EXHIBIT 10.04
MORTGAGE INVESTMENTS
SUB-MANAGEMENT AGREEMENT
THIS AGREEMENT is made and entered into as of February 14, 2000, by and
between FIXED INCOME DISCOUNT ADVISORY COMPANY, INC. (the "Sub-Manager") and
FRIEDMAN, BILLINGS, RAMSEY INVESTMENT MANAGEMENT, INC. (the "Manager").
RECITALS
WHEREAS, FBR Asset Investment Corporation (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 managing a portfolio of
mortgage loans and mortgage securities ("mortgage investments"); and
WHEREAS, the Company conducts its business and intends to continue 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 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.
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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.
SECTION 2. Duties of the Sub-Manager.
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(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.
Sub-Manager's authority to buy, sell or otherwise effect investment transactions
involving investments in its name for the Portfolio shall be evidenced by a
Trading Authorization in the form attached hereto as Appendix C, which
Sub-Manager may show to third parties and on which third parties may rely,
provided that in no event shall the actions of Sub-Manager made pursuant to such
Trading Authorization modify, amend, diminish or otherwise alter the respective
rights, duties and obligations of the Company, Sub-Manager and Manager
hereunder. 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.
SECTION 3. Additional Activities of Sub-Manager. Nothing herein shall
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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
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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
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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
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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
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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.
SECTION 7. Obligations of Sub-Manager.
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(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 would adversely
affect the status of the Company as a REIT or that, to the best of its
knowledge, would violate any law, rule or regulation of any governmental body or
agency having jurisdiction over the Company or the
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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
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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
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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.
SECTION 10. Limits of Sub-Manager Responsibility. The Sub-Manager
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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
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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
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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
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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
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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.
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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
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
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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
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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, Ramsey Investment Management, Inc.
1001 Nineteenth Street, North
Arlington, Virginia 22209
Attention: Robert S. Smith, Esq.
or by facsimile to (703) 312-9756
(b) If to the Sub-Manager:
Fixed Income Discount Advisory Company, Inc.
12 East 41st Street
New York, NY 10017
Attention: Michael A.J. Farrell, Chairman and CEO
or by facsimile to (212) __________
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.
SECTION 16. Binding Nature of Agreement; Successors and Assigns. This
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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
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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
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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
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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
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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
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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
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paragraphs and subparagraphs contained in this Agreement are for convenience
only, and they neither form a part o f this Agreement nor are they to be used in
the construction or interpretation hereof.
SECTION 22. Execution in Counterparts. This Agreement may be executed
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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.
SECTION 23. Provisions Separable. The provisions of this Agreement are
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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
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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.
FIXED INCOME DISCOUNT
ADVISORY COMPANY, INC.
By:________________________________
Name:______________________________
Title:_____________________________
FRIEDMAN, BILLINGS, RAMSEY
INVESTMENT MANAGEMENT, INC.
By:________________________________
Name:______________________________
Title:_____________________________
Agreed to:
FBR ASSET INVESTMENT CORPORATION
By:________________________________
Name:______________________________
Title:_____________________________
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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 Fixed
Income Discount Advisory
Company, Inc. (FIDAC) 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.
Approximately 4-15% 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
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.
Credit Criteria............................... Securities must be rated
investment grade or
A-1
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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.
A-2
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Appendix A1
DESCRIPTION OF MORTGAGE LOAN PORTFOLIO
Overview
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Fixed Income Discount Advisory Company, Inc. (FIDAC) 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.
FIDAC 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
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FIDAC 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.
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. FIDAC will generally buy seasoned, short
weighted-average maturity ("WAM"), fixed-rate securities. FIDAC 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
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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 risk. 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. FIDAC 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 FIDAC intends to
purchase them from various Wall Street broker/dealers.
Non-Conforming or "Whole-Loan" Mortgages
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FIDAC 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. FIDAC intends to purchase these assets from
various Wall Street dealers and mortgage originators. As an example, FIDAC has
identified for purchase loans originated by Merrill Lynch as an attractive
source of product. These loans are uncapped adjustable-rate mortgage loans that
Merrill Lynch offers to its brokerage clients ("Prime First" Program).
Putable and Non-Putable FHA/GNMA Project Loans
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Project loans are government-insured (via FHA insurance or GNMA guarantee)
two-part
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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.
FIDAC intends to purchase these assets from various Wall Street broker/dealers
and mortgage originators.
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Sample Portfolio of December 31, 1999
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ALLOCATION YIELD DURATION
ASSET CLASS RANGE RANGE RANGE
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Short-WAM Pools 8-12% 6.25-6.75% 2.00-2.50
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Agency ARMs 15-25% 6.00-6.50% 0.50-1.00
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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, FIDAC 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, FIDAC 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.
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. FIDAC will seek to manage the interest-rate risk
of the portfolio's mark-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
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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.
Sample Asset-Liability Position as of December 31, 1999
- -------------------------------------------------------
Leverage Ratio: [7:1] (debt to equity)
-------------------------------------------------------------------------
AMOUNT NET YIELD DURATION
-------------------------------------------------------------------------
Assets $360,000 6.40% 2.00
Liabilities $[315,000 6.00% 0.25
including hedge 6.25% 2.00
-------------------------------------------------------------------------
Net Assets $45,000 7.45% 0.00
-------------------------------------------------------------------------
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Appendix B
COMPENSATION OF SUB-MANAGER
As compensation for rendering services under the Mortgage Investment
Sub-Management 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.
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Appendix C
FORM OF TRADING AUTHORIZATION
To: Fixed Income Discount Advisory Company, Inc. (FIDAC)
Ladies and Gentlemen:
Pursuant to that certain Mortgage Investments Sub-Management Agreement
(the "Sub-Management Agreement") by and between Friedman, Billings, Ramsey
Investment Management, Inc. (the "Undersigned") and Fixed Income Discount
Advisory Company, Inc. ("Authorized Agent"), the Undersigned hereby authorizes
Authorized Agent to act as its agent and attorney to buy, sell and trade in
bonds and other securities for the Undersigned's account(s) and risk and in the
Undersigned's name or number on your books.
You may follow the express instructions of the Undersigned in every
respect concerning the Undersigned's account(s) with you, and make deliveries of
securities and/or payment of moneys to the Undersigned or otherwise as the
Undersigned may order and direct. In all matters and things aforementioned, as
well as in all other things necessary or incidental to the furtherance or
conduct of the account of the Undersigned permitted under the Sub-Management
Agreement, the Authorized Agent is authorized to act for the Undersigned and on
the Undersigned's behalf in the same manner and with the same force and effect
as the Undersigned might or could do. Third parties are permitted to rely on
this authorization as evidence of your authority to act as the Undersigned's
agent, but no such reliance by a third party shall have any affect on the rights
and obligation of you or the Undersigned under the Sub-Management Agreement.
The Undersigned hereby ratifies and confirms any and all transactions
heretofore made by the Authorized Agent for the Undersigned's account which have
been disclosed to the Undersigned.
This authorization is made pursuant to the Sub-Management Agreement and
does not modify, amend, restrict or limit any rights or obligations you or the
Undersigned may have under the Sub-Management Agreement or any other agreement
between you and the Undersigned.
This authorization shall continue and remain in full force and effect
until revoked by the Undersigned by a written notice addressed to you and
delivered to your principal office (via mail or facsimile), but such revocation
shall not affect any liability either you or the Undersigned may have resulting
from transactions initiated prior to such revocation.
This authorization and its enforcement shall be governed by the laws of
the State of New York. This authorization may not be assigned by you to any
successor firm or firms without the express prior written consent of the
Undersigned, which may given or withheld in the sole and absolute discretion of
the Undersigned. The provisions hereof shall inure to the benefit of you or, to
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the extent consented to in writing by the Undersigned, any assignee,
irrespective of any change or changes at any time in the personnel thereof for
any cause whatsoever, and shall be binding upon the Undersigned, and/or the
estate executors, administrators and assigns of the Undersigned.
If any provision of this authorization shall be rendered invalid for
any reason, the provisions of this agreement so affected shall be deemed
modified or superseded, as the case may be, and all other provisions, and the
provisions so modified or superseded shall in all respects continue and be in
full force and effect.
INITIAL APPROPRIATE LINES IF AUTHORITY IS BEING GRANTED TO EFFECT MARGIN
TRANSACTIONS OR WITHDRAW MONEY AND/OR SECURITIES.
Agent shall be authorized to purchase on margin: _____ _____ __________
Yes No Initials
Agent shall be authorized to wire money and/or securities to the designated
accounts only:
_____ _____ __________
Yes No Initials
Very truly yours,
FRIEDMAN, BILLINGS, RAMSEY
INVESTMENT MANAGEMENT, INC.
By:___________________________
William R. Swanson, Chief
Operating Officer
Dated:________________________
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