SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): January 7, 2013 (January 4, 2013)
Newcastle Investment Corp.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction
1345 Avenue of the Americas, 46th Floor
New York, New York
|(Address of principal executive offices)
Registrants telephone number, including area code (212) 798-6100
(Former name or former address, if changed since last report.)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2.
||Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
||Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
||Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
||Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
||Entry into a Material Definitive Agreement. |
$215 Billion UPB Excess MSR Transaction
On January 6, 2013, Newcastle
Investment Corp. (Newcastle), through a newly formed joint venture in which Newcastle holds a 50% interest, entered into definitive agreements (the BofA Acquisition Agreements) with Nationstar Mortgage LLC
(Nationstar), an affiliate of Newcastles manager, to acquire excess mortgage servicing rights (Excess MSRs). Also on January 6, 2013, Nationstar entered into an agreement to acquire mortgage servicing rights
(MSRs) on residential mortgage loans with a total unpaid principal balance (UPB) of approximately $215 billion as of November 30, 2012 (the BofA Portfolio) from Bank of America.
Under the Acquisition Agreements, Newcastle agreed to purchase one-third of the Excess MSRs on the BofA Portfolio for approximately $340 million.
Newcastle will be required to pay an earnest money deposit of approximately $21.3 million (the Deposit). For each respective pool within the BofA Portfolio, Newcastle shall pay to Nationstar 50% of their share of the remaining portion of
the purchase price of the Excess MSRs (net of the Deposit) upon closing of the purchase thereof, and 50% upon Nationstars assumption of servicing responsibilities from Bank of America. Newcastle expects a majority of the investment to close in
the first quarter of 2013. Nationstar will retain all ancillary income associated with the servicing of the BofA Portfolio and one-third of the Excess MSRs. Approximately 47% of the loans in the BofA Portfolio are owned, insured or guaranteed by
Fannie Mae (as defined below), Freddie Mac (as defined below) or the Government National Mortgage Association (Ginnie Mae) and the remaining 53% of loans are non-conforming loans in private label securitizations. Nationstar will be the
servicer of the loans and will provide all servicing and advancing functions for the BofA Portfolio. Newcastle will not own the servicing rights and therefore will not have any prior or ongoing servicing duties, liabilities or obligations associated
with the servicing of the BofA Portfolio.
On January 6, 2013, Newcastle also entered into future spread agreements (the BofA
Recapture Agreements) with Nationstar. Under the BofA Recapture Agreements, if Nationstar refinances any loan in the BofA Portfolio, subject to certain limitations, Nationstar will be required to transfer a new loan into a portfolio with
respect to which Newcastle and Nationstar will share the related Excess MSRs in the same proportion as their interest in the BofA Portfolio.
The transaction is subject to customary closing conditions, including certain regulatory approvals and third party consents. The BofA Acquisition
Agreements provide that each party will indemnify the other for breaches of representations and warranties and covenants and certain other matters, subject to the limitations set forth therein.
The foregoing summary of the BofA Acquisition Agreements and BofA Recapture Agreements does not purport to be a complete description and is qualified in
its entirety by the BofA Acquisition Agreements and BofA Recapture Agreements, which will be filed as exhibits to Newcastles Annual Report on Form 10-K for the fiscal year ending December 31, 2012.
$13 Billion UPB Excess MSR Transaction
On January 4, 2013, Newcastle, through a newly formed joint venture in which Newcastle holds a 50% interest, entered into a servicing spread acquisition agreement (the Ginnie Mae Acquisition
Agreement) with Nationstar to acquire Excess MSRs. On November 16, 2012, Nationstar entered into an agreement to acquire MSRs on residential mortgage loans with a UPB of approximately $13 billion as of November 30, 2012 (the
Ginnie Mae Portfolio) from Bank of America.
Pursuant to the Ginnie Mae Acquisition Agreement, Newcastle agreed to purchase
one-third of the Excess MSRs on the Ginnie Mae Portfolio for approximately $27 million. Nationstar will retain all ancillary income associated with the servicing of the Ginnie Mae Portfolio and one-third of the Excess MSRs. The Portfolio is
comprised of loans in Ginnie Mae pools. Nationstar will be the servicer of the loans and will provide all servicing and advancing functions for the Ginnie Mae Portfolio. Newcastle will not own the servicing rights and therefore will not have any
prior or ongoing servicing duties, liabilities or obligations associated with the servicing of the Ginnie Mae Portfolio.
On January 4,
2013, Newcastle also entered into a future spread agreement (the Ginnie Mae Recapture Agreement) with Nationstar. Under the Ginnie Mae Recapture Agreement, if Nationstar refinances any loan in the Ginnie Mae Portfolio, subject to certain
limitations, Nationstar will be required to transfer a new loan into a portfolio with respect to which Newcastle and Nationstar will share the related Excess MSRs in the same proportion as their interest in the Ginnie Mae Portfolio.
The foregoing summary of the Ginnie Mae Acquisition Agreement and the Ginnie Mae Recapture Agreement does not purport to be a complete description and is
qualified in its entirety by the Ginnie Mae Acquisition Agreement and Ginnie Mae Recapture Agreement, which will be filed as exhibits to Newcastles Annual Report on Form 10-K for the fiscal year ending December 31, 2012.
||Regulation FD Disclosure. |
disclosing under this Item 7.01 certain information that was included in the prospectus supplement filed today with the Securities and Exchange Commission (the SEC) in connection with the Offering described under Item 8.01
below. Certain of this information has not previously been made publicly available by Newcastle and may be deemed to be material. This Current Report on Form 8-K also updates certain information previously reported by Newcastle.
The information furnished pursuant to this Item 7.01 shall not be deemed to be filed for the purposes of Section 18 of the
Securities Exchange Act of 1934, as amended (the Exchange Act), or otherwise subject to the liabilities of such section, nor will such information be deemed incorporated by reference in any filing under the Securities Act of 1933, as
amended, or the Exchange Act, except as may be expressly set forth by specific reference in such filing.
Investments in Non-Agency
Newcastle is actively seeking investments in non-Agency residential mortgage-backed securities (non-Agency
RMBS). Since the beginning of the second quarter of 2012, Newcastle purchased non-Agency RMBS outside of its collateralized debt obligations (CDOs) with an aggregate face amount of approximately $309 million and a fair value of
approximately $200 million as of September 30, 2012. Subsequent to September 30, 2012, Newcastle acquired an additional $136 million face amount of non-Agency RMBS for approximately $88 million.
In July 2012, Newcastle financed two of the securities with approximately $59 million of repurchase agreements at a cost of one-month LIBOR plus 200
basis points and a 65% advance rate. These repurchase agreements, which contain customary margin call provisions, had an initial 90-day term, which was extended on October 11, 2012 to January 26, 2013. On October 11, 2012, the
repurchase agreements had an outstanding principal balance of approximately $60.6 million.
In December 2012, Newcastle financed previously
acquired non-Agency RMBS with approximately $90.2 million of repurchase agreements at a cost of one-month LIBOR plus 200 basis points. The weighted average advance rate for these repurchase agreements is approximately 65%. These repurchase
agreements, which contain customary margin call provisions, have an initial term ending on January 28, 2013.
Newcastle intends to
include these assets in a portfolio of residential real estate related assets that it expects to separate from Newcastle in the first quarter of 2013, as described under Item 8.01 below.
Uninvested Cash Balance during the Fourth Quarter
estimates indicate that its average balance of uninvested, unrestricted cash during the fourth quarter may negatively affect its per-share results relative to the third quarter of 2012. Although as of the date hereof, Newcastle had committed or
deployed substantially all of its uninvested cash for investments in Excess MSRs, senior living facilities, RMBS and other investments, the delay in deploying such cash, which was due in part to Newcastles potential co-investment in Excess
MSRs from Residential Capital, LLC (ResCap), resulted in a higher average balance during the beginning of the fourth quarter. Certain events in the fourth quarter, such as the breakup fee related to the termination of the ResCap
agreements, will offset a portion of the impact of Newcastles uninvested cash during the quarter.
Spin-Off of Certain
Newcastles board of directors has determined that a spin-off of certain of its residential real estate assets
is in its best interests. The spin-off will be effected as a distribution to the holders of Newcastles common stock of shares of New Residential Investment Corp. (New Residential), which is currently a wholly-owned subsidiary of
Newcastle. New Residential intends to elect and qualify to be taxed as a real estate investment trust (REIT) and to be listed on the New York Stock Exchange (NYSE). New Residential will be externally managed by
Newcastles manager pursuant to a new management agreement. Following the spin-off, Newcastles business strategy will be focused on commercial real estate related investments in, among others, commercial real estate debt and senior
housing, as well as pursuing strategic opportunities to liquidate, or collapse, its CDOs.
New Residential will target investments
in residential real estate related investments, including, but not limited to, Excess MSRs, RMBS, servicing advances and non-performing loans. New Residentials initial portfolio will include all of Newcastles investments in Excess MSRs
to date and any investments in Excess MSRs that Newcastle makes with the proceeds of the Offering or otherwise prior to the spin-off. New Residentials initial portfolio will also include the non-Agency RMBS Newcastle has acquired since the
second quarter of 2012 and certain Agency RMBS.
Newcastle expects the spin-off of New Residential to be completed in the first quarter of
2013. However, there can be no assurance that the spin-off will be completed as anticipated or at all. Newcastles ability to complete the spin-off is subject to, among other things, the SEC declaring the registration statement filed with
regard to the spin-off effective, the filing and approval of an application to list New Residentials common stock on the NYSE and the formal declaration of the distribution by Newcastles board of directors. Failure to complete the
spin-off could negatively affect the price of the shares of Newcastles common stock. Stockholder approval will not be required or sought in connection with the spin-off.
In addition, the spin-off may not have the full or any strategic and financial benefits that Newcastle
expects, or such benefits may be delayed or may not materialize at all. The anticipated benefits of the spin-off are based on a number of assumptions, which may prove incorrect. For example, Newcastle believes that analysts and investors will regard
New Residentials focused investment strategy and asset portfolio more favorably as a separate company than as part of Newcastles existing portfolio and strategy and thus place a greater value on New Residential as a stand-alone REIT than
as a business that is a part of Newcastle. In the event that the spin-off does not have these and other expected benefits, the costs associated with the transaction, including an expected increase in management compensation and general and
administrative expenses, could have a negative effect on Newcastles financial condition and ability to make distributions to the stockholders of each company.
Pro forma financial information regarding the impact of the spin-off is attached hereto as Exhibit 99.1.
Public Offering of Common Stock
On January 7, 2013, Newcastle also issued a
press release announcing the commencement of a public offering of 40,000,000 shares of its common stock (the Offering). In connection with the Offering, Newcastle intends to grant the underwriters an option for 30 days to purchase up to
an additional 6,000,000 shares of common stock. The press release announcing the commencement of the Offering is attached hereto as Exhibit 99.2 and is incorporated by reference herein.
Newcastle is filing the below risk factors for the purpose of updating
the risk factor disclosure contained in its public filings, including those discussed under the caption Risk Factors in its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2012, which was filed with the
SEC on October 26, 2012. All references to we, our, us, the Company and Newcastle in the follow risk factors mean Newcastle Investment Corp. and its consolidated subsidiaries, except
where it is made clear that the term means only the parent company.
Risks Related to the Financial Markets
We do not know what impact the Dodd-Frank Act will have on our business.
On July 21, 2010, the United States enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the
Dodd-Frank Act or Act). The Dodd-Frank Act affects almost every aspect of the U.S. financial services industry, including certain aspects of the markets in which we operate. The Act imposes new regulations on us and how we
conduct our business. For example, the Act will impose additional disclosure requirements for public companies and generally require issuers or originators of asset-backed securities to retain at least five percent of the credit risk associated with
the securitized assets. In addition, as a result of the Act, we were required to register as an investment adviser with the SEC, which increases our regulatory compliance costs and subjects us to the Investment Advisers Act of 1940, as amended (the
Advisers Act). The Advisers Act imposes numerous obligations on registered investment advisers, including record-keeping, reporting, operational and marketing requirements, disclosure obligations and prohibitions on fraudulent
activities. The SEC is authorized to institute proceedings and impose sanctions for violations of the Advisers Act, ranging from fines and censure to termination of an investment advisers registration. Investment advisers also are subject to
certain state securities laws and regulations. Non-compliance with the Advisers Act or other federal and state securities laws and regulations could result in investigations, sanctions, disgorgement, fines and reputational damage.
The Act will impose mandatory clearing, exchange-trading and margin requirements on many derivatives transactions (including formerly
unregulated over-the-counter derivatives) in which we may engage. The Act also creates new categories of regulated market participants, such as swap-dealers, security-based swap dealers, major swap participants
and major security-based swap participants, who will be subject to significant new capital, registration, recordkeeping, reporting, disclosure, business conduct and other regulatory requirements that will give rise to new administrative
Even if certain new requirements are not directly applicable to us, they may still increase our costs of entering into
transactions with the parties to whom the requirements are directly applicable. Moreover, new exchange-trading and trade reporting requirements may lead to reductions in the liquidity of derivative transactions, causing higher pricing or reduced
availability of derivatives, or the reduction of arbitrage opportunities for us, which could adversely affect the performance of certain of our trading strategies. Importantly, many key aspects of the changes imposed by the Act will be established
by various regulatory bodies and other groups over the next several years. As a result, we do not know how significantly the Act will affect us. It is possible that the Act could, among other things, increase our costs of operating as a public
company, impose restrictions on our ability to securitize assets and reduce our investment returns on securitized assets.
We do not
know what impact certain U.S. government programs intended to stabilize the economy and the financial markets will have on our business.
In recent years, the U.S. government has taken a number of steps to attempt to strengthen the financial markets and U.S. economy, including direct government investments in, and guarantees of,
troubled financial institutions as well as government-sponsored programs such as the Term Asset-Backed Securities Loan Facility program (TALF) and the Public Private Investment Partnership Program (PPIP). The U.S. government continues to evaluate or
implement an array of other measures and programs intended to help improve U.S. financial and market conditions. While conditions appear to have improved relative to the depths of the global financial crisis, it is not clear whether this improvement
is real or will last for a significant period of time. It is not clear what impact the governments future actions to improve financial and market conditions will have on our business. To
date, we have not benefited in a direct, material way from any government programs, and we may not derive any meaningful benefit from these programs in the future. Moreover, if any of our
competitors are able to benefit from one or more of these initiatives, they may gain a significant competitive advantage over us.
Legislation that permits modifications to the terms of outstanding loans has negatively affected our business, financial condition and results of
The U.S. government has enacted legislation that enables government agencies to modify the terms of a
significant number of residential and other loans to provide relief to borrowers without the applicable investors consent. These modifications allow for outstanding principal to be deferred, interest rates to be reduced, the term of the loan
to be extended or other terms to be changed in ways that can permanently eliminate the cash flow (principal and interest) associated with a portion of the loan. These modifications are currently reducing, or in the future may reduce, the value of a
number of our current or future investments, including investments in mortgage-backed securities and Excess MSRs. As a result, such loan modifications are negatively affecting our business, results of operations and financial condition. In addition,
certain market participants propose reducing the amount of paperwork required by a borrower to modify a loan, which could increase the likelihood of fraudulent modifications and materially harm the U.S. mortgage market and investors that have
exposure to this market. Additional legislation intended to provide relief to borrowers may be enacted and could further harm our business, results of operations and financial condition.
Risks Relating to Our Manager
We are dependent on our manager and may
not find a suitable replacement if our manager terminates the management agreement.
We have no employees. Our
officers and other individuals who perform services for us are employees of our manager. We are completely reliant on our manager, which has significant discretion as to the implementation of our operating policies and strategies, to conduct our
business. We are subject to the risk that our manager will terminate the management agreement and that we will not be able to find a suitable replacement for our manager in a timely manner, at a reasonable cost or at all. Furthermore, we are
dependent on the services of certain key employees of our manager whose compensation is partially or entirely dependent upon the amount of incentive or management compensation earned by our manager and whose continued service is not guaranteed, and
the loss of such services could adversely affect our operations.
There are conflicts of interest in our relationship with our manager.
Our chairman serves as an officer of our manager. Our management agreement with our manager was not negotiated
at arms-length, and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party.
There are conflicts of interest inherent in our relationship with our manager insofar as our manager and its affiliatesincluding investment funds, private investment funds, or businesses managed by
our managerinvest in real estate securities, real estate related loans, Excess MSRs and operating real estate, including senior living facilities, and whose investment objectives overlap with our investment objectives. Certain investments
appropriate for us may also be appropriate for one or more of these other investment vehicles. Members of our board of directors and employees of our manager who are our officers may serve as officers and/or directors of these other entities. In
addition, our manager or its affiliates may have investments in and/or earn fees from such other investment vehicles that are higher than their economic interests in us and which may therefore create an incentive to allocate investments to such
other investment vehicles. Our manager or its affiliates may determine, in their discretion, to make a particular investment through another investment vehicle rather than through us and have no obligation to offer to us the opportunity to
participate in any particular investment opportunity. For example, Fortress Investment Group LLC (Fortress) has a fund primarily focused on investments in Excess MSRs. These funds generally have a fee structure similar to ours, but the
fees actually paid will vary depending on the size and performance of each fund.
Our management agreement with our manager generally does not limit or restrict our manager
or its affiliates from engaging in any business or managing other pooled investment vehicles that invest in investments that meet our investment objectives, except that under our management agreement neither our manager nor any entity controlled by
or under common control with our manager is permitted to raise or sponsor any new pooled investment vehicle whose investment policies, guidelines or plan target as its primary investment category investment in U.S. dollar-denominated credit
sensitive real estate related securities reflecting primarily U.S. loans or assets. Our manager intends to engage in additional real estate related management and investment opportunities in the future, which may compete with us for investments or
result in a change in our current investment strategy.
The ability of our manager and its officers and employees to engage in
other business activities, subject to the terms of our management agreement with our manager, may reduce the amount of time our manager, its officers or other employees spend managing us. In addition, we may engage (subject to our investment
guidelines) in material transactions with our manager or another entity managed by our manager or one of its affiliates, including, but not limited to, certain financing arrangements, purchases of debt, co-investments in Excess MSRs, servicing
advances and other assets, that present an actual, potential or perceived conflict of interest. For instance, we recently entered into agreements with an affiliate of our manager to manage the senior living facilities that we own. It is possible
that actual, potential or perceived conflicts could give rise to investor dissatisfaction, litigation or regulatory enforcement actions. Appropriately dealing with conflicts of interest is complex and difficult, and our reputation could be damaged
if we fail, or appear to fail, to deal appropriately with one or more potential, actual or perceived conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest could have a material adverse effect on our
reputation, which could materially adversely affect our business in a number of ways, including causing an inability to raise additional funds, a reluctance of counterparties to do business with us, a decrease in the prices of our common and
preferred securities and a resulting increased risk of litigation and regulatory enforcement actions.
compensation structure that we have agreed to with our manager, as well as compensation arrangements that we may enter into with our manager in the future (in connection with new lines of business or other activities), may incentivize our manager to
invest in high risk investments. In addition to its management fee, our manager is currently entitled to receive incentive compensation based in part upon our achievement of targeted levels of funds from operations (as defined in the management
agreement). In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on funds from operations or, in the case of any future incentive compensation arrangement, other financial measures on which
incentive compensation may be based, may lead our manager to place undue emphasis on the maximization of such measures at the expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation, particularly
in light of the fact that our manager has not received any incentive compensation since 2008. Investments with higher yield potential are generally riskier or more speculative than lower-yielding investments. Moreover, because our manager receives
compensation in the form of options in connection with the completion of our common equity offerings, our manager may be incentivized to cause us to issue additional common stock, which could be dilutive to existing stockholders.
If the spin-off of New Residential is completed, our manager, FIG LLC, will enter into a separate management agreement with New
Residential, and the terms of that management agreement would be substantially similar to the terms of Newcastles existing management agreement. As a result, FIG LLC will be entitled to earn a management fee from New Residential and will be
eligible to receive incentive compensation based in part upon New Residentials achievement of targeted levels of funds from operations tested from the date of the spin-off and without regard to Newcastles prior performance.
It would be difficult and costly to terminate our management agreement with our manager.
It would be difficult and costly for us to terminate our management agreement with our manager. The management agreement may only
be terminated annually upon (i) the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of a simple majority of the outstanding shares of our
common stock, that there has been unsatisfactory performance by our manager that is materially detrimental to us or (ii) a determination by a simple majority of our independent directors that the
management fee payable to our manager is not fair, subject to our managers right to prevent such a termination by accepting a mutually acceptable reduction of fees. Our manager will be provided 60 days prior notice of any such
termination and will be paid a termination fee equal to the amount of the management fee earned by the manager during the twelve-month period preceding such termination. In addition, following any termination of the management agreement, the manager
may require us to purchase its right to receive incentive compensation at a price determined as if our assets were sold for their fair market value (as determined by an appraisal, taking into account, among other things, the expected future value of
the underlying investments) or otherwise we may continue to pay the incentive compensation to our manager. These provisions may increase the effective cost to us of terminating the management agreement, thereby adversely affecting our ability to
terminate our manager without cause.
Our directors have approved very broad investment guidelines for our manager and do not approve
each investment decision made by our manager.
Our manager is authorized to follow very broad investment guidelines.
Consequently, our manager has great latitude in determining the types of assets it may decide are proper investments for us. Our directors periodically review our investment guidelines and our investment portfolio. However, our board does not review
or pre-approve each proposed investment or our related financing arrangements. In addition, in conducting periodic reviews, the directors rely primarily on information provided to them by our manager. Furthermore, transactions entered into by our
manager may be difficult or impossible to unwind by the time they are reviewed by the directors even if the transactions contravene the terms of the management agreement.
We may change our investment strategy without stockholder consent, which may result in our making investments that are different, riskier or less profitable than our current investments.
Our investment strategy may evolve in light of existing market conditions and investment opportunities, and
this evolution may involve additional risks depending upon the nature of the assets in which we invest and our ability to finance such assets on a short or long-term basis. Investment opportunities that present unattractive risk-return profiles
relative to other available investment opportunities under particular market conditions may become relatively attractive under changed market conditions and changes in market conditions may therefore result in changes in the investments we target.
Decisions to make investments in new asset categories present risks that may be difficult for us to adequately assess and could therefore reduce our ability to pay dividends on both our common stock and preferred stock or have adverse effects on our
liquidity or financial condition. A change in our investment strategy may also increase our exposure to interest rate, foreign currency, real estate market or credit market fluctuations. In addition, a change in our investment strategy may increase
our use of non-match-funded financing, increase the guarantee obligations we agree to incur or increase the number of transactions we enter into with affiliates. Our failure to accurately assess the risks inherent in new asset categories or the
financing risks associated with such assets could adversely affect our results of operations and our financial condition.
actively exploring new business opportunities and asset classes, which may be unsuccessful, divert managerial attention or require significant financial resources, which could have a negative impact on our financial results.
Consistent with our broad investment guidelines and our investment objectives, we have acquired and are actively exploring
additional opportunities to acquire Excess MSRs and additional classes of operating real estate, including senior living facilities. See We invest in Excess MSRs, and such investments could have a negative impact on our financial
results, and We invest in senior living facilities, which are subject to various risks that could have a negative impact on our financial results. We may also pursue opportunities to invest in a variety of other types of
assets, including, but not limited to, servicing advances.
Although we currently believe that we will have significant investment opportunities in the
future, these opportunities may not materialize and our ability to act on new investment opportunities may be constrained by requirements of the Investment Company Act of 1940, as amended (the 1940 Act), and federal tax law. We also
believe investing in our target assets will provide us attractive risk-adjusted returns, but, assuming we are successful in acquiring these assets, they may not achieve the returns we anticipate and may not even be profitable. Moreover, these
investments may not be successful as a result of our managers limited experience with certain types of assets, or for other reasons. Further, new business opportunities may divert managerial attention from more profitable opportunities, and
they may require significant financial resources. Any or all of the foregoing could have a negative impact on our financial results.
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.
Pursuant to our management agreement, our manager will not assume any
responsibility other than to render the services called for thereunder and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Under the terms of our management
agreement, our manager, its officers, partners, members, managers, directors, personnel, other agents, any person controlling or controlled by our manager and any person providing sub-advisory services to our manager will not be liable to us, any
subsidiary of ours, our directors, our stockholders or any subsidiarys stockholders or partners for acts or omissions performed in accordance with and pursuant to our management agreement, except because of acts constituting bad faith, willful
misconduct or gross negligence, as determined by a final non-appealable order of a court of competent jurisdiction. In addition, we have agreed to indemnify our manager, its officers, partners, members, managers, directors, personnel, other agents,
any person controlling or controlled by our manager and any person providing sub-advisory services to our manager with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our manager not
constituting bad faith, willful misconduct or gross negligence, pursuant to our management agreement.
Our managers due diligence
of investment opportunities or other transactions may not identify all pertinent risks, which could materially affect our business, financial condition, liquidity and results of operations.
Our manager intends to conduct due diligence with respect to each investment opportunity or other transaction it pursues. It is
possible, however, that our managers due diligence processes will not uncover all relevant facts, particularly with respect to any assets we acquire from third parties. In these cases, our manager may be given limited access to information
about the investment and will rely on information provided by the target of the investment. In addition, if investment opportunities are scarce, the process for selecting bidders is competitive, or the timeframe in which we are required to complete
diligence is short, our ability to conduct a due diligence investigation may be limited, and we would be required to make investment decisions based upon a less thorough diligence process than would otherwise be the case. Accordingly, investments
and other transactions that initially appear to be viable may prove not to be over time due to the limitations of the due diligence process or other factors.
Risks Relating to Our Business
Market conditions could negatively impact our
business, results of operations and financial condition.
The market in which we operate is affected by a number
of factors that are largely beyond our control but can nonetheless have a potentially significant, negative impact on us. These factors include, among other things:
Interest rates and credit spreads;
The availability of credit, including the price, terms and conditions under which it can be obtained;
The quality, pricing and availability of suitable investments and credit losses with respect to our investments;
The ability to obtain accurate market-based valuations;
Loan values relative to the value of the underlying real estate assets;
Default rates on both residential and commercial mortgages and the amount of the related losses;
Prepayment speeds, delinquency rates and legislative/regulatory changes with respect to our investments in Excess MSRs;
The actual and perceived state of the real estate markets, market for dividend-paying stocks and the U.S. economy and public capital markets generally;
Unemployment rates; and
The attractiveness of other types of investments relative to investments in real estate or REITs generally.
Changes in these factors are difficult to predict, and a change in one factor can affect other factors. For example, during 2007,
increased default rates in the subprime mortgage market played a role in causing credit spreads to widen, reducing availability of credit on favorable terms, reducing liquidity and price transparency of real estate related assets, resulting in
difficulty in obtaining accurate mark-to-market valuations, and causing a negative perception of the state of the real estate markets and of REITs generally. These conditions worsened during 2008, and intensified meaningfully during the fourth
quarter of 2008 as a result of the global credit and liquidity crisis, resulting in extraordinarily challenging market conditions. Since then, market conditions have generally improved, but they could deteriorate in the future, including as a result
of increased taxes and the pending mandatory reductions in federal spending during 2013.
A prolonged economic slowdown, a lengthy or
severe recession, or declining real estate values could harm our operations.
We believe the risks associated
with our business are more severe during periods similar to those we recently experienced in which an economic slowdown or recession is accompanied by declining real estate values. Declining real estate values generally reduce the level of new
mortgage loan originations, since borrowers often use increases in the value of their existing properties to support the purchase of, or investment in, additional properties. Borrowers may also be less able to pay principal and interest on our
loans, and the loans underlying our securities and Excess MSRs if the economy weakens. Further, declining real estate values significantly increase the likelihood that we will incur losses on our loans and securities in the event of default because
the value of our collateral may be insufficient to cover our basis. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect our net interest income from loans and securities in our portfolio and our
income from Excess MSRs, as well as our ability to originate, sell and securitize loans, which would significantly harm our revenues, results of operations, financial condition, liquidity, business prospects and our ability to make distributions to
our stockholders. For more information on the impact of market conditions on our business and results of operations see the section entitled Managements Discussion and Analysis of Financial Condition and Results of OperationsMarket
Considerations in our Quarterly Report on Form 10-Q for the nine months ended September 30, 2012, filed with the SEC on October 26, 2012.
The geographic distribution of the residential mortgage loans underlying, and collateral securing, certain of our investments subjects us to geographic real estate market risks, which could
adversely affect the performance of our investments, our results of operations and our financial condition.
geographic distribution of the residential mortgage loans underlying, and collateral securing, certain of our investments, including our Excess MSRs and non-Agency RMBS, exposes us to risks associated with the real estate industry in general
within the states and regions in which we hold significant investments. These risks include, without limitation: possible declines in the value of real estate; risks related to general and local economic conditions; possible lack of availability of
mortgage funds; overbuilding; extended vacancies of properties; increases in competition, property taxes and operating expenses; changes in zoning laws; costs
resulting from the clean-up of, and liability to third parties for damages resulting from, environmental problems; casualty or condemnation losses; uninsured damages from floods, earthquakes or
other natural disasters; and changes in interest rates. To the extent any of the foregoing risks arise in states and regions where we hold significant investments, the performance of our investments, our results of operations and our financial
condition could suffer a material adverse effect.
The coverage tests applicable to our CDO financings may have a negative impact on our
operating results and cash flows.
We have retained, and may in the future retain or repurchase, subordinate
classes of bonds issued by certain of our subsidiaries in our CDO financings. Each of our CDO financings contains tests that measure the amount of over collateralization and excess interest in the transaction. Failure to satisfy these tests would
generally result in principal and/or interest cash flow that would otherwise be distributed to more junior classes of securities (including those held by us) to be redirected to pay down the most senior class of securities outstanding until the
tests are satisfied. As a result, failure to satisfy the coverage tests could adversely affect our operating results and cash flows by temporarily or permanently directing funds that would otherwise come to us to holders of the senior classes of
bonds. In addition, the redirected funds would be used to pay down financing, which currently bears an attractive rate, thereby reducing our future earnings from the affected CDO. The ratings assigned to the
assets in each CDO affect the results of the tests governing whether a CDO can distribute cash to the various classes of securities in the CDO. As a result, ratings downgrades of the assets in a
CDO can result in a CDO failing its tests and thereby cause us not to receive cash flows from the affected CDO.
approximately $57.0 million of assets in our consolidated CDOs as of September 2012, as appropriate, that are under negative watch for possible downgrade by at least one of the rating agencies. One or more of the rating agencies could downgrade some
or all of these assets at any time, and any such downgrade could negatively affectand possibly materially affectour future cash flows. As of the September 2012 remittance date, we are not receiving residual cash flows from CDO IV and CDO
VI. However, we continue to receive senior management fees and cash flow distributions from senior classes of bonds we own. Based upon our current calculations, we expect CDO VI to remain out of compliance for the foreseeable future. Moreover, given
current market conditions, it is possible that all of our CDOs could be out of compliance with their over collateralization tests as of one or more measurement dates within the next twelve months.
Our ability to rebalance will depend upon a variety of factors, such as the availability of suitable securities, market prices, available
cash, whether the reinvestment period of the applicable CDO has ended, and other factors that may be beyond our control. For example, one strategy we have employed to facilitate compliance with over collateralization tests has been to repurchase
notes issued by our CDOs and subsequently cancel them in accordance with the terms of the relevant governing documentation. However, there can be no assurance that the trustee of our CDOs will not impose guidelines for such cancelations that would
make it more difficult or impossible to employ this strategy in the future. While there are other permissible methods to rebalance or otherwise correct CDO test failures, such methods may be extremely difficult to employ as a result of market
conditions or other factors, and we cannot assure you that we will be successful in our rebalancing efforts. If the liabilities of our CDOs are downgraded by Moodys Investors Service to certain predetermined levels, our discretion to rebalance
the applicable CDO portfolios may be negatively impacted. Moreover, if we bring these coverage tests into compliance, we cannot assure you that they will not fall out of compliance in the future or that we will be able to correct any noncompliance.
Failure of the over collateralization tests can also cause a phantom income issue if cash that constitutes income
is diverted to pay down debt instead of distributed to us. For more information regarding noncompliance with the terms of certain of our CDO financings in the near future, please see the section entitled Managements Discussion and
Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources and Debt Obligations in our Quarterly Report on Form 10-Q for the nine months ended September 30, 2012, filed with the SEC on
October 26, 2012.
We may experience an event of default or be removed as collateral manager under one or more of our CDOs, which
would negatively affect us in a number of ways.
The documentation governing our CDOs specifies certain events
of default, which, if they occur, would negatively affect us. Events of default include, among other things, failure to pay interest on senior classes of securities within the CDO, breaches of covenants, representations or warranties, bankruptcy,
and failure to satisfy specific over collateralization and interest coverage tests. If an event of default occurs under any of our CDOs, it could negatively affect our cash flows, business, results of operations and financial condition.
In addition, we can be removed as manager of a CDO if certain events occur, including the failure to satisfy specific over
collateralization and interest coverage tests, failure to satisfy certain key man requirements or an event of default occurring for the failure to pay interest on the related senior classes of securities of the CDO. If we are removed as
collateral manager, we would no longer receive management fees fromand no longer be able to manage the assets ofthe applicable CDO, which could negatively affect our cash flows, business, results of operations and financial condition. On
June 17, 2011, CDO V failed additional over collateralization tests. The consequences of failing these tests are that an event of default has occurred, and we may be removed as the collateral manager under the documentation governing CDO V. So
long as the event of default continues, we
will not be permitted to purchase or sell any collateral in CDO V. If we are removed as the collateral manager of CDO V, we would no longer receive the senior management fees from such CDO. As of
the date hereof, we have not been removed as collateral manager. Based upon our current calculations, we estimate that if we are removed as the collateral manager of CDO V, the loss of senior management fees would not have a material negative impact
on our cash flows, business, results of operations or financial condition. Given current market conditions, it is possible that events of default may occur in other CDOs, and we could be removed as the collateral manager of those CDOs if certain
events of default occur. Moreover, our cash flows, business, results of operations and/or financial condition could be materially and negatively impacted if certain events of default occur.
We have assumed the role of manager of numerous CDOs previously managed by a third party, and we may assume the role of manager of additional CDOs in the future. Each such engagement exposes us to a
number of potential risks.
Changes within our industry may result in CDO collateral managers being replaced. In such
instances, we may seek to be engaged as the collateral manager of CDOs currently managed by third parties. For example, in February 2011, one of our subsidiaries became the collateral manager of certain CDOs previously managed by C-BASS Investment
Management LLC (C-BASS).
While being engaged as the collateral manager of such CDOs potentially enables us to
grow our business, it also entails a number of risks that could harm our reputation, results of operations and financial condition. For example, we purchased the management rights with respect to the C-BASS CDOs pursuant to a bankruptcy proceeding.
As a result, we were not able to conduct extensive due diligence on the CDO assets even though many classes of securities issued by the CDOs were rated as distressed by the rating agencies as of the most recent rating date prior to our
becoming the collateral manager of the CDOs. We may willingly or unknowingly assume actual or contingent liabilities for significant expenses, we may become subject to new laws and regulations with which we are not familiar, and we may become
subject to increased risk of litigation, regulatory investigation or negative publicity. For example, we determined that it would be prudent to register the subsidiary that became the collateral manager of the C-BASS CDOs as a registered investment
adviser, which has increased our regulatory compliance costs. In addition to defending against litigation and complying with regulatory requirements, being engaged as collateral manager may require us to invest other resources for various other
reasons, which could detract from our ability to capitalize on future opportunities. Moreover, being engaged as collateral manager may require us to integrate complex technological, accounting and management systems, which may be difficult,
expensive and time-consuming and which we may not be successful in integrating into our current systems. In addition to the risk that we face if we are successful in becoming the manager of additional CDOs, we may attempt but fail to become the
collateral manager of CDOs in the future, which could harm our reputation and subject us to costly litigation. Finally, if we include the financial performance of the C-BASS CDOs or other CDOs for which we become the collateral manager in our public
filings, we are subject to the risk that, particularly during the period immediately after we become the collateral manager, this information may prove to be inaccurate or incomplete. The occurrence of any of these negative integration events could
negatively impact our reputation with both regulators and investors, which could, in turn, subject us to additional regulatory scrutiny and impair our relationships with the investment community. The occurrence of any of these problems could
negatively affect our reputation, financial condition and results of operations.
Our investments have previously beenand in the
future may besubject to significant impairment charges, which adversely affect our results of operations.
We are required to periodically evaluate our investments for impairment indicators. The value of an investment is impaired when our
analysis indicates that, with respect to a loan, it is probable that we will not be able to collect the full amount we intended to collect from the loan or, with respect to a security, it is probable that the value of the security is other than
temporarily impaired. The judgment regarding the existence of
impairment indicators is based on a variety of factors depending upon the nature of the investment and the manner in which the income related to such investment was calculated for purposes of our
financial statements. If we determine that an impairment has occurred, we are required to make an adjustment to the net carrying value of the investment, which could adversely affect our results of operations in the applicable period and thereby
adversely affect our ability to pay dividends to our stockholders.
As has been widely publicized, the recent market
conditions have resulted in a number of financial institutions recording an unprecedented amount of impairment charges, and we were also affected by these conditions. These challenging conditions have reduced the market trading activity for many
real estate securities, resulting in less liquid markets for those securities. These lower valuations have affected us by, among other things, decreasing our net book value and contributing to our decision to record impairment charges.
The lenders under our repurchase agreements may elect not to extend financing to us, which could quickly and seriously impair our liquidity.
We have historically financed a meaningful portion of our investments not held in CDOs with repurchase
agreements, which are short-term financing arrangements, and we may enter into additional repurchase agreements in the future. Under the terms of these agreements, we sell a security to a counterparty for a specified price and concurrently agree to
repurchase the same security from our counterparty at a later date for a higher specified price. During the term of the repurchase agreementgenerally 30 daysthe counterparty makes funds available to us and holds the security as
collateral. Our counterparties can also require us to post additional margin as collateral at any time during the term of the agreement. When the term of a repurchase agreement ends, we are required to repurchase the security for the specified
repurchase price, with the difference between the sale and repurchase prices serving as the equivalent of paying interest to the counterparty in return for extending financing to us. If we want to continue to finance the security with a repurchase
agreement, we ask the counterparty to extendor rollthe repurchase agreement for another term.
counterparties are not required to roll our repurchase agreements upon the expiration of their stated terms, which subjects us to a number of risks. As we have experienced recently and may experience in the future, counterparties electing to roll
our repurchase agreements may charge higher spread and impose more onerous terms upon us, including the requirement that we post additional margin as collateral. More significantly, if a repurchase agreement counterparty elects not to extend our
financing, we would be required to pay the counterparty the full repurchase price on the maturity date and find an alternate source of financing. Alternate sources of financing may be more expensive, contain more onerous terms or simply may not be
available. If we were unable to pay the repurchase price for any security financed with a repurchase agreement, the counterparty has the right to sell the underlying security being held as collateral and require us to compensate for any shortfall
between the value of our obligation to the counterparty and the amount for which the collateral was sold (which may be a significantly discounted price). As of September 30, 2012, we had $605.3 million outstanding under repurchase agreement
financings. Moreover, these repurchase agreement obligations are with four counterparties. If any of our counterparties elected not to roll these repurchase agreements, we may not be able to find a replacement counterparty in a timely manner.
Our determination of how much leverage to apply to our investments may adversely affect our return on our investments and may reduce
cash available for distribution.
We leverage a meaningful portion of our portfolio through borrowings,
generally through the use of credit facilities, warehouse facilities, repurchase agreements, mortgage loans on real estate, securitizations, including the issuance of CDOs, private or public offerings of debt by subsidiaries, loans to entities in
which we hold, directly or indirectly, interests in pools of properties or loans, and other borrowings. Our investment policies do not limit the amount of leverage we may incur with respect to any specific asset or pool of assets, subject to an
overall limit on our use of leverage to 90% (as defined in our governing documents) of the value of our assets on an aggregate basis. During the recent financial crisis, the return we were able to earn on our investments and cash
available for distribution to our stockholders was significantly reduced due to changes in market conditions causing the cost of our financing to increase relative to the income that can be
derived from our assets. While our liquidity position has improved, we cannot assure you that we will be able to sustain our improved liquidity position.
We may become party to agreements that require cash payments at periodic intervals. Failure to make such required payments may adversely affect our business, financial condition and results of
We are currently party to repurchase agreements that may require us to post additional margin as
collateral at any time during the term of the agreement, based on the value of the collateral. We may become party to additional financing agreements that require us to make cash payments at periodic intervals or upon the occurrence of certain
events. Events could occur or circumstances could arise, which we may not be able to foresee, that may cause us to be unable to make any such cash payments when they become due. Failure to make the payments required under our financing documents
would give the lenders the right to require us to repay all amounts owed to them under the applicable financing immediately.
subject to counterparty default and concentration risks.
In the ordinary course of our business, we enter into
various types of financing arrangements with counterparties. Currently, the majority of our financing arrangements take the form of repurchase agreements, securitization vehicles, loans, hedge contracts, swaps and other derivative and non-derivative
contracts. The terms of these contracts are often customized and complex, and many of these arrangements occur in markets or relate to products that are not subject to regulatory oversight.
We are subject to the risk that the counterparty to one or more of these contracts defaults, either voluntarily or involuntarily, on its
performance under the contract. Any such default may occur rapidly and without notice to us. Moreover, if a counterparty defaults, we may be unable to take action to cover our exposure, either because we lack the contractual ability or because
market conditions make it difficult to take effective action. This inability could occur in times of market stress consistent with the conditions we are currently experiencing, which are precisely the times when defaults may be most likely to occur.
In addition, our risk-management processes may not accurately anticipate the impact of market stress or counterparty
financial condition, and, as a result, we may not take sufficient action to reduce our risks effectively. Although we monitor our credit exposures, default risk may arise from events or circumstances that are difficult to detect, foresee or
evaluate. In addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other participants, which may in turn expose us to significant losses.
In the event of a counterparty default, particularly a default by a major investment bank, we could incur material losses rapidly, and
the resulting market impact of a major counterparty default could seriously harm our business, results of operations and financial condition. In the event that one of our counterparties becomes insolvent or files for bankruptcy, our ability to
eventually recover any losses suffered as a result of that counterpartys default may be limited by the liquidity of the counterparty or the applicable legal regime governing the bankruptcy proceeding.
In addition, with respect to our CDOs, certain of our derivative counterparties are required to maintain certain ratings to avoid having
to post collateral or transfer the derivative to another counterparty. If a counterparty was downgraded below these levels, it may not be able to satisfy its obligations under the derivative, which could have a material negative effect on the
With respect to our Excess MSRs, we are subject to counterparty concentration risk as a result of our
co-investments with Nationstar. All of our investments in Excess MSRs to date relate to loans serviced by Nationstar. If Nationstar is terminated as the servicer of the underlying mortgages, Newcastles right to receive
its portion of the excess mortgage servicing amount is also terminated. Moreover, in the event that Nationstar files for bankruptcy, our expected returns on these investments would be severely
impacted. See We will be dependent on mortgage servicers, including Nationstar, to service the mortgage loans underlying the Excess MSRs that we acquire. Moreover, Nationstar has no obligation to offer us any future co-investment
opportunity on the same terms of prior transactions, or at all, and we may not be able to find suitable counterparties other than Nationstar from which to acquire Excess MSRs, which could impact our business strategy.
The counterparty risks that we face have increased in complexity and magnitude as a result of the insolvency of a number of major
financial institutions (such as Lehman Brothers). For example, the consolidation and elimination of counterparties has increased our concentration of counterparty risk and decreased the universe of potential counterparties. We are currently party to
repurchase agreements with two counterparties. If any of our counterparties elected not to roll these repurchase agreements, we may not be able to find a replacement counterparty. In addition, counterparties have generally tightened their
underwriting standards and increased their margin requirements for financing, which has negatively impacted us in several ways, including decreasing the number of counterparties willing to provide financing to us, decreasing the overall amount of
leverage available to us, and increasing the costs of borrowing.
We are not restricted from dealing with any particular
counterparty or from concentrating any or all of our transactions with a few counterparties. Any loss suffered by us as a result of a counterparty defaulting, refusing to conduct business with us or imposing more onerous terms on us would also
negatively affect our business, results of operations and financial condition.
We may not match fund certain of our investments, which
may increase the risks associated with these investments.
One component of our investment strategy is to use
match funded financing structures for certain of our investments, which match assets and liabilities with respect to maturities and interest rates. When available, this strategy mitigates the risk of not being able to refinance an investment on
favorable terms or at all. However, our manager may elect for us to bear a level of refinancing risk on a short-term or longer-term basis, as in the case of investments financed with repurchase agreements, when, based on its analysis, our manager
determines that bearing such risk is advisable or unavoidable (which is generally the case with respect to the residential mortgage loans and Federal National Mortgage Association (FNMA or Fannie Mae)/Federal Home Loan
Mortgage Corporation (FHLMC or Freddie Mac) securities in which we invest). In addition, we may be unable, as a result of conditions in the credit markets, to match fund our investments. For example, non-recourse term
financing not subject to margin requirements was generally not available or economical for the past three years and is currently still difficult to obtain, which impairs our ability to match fund our investments. Moreover, we may not be able to
enter into interest rate swaps. Lastly, lenders may be unwilling to finance certain types of assets, such as Excess MSRs, because of the challenges with perfecting security interests in the underlying collateral. A decision not to, or the inability
to, match fund certain investments exposes us to additional risks.
Furthermore, we anticipate that, in most cases, for any
period during which our floating rate assets are not match funded with respect to maturity, the income from such assets may respond more slowly to interest rate fluctuations than the cost of our borrowings. Because of this dynamic, interest income
from such investments may rise more slowly than the related interest expense, with a consequent decrease in our net income. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for
us from these investments.
Accordingly, if we do not or are unable to match fund our investments with respect to maturities
and interest rates, we will be exposed to the risk that we may not be able to finance or refinance our investments on economically favorable terms or may have to liquidate assets at a loss.
We may not be able to finance our investments on attractive terms or at all, and financing for Excess
MSRs may be particularly difficult or impossible to obtain.
When we acquire securities and loans that we
finance on a short-term basis with a view to securitization or other long-term financing, we bear the risk of being unable to securitize the assets or otherwise finance them on a long-term basis at attractive prices or in a timely matter, or at all.
If it is not possible or economical for us to securitize or otherwise finance such assets on a long-term basis, we may be unable to pay down our short-term credit facilities, or be required to liquidate the assets at a loss in order to do so. For
example, our ability to finance investments with securitizations or other long-term non-recourse financing not subject to margin requirements has been impaired since 2007 as a result of market conditions. These conditions make it highly likely that
we will have to use less efficient forms of financing for any new investments, which will likely require a larger portion of our cash flows to be put toward making the initial investment and thereby reduce the amount of cash available for
distribution to our stockholders and funds available for operations and investments, and which will also likely require us to assume higher levels of risk when financing our investments. In addition, there is no established market for financing of
investments in Excess MSRs, and it is possible that one will not develop. Any such financing would likely require the consent of the applicable government sponsored enterprise (GSE) or other owner of the underlying loans, and such
consent may be costly or impossible to obtain. Moreover, obtaining such consent may require us or our co-investment counterparties to agree to material structural, economic and indemnification or other terms that expose us to risks to which we have
not previously been exposed and that could negatively affect our returns from our investments.
As non-recourse long-term financing
structures become available to us and are utilized, such structures expose us to risks which could result in losses to us.
We may use securitization and other non-recourse long-term financing for our investments to the extent available. In such structures, our lenders typically would have only a claim against the
assets included in the securitizations rather than a general claim against us as an entity. Prior to any such financing, we would seek to finance our investments with relatively short-term facilities until a sufficient portfolio is accumulated. As a
result, we would be subject to the risk that we would not be able to acquire, during the period that any short-term facilities are available, sufficient eligible assets or securities to maximize the efficiency of a securitization. We also bear the
risk that we would not be able to obtain new short-term facilities or would not be able to renew any short-term facilities after they expire should we need more time to seek and acquire sufficient eligible assets or securities for a securitization.
In addition, conditions in the capital markets may make the issuance of any such securitization less attractive to us even when we do have sufficient eligible assets or securities. While we would intend to retain the unrated equity component of
securitizations and, therefore, still have exposure to any investments included in such securitizations, our inability to enter into such securitizations may increase our overall exposure to risks associated with direct ownership of such
investments, including the risk of default. Our inability to refinance any short-term facilities would also increase our risk because borrowings thereunder would likely be recourse to us as an entity. If we are unable to obtain and renew short-term
facilities or to consummate securitizations to finance our investments on a long-term basis, we may be required to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price.
The loans we invest in and the loans underlying the securities we invest in are subject to delinquency, foreclosure and loss, which could result in
losses to us.
Commercial mortgage loans are secured by multifamily or commercial property and are subject to risks of
delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of
independent income or assets of the borrower. If the net operating income of the property is reduced, the borrowers ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other
things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that
increase operating expense or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes
in national, regional or local economic conditions and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, changes in the availability
of credit on favorable terms, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances.
Residential mortgage loans, manufactured housing loans and subprime mortgage loans are secured by single-family residential
property and are also subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of factors may
impair borrowers abilities to repay their loans, including, among other things, changes in the borrowers employment status, changes in national, regional or local economic conditions, changes in interest rates or the availability of
credit on favorable terms, changes in regional or local real estate values, changes in regional or local rental rates and changes in real estate taxes.
In the event of default under a loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the outstanding principal and
accrued but unpaid interest of the loan, which could adversely affect our cash flow from operations. Foreclosure of a loan, particularly a commercial loan, or any other restructuring activities related to an investment, can be an expensive and
lengthy process, which would negatively affect our anticipated return on the foreclosed loan or such other investment. In addition, as part of any foreclosure or other restructuring, we may acquire control of a property securing a defaulted loan,
which would expose us to additional risks specific to the property, including, but not limited to, the risks related to any business conducted on such property. As part of a restructuring, we may also exchange our debt foror otherwise
acquireequity of an entity as part of a restructuring, which may involve contested negotiations and expose us to risks associated with owning the entity.
Mortgage and asset backed securities are bonds or notes backed by loans and/or other financial assets and include commercial mortgage back securities (CMBS), FNMA/FHLMC securities, and real estate related
asset backed securities (ABS). The ability of a borrower to repay these loans or other financial assets is dependent upon the income or assets of these borrowers. If a borrower has insufficient income or assets to repay these loans, it will default
on its loan. While we intend to focus on real estate related asset backed securities, there can be no assurance that we will not invest in other types of asset backed securities.
Our investments in mortgage and asset backed securities will be adversely affected by defaults under the loans underlying such
securities. To the extent losses are realized on the loans underlying the securities in which we invest, we may not recover the amount invested in, or, in extreme cases, any of our investment in such securities.
Our investments in debt securities are subject to specific risks relating to the particular issuer of the securities and to the general risks of
investing in subordinated real estate securities.
Our investments in debt securities involve special risks.
REITs generally are required to invest substantially in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed in this report. Our investments in debt are subject to
the risks described above with respect to mortgage loans and mortgage backed securities and similar risks, including:
risks of delinquency and foreclosure, and risks of loss in the event thereof;
the dependence upon the successful operation of and net income from real property;
risks generally incident to interests in real property; and
risks that may be presented by the type and use of a particular property.
Debt securities may be unsecured and may also be subordinated to other obligations of the
issuer. We may also invest in debt securities that are rated below investment grade. As a result, investments in debt securities are also subject to risks of:
limited liquidity in the secondary trading market;
substantial market price volatility resulting from changes in prevailing interest rates or credit spreads;
subordination to the prior claims of senior lenders to the issuer;
the possibility that earnings of the debt security issuer may be insufficient to meet its debt service; and
the declining creditworthiness and potential for insolvency of the issuer of such debt securities during periods of rising interest rates and economic
These risks may adversely affect the value of outstanding debt securities and the ability of the
issuers thereof to repay principal and interest.
We invest in Excess MSRs, and such investments could have a negative impact on our
Subject to maintaining our qualification as a REIT and our exemption from the 1940 Act, we
expect to continue to co-invest in Excess MSRs with Nationstar, which is a leading residential mortgage servicer and is majority-owned by funds managed by our manager. We may also invest in Excess MSRs with other servicers.
An MSR provides a mortgage servicer with the right to service a pool of mortgages in exchange for a portion of the interest payments made
on the underlying mortgages. This amount typically ranges from 25 to 50 basis points times the UPB of the mortgages. The MSR can be divided into two components: a basic fee and an Excess MSR. The basic fee is the amount of compensation for the
performance of servicing duties, and the Excess MSR is the amount that exceeds the basic fee. For example, if an MSR is 30 basis points and the basic fee is 5 basis points, then the Excess MSR is 25 basis points.
We record Excess MSRs on our balance sheet at fair value, and changes in their fair value are reflected in our consolidated results of
operations. The determination of the fair value of Excess MSRs requires our management to make numerous estimates and assumptions that could materially differ from actual results. Such estimates and assumptions include, without limitation, estimates
of the future cash flows from the Excess MSRs, which in turn are based upon assumptions about interest rates as well as prepayment rates, delinquencies and foreclosure rates of the underlying mortgage loans.
The ultimate realization of the value of Excess MSRs, which are measured at fair value on a recurring basis, may be materially different
than the fair values of such Excess MSRs as may be reflected in our consolidated statement of financial position as of any particular date. The use of different estimates or assumptions in connection with the valuation of these assets could produce
materially different fair values for such assets, which could have a material adverse effect on our consolidated financial position, results of operations and cash flows. Accordingly, there may be material uncertainty about the fair value of any
Excess MSRs we acquire.
The values of Excess MSRs are highly sensitive to changes in interest rates. Historically, the value
of Excess MSRs has increased when interest rates rise and decreased when interest rates decline due to the effect those changes in interest rates have on prepayment estimates. We may pursue various hedging strategies to seek to reduce our exposure
to adverse changes in interest rates. Our hedging activity will vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions. Interest rate hedging may fail to protect or could
adversely affect us. To the extent we do not utilize derivatives to hedge against changes in the fair value of Excess MSRs, our balance sheet, results of operations and cash flows would be susceptible to significant volatility due to changes in the
fair value of, or cash flows from, Excess MSRs as interest rates change.
Prepayment speeds significantly affect the value of Excess MSRs. Prepayment speed is the
measurement of how quickly borrowers pay down the UPB of their loans or how quickly loans are otherwise brought current, modified, liquidated or charged off. When we invest in Excess MSRs, we base the price we pay and the rate of amortization of
those assets on, among other things, our projection of the cash flows from the related pool of mortgage loans. Our expectation of prepayment speeds is a significant assumption underlying those cash flow projections. If prepayment speeds are
significantly greater than expected, the carrying value of Excess MSRs could exceed their estimated fair value. If the fair value of Excess MSRs decreases, we would be required to record a non-cash charge, which would have a negative impact on our
financial results. Furthermore, a significant increase in prepayment speeds could materially reduce the ultimate cash flows we receive from Excess MSRs, and we could ultimately receive substantially less than what we paid for such assets.
Moreover, delinquency rates have a significant impact on the value of Excess MSRs. An increase in delinquencies will
generally result in lower revenue because typically we will only collect the mortgage servicing amount from GSEs or mortgage owners for performing loans. The price we pay for Excess MSRs is based on, among other things, our projections of the cash
flows from related pools of mortgage loans. Our expectation of delinquencies is a significant assumption underlying those cash flow projections. If delinquencies are significantly greater than expected, the estimated fair value of the Excess MSRs
could be diminished. As a result, we could suffer a loss, which would have a negative impact on our financial results.
Furthermore, MSRs are subject to numerous federal, state and local laws and regulations and may be subject to various judicial and
administrative decisions imposing various requirements and restrictions on our business. If the servicer actually or allegedly failed to comply with applicable laws, rules or regulations, it could be terminated as the servicer, which could have a
material adverse effect on our business, financial condition, results of operations or cash flows.
Our ability to acquire
Excess MSRs will be subject to the applicable REIT qualification tests, and we may have to hold these interests through taxable REIT subsidiaries, which would negatively impact our returns from these assets.
We will be dependent on mortgage servicers, including Nationstar, to service the mortgage loans underlying the Excess MSRs that we acquire.
Our investments in Excess MSRs are dependent on the mortgage servicer to perform the servicing obligations. As
a result, we could be materially and adversely affected if the servicer is terminated. The duties and obligations of mortgage servicers are defined through contractual agreements, generally referred to as Servicing Guides in the case of GSEs, or
Pooling and Servicing Agreements in the case of private-label securities (collectively, the Servicing Guidelines). Such Servicing Guidelines generally provide for the possibility for termination of the contractual rights of the servicer
in the absolute discretion of the owner of the mortgages being serviced. In the event of such termination by a mortgage owner with respect to a particular servicer, the related Excess MSRs could potentially lose all value on a going forward basis.
Moreover, the termination by a mortgage owner of a servicer could take effect across all mortgages of such mortgage owner. Therefore, to the extent we make multiple investments relating to mortgages owned by the same owner and serviced by the same
servicer, all such investments, including our investments with Nationstar, could lose all their value in the event of the termination of the servicer by the mortgage owner.
We could also be materially and adversely affected if the servicer is unable to adequately service the underlying mortgage loans due to:
its failure to comply with applicable laws and regulation;
its failure to perform its loss mitigation obligations;
a downgrade in its servicer rating;
its failure to perform adequately in its external audits;
a failure in or poor performance of its operational systems or infrastructure;
regulatory scrutiny regarding foreclosure processes lengthening foreclosure timelines;
a GSEs or a whole-loan owners transfer of servicing to another party; or
Favorable ratings from third-party rating agencies such as Standard & Poors, Moodys Investor Service and Fitch Ratings are important to the conduct of a mortgage servicers loan
servicing business and a downgrade in a mortgage servicers ratings could have an adverse effect on us and the value of our Excess MSRs. Downgrades in a mortgage servicers servicer ratings could adversely affect their ability to finance
servicing advances and maintain their status as an approved servicer by Fannie Mae and Freddie Mac. Downgrades in servicer ratings could also lead to the early termination of existing advance facilities and affect the terms and availability of match
funded advance facilities that a mortgage servicer may seek in the future. A mortgage services failure to maintain favorable or specified ratings may cause their termination as a servicer and may impair their ability to consummate future
servicing transactions, which could have an adverse effect on our operations since we will rely heavily on mortgage servicers to achieve our investment objective with respect to Excess MSRs.
In addition, a bankruptcy by any mortgage servicer that services the mortgage loans underlying any Excess MSRs that we have acquired or
may acquire in the future could result in:
the validity and priority of our ownership of the Excess MSRs being challenged in a bankruptcy proceeding;
payments made by such servicer to us, or obligations incurred by it, being avoided by a court under federal or state preference laws or federal or
state fraudulent conveyance laws;
a re-characterization of any sale of the Excess MSRs or other assets to us as a pledge of such assets in a bankruptcy proceeding; or
any agreement pursuant to which we acquired the Excess MSRs being rejected in a bankruptcy proceeding.
Any of the foregoing events could have a material and adverse effect on us.
GSE initiatives and other actions may adversely affect returns from investments in Excess MSRs.
On January 17, 2011, the Federal Housing Finance Agency (FHFA) announced that it has instructed FNMA and FHLMC to study possible alternatives to the current residential mortgage
servicing and compensation system used for single-family mortgage loans. It is too early to determine what the GSEs, including FNMA and FHLMC, may propose as alternatives to current servicing compensation practices, or when any such alternatives
would become effective. Although we do not expect MSRs that have already been created to be subject to any changes implemented by FNMA and FHLMC, it is possible that, because of the significant role of FNMA and FHLMC in the secondary mortgage
market, any changes they implement could become prevalent in the mortgage servicing industry generally. Other industry stakeholders or regulators may also implement or require changes in response to the perception that the current mortgage servicing
practices and compensation do not appropriately serve broader housing policy objectives. These proposals are still evolving. To the extent the GSEs implement reforms that materially affect the market for conforming loans, there may be secondary
effects on the subprime and Alt-A markets. These reforms may have a material adverse effect on the economics or performance of any Excess MSRs that we may acquire in the future.
Changes to the minimum servicing amount for GSE loans could occur at any time and could impact us in
significantly negative ways that we are unable to predict or protect against.
Currently, when a loan is sold
into the secondary market for FNMA and FHLMC loans, the servicer is generally required to retain a minimum servicing amount (MSA) of 25 basis points of the outstanding principal balance for fixed rate mortgages. As has been widely
publicized, in September 2011, the FHFA announced that a Joint Initiative on Mortgage Servicing Compensation was seeking public comment on two alternative mortgage servicing compensation structures detailed in a discussion paper. Changes to the MSA
structure could significantly impact our business in negative ways that we cannot predict or protect against. For example, the elimination of an MSA could radically change the mortgage servicing industry and could severely limit supply of the Excess
MSRs available for us to invest in. In addition, a removal of, or a reduction in, the MSA could significantly reduce the recapture rate of the affected portfolio, which would negatively affect the investment return on our Excess MSRs. We cannot
predict whether any changes to current MSA rules will occur or what impact any changes will have on our business, results of operations, liquidity or financial condition.
We are subject to significant competition, and we may not compete successfully.
We are subject to significant competition in seeking investments. We compete with other companies, including other REITs, mortgage servicers, insurance companies and other investors, including
funds and companies affiliated with our manager. Some of our competitors have greater resources than we possess or have greater access to capital or various types of financing structures than are available to us, and we may not be able to compete
successfully for investments or provide attractive investment returns relative to our competitors. These competitors may be willing to accept lower returns on their investments or to compromise underwriting standards and, as a result, our
origination volume and profit margins could be adversely affected. Furthermore, competition for investments that are suitable for us may lead to the returns available from such investments decreasing, which may further limit our ability to generate
our desired returns. We cannot assure you that other companies will not be formed that compete with us for investments or otherwise pursue investment strategies similar to ours or that we will be able to complete successfully against any such
Furthermore, we do not intend to build a mortgage servicing platform. Therefore, we may not be an attractive buyer
for those sellers of MSRs that prefer to sell MSRs and their mortgage servicing platform in a single transaction. Since our business model does not currently include acquiring and running servicing platforms, to engage in a bid for such a business
we would need to find a servicer to acquire and run the platform or we would need to incur additional costs to shut down the acquired servicing platform. The need to work with a servicer in these situations increases the complexity of such potential
acquisitions, and Nationstar may be unwilling or unable to act as servicer or subservicer on any Excess MSRs acquisition we want to execute. The complexity of these transactions and the additional costs incurred by us if we were to execute future
acquisition of this type could adversely affect our future operating results.
Following the closing of a CDO financing when we have
locked in the liability costs for a CDO during the reinvestment period, the rate at which we are able to acquire eligible investments and changes in market conditions may adversely affect our anticipated returns.
During the reinvestment period, we must invest the restricted cash available for reinvestments in our CDOs. Until we are able to acquire
sufficient assets, our returns will reflect income earned on uninvested cash and, having locked in the cost of liabilities for the particular CDO, the particular CDOs returns will be at risk of declining to the extent that yields on the assets
to be acquired decline. In general, our ability to acquire appropriate investments depends upon the supply in the market of investments we deem suitable, and changes in various economic factors may affect our determination of what constitutes a
Our returns will be adversely affected when investments held in CDOs are prepaid or sold subsequent to
the reinvestment period.
Real estate securities and loans are subject to prepayment risk. In addition, we may
sell, and realize gains (or losses) on, investments. To the extent such assets were held in CDOs subsequent to the end of the reinvestment period, the proceeds are fully utilized to pay down the related CDOs debt. This causes the leverage on
the CDO to decrease, thereby lowering our returns on equity.
Our investments in senior unsecured REIT securities are subject to
specific risks relating to the particular REIT issuer and to the general risks of investing in subordinated real estate securities, which may result in losses to us.
Our investments in REIT securities involve special risks relating to the particular REIT issuer of the securities, including the financial condition and business outlook of the issuer. REITs
generally are required to substantially invest in operating real estate or real estate related assets and are subject to the inherent risks associated with real estate related investments discussed in this report.
Our investments in REIT securities are also subject to the risks described above with respect to mortgage loans and mortgage backed
securities and similar risks, including (i) risks of delinquency and foreclosure, and risks of loss in the event thereof, (ii) the dependence upon the successful operation of and net income from real property, (iii) risks generally
incident to interests in real property, and (iv) risks that may be presented by the type and use of a particular commercial property.
REIT securities are generally unsecured and may also be subordinated to other obligations of the issuer. We may also invest in REIT securities that are rated below investment grade. As a result,
investments in REIT securities are also subject to risks of: (i) limited liquidity in the secondary trading market; (ii) substantial market price volatility resulting from changes in prevailing interest rates; (iii) subordination to
the prior claims of banks and other senior lenders to the issuer; (iv) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest premature redemption
proceeds in lower yielding assets; (v) the possibility that earnings of the REIT issuer may be insufficient to meet its debt service and dividend obligations; and (vi) the declining creditworthiness and potential for insolvency of the
issuer of such REIT securities during periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding REIT securities and the ability of the issuers thereof to repay principal and interest or make
The real estate related loans and other direct and indirect interests in pools of real estate properties or other
loans that we invest in may be subject to additional risks relating to the structure and terms of these transactions, which may result in losses to us.
We invest in real estate related loans and other direct and indirect interests in pools of real estate properties or loans such as mezzanine loans and B Note mortgage loans. We invest
in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying real property or other business assets or revenue streams or loans secured by a pledge of the ownership interests of the entity owning real
property or other business assets or revenue streams (or the ownership interest of the parent of such entity). These types of investments involve a higher degree of risk than long-term senior lending secured by business assets or income producing
real property because the investment may become unsecured as a result of foreclosure by a senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the
assets of such entity, or the assets of the entity may not be sufficient to repay our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be
satisfied only after the senior debt is repaid in full. As a result, we may not recover some or all of our investment. In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans, resulting in less equity in
the property and increasing the risk of loss of principal.
We also invest in mortgage loans (B Notes) that while secured by a first
mortgage on a single large commercial property or group of related properties are subordinated to an A Note secured by the same first mortgage on the same collateral. As a result, if an issuer defaults, there may not be sufficient funds
remaining for B Note holders. B Notes reflect similar credit risks to comparably rated commercial mortgage backed securities. In addition, we invest, directly or indirectly, in pools of real estate properties or loans. Since each transaction is
privately negotiated, these investments can vary in their structural characteristics and risks. For example, the rights of holders of B Notes to control the process following a borrower default may vary from transaction to transaction, while
investments in pools of real estate properties or loans may be subject to varying contractual arrangements with third party co-investors in such pools. Further, B Notes typically are secured by a single property, and so reflect the risks associated
with significant concentration. These investments also are less liquid than commercial mortgage backed securities.
non-investment grade loans may involve increased risk of loss.
We have acquired and may continue to acquire in
the future certain loans that do not conform to conventional loan criteria applied by traditional lenders and are not rated or are rated as non-investment grade (for example, for investments rated by Moodys Investors Service, ratings lower
than Baa3, and for Standard & Poors, BBB- or below). The non-investment grade ratings for these loans typically result from the overall leverage of the loans, the lack of a strong operating history for the properties underlying the
loans, the borrowers credit history, the properties underlying cash flow or other factors. As a result, these loans have a higher risk of default and loss than conventional loans. Any loss we incur may reduce distributions to our
stockholders. There are no limits on the percentage of unrated or non-investment grade assets we may hold in our portfolio.
on real estate in which we have interests (including the real estate serving as collateral for our real estate securities and loans) may not cover all losses.
There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, that may be uninsurable or not economically insurable. Inflation,
changes in building codes and ordinances, environmental considerations, and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under
such circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. As a result of the events of September 11, 2001, insurance companies have limited or excluded
coverage for acts of terrorism in insurance policies. As a result, we may suffer losses from acts of terrorism that are not covered by insurance.
In addition, the mortgage loans that are secured by certain of the properties in which we have interests contain customary covenants, including covenants that require property insurance to be maintained
in an amount equal to the replacement cost of the properties. There can be no assurance that the lenders under these mortgage loans will not take the position that exclusions from coverage for losses due to terrorist acts is a breach of a covenant
which, if uncured, could allow the lenders to declare an event of default and accelerate repayment of the mortgage loans.
Many of our
investments are illiquid, and this lack of liquidity could significantly impede our ability to vary our portfolio in response to changes in economic and other conditions or to realize the value at which such investments are carried if we are
required to dispose of them.
The real estate properties that we own and operate and our other direct and
indirect investments in real estate and real estate related assets are generally illiquid. In addition, the real estate securities that we purchase in connection with privately negotiated transactions are not registered under the relevant securities
laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, those laws. In addition, there are no
established trading markets for a majority of our investments. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be limited.
Our securities have historically been valued based primarily on third party quotations,
which are subject to significant variability based on the liquidity and price transparency created by market trading activity. The ongoing dislocation in the trading markets has continued to reduce the trading for many real estate securities,
resulting in less transparent prices for those securities. Consequently, it is currently more difficult for us to sell many of our assets than it has been historically because, if we were to sell such assets, we would likely not have access to
readily ascertainable market prices when establishing valuations of them. Moreover, currently there is a relatively low market demand for the vast majority of the types of assets that we hold, which may make it extremely difficult to sell our
assets. If we are required to liquidate all or a portion of our illiquid investments quickly, we may realize significantly less than the amount at which we have previously valued these investments.
In addition, Excess MSRs are highly illiquid and subject to numerous restrictions on transfers. For example, the Servicing Guidelines of
a mortgage owner generally require that holders of Excess MSRs obtain the mortgage owners prior approval of any change of ownership of such Excess MSRs. Such approval may be withheld for any reason or no reason in the discretion of the
mortgage owner. Additionally, investments in Excess MSRs are a new type of transaction, and there have been extremely few investment products that pursue a similar investment strategy. Accordingly, the risks associated with the transaction and
structure are not fully known to buyers or sellers. As a result of the foregoing, there is some risk that we will be unable to locate a buyer at the time we wish to sell an Excess MSR. Additionally, there is some risk that we will be required to
dispose of Excess MSRs either through an in-kind distribution or other liquidation vehicle, which will, in either case, provide little or no economic benefit to us, or a sale to a co-investor in the Excess MSR, which may be an affiliate. Therefore,
we cannot provide any assurance that we will obtain any return or any benefit of any kind from any disposition of Excess MSRs.
ability to invest in, and dispose of our investments in Excess MSRs may be subject to the receipt of third-party consents.
GSEs may require that we submit ourselves to costly or burdensome conditions as a prerequisite to their consent to our investments in Excess MSRs. GSE conditions may diminish or eliminate the
investment potential of certain Excess MSRs by making such investments too expensive for us or by severely limiting the potential returns available from Excess MSRs. Moreover, we have not received and do not expect to receive any assurances from any
GSEs that their conditions for the disposition of an investment in Excess MSRs will not change. Therefore the potential costs, issues or restrictions associated with receiving such GSEs consent for any such dispositions by us cannot be
determined with any certainty.
Our investments in Excess MSRs may involve complex or novel structures.
Our manager has extremely limited transaction history involving GSEs, and our investments in Excess MSRs may involve complex or
novel structures. It is possible that a GSEs views on whether any such investment structure is appropriate or acceptable may not be known to us when we make an investment and may change from time to time for any reason or for no reason, even
with respect to a completed investment. Accordingly, the terms of any future transaction may differ significantly from the terms of our existing investments in Excess MSRs. A GSEs evolving posture toward an acquisition or disposition structure
through which we invest in or dispose of Excess MSRs may cause such GSE to impose new conditions on our existing investments in Excess MSRs, including the owners ability to hold such Excess MSRs directly or indirectly through a grantor trust
or other means. Such new conditions may be costly or burdensome and may diminish or eliminate the investment potential of the Excess MSRs that are already owned by us. Moreover, obtaining such consent may require us or our co-investment
counterparties to agree to material structural, economic and indemnification or other terms that expose us to risks to which we have not previously been exposed and that could negatively affect our returns from our investments.
In addition, the requirements imposed by mortgage owners on servicers may require us to structure the terms, purchase price and form of
consideration that we and the servicer pay differently in various deals. For example, if a mortgage owner imposes stricter requirements on a servicer to repurchase loans under certain
circumstances, the servicer will be required to assume a significantly higher level of risk in connection with servicing the loans underlying the applicable mortgage servicing right and related
Excess MSR than the servicer would assume if the mortgage owner did not impose such requirements. As a result, the base fee paid to the servicer with respect to those mortgage servicing rights may be higherand the related Excess MSR may
be lowerthan in deals where the mortgage owner does not impose such requirements.
Interest rate fluctuations and shifts in the
yield curve may cause losses.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Our primary interest rate exposures relate to our real estate securities, loans, floating rate debt obligations and
interest rate swaps. Changes in interest rates, including changes in expected interest rates or yield curves, affect our business in a number of ways. Changes in the general level of interest rates can affect our net interest income,
which is the difference between the interest income earned on our interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities and hedges. Changes in the level of interest rates also can affect, among
other things, our ability to acquire real estate securities and loans at attractive prices, the value of our real estate securities, loans and derivatives and our ability to realize gains from the sale of such assets. In the past, we have utilized
hedging transactions to protect our positions from interest rate fluctuations, but as a result of current market conditions we face significant obstacles to entering into new hedging transactions. As a result, we may not be able to protect new
investments from interest rate fluctuations to the same degree as in the past, which could adversely affect our financial condition and results of operations.
In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and
operating results. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond our control.
Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a significant degree on our
ability to obtain additional capital. Our financing strategy is dependent on our ability to place the match funded debt we use to finance our investments at rates that provide a positive net spread. If spreads for such liabilities widen or if demand
for such liabilities ceases to exist, then our ability to execute future financings will be severely restricted.
rate changes may also impact our net book value as our real estate securities, real estate related loans and hedge derivatives are marked to market each quarter. Debt obligations are not marked to market. Generally, as interest rates increase, the
value of our fixed rate securities decreases, which will decrease the book value of our equity.
Furthermore, shifts in the
U.S. Treasury yield curve reflecting an increase in interest rates would also affect the yield required on our real estate securities and therefore their value. For example, increasing interest rates would reduce the value of the fixed rate assets
we hold at the time because the higher yields required by increased interest rates result in lower market prices on existing fixed rate assets in order to adjust the yield upward to meet the market, and vice versa. This would have similar effects on
our real estate securities portfolio and our financial position and operations to a change in interest rates generally.
We invest in
RMBS collateralized by subprime mortgage loans, which are subject to increased risks.
We invest in RMBS backed
by collateral pools of subprime residential mortgage loans. Subprime mortgage loans refer to mortgage loans that have been originated using underwriting standards that are less restrictive than the
underwriting requirements used as standards for other first and junior lien mortgage loan purchase programs, such as the programs of FNMA and FHLMC. These lower standards include mortgage loans made to borrowers having imperfect or impaired
credit histories (including outstanding judgments or prior
bankruptcies), mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgage property, mortgage loans made to borrowers with low credit scores, mortgage
loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified. Due to economic conditions, including increased interest rates
and lower home prices, as well as aggressive lending practices, subprime mortgage loans have in recent periods experienced increased rates of delinquency, foreclosure, bankruptcy and loss, and they are likely to continue to experience delinquency,
foreclosure, bankruptcy and loss rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus, because of the higher delinquency rates and losses associated
with subprime mortgage loans, the performance of RMBS backed by subprime mortgage loans in which we may invest could be correspondingly adversely affected, which could adversely impact our results of operations, financial condition and business.
The value of our RMBS may be adversely affected by deficiencies in servicing and foreclosure practices, as well as related delays in
the foreclosure process.
Allegations of deficiencies in servicing and foreclosure practices among several large
sellers and servicers of residential mortgage loans that surfaced in 2010 raised various concerns relating to such practices, including the improper execution of the documents used in foreclosure proceedings (so-called robo signing),
inadequate documentation of transfers and registrations of mortgages and assignments of loans, improper modifications of loans, violations of representations and warranties at the date of securitization and failure to enforce put-backs.
As a result of alleged deficiencies in foreclosure practices, a number of servicers temporarily suspended foreclosure proceedings
beginning in the second half of 2010 while they evaluated their foreclosure practices. In late 2010, a group of state attorneys general and state bank and mortgage regulators representing nearly all 50 states and the District of Columbia, along
with the U.S. Justice Department and the Department of Housing and Urban Development, began an investigation into foreclosure practices of banks and servicers. The investigations and lawsuits by several state attorneys general lead to a proposed
settlement agreement in early February 2012 with five of the nations largest banks, pursuant to which the banks agreed to pay more than $25 billion to settle claims relating to improper foreclosure practices. The proposed settlement does
not prohibit the states, the federal government, individuals or investors in RMBS from pursuing additional actions against the banks and servicers in the future.
The integrity of the servicing and foreclosure processes are critical to the value of the mortgage loan portfolios underlying our RMBS, and our financial results could be adversely affected by
deficiencies in the conduct of those processes. For example, delays in the foreclosure process that have resulted from investigations into improper servicing practices may adversely affect the values of, and our losses on, our non-Agency RMBS.
Foreclosure delays may also increase the administrative expenses of the securitization trusts for the non-Agency RMBS, thereby reducing the amount of funds available for distribution to investors. In addition, the subordinate classes of securities
issued by the securitization trusts may continue to receive interest payments while the defaulted loans remain in the trusts, rather than absorbing the default losses. This may reduce the amount of credit support available for the senior classes we
own, thus possibly adversely affecting these securities. Additionally, a substantial portion of the proposed $25 billion settlement is intended to be a credit to the banks and servicers for principal write-downs or reductions they may
make to certain mortgages underlying RMBS. There remains considerable uncertainty as to how these principal reductions will work and what effect they will have on the value of related RMBS; as a result, there can be no assurance that any such
principal reductions will not adversely affect the value of certain of our RMBS.
While we believe that the sellers and
servicers would be in violation of their servicing contracts to the extent that they have improperly serviced mortgage loans or improperly executed documents in foreclosure or bankruptcy proceedings, or do not comply with the terms of servicing
contracts when deciding whether to apply principal reductions, it may be difficult, expensive, and time consuming for us to enforce our contractual rights. We continue to monitor and review the issues raised by the alleged improper foreclosure
practices. While we
cannot predict exactly how the servicing and foreclosure matters or the resulting litigation or settlement agreements will affect our business, there can be no assurance that these matters will
not have an adverse impact on our results of operations and financial condition.
We invest in senior living facilities, which are
subject to various risks that could have a negative impact on our financial results.
Subject to maintaining our
qualification as a REIT, we may continue to purchase senior living facilities. In connection with any such investment, we expect that we would engage an affiliate of our manager to manage the operations of these facilities, as we have previously
done, for which we would pay a management fee. The income from any senior living facilities would be dependent on the ability of the managers of such facilities to successfully manage these properties. The managers would compete with other companies
on a number of different levels, including: the quality of care provided, reputation, the physical appearance of a facility, price and range of services offered, alternatives for healthcare delivery, the supply of competing properties, physicians,
staff, referral sources, location, the size and demographics of the population in surrounding areas, and the financial condition of tenants and managers. A managers inability to successfully compete with other companies on one or more of the
foregoing levels could adversely affect the senior living facility and materially reduce the income we would receive from an investment in such facility.
As a public company, we are required to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. Internal control over financial
reporting is complex and may be revised over time to adapt to changes in our business or applicable accounting rules. For example, as a result of new investments, including any investments in senior living facilities, we may be required to
consolidate additional entities, and, therefore, to document and test effective internal controls over the financial reporting of these entities in accordance with Section 404, which we may not be able to do. Even if we are able to do so, there
could be significant costs and delays, particularly if these entities were not subject to Section 404 prior to being acquired by us. Under certain circumstances, the SEC permits newly acquired businesses to be excluded for a limited period of
time from managements annual assessment of the effectiveness of internal control. We may avail ourselves of this flexibility with respect to any newly acquired business, such as the senior living assets we acquired in 2012. If we are not able
to maintain or document effective internal control over financial reporting, our independent registered public accounting firm would not be able to certify as to the effectiveness of our internal control over financial reporting as of the required
dates, which could subject us to adverse regulatory consequences, including sanctions or investigations by the SEC, or violations of applicable stock exchange listing rules. There could also be a negative reaction in the financial markets due to a
loss of investor confidence in us and the reliability of our financial statements, which could lead to a decline in our share price, impair our ability to raise capital and other adverse consequences.
In addition, private, federal and state payment programs as well as the effect of laws and regulations may also have a significant impact
on the profitability of such facilities. The failure of a manager to comply with any of these laws could result in the loss of accreditation, denial of reimbursement, imposition of fines, suspension or decertification from federal and state
healthcare programs, loss of license or closure of the facility. These events, among others, could result in the loss of part or all of any investment we make in a senior living facility.
Furthermore, the ability to successfully manage a senior living facility depends on occupancy levels. Any senior living facility in which
we invest may have relatively flat or declining occupancy levels due to falling home prices, declining incomes, stagnant home sales and other economic factors. In addition, the senior housing segment may continue to experience a decline in occupancy
due to the weak economy and the associated decision of certain residents to vacate a facility and instead be cared for at home. A material decline in occupancy levels and revenues may make it more difficult for the manager of any senior living
facility in which we invest to successfully generate income for us. Alternatively, to avoid a decline in occupancy, a manager may reduce the rates charged, which would also reduce our revenues and therefore negatively impact the ability to generate
Our ability to acquire senior living facilities will be subject to the applicable REIT
qualification tests, and we may have to hold these interests through taxable REIT subsidiaries, which may negatively impact our returns from these assets.
Our investments in real estate securities and loans are subject to changes in credit spreads, which could adversely affect our ability to realize gains on the sale of such investments.
Real estate securities and loans are subject to changes in credit spreads. Credit spreads measure the yield
demanded on securities and loans by the market based on their credit relative to a specific benchmark.
Fixed rate securities
and loans are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. Floating rate securities and loans are valued based on a market credit spread over LIBOR and are affected similarly by changes
in LIBOR spreads. Excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities and loans, resulting in the use of a higher, or wider, spread over the
benchmark rate to value such securities. Under such conditions, the value of our real estate securities and loan portfolios would tend to decline. Conversely, if the spread used to value such securities were to decrease, or tighten, the
value of our real estate securities portfolio would tend to increase. Such changes in the market value of our real estate securities and loan portfolios may affect our net equity, net income or cash flow directly through their impact on unrealized
gains or losses on available-for-sale securities, and therefore our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital. During 2008 through the first quarter of 2009, credit
spreads widened substantially. This widening of credit spreads caused the net unrealized gains on our securities, loans and derivatives, recorded in accumulated other comprehensive income or retained earnings, and therefore our book value per share,
to decrease and resulted in net losses.
In addition, if the value of our loans subject to financing agreements were to
decline, it could affect our ability to refinance such loans upon the maturity of the related repurchase agreements. Any credit or spread related losses incurred with respect to our loans would affect us in the same way as similar losses on our real
estate securities portfolio as described above.
Any hedging transactions that we enter into may limit our gains or result in losses.
We have used (and may continue to use, when feasible and appropriate) derivatives to hedge a portion of our
interest rate exposure, and this approach has certain risks, including the risk that losses on a hedge position will reduce the cash available for distribution to stockholders and that such losses may exceed the amount invested in such instruments.
We have adopted a general policy with respect to the use of derivatives, which generally allows us to use derivatives where appropriate, but does not set forth specific policies and procedures or require that we hedge any specific amount of risk.
From time to time, we use derivative instruments, including forwards, futures, swaps and options, in our risk management strategy to limit the effects of changes in interest rates on our operations. A hedge may not be effective in eliminating all of
the risks inherent in any particular position. Our profitability may be adversely affected during any period as a result of the use of derivatives.
There are limits to the ability of any hedging strategy to protect us completely against interest rate risks. When rates change, we expect the gain or loss on derivatives to be offset by a related but
inverse change in the value of the items, generally our liabilities, that we hedge. We cannot assure you, however, that our use of derivatives will offset the risks related to changes in interest rates. We cannot assure you that our hedging strategy
and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. In addition, our hedging strategy may limit our flexibility by causing us to refrain from taking
certain actions that would be potentially profitable but would cause adverse consequences under the terms of our hedging arrangements.
The REIT provisions of the Internal Revenue Code of 1986, as amended (the Code) limit our ability to hedge. In managing our hedge instruments, we consider the effect of the expected hedging
income on the REIT
qualification tests that limit the amount of gross income that a REIT may receive from hedging. We need to carefully monitor, and may have to limit, our hedging strategy to assure that we do not
realize hedging income, or hold hedges having a value, in excess of the amounts that would cause us to fail the REIT gross income and asset tests.
Accounting for derivatives under U.S. generally accepted accounting principles (GAAP) is extremely complicated. Any failure by us to account for our derivatives properly in accordance with
GAAP in our financial statements could adversely affect our earnings.
Under certain conditions, increases in prepayment rates can
adversely affect yields on many of our investments.
The value of the majority of assets in which we invest may
be affected by prepayment rates on these assets. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be
predicted with certainty. In periods of declining mortgage interest rates, prepayments on loans generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periods are likely to be reinvested
by us in assets yielding less than the yields on the assets that were prepaid. In addition, the market value of floating rate assets may, because of the risk of prepayment, benefit less than fixed rate assets from declining interest rates.
Conversely, in periods of rising interest rates, prepayments on loans generally decrease, in which case we would not have the prepayment proceeds available to invest in assets with higher yields. Under certain interest rate and prepayment scenarios
we may fail to recoup fully our cost of acquisition of certain investments.
In addition, when market conditions lead us to
increase the portion of our CDO investments that are comprised of floating rate securities, the risk of assets inside our CDOs prepaying increases. Since our CDO financing costs are locked in, reinvestment of such prepayment proceeds at lower yields
than the initial investments, as a result of changes in the interest rate or credit spread environment, will result in a decrease of the return on our equity and therefore our net income.
Changes in accounting rules could occur at any time and could impact us in significantly negative ways that we are unable to predict or protect against.
As has been widely publicized, the SEC, the Financial Accounting Standards Board and other regulatory bodies that establish the
accounting rules applicable to us have recently proposed or enacted a wide array of changes to accounting rules. Moreover, in the future these regulators may propose additional changes that we do not currently anticipate. Changes to accounting rules
that apply to us could significantly impact our business or our reported financial performance in negative ways that we cannot predict or protect against. We cannot predict whether any changes to current accounting rules will occur or what impact
any codified changes will have on our business, results of operations, liquidity or financial condition.
Environmental compliance costs
and liabilities related to real estate that we own, or in which we have interests, may adversely affect our results of operations.
Our operating costs may be affected by the cost of complying with existing or future environmental laws, ordinances and regulations with respect to the properties, or loans secured by such
properties, or by environmental problems that materially impair the value of such properties. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic substances on, under, or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or
toxic substances. In addition, the presence of hazardous or toxic substances, or the failure to remediate properly, may adversely affect the owners ability to borrow using such real property as collateral. Certain environmental laws and common
law principles could be used to impose liability for releases
of hazardous materials, including asbestos-containing materials, into the environment, and third parties may seek recovery from owners or operators of real properties for personal injury
associated with exposure to released asbestos-containing materials or other hazardous materials. Environmental laws may also impose restrictions on the manner in which a property may be used or transferred or in which businesses it may be operated,
and these restrictions may require expenditures. In connection with the direct or indirect ownership and operation of properties, we may be potentially liable for any such costs. The cost of defending against claims of liability or remediating
contaminated property and the cost of complying with environmental laws could adversely affect our results of operations and financial condition.
Lawsuits, investigations and indemnification claims could result in significant liabilities and reputational harm, which could materially adversely affect our results of operations, financial
condition and liquidity.
From time to time, we may be involved in lawsuits or investigations or receive claims
for indemnification. Our efforts to resolve any such lawsuits, investigations or claims could be very expensive and highly damaging to our reputation, even if the underlying claims are without merit. We could potentially be found liable for
significant damages or indemnification obligations. Such developments could have a material adverse effect on our business, results of operations and financial condition.
Risks Relating to Our REIT Status and Other Matters
Our failure to qualify as
a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.
in a manner intended to qualify us as a REIT for federal income tax purposes. Our ability to satisfy the asset tests depends upon our analysis of the fair market values of our assets, some of which are not susceptible to a precise determination, and
for which we do not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Moreover, the
proper classification of an instrument as debt or equity for federal income tax purposes, and the tax treatment of participation interests that we hold in mortgage loans and mezzanine loans, may be uncertain in some circumstances, which could affect
the application of the REIT qualification requirements. Accordingly, there can be no assurance that the Internal Revenue Service (the IRS) will not contend that our interests in subsidiaries or other issuers violate the REIT
If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax,
including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be
substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of, and trading prices for, our stock. Unless entitled to relief under certain provisions of the
Code, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we initially ceased to qualify as a REIT.
Our failure to qualify as a REIT would create issues under a number of our financings and other agreements and would cause our common and preferred stock to be delisted from the NYSE.
Our failure to qualify as a REIT would create issues under a number of our financing and other agreements. In
addition, the NYSE requires, as a condition to the continued listing of our common and preferred stock, that we maintain our REIT status. Consequently, if we fail to maintain our REIT status, our common and preferred stock would promptly be delisted
from the NYSE, which would decrease the trading activity of such shares. This could make it difficult to sell shares and could cause the market volume of the shares trading to decline.
If we were delisted as a result of losing our REIT status and desired to relist our shares on the NYSE, we would have to reapply to the
NYSE to be listed as a domestic corporation. As the NYSEs listing standards for
REITs are less onerous than its standards for domestic corporations, it would be more difficult for us to become a listed company under these heightened standards. We might not be able to satisfy
the NYSEs listing standards for a domestic corporation. As a result, if we were delisted from the NYSE, we might not be able to relist as a domestic corporation, in which case our common and preferred stock could not trade on the NYSE.
The failure of assets subject to repurchase agreements to qualify as real estate assets could adversely affect our ability to qualify
as a REIT.
We have historically financed a meaningful portion of our investments not held in CDOs with
repurchase agreements, which are short-term financing arrangements and we may enter into additional repurchase agreements in the future. Under these agreements, we nominally sell certain of our assets to a counterparty and simultaneously enter into
an agreement to repurchase these assets at a later date in exchange for a purchase price. Economically, these agreements are financings that are secured by the assets sold pursuant thereto. We believe that, for purposes of the REIT asset and income
tests, we should be treated as the owner of the assets that are the subject of any such sale and repurchase agreement, notwithstanding that those agreements may transfer record ownership of the assets to the counterparty during the term of the
agreement. It is possible, however, that the IRS could assert that we did not own the assets during the term of the sale and repurchase agreement, in which case we might fail to qualify as a REIT.
The failure of our Excess MSRs to qualify as real estate assets, or the income from our Excess MSRs to qualify as mortgage interest, could
adversely affect our ability to continue to make this type of investment or to qualify as a REIT.
received from the IRS a private letter ruling substantially to the effect that our Excess MSRs represent interests in mortgages on real property and thus are qualifying real estate assets for purposes of the REIT asset test, which
generate income that qualifies as interest on obligations secured by mortgages on real property for purposes of the REIT income test. The ruling is based on, among other things, certain assumptions as well as on the accuracy of certain factual
representations and statements that we have made to the IRS. If any of the representations or statements that we have made in connection with the private letter ruling, are, or become, inaccurate or incomplete in any material respect with respect to
one or more Excess MSR investments, or if we acquire an Excess MSR investment with terms that are not consistent with the terms of the Excess MSR investments described in the private letter ruling, then we will not be able to rely on the private
letter ruling. If we are unable to rely on the private letter ruling with respect to an Excess MSR investment, the IRS could assert that such Excess MSR investments do not qualify under the REIT asset and income tests, and if successful, our ability
to continue to make this type of investment and our ability to qualify as a REIT could be adversely affected.
Rapid changes in the
values of assets that we hold may make it more difficult for us to maintain our qualification as a REIT or our exemption from the 1940 Act.
If the market value or income potential of qualifying assets for purposes of our qualification as a REIT or our exemption from registration as an investment company under the 1940 Act declines as a
result of increased interest rates, changes in prepayment rates or other factors, we may need to increase our investments in qualifying assets and/or liquidate our non-qualifying assets to maintain our REIT qualification or our exemption from
registration under the 1940 Act. If the decline in market values or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of any non-qualifying assets we may own. We may have
to make investment decisions that we otherwise would not make absent the intent to maintain our qualification as a REIT and exemption from registration under the 1940 Act.
Dividends payable by REITs do not qualify for the reduced tax rates.
Dividends payable to domestic stockholders that are individuals, trusts or estates are generally taxed at reduced rates. Dividends
payable by REITs, however, are generally not eligible for the reduced rates. Although
these rules do not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals,
trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common
stock. In addition, the relative attractiveness of real estate in general may be adversely affected by the favorable tax treatment given to corporate dividends, which could affect the value of our real estate assets negatively.
Qualifying as a REIT involves highly technical and complex provisions of the Code.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which only limited judicial
and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder
ownership and other requirements on a continuing basis. Compliance with these requirements must be carefully monitored on a continuing basis, and there can be no assurance that our managers personnel responsible for doing so will be able to
successfully monitor our compliance.
REIT distribution requirements could adversely affect our liquidity and our ability to execute our
In order to maintain our tax status as a REIT, we are generally required to distribute at least
90% of our REIT taxable income (determined without regard to the dividends paid deduction and not including net capital gains) each year to our stockholders. We intend to make distributions to our stockholders to comply with the requirements of the
Code. However, differences in timing between the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short-term or long-term basis to meet the 90% distribution requirement of the Code.
Certain of our assets may generate substantial mismatches between taxable income and available cash. As a result, the requirement to distribute a substantial portion of our net taxable income could cause us to: (i) sell assets in adverse market
conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, or (iv) make taxable distributions of our capital stock in
order to comply with REIT requirements. Further, amounts distributed will not be available to fund investment activities. If we fail to obtain debt or equity capital in the future, it could limit our ability to satisfy our liquidity needs, which
could adversely affect the value of our common stock.
We believe that as a result of the proposed offering, we will experience an
ownership change for purposes of Section 382 of the Code, which limits our ability to utilize our net operating loss carryforwards and certain built-in losses to reduce our future taxable income, potentially increases our related
REIT distribution requirement, and potentially adversely affects our liquidity.
In order to maintain our tax status as
a REIT, we are generally required to distribute at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and not including net capital gains) each year to our stockholders. To qualify for the tax benefits
accorded to REITs, we intend to make distributions to our stockholders such that we distribute all or substantially all our net taxable income (if any) each year, subject to certain adjustments. However, our ability to meet this distribution
requirement and maintain our status as a REIT may be adversely affected if certain provisions of the Code limit our ability to utilize our net operating loss carryforwards and certain built-in losses to reduce our taxable income, thereby increasing
both our taxable income and the related REIT distribution requirement to a level that we are unable to satisfy.
the Code limits the ability of a company that undergoes an ownership change to utilize its net operating loss carryforwards and certain built-in losses to offset taxable income earned in years after the ownership change. An ownership
change occurs if, during a three-year testing period, more than 50% of the stock of a company is acquired by one or more persons (or certain groups of persons) who own, directly or constructively, 5% or more of the stock of such company. An
ownership change can occur as a result of a public
offering of stock, as well as through secondary market purchases of our stock and certain types of reorganization transactions. Generally, when an ownership change occurs, the annual limitation
on the use of net operating loss carryforwards and certain built-in losses is equal to the product of the applicable long-term tax exempt rate and the value of the companys stock immediately before the ownership change. We have substantial net
operating and net capital loss carry forwards which we have used, and in the absence of such a limit would continue to use, to offset our tax and distribution requirements. We believe that as a result of the proposed offering, an ownership
change for purposes of Section 382 of the Code will occur. If an ownership change occurs, the provisions of Section 382 of the Code will impose an annual limit on the amount of net operating loss carryforwards and built in losses
that we can use to offset future taxable income. Such limitation may increase our dividend distribution requirement in the future, which could adversely affect our liquidity. We do not believe that the limitation as a result of this ownership change
will prevent us from satisfying our REIT distribution requirement for the current year and future years. No assurance, however, can be given that we will be able to satisfy our distribution requirement following a current or future ownership change
or otherwise. If we were to fail to satisfy our distribution requirement, it would cause us to lose our REIT status and thereby materially negatively impact our business, financial condition and potentially impair our ability to continue operating
in the future.
Certain properties are leased to our taxable REIT subsidiaries pursuant to special provisions of the Code.
We currently lease certain qualified healthcare properties to our taxable REIT subsidiaries
(TRSs) (or a limited liability company of which a TRS is a member). These TRSs in turn contract with an affiliate of our manager to manage the healthcare operations at these properties. The rents paid by the TRSs in this structure will
be treated as qualifying rents from real property for purposes of the REIT requirements if (i) they are paid pursuant to an arms-length lease of a qualified healthcare property and (ii) the operator qualifies as an eligible
independent contractor with respect to the property. An operator will qualify as an eligible independent contractor if it meets certain ownership tests with respect to us, and if, at the time the operator enters into the management agreement,
the operator is actively engaged in the trade or business of operating qualified healthcare properties for any person who is not a related person to us or the lessee. If any of the above conditions were not satisfied, then the rents would not be
considered income from a qualifying source for purposes of the REIT rules, which could cause us to incur penalty taxes or to fail to qualify as a REIT.
We may be required to report taxable income for certain investments in excess of the economic income we ultimately realize from them.
We may acquire debt instruments in the secondary market for less than their face amount. The amount of such discount will generally
be treated as market discount for federal income tax purposes. Accrued market discount is generally recognized as taxable income over our holding period in the instrument in advance of the receipt of cash. If we collect less on the debt
instrument than our purchase price plus the market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions.
In addition, we may acquire debt investments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding debt are significant modifications under the
applicable Treasury regulations, the modified debt may be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, we may be required to recognize taxable gain to the extent the principal amount of the
modified debt exceeds our adjusted tax basis in the unmodified debt, even if the value of the debt or the payment expectations have not changed. Following such a taxable modification, we would hold the modified loan with a cost basis equal to its
principal amount for federal tax purposes.
Moreover, in the event that any debt instruments acquired by us are delinquent as
to mandatory principal and interest payments, or in the event payments with respect to a particular debt instrument are not made when due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income. Similarly, we
may be required to accrue interest income with respect to subordinate mortgage-backed securities at the stated rate regardless of whether corresponding cash payments are received.
The IRS tax rules regarding recognizing capital losses and ordinary income for our non-recourse
financings, coupled with current REIT distribution requirements, could result in our recognizing significant taxable net income without receiving an equivalent amount of cash proceeds from which to make required distributions. This disconnect could
have a serious, negative effect on us.
We may experience issues regarding the characterization of income for tax
purposes. For example, we may recognize significant ordinary income, which we would not be able to offset with capital losses, which would, in turn, increase the amount of income we would be required to distribute to stockholders in order to
maintain our REIT status. We expect that this disconnect will occur in the case of one or more of our non-recourse financing structures, including off balance sheet structures such as our subprime securitizations and non-consolidated CDOs, where we
incur capital losses on the related assets, and ordinary income from the cancellation of the related non-recourse financing if the ultimate proceeds from the assets are insufficient to repay such debt. Through September 30, 2012, no such
cancellation of CDO debt had been effected as a result of losses incurred. However, we expect that such cancellation of indebtedness within our CDOs, consolidated or non-consolidated, may occur in the future. In the case of our subprime
securitizations, $60.5 million of such cancellations had been effected through September 30, 2012, and we expect such cancellations will continue as losses are realized. This disconnect could also occur, and has occurred, as a result of the
repurchase of our outstanding debt at a discount as the gain recorded upon the cancellation of indebtedness is characterized as ordinary income for tax purposes. We have repurchased our debt at a discount in the past, and we intend to attempt to do
so in the future. During 2009 and 2010, we repurchased $787.8 million face amount of our outstanding CDO debt and junior subordinated notes at a discount, and recorded $521.1 million of gain. In compliance with tax laws, we had the ability to defer
the ordinary income recorded as a result of this cancellation of indebtedness to future years and have deferred or intend to defer all or a portion of such gain for 2009 and 2010. While such deferral may postpone the effect of the disconnect on the
ability to offset taxable income and losses, it does not eliminate it. Furthermore, cancellation of indebtedness income recognized on or after January 1, 2011 cannot be deferred and must generally be recognized as ordinary income in the year of
such cancellation. During the year ended December 31, 2011 and the period ended September 30, 2012, we repurchased $193.2 million and $34.1 million face amount of our outstanding CDO debt and notes payable at a discount and recorded $82.2
million and $23.1 million of gain for tax purposes, respectively, (of which only $66.1 million and $23.1 million gain relating to $171.8 million and $34.1 million face amount of debt repurchased, respectively, was recognized for GAAP purposes).
The elimination of the ability to defer the recognition of cancellation of indebtedness income introduces additional tax implications that may significantly reduce the economic benefit of repurchasing our outstanding CDO debt.
When we experience any of these disconnects, and to the extent that a distribution through stock dividends is not viable, we may not have
sufficient cash flow to make the distributions necessary to satisfy our REIT distribution requirements, which would cause us to lose our REIT status and thereby materially negatively impact our business, financial condition and potentially impair
our ability to continue operating in the future. Under current market conditions, this type of disconnect between taxable income and cash proceeds would be likely to occur at some point in the future if the current regulations that create the
disconnect are not revised, but we cannot predict at this time when such a disconnect might occur.
We may be unable to generate
sufficient revenue from operations to pay our operating expenses and to pay distributions to our stockholders.
As a REIT, we are generally required to distribute at least 90% of our REIT taxable income (determined without regard to the
dividends paid deduction and not including net capital losses) each year to our stockholders. To qualify for the tax benefits accorded to REITs, we intend to make distributions to our stockholders in amounts such that we distribute all or
substantially all of our net taxable income each year, subject to certain adjustments. However, our ability to make distributions may be adversely affected by the risk factors described herein, particularly in light of current market conditions. In
the event of a sustained downturn in our operating results and financial performance relative to previous periods or sustained declines in the value of our asset portfolio, we may be unable to declare or pay quarterly distributions or make
distributions to our stockholders, and we may
elect to comply with our REIT distribution requirements by, after completing various procedural steps, distributing, under certain circumstances, a portion of the required amount in the form of
common stock in lieu of cash. The timing and amount of distributions are in the sole discretion of our board of directors, which considers, among other factors, our earnings, financial condition, debt service obligations and applicable debt
covenants, REIT qualification requirements and other tax considerations and capital expenditure requirements as our board may deem relevant from time to time.
The stock ownership limit imposed by the Code for REITs and our charter may inhibit market activity in our stock and restrict our business combination opportunities.
In order for us to maintain our qualification as a REIT under the Code, not more than 50% in value of our outstanding stock may be
owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half of each taxable year after our first year. Our charter, with certain exceptions, authorizes our board
of directors to take the actions that are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person may own more than 8% of the aggregate value of our outstanding capital stock, treating
classes and series of our stock in the aggregate, or more than 25% of the outstanding shares of our Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock. Our board may grant an exemption in its sole discretion, subject to
such conditions, representations and undertakings as it may determine in its sole discretion. These ownership limits could delay or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise
be in the best interest of our stockholders.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our
Even if we remain qualified 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, such as mortgage recording taxes.
Moreover, if a REIT distributes less than 85% of its taxable income to its stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then it is required to pay
an excise tax of 4% on any shortfall between the required 85% and the amount that was actually distributed. Any of these taxes would decrease cash available for distribution to our stockholders. In addition, in order to meet the REIT qualification
requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we may hold some of our assets through taxable REIT subsidiaries. Such subsidiaries will be subject to
corporate level income tax at regular rates.
Complying with REIT requirements may cause us to forego otherwise attractive
To qualify as a REIT for federal income tax purposes, we must continually satisfy tests
concerning, among other things, 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. We also may be required to make distributions to stockholders at
disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments.
Complying with REIT requirements may limit our ability to hedge effectively.
The existing REIT provisions of the Code may substantially limit our ability to hedge our operations because a significant amount of the
income from those hedging transactions is likely to be treated as non-qualifying income for purposes of both REIT gross income tests. In addition, we must limit our aggregate income from non-qualified hedging transactions, from our provision of
services and from other non-qualifying sources, to less than 5% of our annual gross income (determined without regard to gross income from qualified hedging transactions). As a result, we may have to limit our use of certain hedging techniques or
hedges through total return swaps. This could result in greater risks associated with changes in interest rates than we would otherwise want to incur or could increase the cost of our hedging
activities. If we fail to comply with these limitations, we could lose our REIT qualification for federal income tax purposes, unless our failure was due to reasonable cause, and not due to willful neglect, and we meet certain other technical
requirements. Even if our failure were due to reasonable cause, we might incur a penalty tax.
The taxable mortgage pool
rules may increase the taxes that we or our stockholders may incur, and may limit the manner in which we effect future securitizations.
Certain of our securitizations have resulted in the creation of taxable mortgage pools for federal income tax purposes. As a REIT, so long as we own 100% of the equity interests in a taxable
mortgage pool, we would generally not be adversely affected by the characterization of the securitization as a taxable mortgage pool. Certain categories of stockholders, however, such as foreign stockholders eligible for treaty or other benefits,
stockholders with net operating losses, and certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to the taxable
mortgage pool. In addition, to the extent that our stock is owned by tax-exempt disqualified organizations, such as certain government-related entities and charitable remainder trusts that are not subject to tax on unrelated business
income, we could incur a corporate level tax on a portion of our income from the taxable mortgage pool. In that case, we might reduce the amount of our distributions to any disqualified organization whose stock ownership gave rise to the tax.
Moreover, we may be precluded from selling equity interests in these securities to outside investors, or selling any debt securities issued in connection with these securitizations that might be considered to be equity interests for tax purposes.
These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions.
our 1940 Act exemption imposes limits on our operations.
We or one or more of our subsidiaries conduct our
operations in reliance on an exemption from the 1940 Act. The assets that we may acquire, therefore, are limited by the provisions of the 1940 Act and the rules and regulations promulgated under the 1940 Act. The SEC recently solicited public
comment on a wide range of issues relating to Section 3(c)(5)(C) of the 1940 Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage REITs should be regulated in a manner similar to investment
companies. There can be no assurance that the laws and regulations governing the 1940 Act status of REITs, or SEC guidance regarding these exemptions, will not change in a manner that adversely affects our operations. If the SEC takes action that
could result in our or our subsidiaries failure to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either to (a) change the manner in which we conduct our operations to maintain our
exemption from registration as an investment company, (b) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (c) register as an investment company (which, among other things, would
require us to comply with the leverage constraints applicable to investment companies), any of which could negatively affect the value of our common stock, the sustainability of our business model, and our ability to make distributions to our
stockholders, which could, in turn, materially and adversely affect us and the market price of our shares.
Our staggered board and
other provisions of our charter and bylaws may prevent a change in our control.
Our board of directors is
divided into three classes of directors. Directors of each class are chosen for three-year terms upon the expiration of their current terms, and each year one class of directors is elected by the stockholders. The staggered terms of our directors
may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest of our stockholders. In addition, our charter and bylaws also contain other provisions
that may delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Risks Related to Our Common Stock
Our share price has fluctuated meaningfully, particularly on a percentage basis, and may fluctuate meaningfully in the future. Accordingly, you may not be able to resell your shares at or above the
price at which you purchased them.
The trading price of our common stock has fluctuated significantly over the
last three years. Moreover, future share price fluctuations could likely be subject to similarly wide price fluctuations in the future in response to various factors, including:
market conditions in the broader stock market in general, or in the REIT or real estate industry in particular;
our ability to make investments with attractive risk-adjusted returns, including, without limitation, investments in Excess MSRs or senior living
market perception of our current and projected financial condition, potential growth, future earnings and future cash dividends;
announcements we make regarding dividends;
actual or anticipated fluctuations in our quarterly financial and operating results;
market perception or media coverage of our manager or its affiliates;
actions by rating agencies;
short sales of our common stock;
issuance of new or changed securities analysts reports or recommendations;
media coverage of us, other REITs or the outlook of the real estate industry;
major reductions in trading volumes on the exchanges on which we operate;
credit deterioration within our portfolio;
legislative or regulatory developments, including changes in the status of our regulatory approvals or licenses;
litigation and governmental investigations; and
the consummation of the spin out of a portion of our assets.
These and other factors may cause the market price and demand for our common stock to fluctuate substantially, which may negatively
affect the price or liquidity of our common stock. Moreover, the recent market conditions negatively impacted our share price and may do so in the future. When the market price of a stock has been volatile or has decreased significantly in the past,
holders of that stock have, at times, instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending, settling or paying
any resulting judgments related to the lawsuit. Such a lawsuit could also divert the time and attention of our management from our business and hurt our share price.
We may be unableor elect notto pay dividends on our common or preferred stock in the future, which would negatively impact our business in a number of ways and decrease the price of our
common and preferred stock.
While we are required to make distributions in order to maintain our REIT status
(as described above under Risks Relating to Our REIT Status and Other MattersWe may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay distributions to our stockholders), we may elect
maintain our REIT status, in which case we would no longer be required to make such distributions. Moreover, even if we do elect to maintain our REIT status, we may elect to comply with the
applicable requirements by, after completing various procedural steps, distributing, under certain circumstances, a portion of the required amount in the form of shares of our common stock in lieu of cash. If we elect not to maintain our REIT status
or to satisfy any required distributions in common stock in lieu of cash, such action could negatively affect our business and financial condition as well as the price of both our common and preferred stock. No assurance can be given that we will
pay any dividends on our common stock in the future.
We do not currently have unpaid accrued dividends on our preferred
stock. However, to the extent we do, we cannot pay any dividends on our common stock, pay any consideration to repurchase or otherwise acquire shares of our common stock or redeem any shares of any series of our preferred stock without redeeming all
of our outstanding preferred shares in accordance with the governing documentation. Consequently, the failure to pay dividends on our preferred stock restricts the actions that we may take with respect to our common stock and preferred stock.
Moreover, if we do not pay dividends on any series of preferred stock for six or more periods, then holders of each affected series obtain the right to call a special meeting and elect two members to our board of directors. We cannot predict whether
the holders of our preferred stock would take such action or, if taken, how long the process would take or what impact the two new directors on our board of directors would have on our company (other than increasing our director compensation costs).
However, the election of additional directors would affect the composition of our board of directors and, thus, could affect the management of our business.
We may in the future choose to pay dividends in our own stock, in which case you could be required to pay income taxes in excess of the cash dividends you receive.
We may in the future distribute taxable dividends that are payable in cash and shares of our common stock at the election of each
stockholder. 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 and accumulated earnings and profits for federal income tax purposes. As a result,
stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells the stock that it receives as a dividend in order to pay this tax, the sale proceeds may be less
than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to
such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if 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.
It is unclear whether and to what extent we will be able to
pay taxable dividends in cash and stock. Moreover, various aspects of such a taxable cash/stock dividend 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.
Shares eligible for future sale may adversely affect our common stock price.
Sales of our common stock or other securities in the public or private market, or the perception that these sales may occur, could cause the market price of our common stock to decline. This could also
impair our ability to raise additional capital through the sale of our equity securities. Under our certificate of incorporation, we are authorized to issue up to 500,000,000 shares of common stock, of which 172,487,757 shares of common stock were
outstanding as of September 30, 2012. We cannot predict the size of future issuances of our common stock or other securities or the effect, if any, that future sales and issuances would have on the market price of our common stock.
An increase in market interest rates may have an adverse effect on the market price of our common
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 will likely affect the market price of our common stock. For
instance, if market interest 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 adversely affecting cash flow and our ability to service our indebtedness and pay
ERISA may restrict investments by plans in our common stock.
A plan fiduciary considering an investment in our common stock should consider, among other things, whether such an investment is
consistent with the fiduciary obligations under the Employee Retirement Income Security Act of 1974, as amended (ERISA), including whether such investment might constitute or give rise to a prohibited transaction under ERISA, the Code or
any substantially similar federal, state or local law and, if so, whether an exemption from such prohibited transaction rules is available.
Maryland takeover statutes may prevent a change of our control, which could depress our stock price.
Under Maryland law, business combinations between a Maryland corporation and an interested stockholder or an affiliate of an
interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include certain mergers, consolidations, share exchanges, or, in
circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities or a liquidation or dissolution. An interested stockholder is defined as:
any person who beneficially owns 10% or more of the voting power of the corporations outstanding shares; or
an affiliate or associate of a corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10%
or more of the voting power of the then outstanding stock of the corporation.
A person is not an interested
stockholder under the statute if the board of directors approved in advance the transaction by which he or she otherwise would have become an interested stockholder.
After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and
approved by the affirmative vote of at least:
80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation voting together as a single group; and
two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with
whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder voting together as a single voting group.
The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of consummating
any offer, including potential acquisitions that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Our authorized, but unissued common and preferred stock may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock.
In addition, our board of directors may classify or reclassify any unissued shares of our common stock or preferred stock and may set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board may
establish a series of preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Risks Related to the Spin-Off of New Residential
We may not be able to complete the spin-off on the terms anticipated or at all.
Our board of directors has determined that a spin-off of certain of our residential real estate assets is in our best interests. The spin-off will be effected as a distribution to the holders of our
common stock of shares of New Residential, which is currently a wholly-owned subsidiary of us. New Residential intends to elect and qualify to be taxed as a REIT and to be listed on the NYSE. New Residential will be externally managed by our manager
pursuant to a new management agreement. Following the spin-off, our business strategy will be focused on commercial real estate related investments in, among others, commercial real estate debt and senior housing, as well as pursuing strategic
opportunities to liquidate, or collapse, its CDOs.
New Residential will target investments in residential real
estate related investments, including, but not limited to, Excess MSRs, RMBS, servicing advances and non-performing loans. New Residentials initial portfolio will include all of our investments in Excess MSRs to date and any investments in
Excess MSRs that we make with the proceeds of the proposed offering or otherwise prior to the spin-off. New Residentials initial portfolio will also include the non-Agency RMBS we have acquired since the second quarter of 2012 and certain
We expect the spin-off of New Residential to be completed in the first quarter of 2013. However, there can be no
assurance that the spin-off will be completed as anticipated or at all. Our ability to complete the spin-off is subject to, among other things, the SEC declaring the registration statement filed with regard to the spin-off effective, the filing and
approval of an application to list New Residentials common stock on the NYSE and the formal declaration of the distribution by Newcastles board of directors. There can be no assurance that the spin-off will be completed, and a failure to
complete the spin-off could negatively affect the price of the shares of our common stock. Stockholder approval will not be required or sought in connection with the spin-off.
The spin-off may not have the benefits we anticipate.
may not have the full or any strategic and financial benefits that we expect, or such benefits may be delayed or may not materialize at all. The anticipated benefits of the spin-off are based on a number of
assumptions, which may prove incorrect. For example, we believe that analysts and investors will regard New Residentials focused investment strategy and asset portfolio more favorably as a
separate company than as part of our existing portfolio and strategy and thus place a greater value on New Residential as a stand-alone REIT than as a business that is a part of us. In the event that the spin-off does not have these and other
expected benefits, the costs associated with the transaction, including an expected increase in management compensation and general and administrative expenses, could have a negative effect on our financial condition and ability to make
distributions to the stockholders of each company. Stockholder approval will not be required or sought in connection with the spin-off.
New Residential may not be able to successfully implement its business strategy.
Assuming the spin-off is completed, there can be no assurance that New Residential will be able to generate sufficient
returns to pay its operating expenses and make satisfactory distributions to its stockholders, or any distributions at all, once it commences operations as an independent company. New Residentials financial condition, results of
operations and cash flows will be affected by the expenses it will incur as a stand-alone public company, including fees paid to its manager, legal, accounting, compliance and other costs associated with being a public company with equity securities
traded on the NYSE. In addition, its results of operations and its ability to make or sustain distributions to its stockholders depend on the availability of opportunities to acquire attractive assets, the level and volatility of interest rates, the
availability of adequate short- and long-term financing, conditions in the real estate market, the financial markets and economic conditions, among other factors described in the registration statement for the transaction. After the separation, we
will not be required, and do not intend, to provide New Residential with funds to finance its working capital or other cash requirements, so New Residential would need to obtain additional financing from banks, through public offerings or private
placements of debt or equity securities, strategic relationships or other arrangements.
Our agreements with New
Residential may not reflect terms that would have resulted from arms-length negotiations among unaffiliated third parties.
The terms of the agreements related to New Residentials separation from us, including a separation and distribution agreement and a management agreement between our manager and New Residential, were
not negotiated among unaffiliated third parties. Such terms were proposed by our officers and other employees of our manager and approved by our board of directors. As a result, these terms may be less favorable to us than the terms that would have
resulted from arms-length negotiations among unaffiliated third parties.
For example, the terms of New
Residentials management agreement with our manager will be substantially similar to the terms of our existing management agreement. As a result, our manager will be entitled to earn a management fee from New Residential and will be eligible to
receive incentive compensation based in part upon New Residentials achievement of targeted levels of funds from operations tested from the date of the spin-off and without regard to our prior performance.
The distribution of New Residential common stock will not qualify for tax-free treatment and may be taxable to you as a dividend.
The distribution of New Residential common stock will not qualify for tax-free treatment. An amount equal to the fair
market value of the shares received by you (assuming you are a stockholder of us as of the applicable record date), including any fractional shares deemed to be received, on the distribution date will be treated as a taxable dividend to the extent
of your ratable share of any of our current or accumulated earnings and our profits, with the excess treated first as a non-taxable return of capital to the extent of your tax basis in our common stock and then as capital gain. In addition, we or
other applicable withholding agents may be required or permitted to withhold at the applicable rate on all or a portion of the distribution payable to non-U.S. stockholders, and any such withholding would be satisfied by us or such agent withholding
and selling a portion of the New Residential stock otherwise distributable to non-U.S. stockholders. Such non-U.S. stockholders may bear brokerage fees or other costs from this withholding procedure. Your tax basis in our shares held at the time of
the distribution will
be reduced (but not below zero) to the extent the fair market value of the New Residential shares distributed by us to you in the distribution exceeds your ratable share of our current and
accumulated earnings and profits. Your holding period for such our shares will not be affected by the distribution. We will not be able to advise you of the amount of its earnings and profits until after the end of the 2013 calendar year.
Although we will be ascribing a value to New Residentials shares in the distribution for tax purposes, this valuation
is not binding on the IRS or any other tax authority. These taxing authorities could ascribe a higher valuation to your shares, particularly if New Residentials stock trades at prices significantly above the value ascribed to the shares by us
in the period following the distribution. Such a higher valuation may cause a larger reduction in the tax basis of your shares of us or may cause you to recognize additional dividend or capital gain income. You should consult your own tax advisor as
to the particular tax consequences of the distribution to you.
||Financial Statements and Exhibits. |
||Pro Forma Financial Information.|
||Press Release, dated January 7, 2013, announcing the commencement of the Offering.|
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
|NEWCASTLE INVESTMENT CORP.|
/s/ Brian C. Sigman
|Brian C. Sigman|
|Chief Financial Officer|
Date: January 7, 2013