| ORIGEN FINANCIAL INC ITEM 1A RISK FACTORS Our prospects are subject to certain uncertainties and risks |
| Our future results could differ materially from current results, and our actual results could differ materially from those projected in forward-looking statements as a result of certain risk factors |
| These risk factors include, but are not limited to, those set forth below, other one-time events, and important factors disclosed previously and from time to time in our other filings with the Securities and Exchange Commission |
| Risks Related to Our Business We may not generate sufficient revenue to make or sustain distributions to stockholders |
| We intend to distribute to our stockholders substantially all of our REIT net taxable income each year so as to avoid paying corporate income tax on our earnings and to qualify for the tax benefits accorded to a REIT under the Internal Revenue Code |
| Distributions will be made at the discretion of our Board of Directors |
| Our ability to make and sustain cash distributions is based on many factors, including the performance of our manufactured housing loans, our ability to borrow at favorable rates and terms, interest rate levels and changes in the yield curve and our ability to use hedging strategies to insulate our exposure to changing interest rates |
| Some of these factors are beyond our control and a change in any such factor could affect our ability to pay future distributions |
| We cannot assure our stockholders that we will be able to pay or maintain distributions in the future |
| We also cannot assure stockholders that the level of distributions will increase over time and that our loans will perform as expected or that the growth of our loan acquisition and servicing business will be sufficient to increase our actual cash available for distribution to stockholders |
| Our ability to achieve our investment objectives depends to a significant extent on our ability to raise equity and to borrow money in sufficient amounts and on sufficiently favorable terms to earn incremental returns and on our ability to securitize our loans |
| There can be no assurance that we will be able to obtain such funding on terms favorable to us or at all |
| Even if such funding is available, we may not be able to achieve the degree of leverage we believe to be optimal due to decreases in the proportion of the value of our assets that we can borrow against, decreases in the market value of our assets, increases in interest rates, changes in the availability of financing in the market, conditions then applicable in the lending market and other factors |
| Our inability to access capital could jeopardize our ability to fund loan originations and continue operations |
| We incur indebtedness to fund our operations, and there is no limit on the total amount of indebtedness that we can incur |
| We borrow against, or “leverage,” our assets primarily through repurchase agreements, securitizations of manufactured housing loans and secured and unsecured loans |
| The terms of such borrowings may provide for us to pay a fixed or adjustable rate of interest, and may provide for any term to maturity that management deems appropriate |
| The total amount of indebtedness we can incur is not expressly limited by our certificate of incorporation or bylaws |
| Instead, management has discretion as to the amount of leverage to be employed depending on management’s measurement of acceptable risk consistent with the nature of the assets then held by us |
| We face the risk that we might not be able to meet our debt service obligations and, to the extent we cannot, we might be forced to liquidate some of our assets at disadvantageous prices |
| Also, our debt service payments will reduce the net income available for distributions to stockholders |
| Our use of leverage amplifies the risks associated with other risk factors, which could reduce our net income or cause us to suffer a loss |
| 8 _________________________________________________________________ [37]Table of Contents We may not be able to securitize our manufactured housing loans or do so on favorable terms |
| We intend to securitize a substantial portion of the manufactured housing loans we originate |
| We intend to account for securitizations as secured financings |
| In a typical securitization, we issue collateralized debt securities of a subsidiary in multiple classes, which securities are secured by an underlying portfolio of manufactured housing loans owned by the subsidiary |
| Factors affecting our ability to securitize loans and to do so profitably, include: • conditions in the asset-backed securities markets generally; • conditions in the manufactured housing asset-backed securities markets specifically, including rating agencies’ views on the manufactured housing industry; • the performance of the securities issued in connection with our securitizations; • the nominal interest rate and credit quality of our loans; • our relationship with our bond and other investors in our securities and loans; • compliance of our loans with the eligibility requirements for a particular securitization; • our ability to adequately service our loans, including our ability to obtain a servicer rating; • adverse changes in state and federal regulations regarding high-cost and predatory lending; and • any material negative rating agency action pertaining to certificates issued in our securitizations |
| In addition, federal income tax requirements applicable to REITs may limit our ability to use particular types of securitization structures |
| If we are unable to securitize, or securitize profitably, the manufactured housing loans that we originate and that we may invest in from time to time, our net revenues for the duration of our investment in those manufactured housing loans would decline, which would lower our earnings for the time the loans remain in our portfolio |
| We cannot assure stockholders that we will be able to complete loan securitizations in the future on favorable terms, or at all |
| Certain securitization structures may cause us to recognize income for accounting and tax purposes without concurrently receiving the associated cash flow |
| Certain securitizations are structured to build overcollateralization over time with respect to the loans that are the subject of the securitization or to accelerate the payment on senior securities to enhance the credit ratings of such securities |
| Accordingly, these structures may cause us to recognize income without concurrently receiving the associated cash flow |
| We have used such securitization structures in the past and may use them in the future |
| These securitization structures and the possible resulting mismatch between income recognition and receipt of cash flow may require us to access the capital markets at times which may not be favorable to us |
| We incurred net losses of approximately dlra2dtta7 million and dlra3dtta0 million during the twelve months ended December 31, 2005 and 2004, respectively |
| Origen Financial LLC, our predecessor company, which we acquired in October 2003, experienced net losses in each year of its existence while growing its loan origination platform and business, including net losses of approximately dlra23dtta9 million for the period from January 1, 2003 through October 7, 2003 and dlra29dtta2 million for fiscal year 2002 |
| We will need to generate significant revenues to achieve and maintain profitability |
| If we are unable to achieve and maintain sufficient revenue growth, we may not be profitable in the future |
| Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis |
| 9 _________________________________________________________________ [38]Table of Contents We depend on key personnel, the loss of whom could threaten our ability to operate our business successfully |
| Our future success depends, to a significant extent, upon the continued services of our senior management team |
| In general, we have entered into employment agreements with these individuals |
| There is no guarantee that these individuals will renew their employment agreements prior to the termination of the employment agreements, some of which are scheduled to expire in 2006, or that they otherwise will remain employed with us |
| The market for skilled personnel, especially those with the technical abilities we require, is currently very competitive, and we must compete with much larger companies with significantly greater resources to attract and retain such personnel |
| The loss of services of one or more key employees may harm our business and our prospects |
| Future acquisitions of loan portfolios, servicing portfolios and other assets may not yield the returns we expect |
| We expect to make future acquisitions or investments in loan portfolios, servicing portfolios and bonds in outstanding securitizations backed by manufactured housing loans |
| The relevant economic characteristics of the assets we may acquire in the future may not generate returns or may not meet a risk profile that our investors find acceptable |
| Furthermore, we may not be successful in executing our acquisition strategy |
| Our profitability may be affected if we are unable to effectively manage interest rate risk and leverage |
| We derive our income in part from the difference, or “spread,” between the interest earned on loans and interest paid on borrowings |
| In addition, at any point in time there is an optimal amount of leverage to employ in the business in order to generate the highest rate of return to our stockholders |
| When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities will fluctuate |
| In addition, interest rate changes affect the optimal amount of leverage to employ |
| This can cause increases or decreases in our spread and can affect our income, require us to modify our leverage strategy and affect returns to our stockholders |
| Factors such as inflation, recession, unemployment, money supply, international disorders, instability in domestic and foreign financial markets and other factors beyond our control may affect interest rates |
| We may pay distributions that result in a return of capital to stockholders, which may cause stockholders to realize lower overall returns |
| Until we are able to originate and securitize a sufficient number of loans to achieve our desired asset level and target leverage ratio, we may pay quarterly distributions that result in a return of capital to our stockholders |
| Any such return of capital to our stockholders will reduce the amount of capital available to us to originate and acquire manufactured housing loans, which may result in lower returns to our stockholders |
| Return of capital amounted to 77dtta8prca and 46dtta9prca of distributions in 2005 and 2004, respectively |
| Some of our investments are illiquid and their value may decrease |
| Some of our assets are and will continue to be relatively illiquid |
| In addition, certain of the asset-backed securities that we may acquire may include interests that have not been registered under the relevant securities laws, resulting in a prohibition against transfer, sale, pledge or other disposition of those securities except in a transaction that is exempt from the registration requirements of, or otherwise in accordance with, those laws |
| Our ability to vary our portfolio in response to changes in economic and other conditions, therefore, may be relatively limited |
| No assurances can be given that the fair market value of any of our assets will not decrease in the future |
| 10 _________________________________________________________________ [39]Table of Contents We may engage in hedging transactions, which can limit gains and increase exposure to losses |
| Periodically, we have entered into interest rate swap agreements in an effort to manage interest rate risk |
| An interest rate swap is considered to be a hedging transaction designed to protect us from the effect of interest rate fluctuations on our floating rate debt and also to protect our portfolio of assets from interest rate and prepayment rate fluctuations |
| The nature and timing of interest rate risk management strategies may impact their effectiveness |
| Poorly designed strategies may increase rather than mitigate risk |
| For example, if we enter into hedging instruments that have higher interest rates embedded in them as a result of the forward yield curve, and at the end of the term of these hedging instruments the spot market interest rates for the liabilities that we hedged are actually lower, then we will have locked in higher interest rates for our liabilities than would be available in the spot market at the time and this could result in a narrowing of our net interest rate margin or result in losses |
| In some situations, we may sell assets or hedging instruments at a loss in order to maintain adequate liquidity |
| There can be no assurance that our hedging activities will have the desired beneficial impact on our financial condition or results of operations |
| Moreover, no hedging activity can completely insulate us from the risks associated with changes in interest rates and prepayment rates |
| The competition we face could adversely affect our profitability |
| The demand for manufactured housing financing is driven by the demand for manufactured housing |
| The manufactured housing industry faces competition from the traditional site built housing industry |
| To the extent that an increase in the demand for site built housing decreases the demand for manufactured housing and manufactured housing financing, we could be adversely affected |
| The manufactured housing finance industry is very fragmented |
| The market is served by both traditional and non-traditional consumer finance sources |
| In addition, some of the manufactured housing industry’s larger manufacturers maintain their own finance subsidiaries to provide financing for purchasers of their manufactured houses |
| Our largest competitors in the industry include Clayton Homes, Inc, through its subsidiaries 21st Mortgage Corporation and Vanderbilt Mortgage and Finance, Inc, US Bank, San Antonio Federal Credit Union and Triad Financial Services, Inc |
| Traditional financing sources such as commercial banks, savings and loans, credit unions and other consumer lenders, many of which have significantly greater resources than us and may be able to offer more attractive terms to potential customers, including non-traditional mortgage products, also provide competition in our market |
| Competition among industry participants can take many forms, including convenience in obtaining a loan, amount and term of the loan, customer service, marketing/distribution channels, loan origination fees, interest rates and credit related factors |
| To the extent any competitor expands their activities in the manufactured housing industry, we could be adversely affected |
| The success and growth of our business will depend upon our ability to adapt to and implement technological changes |
| Our manufactured housing loan origination business is currently dependent upon our ability to effectively develop relationships with retailers, brokers, correspondents, borrowers and other third parties and to efficiently process loan applications and closings |
| The origination process is becoming more dependent upon technological advancement, such as the ability to process applications over the Internet, accept electronic signatures, to provide process status updates instantly and other customer-expected conveniences that are cost-efficient to our process |
| Implementing new technology and becoming proficient with it may also require significant capital expenditures |
| As these requirements increase in the future, we will have to continually develop our technological capabilities to remain competitive or our business will be significantly harmed |
| 11 _________________________________________________________________ [40]Table of Contents We may experience capacity constraints or system failures that could damage our business |
| If our systems or third-party systems cannot be expanded to support increased loan originations, acquisitions of loan portfolios or additional servicing opportunities, or if such systems fail to perform effectively, we could experience: • disruptions in servicing and originating loans; • reduced borrower satisfaction; • delays in the introduction of new loan services; or • vulnerability to Internet “hacker” raids, any of which could impair our reputation, damage the Origen brand, or otherwise have a material adverse effect on our business, operating results and financial condition |
| Our ability to provide high-quality service also depends on the efficient and uninterrupted operation of our technology infrastructure |
| Even though we have developed a redundant infrastructure to protect our systems and operations, our systems are vulnerable to damage or interruption from human error, natural disasters, telecommunication failures, break-ins, sabotage, failure to adequately document the operation of software and hardware systems and procedures, computer viruses, intentional acts of vandalism and similar events |
| If any of these events were to occur, our business could be materially and adversely affected |
| Although we maintain business interruption insurance to compensate for losses that could occur for any of these risks, such insurance may not be sufficient to cover a significant loss |
| If the prepayment rates for our manufactured housing loans are higher than expected, our results of operations may be significantly harmed |
| Prepayments of our manufactured housing loans, whether due to refinancing, repayments, repossessions or foreclosures, in excess of management’s estimates could adversely affect our future cash flow as a result of the resulting loss of any servicing fee revenue and net interest income on such prepaid loans |
| Prepayments can result from a variety of factors, many of which are beyond our control, including changes in interest rates and general economic conditions |
| If we are unable to maintain our network of retailers, brokers and correspondents, our loan origination business will decrease |
| A significant majority of our originations of manufactured housing loans comes from retailers and brokers |
| The retailers and brokers with whom we do business are not contractually obligated to do business with us |
| Further, our competitors may also have relationships with these retailers and brokers and actively compete with us in our efforts to strengthen our retailer and broker networks |
| Accordingly, we cannot assure stockholders that we will be successful in maintaining our retailer and broker networks, the failure of which could adversely affect our ability to originate manufactured housing loans |
| Part of our loan acquisition growth strategy involves the creation of correspondent relationships |
| To the extent we are not successful in forming these relationships, our loan acquisition volume could suffer |
| 12 _________________________________________________________________ [41]Table of Contents We may not realize the expected recovery rate on the resale of a manufactured house upon its repossession or foreclosure |
| Most states impose requirements and restrictions relating to resales of repossessed manufactured houses and foreclosed manufactured houses and land, and obtaining deficiency judgments following such sales |
| In addition to these requirements and restrictions, our ability to realize the expected recovery rate upon such sales may be affected by depreciation or loss of or damage to the manufactured house |
| Federal bankruptcy laws and related state laws also may impair our ability to realize upon collateral or enforce a deficiency judgment |
| For example, in a Chapter 13 proceeding under federal bankruptcy law, a court may prevent us from repossessing a manufactured house or foreclosing on a manufactured house and land |
| As part of the debt repayment plan, a bankruptcy court may reduce the amount of our secured debt to the market value of the manufactured house at the time of the bankruptcy, leaving us as a general unsecured creditor for the remainder of the debt |
| A Chapter 7 bankruptcy debtor, under certain circumstances, may retain possession of his or her house, while enforcement of our loan may be limited to the value of our collateral |
| Data security breaches may subject us to liability or tarnish our reputation |
| In the ordinary course of our business, we acquire and maintain confidential customer information |
| While we take great care in protecting customer information, we may incur liability if it is accessed by third parties and our customers suffer negative consequences, such as identity theft |
| For example, in February 2006 we confirmed that a computer stolen by thieves from our Fort Worth, Texas office contained personal information on certain of our current and former borrowers and employees |
| The server was stolen when thieves broke into an unoccupied building space adjacent to our Fort Worth offices and cut through a wall to access our office space |
| Other office equipment was stolen in addition to this particular computer |
| Discussions with our insurance carrier regarding coverage of expenses incurred in connection with this incident are in progress |
| We also believe that there may be liability on the part of our Texas facility landlord based upon this incident |
| We are taking new precautions to guarantee the safety of all of our customers’ confidential information |
| We are also reviewing all our data security policies and procedures and are taking all necessary steps to avoid a similar incident in the future |
| Although we have no reason to believe that customer and employee information has been misused and we are not aware that anyone has been a victim of identity theft in connection with this incident, there can be no guarantee that we will not be subject to future claims arising from this or similar incidents |
| In addition, our relationships with our borrowers, retailers and brokers may be harmed if our reputation is tarnished by any such incident |
| Risks Related to the Manufactured Housing Industry Manufactured housing loan borrowers may be relatively high credit risks |
| Manufactured housing loans make up substantially our entire loan portfolio |
| Typical manufactured housing loan borrowers may be relatively higher credit risks due to various factors, including, among other things, the manner in which borrowers have handled previous credit, the absence or limited extent of borrowers’ prior credit history, limited financial resources, frequent changes in or loss of employment and changes in borrowers’ personal or domestic situations that affect their ability to repay loans |
| Consequently, the manufactured housing loans we originate and have an ownership interest in bear a higher rate of interest, have a higher probability of default and may involve higher delinquency rates and greater servicing costs relative to loans to more creditworthy borrowers |
| Our profitability depends upon our ability to properly evaluate the creditworthiness of borrowers and price each loan accordingly and efficiently service the contracts by limiting our delinquency and default rates and foreclosure and repossession costs and by maximizing our recovery rates |
| To the extent that aggregate losses on the resale of repossessed and foreclosed houses exceed our estimates, our profitability will be adversely affected |
| 13 _________________________________________________________________ [42]Table of Contents Delinquency interrupts the flow of projected interest income from a manufactured housing loan, and default can ultimately lead to a loss if the net realizable value of the collateral or real property securing the manufactured housing loan is insufficient to cover the principal and interest due on the loan |
| Also, our cost of financing and servicing a delinquent or defaulted loan is generally higher than for a performing loan |
| We bear the risk of delinquency and default on loans beginning when we originate them and continuing even after we sell loans with a retained interest or securitize them |
| We also reacquire the risks of delinquency and default for loans that we are obligated to repurchase |
| Repurchase obligations are typically triggered in any sale or securitization if the loan materially violates our representations or warranties |
| If we experience higher-than-expected levels of delinquency or default in pools of loans that we service, resulting in higher than anticipated losses we may trigger termination of our servicing rights, which would result in a loss of future servicing income and damage to our reputation as a loan servicer |
| We attempt to manage these risks with risk-based loan pricing and appropriate underwriting policies and loan collection methods |
| However, if such policies and methods are insufficient to control our delinquency and default risks and do not result in appropriate loan pricing, our business, financial condition, liquidity and results of operations could be significantly harmed |
| The manufactured housing industry has been in a downturn since 1998 |
| The manufactured housing industry historically has been cyclical and is generally subject to many of the same national and regional economic and demographic factors that affect the housing industry generally |
| These factors, including consumer confidence, inflation, regional population and employment trends, availability of and cost of alternative housing, weather conditions and general economic conditions, tend to impact manufactured housing buyers to a greater degree than buyers of traditional site built houses |
| In addition, sales of manufactured houses typically peak during the spring and summer seasons and decline to lower levels from mid-November through February |
| Due to aggressive underwriting practices by some industry lenders that led to increased defaults, decreased recovery rates on repossessions, the continued excessive inventory of repossessed houses and unfavorable volatility in the secondary markets for manufactured housing loans, companies in the manufactured housing finance business have generally not been profitable since 1998 |
| Some of the industry’s largest lenders have exited the business |
| Although we believe that our business plan will be profitable in the long term, there can be no assurance that we will in fact be profitable either in the long term or the short term |
| Wide spreads between interest rates for manufactured housing loans and traditional site built housing loans decrease the relative demand for manufactured houses |
| In the current interest rate environment, traditional site built houses have become more affordable relative to manufactured houses |
| If the difference between interest rates for manufactured housing loans and traditional site built housing loans does not decrease, demand for manufactured housing loans may decrease, which would decrease our loan originations |
| Any substantial economic slowdown could increase delinquencies, defaults, repossessions and foreclosures and reduce our ability to originate loans |
| Periods of economic slowdown or recession may be accompanied by decreased demand for consumer credit, decreased real estate values, and an increased rate of delinquencies, defaults, repossessions and foreclosures |
| We originate loans to some borrowers who make little or no down payment, resulting in high loan-to-value ratios |
| A lack of equity in the house may reduce the incentive a borrower has to meet his payment obligations during periods of financial hardship, which might result in higher delinquencies, defaults, repossessions and foreclosures |
| These factors would reduce our ability to originate loans and increase our losses on loans in which we have a residual or retained interest |
| In addition, loans we originate during an economic slowdown may not be as valuable to us because potential investors in or purchasers of our loans might reduce the premiums they pay for the loans or related bonds to compensate for any increased risks arising during such periods |
| Any sustained increase in delinquencies, defaults, repossessions or foreclosures is likely to significantly harm the pricing of our future loan sales and securitizations and also our ability to finance our loan originations |
| 14 _________________________________________________________________ [43]Table of Contents Our business may be significantly harmed by a slowdown in the economies of California or Texas, in each of which we conduct a significant amount of business |
| We have no geographic concentration limits on our ability to originate, purchase or service loans |
| A significant portion of the manufactured housing loans we have originated, purchased or serviced historically has been in California and Texas |
| For the year ended December 31, 2005, approximately 38prca and 9prca by principal balance and 23prca and 12prca by number of loans, respectively, of the loans we originated were in California and Texas |
| An overall decline in the economy or the residential real estate market in California or Texas or in any other state in which we have a high concentration of loans could decrease the value of manufactured houses and increase the risk of delinquency |
| This, in turn, would increase the risk of default, repossession or foreclosure on manufactured housing loans in our portfolio or that we have sold to others |
| Geographic concentration could adversely affect our ability to securitize pools of manufactured housing loans |
| Depreciation in the value of manufactured houses may decrease sales of new manufactured houses and lead to increased defaults and delinquencies |
| Over the last several years, the value of manufactured houses has tended to depreciate over time |
| This depreciation makes pre-owned houses, even relatively new ones, significantly less expensive than new manufactured houses, thereby decreasing the demand for new houses, which negatively affects the manufactured housing lending industry |
| Additionally, rapid depreciation may cause the fair market value of borrowers’ manufactured houses to be less than the outstanding balance of their loans |
| In cases where borrowers have negative equity in their houses, they may not be able to resell their manufactured houses for enough money to repay their loans and may have less incentive to continue to repay their loans, which may lead to increased delinquencies and defaults |
| Tax Risks of Our Business and Structure Distribution requirements imposed by law limit our flexibility in executing our business plan, and we cannot assure stockholders that we will have sufficient funds to meet our distribution obligations |
| To maintain our status as a REIT for federal income tax purposes, we generally are required to distribute to our stockholders at least 90prca of our REIT taxable net income each year |
| REIT taxable net income is determined without regard to the deduction for dividends paid and by excluding net capital gains |
| We are also required to pay federal income tax at regular corporate rates to the extent that we distribute less than 100prca of our net taxable income (including net capital gains) each year |
| In addition, to the extent such income is not subject to corporate tax, we are required to pay a 4prca nondeductible excise tax on the amount, if any, by which certain distributions we pay with respect to any calendar year are less than the sum of 85prca of our ordinary income for that calendar year, 95prca of our capital gain net income for the calendar year and any amount of our income that was not distributed in prior years |
| We intend to distribute to our stockholders at least 90prca of our REIT taxable net income each year in order to comply with the distribution requirements of the Internal Revenue Code and to avoid federal income tax and the nondeductible excise tax |
| Differences in timing between the receipt of income and the payment of expenses in arriving at REIT taxable net income and the effect of required debt amortization payments could require us to borrow funds on a short-term basis, access the capital markets or liquidate investments to meet the distribution requirements that are necessary to achieve the federal income tax benefits associated with qualifying as a REIT even if our management believes that it is not in our best interest to do so |
| We cannot assure our stockholders that any such borrowing or capital market financing will be available to us or, if available to us, will be on terms that are favorable to us |
| Borrowings incurred to pay distributions will reduce the amount of cash available for operations |
| Any inability to borrow such funds or access the capital markets, if necessary, could jeopardize our REIT status and have a material adverse effect on our financial condition |
| 15 _________________________________________________________________ [44]Table of Contents We may suffer adverse tax consequences and be unable to attract capital if we fail to qualify as a REIT Since our taxable period ended December 31, 2003, we have been organized and operated, and intend to continue to operate, so as to qualify for taxation as a REIT under the Internal Revenue Code |
| Although we believe that we have been and will continue to be organized and have operated and will continue to operate so as to qualify for taxation as a REIT, we cannot assure stockholders that we have been or will continue to be organized or operated in a manner to so qualify or remain so qualified |
| Qualification as a REIT involves the satisfaction of numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within our control |
| In addition, frequent changes may occur in the area of REIT taxation, which require the Company continually to monitor its tax status |
| If we fail to qualify as a REIT in any taxable year, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable net income at regular corporate rates |
| Moreover, unless entitled to relief under certain statutory provisions, (generally requiring reasonable cause for any REIT testing violations), we also would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost |
| This treatment would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability to us for the years involved |
| In addition, distributions to stockholders would no longer be required to be made |
| Even if we qualify for and maintain our REIT status, we will be subject to certain federal, state and local taxes on our property and certain of our operations |
| Our use of taxable REIT subsidiaries will cause income from our servicing and insurance activities to be subject to corporate level tax and may cause us to restrict our business activities |
| To preserve our qualification as a REIT, we conduct all of our servicing and insurance activities through one or more taxable REIT subsidiaries |
| A taxable REIT subsidiary is subject to federal income tax, and state and local income tax where applicable, as a regular “C” corporation |
| Accordingly, net income from activities conducted by our taxable REIT subsidiaries is subject to corporate level tax |
| In addition, under the Internal Revenue Code, no more than 20prca of the total value of the assets of a REIT may be represented by securities of one or more taxable REIT subsidiaries |
| This limitation may cause us to restrict the use of certain securitization transactions and limit the growth of our taxable REIT subsidiaries with the potential for decreased revenue |
| Our ability to sell and securitize our loans is limited due to various federal income tax rules applicable to REITs |
| Under the Internal Revenue Code, a REIT is subject to a 100prca tax on its net income derived from “prohibited transactions |
| ” The phrase “prohibited transactions” refers to the sales of inventory or assets held primarily for sale to customers in the ordinary course of a taxpayer’s business |
| A taxpayer who engages in such sales is typically referred to as a dealer |
| If the Internal Revenue Service does not respect the legal structure of certain of our third party loan origination programs (see “Business—Loan Origination, Acquisition and Underwriting —Third-Party Originations”), we may be subject to the prohibited transactions tax on any net income derived from these origination programs |
| The Internal Revenue Service has taken the position that if a REIT securitizes loans using a real estate mortgage investment conduit (“REMIC”) structure, then such activity will cause the REIT to be treated as a dealer, with the result that the 100prca tax would apply to the net income generated from such activity |
| If we securitize loans using a REMIC, we intend to do so through one or more taxable REIT subsidiaries, which will not be subject to such 100prca tax, but will be taxable at regular corporate federal income tax rates |
| We also may securitize mortgage assets through the issuance of non-REMIC securities, whereby we retain an equity interest in the mortgage-backed assets used as collateral in the securitization transaction |
| The issuance of any such instruments could result, however, in a portion of our assets being classified as a “taxable mortgage pool,” which would be treated as a separate corporation for US federal income tax purposes, which in turn could adversely affect the treatment of our stockholders for federal income tax purposes or jeopardize our status as a REIT 16 _________________________________________________________________ [45]Table of Contents Special rules apply to a REIT, however, including a qualified REIT subsidiary that is classified as a taxable mortgage pool |
| In this event, neither the REIT nor the qualified REIT subsidiary will be subject to the corporate tax generally applicable to taxable mortgage pools |
| As described below, however, the REIT’s stockholders may have to report excess inclusion income |
| A portion of our income from assets held directly by or through a qualified REIT subsidiary that is classified as a taxable mortgage pool may represent “phantom” taxable income |
| A portion of our income from a qualified REIT subsidiary that would otherwise be classified as a taxable mortgage pool may be treated as “excess inclusion income,” which would be subject to the distribution requirements that apply to us and could therefore adversely affect our liquidity |
| Generally, a stockholder’s share of excess inclusion income would not be allowed to be offset by any operating losses otherwise available to the stockholder |
| Tax exempt entities that own shares in a REIT must treat their allocable share of excess inclusion income as unrelated business taxable income |
| Any portion of a REIT dividend paid to foreign stockholders that is allocable to excess inclusion income will not be eligible for exemption from the 30prca withholding tax (or reduced treaty rate) on dividend income |
| We may pay distributions that are in excess of our current and accumulated earnings and profits, which may cause our stockholders to incur adverse federal income tax consequences |
| We may pay quarterly distributions to our stockholders in excess of 100prca of our estimated REIT taxable net income |
| Distributions in excess of our current and accumulated earnings and profits are not treated as a dividend and generally will not be taxable to a taxable US stockholder under current US federal income tax law to the extent those distributions do not exceed the stockholder’s adjusted tax basis in his or her common stock |
| Instead, any such distribution generally will constitute a return of capital, which will reduce the stockholder’s adjusted basis and could result in the recognition of increased gain or decreased loss to the stockholder upon a sale of the stockholder’s stock |
| Other Risks We operate in a highly regulated industry and failure to comply with applicable laws and regulations at the federal, state or local level could negatively affect our business |
| Currently, we originate both chattel, or home-only, loans and loans collateralized by both the manufactured house and real property, or land-home loans, in 45 states |
| We also currently conduct servicing operations in 47 states |
| Most states where we operate require that we comply with a complex set of laws and regulations |
| These laws, which include installment sales laws, consumer lending laws, mortgage lending laws and mortgage servicing laws, differ from state to state, making uniform operations difficult |
| Most states periodically conduct examinations of our contracts and loans for compliance with state laws |
| In addition to state laws regulating our business, our consumer lending and servicing activities are subject to numerous federal laws and the rules and regulations promulgated there-under |
| These federal and state laws and regulations and other laws and regulations affecting our business, including zoning, density and development requirements and building and environmental rules and regulations, create a complex framework in which we originate and service manufactured housing loans |
| Moreover, because these laws and regulations are constantly changing, it is difficult to comprehensively identify, accurately interpret, properly program our technology systems and effectively train our personnel with respect to all of these laws and regulations, thereby potentially increasing our exposure to the risks of noncompliance with these laws and regulations |
| As a result, we have not always been, and may not always be, in compliance with these requirements, including licensing requirements |
| 17 _________________________________________________________________ [46]Table of Contents Our failure to comply with these laws and regulations can lead to: • defaults under contracts we have with third parties, which could cause those contracts to be terminated or renegotiated on less favorable terms; • civil fines and penalties and criminal liability; • loss of licenses, exemptions or other approved status, which could in turn require us temporarily or permanently to cease our affected operations; • demands for indemnification, loan repurchases or modification of our loans; • class action lawsuits; and • administrative enforcement actions |
| The increasing number of federal, state and local ‘‘anti-predatory lending’’ laws may restrict our ability to originate or increase our risk of liability with respect to certain manufactured housing loans and could increase our cost of doing business |
| In recent years, several federal, state and local laws, rules and regulations have been adopted, or are under consideration, that are intended to eliminate so-called ‘‘predatory’’ lending practices |
| These laws, rules and regulations impose certain restrictions on loans on which certain points and fees or the annual percentage rate, or APR, exceeds specified thresholds |
| Some of these restrictions expose a lender to risks of litigation and regulatory sanction no matter how carefully a loan is underwritten |
| In addition, an increasing number of these laws, rules and regulations seek to impose liability for violations on purchasers of loans, regardless of whether a purchaser knew of or participated in the violation |
| It is against our policy to engage in predatory lending practices and we have generally avoided originating loans that exceed the APR or ‘‘points and fees’’ thresholds of these laws, rules and regulations |
| These laws, rules and regulations may prevent us from making certain loans and may cause us to reduce the APR or the points and fees on loans that we do make |
| In addition, the difficulty of managing the risks presented by these laws, rules and regulations may decrease the availability of warehouse financing and the overall demand for our loans in the secondary market, making it difficult to fund, sell or securitize our loans |
| If nothing else, the growing number of these laws, rules and regulations will increase our cost of doing business as we are required to develop systems and procedures to ensure that we do not violate any aspect of these new requirements |
| We may be subject to fines, judgments or other penalties based upon the conduct of third parties with whom we do business |
| The majority of our business consists of purchasing from retailers retail installment sales contracts for the sale of a manufactured house |
| These contracts are subject to the Federal Trade Commission’s ‘‘Holder Rule,’’ which makes us subject generally to the same claims and defenses that a consumer might have against the retailer that sold the consumer his or her manufactured house up to the value of the payments made by the consumer |
| Increasingly federal and state agencies, as well as private plaintiffs, have sought to impose third-party or assignee liability on purchasers or originators of loans even where the Holder Rule and similar laws do not specifically apply |
| We attempt to mitigate our risk for this liability by ending our relationships with retailers whose practices we believe may put us at risk and limiting our retailer network to retailers that have the ability to indemnify us against these types of claims |
| Although we routinely seek indemnification from retailers in these situations, there is no assurance that we will not be liable for these types of claims or that the retailer will indemnify us if we are held liable |
| 18 _________________________________________________________________ [47]Table of Contents Common stock eligible for future sale may have adverse effects on our share price |
| We cannot predict the effect, if any, of future sales of shares of our common stock (including shares of common stock issuable upon the exercise of currently outstanding options, and non-vested shares issued under our 2003 Equity Incentive Plan), or the availability of shares for future sales, or the market price of our common stock |
| Sales of substantial amounts of common stock, or the perception that these sales could occur, may adversely affect prevailing market prices for our common stock |
| We also may issue from time to time additional shares of common stock and we may grant registration rights in connection with these issuances |
| Sales of substantial amounts of shares of common stock or the perception that these sales could occur may adversely affect the prevailing market price for our common stock |
| In addition, the sale of these shares could impair our ability to raise capital through a sale of additional equity securities |
| Market interest rates may affect the value of our securities |
| One of the factors that investors may consider in deciding whether to buy or sell our securities is our distribution rate as a percentage of our share price, relative to market interest rates |
| If market interest rates increase, prospective investors may desire a higher distribution or interest rate on our securities or seek securities paying higher distributions or interest |
| It is likely that the public valuation of our common stock will be based primarily on the earnings that we derive from the difference between the interest earned on our loans less net credit losses and the interest paid on borrowed funds |
| As a result, interest rate fluctuations and capital market conditions can affect the market value of our common stock |
| Our rights and the rights of our stockholders to take action against our directors are limited, which could limit stockholders’ recourse in the event of certain actions |
| Our certificate of incorporation limits the liability of our directors for money damages for breach of a fiduciary duty as a director, except under limited circumstances |
| As a result, we and our stockholders may have more limited rights against our directors than might otherwise exist |
| Our bylaws require us to indemnify each director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made a party by reason of his or her service to us |
| In addition, we may be obligated to fund the defense costs incurred by our directors and officers |
| Our board of directors may change our investment and operational policies and practices without a vote of our stockholders, which limits stockholder control of our policies and practices |
| Our major policies, including our policies and practices with respect to investments, financing, growth, debt capitalization, REIT qualification and distributions, are determined by our Board of Directors |
| Although we have no present intention to do so, our board of directors may amend or revise these and other policies from time to time without a vote of our stockholders |
| Accordingly, our stockholders will have limited control over changes in our policies |
| Our organizational documents do not limit the amount of indebtedness that we may incur |
| Although we intend to maintain a balance between our total outstanding indebtedness and the value of our assets, we could alter this balance at any time |
| If we become highly leveraged, then the resulting increase in debt service could adversely affect our ability to make payments on our outstanding indebtedness and harm our financial condition |
| Certain provisions of Delaware law and our governing documents may make it difficult for a third-party to acquire us |
| In order to qualify and maintain our qualification as a REIT, not more than 50prca of the outstanding shares of our capital stock may be owned, directly or indirectly, by five or fewer individuals |
| Thus, ownership of more than 9dtta25prca of our outstanding shares of common stock by any single stockholder has been restricted, with certain exceptions, for the purpose of maintaining our qualification as a REIT under the Internal Revenue Code |
| 19 _________________________________________________________________ [48]Table of Contents The 9dtta25prca ownership limit, as well as our ability to issue additional shares of common stock or shares of other stock (which may have rights and preferences over the common stock), may discourage a change of control of the Company and may also: (1) deter tender offers for the common stock, which offers may be advantageous to stockholders; and (2) limit the opportunity for stockholders to receive a premium for their common stock that might otherwise exist if an investor were attempting to assemble a block of common stock in excess of 9dtta25prca of the outstanding shares of the Company or otherwise effect a change of control of the Company |
| Preferred Stock |
| Our charter authorizes the Board of Directors to issue up to 10cmam000cmam000 shares of preferred stock and to establish the preferences and rights (including the right to vote and the right to convert into shares of common stock) of any shares issued |
| The power to issue preferred stock could have the effect of delaying or preventing a change in control of the Company even if a change in control were in the stockholders’ interest |
| Section 203 of the Delaware General Corporation Law is applicable to certain types of corporate takeovers |
| Subject to specified exceptions listed in this statute, Section 203 of the Delaware General Corporation Law provides that a corporation may not engage in any “business combination” with any “interested stockholder” for a three-year period following the date that the stockholder becomes an interested stockholder |
| Although these provisions do not apply in certain circumstances, the provisions of this section could discourage offers from third parties to acquire us and increase the difficulty of successfully completing this type of offer |