Exhibit 10.4
MORTGAGE INVESTMENTS
SUB-MANAGEMENT AGREEMENT
THIS AGREEMENT is made and entered into as of December 17, 1997, by and
between BLACKROCK FINANCIAL MANAGEMENT, INC. (the "Sub-Manager") and FRIEDMAN,
BILLINGS, XXXXXX INVESTMENT MANAGEMENT, INC. (the "Manager").
RECITALS
WHEREAS, FBR Asset Management Corporation (the "Company") is scheduled
to close the sale of shares of its common stock and acquire approximately $200
million that is to be invested from time to time; and
WHEREAS, the Company has retained the Manager to manage its business
and affairs including the investment of assets of the Company; and
WHEREAS, the Sub-Manager has expertise in acquiring and managing a
portfolio of mortgage loans and mortgage securities ("mortgage investments");
and
WHEREAS, the Company intends to conduct its business in a manner that
will permit it to qualify for the tax benefits accorded by Sections 856 through
860 of the Internal Revenue Code of 1986, as amended (the "Code"); and
WHEREAS, the Manager with the consent of the Company desires to retain
the Sub-Manager to acquire and otherwise manage a portfolio of mortgage
investments for the account of the Company in such amounts from time to time as
may be determined by the Manager in consultation with the Sub-Manager; and
WHEREAS, the Sub-Manager is willing to provide such services on the
terms and conditions set forth below;
NOW THEREFORE, in consideration of the mutual agreements herein set
forth, the parties hereto agree as follows:
SECTION 1. Appointment and Acceptance.
The Manager hereby appoints the Sub-Manager as an "Investment Manager."
The Manager represents and warrants that (a) it has all requisite authority to
appoint the Sub-Manager hereunder, (b) the terms of the Agreement do not
conflict with any obligations by which the Manager or the Company is bound,
whether arising by contract, operation of law or otherwise and (c) this
Agreement has been duly authorized by appropriate corporate action. The
Sub-Manager does hereby accept said appointment and by its execution of this
Agreement the Sub-Manager represents and warrants that it is registered as an
investment adviser under the Investment Advisers Act of 1940.
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SECTION 2. Duties of the Sub-Manager.
(a) The Sub-Manager at all times will be subject to the supervision of
the Manager and will have only such functions and authority as the Manager may
delegate to it. The Sub-Manager will be responsible for the day-to-day
operations of the Company with respect to its mortgage investments. The
Sub-Manager will be responsible for the investment and reinvestment of those
assets designated by the Manager as subject to the Sub-Manager's management
(which assets, together with all additions, substitutions, and alterations
thereto are hereinafter called the "Portfolio"). The Portfolio may include
investments and instruments described in the guidelines for mortgage investments
for the account of the Company. Until modified by the Manager, these guidelines
shall be those set forth in Appendices A and A-1. The Company and the Manager
hereby delegate to the Sub-Manager all of its powers, duties and
responsibilities with regard to such investment and reinvestment and hereby
appoints the Sub-Manager as its agent in fact with full authority to buy, sell
or otherwise effect investment transactions involving investments in its name
for the Portfolio. Said powers, duties and responsibilities shall be exercised
by the Sub-Manager pursuant to and in accordance with this Agreement.
Notwithstanding the foregoing, the Manager shall have full authority to direct
the Sub-Manager with respect to the investments in the Portfolio.
(b) The Sub-Manager will perform (or cause to be performed) such
services and activities relating to mortgage investments of the Company as may
be appropriate, including:
(i) serving as the Company's consultant with respect to
formulation of mortgage investment criteria and preparation of mortgage
investment policy guidelines;
(ii) furnishing reports to the Manager regarding the Company's
mortgage investments and the services performed for the account of the
Company by the Sub-Manager;
(iii) monitoring and providing to the Manager on an ongoing
basis price information and other data, obtained from certain
nationally recognized dealers that maintain markets in mortgage
investments from time to time, and providing data and advice to the
Manager in connection with the identification of such dealers;
(iv) performing and supervising the performance of such
administrative functions necessary in the management of the Company's
mortgage investments as may be agreed upon by the Sub-Manager and the
Manager, including the maintenance of appropriate computer services to
perform such administrative functions;
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(v) to the extent not otherwise subject to an agreement
executed by the Manager or the Company, designating a servicer for
mortgage loans sold to the Company by originators and arranging for the
monitoring and supervision of such servicers;
(vi) counseling the Manager in connection with policy
decisions relating to mortgage investments to be made by the Company;
(vii) consulting with the Manager regarding the maintenance of
the Company's status as a REIT and assisting the Manager in monitoring
compliance with the various REIT qualification tests and other rules
set out in the Code and regulations thereunder;
(viii) engaging in hedging activities relating to the Company's
mortgage investments and consulting with the Manager to assure that
such activities are consistent with maintaining the Company's status as
a REIT;
(ix) upon request by and in accordance with the mortgage
investment policy guidelines or with the direction of the Manager,
investing or reinvesting any money of the Company; and
(x) consulting with the Manager regarding the maintenance of
the Company's exemption from the Investment Company Act and assisting
the Manager in monitoring compliance with the various requirements for
such exemption.
(c) Portfolio Management. The Sub-Manager will perform portfolio
management services on behalf of the Manager with respect to the Company's
mortgage investments. Such services will include, but not be limited to,
consulting with the Manager on purchase and sale policies, collection of
information and submission of reports pertaining to the Company's mortgage
investments, periodic review and evaluation of the performance of the Company's
portfolio of mortgage investments, acting as liaison between the Company and
banking, mortgage banking, investment banking and other parties with respect to
the purchase, financing and disposition of mortgage investments, and other
customary functions related to mortgage investment portfolio management.
(d) Reasonable Best Efforts. The Manager agrees to use its reasonable
best efforts at all times in performing services for the Manager and the Company
hereunder.
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SECTION 3. Additional Activities of Sub-Manager. Nothing herein shall
prevent the Sub-Manager or any of its Affiliates from engaging in other
businesses or from rendering services of any kind to any other person or entity,
including investment in, or advisory service to others investing in, any type of
mortgage investment, including investments that meet the principal investment
objectives of the Company. It is specifically understood and agreed that the
Sub-Manager may directly or indirectly supply services of any nature, including
investment advice and portfolio administration, to other companies seeking to
qualify as a REIT, including companies sponsored or organized by it, that may be
in direct or indirect competition with the Company. The Sub-Manager will not be
required to resolve any conflicts of interest that may arise in connection with
such competing services in favor of the Company, although employees performing
services for multiple accounts will seek to allocate investment and disposition
opportunities available to and appropriate for the accounts in a manner that is
reasonably fair over time to each such account. The Manager agrees that the
Sub-Manager may refrain from rendering any advice or services concerning
securities of companies of which any of the Sub-Manager's, or affiliates of the
Sub-Manager's officers, directors, or employees are directors or officers, or
companies for which the Sub-Manager or any of the Manager's affiliates or the
officers, directors and employees of any of them has any substantial economic
interest, unless the Sub-Manager either determines in good faith that it may
appropriately do so without disclosing such conflict to the Manager or discloses
such conflict to the Manager prior to rendering such advice or services with
respect to the Company's mortgage investments. From time to time, when
determined by the Sub-Manager in its capacity of a fiduciary to be in the best
interest of the Company, the Sub-Manager may on behalf of the Company purchase
securities from or sell securities to an account managed by the Sub-Manager at
prevailing market levels in accordance with the procedure under section 17(a)(7)
of the Investment Company Act of 1940.
SECTION 4. Commitments. In order to meet the investment requirements of
the Company, as determined by the Manager from time to time, the Sub-Manager
agrees, at the direction of the Manager, to issue on behalf of the Company
commitments for the purchase of mortgage investments.
SECTION 5. Bank Accounts. At the direction of the Manager, the
Sub-Manager may establish and maintain one or more bank accounts in the name of
the Company, and may collect and deposit into any such account or accounts, and
disburse funds from any such account or accounts, under such terms and
conditions as the Manager may approve; and the Sub-Manager shall from time to
time render appropriate accountings of such collections and payments to the
Manager, the Company and, upon request, to the auditors of the Manager and the
Company.
SECTION 6. Records; Confidentiality. The Sub-Manager shall maintain
appropriate books of accounts and records relating to services performed
hereunder, and such books of account and records shall be accessible for
inspection by representatives of the Manager and the Company at any time during
normal business hours. The Sub-Manager shall keep confidential any and all
information obtained in connection with the services rendered hereunder and
shall not disclose any such information to nonaffiliated third parties except
with the prior written consent of the Manager.
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SECTION 7. Obligations of Sub-Manager.
(a) At the sole cost and expense of the Company, the Sub-Manager shall
require each seller or transferor of mortgage investments to the Company to make
such representations and warranties regarding such investments as may, in the
judgment of the Sub-Manager, be necessary and appropriate. In addition, the
Sub-Manager shall take such other action as it deems necessary or appropriate
with regard to the protection of the Company's mortgage investments.
(b) The Sub-Manager shall refrain from any action that, to the best of
its knowledge, in its sole judgment made in good faith, would adversely affect
the status of the REIT as a REIT or that, to the best of its knowledge, in its
sole judgment made in good faith, would violate any law, rule or regulation of
any governmental body or agency having jurisdiction over the Company or the
Manager or that would otherwise not be permitted by the Company's charter or
by-laws. If the Sub-Manager is ordered to take any such action by the Manager,
the Sub-Manager shall promptly notify the Manager of the Sub-Manager's judgment
that such action would adversely affect such status or violate any such law,
rule or regulation, or the Company's charter or by-laws and shall not be
required to take such action. Notwithstanding the foregoing, the Sub-Manager,
its directors, officers, stockholders and employees shall not be liable to the
Manager, the Company, or the Company's stockholders for any act or omission by
the Sub-Manager, its directors, officers, stockholders or employees except as
provided in Section 10 of this Agreement.
SECTION 8. Compensation. For services hereunder, the Manager shall be
compensated in accordance with Exhibit B, attached hereto. If this agreement
terminates at any time other than the end of a calendar quarter, the last
quarterly fee shall be prorated based on the portion of such calendar quarter
during which this Agreement was in force.
SECTION 9. Custodian. Securities representing Company mortgage
investments shall be held by a custodian duly appointed by the Company, and the
Sub-Manager is authorized to give instructions to the custodian with respect to
all investment decisions regarding such mortgage investments. Except as provided
in Paragraph 2 above, nothing contained herein shall be deemed to authorize the
Sub-Manager to take or receive physical possession of any of the mortgage
investments for the account of the Company, it being intended that sole
responsibility for safekeeping thereof (in such investments as the Sub-Manager
may direct) and the consummation of all purchases, sales, deliveries and
investments made pursuant to the Sub-Manager's direction shall rest upon the
custodian.
The Sub-Manager is authorized to enter into Tri-Party Repurchase
Agreements and sign the standard PSA tri-party agreement (the "Tri-Party
Agreement") on behalf of the Company and the subcustodian thereunder is
authorized to act as a subcustodian for the Company mortgage investments
involved in any tri-party repurchase agreement pursuant to such Tri-Party
agreement.
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SECTION 10. Limits of Sub-Manager Responsibility. The Sub-Manager
assumes no responsibility under this Agreement other than to render the services
called for hereunder in good faith and shall not be responsible for any action
of the Manager or the Company in following or declining to follow any advice or
recommendations of the Sub-Manager, including as set forth in Section 7 of this
Agreement. The Sub-Manager, its directors, officers, stockholders and employees
will not be liable to the Manager, the Company, or the Company's or any
subsidiary's shareholders for any acts or omissions by the Sub-Manager, its
directors, officers, stockholders or employees under or in connection with this
Agreement, except by reason of acts constituting bad faith, willful misconduct,
negligence or reckless disregard of their duties. The Manager shall reimburse,
indemnify and hold harmless the Sub-Manager, its stockholders, directors,
officers and employees of and from any and all expenses, losses, damages,
liabilities, demands, charges and claims of any nature whatsoever, (including
attorneys' fees) in respect of or arising from any acts or omissions of the
Sub-Manager, its stockholders, directors, officers and employees made in good
faith in the performance of the Sub-Manager's duties under this Agreement and
not constituting bad faith, willful misconduct, negligence or reckless disregard
of its duties.
SECTION 11. No Joint Venture. The Manager and the Sub-Manager are not
partners or joint venturers with each other and nothing herein shall be
construed to make them such partners or joint venturers or impose any liability
as such on either of them.
SECTION 12. Resignation or Removal of the Sub-Manager. The Sub-Manager
may be removed by the Manager or may resign upon 30 days' notice in writing. On
the effective date of the removal or resignation of the Sub-Manager or as close
to such date as is reasonably possible, the Sub-Manager shall provide the
Manager with a final report containing such information concerning the Company's
mortgage investments as the Manager may reasonably request.
SECTION 13. Assignment, Changes in Organization of Sub-Manager. Unless
the Manager expressly consents thereto in writing, any assignment (as defined in
the Investment Advisers Act of 1940) by the Sub-Manager of this Agreement shall
automatically terminate this Agreement. If the Sub-Manager hereunder is
converted into, merges or consolidates with or sells or transfers substantially
all of its assets or business to another entity, the resulting entity or the
entity to which such sale or transfer has been made shall notify the Manager of
such sale or transfer and shall become the Sub-Manager hereunder only if the
Manager specifically so consents in writing.
SECTION 14. Release of Money or Other Property Upon Written Request.
The Sub-Manager agrees that any money or other property of the Company held by
the Sub-Manager under this Agreement shall be held by the Sub-Manager as
custodian for the Company, and the Sub-Manager's records shall be appropriately
marked clearly to reflect the ownership of such money or other property by the
Company. Upon the receipt by the Sub-Manager of a written request signed by a
duly authorized officer of the Company or the Manager requesting the Sub-Manager
to release to the Company any money or other property then held by the
Sub-Manager for the account of the Company under this Agreement, the Sub-Manager
shall release such money or other property to the Company within a reasonable
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period of time, but in no event later than 30 days following such request. The
Sub-Manager shall not be liable to the Manager, Company, or the Company's or a
subsidiary's stockholders for any acts performed or omissions to act by the
Company or the Manager in connection with the money or other property released
to the Company in accordance with this Section. The Company shall indemnify the
Sub-Manager, its directors, officers, stockholders and employees against any and
all expenses, losses, damages, liabilities, demands, charges and claims of any
nature whatsoever, which arise in connection with the Sub-Manager's release of
such money or other property to the Company in accordance with the terms of this
Section 14. Indemnification pursuant to this provision shall be in addition to
any right of the Sub-Manager to indemnification under Section 10 of this
Agreement.
SECTION 15. Notices. Unless expressly provided otherwise herein, all
notices, requests, demands and other communications required or permitted under
this Agreement shall be in writing and shall be deemed to have been duly given,
made and received when delivered against receipt or upon actual receipt of
registered or certified mail, postage prepaid, return receipt requested,
addressed as set forth below:
(a) If to the Manager or the Company:
Friedman, Billings, Xxxxxx Investment Management, Inc.
0000 Xxxxxxxxxx Xxxxxx, Xxxxx
Xxxxxxxxx, Xxxxxxxx 00000
Attention: Xxxxxx X. Xxxxx, Esq.
or by facsimile to (000) 000-0000
(b) If to the Sub-Manager:
BlackRock Financial Management, Inc.
000 Xxxx Xxxxxx, 00xx Xxxxx
Xxx Xxxx, XX 00000
Attention: Xxxxx Xxxxxx, Chief Operating Officer
or by facsimile to (000) 000-0000
Either party may alter the address to which communications or copies
are to be sent by giving notice of such change of address in conformity with the
provisions of this Section 19 for the giving of notice.
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SECTION 16. Binding Nature of Agreement; Successors and Assigns. This
Agreement shall be binding upon and inure to the benefit of the parties hereto
and their respective heirs, personal representatives, successors and assigns as
provided herein.
SECTION 17. Entire Agreement. This Agreement contains the entire
agreement and understanding among the parties hereto with respect to the subject
matter hereof, and supersedes all prior and contemporaneous agreements,
understandings, inducements and conditions, express or implied, oral or written,
of any nature whatsoever with respect to the subject matter hereof. The express
terms hereof control and supersede any course of performance and/or usage of the
trade inconsistent with any of the terms hereof. This Agreement may not be
modified or amended other than by an agreement in writing.
SECTION 18. Controlling Law. This Agreement and all questions relating
to its validity, interpretation, performance and enforcement shall be governed
by and construed, interpreted and enforced in accordance with the laws of the
Commonwealth of Virginia, notwithstanding any Virginia or other conflict-of-law
provisions to the contrary.
SECTION 19. Indulgences, Not Waivers. Neither the failure nor any delay
on the part of a party to exercise any right, remedy, power or privilege under
this Agreement shall operate as a waiver thereof, nor shall any single or
partial exercise of any right, remedy, power or privilege preclude any other or
further exercise of the same or of any other right, remedy, power or privilege,
nor shall any waiver of any right, remedy, power or privilege with respect to
any occurrence be construed as a waiver of such right, remedy, power or
privilege with respect to any other occurrence. No waiver shall be effective
unless it is in writing and is signed by the party asserted to have granted such
waiver.
SECTION 20. Costs and Expenses. Each party hereto shall bear its own
costs and expenses incurred in connection with the negotiations and preparation
of and the closing under this Agreement, and all matters incident thereto.
SECTION 21. Titles Not to Affect Interpretation. The titles of
paragraphs and subparagraphs contained in this Agreement are for convenience
only, and they neither form a part of this Agreement nor are they to be used in
the construction or interpretation hereof.
SECTION 22. Execution in Counterparts. This Agreement may be executed
in any number of counterparts, each of which shall be deemed to be an original
as against any party whose signature appears thereon, and all of which shall
together constitute one and the same instrument. This Agreement shall become
binding when one or more counterparts hereof, individually or taken together,
shall bear the signatures of all of the parties reflected hereon as the
signatories.
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SECTION 23. Provisions Separable. The provisions of this Agreement are
independent of and separable from each other, and no provision shall be affected
or rendered invalid or unenforceable by virtue of the fact that for any reason
any other or others of them may be invalid or unenforceable in whole or in part.
SECTION 24. Investment Manager Brochure. The Manager hereby
acknowledges that it has received from the Sub-Manager a copy of the ADV Form,
Part II, as currently filed, at least forty-eight hours prior to entering into
this Agreement.
SIGNATURE PAGE FOLLOWS
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IN WITNESS WHEREOF, the parties hereto have executed this Management
Agreement as of the date first written above.
BLACKROCK FINANCIAL
MANAGEMENT, INC.
By: /s/ Xxxxxxxx X. Xxxx
------------------------------------------
Name: Xxxxxxxx X. Xxxx
Title: Chairman and Chief Executive Officer
FRIEDMAN, BILLINGS, XXXXXX
INVESTMENT MANAGEMENT, INC.
By: /s/ Xxxxxxxx X. Xxxxxxx
------------------------------------------
Name: Xxxxxxxx X. Xxxxxxx
Title: Principal
Agreed to:
FBR ASSET INVESTMENT CORPORATION
By: /s/ Xxxxxxx X. Xxxxxxx
------------------------------------------
Name: Xxxxxxx X. Xxxxxxx
Title: Chief Operating Officer
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Appendix A
MORTGAGE LOAN PORTFOLIO
Proposed Investment Guidelines
The Portfolio................ The Mortgage Loan Portfolio (the Portfolio) is a
separate account managed by BlackRock Financial
Management (BFM) for the benefit of the FBR
Asset Investment Corporation (the Corporation).
Investment Objective......... The Portfolio will consist of qualifying REIT
mortgage assets that will earn both a positive
spread to their funding costs and an attractive
return on capital. Once the Corporation is fully
invested in REIT securities, approximately 15%
of the Corporation's total equity will be
allocated to the Portfolio. This equity will be
levered in order to meet the 55% qualifying
"Non-RIC" asset requirement.
Duration Guidelines.......... The Portfolio will be managed with a very low
duration target.
Asset Guidelines............. Following are eligible investments:
Loans secured by residential properties and
agency and non-agency mortgage-backed securities
backed by loans secured by residential and
multifamily properties including, but not
limited to 1) pass-throughs, 2) project loans,
and 3) adjustable rate mortgages (further
details follow in Appendix A1);
The Portfolio may only invest in U.S. dollar
denominated securities.
The Portfolio may use interest rate swaps and/or
exchange traded options for purposes of yield
curve management and maintaining a target
duration.
The Portfolio may purchase private placement or
Rule 144A securities.
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Credit Criteria.............. Securities must be rated investment grade or
better by a national recognized credit rating
agency at the time of purchase.
In the event that a Portfolio investment is
downgraded below these credit quality
guidelines, the Investment Manager shall notify
the Corporation and provide an evaluation and a
recommended course of action.
Leverage..................... The Portfolio may enter into reverse repurchase
agreements. Other financing strategies will be
used from time to time with the prior approval
of the Company.
Reinvestment of Income....... All investment income of the Portfolio and
capital gains, if any, will be added to the
assets of the Portfolio.
Custodian.................... As selected by the Corporation.
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Appendix A1
DESCRIPTION OF MORTGAGE LOAN PORTFOLIO
Overview
BlackRock Financial Management (BlackRock) will be the sub-advisor on the
Mortgage Portfolio. The investment objective of the Mortgage Portfolio is to
manage a portfolio of qualifying REIT mortgage assets that will earn both a
positive spread to their funding costs and an attractive return on capital.
BlackRock intends to invest primarily in the following three sectors of the
mortgage market:
1. Whole-pool agency pass-through securities
2. Non-conforming residential mortgage loans
3. Project loans.
These sectors are described below.
Agency Pass-Through Securities
BlackRock will buy agency pass-through securities that represent 100% interest
in the underlying conforming mortgage loans ("whole pools"). Most of the loans
will fully amortize over the terms of their mortgages, but some may require a
"balloon" payment upon maturity. Conforming loans comply with the underwriting
requirements for purchase by one of the following agencies: Federal Home Loan
Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA), and
Government National Mortgage Association (GNMA). Under current requirements,
conforming loans must be secured by first liens on single-family residential
properties that comply with requirements governing original outstanding
principal balances, loan-to-value ratios, and various other underwriting
criteria.
These securities do not bear the risk of credit loss due to defaults as they are
guaranteed by the agencies. GNMA is a wholly owned corporate instrumentality of
the U.S. Government within the U.S. Department of Housing and Urban Development
(HUD) and, therefore, its guarantee is backed by the full faith and credit of
the U.S. Government. FNMA and FHLMC are government-sponsored agencies that are
not backed by the full faith and credit of the U.S. Government, although they
have implicit government guarantees.
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Agency securities may be collateralized by either fixed or adjustable coupons.
Fixed-rate mortgage loans have a constant coupon over the life of the loan,
generally 15 or 30 years. BlackRock will generally buy seasoned, short
weighted-average maturity ("WAM"), fixed-rate securities. BlackRock will also
invest in securities backed by adjustable-rate mortgage ("ARM") loans, which
provide for the periodic adjustment of the coupon. The coupon is set as the sum
of a fixed margin and an index, subject to certain periodic and life-time
interest-rate caps. The most common reference indices for ARMs are the
Constant-Maturity Treasury Indices (CMT), LIBOR, and the CD rate. Agency
securities may also include hybrid ARMs, which are securities that have an
adjustable coupon for an initial period and thereafter a fixed coupon.
Mortgage loans are subject to prepayment risks. The rate at which prepayments
occur on mortgage loans will be affected by a variety of factors, including
current interest rates and economic, demographic, tax, social, legal, and other
factors. Generally, prepayments increase when interest rates fall and decrease
when interest rates rise. To the extent that actual prepayment rates are
different than originally anticipated, the yield on and duration of investments
in mortgage loans may be adversely affected. This may adversely affect the
expected rate of return on the investments. BlackRock will seek to manage this
risk through constant monitoring of the portfolio and an active funding and
hedging program.
The markets for all of these assets are very liquid and BlackRock intends to
purchase them from various Wall Street broker/dealers.
Non-Conforming or "Whole-Loan" Mortgages
BlackRock will also buy non-conforming adjustable-rate and hybrid mortgage loans
and securities collateralized by such loans. Non-conforming mortgage loans are
loans secured by first liens on single-family residential properties that do not
qualify for purchase by FHLMC, FNMA, or GNMA. Non-conforming loans generally
have outstanding principal balances in excess of agency-program guidelines or
are issued based upon different underwriting criteria than those required by the
agencies.
Pass-through securities collateralized by non-conforming loans (private
pass-through securities) are issued by originators of and investors in mortgage
loans, including savings and loan associations, mortgage banks, commercial
banks, investment banks, and special-purpose subsidiaries of those instruments.
Although these securities are generally structured similarly to the GNMA, FNMA,
and FHLMC securities, they typically are not guaranteed by an entity having the
credit status of one of the agencies and, therefore, generally offer higher
yield than their agency counterparts. Although some credit risk does exist for
both whole loans and whole loan-backed securities, historical losses from
well-underwritten loan packages are extremely small.
While less liquid, there are active markets for both whole loans and securities
collateralized by these loans. BlackRock intends to purchase these assets from
various Wall Street dealers and mortgage originators. As an example, BlackRock
has identified for purchase loans originated by Xxxxxxx Xxxxx as an attractive
source of product. These loans are uncapped adjustable-rate mortgage loans that
Xxxxxxx Xxxxx offers to its brokerage clients ("Prime First" Program).
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Putable and Non-Putable FHA/GNMA Project Loans
Project loans are government-insured (via FHA insurance or GNMA guarantee)
two-part financing vehicles that (i) finance the construction or rehabilitation
of multifamily residential housing and healthcare facilities and (ii) provide
permanent financing for the project once construction is completed. The loans
can have final maturities as long as forty years and, unlike single-family
mortgage loans, often contain explicit call protection in the form of prepayment
lock-outs or prepayment penalties that can last up to ten years. Project loans
are sold as either single-loan participation or multiple-loan pools. Many
project loans issued prior to 1984 contain a put-option provision which permits
the loans to be assigned to HUD after twenty years.
Project loans are administratively complex, demanding significant knowledge of
the project loans and the mortgage market in general. As a result of their
complexity and various operational concerns, the market for these loans is less
liquid than traditional mortgage loans.
Default risk is largely mitigated with project loans, since the FHA and GNMA
insures the loans against default. FHA-insured project loans are effectively 99%
insured, while GNMA-backed project loans are 100% insured.
One major advantage of these securities, relative to residential loans and
securities, is that their cash flows are generally more stable. Non-putable
project loans exhibit very stable cash flows over the first ten years of their
term, owing to the explicit call protection of the loans. At the end of the
call-protection period, the loans are fully prepayable. However, the greater
costs associated with refinancing multifamily housing are a disincentive, even
for loans at above market rates. The long maturity of the loans poses extension
risk in the event of a significant rise in rates.
Putable project loans do not possess significant extension risk due to the
ability to assign the loans to HUD. However, the loans generally do not possess
significant call protection, because most of the loans are seasoned and,
therefore, well into their lock-out period. Most putable project loans are
lower-coupon issues, providing little incentive for the mortgagor to refinance
based on changes in interest rates.
Project loans offer a significantly higher yield than single-family mortgage
loans and, as mentioned above, these loans offer more stable cash flows than
single-family mortgage loans due to their explicit prepayment protection, making
them a unique asset class in the mortgage market. The value of the
call-protection feature has increased as the single-family market has become
more efficient in exercising imbedded refinancing options. On an
option-adjusted-spread (OAS) basis, project loans are estimated to be at least
thirty basis points cheaper than single-family mortgage loans.
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BlackRock intends to purchase these assets from various Wall Street
broker/dealers and mortgage originators.
Sample Portfolio of November 10, 1997
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Allocation Range Yield Range Duration Range
Asset Class
---------------------------------------------------------------------------------------------
Short-WAM Pools 8-12% 6.25-6.75% 2.00-2.50
---------------------------------------------------------------------------------------------
Agency ARMs 15-25% 6.00-6.50% 0.50-1.00
---------------------------------------------------------------------------------------------
Hybrid ARMs 8-12% 6.75-7.25% 1.75-2.25
---------------------------------------------------------------------------------------------
Whole-Loan ARMs (ML Prime First) 8-12% 6.75-7.25% 0.25-0.75
---------------------------------------------------------------------------------------------
Whole-Loan ARMs 15-25% 6.25-6.75% 0.50-1.00
---------------------------------------------------------------------------------------------
Putable Project Loans 8-12% 6.25-6.75% 2.50-3.50
---------------------------------------------------------------------------------------------
Non-Putable Project Loans 15-25% 6.50-7.50% 4.50-5.50
---------------------------------------------------------------------------------------------
Total Portfolio 100% 6.25-7.00% 1.50-2.50
---------------------------------------------------------------------------------------------
Timing of Investments
It is anticipated that once the Company is fully invested in equity REIT
securities, approximately 15% of the Company's total equity capital will be
allocated to the Mortgage Loan Portfolio. This equity will be levered in order
to meet the 55% qualifying "Non-RIC" asset requirement. Assuming total equity
capital of $300 million, approximately $45 million will be allocated to the
Mortgage Loan portfolio. Once fully invested, the portfolio will typically have
leverage in the range of 6:1 to 9:1 (debt to equity), implying a total Mortgage
Loan Portfolio of $300 million to $450 million.
In order to build a portfolio of this size, BlackRock will begin to invest in
these securities as soon as possible after the closing date. While all of the
sectors discussed above have fairly liquid markets, BlackRock would begin by
investing in the most liquid sectors (agency securities), and slowly building
toward our target allocations over a six-to-nine month time frame. The timing of
investments and the amount of leverage in the portfolio will ultimately be a
function of not only the availability of appropriate product, but also the
timing and leverage of the non-Mortgage Loan Portfolio.
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Funding/Hedging Strategy
The portfolio will be funded with equity, as well as with LIBOR-based
collateralized borrowings. Derivatives may be used to effectively lock in
longer-term funding costs to better match the maturities of the liabilities with
the maturities of the assets. BlackRock will seek to manage the interest-rate
risk of the portfolio's xxxx-to-market and net interest margin through the use
of derivatives, as well as the asset-liability structure of the portfolio. One
such measure of this risk is "duration," which measures the portfolio's
sensitivity to changes in interest rates. The duration target of the portfolio's
net assets (total assets less liabilities) will generally be set at very low
levels.
Some of the derivatives used to manage interest-rate risk will include
interest-rate swaps and caps. Interest-rate swaps are arrangements whereby
parties "swap" interest payments. The most common type of swap is one in which
the two parties exchange fixed- for floating-rate payments. For example, if the
rate to swap 5-year fixed for 3-month LIBOR is ten percent, the fixed payer will
make fixed payments equal to ten percent per annum and receive 3-month LIBOR.
Swaps will be used for asset-liability management in that they will allow
investors to swap floating-rate liabilities into a fixed rate.
Interest-rate caps, also referred to as interest-rate ceilings, allow the
purchaser to "cap" the contractual rate associated with a floating-rate
liability. The seller of the cap pays the purchaser any amount above the
periodic capped rate on the settlement date. As mentioned above, the coupons of
adjustable-rate mortgages are usually subject to certain periodic and life-time
interest-rate caps. Purchasing caps allows the investor to effectively uncap the
portfolio's ARM positions or, alternatively, to cap the portfolio's liability
costs.
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Sample Asset-Liability Position as of November 10, 1997
Leverage Ratio: 7:1 (debt to equity)
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AMOUNT NET YIELD DURATION
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Assets $360,000 6.40% 2.00
Liabilities $315,000 6.00% 0.25
including hedge 6.25% 2.00
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Net Assets $45,000 7.45% 0.00
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Appendix B
As compensation for rendering services under the Investment Manager Agreement,
the Sub-Manager shall be paid a quarterly management fee in arrears at the
annual rate of 0.20% based on the average gross asset value of each calendar
quarter (calculated as the average of the beginning and ending gross asset value
of the calendar quarter) with a minimum annual fee of $100,000. The Sub-Manager
will be reimbursed for reasonable out-of-pocket expenses incurred in connection
with managing the Mortgage Assets, including travel, meals, hotels, and other
miscellaneous expenses. The Sub-Manager agrees that the aggregate amount of such
expenses shall not exceed $15,000 annually, without the prior approval of the
Manager. The Sub-Manager shall also receive options equal to 1/2% of common
shares outstanding on the closing date of the initial private placement of the
Company. The options will have a strike price of $20.00 (the initial price),
have a ten year term and may be exercised at any time at the Sub-Manager's
discretion.
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