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10-Q - BLACKSTONE MORTGAGE TRUST, INC. | e605983_10q-ct.htm |
EX-31.1 - BLACKSTONE MORTGAGE TRUST, INC. | e605983_ex31-1.htm |
EX-31.2 - BLACKSTONE MORTGAGE TRUST, INC. | e605983_ex31-2.htm |
EX-32.2 - BLACKSTONE MORTGAGE TRUST, INC. | e605983_ex32-2.htm |
EX-32.1 - BLACKSTONE MORTGAGE TRUST, INC. | e605983_ex32-1.htm |
Exhibit
99.1
RISK
FACTORS
Risks Related to Our
Investment Activities
Our
current business is subject to a high degree of risk. Our assets and liabilities
are subject to increasing risk due to the impact of the current financial market
turmoil on the commercial real estate industry. Our efforts to stabilize our
business with the restructuring of our debt obligations may not be successful as
our balance sheet portfolio is subject to the risk of further deterioration
and ongoing turmoil in the financial markets.
Our
portfolio is comprised of debt and related interests, directly or indirectly
secured by commercial real estate. A significant portion of these investments
are in subordinate positions, increasing the risk profile of our investments as
underlying property performance deteriorates. Furthermore, we have leveraged our
portfolio at the corporate level, effectively further increasing our exposure to
loss on our investments. The recent financial market turmoil and economic
recession has resulted in a material deterioration in the value of commercial
real estate and dramatically reduced the amount of capital to finance the
commercial real estate industry (both at the property and corporate level).
Given the composition of our portfolio, the leverage in our capital structure
and the continuing negative impact of the financial market turmoil, the risks
associated with our business have dramatically increased. Even with the March
2009 restructuring of our debt obligations, we may not be able to satisfy our
obligations to our lenders and maintain the stability we intend from our
restructuring. There can be no assurance that further restructuring will
not be required and that any such restructuring will be successful. The impact
of the economic recession on the commercial real estate sector in general, and
our portfolio in particular, cannot be predicted and we expect to
experience significant defaults by borrowers and other impairments to our
investments. These events may trigger defaults under our restructured debt
obligations that may result in the exercise of remedies that cause severe
(and potentially complete) losses in the book value of our
investments. Therefore, an investment in our class A common stock is subject to
a high degree of risk.
Given
current conditions, our restructured debt obligations are an unstable source of
financing and expose us to further erosions of shareholders equity.
Our
$492.5 million in secured obligations require substantial scheduled repayments
by March 2010 in order for us to qualify for a one-year extension. We may sell
assets to extend the maturity date, and even if extended, further deterioration
in our portfolio may (i) impact our ability to refinance the obligations when
they mature and/or (ii) otherwise reduce our cash flows which may impede our
ability to service our debt obligations. If in the face of such developments, we
are unable to improve our liquidity position, or obtain waivers from our
lenders, we may need to liquidate assets on unfavorable terms, further eroding
shareholders equity.
Our
restructured debt obligations with our lenders prohibit new balance sheet
investment activities, which prevents us from growing our balance sheet
portfolio.
Following
a series of negotiations that were precipitated by our decision to conserve our
cash resources and not meet further margin calls made by our secured lenders, we
have restructured our debt obligations with our participating secured and
unsecured lenders, a development that has consequences to our business. Under
the terms of the restructured debt obligations, we are prohibited from acquiring
or originating new investments. This restriction precludes us from growing our
balance sheet portfolio at a time when investment opportunities that provide
attractive risk-adjusted returns may otherwise be available to us. Our interest
earning investments will continue to be reduced which will negatively impact our
net investment income. There can be no assurance that we will be able to retire
completely or refinance our restructured debt obligations so that we can resume
our balance sheet investment activities.
Our
liquidity will be impacted by our restructured debt obligations.
Our
restructured debt obligations further reduce our current liquidity as a result
of up front payments and ongoing required amortization and additional interest
payments. The reduction in liquidity may impair our ability to meet our
obligations and, given the covenants contained in our restructured debt
obligations, our ability to improve our liquidity position will be constrained.
In addition, we must maintain a minimum of $7.0 million in liquidity during 2009
and $5.0 million thereafter, a requirement that may limit our ability to make
commitments to investment management vehicles and, ultimately, that we may not
be able to achieve.
Our
restructured debt obligations are subject to debt to collateral value ratio
maintenance covenants for which we can provide no assurance as to our
future compliance.
Under the
terms of our debt restructuring, we eliminated the cash margin call provisions
and amended the mark-to-market provisions that were in effect under
the original terms of the secured credit facilities. The revised
secured credit facilities allow our secured lenders to determine collateral
value based upon changes in the performance of the underlying real estate
collateral as opposed to changes in market spreads under the
original terms. Beginning September 2009, or earlier in the case
of defaults on loans that collateralize any of our secured credit
facilities, each collateral pool may be valued monthly on this basis. If the
ratio of a secured lender’s total outstanding secured credit facility
balance to total collateral value exceeds 1.15x the ratio calculated as of the
effective date of the amended agreements, we may be required to liquidate
collateral and reduce the borrowings or post other collateral to bring
the ratio back into compliance with the prescribed ratio. There
can be no assurances that we will pass these tests and, as the commercial real
estate markets continue to deteriorate, we expect that passing these tests
will become more difficult. If we fail these tests, sales of
assets to return to compliance will be extremely difficult in light of the
lack of liquidity for the types of assets that serve as
collateral and, even if we locate buyers for
the collateral, the sales prices may be insufficient to
reduce the ratio of outstanding secured credit facility balance to total
collateral value. Failure to remedy these tests is an event of default
under our secured credit facilities and would trigger a cross default under
other of our financial instruments. Any such action would have a material
adverse impact on our business and financial condition and would
negatively impact our share price.
The
U.S. and other financial markets have been in turmoil and the U.S. and other
economies in which we operate are in the midst of an economic recession which
can be expected to negatively impact our operations.
The U.S.
and other financial markets have been experiencing extreme dislocations and a
severe contraction in available liquidity globally as important segments of the
credit markets are frozen as lenders are unwilling or unable to originate new
credit. Global financial markets have been disrupted by, among other things,
volatility in security prices, credit rating downgrades, the failure and near
failure of a number of large financial institutions and declining valuations,
and this disruption has been acute in real estate related markets. This
disruption has lead to a decline in business and consumer confidence and
increased unemployment and has precipitated an economic recession around the
globe. As a consequence, owners and operators of commercial real estate that
secure or back our investments have experienced distress and commercial real
estate values have declined substantially. We are unable to predict the likely
duration or severity of the current disruption in financial markets and adverse
economic conditions which could materially and adversely affect our business,
financial condition and results of operations, including leading to significant
impairment to our assets and our ability to generate income.
Our
existing loans and investments expose us to a high degree of risk associated
with investing in real estate assets.
Real
estate historically has experienced significant fluctuations and cycles in
performance that may result in reductions in the value of our real estate
related investments. The performance and value of our loans and investments once
originated or acquired by us depends upon many factors beyond our control. The
ultimate performance and value of our investments is subject to the varying
degrees of risk generally incident to the ownership and operation of the
properties which collateralize or support our investments. The ultimate
performance and value of our loans and investments depends upon, in large part,
the commercial property owner’s ability to operate the property so that it
produces sufficient cash flows necessary either to pay the interest and
principal due to us on our loans and investments or pay us as an equity advisor.
Revenues and cash flows may be adversely affected by:
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changes
in national economic conditions;
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changes
in local real estate market conditions due to changes in national or local
economic conditions or changes in local property market
characteristics;
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the
extent of the impact of the current turmoil in the financial markets,
including the lack of available debt financing for commercial real
estate;
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tenant
bankruptcies;
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competition
from other properties offering the same or similar
services;
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changes
in interest rates and in the state of the debt and equity capital
markets;
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the
ongoing need for capital improvements, particularly in older building
structures;
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changes
in real estate tax rates and other operating
expenses;
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adverse
changes in governmental rules and fiscal policies, civil unrest, acts of
God, including earthquakes, hurricanes and other natural disasters, and
acts of war or terrorism, which may decrease the availability of or
increase the cost of insurance or result in uninsured
losses;
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adverse
changes in zoning laws;
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the
impact of present or future environmental legislation and compliance with
environmental laws;
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the
impact of lawsuits which could cause us to incur significant legal
expenses and divert management’s time and attention from our day-to-day
operations; and
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other
factors that are beyond our control and the control of the commercial
property owners.
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In the
event that any of the properties underlying or collateralizing our loans or
investments experiences any of the foregoing events or occurrences, the value
of, and return on, such investments, our profitability and the market price of
our class A common stock would be negatively impacted. In addition, our
restructured debt obligations contain covenants which limit the amount of
protective investments we may make to preserve value in collateral securing our
investments.
A
prolonged economic slowdown, a lengthy or severe recession, a credit crisis, or
declining real estate values could harm our operations or may adversely affect
our liquidity.
We
believe the risks associated with our business are more severe during periods of
economic slowdown or recession like those we are currently experiencing,
particularly if these periods are accompanied by declining real estate values.
The recent dislocation of the global credit markets and anticipated collateral
consequences to commercial activity of businesses unable to finance their
operations as required has lead to a weakening of general economic conditions
and precipitated declines in real estate values and otherwise exacerbate
troubled borrowers’ ability to repay loans in our portfolio or backing our CMBS.
We have made loans to hotels, an industry whose performance has been severely
impacted by the current recession. Declining real estate values would likely
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, which in turn could lead to fewer
opportunities for our investment. Borrowers may also be less able to pay
principal and interest on our loans as the real estate economy continues to
weaken. Continued weakened economic conditions could negatively affect occupancy
levels and rental rates in the markets in which the collateral supporting our
investments are located, which, in turn, may have a material adverse impact on
our cash flows and operating results of our borrowers. Further, declining real
estate values like those occurring in the commercial real estate sector
significantly increase the likelihood that we will incur losses on our loans in
the event of default because the value of our collateral may be insufficient to
cover our basis in the loan. Any sustained period of increased payment
delinquencies, foreclosures or losses could adversely affect both our net
interest income from loans in our portfolio as well as our ability to operate
our investment management business, which would significantly harm our revenues,
results of operations, financial condition, liquidity, business prospects and
our share price.
3
We
are exposed to the risks involved with making subordinated
investments.
Our
subordinated investments involve the risks attendant to investments consisting
of subordinated loans and similar positions. Subordinate positions incur losses
before the senior positions in a capital structure and as a result,
foreclosures, on the underlying collateral can reduce or eliminate the proceeds
available to satisfy our investment. In many cases, management of our
investments and our remedies with respect thereto, including the ability to
foreclose on or direct decisions with respect to the collateral securing such
investments, is subject to the rights of senior lenders and the rights set forth
in inter-creditor or servicing agreements. Our interests and those of the senior
lenders and other interested parties may not be aligned.
We
may not be able to obtain the level of leverage necessary to optimize or achieve
our target rate of returns.
Our
return on investment depends, in part, upon our ability to grow our balance
sheet portfolio of invested assets and those of our investment management
vehicles through the use of leverage at a cost of debt that is lower than the
yield earned on our investments. Under the terms of the restructured debt
obligations, we are required to cease our balance sheet investment activities
and may not incur any further indebtedness unless used to retire the debt due
our lenders. As a result, we are precluded from carrying out our historical
leveraged investment strategy for our balance sheet.
We have
historically obtained leverage through the issuance of CDOs, repurchase
agreements and other borrowings. Our failure to obtain and/or maintain leverage
at desired levels, or to obtain leverage on attractive terms, would have an
adverse effect on our performance or that of our investment management vehicles.
Moreover, we are dependent upon a limited universe of lenders to provide
financing under repurchase agreements, and there can be no assurance that these
agreements will be renewed or extended at expiration. Our ability to obtain
financing through the CDO market, which has been closed since 2007, is subject
to conditions in the financial markets which are impacted by factors beyond our
control that may at times be adverse and reduce the level of investor demand for
such securities. In particular, recent turmoil in the credit markets has
severely impeded the ability of borrowers, even well capitalized borrowers, to
obtain credit from lenders operating in virtually frozen credit markets, and it
can be expected that this development will negatively impact our ability to
finance our assets. At this time, we are unable to refinance our restructured
debt obligations with our lenders. There can be no assurance that U.S. and
non-U.S. government efforts to improve conditions in the credit markets will be
successful in the short term or at all, and the amount of leverage available
from our investment management vehicles’ lenders may be significantly reduced
or, in certain cases, even eliminated.
We
are obligated to fund unfunded commitments under our loan
agreements.
We are
required to fund unfunded obligations to our borrowers. Historically, prior to
our restructuring, we relied upon our lenders to fund a portion of these
commitments. Going forward, we can rely only on our immediately available
liquidity to meet these commitments. If we do not have the liquidity in excess
of the minimum amounts required under our restructured debt obligations, and the
lenders do not consent to our obtaining additional financing, if available, we
would default on these commitments and potentially lose value in these
investments and expose ourselves to litigation.
We
are subject to counterparty risk associated with our debt obligations and
interest rate swaps.
Our
counterparties for these critical financial relationships include both domestic
and international financial institutions. Many of them have been severely
impacted by the credit market turmoil and have been experiencing financial
pressures. In some cases, our counterparties have filed bankruptcy.
4
We
are subject to the general risk of a leveraged investment strategy and the
specific risks of our restructured indebtedness.
Our
restructured secured debt obligations are secured by our investments, which are
subject to being revalued by our credit providers. If the value of the
underlying property collateralizing our investments declines, we may be required
to liquidate our investments, the impact of which could be magnified if such a
liquidation is at a commercially inopportune time, such as the market
environment we are currently experiencing. In addition, the occurrence of any
event or condition which causes any obligation or liability of more than $1.0
million to become due prior to its scheduled maturity or any monetary default
under our restructured debt obligations if the amount of such obligation is at
least $1.0 million could constitute a cross-default under our restructured debt
obligations. If a cross-default occurs, the maturity of almost all of our
indebtedness could be accelerated and become immediately due and
payable.
We
guarantee many of our debt and contingent obligations.
We
guarantee the performance of many of our obligations, including, but not limited
to, our repurchase agreements, derivative agreements, obligations to co-invest
in our investment management vehicles and unsecured indebtedness. The
non-performance of such obligations may cause losses to us in excess of the
capital we initially may have invested or committed under such obligations and
there is no assurance that we will have sufficient capital to cover any such
losses.
Our
secured and unsecured credit agreements may impose restrictions on our operation
of the business.
Under our
secured and unsecured indebtedness, such as our credit and derivative
agreements, we make certain representations, warranties and affirmative and
negative covenants that restrict our ability to operate while still utilizing
those sources of credit. Currently, our restructured debt obligations prohibit
us from acquiring or originating new balance sheet investments except, subject
to certain limitations, co-investments in our investment management vehicles or
protective investments to defend existing collateral assets on our balance
sheet, and from incurring additional indebtedness unless used to pay down such
obligations. In addition, such representations, warranties and covenants
include, but are not limited to covenants which:
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limit
the total cash compensation to all employees and, specifically with
respect to our chief executive officer, chief operating officer and chief
financial officer, freeze their base salaries at 2008 levels, and require
cash bonuses to any of them to be approved by a committee comprised of one
representative designated by the secured lenders, the administrative agent
under the senior unsecured credit facility and the chairman of our board
of directors;
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prohibit
the payment of cash dividends to our common shareholders except to the
minimum extent necessary to maintain our REIT
status;
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require
us to maintain a minimum amount of liquidity, as defined, of $7.0 million
in 2009 and $5.0 million
thereafter;
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trigger
an event of default if both our chief executive officer and chief
operating officer cease their current employment with us during the term
of the agreement and we fail to hire a replacement acceptable to the
lenders; and
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trigger
an event of default, if any event or condition occurs which causes any
obligation or liability of more than $1.0 million to become due prior to
its scheduled maturity or any monetary default under our restructured debt
obligations if the amount of such obligation is at least $1.0
million.
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Our
success depends on the availability of attractive investments and our ability to
identify, structure, consummate, leverage, manage and realize returns on
attractive investments.
Our
operating results are dependent upon the availability of, as well as our ability
to identify, structure, consummate, leverage, manage and realize returns on,
credit sensitive investment opportunities for our managed vehicles and our
balance sheet assuming we are able to resume balance sheet investment activity.
In general, the availability of desirable investment opportunities and,
consequently, our balance sheet returns and our investment management vehicles’
returns, will be affected by the level and volatility of interest rates,
conditions in the financial markets, general economic conditions, the demand for
credit sensitive investment opportunities and the supply of capital for such
investment opportunities. We cannot make any assurances that we will be
successful in identifying and consummating investments which satisfy our rate of
return objectives or that such investments, once consummated, will perform as
anticipated. In addition, if we are not successful in investing for our
investment management vehicles, the potential revenues we earn from management
fees and co-investment returns will be reduced. We may expend significant time
and resources in identifying and pursuing targeted investments, some of which
may not be consummated.
5
The
real estate investment business is highly competitive. Our success depends on
our ability to compete with other providers of capital for real estate
investments.
Our
business is highly competitive. Competition may cause us to accept economic or
structural features in our investments that we would not have otherwise accepted
and it may cause us to search for investments in markets outside of our
traditional product expertise. We compete for attractive investments with
traditional lending sources, such as insurance companies and banks, as well as
other REITs, specialty finance companies and private equity vehicles with
similar investment objectives, which may make it more difficult for us to
consummate our target investments. Many of our competitors have greater
financial resources and lower costs of capital than we do, which provides them
with greater operating flexibility and a competitive advantage relative to
us.
Our
loans and investments may be subject to fluctuations in interest rates which may
not be adequately protected, or protected at all, by our hedging
strategies.
Our
current balance sheet investments include loans with both floating interest
rates and fixed interest rates. Floating rate investments earn interest at rates
that adjust from time to time (typically monthly) based upon an index (typically
one month LIBOR). These floating rate loans are insulated from changes in value
specifically due to changes in interest rates, however, the coupons they earn
fluctuate based upon interest rates (again, typically one month LIBOR) and, in a
declining and/or low interest rate environment, these loans will earn lower
rates of interest and this will impact our operating performance. Fixed interest
rate investments, however, do not have adjusting interest rates and, as
prevailing interest rates change, the relative value of the fixed cash flows
from these investments will cause potentially significant changes in value. We
may employ various hedging strategies to limit the effects of changes in
interest rates (and in some cases credit spreads), including engaging in
interest rate swaps, caps, floors and other interest rate derivative products.
We believe that no strategy can completely insulate us or our investment
management vehicles from the risks associated with interest rate changes and
there is a risk that they may provide no protection at all and potentially
compound the impact of changes in interest rates. Hedging transactions involve
certain additional risks such as counterparty risk, the legal enforceability of
hedging contracts, the early repayment of hedged transactions and the risk that
unanticipated and significant changes in interest rates may cause a significant
loss of basis in the contract and a change in current period expense. We cannot
make assurances that we will be able to enter into hedging transactions or that
such hedging transactions will adequately protect us or our investment
management vehicles against the foregoing risks.
Accounting
for derivatives under GAAP is extremely complicated. Any failure by us to
account for our derivatives properly in accordance with GAAP in our consolidated
financial statements could adversely affect our earnings. In particular, cash
flow hedges which are not perfectly correlated (and appropriately designated
and/or documented as such) with a variable rate financing will impact our
reported income as gains, and losses on the ineffective portion of such
hedges.
Our
use of leverage may create a mismatch with the duration and index of the
investments that we are financing.
We
attempt to structure our leverage to minimize the difference between the term of
our investments and the leverage we use to finance such an investment. In light
of the financial market turmoil, we can no longer rely on a functioning market
to be available to us in order to refinance our existing debt. In March 2009, in
the face of the financial market dislocation, we restructured our recourse debt
obligations; however, there can be no assurances that our restructuring will be
successful. The risks of a duration mismatch are further magnified by the trends
we are experiencing in our portfolio which results from extending loans made to
our borrowers in order to maximize the likelihood and magnitude of our recovery
on our assets. This trend effectively extends the duration of our assets, while
the ultimate duration of our liabilities is uncertain.
6
Our
loans and investments are illiquid, which will constrain our ability to vary our
portfolio of investments.
Our real
estate investments and structured financial product investments are relatively
illiquid and some are highly illiquid. Such illiquidity may limit our ability to
vary our portfolio or our investment management vehicles’ portfolios of
investments in response to changes in economic and other conditions. Illiquidity
may result from the absence of an established market for investments as well as
the legal or contractual restrictions on their resale. In addition, illiquidity
may result from the decline in value of a property securing these investments.
We cannot make assurances that the fair market value of any of the real property
serving as security will not decrease in the future, leaving our or our
investment management vehicles’ investments under-collateralized or not
collateralized at all, which could impair the liquidity and value, as well as
our return on such investments.
We
may not have control over certain of our loans and investments.
Our
ability to manage our portfolio of loans and investments may be limited by the
form in which they are made. In certain situations, we or our investment
management vehicles may:
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acquire
investments subject to rights of senior classes and servicers under
inter-creditor or servicing
agreements;
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acquire
only a participation in an underlying
investment;
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co-invest
with third parties through partnerships, joint ventures or other entities,
thereby acquiring non-controlling interests;
or
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rely
on independent third party management or strategic partners with respect
to the management of an asset.
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Therefore,
we may not be able to exercise control over the loan or investment. Such
financial assets may involve risks not present in investments where senior
creditors, servicers or third party controlling investors are not involved. Our
rights to control the process following a borrower default may be subject to the
rights of senior creditors or servicers whose interests may not be aligned with
ours. A third party partner or co-venturer may have financial difficulties
resulting in a negative impact on such asset, may have economic or business
interests or goals which are inconsistent with ours and those of our investment
management vehicles, or may be in a position to take action contrary to our or
our investment management vehicles’ investment objectives. In addition, we and
our investment management vehicles may, in certain circumstances, be liable for
the actions of our third party partners or co-venturers.
The
use of CDO financings may have a negative impact on our cash flow.
The terms
of CDOs generally provide that the principal amount of investments must exceed
the principal balance of the related bonds by a certain amount and that interest
income exceeds interest expense by a certain amount. Certain of our CDOs provide
that, if defaults, losses, or rating agency downgrades cause a decline in
collateral value or cash flow levels, the cash flow otherwise payable to our
retained subordinated classes may be redirected to repay classes of CDOs senior
to ours until the tests are brought in compliance. In certain instances, we have
breached these tests and cash flow has been redirected and there can be no
assurances that this will not occur on all of our CDOs. Once breached there is
no certainty about when or if the cash flow redirection will remedy the tests’
failure or that cash flow will be restored to our subordinated classes. Other
than collateral management fees, we currently receive cash payments from only
one of our four CDOs, CDO III, which has caused a material deterioration in our
cash flow available for operations, debt service, debt repayments and unfunded
loan and fund management commitments.
We
may be required to repurchase loans that we have sold or to indemnify holders of
our CDOs.
If any of
the loans we originate or acquire and sell or securitize through CDOs do not
comply with representations and warranties that we make about certain
characteristics of the loans, the borrowers and the underlying properties, we
may be required to repurchase those loans or replace them with substitute loans.
In addition, in the case of loans that we have sold instead of retained, we may
be required to indemnify persons for losses or expenses incurred as a result of
a breach of a representation or warranty. Repurchased loans typically require a
significant allocation of working capital to carry on our books, and our ability
to borrow against such assets is limited. Any significant repurchases or
indemnification payments could adversely affect our financial condition and
operating results.
7
The
commercial mortgage and mezzanine loans we originate or acquire and the
commercial mortgage loans underlying the commercial mortgage backed securities
in which we invest are subject to delinquency, foreclosure and loss, which could
result in losses to us.
Our
commercial mortgage and mezzanine loans are secured by commercial property and
are subject to risks of delinquency and foreclosure, and risks of loss that are
greater than similar risks associated with loans made on the security of
single-family residential property. The ability of a borrower to repay a loan
secured by an income-producing property typically is dependent primarily upon
the successful operation of the 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 borrower’s 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 expenses or limit rents that
may be charged, any need to address environmental contamination 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, real
estate tax rates and other operating expenses, and changes in governmental
rules, regulations and fiscal policies, including environmental legislation,
acts of God, terrorism, social unrest and civil disturbances.
Our
investments in subordinated commercial mortgage backed securities and similar
investments are subject to losses.
In
general, losses on an asset securing a mortgage loan included in a
securitization will be borne first by the equity holder of the property and then
by the most junior security holder, referred to as the “first loss” position. In
the event of default and the exhaustion of any equity support and any classes of
securities junior to those in which we invest (and in some cases we may be
invested in the junior most classes of securitizations), we may not be able to
recover all of our investment in the securities we purchase. In addition, if the
underlying mortgage portfolio has been overvalued by the originator, or if the
values subsequently decline and, as a result, less collateral is available to
satisfy interest and principal payments due on the related mortgage backed
securities, the securities in which we invest may incur significant losses.
Subordinate interests generally are not actively traded and are relatively
illiquid investments and recent volatility in CMBS trading markets has caused
the value of these investments to decline.
The
prices of lower credit quality CMBS are generally less sensitive to interest
rate changes than more highly rated investments, but more sensitive to adverse
economic downturns and underlying borrower developments. A projection of an
economic downturn, for example, could cause a decline in the price of lower
credit quality CMBS because the ability of borrowers to make principal and
interest payments on the mortgages underlying the mortgage backed securities may
be impaired. In such event, existing credit support in the securitization
structure may be insufficient to protect us against the loss of our principal on
these securities.
We
may have difficulty or be unable to sell some of our loans and commercial
mortgage backed securities.
A
prolonged period of frozen capital markets, decline in commercial real estate
values and an out of favor real estate sector may prevent us from selling our
loans and CMBS. Given the terms of our recent restructuring, we may be forced to
sell assets in order to meet required debt reduction levels. If the market for
real estate loans and CMBS remains in its current state, this may be difficult
or impossible, causing further losses or events of default.
The
impact of the events of September 11, 2001 and the effect thereon on terrorism
insurance expose us to certain risks.
The
terrorist attacks on September 11, 2001 disrupted the U.S. financial markets,
including the real estate capital markets, and negatively impacted the U.S.
economy in general. Any future terrorist attacks, the anticipation of any such
attacks, and the consequences of any military or other response by the U.S. and
its allies may have a further adverse impact on the U.S. financial markets and
the economy generally. We cannot predict the severity of the effect that such
future events would have on the U.S. financial markets, the economy or our
business.
8
In
addition, the events of September 11, 2001 created significant uncertainty
regarding the ability of real estate owners of high profile assets to obtain
insurance coverage protecting against terrorist attacks at commercially
reasonable rates, if at all. The Terrorism Risk Insurance Act of 2002, or TRIA,
was extended in December 2007. Coverage under the new law, the Terrorism Risk
Insurance Program Reauthorization Act, or TRIPRA, now expires in 2014. There is
no assurance that TRIPRA will be extended beyond 2014. The absence of affordable
insurance coverage may adversely affect the general real estate lending market,
lending volume and the market’s overall liquidity and may reduce the number of
suitable investment opportunities available to us and the pace at which we are
able to make investments. If the properties that we invest in are unable to
obtain affordable insurance coverage, the value of those investments could
decline and in the event of an uninsured loss, we could lose all or a portion of
our investment.
The
economic impact of any future terrorist attacks could also adversely affect the
credit quality of some of our loans and investments. Some of our loans and
investments will be more susceptible to such adverse effects than others. We may
suffer losses as a result of the adverse impact of any future attacks and these
losses may adversely impact our results of operations.
Our
non-U.S. investments will expose us to certain risks.
We make
investments in foreign countries. Investing in foreign countries involves
certain additional risks that may not exist when investing in the United States.
The risks involved in foreign investments include:
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exposure
to local economic conditions, local interest rates, foreign exchange
restrictions and restrictions on the withdrawal of foreign investment and
earnings, investment restrictions or requirements, expropriations of
property and changes in foreign taxation
structures;
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potential
adverse changes in the diplomatic relations of foreign countries with the
United States and government policies against investments by
foreigners;
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changes
in foreign regulations;
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hostility
from local populations, potential instability of foreign governments and
risks of insurrections, terrorist attacks, war or other military
action;
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fluctuations
in foreign currency exchange rates;
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changes
in social, political, legal, taxation and other conditions affecting our
international investment;
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logistical
barriers to our timely receiving the financial information relating to our
international investments that may need to be included in our periodic
reporting obligations as a public company;
and
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lack
of uniform accounting standards (including availability of information in
accordance with U.S. generally accepted accounting
principles).
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Unfavorable
legal, regulatory, economic or political changes such as those described above
could adversely affect our financial condition and results of
operations.
We may
from time to time invest a portion of our assets in non-U.S. investments or in
instruments denominated in non-U.S. currencies, the prices of which will be
determined with reference to currencies other than the U.S. dollar. We may hedge
our foreign currency exposure. To the extent unhedged, the value of our non-U.S.
assets will fluctuate with U.S. dollar exchange rates as well as the price
changes of our investments in the various local markets and currencies. Among
the factors that may affect currency values are trade balances, the level of
short-term interest rates, differences in relative values of similar assets in
different currencies, long-term opportunities for investment and capital
appreciation and political developments. An increase in the value of the U.S.
dollar compared to the other currencies in which we make our investments will
reduce the effect of increases and magnify the effect of decreases in the prices
of our securities in their local markets. We could realize a net loss on an
investment, even if there were a gain on the underlying investment before
currency losses were taken into account. We may seek to hedge currency risks by
investing in currencies, currency futures contracts and options on currency
futures contracts, forward currency exchange contracts, swaps, options or any
combination thereof (whether or not exchange traded), but there can be no
assurance that these strategies will be effective, and such techniques entail
costs and additional risks.
9
There
are increased risks involved with construction lending activities.
We
originate loans for the construction of commercial and residential use
properties. Construction lending generally is considered to involve a higher
degree of risk than other types of lending due to a variety of factors,
including generally larger loan balances, the dependency on successful
completion of a project, the dependency upon the successful operation of the
project (such as achieving satisfactory occupancy and rental rates) for
repayment, the difficulties in estimating construction costs and loan terms
which often do not require full amortization of the loan over its term and,
instead, provide for a balloon payment at stated maturity.
Some
of our investments and investment opportunities may be in synthetic
form.
Synthetic
investments are contracts between parties whereby payments are exchanged based
upon the performance of an underlying obligation. In addition to the risks
associated with the performance of the obligation, these synthetic interests
carry the risk of the counterparty not performing its contractual obligations.
Market standards, GAAP accounting methodology and tax regulations related to
these investments are evolving, and we cannot be certain that their evolution
will not adversely impact the value or sustainability of these investments.
Furthermore, our ability to invest in synthetic investments, other than through
taxable REIT subsidiaries, may be severely limited by the REIT qualification
requirements because synthetic investment contracts generally are not qualifying
assets and do not produce qualifying income for purposes of the REIT asset and
income tests.
Risks Related to Our
Investment Management Business and Management of CDOs
Our
recent balance sheet restructuring may adversely impact our investment
management business.
In large
part, our ability to raise capital and garner other investment management and
advisory business is dependent upon our reputation as a balance sheet manager
and credit underwriter, as well as the ability to demonstrate that we have the
resources to execute mandates. Our recent restructuring will likely negatively
impact our abilities in this regard.
We
are subject to risks and uncertainties associated with operating our investment
management business, and we may not achieve the investment returns that we
expect.
We will
encounter risks and difficulties as we operate our investment management
business. In order to achieve our goals as an investment manager, we
must:
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manage
our investment management vehicles successfully by investing their capital
in suitable investments that meet their respective investment
criteria;
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actively
manage the assets in our portfolios in order to realize targeted
performance;
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create
incentives for our management and professional staff to develop and
operate the investment management business;
and
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structure,
sponsor and capitalize future investment management vehicles that provide
investors with attractive investment
opportunities.
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If we do
not successfully operate our investment management business to achieve the
investment returns that we or the market anticipates, our results of operations
may be adversely impacted.
We may
expand our investment management business to involve other investment classes
where we do not have prior investment experience. We may find it difficult to
attract third party investors without a performance track record involving such
investments. Even if we attract third party capital, there can be no assurance
that we will be successful in deploying the capital to achieve targeted returns
on the investments.
We face
substantial competition from established participants in the private equity
market as we offer investment management vehicles to third party
investors.
10
We face
significant competition from large financial and other institutions that have
proven track records in marketing and managing vehicles and otherwise have a
competitive advantage over us because they have access to pre-existing third
party investor networks into which they can channel competing investment
opportunities. If our competitors offer investment products that are competitive
with products offered by us, we will find it more difficult to attract investors
and to capitalize our investment management vehicles.
Our
investment management vehicles are subject to the risk of defaults by third
party investors on their capital commitments.
The
capital commitments made by third party investors to our investment management
vehicles represent unsecured promises by those investors to contribute cash to
the investment management vehicles from time to time as investments are made by
the investment management vehicles. Accordingly, we are subject to general
credit risks that the investors may default on their capital commitments. If
defaults occur, we may not be able to close loans and investments we have
identified and negotiated which could materially and adversely affect the
investment management vehicles’ investment program or make us liable for breach
of contract, in either case to the detriment of our franchise in the private
equity market.
CTIMCO’s
role as collateral manager for our CDOs and investment manager for our funds may
expose us to liabilities to investors.
We are
subject to potential liabilities to investors as a result of CTIMCO’s role as
collateral manager for our CDOs and our investment management business
generally. In serving in such roles, we could be subject to claims by CDO
investors and investors in our funds that we did not act in accordance with our
duties under our CDO and investment fund documentation or that we were negligent
in taking or refraining from taking actions with respect to the underlying
collateral in our CDOs or in making investments. In particular, the discretion
that we exercise in managing the collateral for our CDOs and the investments in
our investment management business could result in liability due to the current
negative conditions in the commercial real estate market and the inherent
uncertainties surrounding the course of action that will result in the best long
term results with respect to such collateral and investments. This risk could be
increased due to the affiliated nature of our roles. If we were found liable for
our actions as collateral manager or investment manager and we were required to
pay significant damages to our CDO and investment advisory investors, our
financial condition could be materially adversely effected.
Risks Related to Our
Company
We
are dependent upon our senior management team to develop and operate our
business.
Our
ability to develop and operate our business depends to a substantial extent upon
the experience, relationships and expertise of our senior management and key
employees. We cannot assure you that these individuals will remain in our
employ. The employment agreements with our chief executive officer, John R.
Klopp, and our chief credit officer, Thomas C. Ruffing, expired on December 31,
2008. The employment agreement with our chief operating officer, Stephen D.
Plavin, expires on December 28, 2009 and the employment agreement with our chief
financial officer, Geoffrey G. Jervis, expires on December 31, 2010. There can
be no assurance that Messrs. Klopp and Ruffing will enter into amended
employment agreements extending their employment with us. In addition, the
departure of both Mr. Klopp and Mr. Plavin from their employment with us
constitutes an event of default under our restructured debt obligations unless a
suitable replacement acceptable to the lenders is hired by us.
Our
ability to compensate our employees is limited by our restructured debt
obligations.
Our
restructured debt obligations limit the aggregate cash compensation we are able
to pay our employees (excluding our chief executive officer, chief operating
officer and chief financial officer), to 2008 aggregate compensation levels. In
the case of our chief executive officer, chief operating officer and chief
financial officer, cash compensation must be approved by our lenders. This may
impact our ability to retain our employees or attract new
employees.
11
There
may be conflicts between the interests of our investment management vehicles and
us.
We are
subject to a number of potential conflicts between our interests and the
interests of our investment management vehicles. We are subject to potential
conflicts of interest in the allocation of investment opportunities between our
balance sheet once our balance sheet investment activity resumes and our
investment management vehicles. In addition, we may make investments that are
senior or junior to, participations in, or have rights and interests different
from or adverse to, the investments made by our investment management vehicles.
Our interests in such investments may conflict with the interests of our
investment management vehicles in related investments at the time of origination
or in the event of a default or restructuring of the investment. Finally, our
officers and employees may have conflicts in allocating their time and services
among us and our investment management vehicles.
We
must manage our portfolio in a manner that allows us to rely on an exclusion
from registration under the Investment Company Act of 1940 in order to avoid the
consequences of regulation under that Act.
We rely
on an exclusion from registration as an investment company afforded by Section
3(c)(5)(C) of the Investment Company Act of 1940. Under this exclusion, we are
required to maintain, on the basis of positions taken by the SEC staff in
interpretive and no-action letters, a minimum of 55% of the value of the total
assets of our portfolio in “mortgages and other liens on and interests in real
estate,” which we refer to as “Qualifying Interests,” and a minimum of 80% in
Qualifying Interests and real estate related assets. Because registration as an
investment company would significantly affect our ability to engage in certain
transactions or to organize ourselves in the manner we are currently organized,
we intend to maintain our qualification for this exclusion from registration. In
the past, when required due to the mix of assets in our balance sheet portfolio,
we have purchased all of the outstanding interests in pools of whole residential
mortgage loans, which we treat as Qualifying Interests based on SEC staff
positions. Investments in such pools of whole residential mortgage loans may not
represent an optimum use of our investable capital when compared to the
available investments we target pursuant to our investment strategy. These
investments present additional risks to us, and these risks are compounded by
our inexperience with such investments. We continue to analyze our investments
and may acquire other pools of whole loan residential mortgage backed securities
when and if required for compliance purposes.
We treat
our investments in CMBS, B Notes and mezzanine loans as Qualifying Interests for
purposes of determining our eligibility for the exclusion provided by Section
3(c)(5)(C) to the extent such treatment is consistent with guidance provided by
the SEC or its staff. In the absence of such guidance that otherwise supports
the treatment of these investments as Qualifying Interests, we will treat them,
for purposes of determining our eligibility for the exclusion provided by
Section 3(c)(5)(C), as real estate related assets or miscellaneous assets, as
appropriate.
We
understand the SEC staff is currently reconsidering its interpretive policy
under Section 3(c)(5)(C) and whether to advance rulemaking to define the basis
for the exclusion. We cannot predict the outcome of this reconsideration or
potential rulemaking initiative and its impact on our ability to rely on the
exclusion.
If our
portfolio does not comply with the requirements of the exclusion we rely upon,
we could be forced to alter our portfolio by selling or otherwise disposing of a
substantial portion of the assets that are not Qualifying Interests or by
acquiring a significant position in assets that are Qualifying Interests.
Altering our portfolio in this manner may have an adverse effect on our
investments if we are forced to dispose of or acquire assets in an unfavorable
market and may adversely affect our stock price.
If it
were established that we were an unregistered investment company, there would be
a risk that we would be subject to monetary penalties and injunctive relief in
an action brought by the SEC, that we would be unable to enforce contracts with
third parties and that third parties could seek to obtain rescission of
transactions undertaken during the period it was established that we were an
unregistered investment company and limitations on corporate leverage that would
have an adverse impact on our investment returns.
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Changes
in accounting pronouncements may materially change the presentation and content
of our financial statements.
Our
balance sheet and statement of operations may be less meaningful if we are
required to consolidate certain entities as a result of our adoption of
Financial Accounting Standard Board Statement of Financial Accounting Standards
No. 166, “Accounting for Transfers of Financial Assets, an amendment of FASB
Statement No. 140,” or Statement of Financial Accounting Standards No. 167,
“Amendments to FASB Interpretation No. 46(R)”, both of which are effective for
the first annual reporting period that begins after November 15, 2009. The
adoption of these accounting pronouncements is expected to substantially
increase the financial assets and liabilities included on our balance sheet. The
adoption of these accounting pronouncements is likely to result in increased
operating costs as we develop controls and review the information necessary to
account for the assets in accordance with GAAP.
Risks Relating to Our Class
A Common Stock
Sales
or other dilution of our equity may adversely affect the market price of our
class A common stock.
In
connection with restructuring our debt obligations, we issued warrants to
purchase 3,479,691 shares of our class A common stock, which represents
approximately 15.8% of our outstanding class A common stock as of October 28,
2009. The market price of our class A common stock could decline as a result of
sales of a large number of shares of class A common stock acquired upon exercise
of the warrants in the market. If the warrants are exercised, the issuance of
additional shares of class A common stock would dilute the ownership interest of
our existing shareholders.
Because
a limited number of shareholders, including members of our management team, own
a substantial number of our shares, they may make decisions or take actions that
may be detrimental to your interests.
Our
executive officers and directors, along with vehicles for the benefit of their
families, collectively own and control 2,583,043 shares of our class A common
stock representing approximately 11.7% of our outstanding class A common stock
as of October 28, 2009. W. R. Berkley Corporation, or WRBC, which employs one of
our directors, owns 3,843,413 shares of our class A common stock, which
represents 17.4% of our outstanding class A common stock as of October 28, 2009.
By virtue of their voting power, these shareholders have the power to
significantly influence our affairs and are able to influence the outcome of
matters required to be submitted to shareholders for approval, including the
election of our directors, amendments to our charter, mergers, sales of assets
and other acquisitions or sales. The influence exerted by these shareholders
over our affairs might not be consistent with the interests of some or all of
our other shareholders. In addition, the concentration of ownership in our
officers or directors or shareholders associated with them may have the effect
of delaying or preventing a change in control of our company, including
transactions in which you might otherwise receive a premium for your class A
common stock, and might negatively affect the market price of our class A common
stock.
Some
provisions of our charter and bylaws and Maryland law may deter takeover
attempts, which may limit the opportunity of our shareholders to sell their
shares at a favorable price.
Some of
the provisions of our charter and bylaws and Maryland law discussed below could
make it more difficult for a third party to acquire us, even if doing so might
be beneficial to our shareholders by providing them with the opportunity to sell
their shares at a premium to the then current market price.
Issuance of Preferred Stock Without
Shareholder Approval. Our charter authorizes our board of directors to
authorize the issuance of up to 100,000,000 shares of preferred stock and up to
100,000,000 shares of class A common stock. Our charter also authorizes our
board of directors, without shareholder approval, to classify or reclassify any
unissued shares of our class A common stock and preferred stock into other
classes or series of stock and to amend our charter to increase or decrease the
aggregate number of shares of stock of any class or series that may be issued.
Our board of directors, therefore, can exercise its power to reclassify our
stock to increase the number of shares of preferred stock we may issue without
shareholder approval. Preferred stock may be issued in one or more series, the
terms of which may be determined without further action by shareholders. These
terms may include preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends or other distributions, qualifications
or terms or conditions of redemption. The issuance of any preferred stock,
however, could materially adversely affect the rights of holders of our class A
common stock and, therefore, could reduce the value of the class A common stock.
In addition, specific rights granted to future holders of our preferred stock
could be used to restrict our ability to merge with, or sell assets to, a third
party. The power of our board of directors to issue preferred stock could make
it more difficult, delay, discourage, prevent or make it more costly to acquire
or effect a change in control, thereby preserving the current shareholders’
control.
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Advance Notice Bylaw. Our
bylaws contain advance notice procedures for the introduction of business and
the nomination of directors. These provisions could discourage proxy contests
and make it more difficult for you and other shareholders to elect
shareholder-nominated directors and to propose and approve shareholder proposals
opposed by management.
Maryland Takeover Statutes.
We are subject to the Maryland Business Combination Act which could delay or
prevent an unsolicited takeover of us. The statute substantially restricts the
ability of third parties who acquire, or seek to acquire, control of us to
complete mergers and other business combinations without the approval of our
board of directors even if such transaction would be beneficial to shareholders.
“Business combinations” between such a third party acquirer or its affiliate and
us are prohibited for five years after the most recent date on which the
acquirer or its affiliate becomes an “interested shareholder.” An “interested
shareholder” is defined as any person who beneficially owns 10 percent or more
of our shareholder voting power or an affiliate or associate of ours who, at any
time within the two-year period prior to the date interested shareholder status
is determined, was the beneficial owner of 10 percent or more of our shareholder
voting power. If our board of directors approved in advance the transaction that
would otherwise give rise to the acquirer or its affiliate attaining such
status, such as the issuance of shares of our class A common stock to WRBC, the
acquirer or its affiliate would not become an interested shareholder and, as a
result, it could enter into a business combination with us. Our board of
directors could choose not to negotiate with an acquirer if the board determined
in its business judgment that considering such an acquisition was not in our
strategic interests. Even after the lapse of the five-year prohibition period,
any business combination with an interested shareholder must be recommended by
our board of directors and approved by the affirmative vote of at
least:
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80%
of the votes entitled to be cast by shareholders;
and
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two-thirds
of the votes entitled to be cast by shareholders other than the interested
shareholder and affiliates and associates
thereof.
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The
super-majority vote requirements do not apply if the transaction complies with a
minimum price requirement prescribed by the statute.
The
statute permits various exemptions from its provisions, including business
combinations that are exempted by the board of directors prior to the time that
an interested shareholder becomes an interested shareholder. Our board of
directors has exempted any business combination involving family partnerships
controlled separately by John R. Klopp and Craig M. Hatkoff, and a limited
liability company indirectly controlled by a trust for the benefit of Samuel
Zell and his family. As a result, these persons and WRBC may enter into business
combinations with us without compliance with the super-majority vote
requirements and the other provisions of the statute.
We are
subject to the Maryland Control Share Acquisition Act. With certain exceptions,
the Maryland General Corporation Law provides that “control shares” of a
Maryland corporation acquired in a control share acquisition have no voting
rights except to the extent approved by a vote of two-thirds of the votes
entitled to be cast on the matter, excluding shares owned by the acquiring
person or by our officers or by our directors who are our employees, and may be
redeemed by us. “Control shares” are voting shares which, if aggregated with all
other shares owned or voted by the acquirer, would entitle the acquirer to
exercise voting power in electing directors within one of the specified ranges
of voting power. A person who has made or proposes to make a control share
acquisition, upon satisfaction of certain conditions, including an undertaking
to pay expenses, may compel our board to call a special meeting of shareholders
to be held within 50 days of demand to consider the voting rights of the
“control shares” in question. If no request for a meeting is made, we may
present the question at any shareholders’ meeting.
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If voting
rights are not approved at the shareholders’ meeting or if the acquiring person
does not deliver the statement required by Maryland law, then, subject to
certain conditions and limitations, we may redeem for fair value any or all of
the control shares, except those for which voting rights have previously been
approved. If voting rights for control shares are approved at a shareholders’
meeting and the acquirer may then vote a majority of the shares entitled to
vote, then all other shareholders may exercise appraisal rights. The fair value
of the shares for purposes of these appraisal rights may not be less than the
highest price per share paid by the acquirer in the control share acquisition.
The control share acquisition statute does not apply to shares acquired in a
merger, consolidation or share exchange if we are not a party to the
transaction, nor does it apply to acquisitions approved or exempted by our
charter or bylaws. Our bylaws contain a provision exempting certain holders
identified in our bylaws from this statute, including WRBC, family partnerships
controlled separately by John R. Klopp and Craig M. Hatkoff, and a limited
liability company indirectly controlled by a trust for the benefit of Samuel
Zell and his family.
We are
also subject to the Maryland Unsolicited Takeovers Act which permits our board
of directors, among other things and notwithstanding any provision in our
charter or bylaws, to elect on our behalf to stagger the terms of directors and
to increase the shareholder vote required to remove a director. Such an election
would significantly restrict the ability of third parties to wage a proxy fight
for control of our board of directors as a means of advancing a takeover offer.
If an acquirer was discouraged from offering to acquire us, or prevented from
successfully completing a hostile acquisition, you could lose the opportunity to
sell your shares at a favorable price.
The
price of our class A common stock may be impacted by many factors.
As with
any public company, a number of factors may impact the trading price of our
class A common stock, many of which are beyond our control. These factors
include, in addition to other risk factors mentioned in this
section:
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the
level of institutional interest in
us;
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the
perception of REITs generally and REITs with portfolios similar to ours,
in particular, by market
professionals;
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the
attractiveness of securities of REITs in comparison to other
companies;
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the
market’s perception of our ability to successfully manage our portfolio
and our recent restructuring; and;
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the
general economic environment and the commercial real estate property and
capital markets.
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Our
restructured debt obligations restrict us from paying cash dividends, which
reduces the attractiveness of an investment in our class A common
stock.
The
restrictions on our inability to pay cash dividends, except in a limited manner,
will reduce the current dividend yield on our class A common stock and this can
negatively impact the price of our class A common stock as investors seeking
current income pursue alternative investments.
Your
ability to sell a substantial number of shares of our class A common stock may
be restricted by the low trading volume historically experienced by our class A
common stock.
Although
our class A common stock is listed on the New York Stock Exchange, the daily
trading volume of our shares of class A common stock has historically been lower
than the trading volume for certain other companies. As a result, the ability of
a holder to sell a substantial number of shares of our class A common stock in a
timely manner without causing a substantial decline in the market value of the
shares, especially by means of a large block trade, may be restricted by the
limited trading volume of the shares of our class A common stock.
15
Risks Related to our REIT
Status and Certain Other Tax Items
Our
charter does not permit any individual to own more than 9.9% of our class A
common stock, and attempts to acquire our class A common stock in excess of the
9.9% limit would be void without the prior approval of our board of
directors.
For the
purpose of preserving our qualification as a REIT for federal income tax
purposes, our charter prohibits direct or constructive ownership by any
individual of more than a certain percentage, currently 9.9%, of the lesser of
the total number or value of the outstanding shares of our class A common stock
as a means of preventing ownership of more than 50% of our class A common stock
by five or fewer individuals. The charter’s constructive ownership rules are
complex and may cause the outstanding class A common stock owned by a group of
related individuals or entities to be deemed to be constructively owned by one
individual. As a result, the acquisition of less than 9.9% of our outstanding
class A common stock by an individual or entity could cause an individual to own
constructively in excess of 9.9% of our outstanding class A common stock, and
thus be subject to the charter’s ownership limit. There can be no assurance that
our board of directors, as permitted in the charter, will increase, or will not
decrease, this ownership limit in the future. Any attempt to own or transfer
shares of our class A common stock in excess of the ownership limit without the
consent of our board of directors will be void, and will result in the shares
being transferred by operation of the charter to a charitable trust, and the
person who acquired such excess shares will not be entitled to any distributions
thereon or to vote such excess shares.
The 9.9%
ownership limit may have the effect of precluding a change in control of us by a
third party without the consent of our board of directors, even if such change
in control would be in the interest of our shareholders or would result in a
premium to the price of our class A common stock (and even if such change in
control would not reasonably jeopardize our REIT status). The ownership limit
exemptions and the reset limits granted to date would limit our board of
directors’ ability to reset limits in the future and at the same time maintain
compliance with the REIT qualification requirement prohibiting ownership of more
than 50% of our class A common stock by five or fewer individuals.
There
are no assurances that we will be able to pay dividends in the
future.
We expect
in the future when we generate taxable income to pay quarterly dividends and to
make distributions to our shareholders in amounts so that all or substantially
all of our taxable income in each year, subject to certain adjustments, is
distributed. This, along with our compliance with other requirements, should
enable us to qualify for the tax benefits accorded to a REIT under the Internal
Revenue Code. All distributions will be made at the discretion of our board of
directors and will depend on our earnings, our financial condition, maintenance
of our REIT status and such other factors as our board of directors may deem
relevant from time to time. There are no assurances that we will be able to pay
dividends in the future. In addition, some of our distributions may include a
return of capital, which would reduce the amount of capital available to operate
our business. There have been recent changes to the Internal Revenue Code that
would allow us to pay required dividends in the form of additional shares of
common stock equal in value up to 90% of the required dividend. We expect that
as we undertake efforts to conserve cash and enhance our liquidity and comply
with our restructured debt obligations covenants, future required dividends on
our class A common stock will be paid in the form of class A common stock to the
fullest extent permitted. There can be no assurance as to when we will no longer
be subject to debt obligation covenants or will cease our efforts to conserve
cash and enhance liquidity to an extent we believe positions us to resume the
payment of dividends completely or substantially in cash.
We
will be dependent on external sources of capital to finance our
growth.
As with
other REITs, but unlike corporations generally, our ability to finance our
growth must largely be funded by external sources of capital because we
generally will have to distribute to our shareholders 90% of our taxable income
in order to qualify as a REIT, including taxable income where we do not receive
corresponding cash. Our access to external capital will depend upon a number of
factors, including general market conditions, the market’s perception of our
growth potential, our current and potential future earnings, cash distributions
and the market price of our class A common stock.
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If
we do not maintain our qualification as a REIT, we will be subject to tax as a
regular corporation and face a substantial tax liability. Our taxable REIT
subsidiaries will be subject to income tax.
We expect
to continue to operate so as to qualify as a REIT under the Internal Revenue
Code. However, qualification as a REIT involves the application of highly
technical and complex Internal Revenue Code provisions for which only a limited
number of judicial or administrative interpretations exist. Notwithstanding the
availability of cure provisions in the tax code, various compliance requirements
could be failed and could jeopardize our REIT status. Furthermore, new tax
legislation, administrative guidance or court decisions, in each instance
potentially with retroactive effect, could make it more difficult or impossible
for us to qualify as a REIT. If we fail to qualify as a REIT in any tax year,
then:
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·
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we
would be taxed as a regular domestic corporation, which under current
laws, among other things, means being unable to deduct distributions to
shareholders in computing taxable income and being subject to federal
income tax on our taxable income at regular corporate
rates;
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·
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any
resulting tax liability could be substantial, could have a material
adverse effect on our book value and would reduce the amount of cash
available for distribution to
shareholders;
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·
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unless
we were entitled to relief under applicable statutory provisions, we would
be required to pay taxes, and thus, our cash available for distribution to
shareholders would be reduced for each of the years during which we did
not qualify as a REIT; and
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·
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we
generally would not be eligible to requalify as a REIT for four full
taxable years.
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Fee
income from our investment management business is expected to be realized by one
of our taxable REIT subsidiaries, and, accordingly, will be subject to income
tax.
Complying
with REIT requirements may cause us to forego otherwise attractive opportunities
and limit our expansion opportunities.
In order
to qualify as a REIT for federal income tax purposes, we must continually
satisfy tests concerning, among other things, our sources of income, the nature
of our investments in commercial real estate and related assets, the amounts we
distribute to our shareholders and the ownership of our stock. We may also be
required to make distributions to shareholders at disadvantageous times or when
we do not have funds readily available for distribution. Thus, compliance with
REIT requirements may hinder our ability to operate solely on the basis of
maximizing profits.
Complying
with REIT requirements may force us to liquidate or restructure otherwise
attractive investments.
In order
to qualify as a REIT, we must also ensure that at the end of each calendar
quarter, at least 75% of the value of our assets consists of cash, cash items,
government securities and qualified REIT real estate assets. The remainder of
our investments in securities cannot include more than 10% of the outstanding
voting securities of any one issuer or 10% of the total value of the outstanding
securities of any one issuer unless we and such issuer jointly elect for such
issuer to be treated as a “taxable REIT subsidiary” under the Internal Revenue
Code. The total value of all of our investments in taxable REIT subsidiaries
cannot exceed 20% of the value of our total assets. In addition, no more than 5%
of the value of our assets can consist of the securities of any one issuer. If
we fail to comply with these requirements, we must dispose of a portion of our
assets within 30 days after the end of the calendar quarter in order to avoid
losing our REIT status and suffering adverse tax consequences.
Complying
with REIT requirements may force us to borrow to make distributions to
shareholders.
From time
to time, our taxable income may be greater than our cash flow available for
distribution to shareholders. If we do not have other funds available in these
situations, we may be unable to distribute substantially all of our taxable
income as required by the REIT provisions of the Internal Revenue Code. Thus, we
could be required to borrow funds, sell a portion of our assets at
disadvantageous prices or find another alternative. These options could increase
our costs or reduce our equity. Our restructured debt obligations may cause us
to recognize taxable income without any corresponding cash income and we may be
required to distribute additional dividends in cash and/or class A common
stock.
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