussion of how movements in
prepayment rates affect our portfolio.
Prepayment rates generally increase when interest rates fall and
decrease when interest rates rise; however, changes in
prepayment rates are difficult to accurately predict. Other
factors also affect prepayment rates, including homeowners
ability and desire to refinance their mortgages, conditions in
the housing and financial markets, conditions in the mortgage
origination industry, general economic conditions and the
relative interest rates on adjustable-rate and fixed-rate
mortgage loans.
According to Bloomberg, interest rates on
30-year
fixed-rate mortgages have increased from 4.17% to 4.80% from
November 11, 2010 to April 21, 2011, and interest
rates on
15-year
fixed-rate mortgages have increased from 3.57% to 4.02% during
the same period. Conditions in the U.S. residential housing
market have yet to materially improve. Sales of existing and new
homes remain materially below pre-crisis levels. Foreclosure
activity is, and is expected to remain, elevated because of
depressed home prices, high unemployment, record delinquency and
foreclosure rates, and delays in the initiation of foreclosure
proceedings over the last year stemming from legal issues raised
with many mortgage loan servicers. The supply of new and
existing homes for sale, plus the shadow inventory
of homes expected to be on the market as a result of future
foreclosures, is likely to keep home prices depressed for an
extended period. The trend in rising mortgage rates coupled with
depressed housing prices have led to a decrease in prepayment
rates among borrowers. Although prepayment rates have been
decreasing, certain recently-enacted government programs have
resulted in prepayments on Agency RMBS. For example, in early
March 2010, both Fannie Mae and Freddie Mac announced they would
purchase from the pools of mortgage loans underlying their RMBS
all mortgage loans that are more than 120 days delinquent.
Due to the recent increase in mortgage interest rates and
currently depressed housing prices, we believe overall
prepayment rates will continue to remain low for the near future.
Loan Modification
Programs
During the second half of 2008, the U.S. Government,
through the FHA and the FDIC, implemented programs to help
homeowners avoid foreclosures. Such programs include extensions
to payment terms or reductions in mortgage principal balances or
interest rates. For example, the Hope
63
for Homeowners program has enabled certain distressed borrowers
to refinance their mortgages into FHA-insured loans.
In February 2009, the U.S. Treasury announced the HASP, a
multi-faceted plan to prevent residential mortgage foreclosures
which:
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allows certain homeowners, whose homes are encumbered by Fannie
Mae or Freddie Mac conforming mortgages, to refinance those
mortgages into lower interest rate mortgages with either Fannie
Mae or Freddie Mac;
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|
created the Homeowner Stability Initiative, which provides
incentives to banks and mortgage servicers to reduce monthly
mortgage principal and interest payments for certain qualified
homeowners; and
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allows judicial modifications of Fannie Mae and Freddie Mac
conforming residential mortgages loans during bankruptcy
proceedings.
|
The various mortgage loan modification programs have not had a
material impact on the level of foreclosures in the
U.S. housing market. It is unclear if the
U.S. Government will continue pursuing these programs due
to their limited success, controversial nature and in light of
the current political climate related to deficit spending.
However, the current conditions of the U.S. housing market
combined with the current high unemployment rate may persuade
the FHA and the FDIC to extend homeownership assistance programs
beyond their termination dates.
Effect on
Us
Regulatory developments, movements in interest rates and
prepayment rates as well as loan modification programs affect us
in many ways, including the following:
Regulatory
Developments
A change in or elimination of the guarantee structure of Agency
RMBS may increase our costs (if, for example, guarantee fees
increase) or require us to change our investment strategy
altogether. For example, the elimination of the guarantee
structure of Agency RMBS may cause us to change our investment
strategy to focus on non-Agency RMBS, which in turn would
require us to significantly increase our monitoring of the
credit risks of our investments in addition to interest rate and
prepayment risks.
Movements in
Interest Rates
With respect to our pass-through Agency RMBS portfolio, an
increase in long-term interest rates may cause prices on certain
Agency RMBS to decrease, which would decrease the fair value of
our pass-through Agency RMBS portfolio but also decrease the
price of pass-through Agency RMBS we may purchase in the future.
Because we base our investment decisions on risk management
principles rather than anticipated movements in interest rates,
in a volatile interest rate environment we intend to allocate
more capital to structured Agency RMBS with shorter durations,
such as short-term fixed and floating rate CMOs. We believe
these securities have a lower sensitivity to changes in
long-term interest rates than other asset classes. We may also
mitigate our exposure to changes in long-term interest rates by
investing in IOs and IIOs, which typically have different
sensitivities to changes in long-term interest rates than
pass-through Agency RMBS, particularly pass-through Agency RMBS
backed by fixed-rate mortgages.
An increase in LIBOR (which could result from an increase in the
U.S. Federal Funds Target Rate) would increase our
borrowing costs, which could lower our net interest margin.
Because we finance our pass-through Agency RMBS portfolio and a
portion of our structured Agency RMBS portfolio with
LIBOR-based, short-term borrowings, an increase in LIBOR would
quickly be reflected in our borrowing costs unless we have
properly hedged the leveraged portion of our Agency RMBS
64
portfolio. Additionally, an increase in LIBOR would reduce the
coupon payments and possibly the market value of IIOs.
Movements in
Prepayment Rates and Loan Modification Programs
We believe that our pass-through Agency RMBS portfolio will
benefit from the current and expected lower prepayment rates. An
increase in prepayment rates would cause us to receive the
principal balances of our pass-through Agency RMBS faster than
expected. If such an increase in prepayment rates were to be
caused by lower levels of prevailing interest rates, we would
most likely have to reinvest the principal received in
lower-yielding investments. We believe our IOs and IIOs will
also benefit from lower prepayment rates. Because the value of
IOs and IIOs are contingent on the existence of a principal
balance on the underlying mortgages, a decrease in prepayment
rates will extend the effective term of these securities.
Despite the current level of prepayment rates, our portfolio may
experience increased prepayment rates due to the Fannie Mae and
Freddie Mac repurchase programs described above.
We do not believe our investment portfolio will be materially
affected by loan modification programs because Agency RMBS
backed by loans that would qualify for such programs (i.e.
seriously delinquent loans) will be purchased by Fannie Mae and
Freddie Mac at their par value prior to the implementation of
such programs. However, if Fannie Mae and Freddie Mac were to
modify or end their repurchase programs or if the
U.S. Government modified its loan modification programs to
modify non-delinquent mortgage loans, our investment portfolio
could be materially negatively impacted.
Critical
Accounting Policies
Our financial statements are prepared in accordance with GAAP.
GAAP requires our management to make some complex and subjective
decisions and assessments. Our most critical accounting policies
involve decisions and assessments which could significantly
affect reported assets, liabilities, revenues and expenses.
Management has identified its most critical accounting policies:
Mortgage-Backed
Securities
Our investments in Agency RMBS are classified as held for
trading. We acquire our Agency RMBS for the purpose of
generating long-term returns, and not for the short-term
investment of idle capital. Under FASB ASC Topic 320,
Investments Debt and Equity Securities, we
have the option to classify our Agency RMBS as either trading
securities or available-for-sale securities. Changes in the fair
value of securities held for trading are reflected as part of
our net income or loss in our statement of operations, as
opposed to a component of other comprehensive income in our
statement of stockholders equity if they were instead
reclassified as
available-for-sale
securities. We elected to classify our Agency RMBS as trading
securities in order to reflect changes in the fair value of our
Agency RMBS in our statement of operations, which we believe
more appropriately reflects the results of our operations for a
particular reporting period. We have a three-level valuation
hierarchy for determining the fair value of our Agency RMBS.
These levels include:
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Level 1 valuations, where the valuation is based on quoted
market prices for identical assets or liabilities traded in
active markets (which include exchanges and
over-the-counter
markets with sufficient volume),
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Level 2 valuations, where the valuation is based on quoted
market prices for similar instruments traded in active markets,
quoted prices for identical or similar instruments in markets
that are not active and model-based valuation techniques for
which all significant assumptions are observable in the
market, and
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Level 3 valuations, where the valuation is generated from
model-based techniques that use significant assumptions not
observable in the market, but observable based on Company-
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65
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|
specific data. These unobservable assumptions reflect the
Companys own estimates for assumptions that market
participants would use in pricing the asset or liability.
Valuation techniques typically include option pricing models,
discounted cash flow models and similar techniques, but may also
include the use of market prices of assets or liabilities that
are not directly comparable to the subject asset or liability.
|
Our Agency RMBS are valued using Level 2 valuations, and
such valuations currently are determined by Bimini based on the
average of third-party broker quotes
and/or by
independent pricing sources when available. Because the price
estimates may vary, Bimini must make certain judgments and
assumptions about the appropriate price to use to calculate the
fair values. Alternatively, Bimini could opt to have the value
of all of our positions in Agency RMBS determined by either an
independent third-party or do so internally.
In managing our portfolio, Bimini employs the following
four-step process at each valuation date to determine the fair
value of our Agency RMBS:
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First, Bimini obtains fair values from a subscription-based
independent pricing source through AVM, LLP, our repurchase
agreement funding services provider. These prices are used by
both Bimini as well as our repurchase agreement counterparty on
a daily basis to establish margin requirements for our
borrowings. As of June 30, 2011, Bimini subscribed to a
second subscription-based pricing service through Bank of
America, which receives market values directly from Bank of
Americas trading desk.
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Second, Bimini requests non-binding quotes from one to four
broker-dealers for each of its Agency RMBS in order to validate
the values obtained by the pricing service. Bimini requests
these quotes from broker-dealers that actively trade and make
markets in the respective asset class for which the quote is
requested.
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Third, Bimini reviews the values obtained by the pricing source
and the broker-dealers for consistency across similar assets.
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Finally, if the data from the pricing services and
broker-dealers is not homogenous or if the data obtained is
inconsistent with Biminis market observations, Bimini
makes a judgment to determine which price appears the most
consistent with observed prices from similar assets and selects
that price. To the extent Bimini believes that none of the
prices are consistent with observed prices for similar assets,
which is typically the case for only an immaterial portion of
our portfolio each quarter, Bimini may use a third price that is
consistent with observed prices for identical or similar assets.
In the case of assets that have quoted prices such as Agency
RMBS backed by fixed-rate mortgages, Bimini generally uses the
quoted or observed market price. For assets such as Agency RMBS
backed by ARMs or structured Agency RMBS, Bimini may determine
the price based on the yield or spread that is identical to an
observed transaction or a similar asset for which a dealer mark
or subscription-based price has been obtained.
|
After the completion of this offering, we expect our Manager to
continue to employ the process described above to value our
Agency RMBS.
Management believes its pricing methodology to be consistent
with the definition of fair value described in FASB
ASC 820, Fair Value Measurements and Disclosures.
Repurchase
Agreements
We intend to finance the acquisition of a portion of our Agency
RMBS through repurchase transactions under master repurchase
agreements. Repurchase transactions will be treated as
collateralized financing transactions and will be carried at
their contractual amounts, including accrued interest. We have
entered into master repurchase agreements with two financial
institutions (and have taken the initial steps to begin securing
additional repurchase agreement capacity with other
66
counterparties, which we intend to have in place shortly before
or concurrently with the completion of this offering).
In instances where we acquire Agency RMBS through repurchase
agreements with the same counterparty from whom the Agency RMBS
were purchased, we will account for the purchase commitment and
repurchase agreement on a net basis and record a forward
commitment to purchase Agency RMBS as a derivative instrument if
the transaction does not comply with the criteria in FASB
ASC 860, Transfers and Servicing, for gross
presentation. If the transaction complies with the criteria for
gross presentation, we will record the assets and the related
financing on a gross basis in our statements of financial
condition, and the corresponding interest income and interest
expense in our statement of operations and comprehensive income
(loss). Such forward commitments are recorded at fair value with
subsequent changes in fair value recognized in income.
Additionally, we will record the cash portion of our investment
in Agency RMBS as a mortgage related receivable from the
counterparty on our balance sheet.
Derivatives
and Hedging Activities
We may account for derivative financial instruments in
accordance with FASB ASC 815, Disclosure about
Derivative Instruments, which requires an entity to
recognize all derivatives as either assets or liabilities on the
balance sheet and to measure those instruments at fair value.
Additionally, the fair value adjustments will affect either
other comprehensive income in stockholders equity until
the hedged item is recognized in earnings or net income
depending on whether the derivative instrument qualifies as a
hedge for accounting purposes and, if so, the nature of the
hedging activity. We use derivatives for hedging purposes rather
than speculation. We will use quotations from counterparties to
determine their fair values.
In the normal course of business, subject to qualifying and
maintaining our qualification as a REIT, we may use a variety of
derivative financial instruments to manage, or hedge, interest
rate risk on our borrowings. These derivative financial
instruments must be effective in reducing our interest rate risk
exposure in order to qualify for hedge accounting. When the
terms of an underlying transaction are modified, or when the
underlying hedged item ceases to exist, all changes in the fair
value of the instrument are
marked-to-market
with changes in value included in net income for each period
until the derivative instrument matures or is settled. Any
derivative instrument used for risk management that does not
meet the effective hedge criteria is
marked-to-market
with the changes in value included in net income.
We do not intend to elect GAAP hedge accounting for any
derivative financial instruments that we may utilize.
Income
Recognition
For securities classified as held for trading, interest income
is based on the stated interest rate and the outstanding
principal balance. We have elected the fair value option,
therefore, premium or discount associated with the purchase of
Agency RMBS are not amortized. Since we commenced operations,
all of our Agency RMBS have been classified as held for trading.
All of our Agency RMBS will be either pass-through securities or
structured Agency RMBS, including CMOs, IOs, IIOs or POs.
Income on pass-through securities, POs and CMOs that contain
principal balances is based on the stated interest rate of the
security. Premium or discount present at the date of purchase is
not amortized. For IOs, IIOs and CMOs that do not contain
principal balances, income is accrued based on the carrying
value and the effective yield. As cash is received it is first
applied to accrued interest and then to reduce the carrying
value of the security. At each reporting date, the effective
yield is adjusted prospectively from the reporting period based
on the new estimate of prepayments, current interest rates and
current asset prices. The new effective yield is calculated
based on the carrying value at the end of the previous reporting
period, the new prepayment estimates and the contractual terms
of the security. Changes in fair value of all of our Agency RMBS
during the
67
period are recorded in earnings and reported as losses on
trading securities in the accompanying statement of operations.
Our
Portfolio
As of March 31, 2011, our Agency RMBS portfolio had a fair
value of approximately $28.9 million, weighted average
coupon on assets of 4.22% and a net weighted average borrowing
cost of 0.33%. The following tables summarize our portfolio as
of March 31, 2011:
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Weighted
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Weighted
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Percentage
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Average
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Average
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Weighted
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Weighted
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of
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Weighted
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Maturity
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Coupon
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Average
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Average
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Weighted
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Entire
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Average
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in
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Longest
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Reset in
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Lifetime
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Periodic
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Average
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Asset Category
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Fair Value
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Portfolio
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Coupon
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Months
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Maturity
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Months
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Cap
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Cap
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CPR(1)
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(In thousands)
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Pass-through Agency RMBS backed by:
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Adjustable-Rate Mortgages
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$
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7,721
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26.7
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%
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2.53
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%
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288
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April 2035
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5.03
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9.55
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%
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2.00
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%
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0.11
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%
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Fixed-Rate Mortgages
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16,418
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56.8
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%
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4.54
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%
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171
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November 2025
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N/A
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N/A
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N/A
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0.75
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%
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Hybrid Adjustable-Rate Mortgages
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Total/Weighted Average Whole-pool Mortgage Pass-through Agency
RMBS
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$
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24,139
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83.5
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%
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3.90
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%
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208
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April 2035
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|
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5.03
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9.55
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%
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|
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2.00
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%
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|
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0.54
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%
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Structured Agency RMBS:
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CMOs
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IOs
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|
|
966
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3.3
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%
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|
|
4.50
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%
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|
|
163
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October 2024
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N/A
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N/A
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N/A
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N/A
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IIOs
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3,799
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13.2
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%
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6.22
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%
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297
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April 2037
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N/A
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N/A
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N/A
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19.73
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%
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POs
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Total/Weighted Average Structured Agency RMBS
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4,765
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16.5
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%
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5.87
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%
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270
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April 2037
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N/A
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N/A
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N/A
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19.73
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%
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Total/Weighted Average
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$
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28,904
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100
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%
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4.22
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%
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|
218
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April 2037
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5.03
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9.55
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%
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2.00
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%
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5.67
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%
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68
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Percentage of
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Agency
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Fair Value
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|
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Entire Portfolio
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(In thousands)
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|
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|
|
|
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|
|
Fannie Mae
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|
$
|
22,310
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|
|
|
77.2
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%
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|
|
Freddie Mac
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|
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4,337
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|
|
15.0
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%
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|
|
Ginnie Mae
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|
|
2,257
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|
|
7.8
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%
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
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|
Total Portfolio
|
|
$
|
28,904
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Entire Portfolio
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average Pass-through Purchase Price
|
|
$
|
105.44
|
|
Weighted Average Structured Agency RMBS Purchase Price
|
|
$
|
13.55
|
|
Weighted Average Pass-through Current Price
|
|
$
|
105.22
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|
Weighted Average Structured Agency RMBS Current Price
|
|
$
|
12.66
|
|
Effective
Duration(2)
|
|
|
3.26
|
|
|
|
|
(1) |
|
CPR is a method of expressing the
prepayment rate for a mortgage pool that assumes that a constant
fraction of the remaining principal is prepaid each month or
year. Specifically, the constant prepayment rate in the chart
above represents the three month prepayment rate of our
securities in the respective asset category.
|
(2) |
|
Effective duration of 3.26
indicates that an interest rate increase of 1.0% would be
expected to cause a 3.26% decline in the value of our Agency
RMBS as of March 31, 2011. These figures include the
structured RMBS securities in the portfolio.
|
Liabilities
We have entered into repurchase agreements to finance
acquisitions of our Agency RMBS. As of March 31, 2011, we
had entered into master repurchase agreements with two
counterparties and had funding in place with one of those
parties. The material terms of this repurchase agreement are
described below:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
|
|
|
|
|
|
|
|
|
Weighted
|
|
Weighted Average
|
|
|
|
|
|
|
Average
|
|
Maturity of
|
|
|
|
|
|
|
Borrowing
|
|
Repurchase
|
|
|
Counterparty
|
|
Balance
|
|
Cost
|
|
Agreements in Days
|
|
Amount at
Risk(1)
|
|
MF Global, Inc.
|
|
$
|
22,530,842
|
|
|
|
0.33
|
%
|
|
|
77
|
|
|
$
|
1,673,253
|
|
|
|
|
(1) |
|
Equal to the fair value of
securities sold, plus accrued interest income, minus the sum of
repurchase agreement liabilities and accrued interest expense.
|
During the three months ended March 31, 2011, the average
balance of our repurchase agreement financing was $22,680,448.
As of May 10, 2011, the weighted average haircut on the
repurchase agreement was approximately 5.0%. We have since
entered into three more master repurchase agreements (for a
total of five) and are currently negotiating, and intend to
enter into, additional master repurchase agreements with
additional counterparties after the completion of this offering.
Our master repurchase agreement has no stated expiration but can
be terminated at any time at our option or at the option of the
counterparty. However, once a definitive repurchase agreement
under a master repurchase agreement has been entered into, it
generally may not be terminated by either party absent an event
of default. A negotiated termination can occur but may involve a
fee to be paid by the party seeking to terminate the repurchase
agreement transaction.
Liquidity and
Capital Resources
Liquidity refers to our ability to meet our cash needs. Our
short-term (one-year or less) and long-term liquidity
requirements include asset acquisition, compliance with margin
requirements,
69
repayment of borrowings to the extent we are unable to or
unwilling to roll forward our repurchase agreements and payment
of our general operating expenses.
Our principal sources of capital generally consist of borrowings
under repurchase agreements, proceeds from equity offerings and
payments of principal and interest we receive on our Agency RMBS
portfolio. We believe that these sources of funds will be
sufficient to meet our short-term and long-term liquidity needs.
Based on our current portfolio, amount of free cash on hand,
debt-to-equity
ratio and current and anticipated availability of credit, we
believe that our capital resources will be sufficient to enable
us to meet anticipated short-term and long-term liquidity
requirements. However, the unexpected inability to finance our
pass-through Agency RMBS portfolio would create a serious
short-term strain on our liquidity and would require us to
liquidate much of that portfolio, which in turn would require us
to restructure our portfolio to maintain our exclusion from
registration under the Investment Company Act. Steep declines in
the values of our Agency RMBS assets financed using repurchase
agreements would result in margin calls that would significantly
reduce our free cash position. Furthermore, a substantial
increase in prepayment rates on our assets financed by
repurchase agreements could cause a temporary liquidity
shortfall, because on such assets we are generally required to
post margin in proportion to the amount of the announced
principal pay-downs before the actual receipt of the cash from
such principal pay-downs. If our cash resources are at any time
insufficient to satisfy our liquidity requirements, we may have
to sell assets or issue debt or additional equity securities.
Contractual
Obligations
We are currently party to a management agreement with Bimini.
Upon completion of this offering, we will terminate our
management agreement with Bimini and enter into a new management
agreement as described below. Under our existing management
agreement with Bimini, we paid Bimini aggregate management fees
of $26,400 for the period beginning on November 24, 2010
(date operations commenced) to March 31, 2011, and we
reimbursed Bimini an aggregate of $28,800 in expenses for the
period beginning on November 24, 2010 (date operations
commenced) to March 31, 2011.
We intend to enter into a management agreement with our Manager.
Our Manager will be entitled to receive a management fee, be
reimbursed for its expenses incurred on our behalf, and, in
certain circumstances, receive a termination fee, each as
described in the management agreement. Such fees and expenses do
not have fixed and determinable payments. The management fee
will be payable monthly in arrears in an amount equal to 1/12th
of (a) 1.50% of the first $250,000,000 of our equity (as defined
below), (b) 1.25% of our equity that is greater than
$250,000,000 and less than or equal to $500,000,000, and (c)
1.00% of our equity that is greater than $500,000,000.
Equity equals our month-end stockholders
equity, adjusted to exclude the effect of any unrealized gains
or losses included in either retained earnings or other
comprehensive income (loss), as computed in accordance with GAAP.
We will be required to pay or reimburse our Manager for all
expenses incurred by it related to our operations, but excluding
all employment related expenses of our and our Managers
officers and any Bimini employees who provide services to us
pursuant to the management agreement (other than our Chief
Financial Officer). We will reimburse our Manager for our
allocable share of the compensation of our Chief Financial
Officer based our percentage of the aggregate amount of our
Managers assets under management and Biminis assets.
We will also reimburse our pro rata portion of our
Managers and Biminis overhead expenses based on our
percentage of the aggregate amount of our Managers assets
under management and Biminis assets. We will also be
required to pay a termination fee for our non-renewal of the
management agreement without cause. This fee will be equal to
three times the average annual management fee earned by our
Manager during the prior
24-month
period immediately preceding the most recently completed
calendar quarter prior to the effective date of termination.
70
We enter into repurchase agreements to finance some of our
purchases of our pass-through Agency RMBS. As of March 31,
2011, we had outstanding $22,530,842 of liabilities pursuant to
a repurchase agreement that had a borrowing rate of
approximately 0.33% and maturity of 77 days. As of
March 31, 2011, interest payable on our repurchase
agreements was $9,103.
Off-Balance Sheet
Arrangements
As of March 31, 2011, we had no off-balance sheet
arrangements.
Inflation
Virtually all of our assets and liabilities are financial in
nature. As a result, interest rates and other factors influence
our performance far more so than does inflation. Changes in
interest rates do not necessarily correlate with inflation rates
or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our distributions are
determined by our Board of Directors based primarily on our net
income as calculated for tax purposes. In each case, our
activities and balance sheet are measured with reference to
historical cost and or fair market value without considering
inflation.
71
QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We believe the primary risk inherent in our investments is the
effect of movements in interest rates, especially with respect
to our use of leverage and the uncertainty of principal payment
cash flows, which we refer to as prepayment risk. We, therefore,
follow a risk management program designed to offset the
potential adverse effects resulting from these risks.
Interest Rate
Risk
We believe that the risk of adverse interest rate movements
represents the most significant risk to our portfolio. This risk
arises because (i) the interest rate indices used to
calculate the interest rates on the mortgages underlying our
assets may be different from the interest rate indices used to
calculate the interest rates on the related borrowings, and
(ii) interest rate movements affecting our borrowings may
not be reasonably correlated with interest rate movements
affecting our assets.
Interest Rate
Mismatch Risk
We intend to fund a substantial portion of our acquisitions of
Agency RMBS backed by ARMs and hybrid ARMs with borrowings that
have interest rates based on indices and repricing terms similar
to, but of somewhat shorter maturities than, the interest rate
indices and repricing terms of the Agency RMBS we are financing.
The interest rate indices and repricing terms of our Agency RMBS
and our funding sources will be mismatched. Our cost of funds
will likely rise or fall more quickly than the yield on assets.
During periods of changing interest rates, such interest rate
mismatches could negatively impact our business, financial
condition and results of operations and our ability to pay
distributions to our stockholders.
Extension
Risk
We invest in Agency RMBS backed by fixed-rate and hybrid ARMs.
Hybrid ARMs have interest rates that are fixed for the first few
years of the loan typically three, five, seven or
10 years and thereafter their interest rates
reset periodically on the same basis as ARMs. As of
March 31, 2011, we did not own any Agency RMBS backed by
hybrid ARMs. We compute the projected weighted average life of
our Agency RMBS backed by fixed-rate mortgages and hybrid ARMs
based on the markets prepayment rate assumptions. In
general, when an Agency RMBS backed by fixed-rate mortgages or
hybrid ARMs is acquired with borrowings, subject to qualifying
and maintaining our qualification as a REIT, we may, but are not
required to, enter into interest rate swap and cap contracts or
forward funding agreements that effectively cap or fix our
borrowing costs for a period close to the anticipated average
life of the fixed-rate portion of the related Agency RMBS. This
strategy is designed to protect us from rising interest rates
because the borrowing costs are fixed for the duration of the
fixed-rate portion of the related Agency RMBS. However, if
prepayment rates decrease as interest rates rise, the life of
the fixed-rate portion of the related Agency RMBS could extend
beyond the term of the swap agreement or other hedging
instrument. Our borrowing costs would no longer be fixed after
the end of the hedging instrument, but the income earned on the
related Agency RMBS would remain fixed. This situation may also
cause the market value of our Agency RMBS to decline with little
or no offsetting gain from the related hedging transactions. In
extreme situations, we may be forced to sell assets and incur
losses to maintain adequate liquidity.
Interest Rate
Cap Risk
We invest in Agency RMBS backed by ARMs and hybrid ARMs, which
are typically subject to periodic and lifetime interest rate
caps and floors. Interest rate caps and floors may limit changes
to the Agency RMBS yield. However, our borrowing costs pursuant
to our repurchase agreements will not be subject to similar
restrictions. As interest rates rise, the interest rate costs on
our borrowings could increase without limitation by caps, but
the interest-rate yields on the related assets would effectively
be limited by caps. The effect of ARM interest rate caps is
magnified to the extent we acquire Agency
72
RMBS backed by ARMs and hybrid ARMs whose current coupon is
below the fully-indexed coupon. Further, the underlying
mortgages may be subject to periodic payment caps that result in
some portion of the interest being deferred and added to the
principal outstanding, affecting available liquidity needed to
pay our financing costs. These factors could lower our net
interest income or cause a net loss during periods of rising
interest rates.
Effect on Fair
Value
The market value of our assets is sensitive to changes in
interest rates and may increase or decrease at different rates
than the market value of our liabilities, including our hedging
instruments. We primarily assess our interest rate risk by
estimating the duration of our assets and the duration of our
liabilities. Duration essentially measures the market price
volatility of financial instruments as interest rates change. We
generally calculate duration using various financial models and
empirical data, and different models and methodologies can
produce different duration numbers for the same securities. If
our duration estimates are inaccurate, we could underestimate
our interest rate risk.
Prepayment
Risk
Risk of mortgage prepayments is another significant risk to our
portfolio. When prepayment rates increase, we may not be able to
reinvest the money received from prepayments at yields
comparable to those of the securities prepaid. Also, some ARMs
and hybrid ARMs which back our Agency RMBS may bear initial
teaser interest rates that are lower than their
fully-indexed interest rates. If these mortgages are prepaid
during this teaser period, we may lose the
opportunity to receive interest payments at the higher,
fully-indexed rate over the expected life of the security.
Additionally, some of our structured Agency RMBS, such as IOs
and IIOs, may be negatively affected by an increase in
prepayment rates because their value is wholly contingent on the
underlying mortgage loans having an outstanding principal
balance.
A decrease in prepayment rates may also have an adverse effect
on our portfolio. Also, if we invest in POs, the purchase price
of such securities will be based, in part, on an assumed level
of prepayments on the underlying mortgage loan. Because the
returns on POs decrease the longer it takes the principal
payments on the underlying loans to be paid, a decrease in
prepayment rates could decrease our returns on these securities.
Prepayment risk also affects our hedging activities. When an
Agency RMBS backed by a fixed-rate mortgage or hybrid ARM is
acquired with borrowings, subject to qualifying and maintaining
our qualification as a REIT, we may cap or fix our borrowing
costs for a period close to the anticipated average life of the
fixed-rate portion of the related Agency RMBS. If prepayment
rates are different than our projections, the term of the
related hedging instrument may not match the fixed-rate portion
of the security, which could cause us to incur losses.
When prevailing interest rates fall below (rise above) the
coupon rate of a mortgage, it becomes more (less) likely to
prepay. Our business may be adversely affected if prepayment
rates are significantly different than our projections.
73
Analyzing
Interest Rate and Prepayment Risks
The following sensitivity analysis shows the estimated impact on
the fair value of our interest rate-sensitive investments as of
March 31, 2011, assuming rates instantaneously fall
100 basis points, rise 100 basis points and rise
200 basis points, or BPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rates Fall
|
|
Interest Rates
|
|
Interest Rates
|
|
|
|
|
100 BPS
|
|
Rise 100 BPS
|
|
Rise 200 BPS
|
|
|
|
|
(In thousands)
|
|
Agency RMBS backed by ARMs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
7,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
184
|
|
|
$
|
(184
|
)
|
|
$
|
(368
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
2.38
|
%
|
|
|
(2.38
|
)%
|
|
|
(4.76
|
)%
|
Agency RMBS backed by fixed-rate mortgages
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
16,418
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
608
|
|
|
$
|
(608
|
)
|
|
$
|
(1,217
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
3.70
|
%
|
|
|
(3.70
|
)%
|
|
|
(7.41
|
)%
|
Agency RMBS backed by hybrid ARMS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Change as a % of Fair Value
|
|
|
|
|
|
|
|
%
|
|
|
|
%
|
|
|
|
%
|
Structured RMBS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
4,765
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
151
|
|
|
$
|
(151
|
)
|
|
$
|
(303
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
3.18
|
%
|
|
|
(3.18
|
)%
|
|
|
(6.36
|
)%
|
Portfolio Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
28,904
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
943
|
|
|
$
|
(943
|
)
|
|
$
|
(1,887
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
3.26
|
%
|
|
|
(3.26
|
)%
|
|
|
(6.53
|
)%
|
Cash
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
684
|
|
|
|
|
|
|
|
|
|
|
|
|
|
74
The table below reflects the same analysis presented above but
with figures in the columns that indicate the estimated impact
of a 100 basis point fall or rise and a 200 basis point
rise adjusted to reflect the impact of convexity, which is the
measure of the sensitivity of our Agency RMBSs effective
duration to movements in interest rates.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rates
|
|
Interest Rates
|
|
Interest Rates
|
|
|
|
|
Fall 100 BPS
|
|
Rise 100 BPS
|
|
Rise 200 BPS
|
|
|
|
|
(In thousands)
|
|
Agency RMBS backed by ARMs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
7,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
109
|
|
|
$
|
(216
|
)
|
|
$
|
(489
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
1.42
|
%
|
|
|
(2.79
|
)%
|
|
|
(6.33
|
)%
|
Agency RMBS backed by fixed-rate mortgages
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
16,418
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
459
|
|
|
$
|
(686
|
)
|
|
$
|
(1,427
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
2.80
|
%
|
|
|
(4.18
|
)%
|
|
|
(8.69
|
)%
|
Agency RMBS backed by hybrid ARMs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Change as a % of Fair Value
|
|
|
|
|
|
|
|
%
|
|
|
|
%
|
|
|
|
%
|
Structured RMBS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
4,765
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
(132
|
)
|
|
$
|
(303
|
)
|
|
$
|
(829
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
(2.77
|
)%
|
|
|
(6.37
|
)%
|
|
|
(17.40
|
)%
|
Portfolio Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
28,904
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Fair Value
|
|
|
|
|
|
$
|
436
|
|
|
$
|
(1,205
|
)
|
|
$
|
(2,745
|
)
|
Change as a % of Fair Value
|
|
|
|
|
|
|
1.51
|
%
|
|
|
(4.17
|
)%
|
|
|
(9.50
|
)%
|
Cash
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
$
|
684
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As interest rates change, the change in the fair value of our
assets would likely differ from that shown above and such
difference might be material and adverse to us. The volatility
in the fair value of our assets could increase significantly
when interest rates change beyond 100 basis points. In
addition to changes in interest rates, other factors impact the
fair value of our interest rate-sensitive investments and
hedging instruments, if any, such as the shape of the yield
curve, the level of 30-day LIBOR, market expectations about
future interest rate changes and disruptions in the financial
markets.
Our liabilities, consisting primarily of repurchase agreements,
are also affected by changes in interest rates. As rates rise,
the value of the underlying asset, or the collateral, declines.
In certain circumstances, we could be required to post
additional collateral in order to maintain the repurchase
agreement. We maintain cash and unpledged securities to cover
these possible situations. Typically, our cash position is
approximately equal to the haircut on our pledged assets, and
the balance of our unpledged assets exceeds our cash balance. As
an example, if interest rates increased 200 basis points,
as shown on the prior table, our collateral as of March 31,
2011 would decline in value by approximately $2.7 million,
which would require that we post $2.7 million of additional
collateral to meet a margin call. Our cash and unpledged assets
are currently sufficient to cover such a margin call. There can
be no assurance, however, that we will always have sufficient
cash or unpledged assets to cover such shortfalls in all
situations.
75
MARKET
OPPORTUNITY
We believe that the Agency RMBS market presents compelling
opportunities for earning attractive risk-adjusted returns,
particularly in the structured Agency RMBS market. For
example, IIOs have provided strong returns since the peak
of the housing market collapse in the fall of 2008 due to
persistently low short-term interest rates and lower prepayment
rates.
Attractive
Financing Spreads
Financing spreads (the difference between the yields on our
Agency RMBS and our related financing costs) are at high levels
due mainly to historically low financing rates on repurchase
agreement debt.
As of March 31, 2011, three month LIBOR was approximately
0.24% and the Federal Funds Target Rate was 0.25%. We finance
almost all of our Agency RMBS with short-term repurchase
agreement debt, the interests rates of which are tied to LIBOR.
We expect LIBOR and the Federal Funds Target Rate to remain at
historically low levels as long as the U.S. unemployment
rate remains high and inflation in the United States is at or
near the low end of the U.S. Federal Reserves target
range of 1% to 2%.
Lower Prepayment
Rates
The recent housing market collapse has caused a dramatic
decrease in home prices. Also, loan losses on residential
mortgages have caused lenders to tighten their lending
standards, making it difficult for home owners to refinance
their mortgages. The combination of lower home prices and
tighter lending standards has lowered prepayment rates on
mortgage loans underlying Agency RMBS.
We believe the current low prepayment rate environment will
reduce portfolio volatility and increase our ability to hedge
our portfolio more effectively. Additionally, lower prepayment
rates may increase the value of our structured Agency RMBS, such
as IOs and IIOs, because the value of such securities are
contingent on the duration of the principal balance of the
underlying mortgage loans.
Availability of
Financing
Data from the Federal Reserve shows that primary dealers are
currently providing approximately $380 billion of term
financing for Agency RMBS as opposed to less than
$250 billion at the beginning of 2010.
We believe the combination of (i) attractive financing
spreads, (ii) lower prepayment rates and
(iii) available financing will result in attractive
risk-adjusted returns.
76
BUSINESS
Our
Company
Orchid Island Capital, Inc. is a specialty finance company that
invests in Agency RMBS. Our investment strategy focuses on, and
our portfolio consists of, two categories of Agency RMBS:
(i) traditional pass-through Agency RMBS and
(ii) structured Agency RMBS, such as CMOs, IOs, IIOs
and POs, among other types of structured Agency RMBS.
Our business objective is to provide attractive risk-adjusted
total returns to our investors over the long term through a
combination of capital appreciation and the payment of regular
quarterly distributions. We intend to achieve this objective by
investing in and strategically allocating capital between the
two categories of Agency RMBS described above. We seek to
generate income from (i) the net interest margin, which is
the spread or difference between the interest income we earn on
our assets and the interest cost of our related borrowing and
hedging activities, on our leveraged pass-through Agency RMBS
portfolio and the leveraged portion of our structured Agency
RMBS portfolio, and (ii) the interest income we generate
from the unleveraged portion of our structured Agency RMBS
portfolio. We intend to fund our pass-through Agency RMBS and
certain of our structured Agency RMBS, such as fixed and
floating rate tranches of CMOs and POs, through short-term
borrowings structured as repurchase agreements. However, we do
not intend to employ leverage on the securities in our
structured Agency RMBS portfolio that have no principal balance,
such as IOs and IIOs. We do not intend to use leverage in these
instances because the securities contain structural leverage.
Pass-through Agency RMBS and structured Agency RMBS typically
exhibit materially different sensitivities to movements in
interest rates. Declines in the value of one portfolio may be
offset by appreciation in the other. The percentage of capital
that we allocate to our two Agency RMBS asset categories will
vary and will be actively managed in an effort to maintain the
level of income generated by the combined portfolios, the
stability of that income stream and the stability of the value
of the combined portfolios. We believe that this strategy will
enhance our liquidity, earnings, book value stability and asset
selection opportunities in various interest rate environments.
We were formed by Bimini in August 2010. We commenced operations
on November 24, 2010, and through March 31, 2011,
Bimini had contributed approximately $7.5 million in cash
to us. Bimini has agreed to contribute an additional
$7.5 million in cash to us prior to the completion of this
offering pursuant to a subscription agreement to purchase
additional shares of our common stock. Bimini is currently our
sole stockholder. Bimini has managed our portfolio since
inception by utilizing the same investment strategy that we
expect our Manager and its experienced RMBS investment team to
continue to employ after completion of this offering. As of
March 31, 2011, our Agency RMBS portfolio had a fair value
of approximately $28.9 million and was comprised of
approximately 83.5% pass-through Agency RMBS and 16.5%
structured Agency RMBS. Our net asset value as of March 31,
2011 was approximately $7.5 million.
We intend to qualify and will elect to be taxed as a REIT under
the Code commencing with our short taxable year ending
December 31, 2011. We generally will not be subject to
U.S. federal income tax to the extent that we annually
distribute all of our REIT taxable income to our stockholders
and qualify as a REIT.
Our
Manager
We are currently managed by Bimini. Upon completion of this
offering, we will be externally managed and advised by Bimini
Advisors, Inc., or our Manager, pursuant to the terms of a
management agreement. Our Manager is a newly-formed Maryland
corporation and wholly-owned subsidiary of Bimini. Our Manager
will be responsible for administering our business activities
and
day-to-day
operations, subject to the supervision and oversight of our
Board of Directors. Members of Biminis and our
Managers senior management team will also serve as our
executive officers. We will not have any employees.
77
Bimini Capital
Management, Inc.
Bimini is a mortgage REIT that has operated since 2003 and had
approximately $117 million of pass-through Agency RMBS and
structured Agency RMBS as of March 31, 2011. Bimini has
employed this strategy with its own portfolio since the third
quarter of 2008 and with our portfolio since our inception. The
following table shows Biminis returns on invested capital
since employing our investment strategy in the third quarter of
2008. The returns on Biminis invested capital provided
below are net of the interest paid pursuant to Biminis
repurchase agreements but does not give effect to the cost of
Biminis other long-term financing costs as described below.
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative Return
|
|
|
Quarterly Return on
|
|
on Invested
|
|
|
Invested
Capital(1)
|
|
Capital(1)(2)
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
September 30, 2008
|
|
|
2.5
|
%
|
|
|
2.5
|
%
|
December 31, 2008
|
|
|
8.9
|
%
|
|
|
11.7
|
%
|
March 31, 2009
|
|
|
13.2
|
%
|
|
|
26.4
|
%
|
June 30, 2009
|
|
|
14.0
|
%
|
|
|
44.0
|
%
|
September 30, 2009
|
|
|
10.7
|
%
|
|
|
59.4
|
%
|
December 31, 2009
|
|
|
7.0
|
%
|
|
|
70.6
|
%
|
March 31, 2010
|
|
|
(0.3
|
)%
|
|
|
70.1
|
%
|
June 30, 2010
|
|
|
9.4
|
%
|
|
|
86.0
|
%
|
September 30, 2010
|
|
|
3.0
|
%
|
|
|
91.6
|
%
|
December 31, 2010
|
|
|
8.0
|
%
|
|
|
106.9
|
%
|
March 31, 2011
|
|
|
6.2
|
%
|
|
|
119.7
|
%
|
Annualized Return on Invested
Capital(3)
|
|
|
|
|
|
|
33.1
|
%
|
|
|
|
(1) |
|
Returns on invested capital are
calculated by dividing (i) the sum of (A) net interest
income, before interest on junior subordinated notes (which
equals the difference between interest income and interest
expense), and (B) gains/losses on trading securities by
(ii) invested capital. Invested capital consists of the sum
of: (i) mortgage-backed securities pledged to
counterparties (less repurchase agreements and unsettled
security transactions), (ii) mortgage-backed
securities unpledged (which consists of unpledged
pass-through Agency RMBS and structured Agency RMBS less any
unsettled Agency RMBS), (iii) cash and cash equivalents and
(iv) restricted cash. The components of invested capital
and returns on invested capital are based entirely on
information contained in the SEC filings of Bimini Capital
Management, Inc., which are publicly available through the
SECs website at www.sec.gov. The information contained in
the SEC filings of Bimini Capital Management, Inc. do not
constitute a part of this prospectus or any amendment or
supplement thereto.
|
|
|
|
(2) |
|
Cumulative return on invested
capital represents the return on invested capital assuming the
reinvestment of all prior period returns beginning on
July 1, 2008. For example, the cumulative return on
invested capital as of December 31, 2008 was calculated as
follows: ((1+0.0252)*(1+0.0891))-1.
|
|
(3) |
|
Calculated by annualizing the total
cumulative return on invested capital for the periods presented
above.
|
The table below shows the components of Biminis invested
capital. All information in the table below is based entirely on
information contained in the SEC filings of Bimini which are
publicly
78
available through the SECs website at www.sec.gov. The
information contained in the SEC filings of Bimini do not
constitute a part of this prospectus or any amendment or
supplement thereto.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase
|
|
|
|
|
|
|
|
|
|
|
Mortgage-Backed
|
|
Agreements
|
|
|
|
|
|
|
|
|
|
|
Securities -
|
|
and Unsettled
|
|
Mortgage-Backed
|
|
|
|
|
|
|
|
|
Pledged to
|
|
Security
|
|
Securities -
|
|
Cash and Cash
|
|
|
|
Total Invested
|
As of:
|
|
Counterparties
|
|
Transactions(1)
|
|
Unpledged
|
|
Equivalents
|
|
Restricted Cash
|
|
Capital
|
|
|
(Dollars in thousands)
|
|
September 30, 2008
|
|
$
|
208,921
|
|
|
$
|
(200,708
|
)
|
|
$
|
17,647
|
|
|
$
|
12,377
|
|
|
$
|
250
|
|
|
$
|
38,487
|
|
December 31, 2008
|
|
|
158,444
|
|
|
|
(148,695
|
)
|
|
|
13,664
|
|
|
|
7,669
|
|
|
|
|
|
|
|
31,082
|
|
March 31, 2009
|
|
|
80,618
|
|
|
|
(74,736
|
)
|
|
|
10,786
|
|
|
|
22,113
|
|
|
|
|
|
|
|
38,781
|
|
June 30, 2009
|
|
|
75,159
|
|
|
|
(69,887
|
)
|
|
|
19,335
|
|
|
|
4,821
|
|
|
|
|
|
|
|
29,427
|
|
September 30, 2009
|
|
|
66,286
|
|
|
|
(82,733
|
)
|
|
|
39,992
|
|
|
|
14,785
|
|
|
|
|
|
|
|
38,330
|
|
December 31, 2009
|
|
|
104,876
|
|
|
|
(100,271
|
)
|
|
|
14,793
|
|
|
|
6,400
|
|
|
|
2,530
|
|
|
|
28,327
|
|
March 31, 2010
|
|
|
79,763
|
|
|
|
(81,077
|
)
|
|
|
22,397
|
|
|
|
5,159
|
|
|
|
950
|
|
|
|
27,191
|
|
June 30, 2010
|
|
|
75,271
|
|
|
|
(73,086
|
)
|
|
|
22,282
|
|
|
|
4,433
|
|
|
|
168
|
|
|
|
29,068
|
|
September 30, 2010
|
|
|
111,886
|
|
|
|
(107,274
|
)
|
|
|
18,891
|
|
|
|
3,071
|
|
|
|
1,539
|
|
|
|
28,114
|
|
December 31, 2010
|
|
|
117,254
|
|
|
|
(113,592
|
)
|
|
|
17,879
|
|
|
|
2,831
|
|
|
|
3,546
|
|
|
|
27,918
|
|
March 31, 2011
|
|
|
99,509
|
|
|
|
(94,927
|
)
|
|
|
17,525
|
|
|
|
5,199
|
|
|
|
1,186
|
|
|
|
28,491
|
|
|
|
|
(1) |
|
On occasion, Bimini enters into
reverse repurchase agreements to facilitate the sale of selected
positions in its pass-through Agency RMBS portfolio without
unwinding an existing repurchase agreement. In accordance with
the terms of a master repurchase agreement, repurchase
agreements and reverse repurchase agreements are reported net of
each other in Biminis consolidated balance sheet. As of
March 31, 2011, Bimini had outstanding a reverse repurchase
agreement with one counterparty of approximately
$12.4 million which matured on May 10, 2011.
|
We believe that this method of calculating returns described
above provides a useful means to measure the performance of
Biminis portfolio because (i) it is based on actual
capital invested in Biminis portfolio (including cash and
cash equivalents and restricted cash that could be used to
satisfy margin calls) instead of overall stockholders
equity, which takes into account Biminis accumulated
deficit and other factors unrelated to the portfolio, and
(ii) it shows Biminis quarterly and cumulative
returns on its Agency RMBS portfolio taking into account the
repurchase agreement financing costs typical to manage this type
of portfolio, but without taking into account its entity-level
capital by excluding from the returns the effects of interest
due on Biminis junior subordinated debt, which is related
to Biminis trust preferred securities. Because of the
terms of its trust preferred securities (which include the
long-term nature of the underlying junior subordinated debt and
the fact that such debt is not held directly by outside
investors, but indirectly through preferred equity securities of
an intervening trust that holds such debt), Bimini characterizes
its trust preferred securities (and the related junior
subordinated debt) as a form of capital, rather than as a form
of financing for Biminis portfolio, when calculating
returns on invested capital.
Our results may differ from Biminis results and will
depend on a variety of factors, some of which are beyond our
control
and/or are
difficult to predict, including changes in interest rates,
changes in prepayment speeds and other changes in market
conditions and economic trends. In addition, Biminis
portfolio results above do not include other expenses necessary
to operate a public company and that we will incur following the
completion of this offering, including the management fee we
will pay to our Manager. Therefore, you should not assume that
Biminis portfolios performance will be indicative of
the performance of our portfolio or the Company.
In 2005, Bimini acquired Opteum Financial Services, LLC, or OFS,
an originator of residential mortgages. At the time OFS was
acquired, Bimini managed an Agency RMBS portfolio with a fair
value of approximately $3.5 billion. OFS operated in
46 states and originated residential mortgages through
three production channels. OFS did not have the capacity to
retain the mortgages it originated, and relied on the ability to
sell loans as they were originated as either whole loans or
through off-balance sheet securitizations. When the residential
housing market in the United States started to collapse in
79
late 2006 and early 2007, the ability to successfully execute
this strategy was quickly impaired as whole loan prices
plummeted and the securitization markets closed. Biminis
management closed a majority of the mortgage origination
operations in early 2007, with the balance sold by June 30,
2007. Additional losses were incurred after June 30, 2007
as the remaining assets were sold or became impaired, and by
December 31, 2009, OFS had an accumulated deficit of
approximately $278 million. The losses generated by OFS
required Bimini to slowly liquidate its Agency RMBS portfolio as
capital was reduced and the operations of OFS drained
Biminis cash resources. On November 5, 2007, Bimini
was delisted by the NYSE. By December 31, 2008,
Biminis Agency RMBS portfolio was reduced to approximately
$172 million and, as a result of the reduced capital
remaining and the financial crisis, Bimini had limited access to
repurchase agreement funding. Bimini and its subsidiaries are
subject to a number of ongoing legal proceedings. Those
proceedings or any future proceedings may divert the time and
attention of our Manager and certain key personnel of our
Manager from us and our investment strategy. The diversion of
time of our Manager and certain key personnel of our Manager may
have a material adverse effect on our reputation, business
operations, financial condition and results of operations and
our ability to pay distributions to our stockholders. See
Risk Factors Legal proceedings involving Bimini
and certain of its subsidiaries have adversely affected Bimini,
may materially adversely affect Biminis ability to
effectively manage our business and could materially adversely
affect our reputation, business operations, financial condition
and results of operations and our ability to pay distributions
to our stockholders.
Although our and Biminis Chief Executive Officer,
Mr. Cauley, and Chief Investment Officer and Chief
Financial Officer, Mr. Haas, both worked at Bimini during
the time it owned OFS (Mr. Cauley was the Chief Investment
Officer and Chief Financial Officer and Mr. Haas was the
Head of Research and Trading), their primary focus and
responsibilities were the management of Biminis securities
portfolio, not the management of OFS. In addition,
Mr. Cauley is the only director still serving on
Biminis board of directors that served when OFS was
acquired. Biminis current investment strategy was
implemented in the third quarter of 2008, the first full quarter
of operations after Mr. Cauley become the Chief Executive
Officer of Bimini and Mr. Haas became the Chief Investment
Officer and Chief Financial Officer of Bimini.
Messrs. Cauley and Haas were appointed to these respective
roles on April 14, 2008.
Our Investment
and Capital Allocation Strategy
Our Investment
Strategy
Our business objective is to provide attractive risk-adjusted
total returns to our investors over the long term through a
combination of capital appreciation and the payment of regular
quarterly distributions. We intend to achieve this objective by
investing in and strategically allocating capital between
pass-through Agency RMBS and structured Agency RMBS. We seek to
generate income from (i) the net interest margin on our
leveraged pass-through Agency RMBS portfolio and the leveraged
portion of our structured Agency RMBS portfolio, and
(ii) the interest income we generate from the unleveraged
portion of our structured Agency RMBS portfolio. We also seek to
minimize the volatility of both the net asset value of, and
income from, our portfolio through a process which emphasizes
capital allocation, asset selection, liquidity and active
interest rate risk management.
We intend to fund our pass-through Agency RMBS and certain of
our structured Agency RMBS, such as fixed and floating rate
tranches of CMOs and POs, through repurchase agreements.
However, we do not intend to employ leverage on our structured
Agency RMBS that have no principal balance, such as IOs and
IIOs. We do not intend to use leverage in these instances
because the securities contain structural leverage.
Our investment strategy consists of the following components:
|
|
|
|
|
investing in pass-through Agency RMBS and certain structured
Agency RMBS, such as fixed and floating rate tranches of CMOs
and POs, on a leveraged basis to increase returns on the capital
allocated to this portfolio;
|
80
|
|
|
|
|
investing in certain structured Agency RMBS, such as IOs and
IIOs, on an unleveraged basis in order to (i) increase
returns due to the structural leverage contained in such
securities, (ii) enhance liquidity due to the fact that
these securities will be unencumbered and (iii) diversify
portfolio interest rate risk due to the different interest rate
sensitivity these securities have compared to pass-through
Agency RMBS;
|
|
|
|
|
|
investing in Agency RMBS in order to minimize credit risk;
|
|
|
|
investing in assets that will cause us to maintain our exclusion
from regulation as an investment company under the Investment
Company Act; and
|
|
|
|
investing in assets that will allow us to qualify and maintain
our qualification as a REIT.
|
Our Manager will make investment decisions based on various
factors, including, but not limited to, relative value, expected
cash yield, supply and demand, costs of hedging, costs of
financing, liquidity requirements, expected future interest rate
volatility and the overall shape of the U.S. Treasury and
interest rate swap yield curves. We do not attribute any
particular quantitative significance to any of these factors,
and the weight we give to these factors depends on market
conditions and economic trends. We believe that this strategy,
combined with our Managers experienced RMBS investment
team, will enable us to provide attractive long-term returns to
our stockholders.
Capital
Allocation Strategy
The percentage of capital invested in our two asset categories
will vary and will be managed in an effort to maintain the level
of income generated by the combined portfolios, the stability of
that income stream and the stability of the value of the
combined portfolios. Typically, pass-through Agency RMBS and
structured Agency RMBS exhibit materially different
sensitivities to movements in interest rates. Declines in the
value of one portfolio may be offset by appreciation in the
other, although we cannot assure you that this will be the case.
Additionally, our Manager will seek to maintain adequate
liquidity as it allocates capital.
We will allocate our capital to assist our interest rate risk
management efforts. The unleveraged portfolio does not require
unencumbered cash or cash equivalents to be maintained in
anticipation of possible margin calls. To the extent more
capital is deployed in the unleveraged portfolio, our liquidity
needs will generally be less.
During periods of rising interest rates, refinancing
opportunities available to borrowers typically decrease because
borrowers are not able to refinance their current mortgage loans
with new mortgage loans at lower interest rates. In such
instances, securities that are highly sensitive to refinancing
activity, such as IOs and IIOs, typically increase in value. Our
capital allocation strategy allows us to redeploy our capital
into such securities when and if we believe interest rates will
be higher in the future, thereby allowing us to hold securities
the value of which we believe is likely to increase as interest
rates rise. Also, by being able to re-allocate capital into
structured Agency RMBS, such as IOs, during periods of rising
interest rates, we may be able to offset the likely decline in
the value of our pass-through Agency RMBS, which are negatively
impacted by rising interest rates.
We intend to qualify as a REIT and operate in a manner that will
not subject us to regulation under the Investment Company Act.
In order to rely on the exemption provided by
Section 3(c)(5)(C) under the Investment Company Act, we
must maintain at least 55% of our assets in qualifying real
estate assets. For purposes of this test, structured
mortgage-backed securities are non-qualifying real estate
assets. Accordingly, while we have no explicit limitation on the
amount of our capital that we will deploy to the unleveraged
structured Agency RMBS portfolio, we will deploy our capital in
such a way so as to maintain our exemption from registration
under the Investment Company Act.
81
Competitive
Strengths
We believe that our competitive strengths include:
|
|
|
|
|
Ability to Successfully Allocate Capital between
Pass-Through and Structured Agency RMBS. We
seek to maximize our risk-adjusted returns by investing
exclusively in Agency RMBS, which has limited credit risk due to
the guarantee of principal and interest payments on such
securities by Fannie Mae, Freddie Mac or Ginnie Mae. Our Manager
will allocate capital between pass-through Agency RMBS and
structured Agency RMBS. The percentage of our capital we
allocate to our two asset categories will vary and will be
actively managed in an effort to maintain the level of income
generated by the combined portfolios, the stability of that
income stream and the stability of the value of the combined
portfolios. We believe this strategy will enhance our liquidity,
earnings, book value stability and asset selection opportunities
in various interest rate environments and provide us with a
competitive advantage over other REITs that invest in only
pass-through Agency RMBS. This is because, among other reasons,
our investment and capital allocation strategies allow us to
move capital out of pass-through Agency RMBS and into structured
Agency RMBS in a rising interest rate environment, which will
protect our portfolio from excess margin calls on our
pass-through Agency RMBS portfolio and reduced net interest
margins, and allow us to invest in securities, such as IOs, that
have historically performed well in a rising interest rate
environment.
|
|
|
|
|
|
Experienced RMBS Investment Team. Mr.
Cauley, our Chief Executive Officer and co-founder of Bimini,
and Mr. Haas, our Chief Investment Officer, have 19 and ten
years of experience, respectively, in analyzing, trading and
investing in Agency RMBS. Additionally, Messrs. Cauley and
Haas each have over seven years of experience managing Bimini,
which is a publicly-traded REIT that has invested in Agency RMBS
since its inception in 2003. Messrs. Cauley and Haas
managed Bimini through the recent housing market collapse and
the related adverse effects on the banking and financial system,
repositioning Biminis portfolio in response to adverse
market conditions. We believe this experience has enabled them
to recognize portfolio risk in advance, hedge such risk
accordingly and manage liquidity and borrowing risks during
adverse market conditions. We believe that
Messrs. Cauleys and Haass experience will
provide us with a competitive advantage over other management
teams that may not have experience managing a publicly-traded
mortgage REIT or managing a business similar to ours during
various interest rate and credit cycles, including the recent
housing market collapse.
|
|
|
|
|
|
Clean Balance Sheet With an Implemented Investment
Strategy. As a recently-formed entity, we
intend to build on our existing investment portfolio. As of
March 31, 2011, our Agency RMBS portfolio had a fair value
of approximately $28.9 million and was comprised of
approximately 83.5% pass-through Agency RMBS and 16.5%
structured Agency RMBS. Our net asset value as of March 31,
2011 was approximately $7.5 million. Bimini has managed our
portfolio since inception by utilizing the same investment
strategy that we expect our Manager and its experienced RMBS
investment team to continue to employ after the completion of
this offering.
|
|
|
|
|
|
Alignment of Interests. Upon completion
of this offering, Bimini will own 1,063,830 shares of our
common stock. Concurrently with this offering, we will sell to
Bimini warrants to purchase an aggregate of
4,500,000 shares of our common stock in a separate private
placement for an aggregate purchase price of $2,475,000. Upon
completion of this offering, Bimini will own common stock
representing approximately 12.42% of the outstanding shares of
our common stock (or 10.98% if the underwriters exercise their
option to purchase additional shares in full). Bimini has agreed
that, for a period of 365 days after the date of this
prospectus, it will not, without the prior written consent of
Barclays Capital Inc., dispose of or hedge any of (i) its
shares of our common stock, including any shares of our common
|
82
|
|
|
|
|
stock issuable upon the exercise of the warrants it intends to
purchase in the concurrent private placement, (ii) the
warrants that it intends to purchase in the concurrent private
placement or (iii) any common stock that it may acquire
after the completion of this offering, subject to certain
exceptions and extensions.
|
Our
Portfolio
As of March 31, 2011, our portfolio consisted of Agency
RMBS with an aggregate fair value of approximately
$28.9 million, a weighted average coupon of 4.22% and a net
weighted average borrowing cost of 0.33%. The following table
summarizes our portfolio as of March 31, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
of
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
Coupon
|
|
|
Average
|
|
|
Average
|
|
|
Weighted
|
|
|
|
|
|
|
Entire
|
|
|
Average
|
|
|
Maturity in
|
|
|
Longest
|
|
|
Reset in
|
|
|
Lifetime
|
|
|
Periodic
|
|
|
Average
|
|
Asset Category
|
|
Fair Value
|
|
|
Portfolio
|
|
|
Coupon
|
|
|
Months
|
|
|
Maturity
|
|
|
Months
|
|
|
Cap
|
|
|
Cap
|
|
|
CPR(1)
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pass-through Agency RMBS backed by:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustable-Rate Mortgages
|
|
$
|
7,721
|
|
|
|
26.7
|
%
|
|
|
2.53
|
%
|
|
|
288
|
|
|
|
April 2035
|
|
|
|
5.03
|
|
|
|
9.55
|
%
|
|
|
2.00
|
%
|
|
|
0.11
|
%
|
Fixed-Rate Mortgages
|
|
|
16,418
|
|
|
|
56.8
|
%
|
|
|
4.54
|
%
|
|
|
171
|
|
|
|
November 2025
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
0.75
|
%
|
Hybrid Adjustable-Rate Mortgages
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total/Weighted Average Whole-pool Mortgage Pass-through Agency
RMBS
|
|
$
|
24,139
|
|
|
|
83.5
|
%
|
|
|
3.90
|
%
|
|
|
208
|
|
|
|
April 2035
|
|
|
|
5.03
|
|
|
|
9.55
|
%
|
|
|
2.00
|
%
|
|
|
0.54
|
%
|
Structured Agency RMBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IOs
|
|
|
966
|
|
|
|
3.3
|
%
|
|
|
4.50
|
%
|
|
|
163
|
|
|
|
October 2024
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
IIOs
|
|
|
3,799
|
|
|
|
13.2
|
%
|
|
|
6.22
|
%
|
|
|
297
|
|
|
|
April 2037
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
19.73
|
%
|
POs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total/Weighted Average Structured Agency RMBS
|
|
|
4,765
|
|
|
|
16.5
|
%
|
|
|
5.87
|
%
|
|
|
270
|
|
|
|
April 2037
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
19.73
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total/Weighted Average
|
|
$
|
28,904
|
|
|
|
100
|
%
|
|
|
4.22
|
%
|
|
|
218
|
|
|
|
April 2037
|
|
|
|
5.03
|
|
|
|
9.55
|
%
|
|
|
2.00
|
%
|
|
|
5.67
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
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CPR is a method of expressing the
prepayment rate for a mortgage pool that assumes that a constant
fraction of the remaining principal is prepaid each month or
year. Specifically the constant prepayment rate in the chart
above represents the three month prepayment rate of the
securities in the respective asset category.
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Description of
Agency RMBS
Pass-through
Agency RMBS
We invest in pass-through securities, which are securities
secured by residential real property in which payments of both
interest and principal on the securities are generally made
monthly. In effect, these securities pass through the monthly
payments made by the individual borrowers on the mortgage loans
that underlie the securities, net of fees paid to the issuer or
guarantor of the securities. Pass-through certificates can be
divided into various categories based on the characteristics of
the underlying mortgages, such as the term or whether the
interest rate is fixed or variable.
The payment of principal and interest on mortgage pass-through
securities issued by Ginnie Mae, but not the market value, is
guaranteed by the full faith and credit of the federal
government. Payment of principal and interest on mortgage
pass-through certificates issued by Fannie Mae and Freddie Mac,
but not the market value, is guaranteed by the respective agency
issuing the security.
A key feature of most mortgage loans is the ability of the
borrower to repay principal earlier than scheduled. This is
called a prepayment. Prepayments arise primarily due to sale of
the underlying
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property, refinancing or foreclosure. Prepayments result in a
return of principal to pass-through certificate holders. This
may result in a lower or higher rate of return upon reinvestment
of principal. This is generally referred to as prepayment
uncertainty. If a security purchased at a premium prepays at a
higher-than-expected
rate, then the value of the premium would be eroded at a
faster-than-expected
rate. Similarly, if a discount mortgage prepays at a
lower-than-expected
rate, the amortization towards par would be accumulated at a
slower-than-expected
rate. The possibility of these undesirable effects is sometimes
referred to as prepayment risk.
In general, declining interest rates tend to increase
prepayments, and rising interest rates tend to slow prepayments.
Like other fixed-income securities, when interest rates rise,
the value of Agency RMBS generally declines. The rate of
prepayments on underlying mortgages will affect the price and
volatility of Agency RMBS and may shorten or extend the
effective maturity of the security beyond what was anticipated
at the time of purchase. If interest rates rise, our holdings of
Agency RMBS may experience reduced returns if the borrowers of
the underlying mortgages pay off their mortgages later than
anticipated. This is generally referred to as extension risk.
The mortgage loans underlying pass-through certificates can
generally be classified into the following three categories:
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Fixed-Rate Mortgages. Fixed-rate
mortgages are those where the borrower pays an interest rate
that is constant throughout the term of the loan. Traditionally,
most fixed-rate mortgages have an original term of
30 years. However, shorter terms (also referred to as final
maturity dates) have become common in recent years. Because the
interest rate on the loan never changes, even when market
interest rates change, over time there can be a divergence
between the interest rate on the loan and current market
interest rates. This in turn can make fixed-rate mortgages price
sensitive to market fluctuations in interest rates. In general,
the longer the remaining term on the mortgage loan, the greater
the price sensitivity.
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ARMs. ARMs are mortgages for which the
borrower pays an interest rate that varies over the term of the
loan. The interest rate usually resets based on market interest
rates, although the adjustment of such an interest rate may be
subject to certain limitations. Traditionally, interest rate
resets occur at regular set intervals (for example, once per
year). We will refer to such ARMs as traditional
ARMs. Because the interest rates on ARMs fluctuate based on
market conditions, ARMs tend to have interest rates that do not
deviate from current market rates by a large amount. This in
turn can mean that ARMs have less price sensitivity to interest
rates.
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Hybrid Adjustable-Rate
Mortgages. Hybrid ARMs have a fixed-rate for
the first few years of the loan, often three, five, or seven
years, and thereafter reset periodically like a traditional ARM.
Effectively, such mortgages are hybrids, combining the features
of a pure fixed-rate mortgage and a traditional ARM. Hybrid ARMs
have price sensitivity to interest rates similar to that of a
fixed-rate mortgage during the period when the interest rate is
fixed and similar to that of an ARM when the interest rate is in
its periodic reset stage. However, because many hybrid ARMs are
structured with a relatively short initial time span during
which the interest rate is fixed, even during that segment of
its existence, the price sensitivity may be high.
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Structured
Agency RMBS
We also invest in structured Agency RMBS, which include CMOs,
IOs, IIOs and POs. The payment of principal and interest,
as appropriate, on structured Agency RMBS issued by Ginnie Mae,
but not the market value, is guaranteed by the full faith and
credit of the federal government. Payment of principal and
interest, as appropriate, on structured Agency RMBS issued by
Fannie Mae and Freddie Mac, but not the market value, is
guaranteed by the respective agency issuing the security. The
types of structured Agency RMBS in which we invest are described
below.
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CMOs. CMOs are a type of RMBS the
principal and interest of which are paid, in most cases, on a
monthly basis. CMOs may be collateralized by whole mortgage
loans, but are more typically collateralized by portfolios of
mortgage pass-through securities issued directly by or under the
auspices of Ginnie Mae, Freddie Mac or Fannie Mae. CMOs are
structured into multiple classes, with each class bearing a
different stated maturity. Monthly payments of principal,
including prepayments, are first returned to investors holding
the shortest maturity class. Investors holding the longer
maturity classes receive principal only after the first class
has been retired. Generally, fixed-rate mortgages are used to
collateralize CMOs. However, the CMO tranches need not all have
fixed-rate coupons. Some CMO tranches have floating rate coupons
that adjust based on market interest rates, subject to some
limitations. Such tranches, often called CMO
floaters, can have relatively low price sensitivity to
interest rates.
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IOs. IOs represent the stream of
interest payments on a pool of mortgages, either fixed-rate
mortgages or hybrid ARMs. Holders of IOs have no claim to any
principal payments. The value of IOs depends primarily on two
factors, which are prepayments and interest rates. Prepayments
on the underlying pool of mortgages reduce the stream of
interest payments going forward, hence IOs are highly sensitive
to prepayment rates. IOs are also sensitive to changes in
interest rates. An increase in interest rates reduces the
present value of future interest payments on a pool of
mortgages. On the other hand, an increase in interest rates has
a tendency to reduce prepayments, which increases the expected
absolute amount of future interest payments.
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IIOs. IIOs represent the stream of
interest payments on a pool of mortgages, either fixed-rate
mortgages or hybrid ARMs. Holders of IIOs have no claim to any
principal payments. The value of IIOs depends primarily on three
factors, which are prepayments, LIBOR rates and term interest
rates. Prepayments on the underlying pool of mortgages reduce
the stream of interest payments, hence IIOs are highly sensitive
prepayment rates. The coupon on IIOs is derived from both the
coupon interest rate on the underlying pool of mortgages and
30-day LIBOR. IIOs are typically created in conjunction with a
floating rate CMO that has a principal balance and which is
entitled to receive all of the principal payments on the
underlying pool of mortgages. The coupon on the floating rate
CMO is also based on 30-day LIBOR. Typically, the coupon on the
floating rate CMO and the IIO, when combined, equal the coupon
on the pool of underlying mortgages. The coupon on the pool of
underlying mortgages typically represents a cap or ceiling on
the combined coupons of the floating rate CMO and the IIO.
Accordingly, when the value of 30-day LIBOR increases, the
coupon of the floating rate CMO will increase and the coupon on
the IIO will decrease. When the value of 30-day LIBOR falls, the
opposite is true. Accordingly, the value of IIOs are sensitive
to the level of 30-day LIBOR and expectations by market
participants of future movements in the level of 30-day LIBOR.
IIOs are also sensitive to changes in interest rates. An
increase in interest rates reduces the present value of future
interest payments on a pool of mortgages. On the other hand, an
increase in interest rates has a tendency to reduce prepayments,
which increases the expected absolute amount of future interest
payments.
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POs. POs represent the stream of
principal payments on a pool of mortgages. Holders of POs have
no claim to any interest payments, although the ultimate amount
of principal to be received over time is known it
equals the principal balance of the underlying pool of
mortgages. What is not known is the timing of the receipt of the
principal payments. The value of POs depends primarily on two
factors, which are prepayments and interest rates. Prepayments
on the underlying pool of mortgages accelerate the stream of
principal repayments, hence POs are highly sensitive to the rate
at which the mortgages in the pool are prepaid. POs are also
sensitive to changes in interest rates. An increase in interest
rates reduces the present value of future principal payments on
a pool of mortgages. Further, an increase in interest rates also
has a tendency to reduce prepayments, which decelerates, or
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pushes further out in time, the ultimate receipt of the
principal payments. The opposite is true when interest rates
decline.
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Our Financing
Strategy
We intend to fund our pass-through Agency RMBS and certain of
our structured Agency RMBS, such as fixed and floating rate
tranches of CMOs and POs, through short-term repurchase
agreements. However, we do not intend to employ leverage on our
structured Agency RMBS that have no principal balance, such as
IOs and IIOs. We do not intend to use leverage in these
instances because the securities contain structural leverage.
Our borrowings currently consist of short-term borrowings
pursuant to repurchase agreements. We may use other sources of
leverage, such as secured or unsecured debt or issuances of
preferred stock. We do not have a policy limiting the amount of
leverage we may incur. However, we generally expect that the
ratio of our total liabilities compared to our equity, which we
refer to as our leverage ratio, will be less than 12 to 1. Our
amount of leverage may vary depending on market conditions and
other factors that we deem relevant. As of March 31, 2011,
our portfolio leverage ratio was approximately 3.0 to 1. As of
March 31, 2011, we had entered into master repurchase
agreements with two counterparties and had funding in place with
one such counterparty, as described below. We have since entered
into master repurchase agreements with three additional
counterparties (for a total of five) and are currently
negotiating, and intend to enter into, additional master
repurchase agreements with additional counterparties after
completion of this offering to attain additional lending
capacity and to diversify counterparty credit risk. However, we
cannot assure you that we will enter into such additional master
repurchase agreements on favorable terms, or at all.
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Net
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Weighted
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Weighted Average
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Percent of
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Average
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Maturity of
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Total
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Borrowing
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Repurchase
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Counterparty
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Balance
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Borrowings
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Cost
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Agreements in Days
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Amount at
Risk(1)
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MF Global Inc.
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$
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22,530,842
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100
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%
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0.33
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%
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77
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$
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1,673,153
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Equal to the fair value of
securities sold, plus accrued interest income, minus the sum of
repurchase agreement liabilities and accrued interest expense.
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During the three months ended March 31, 2011, the average
balance of our repurchase agreement financing was $22,680,448.
Risk
Management
We invest in Agency RMBS to mitigate credit risk. Additionally,
our Agency RMBS are backed by a diversified base of mortgage
loans to mitigate geographic, loan originator and other types of
concentration risks.
Interest Rate
Risk Management
We believe that the risk of adverse interest rate movements
represents the most significant risk to our portfolio. This risk
arises because (i) the interest rate indices used to
calculate the interest rates on the mortgages underlying our
assets may be different from the interest rate indices used to
calculate the interest rates on the related borrowings, and
(ii) interest rate movements affecting our borrowings may
not be reasonably correlated with interest rate movements
affecting our assets. We attempt to mitigate our interest rate
risk by using the following techniques:
Agency RMBS Backed by ARMs. We seek to
minimize the differences between interest rate indices and
interest rate adjustment periods of our Agency RMBS backed by
ARMs and related borrowings. At the time of funding, we
typically align (i) the underlying interest rate index used
to calculate interest rates for our Agency RMBS backed by ARMs
and the related borrowings and (ii) the interest rate
adjustment periods for our Agency RMBS backed by ARMs and the
interest rate adjustment periods for our related borrowings. As
our borrowings mature or are renewed, we may
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adjust the index used to calculate interest expense, the
duration of the reset periods and the maturities of our
borrowings.
Agency RMBS Backed by Fixed-Rate
Mortgages. As interest rates rise, our
borrowing costs increase; however, the income on our Agency RMBS
backed by fixed-rate mortgages remains unchanged. Subject to
qualifying and maintaining our qualification as a REIT, we may
seek to limit increases to our borrowing costs through the use
of interest rate swap or cap agreements, options, put or call
agreements, futures contracts, forward rate agreements or
similar financial instruments to effectively convert our
floating-rate borrowings into fixed-rate borrowings.
Agency RMBS Backed by Hybrid
ARMs. During the fixed-rate period of our
Agency RMBS backed by hybrid ARMs, the security is similar to
Agency RMBS backed by fixed-rate mortgages. During this period,
subject to qualifying and maintaining our qualification as a
REIT, we may employ the same hedging strategy that we employ for
our Agency RMBS backed by fixed-rate mortgages. Once our Agency
RMBS backed by hybrid ARMs convert to floating rate securities,
we may employ the same hedging strategy as we employ for our
Agency RMBS backed by ARMs.
Additionally, our structured Agency RMBS generally exhibit
sensitivities to movements in interest rates different than our
pass-through Agency RMBS. To the extent they do so, our
structured Agency RMBS may protect us against declines in the
market value of our combined portfolio that result from adverse
interest rate movements, although we cannot assure you that this
will be the case.
Prepayment
Risk Management
The risk of mortgage prepayments is another significant risk to
our portfolio. When prevailing interest rates fall below the
coupon rate of a mortgage, mortgage prepayments are likely to
increase. Conversely, when prevailing interest rates increase
above the coupon rate of a mortgage, mortgage prepayments are
likely to decrease.
When prepayment rates increase, we may not be able to reinvest
the money received from prepayments at yields comparable to
those of the securities prepaid. Also, some ARMs and hybrid ARMs
which back our Agency RMBS may bear initial teaser
interest rates that are lower than their fully-indexed interest
rates. If these mortgages are prepaid during this
teaser period, we may lose the opportunity to
receive interest payments at the higher, fully-indexed rate over
the expected life of the security. Additionally, some of our
structured Agency RMBS, such as IOs and IIOs, may be negatively
affected by an increase in prepayment rates because their value
is wholly contingent on the underlying mortgage loans having an
outstanding principal balance.
A decrease in prepayment rates may also have an adverse effect
on our portfolio. For example, if we invest in POs, the purchase
price of such securities will be based, in part, on an assumed
level of prepayments on the underlying mortgage loan. Because
the returns on POs decrease the longer it takes the principal
payments on the underlying loans to be paid, a decrease in
prepayment rates could decrease our returns on these securities.
Prepayment risk also affects our hedging activities. When an
Agency RMBS backed by a fixed-rate mortgage or hybrid ARM is
acquired with borrowings, we may cap or fix our borrowing costs
for a period close to the anticipated average life of the
fixed-rate portion of the related Agency RMBS. If prepayment
rates are different than our projections, the term of the
related hedging instrument may not match the fixed-rate portion
of the security, which could cause us to incur losses.
Because our business may be adversely affected if prepayment
rates are different than our projections, we seek to invest in
Agency RMBS backed by mortgages with well-documented and
predictable prepayment histories. To protect against increases
in prepayment rates, we invest in Agency RMBS backed by
mortgages that we believe are less likely to be prepaid. For
example, we invest in Agency RMBS backed by mortgages
(i) with loan balances low enough such that a borrower
would likely have little incentive to refinance,
(ii) extended to borrowers with credit histories weak
enough to not be eligible to refinance their mortgage loans,
(iii) that are newly originated fixed-rate or
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hybrid ARMs or (iv) that have interest rates low enough
such that a borrower would likely have little incentive to
refinance. To protect against decreases in prepayment rates, we
may also invest in Agency RMBS backed by mortgages with
characteristics opposite to those described above, which would
typically be more likely to be refinanced. We may also invest in
certain types of structured Agency RMBS as a means of mitigating
our portfolio-wide prepayment risks. For example, certain
tranches of CMOs are less sensitive to increases in prepayment
rates, and we may invest in those tranches as a means of hedging
against increases in prepayment rates.
Liquidity
Management Strategy
Because of our use of leverage, we manage liquidity to meet our
lenders margin calls using the following measures:
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Maintaining cash balances or unencumbered assets well in excess
of anticipated margin calls; and
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Making margin calls on our lenders when we have an excess of
collateral pledged against our borrowings.
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We also attempt to minimize the number of margin calls we
receive by:
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Deploying capital from our leveraged Agency RMBS portfolio to
our unleveraged Agency RMBS portfolio;
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Investing in Agency RMBS backed by mortgages that we believe are
less likely to be prepaid to decrease the risk of excessive
margin calls when monthly prepayments are announced. Prepayments
are declared, and the market value of the related security
declines, before the receipt of the related cash flows.
Prepayment declarations give rise to a temporary collateral
deficiency and generally results in margin calls by lenders;
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Obtaining funding arrangements which defer or waive
prepayment-related margin requirements in exchange for payments
to the lender tied to the dollar amount of the collateral
deficiency and a pre-determined interest rate; and
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Reducing our overall amount of leverage.
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Investment
Committee and Investment Guidelines
Our Manager will establish an investment committee, which will
initially consist of Messrs. Cauley and Haas, each of whom
are directors or officers of our Manager. From time to time the
investment committee may propose revisions to our investment
guidelines, which will be subject to the approval of our Board
of Directors. We expect that the investment committee will meet
monthly to discuss diversification of our investment portfolio,
hedging and financing strategies and compliance with the
investment guidelines. Our Board of Directors intends to receive
an investment report and review our investment portfolio and
related compliance with the investment guidelines on at least a
quarterly basis. Our Board of Directors will not review or
approve individual investments unless the investment is outside
our operating policies or investment guidelines.
Our Board of Directors has approved the following investment
guidelines:
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no investment shall be made in any non-Agency RMBS;
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at the end of each quarterly period, our leverage ratio may not
exceed 12 to 1. In the event that our leverage inadvertently
exceeds the leverage ratio of 12 to 1 at the end of a quarterly
period, we may not utilize additional leverage without prior
approval from our Board of Directors until our leverage ratio is
below 12 to 1;
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no leverage on structured Agency RMBS that have no principal
balance, such as IOs and IIOs, because such securities already
contain structural leverage.
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no investment shall be made that would cause us to fail to
qualify as a REIT for U.S. federal income tax purposes; and
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no investment shall be made that would cause us to register as
an investment company under the Investment Company Act.
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The investment committee may change these investment guidelines
at any time with the approval of our Board of Directors but
without any approval from our stockholders.
Repurchase
Agreement Trading, Clearing and Administrative
Services
We have engaged AVM, L.P. (a securities broker-dealer) to
provide us with repurchase agreement trading, clearing and
administrative services. AVM, L.P. acts as our clearing agent
and adviser in arranging for third parties to enter into
repurchase agreements with us, executes and maintains records of
our repurchase transactions and assists in managing the margin
arrangements between us and our counterparties for each of our
repurchase agreements.
Policies With
Respect to Certain Other Activities
If our Board of Directors determines that additional funding is
required, we may raise such funds through additional offerings
of equity or debt securities, the retention of cash flow
(subject to the REIT provisions in the Code concerning
distribution requirements and the taxability of undistributed
REIT taxable income), other funds from debt financing, including
repurchase agreements, or a combination of these methods. In the
event that our Board of Directors determines to raise additional
equity capital, it has the authority, without stockholder
approval, to issue additional common stock or preferred stock in
any manner and on such terms and for such consideration as it
deems appropriate, at any time.
We have authority to offer our common stock or other equity or
debt securities in exchange for property and to repurchase or
otherwise reacquire our shares and may engage in such activities
in the future.
We may, but do not intend to, make loans to third parties or
underwrite securities of other issuers or invest in the
securities of other issuers for the purpose of exercising
control.
Subject to qualifying and maintaining our qualifications as a
REIT, we may, but do not intend to, invest in securities of
other REITs, other entities engaged in real estate activities or
securities of other issuers, including for the purpose of
exercising control over such entities.
Subject to applicable law, our Board of Directors may change any
of these policies, as well as our investment guidelines, without
prior notice to you or a vote of our stockholders.
Custodian
Bank
J.P. Morgan Chase & Co. serves as our custodian bank.
J.P. Morgan Chase & Co. is entitled to fees for
its services.
Tax
Structure
We will elect and intend to qualify to be taxed as a REIT
commencing with our short taxable year ending December 31,
2011. Our qualification as a REIT, and the maintenance of such
qualification, will depend upon our ability to meet, on a
continuing basis, various complex requirements under the Code
relating to, among other things, the sources of our gross
income, the composition and values of our assets, our
distribution levels and the concentration of ownership of our
capital stock. We believe that we will be organized in
conformity with the requirements for qualification and taxation
as a REIT under the Code, and we intend to operate in a manner
that will enable us to meet the requirements for qualification
and taxation as a REIT commencing with our short taxable year
ending December 31, 2011. In connection with this offering,
we will receive an opinion from Hunton & Williams LLP
to the effect that we will be organized in conformity with the
requirements for qualification and taxation as a REIT under the
Code, and that our intended method of operation will enable us
to meet the requirements for qualification and taxation as a
REIT.
As a REIT, we generally will not be subject to U.S. federal
income tax on the REIT taxable income that we currently
distribute to our stockholders, but taxable income generated by
any TRS that
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we may form or acquire will be subject to federal, state and
local income tax. Under the Code, REITs are subject to numerous
organizational and operational requirements, including a
requirement that they distribute annually at least 90% of their
REIT taxable income, determined without regard to the deduction
for dividends paid and excluding any net capital gains. If we
fail to qualify as a REIT in any calendar year and do not
qualify for certain statutory relief provisions, our income
would be subject to U.S. federal income tax, and we would
likely be precluded from qualifying for treatment as a REIT
until the fifth calendar year following the year in which we
failed to qualify. Even if we qualify as a REIT, we may still be
subject to certain federal, state and local taxes on our income
and assets and to U.S. federal income and excise taxes on
our undistributed income.
Investment
Company Act Exemption
We operate our business so that we are exempt from registration
under the Investment Company Act. We rely on the exemption
provided by Section 3(c)(5)(C) of the Investment Company
Act. In order to rely on the exemption provided by
Section 3(c)(5)(C), we must maintain at least 55% of our
assets in qualifying real estate assets. For the purposes of
this test, structured Agency RMBS are non-qualifying real estate
assets. We monitor our portfolio periodically and prior to each
investment to confirm that we continue to qualify for the
exemption. To qualify for the exemption, we make investments so
that at least 55% of the assets we own on an unconsolidated
basis consist of qualifying mortgages and other liens on and
interests in real estate, which we refer to as qualifying real
estate assets, and so that at least 80% of the assets we own on
an unconsolidated basis consist of real estate-related assets,
including our qualifying real estate assets.
We treat whole-pool pass-through Agency RMBS as qualifying real
estate assets based on no-action letters issued by the Staff of
the SEC. To the extent that the SEC publishes new or different
guidance with respect to these matters, we may fail to qualify
for this exemption. Our Manager intends to manage our
pass-through Agency RMBS portfolio such that we will have
sufficient whole-pool pass-through Agency RMBS to ensure we
maintain our exemption from registration under the Investment
Company Act. At present, we generally do not expect that our
investments in structured Agency RMBS will constitute qualifying
real estate assets but will constitute real estate-related
assets for purposes of the Investment Company Act.
Competition
When we invest in Agency RMBS and other investment assets, we
compete with a variety of institutional investors, including
other REITs, insurance companies, mutual funds, pension funds,
investment banking firms, banks and other financial institutions
that invest in the same types of assets. Many of these investors
have greater financial resources and access to lower costs of
capital than we do. The existence of these competitive entities,
as well as the possibility of additional entities forming in the
future, may increase the competition for the acquisition of
mortgage related securities, resulting in higher prices and
lower yields on assets.
Employees
We have no employees.
Properties
We do not own any properties. Our offices are located at 3305
Flamingo Drive, Vero Beach, Florida 32963 and the telephone
number of our offices is (772) 231-1400. Bimini owns these
offices. This property is adequate for our business as currently
conducted.
Legal
Proceedings
There are no legal proceedings pending or threatened involving
Orchid Island Capital, Inc. as of March 31, 2011.
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OUR MANAGER AND
THE MANAGEMENT AGREEMENT
Our
Manager
We are currently managed by Bimini. Upon completion of this
offering, we will be externally managed and advised by Bimini
Advisors, Inc., or our Manager, pursuant to the terms of a
management agreement. Our Manager is a newly-formed Maryland
corporation and wholly-owned subsidiary of Bimini. Our Manager
will be responsible for administering our business activities
and
day-to-day
operations, subject to the supervision and oversight of our
Board of Directors. Members of Biminis and our
Managers senior management team will also serve as our
executive officers. We will not have any employees.
Officers of Our
Manager
Biographical information for each of the executive officers of
our Manager is set forth below.
Robert E. Cauley, CFA has been our Chairman, President
and Chief Executive Officer since August 2010 and is the
Chairman and Chief Executive Officer of our Manager.
Mr. Cauley co-founded Bimini Capital in 2003 and has served
as its Chief Executive Officer and Chairman of the Board of
Directors since 2008. He served as Vice-Chairman, Chief
Financial Officer and Chief Investment Officer prior to 2008.
Prior to co-founding Bimini Capital in 2003, Mr. Cauley was
a vice-president and portfolio manager at Federated Investors in
Pittsburgh from 1996 to 2003. Prior to 1996, Mr. Cauley was
a member of the ABS/MBS structuring desk at Lehman Brothers from
1994 to 1996 and a credit analyst at Barclays Bank, PLC from
1992 to 1994. Mr. Cauley is a CPA (inactive status) and
served in the United States Marine Corps for four years. We
believe that Mr. Cauley should serve as a member of our Board of
Directors due to his experience managing a publicly-traded REIT
and his career as a RMBS portfolio manager.
G. Hunter Haas, IV has been our Chief Financial
Officer and Chief Investment Officer since August 2010 and has
served on our Board of Directors since August 2010.
Mr. Haas is the President, Chief Investment Officer and
Chief Financial Officer of our Manager. Mr. Haas has been
the President, Chief Investment Officer and Chief Financial
Officer of Bimini since 2008. Prior to assuming those roles with
Bimini, he was a Senior Vice President and Head of Research and
Trading. Mr. Haas joined Bimini in April 2004 as Vice
President and Head of Mortgage Research. He has over
10 years experience in this industry and has managed
trading operations for the portfolio since his arrival in May
2004. Mr. Haas has approximately seven years experience as
a member of senior management of a public REIT. Prior to joining
Bimini, Mr. Haas worked in the mortgage industry as a
member of a team responsible for hedging a servicing portfolio
at both National City Mortgage and Homeside Lending, Inc. We
believe that Mr. Haas should serve as a member of our Board of
Directors due to his experience as the Chief Financial Officer
of a publicly-traded REIT and his experience in the mortgage
industry.
Our Management
Agreement
We are currently a party to a management agreement with Bimini.
Upon completion of this offering, we will terminate our
management agreement with Bimini and enter into a new management
agreement with our Manager pursuant to which our Manager will be
responsible for administering our business activities and
day-to-day
operations, subject to the supervision and oversight of our
Board of Directors. The material terms of the management
agreement are described below.
Management
Services
The management agreement requires our Manager to oversee our
business affairs in conformity with our operating policies and
investment guidelines. Our Manager at all times will be subject
to the supervision and direction of our Board of Directors, the
terms and conditions of the management agreement and such
further limitations or parameters as may be imposed from time to
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time by our Board of Directors. Our Manager is responsible for
(i) the selection, purchase and sale of assets in our
investment portfolio, (ii) our financing and hedging
activities and (iii) providing us with investment advisory
services. Our Manager is responsible for our
day-to-day
operations and will perform such services and activities
relating to our assets and operations as may be appropriate,
including, without limitation:
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forming and maintaining our investment committee, which will
have the following responsibilities: (A) proposing the
investment guidelines to the Board of Directors,
(B) reviewing the Companys investment portfolio for
compliance with the investment guidelines on a monthly basis,
(C) reviewing the investment guidelines adopted by our
Board of Directors on a periodic basis, (D) reviewing the
diversification of the Companys investment portfolio and
the Companys hedging and financing strategies on a monthly
basis, and (E) generally be responsible for conducting or
overseeing the provision of the management services;
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serving as our consultant with respect to the periodic review of
our investments, borrowings and operations and other policies
and recommendations with respect thereto, including, without
limitation, the investment guidelines, in each case subject to
the approval of our Board of Directors;
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serving as our consultant with respect to the selection,
purchase, monitoring and disposition of our investments;
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serving as our consultant with respect to decisions regarding
any financings, hedging activities or borrowings undertaken by
us, including (1) assisting us in developing criteria for
debt and equity financing that is specifically tailored to our
investment objectives and (2) advising us with respect to
obtaining appropriate financing for our investments;
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purchasing and financing investments on our behalf;
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providing us with portfolio management;
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engaging and supervising, on our behalf and at our expense,
independent contractors that provide real estate, investment
banking, securities brokerage, insurance, legal, accounting,
transfer agent, registrar and such other services as may be
required relating to our operations or investments (or potential
investments);
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providing executive and administrative personnel, office space
and office services required in rendering services to us;
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performing and supervising the performance of administrative
functions necessary to our management as may be agreed upon by
our Manager and our Board of Directors, including, without
limitation, the collection of revenues and the payment of our
debts and obligations and maintenance of appropriate information
technology services to perform such administrative functions;
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communicating on behalf of the Company with the holders of any
equity or debt securities of the Company as required to satisfy
the reporting and other requirements of any governmental bodies
or agencies or trading exchanges or markets and to maintain
effective relations with such holders, including website
maintenance, logo design, analyst presentations, investor
conferences and annual meeting arrangements;
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counseling us in connection with policy decisions to be made by
our Board of Directors;
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evaluating and recommending to us hedging strategies and
engaging in hedging activities on our behalf, consistent with
our qualification and maintenance of our qualification as a REIT
and with the investment guidelines;
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counseling us regarding our qualification and maintenance of
qualification as a REIT and monitoring compliance with the
various REIT qualification tests and other rules set out in the
Code and U.S. Treasury regulations promulgated thereunder;
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counseling us regarding the maintenance of our exemption from
status as an investment company under the Investment Company Act
and monitoring compliance with the requirements for maintaining
such exemption;
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furnishing reports and statistical and economic research to us
regarding the activities and services performed for us by our
Manager;
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monitoring the operating performance of our investments and
providing periodic reports with respect thereto to our Board of
Directors, including comparative information with respect to
such operating performance and budgeted or projected operating
results;
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investing and re-investing any of our cash and securities
(including in short-term investments, payment of fees, costs and
expenses, or payments of dividends or distributions to
stockholders and partners of the Company) and advising us as to
our capital structure and capital-raising activities;
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causing us to retain qualified accountants and legal counsel, as
applicable, to (i) assist in developing appropriate
accounting procedures, compliance procedures and testing systems
with respect to financial reporting obligations and compliance
with the provisions of the Code applicable to REITs and, if
applicable, TRSs and (ii) conduct quarterly compliance
reviews with respect thereto;
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causing us to qualify to do business in all jurisdictions in
which such qualification is required and to obtain and maintain
all appropriate licenses;
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assisting us in complying with all applicable regulatory
requirements in respect of our business activities, including
preparing or causing to be prepared all financial statements
required under applicable regulations and contractual
undertakings and all reports and documents, if any, required
under the Securities Exchange Act of 1934, as amended, or the
Exchange Act, or the Securities Act of 1933, as amended, or the
Securities Act, or by the NYSE or other stock exchange
requirements as applicable;
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taking all necessary actions to enable us to make required tax
filings and reports, including soliciting stockholders for
required information to the extent necessary under the Code and
U.S. Treasury regulations applicable to REITs;
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handling and resolving all claims, disputes or controversies
(including all litigation, arbitration, settlement or other
proceedings or negotiations) in which the Company may be
involved or to which the Company may be subject arising out of
the Companys
day-to-day
operations;
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arranging marketing materials, advertising, industry group
activities (such as conference participations and industry
organization memberships) and other promotional efforts designed
to promote our business;
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using commercially reasonable efforts to cause expenses incurred
by or on our behalf to be commercially reasonable or
commercially customary and within any budgeted parameters or
expense guidelines set by our Board of Directors from time to
time;
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performing such other services as may be required from time to
time for the management and other activities relating to our
assets and business as our Board of Directors shall reasonably
request or our Manager shall deem appropriate under the
particular circumstances; and
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using commercially reasonable efforts to cause us to comply with
all applicable laws.
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Pursuant to the terms of the management agreement, our Manager
will provide us with a management team, including our Chief
Executive Officer, Chief Financial Officer and Chief Investment
Officer or similar positions, along with appropriate support
personnel to provide the management services to be provided by
our Manager to us as described in the management agreement. None
of the officers or employees of our Manager will be exclusively
dedicated to us.
Our Manager has not assumed any responsibility other than to
render the services called for under the management agreement in
good faith and is not responsible for any action of our Board of
Directors in following or declining to follow its advice or
recommendations, including as set forth in the investment
guidelines. Our Manager and its affiliates, and the directors,
officers, employees, members and stockholders of our Manager and
its affiliates, will not be liable to us, our Board of Directors
or our stockholders for any acts or omissions performed in
accordance with and pursuant to the management agreement, except
by reason of acts constituting bad faith, willful misconduct,
gross negligence or reckless disregard of their respective
duties under the management agreement. We have agreed to
indemnify our Manager and its affiliates, and the directors,
officers, employees, members and stockholders of our Manager and
its affiliates, with respect to all expenses, losses, damages,
liabilities, demands, charges and claims in respect of or
arising from any acts or omissions of our Manager, its
affiliates, and the directors, officers, employees, members and
stockholders of our Manager and its affiliates, performed in
good faith under the management agreement and not constituting
bad faith, willful misconduct, gross negligence or reckless
disregard of their respective duties. Our Manager has agreed to
indemnify us and our directors, officers and stockholders with
respect to all expenses, losses, damages, liabilities, demands,
charges and claims in respect of or arising from any acts or
omissions of our Manager constituting bad faith, willful
misconduct, gross negligence or reckless disregard of its duties
under the management agreement. Our Manager will maintain
reasonable and customary errors and omissions and
other customary insurance coverage upon the completion of this
offering.
Our Manager is required to refrain from any action that, in its
sole judgment made in good faith, (i) is not in compliance
with the investment guidelines, (ii) would adversely affect
our qualification as a REIT under the Code or our status as an
entity exempted from investment company status under the
Investment Company Act, or (iii) would violate any law,
rule or regulation of any governmental body or agency having
jurisdiction over us or of any exchange on which our securities
are listed or that would otherwise not be permitted by our
charter or bylaws. If our Manager is ordered to take any action
by our Board of Directors, our Manager will notify our Board of
Directors if it is our Managers judgment that such action
would adversely affect such status or violate any such law, rule
or regulation or our charter or bylaws. Our Manager, its
directors, officers or members will not be liable to us, our
Board of Directors or our stockholders for any act or omission
by our Manager, its directors, officers or stockholders except
as provided in the management agreement.
Term and
Termination
The management agreement has an initial term expiring
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2014. The management agreement will be automatically renewed for
one-year terms thereafter unless terminated by either us or our
Manager. The management agreement does not limit the number of
renewal terms. Either we or our Manager may elect not to renew
the management agreement upon the expiration of the initial term
of the management agreement or upon the expiration of any
automatic renewal terms, both upon 180 days prior
written notice to our Manager or us. Any decision by us to not
renew the management agreement must be approved by the majority
of our independent directors. If we choose not to renew the
management agreement, we will pay our Manager a termination fee,
upon expiration, equal to three times the average annual
management fee earned by our Manager during the prior
24-month
period immediately preceding the most recently completed
calendar quarter prior to the effective date of termination. We
may only elect not to renew the management agreement without
cause with the consent of the majority of our independent
directors. If we elect not to renew the management agreement
without cause, we may not, without the consent of our Manager,
employ any employee of the Manager or any of its affiliates, or
any person who has been employed by our
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Manager or any of its affiliates at any time within the two year
period immediately preceding the date on which the person
commences employment with us during the term of the management
agreement and for two years after its expiration or termination.
In addition, following any termination of the management
agreement, we must pay our Manager all compensation accruing to
the date of termination. Neither we nor our Manager may assign
the management agreement in whole or in part to a third party
without the written consent of the other party, except that our
Manager may delegate the performance of any its responsibilities
to an affiliate so long as our Manager remains liable for such
affiliates performance.
Furthermore, if we decide not to renew the management agreement
without cause as a result of the determination by the majority
of our independent directors that the management fee is unfair,
our Manager may agree to perform its management services at fees
the majority of our Board of Directors determine to be fair, and
the management agreement will not terminate. Our Manager may
give us notice that it wishes to renegotiate the fees, in which
case we and our Manager must negotiate in good faith, and if we
cannot agree on a revised fee structure at the end of the
60-day
negotiation period following our receipt of our Managers
intent to renegotiate, the agreement will terminate, and we must
pay the termination fees described above.
We may also terminate the management agreement with
30 days prior written notice for cause, without
paying the termination fee, if any of the following events
occur, which will be determined by a majority of our independent
directors:
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our Managers fraud, misappropriation of funds or
embezzlement against us or gross negligence (including such
action or inaction by our Manager which materially impairs our
ability to conduct our business);
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our Manager fails to provide adequate or appropriate personnel
that are reasonably necessary for our Manager to identify
investment opportunities for us and to manage and develop our
investment portfolio if such default continues uncured for a
period of 60 days after written notice thereof, which
notice must contain a request that the same be remedied;
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a material breach of any provision of the management agreement
(including the failure of our Manager to use reasonable efforts
to comply with the investment guidelines) if such default
continues uncured for a period of 30 days after written
notice thereof, which notice must contain a request that the
same be remedied;
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our Manager or Bimini commences any proceeding relating to its
bankruptcy, insolvency, reorganization or relief of debtors or
there is commenced against our Manager or Bimini any such
proceeding;
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our Manager is convicted (including a plea of nolo
contendre) of a felony;
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a change of control (as defined in the management agreement) of
our Manager or Bimini;
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the departure of both Mr. Cauley and Mr. Haas from the
senior management of our Manager during the initial term of the
management agreement; or
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the dissolution of our Manager.
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Management Fee
and Reimbursement of Expenses
We do not intend to employ personnel. As a result, we will rely
on our Manager to administer our business activities and
day-to-day
operations. The management fee is payable monthly in arrears in
cash. The management fee is intended to reimburse our Manager
for providing personnel to provide certain services to us as
described above in Management Services.
Our Manager may also be entitled to certain monthly expense
reimbursements described below.
Management Fee. The management fee will be
payable monthly in arrears in an amount equal to 1/12th of (a)
1.50% of the first $250,000,000 of our equity (as defined
below), (b) 1.25% of
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our equity that is greater than $250,000,000 and less than or
equal to $500,000,000, and (c) 1.00% of our equity that is
greater than $500,000,000.
Equity equals our month-end stockholders
equity, adjusted to exclude the effect of any unrealized gains
or losses included in either retained earnings or other
comprehensive income (loss), as computed in accordance with GAAP.
Our Manager will calculate each monthly installment of the
management fee within 15 days after the end of each
calendar month, and we will pay the monthly management fee with
respect to each calendar month within five business days
following the delivery to us of our Managers statement
setting forth the computation of the monthly management fee for
such month.
Under our existing management agreement with Bimini, which will
be terminated upon the completion of this offering and replaced
by a new management agreement with our Manager, we paid Bimini
aggregate management fees of $5,500 for the period beginning on
November 24, 2010 (date operations commenced) to
December 31, 2010, and we paid Bimini aggregate management
fees of $20,900 for the three months ended March 31, 2011.
Reimbursement of Expenses. We will pay, or
reimburse our Manager, for all of our operating expenses. We
will not have any employees and will not pay our officers any
cash or non-cash equity compensation. Pursuant to the terms of
the management agreement, (i) we are not responsible for
the salaries, benefits or other employment related expenses of
our and our Managers officers and any Bimini employees
that provide services to us under the management agreement
(other than the compensation of our Chief Financial Officer) and
(ii) our Manager will pay the offering expenses that exceed
an amount equal to 1.0% of the total gross proceeds from this
offering. The costs and expenses required to be paid by us
include, but are not limited to:
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costs incurred in connection with this offering of our common
stock up to an amount equal to 1.0% of the total gross proceeds
from this offering;
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transaction costs incident to the acquisition, disposition and
financing of our investments;
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expenses incurred in contracting with third parties;
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our allocable share of the compensation of our Chief Financial
Officer based on our percentage of the aggregate amount of our
Managers assets under management and Biminis assets;
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external legal, auditing, accounting, consulting, investor
relations and administrative fees and expenses, including in
connection with this offering of our common stock;
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the compensation and expenses of our directors (excluding those
directors who are employees of Bimini) and the cost of liability
insurance to indemnify our directors and officers;
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all other insurance costs including (A) liability or other
insurance to indemnify (1) our Manager,
(2) underwriters of any securities of the Company,
(B) errors and omissions insurance coverage and
(C) any other insurance deemed necessary or advisable by
our Board of Directors for the benefit of the Company and our
directors and officers;
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the costs associated with our establishment and maintenance of
any repurchase agreement facilities and other indebtedness
(including commitment fees, accounting fees, legal fees, closing
costs and similar expenses);
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expenses associated with other securities offerings by us;
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expenses relating to the payment of dividends;
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costs incurred by personnel of our Manager for travel on our
behalf;
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expenses connected with communications to holders of our
securities and in complying with the continuous reporting and
other requirements of the SEC and other governmental bodies;
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transfer agent and exchange listing fees;
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the costs of printing and mailing proxies and reports to our
stockholders;
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our pro rata portion (based on our percentage of the aggregate
amount of our Managers assets under management and
Biminis assets) of costs associated with any computer
software, hardware or information technology services that are
used by us;
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our pro rata portion (based on our percentage of the aggregate
amount of our Managers assets under management and
Biminis assets) of the costs and expenses incurred with
respect to market information systems and publications, research
publications and materials used by us;
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settlement, clearing, and custodial fees and expenses relating
to us;
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the costs of maintaining compliance with all federal, state and
local rules and regulations or any other regulatory agency (as
such costs relate to us), all taxes and license fees and all
insurance costs incurred on behalf of us;
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the costs of administering any of our incentive plans; and
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our pro rata portion (based on our percentage of the aggregate
amount of our Managers assets under management and
Biminis assets) of rent (including disaster recovery
facility costs and expenses), telephone, utilities, office
furniture, equipment, machinery and other office, internal and
overhead expenses of our Manager and its affiliates required for
our operations.
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Under our existing management agreement with Bimini, which will
be terminated upon the completion of this offering and replaced
by a new management agreement with our Manager, we reimbursed
Bimini an aggregate of $7,200 in expenses for the period
beginning on November 24, 2010 (date operations commenced)
to December 31, 2010, and we reimbursed Bimini an aggregate
of $21,600 in expenses for the three months ended March 31,
2011.
Assuming aggregate net proceeds from this offering and the
concurrent private placement of warrants for approximately
$81.7 million and no additional increases or decreases in
our stockholders equity, we will pay our Manager
management fees equal to approximately $1.45 million during
the first 12 months after the completion of this offering and
the concurrent private placement.
Payments by the
Manager to the Underwriters
Pursuant to the underwriting agreement among the underwriters,
our Manager, Bimini and us, our Manager will pay the
underwriters $ per share with
respect to each share of common stock sold in this offering on a
deferred basis after the completion of this offering. Our
Manager will pay the underwriters all of the management fees it
receives from us each month until it has paid the underwriters
an aggregate amount of $ .
Overhead Sharing
Agreement
Our Manager will enter into an overhead sharing agreement with
Bimini effective upon the closing of this offering. Pursuant to
this agreement, our Manager will be provided with access to,
among other things, Biminis portfolio management, asset
valuation, risk management and asset management services as well
as administration services addressing accounting, financial
reporting, legal, compliance, investor relations and information
technologies necessary for the performance of our Managers
duties in exchange for a reimbursement of the Managers
allocable cost for these services. The reimbursement paid by our
Manager pursuant to this agreement will not constitute an
expense under the management agreement.
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Conflicts of
Interest; Equitable Allocation of Opportunities
Bimini invests solely in Agency RMBS and, because it is
internally-managed, does not pay a management fee. Additionally,
Bimini currently receives management fees from us and, as the
sole stockholder of our Manager, will indirectly receive the
management fees earned by our Manager through payments under the
overhead sharing agreement and our Managers payment of
dividends to Bimini. Our Manager may in the future manage other
funds, accounts and investment vehicles that have strategies
that are similar to our strategy, although our Manager currently
does not manage any other funds, accounts or investment
vehicles. Our Manager and Bimini make available to us
opportunities to acquire assets that they determine, in their
reasonable and good faith judgment, based on our objectives,
policies and strategies, and other relevant factors, are
appropriate for us in accordance with their written investment
allocation procedures and policies, subject to the exception
that we might not be offered each such opportunity, but will on
an overall basis equitably participate with Bimini and our
Managers other accounts in all such opportunities when
considered together. Bimini and our Manager have agreed not to
sponsor another REIT that has substantially the same investment
strategy as Bimini or us prior to the earlier of (i) the
termination or expiration of the management agreement or (ii)
our Manager no longer being a subsidiary or affiliate of Bimini.
Because many of our targeted assets are typically available only
in specified quantities and because many of our targeted assets
are also targeted assets for Bimini and may be targeted assets
for other accounts our Manager may manage in the future, neither
Bimini nor our Manager may be able to buy as much of any given
asset as required to satisfy the needs of Bimini, us and any
other account our Manager may manage in the future. In these
cases, our Managers and Biminis investment
allocation procedures and policies will typically allocate such
assets to multiple accounts in proportion to their needs and
available capital. The policies will permit departure from such
proportional allocation when (i) allocating purchases of
whole-pool Agency RMBS, because those securities cannot be
divided into multiple parts to be allocated among various
accounts, and (ii) such allocation would result in an
inefficiently small amount of the security being purchased for
an account. In these cases, the policy allows for a protocol of
allocating assets so that, on an overall basis, each account is
treated equitably. Specifically, our investment allocation
procedures and policies stipulate that we will base our
allocation of investment opportunities on the following factors:
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the primary investment strategy and the stage of portfolio
development of each account;
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the effect of the potential investment on the diversification of
each accounts portfolio by coupon, purchase price, size,
prepayment characteristics and leverage;
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the cash requirements of each account;
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the anticipated cash flow of each accounts portfolio; and
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the amount of funds available to each account and the length of
time such funds have been available for investment.
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On a quarterly basis, our independent directors will review with
our Manager its allocation decisions, if any, and discuss with
our Manager the portfolio needs of each account for the next
quarter and whether such needs will give rise to an asset
allocation conflict and, if so, the potential resolution of such
conflict.
Other policies of Bimini and our Manager that will apply to the
management of the Company include controls for:
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Cross transactions defined as transactions between
us or one of our subsidiaries, if any, on the one hand, and an
account (other than us or one of our subsidiaries, if any)
managed by our Manager, on the other hand. It is our
Managers policy to engage in a cross transaction only when
the transaction is in the best interests of, and is consistent
with the objectives and policies of, both accounts involved in
the transaction. Our Manager may enter into cross transactions
where it acts both on our behalf and on behalf of the other
party to
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the transaction. Upon written notice to our Manager, we may at
any time revoke our consent to our Managers executing
cross transactions. Additionally, unless approved in advance by
a majority of our independent directors or pursuant to and in
accordance with a policy that has been approved by a majority of
our independent directors, all cross transactions must be
effected at the then-prevailing market prices. Pursuant to our
Managers current policies and procedures, assets for which
there are no readily observable market prices may be purchased
or sold in cross transactions (i) at prices based upon
third party bids received through auction, (ii) at the
average of the highest bid and lowest offer quoted by third
party dealers or (iii) according to another pricing
methodology approved by our Managers chief compliance
officer.
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Principal transactions defined as transactions
between Bimini or our Manager (or any related party of Bimini or
our Manager, which includes employees of Bimini and our Manager
and their families), on the one hand, and us or one of our
subsidiaries, if any, on the other hand. Certain cross
transactions may also be considered principal transactions
whenever our Manager or Bimini (or any related party of our
Manager or Bimini, which includes employees of our Manager or
Bimini and their families) have a substantial ownership interest
in one of the transacting parties. Our Manager is only
authorized to execute principal transactions with the prior
approval of a majority of our independent directors and in
accordance with applicable law. Such prior approval includes
approval of the pricing methodology to be used, including with
respect to assets for which there are no readily observable
market prices.
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Split price executions pursuant to the management
agreement, our Manager is authorized to combine purchase or sale
orders on our behalf together with orders for Bimini or accounts
managed by our Manager or their affiliates and allocate the
securities or other assets so purchased or sold, on an average
price basis or other fair and consistent basis, among such
accounts.
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To date, we have not entered into any cross transactions;
however, we have entered into one principal transaction and have
conducted split price executions. See Certain
Relationships and Related Transactions Purchases of
Agency RMBS from Bimini, for a description of this
principal transaction. We currently do not anticipate that we
will enter into any
cross-transactions
or principal transactions after the completion of this offering.