| AMERICAN HOME MORTGAGE INVESTMENT CORP Item 1A Risk Factors |
| 12 ITEM 1A RISK FACTORS In addition to the other information contained in this Annual Report on Form 10-K, the following risk factors should be considered carefully in evaluating the Companyapstas business |
| The Companyapstas business, financial condition or results of operations could be materially adversely affected by any of these risks |
| Additional risks not presently known to the Company or that the Company currently deems immaterial may also adversely affect its business, financial condition or results of operations |
| Risks Related to Our Business We have a limited operating history with respect to our portfolio strategy |
| Prior to December of 2003, our business consisted primarily of the origination and sale of mortgage loans |
| Since then, our businessapstas financial results have also been founded on a leveraged portfolio of mortgage assets held for net interest income |
| If we are unsuccessful in managing the risks inherent in our portfolio, we may expect income shortfalls, significant losses and significant losses in the value of our holdings |
| 12 An interruption or reduction in the securitization market would harm our financial position |
| We are dependent on the securitization market for both the sale and financing of a substantial portion of the loans we originate or purchase |
| The securitization market is dependent upon a number of factors, including general economic conditions, conditions in the securities market generally and conditions in the asset-backed securities market specifically |
| In addition, in the event of poor performance of our previously securitized loans, our access to the securitization market could be harmed |
| Accordingly, a decline in the securitization market or a change in the marketapstas demand for our loans could harm our results of operations, financial condition and business prospects |
| Our results from holding mortgage assets may be harmed by changes in the level of interest rates, changes to the difference between short- and longer-term interest rates, changes to the difference between interest rates for mortgage assets compared to other debt instruments, and an absence of or reduction in the availability, at favorable terms, of repurchase financing and other liquidity sources typically utilized by mortgage REITs |
| The value of, and return from, the mortgage-backed securities we hold may be volatile and will be affected by changes in the marketplace for mortgage-backed securities and debt securities in general, as well as market interest rates |
| The impact of changes in the marketplace for mortgage-backed securities and debt securities on our results will be magnified because our mortgage-backed securities holdings are highly leveraged |
| Additionally, much of the financing we use to hold our mortgage-backed securities is cancelable by our lenders on short notice |
| If our lenders cease to provide financing to us on favorable terms, we would be forced to liquidate some or all of our mortgage-backed securities, possibly at a substantial loss |
| Our business requires a significant amount of cash, and if it is not available, our business and financial performance will be significantly harmed |
| We require substantial cash to fund our loan originations, to pay our loan origination expenses, to hold our loans pending securitization or sale and to fund our portfolio of mortgage-backed securities |
| We also need cash to meet our working capital, REIT dividend distribution requirements and other needs |
| Cash could be required to meet margin calls under the terms of our borrowings in the event that there is a decline in the market value of our loans that collateralize our debt, if the terms of our debt become less attractive or for other reasons |
| In addition, if our income as calculated for federal income tax purposes exceeds our cash flow from operations, we could be forced to borrow or raise capital on unfavorable terms in order to make the distributions to avoid federal income tax and maintain our REIT status |
| We expect that our primary sources of cash will consist of: o our repurchase facilities, warehouse lines of credit, mortgage servicing credit facilities and our commercial paper program; o the net interest income we earn on our mortgage asset holdings; o the income we earn from originating and selling mortgage loans; and o the income we earn from servicing mortgage loans |
| Pending sale or securitization of a pool of mortgage loans, we will originate mortgage loans that we finance through borrowings from our warehouse lines of credit and commercial paper program |
| It is possible that our warehouse lenders could experience changes in their ability to advance funds to us, independent of our performance or the performance of our loans |
| In addition, if the regulatory capital requirements imposed on our lenders change, our lenders may be required to increase significantly the cost of the lines of credit that they provide to us |
| As of December 31, 2005, we financed loans through seven warehouse lines of credit |
| Each of these facilities is cancelable by the lender for cause at any time |
| As of December 31, 2005, the aggregate balance outstanding under these facilities was approximately dlra3dtta5 billion |
| Three of these facilities are subject to periodic renewal and four have no expiration date |
| We cannot provide any assurances that we will be able to extend these existing facilities on favorable terms, or at all |
| If we are not able to renew any of these credit facilities or arrange for new financing on terms acceptable to us, or if we default on our covenants or are otherwise unable to access funds under any of these facilities, we may not be able to originate new loans or continue to fund our operations, which would have a material adverse effect on our business, financial condition, liquidity and results of operations |
| 13 In connection with those loans we securitize other than through guaranteed performance swaps and similar transactions with Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Banks, we plan to provide credit enhancement for a portion of the securities that we sell, called "e senior securities, "e to improve the price at which we sell them |
| Our current expectation is that this credit enhancement for the senior securities will be primarily in the form of either designating another portion of the securities we issue as "e subordinate securities "e (on which the credit risk from the loans is concentrated), paying for financial guaranty insurance policies for the loans, or both |
| If we use financial guaranty insurance policies, and the expense of these insurance policies increases, the net interest income we receive will be reduced |
| While we plan to use credit enhancement features in the future, these features may not be available at costs that would allow us to achieve the desired level of net interest income from the securitizations that we anticipate being able to achieve |
| We may not be able to achieve our optimal leverage |
| We use leverage as a strategy to increase the return to our investors |
| However, we may not be able to achieve our desired leverage for various reasons, including, but not limited to, the following: o we determine that the leverage would expose us to excessive risk; o our lenders do not make funding available to us on acceptable terms; or o our lenders require that we provide additional collateral to cover our borrowings |
| Our use of repurchase facilities to borrow funds may be limited or curtailed in the event of disruptions in the repurchase market |
| We rely upon repurchase facilities in order to finance our portfolio of mortgage-backed securities |
| Our repurchase facilities are dependent on our counterparties &apos ability to resell our obligations to third-party purchasers |
| There have been in the past, and in the future there may be, disruptions in the repurchase market |
| If there is a disruption of the repurchase market generally, or if one of our counterparties is itself unable to access the repurchase market, our access to this source of liquidity could be adversely affected |
| Our use of repurchase agreements to borrow funds may give our lenders greater rights in the event that either we or a lender files for bankruptcy |
| Our borrowings under repurchase agreements may qualify for special treatment under the bankruptcy code, giving our lenders the ability to avoid the automatic stay provisions of the bankruptcy code and to take possession of and liquidate our collateral under the repurchase agreements without delay in the event that we file for bankruptcy |
| Furthermore, the special treatment of repurchase agreements under the bankruptcy code may make it difficult for us to recover our pledged assets in the event that a lender files for bankruptcy |
| Thus, the use of repurchase agreements exposes our pledged assets to risk in the event of a bankruptcy filing by either a lender or us |
| Our efforts to match fund our mortgage-backed securities with our borrowings may not be effective to protect against losses due to movements in interest rates |
| The interest rates on our borrowings generally adjust more frequently than the interest rates on our ARM mortgage-backed securities |
| Accordingly, in a period of rising interest rates, we could experience a decrease in net income or a net loss because the interest rates on our borrowings adjust faster than the interest rates on our ARM mortgage-backed securities |
| Although we attempt to limit our exposure to changing interest rates by matching as closely as possible the duration of our liabilities and hedges with the duration of our mortgage loan holdings, our liabilities, hedges and assets could react differently than we expect in response to changes in interest rates, which would cause us to suffer significant losses |
| Matched funding is difficult, if not impossible, to achieve, and there can be no assurances that our efforts to match fund will protect us against losses |
| Our credit facilities contain covenants that restrict our operations and any default under our credit facilities would have a material adverse effect on our financial condition |
| Our existing warehouse and repurchase facilities and commercial paper program contain restrictions and covenants and require us to maintain or satisfy specified financial ratios and tests, including maintenance of asset quality and portfolio performance tests |
| Failure to meet or satisfy any of these covenants, financial ratios or financial tests could result in an event of default under these agreements |
| These agreements are typically recourse borrowing facilities that are secured by specific mortgage loans pledged under those agreements |
| The agreements also contain cross-default provisions, so that if an event of default occurs under any 14 agreement, the lenders could elect to declare all amounts outstanding under all of our agreements to be immediately due and payable, enforce their interests against collateral pledged under the agreements and, in certain circumstances, restrict our ability to make additional borrowings |
| Our warehouse and repurchase facilities contain additional restrictions and covenants that may: o restrict the ability of our TRSs to make distributions to us; o restrict our ability to make certain investments or acquisitions; and o restrict our ability to engage in certain mergers or consolidations |
| These restrictions may interfere with our ability to obtain financing or to engage in other business activities, which may have a material adverse effect on our business, financial condition, liquidity and results of operations |
| Our credit facilities are subject to margin calls based on the lenderapstas opinion of the value of our loan collateral |
| An unanticipated large margin call could harm our liquidity |
| The amount of financing we receive under our credit facilities depends in large part on the lenderapstas valuation of the mortgage loans that secure the financings |
| Each such facility provides the lender the right, under certain circumstances, to reevaluate the loan collateral that secures our outstanding borrowings at any time |
| In the event the lender determines that the value of the loan collateral has decreased, it has the right to initiate a margin call |
| A margin call would require us to provide the lender with additional collateral or to repay a portion of the outstanding borrowings |
| Any such margin call could harm our liquidity, results of operations, financial condition and business prospects |
| If warehouse lenders and securitization underwriters face exposure stemming from legal violations committed by the companies to whom they provide financing or underwriting services, this could increase our borrowing costs and harm the market for whole loans and mortgage-backed securities |
| In June of 2003, a California jury found a warehouse lender and securitization underwriter liable in part for fraud on consumers committed by a lender to whom it provided financing and underwriting services |
| The jury found that the investment bank was aware of the fraud and substantially assisted the lender in perpetrating the fraud by providing financing and underwriting services that allowed the lender to continue to operate, and held the bank liable for 10prca of the plaintiffapstas damages |
| This is the first case we know of in which an investment bank was held partly responsible for violations committed by the bankapstas mortgage lender customer |
| If other courts or regulators adopt this theory, investment banks may face increased litigation as they are named as defendants in lawsuits and regulatory actions against the mortgage companies with which they do business |
| Some investment banks may exit the business, charge more for warehouse lending or reduce the prices they pay for whole loans in order to build in the costs of this potential litigation |
| This could, in turn, harm our results of operations, financial condition and business prospects |
| If the prepayment rates for our mortgage assets are higher than expected, our results of operations may be significantly harmed |
| The rate and timing of unscheduled payments and collections of principal on our loans is impossible to predict accurately and will be affected by a variety of factors including, without limitation, the level of prevailing interest rates, the availability of lender credit and other economic, demographic, geographic, tax and legal factors |
| In general, however, if prevailing interest rates fall significantly below the interest rate on a loan, the borrower is more likely to prepay the then higher-rate loan than if prevailing rates remain at or above the interest rate on the loan |
| Unscheduled principal prepayments could adversely affect our results of operations to the extent we are unable to reinvest the funds we receive at an equivalent or higher yield rate, if at all |
| In addition, a large amount of prepayments, especially prepayments on loans with interest rates that are high relative to the rest of the asset pool, will likely decrease the net interest income we receive |
| We may suffer credit losses with respect to, and be required to repurchase, loans that we originate and sell, regardless of credit enhancements that we purchase |
| Although we typically purchase credit enhancements from Fannie Mae and Freddie Mac with respect to the agency-eligible ARM loans that we originate and sell, we may nevertheless suffer credit losses with respect to these loans if we do not originate the loans correctly |
| We also may be required to repurchase the loans under these circumstances |
| In addition, we may suffer credit losses on non-agency eligible securities to the extent that they do not have, or have only limited, credit enhancements |
| Credit enhancements will not protect us from such credit losses or repurchase obligations |
| 15 Our hedging strategy may adversely affect our borrowing cost and expose us to other risks |
| From time to time, we may enter into hedging transactions with respect to one or more of our assets or liabilities |
| Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items, and futures and forward contracts |
| Currently, we intend to primarily use term reverse repurchase agreements and interest rate swap agreements to manage the interest rate risk of our portfolio of mortgage assets |
| However, our actual hedging decisions will be determined in light of the facts and circumstances existing at the time and may differ from our currently anticipated hedging strategy |
| Developing an effective strategy for dealing with movements in interest rates is complex and no strategy can completely insulate us from risks associated with such fluctuations |
| Our hedging activities may not effectively hedge against adverse interest rate movement |
| The results from our mortgage origination business will be harmed by rising interest rates |
| Rising interest rates have substantially reduced the number of potential customers that can achieve a lower interest rate from refinancing, and to a lesser extent the number of potential customers that can afford to buy homes, and consequently are substantially reducing the amount of loans originated by our loan origination business and the revenue therefrom |
| In addition, rising interest rates are likely to reduce the margins achieved by our loan origination business |
| While rising interest rates generally will have a beneficial impact on our mortgage servicing business, the negative impact from rising interest rates on our mortgage origination business generally has been greater than the offsetting beneficial impact, and consequently, in a period of rising interest rates, our earnings are projected to decline |
| The results from our mortgage servicing business will be harmed by falling interest rates |
| AHM Holdings historically has suffered losses from its mortgage servicing business |
| If interest rates remain low enough to cause a large number of borrowers whose loans are being serviced by our servicing business to refinance, we will experience high amortization and possibly continued impairment of our servicing assets, and would likely experience a loss from our mortgage servicing business |
| An increase in interest rates could reduce the value of our loan inventory and commitments and our hedging strategy may not protect us from interest rate risk and may lead to losses |
| The value of our loan inventory will be based, in part, on market interest rates |
| Accordingly, we may experience losses on loan sales if interest rates change rapidly or unexpectedly |
| If interest rates rise after we fix a price for a loan or commitment but before we close and sell such loan, the value of the loan will decrease |
| If the amount we receive from selling the loan is less than our cost of originating the loan, we may incur net losses, and our business and operating results could be harmed |
| While we will use hedging and other strategies to minimize our exposure to interest rate risks, no hedging or other strategy can completely protect us |
| In addition, the nature and timing of hedging transactions may influence the effectiveness of these strategies |
| Poorly designed strategies or improperly executed transactions could actually increase our risk and losses |
| In addition, hedging strategies involve transaction and other costs |
| Our hedging strategy and the hedges that we make may not adequately offset the risks of interest rate volatility and our hedges may result in losses |
| We may fail to generate expected returns on our mortgage-related assets because of interest rate caps associated with adjustable-rate mortgages |
| ARM assets are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the interest yield of an ARM asset may change during any given period |
| However, our borrowing costs will not be subject to similar restrictions |
| Hence, in a period of rising interest rates, interest rate costs on our borrowings could increase without limitation by caps, while the interest-rate yields on our ARM assets would generally be limited by caps |
| This could result in the receipt of less cash income on our ARM assets than needed in order to pay the interest cost on our related borrowings |
| These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would negatively impact our financial condition, cash flows and results of operations |
| We are subject to losses due to fraudulent and negligent acts on the part of loan applicants, mortgage brokers, other vendors and our employees |
| When we originate mortgage loans, we rely heavily upon information supplied by third parties, including the information contained in the loan application, property appraisal, title information and employment and income documentation |
| If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected |
| Whether a misrepresentation is made by the loan applicant, the mortgage broker, another third party or one of our employees, we generally bear the risk of loss associated with the 16 misrepresentation |
| A loan subject to a material misrepresentation is typically unsaleable or subject to repurchase if it is sold prior to detection of the misrepresentation, the persons and entities involved are often difficult to locate and it is often difficult to collect any monetary losses that we have suffered from the misrepresentation |
| We have controls and processes designed to help us identify misrepresented information in our loan origination operations, but, we may not detect all misrepresented information in our loan originations |
| A material difference between the assumptions used in the determination of the value of our residual interests and our actual experience could harm our financial position |
| As of December 31, 2005, the value on our balance sheet of our residual interests from securitization transactions was dlra276dtta0 million |
| The value of these residuals is a function of the forecasted delinquency, loss, prepayment speed and discount rate assumptions we use |
| It is extremely difficult to validate the assumptions we use in valuing our residual interests |
| In the future, if our actual experience differs materially from these assumptions, our cash flow, financial condition, results of operations and business prospects could be harmed |
| We depend upon distributions from our operating subsidiaries to fund our operations and may be subordinate to the rights of their existing and future creditors |
| We conduct substantially all of our operations through our subsidiaries |
| Without independent means of generating operating revenue, we depend on distributions and other payments from the subsidiaries to make distributions to our stockholders |
| Our subsidiaries must first satisfy their cash needs, which may include salaries of our executive officers, insurance, professional fees and service of indebtedness that may be outstanding at various times before making distributions |
| Financial covenants under future credit agreements, or provisions of the laws of Maryland, where we and our principal operating QRS are organized, or Delaware or New York, where our other operating subsidiaries are organized, may limit our subsidiaries &apos ability to make sufficient dividend, distribution or other payments to permit us to make distributions to stockholders |
| By virtue of our holding company status, our Series A Preferred Stock and Series B Preferred Stock are structurally junior in right of payment to all existing and future liabilities of our subsidiaries |
| The inability of our operating subsidiaries to make distributions to us could have a material adverse effect on our results of operations, financial condition and business |
| Our financial results fluctuate as a result of seasonality and other factors, including the demand for mortgage loans, which makes it difficult to predict our future performance |
| Our business is generally subject to seasonal trends |
| These trends reflect the general pattern of resales of homes, which typically peak during the spring and summer seasons |
| AHM Holdings &apos quarterly results have fluctuated in the past and are expected to fluctuate in the future, reflecting the seasonality of the industry |
| Further, if the sale of a loan is postponed, the recognition of income from the sale is also postponed |
| If such a delay causes us to recognize income in the next quarter, our results of operations for the previous quarter could be harmed |
| Unanticipated delays could also increase our exposure to interest rate fluctuations by lengthening the period during which our variable rate borrowings under credit facilities are outstanding |
| If our results of operations do not meet the expectations of our stockholders and securities analysts, then the price of our securities may be harmed |
| We may not be able to manage our growth efficiently, which may harm our results and may, in turn, harm the market price of our securities and our ability to distribute dividends |
| Over the last several years, AHM Holdings experienced significant growth in its business activities and in the number of its employees |
| We will seek continued growth through both acquisitions and internal growth |
| AHM Holdings &apos growth has required, and our growth will continue to require, increased investment in management and professionals, personnel, financial and management systems and controls and facilities, which could cause our operating margins to decline from historical levels, especially in the absence of revenue growth |
| We face risks in connection with any completed or potential acquisition, which could have a material adverse impact on our growth or our operations |
| AHM Holdings has completed multiple acquisitions over the past few years, and we from time to time will continue to consider additional strategic acquisitions of mortgage lenders and other mortgage banking and finance-related companies |
| Upon completion of an acquisition, we are faced with the challenges of integrating the operations, services, products, personnel and systems of acquired companies into our business, identifying and eliminating duplicated efforts and systems and incorporating 17 different corporate strategies, addressing unanticipated legal liabilities and other contingencies, all of which divert managementapstas attention from ongoing business operations |
| Any acquisition we make may also result in potentially dilutive issuances of equity securities, the incurrence of additional debt and the amortization of expenses related to goodwill and other intangible assets |
| We may not be successful in integrating any acquired business effectively into the operations of our business |
| In addition, there is substantial competition for acquisition opportunities in the mortgage industry |
| This competition could result in an increase in the price of, and a decrease in the number of, attractive acquisition candidates |
| As a result, we may not be able to successfully acquire attractive candidates on terms we deem acceptable |
| We may not be able to overcome the risks associated with acquisitions and such risks may adversely affect our growth and results of operations |
| We face intense competition that could harm our market share and our revenues |
| We face intense competition from commercial banks, savings and loan associations and other finance and mortgage banking companies, as well as from Internet-based lending companies and other lenders participating on the Internet |
| Entry barriers in the mortgage industry are relatively low and increased competition is likely |
| As we seek to expand our business, we will face a greater number of competitors, many of whom will be well established in the markets we seek to penetrate |
| Many of our competitors are much larger than we are, have better name recognition than we do and have far greater financial and other resources than we do |
| We may not be able to effectively compete against them or any future competitors |
| In addition, competition may lower the rates we are able to charge borrowers, thereby potentially lowering the amount of income on future loan sales and sales of servicing rights |
| Increased competition also may reduce the volume of our loan originations and loan sales |
| We may not be able to compete successfully in this evolving market |
| The success and growth of our business will depend on our ability to adapt to technological changes |
| Our mortgage origination business is currently dependent on our ability to effectively interface with our customers and efficiently process loan applications and closings |
| The origination process is becoming more dependent on technology advancement, such as the ability to process applications over the Internet, accept electronic signatures, provide process status updates instantly and other customer expected conveniences |
| As these requirements increase in the future, we will have to remain competitive with new technology and such advances may require significant capital expenditures |
| An interruption in or breach of our information systems may result in lost business |
| We rely heavily upon communications and information systems to conduct our business |
| Any failure or interruption or breach in security of our information systems or the third-party information systems on which we rely could cause underwriting or other delays and could result in fewer loan applications being received, slower processing of applications and reduced efficiency in loan servicing |
| We are required to comply with significant federal and state regulations with respect to the handling of customer information, and a failure, interruption or breach of our information systems could result in regulatory action and litigation against us |
| Failures or interruptions may occur and they may not be adequately addressed by us or the third parties on which we rely |
| The occurrence of any failures or interruptions could harm our results of operations, financial condition and business prospects |
| We face intense competition for personnel that could harm our business and in turn negatively affect the market price of our securities and our ability to distribute dividends |
| Generally, our business is dependent on the highly skilled, and often highly specialized, individuals we employ |
| Our failure to recruit and retain qualified employees, including employees qualified to manage a portfolio of structured products or mortgage-backed securities, could harm our future operating results and may, in turn, negatively affect the market price of our securities and our ability to pay dividends |
| Specifically, we depend on our loan originators to generate customers by, among other things, developing relationships with consumers, real estate agents and brokers, builders, corporations and others, which we believe leads to repeat and referral business |
| Accordingly, we must be able to attract, motivate and retain skilled loan originators |
| In addition, our growth strategy contemplates hiring additional loan originators |
| The market for such persons is highly competitive and historically has experienced a high rate of turnover |
| Competition for qualified loan originators may lead to increased costs to hire and retain them |
| We cannot guarantee that we will be able to attract or retain qualified loan originators |
| If we cannot attract or retain a sufficient number of skilled loan originators, or even if we can retain them but at higher costs, our business and results of operations could be harmed |
| The conduct of the independent brokers through whom we originate our wholesale loans could subject us to fines or other penalties |
| 18 The mortgage brokers through whom we originate wholesale loans have parallel and separate legal obligations to which they are subject |
| While these laws may not explicitly hold the originating lenders responsible for the legal violations of mortgage brokers, federal and state agencies increasingly have sought to impose such liability |
| Recently, for example, the United States Federal Trade Commission (the "e FTC "e ) entered into a settlement agreement with a mortgage lender where the FTC characterized a broker that had placed all of its loan production with a single lender as the "e agent "e of the lender; the FTC imposed a fine on the lender in part because, as "e principal, "e the lender was legally responsible for the mortgage brokerapstas unfair and deceptive acts and practices |
| The United States Department of Justice in the past has sought to hold mortgage lenders responsible for the pricing practices of mortgage brokers, alleging that the mortgage lender is directly responsible for the total fees and charges paid by the borrower under the Fair Housing Act even if the lender neither dictated what the mortgage broker could charge nor kept the money for its own account |
| We exercise little or no control over the activities of the independent mortgage brokers from whom we obtain our wholesale loans |
| Nevertheless, we may be subject to claims for fines or other penalties based upon the conduct of our independent mortgage brokers |
| We depend on brokers for a substantial portion of our loan production |
| We depend on brokers as the source of the majority of our loan originations |
| Our brokers are not contractually obligated to do business with us |
| Further, our competitors also have relationships with the same brokers and actively compete with us in our efforts to expand our broker networks |
| Accordingly, we may not be successful in maintaining our existing relationships or expanding our broker networks |
| The failure to do so could negatively impact the volume and pricing of our loans, which could have a material adverse effect on our business, financial condition, liquidity and results of operations |
| The loss of key purchasers of our loans or a reduction in prices paid could harm our financial condition |
| In 2005, 51prca of the loans that we sold were to three large national financial institutions, two of which compete with us directly for retail originations |
| If these financial institutions or any other significant purchaser of our loans cease to buy our loans and equivalent purchasers cannot be found on a timely basis, then our business and results of operations could be harmed |
| Our results of operations could also be harmed if these financial institutions or other purchasers lower the price they pay to us or adversely change the material terms of their loan purchases from us |
| The prices at which we sell our loans vary over time |
| These factors include: o the number of institutions that are willing to buy our loans; o the amount of comparable loans available for sale; o the levels of prepayments of, or defaults on, loans; o the types and volume of loans that we sell; o the level and volatility of interest rates; and o the quality of our loans |
| We may be required to return proceeds obtained from the sale of loans, which would negatively impact our results of operations |
| When we sell a loan to an investor, we are required to make representations and warranties regarding the loan, the borrower and the property |
| These representations are made based in part on our due diligence and related information provided to us by the borrower and others |
| If any of these representations or warranties is later determined not to be true, we may be required to repurchase the loan, including principal and interest, from the investor and/or indemnify the investor for any damages or losses caused by the breach of such representation or warranty |
| In connection with some non-prime loan sales, we may be required to return a portion of the premium paid by the investor if the loan is prepaid within the first year after its sale |
| If, to any significant extent, we are required to repurchase loans, indemnify investors or return loan premiums, it could have a material adverse effect on our business and results of operations |
| Changes in existing government sponsored and federal mortgage programs could negatively affect our mortgage banking business |
| Our ability to generate revenue through mortgage sales to institutional investors largely depends on programs sponsored by Fannie Mae, Freddie Mac, Ginnie Mae and others which facilitate the issuance of mortgage-backed securities in the secondary market |
| A portion of our business also depends on various programs of the Federal Housing Administration (FHA) and the Veterans Administration (VA) |
| Any discontinuation of, or significant reduction in, the operation of those programs could have a 19 material adverse effect on our mortgage banking business and results of operations |
| Also, any significant adverse change in the level of activity in the secondary market or the underwriting criteria of these entities would reduce our revenues |
| We must comply with numerous government regulations and we are subject to changes in law that could increase our costs and adversely affect our business |
| Our mortgage banking business is subject to the laws, rules and regulations of various federal, state and local government agencies regarding the origination, processing, underwriting, sale and servicing of mortgage loans |
| These laws, rules and regulations, among other things, limit the interest rates, finance charges and other fees we may charge, require us to make extensive disclosure, prohibit discrimination and impose qualification and licensing obligations on us |
| They also impose on us various reporting and net worth requirements |
| We also are subject to inspection by these government agencies |
| Our mortgage banking business is also subject to laws, rules and regulations regarding the disclosure of non-public information about our customers to non-affiliated third parties |
| Our failure to comply with any of these requirements could lead to, among other things, the loss of approved status, termination of contractual rights without compensation, demands for indemnification or mortgage loan repurchases, class action lawsuits and administrative enforcement actions |
| Regulatory and legal requirements are subject to change |
| If such requirements change and become more restrictive, it would be more difficult and expensive for us to comply and could affect the way we conduct our business, which could adversely impact our results of operations |
| While we believe we are currently in material compliance with the laws, rules and regulations to which we are subject, we may not be in full compliance with applicable laws, rules and regulations |
| If we cannot comply with those laws or regulations, or if new laws limit or eliminate some of the benefits of purchasing a mortgage, our business and results of operations may be materially adversely affected |
| As a mortgage lender, we must comply with numerous licensing requirements, and our inability to remain in compliance with such requirements could adversely affect our operations and our reputation generally |
| Like other mortgage companies, we must comply with the applicable licensing and other regulatory requirements of each jurisdiction in which we are authorized to lend |
| These requirements are quite complex and vary from jurisdiction to jurisdiction |
| We monitor and regularly review our compliance with such requirements |
| From time to time we are subject to examination by regulators, and if it is determined that we are not in compliance with the applicable requirements, we may be fined, and our license to lend in one or more jurisdictions may be suspended or revoked |
| We have in the past violated, and we may in the future violate, certain aspects of the licensing requirements in some jurisdictions |
| Although the past violations of which we are aware have not had a material adverse effect on our business, operations or reputation, future violations or past violations of which we are not aware may have such an effect |
| The loss of our relationships with government agencies and related entities would have an adverse effect on our business |
| Our agreements with Fannie Mae, Freddie Mac, Ginnie Mae, the FHA and the VA afford us a number of advantages and may be canceled by the counterparty for cause |
| Cancellation of one or more of these agreements would have a material adverse impact on our operating results and could result in further disqualification with other counterparties, loss of technology and other materially adverse consequences |
| We are exposed to environmental liabilities with respect to properties to which we take title, which could increase our costs of doing business and adversely impact our results of operations |
| In the course of our business, at various times, we may foreclose and take title (for security purposes) to residential properties and could be subject to environmental liabilities with respect to such properties |
| To date, we have not been required to perform any environmental investigation or remediation activities, nor have we been subject to any environmental claims relating to these activities |
| We may be held liable to a governmental entity or to third parties for property damage, personal injury and investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or remediate hazardous or toxic substances or chemical releases at a property |
| The costs associated with an environmental investigation or remediation activities could be substantial |
| In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties seeking damages and costs resulting from environmental contamination emanating from such property |
| 20 Our Board of Directors or management may change our operating policies and strategies without prior notice or stockholder approval and such changes could harm our business and results of operations and the value of our securities |
| Our Board of Directors and, in certain cases, our management, have the authority to modify or waive our current operating policies and our strategies without prior notice and without stockholder approval |
| We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and value of our stock and it is possible that the effects might be adverse |
| Certain provisions of Maryland law and our charter and bylaws could hinder, delay or prevent a change in control of our company |
| Certain provisions of Maryland law and our charter and bylaws could have the effect of discouraging, delaying or preventing transactions that involve an actual or threatened change in control of our company |
| These provisions include the following: o Classified Board of Directors |
| Our Board of Directors is divided into three classes with staggered terms of office of three years each |
| The classification and staggered terms of office of our directors make it more difficult for a third party to gain control of our Board of Directors |
| At least two annual meetings of stockholders, instead of one, generally would be required to effect a change in a majority of our Board of Directors |
| o Removal of Directors |
| Under our charter, subject to any rights of one or more classes or series of preferred stock to elect or remove one or more directors, a director may be removed only for cause and only by the affirmative vote of at least two-thirds of all votes entitled to be cast by our stockholders generally in the election of directors |
| o Number of Directors, Board Vacancies, Term of Office |
| We may, in the future, elect to be subject to certain provisions of Maryland law which vest in the Board of Directors the exclusive right to determine the number of directors and the exclusive right, by the affirmative vote of a majority of the remaining directors, to fill vacancies on the Board even if the remaining directors do not constitute a quorum |
| These provisions of Maryland law, which are applicable even if other provisions of Maryland law or our charter or bylaws provide to the contrary, also provide that any director elected to fill a vacancy shall hold office for the remainder of the full term of the class of directors in which the vacancy occurred, rather than the next annual meeting of stockholders as would otherwise be the case, and until his or her successor is elected and qualifies |
| o Stockholder Requested Special Meetings |
| Our bylaws provide that our stockholders have the right to call a special meeting only upon the written request of the stockholders entitled to cast not less than a majority of all the votes entitled to be cast by the stockholders at such meeting |
| Our bylaws require advance written notice for stockholders to nominate persons for election as directors at, or to bring other business before, any meeting of stockholders |
| This bylaw provision limits the ability of stockholders to make nominations of persons for election as directors or to introduce other proposals unless we are notified in a timely manner prior to the meeting |
| o Exclusive Authority of Our Board to Amend the Bylaws |
| Our bylaws provide that our Board of Directors has the exclusive power to adopt, alter or repeal any provision of the bylaws or to make new bylaws |
| Thus, our stockholders may not effect any changes to our bylaws |
| o Preferred Stock |
| Under our charter, our Board of Directors has authority to issue preferred stock from time to time in one or more series and to establish the terms, preferences and rights of any such series of preferred stock, all without approval of our stockholders |
| The issuance of shares of preferred stock could adversely impact the voting power of the holders of common stock and could have the effect of delaying or preventing a change in control or other corporate action |
| o Duties of Directors with Respect to Unsolicited Takeovers |
| Maryland law provides protection for Maryland corporations against unsolicited takeovers by limiting, among other things, the duties of the directors in unsolicited takeover situations |
| The duties of directors of Maryland corporations do not require them to (i) accept, recommend or respond to any proposal by a person seeking to acquire control of the corporation, (ii) authorize the corporation to redeem any rights under, or modify or render inapplicable, any stockholders &apos rights plan, (iii) make a determination under the Maryland Business Combination Act or the Maryland Control Share Acquisition Act (to the extent either Act is otherwise applicable), or (iv) act or fail to act solely because of the effect that the act or failure to act may have on an acquisition or potential acquisition of control of the corporation or the amount or type of consideration that may be offered or paid to the stockholders in an acquisition |
| Moreover, under Maryland law, the act of the directors of a Maryland corporation relating to or affecting an acquisition or potential acquisition of control is not subject to any higher duty or greater scrutiny than is applied to any other act of a director |
| Maryland law also contains a statutory presumption that an act of a director of a Maryland corporation satisfies the applicable standards of conduct for directors under Maryland law |
| 21 o Ownership Limit |
| In order to preserve our status as a REIT under the Code, our charter prohibits (with certain exceptions) any single stockholder, or any group of affiliated stockholders, from beneficially owning more than (i) 6dtta5prca of our outstanding common stock, or more than 6dtta5prca of our outstanding common and preferred stock, (ii) more than 9dtta8prca of either the total number or the value of the total number of outstanding shares of the Series A Preferred Stock or (iii) more than 9dtta8prca of either the total number or the value of the total number of outstanding shares of the Series B Preferred Stock, unless and to the extent to which our Board of Directors decides to waive or modify this ownership limit |
| o Maryland Business Combination Act |
| The Maryland Business Combination Act provides that, unless exempted, a Maryland corporation may not engage in business combinations, including mergers, dispositions of 10prca or more of its assets, issuances of shares of stock and other specified transactions, with an "e interested stockholder "e or an affiliate of an interested stockholder for five years after the most recent date on which the interested stockholder became an interested stockholder, and thereafter unless specified criteria are met |
| An interested stockholder is generally a person owning or controlling, directly or indirectly, 10prca or more of the voting power of the outstanding stock of a Maryland corporation |
| Our Board of Directors has adopted a resolution exempting the company from this statute |
| However, our Board of Directors may repeal or modify this resolution in the future, in which case the provisions of the Maryland Business Combination Act will be applicable to business combinations between us and other persons |
| o Maryland Control Share Acquisition Act |
| Maryland law provides that "e control shares "e &apos of a corporation acquired in a "e control share acquisition "e shall have no voting rights except to the extent approved by a vote of two-thirds of the votes eligible to be cast on the matter under the Maryland Control Share Acquisition Act |
| "e Control shares "e means shares of stock that, if aggregated with all other shares of stock previously acquired by the acquiror, would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of the voting power: one-tenth or more but less than one-third, one-third or more but less than a majority or a majority or more of all voting power |
| A "e control share acquisition "e means the acquisition of control shares, subject to certain exceptions |
| If voting rights or control shares acquired in a control share acquisition are not approved at a stockholders &apos meeting, then subject to certain conditions and limitations, the issuer may redeem any or all of the control shares for fair value |
| If voting rights of such control shares are approved at a stockholders &apos meeting and the acquiror becomes entitled to vote a majority of the shares of stock entitled to vote, all other stockholders may exercise appraisal rights |
| Our bylaws contain a provision exempting acquisitions of our shares from the Maryland Control Share Acquisition Act |
| However, our Board of Directors may amend our bylaws in the future to repeal or modify this exemption, in which case any control shares of ours acquired in a control share acquisition will be subject to the Maryland Control Share Acquisition Act |
| Loss of Investment Company Act exemption would adversely affect us and negatively affect the market price of shares of our securities and our ability to distribute dividends |
| We are not regulated as an investment company under the Investment Company Act of 1940, as amended, and we intend to operate so as to not become regulated as an investment company under the Investment Company Act |
| We intend to be "e primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate "e |
| Specifically, we intend to invest at least 55prca of our assets in mortgage loans or mortgage-backed securities that represent the entire ownership in a pool of mortgage loans ownership and at least an additional 25prca of our assets in mortgages, mortgage-backed securities, securities of REITs and other real estate-related assets |
| If we fail to qualify for an exemption under the Investment Company Act, we may be required to restructure our activities |
| For example, if the market value of our investments in equity securities were to increase by an amount that resulted in less than 55prca of our assets being invested in mortgage loans or mortgage-backed securities that represent the entire ownership in a pool of mortgage loans, we might have to sell equity securities in order to qualify for exemption under the Investment Company Act |
| In the event we must restructure our activities, our results of operations could be adversely affected |
| Risks Relating to Our Status as a REIT Complying with REIT requirements may limit our ability to hedge effectively |
| The REIT provisions of the Code substantially limit our ability to hedge mortgage-backed securities and related borrowings |
| Under these provisions, our annual income from certain qualified hedges, together with any other income not generated from qualified REIT real estate assets, must be less than 25prca of our gross income |
| As a result, we might in the future be required to limit our use of advantageous hedging techniques |
| Unhedged positions could leave us exposed to greater risks associated with changes in interest rates than we would otherwise bear |
| 22 We may fail to qualify as a REIT and be subject to tax |
| If we are compelled to sell qualifying REIT assets, or we have insufficient cash flow to originate or purchase qualifying REIT assets, we may have insufficient qualifying REIT assets, in which case we may fail to qualify as a REIT To qualify as a REIT, we must satisfy the requirements discussed in Item 1 of this report, "e Business--Certain Federal Income Tax Considerations, "e including the requirement that not more than 20prca of the value of our total assets may be represented by the securities of one or more TRSs at the close of any calendar quarter, subject to certain "e cure "e periods |
| In certain cases, we may need to borrow from third parties to acquire additional qualifying REIT assets or increase the amount and frequency of dividends from our TRSs in order to comply with the 20prca asset test |
| Moreover, the Internal Revenue Service may disagree with our determinations of value |
| If the Internal Revenue Service determines that the value of our investment in our TRSs was more than 20prca of the value of our total assets at the close of any calendar quarter, we could lose our REIT status |
| Our TRSs earn income from activities that are prohibited for REITs and owe income taxes on the taxable income from these activities |
| For example, our TRSs earn income from loan origination and sales activities, as well as from other origination and servicing functions, which would generally not be qualifying income for purposes of the gross income tests applicable to REITs or might otherwise be subject to adverse tax liability if the income were generated by a REIT We may, at some point in the future, borrow funds from one or more of our TRSs |
| Although any such intercompany borrowings will be structured so as to constitute indebtedness for all tax purposes, the Internal Revenue Service may challenge such arrangements, in which case the borrowing may be characterized as a dividend distribution to us by our TRS Any such characterization may cause us to fail one or more of the REIT requirements |
| Even if we continue to qualify as a REIT, we may nevertheless be subject to taxes (and possibly excise taxes) on undistributed income, net income from certain prohibited transactions (including certain transactions between us and our TRSs), and state and local taxes |
| Prohibited transactions could include transactions in which loans are sold by our QRS rather than by our TRSs |
| In addition, in the event that any transactions between us or our QRS and our TRSs are determined not to be on an armapstas-length basis, we could be subject to excise taxes on such transactions |
| We believe that all such transactions are conducted on an armapstas-length basis, but the Internal Revenue Service may successfully contest the armapstas-length nature of such transactions and we may not otherwise be able to avoid application of excise taxes or other additional taxes |
| Any such taxes could affect our overall profitability and the amounts of distributions to our stockholders |
| Our management has limited experience operating a REIT and our managementapstas past experience may not be sufficient to successfully manage our business as a REIT The requirements for qualifying as a REIT are highly technical and complex |
| We have limited experience as a REIT and our management has limited experience in complying with the income, asset and other limitations imposed by the REIT provisions of the Code |
| The REIT provisions are complex and the failure to comply with those provisions in a timely manner could prevent us from qualifying as a REIT or could force us to pay unexpected taxes and penalties |
| In such event, our net income would be substantially reduced, and we could incur a loss, which could materially harm our results of operation, financial condition and business prospects |
| Risks Related to Our Capital Stock Various factors may cause the market price of our capital stock to become volatile, which could harm our ability to access the capital markets in the future |
| The following factors, many of which are beyond our control, could contribute to the volatility of the price of our capital stock: o all of the risk factors described in this report; o actual or anticipated variations in our quarterly results; o changes in our level of dividend payments; o changes in the value of our mortgage holdings and related liabilities; o changes in the prospects for, or results from, our mortgage holdings, mortgage origination or mortgage servicing businesses; o new products or services offered by us or our subsidiaries and our competitors; 23 o our actual results being different from our earnings guidance or other projections; o changes in projections of our financial results by securities analysts; o general conditions or trends in the mortgage holding, mortgage origination and mortgage servicing businesses; o announcements by us of significant acquisitions, strategic relationships, investments or joint ventures; o negative changes in the publicapstas perception of the prospects for returns from holding mortgage assets and from the mortgage origination and servicing businesses, which could depress our stock price, regardless of actual results; o interest rate fluctuations or general economic conditions, such as inflation or a recession; o any obstacles in continuing to qualify as a REIT, including obstacles due to changes in law applicable to REITs; o additions or departures of our key personnel; and o issuing new securities |
| This volatility may make it difficult for us to access the capital markets through additional secondary offerings of our common stock and additional preferred stock offerings, regardless of our financial performance, and such difficulty may preclude us from being able to take advantage of certain business opportunities or meet our obligations, which could, in turn, harm our results of operations, financial condition and business prospects |
| There may be substantial sales of our common stock after an offering, which would cause a decline in our stock price |
| Sales of substantial amounts of our common stock in the public market following an offering of our securities, or the perception that such sales could occur, could have a material adverse effect on the market price of our common stock |
| The amount of our dividends may be less than projected |
| The amount of any dividend paid by us will depend on a number of factors, including the amount of income generated from our mortgage holdings, the amount of income generated from our mortgage origination and servicing businesses and the amount of such earnings retained by our TRSs to provide for future growth |
| Our ability to pay our dividends depends upon the availability of funds and our actual operating results |
| If funds are not available or our actual operating results are below our expectations, we may need to sell assets or borrow funds to pay these distributions |
| Dividends or distributions on shares of our securities may reduce the funds of our company that are legally available for payment of future dividends on any outstanding common or preferred stock |
| In addition, if we do not generate sufficient cash flow from ongoing operations (including principal payments and interest payments on our mortgage-backed securities) to fund our dividends, we may need to sell mortgage-backed securities or borrow funds by entering into repurchase agreements or otherwise borrowing funds under our lines of credit to pay the distributions |
| If we were to borrow funds on a regular basis to make distributions in excess of operating cash flow, it is likely that our operating results and our stock price would be adversely affected |
| Our Board of Directors may authorize the issuance of additional shares that may cause dilution and may depress the price of our common stock |
| Our charter permits our Board of Directors, without stockholder approval, to: o authorize the issuance of additional common or preferred stock in connection with future equity offerings, acquisitions of securities or other assets of companies; and o classify or reclassify any unissued common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares, including the issuance of shares of preferred stock that have preference rights over the common stock with respect to dividends, liquidation, voting and other matters or shares of common stock that have preference rights over our common stock with respect to voting |
| The issuance of additional shares of our common stock could be substantially dilutive to our outstanding shares and may depress the price of our common stock |
| Due to an exception to the stock ownership limitations applicable to our status as a REIT, our Chief Executive Officer and President holds a significant percentage of our outstanding securities |
| 24 Under our charter, the Companyapstas founder, our Chief Executive Officer and President, Michael Strauss, is exempted from the general ownership limitation that applies to holders of our securities in connection with maintaining our status as a REIT and is permitted to beneficially own up to 20prca of the value of the total number of our outstanding common and preferred shares of stock |
| As of December 31, 2005, Mr |
| Strauss beneficially owned approximately 9dtta2prca of our outstanding common stock |
| Accordingly, Mr |
| Strauss has the ability to influence any of our affairs requiring stockholder approval, including, for example, the election and removal of directors, amendments to our charter and approval of significant corporate transactions |