AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 22, 2002
SECURITIES ACT FILE NO. _________
INVESTMENT COMPANY ACT FILE NO. _________
=========================================================================
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM N-2
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO.__ [ ]
POST-EFFECTIVE AMENDMENT NO. __ [ ]
AND/OR
REGISTRATION STATEMENT UNDER
THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. ___ [ ]
(Check Appropriate Box or Boxes)
----------------
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
(Exact Name of Registrant As Specified in Charter )
ONE LIBERTY PLAZA, 165 BROADWAY, 36th FLOOR
NEW YORK, NY 10006-1404
(Address of Principal Executive Offices)
Registrant's Telephone Number, including Area Code: 1(800) Hyperion
----------------
CLIFFORD E. LAI, PRESIDENT
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
ONE LIBERTY PLAZA, 165 BROADWAY, 36th FLOOR
NEW YORK, NY 10006-1404
(Name and Address of Agent for Service)
----------------
With copies to:
DAVID C. MAHAFFEY THOMAS A. DECAPO
SULLIVAN & WORCESTER LLP SKADDEN, ARPS, SLATE, MEAGHER, & FLOM LLP
1666 K STREET, N.W. ONE BEACON STREET
WASHINGTON, D.C. 20006 BOSTON, MA 02108
----------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after the effective date of this Registration Statement.
If any securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. [ ]
This form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act and the Securities Act
registration statement number of the earlier effective registration statement
for the offering is [ ]
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
========================================================================
PROPOSED PROPOSED
PROPOSED MAXIMUM OFFERING PRICE MAXIMUM AMOUNT OF
TITLE OF SECURITIES AMOUNT BEING PER SHARE (*) AGGREGATE REGISTRATION
BEING REGISTERED REGISTERED OFFERING PRICE (*) FEE
Common Shares, $.01 Par Value
............. 4,000,000 shares $15.00 $60,000,000 $5520
========================================================================
(*) Estimated solely for the purpose of computing the registration fee pursuant
to Rule 457.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
Information to be included in Part B is set forth in Part B to this
Registration Statement.
Information to be included in Part C is set forth under the appropriate
item, so numbered in Part C to this Registration Statement.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SEC IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND
IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE
OFFER OR SALE IS NOT PERMITTED.
[SUBJECT TO COMPLETION DATED MAY 22, 2002]
[LOGO]
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
4,000,000 COMMON SHARES
$15.00 PER SHARE
----------------
The Hyperion Strategic Mortgage Income Fund, Inc. (the "Fund") is a
newly organized, diversified, closed-end management investment company. The
Fund's primary investment objective is to provide a high level of current income
by investing primarily in Mortgage-Backed Securities ("MBS") that, in the
opinion of the Fund's adviser, offer an attractive combination of credit
quality, yield and maturity. The Fund's secondary investment objective is to
provide capital appreciation.
Under normal market conditions, the Fund will invest at least 80% of
its total assets in MBS, securities backed by interests in real estate, and may
invest up to 20% of its total assets in U.S. government securities, or cash or
other short-term instruments. The Fund may invest up to 10% of its total assets
in asset-backed securities ("ABS") that are secured by pools of assets that may
not represent interests in real estate. Under normal market conditions, the Fund
will be fully invested in Agency MBS, Non-Agency Residential MBS ("Non-Agency
RMBS"), Commercial MBS ("CMBS"), and ABS. The Fund will invest at least 80% of
its total assets in securities that at the time of investment are investment
grade quality. The Fund may invest up to 20% of its total assets in securities
that at the time of investment are below investment grade. See "INVESTMENT
OBJECTIVES, POLICIES AND RESTRICTIONS" for more information.
The Fund will not invest in corporate bonds, other than those primarily
secured by interests in real estate. The Fund will not invest in interest-only,
principal-only or inverse floating rate securities (see "INVESTMENT RESTRICTIONS
- Prohibited Investments" for more information).
PER SHARE TOTAL
--------- ---------
Public Offering Price................... $15.00 $ _______
Sales Load............................ $____ $ _______
Proceeds, before expenses, to the
Fund1.................. $____ $ _______
The underwriters may purchase up to an additional ____ Common Shares at the
public offering price, less the sales load, within 45 days of this prospectus to
cover over-allotments.
Hyperion Capital Management, Inc., an SEC registered investment adviser
whose officers and employees have substantial experience in originating,
evaluating and investing in MBS and ABS, is the Fund's investment adviser (the
"Adviser"). Lend Lease Hyperion Capital Advisers, L.L.C., an SEC registered
investment adviser, will act as the Fund's subadviser (the "Subadviser") with
respect to CMBS.
Investing in the Common Shares of the Fund involves certain risks. SEE THE
"RISK FACTORS" SECTION ON PAGE ___ OF THIS PROSPECTUS BEFORE BUYING ANY OF THESE
COMMON SHARES FOR A COMPREHENSIVE DISCUSSION OF SUCH RISKS. An investment in the
Fund is not appropriate for all investors. No assurance can be given that the
Fund will achieve its investment objectives.
Neither the Securities and Exchange Commission (the "SEC") nor any state
securities commission has approved or disapproved of these securities or passed
upon the adequacy or accuracy of this Prospectus. Any representation to the
contrary is a criminal offense.
Leverage. The Fund intends to use leverage primarily through the use of
reverse repurchase agreements.
No Prior History. Because the Fund is recently organized, its Common Shares
have no history of public trading. The shares of closed-end investment companies
frequently trade at a discount from their net asset value. This risk may be
greater for investors expecting to sell their shares in a relatively short
period after completion of the public offering. The Fund's Common Shares have
been approved for listing on the New York Stock Exchange (the "Exchange") upon
notice of issuance under the symbol "____."
The Prospectus sets forth concisely the information about the Fund that a
prospective investor ought to know before investing. Investors are advised to
read and retain it for future reference. A Statement of Additional Information
dated _________, 2002 containing additional information about the Fund has been
filed with the SEC and is incorporated by reference in its entirety into this
Prospectus. A copy of the Statement of Additional Information, the table of
contents of which appears on page ___ of the Prospectus, may be obtained without
charge by contacting the Fund at One Liberty Plaza, 165 Broadway, 36th Floor,
New York, NY 10006-1404 or calling (800) HYPERION. The SEC maintains a website
at http://www.sec.gov that contains other information about the Fund.
--------------------------------------------------------------------------------
RAYMOND JAMES A.G. EDWARDS & SONS, INC.
--------------------------------------------------------------------------------
_____________, 2002
PROSPECTUS SUMMARY
This summary highlights some information from this Prospectus. It may not
contain all of the information that is important to you. Before investing, you
should read the entire Prospectus and Statement of Additional Information
carefully, including the risk factors.
INFORMATION ABOUT THE FUND
The Fund is a recently organized, diversified, closed-end management
investment company. The Fund's primary investment objective is to provide a high
level of current income by investing primarily in MBS that, in the opinion of
the Fund's Adviser, offer an attractive combination of credit quality, yield and
maturity. The Fund's secondary investment objective is to provide capital
appreciation. No assurance can be given that the Fund's investment objectives
will be achieved. See "THE FUND" for more information.
THE OFFERING
The Fund is offering 4,000,000 Common Shares at $15.00 per Common Share
through a group of underwriters led by Raymond James & Associates, Inc. and A.G.
Edwards & Sons, Inc. (the "Underwriters"). The Underwriters have been granted an
option to purchase up to _______ Common Shares solely to cover over-allotments,
if any. The minimum investment requirement in this offering is 100 Common
Shares. See "UNDERWRITING" for more information.
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is to provide a high level of
current income by investing primarily in MBS that, in the opinion of the Fund's
adviser, offer an attractive combination of credit quality, yield and maturity.
The Fund's secondary investment objective is to provide capital appreciation.
The Fund will invest at least 80% of its total assets in MBS, and may
invest up to 20% of its total assets in U.S. government securities, or cash or
other short-term instruments. The Fund's investments in MBS will include Agency
MBS, Non-Agency RMBS, and CMBS. The Fund may invest up to 10% of its total
assets in ABS secured by pools of assets, such as credit card receivables or
automobile loans, that may not represent interests in real estate. Under normal
market conditions, the Fund will be fully invested in Agency MBS, Non-Agency
RMBS, CMBS, and ABS.
Under normal market conditions, the Fund will invest at least 80% of its
total assets in securities that at the time of investment are investment grade
quality. Investment grade quality bonds are bonds (1) issued or guaranteed by
the U.S. government or any agency or instrumentality thereof, (2) rated within
the four highest investment grades by at least one rating agency (Baa, BBB or
better by Moody's Investor Service, Inc. ("Moody's"), Standard & Poor's Ratings
Group ("S&P") or Fitch IBCA, Inc. ("Fitch")) or (3) bonds that are unrated but
judged to be of comparable quality by the Fund's Adviser. The Fund may invest up
to 20% of its total assets in securities that at the time of investment are
below investment grade, including securities rated Ba, BB or B by Moody's, S&P
or Fitch, or are unrated. Bonds of below investment grade quality are regarded
as having predominately speculative characteristics with respect to the issuer's
or pool's capacity to pay interest and repay principal, and are commonly
referred to as "junk bonds" and "high risk high yield bonds." Under normal
market conditions, the Fund will attempt to reduce portfolio prepayment risk by
investing in MBS, such as certain Non-Agency RMBS, whose returns may be enhanced
by faster prepayments, and also by investing in MBS, such as certain Agency MBS,
whose returns may be enhanced by slower prepayments.
The Fund cannot assure you that it will achieve its investment objectives.
See "INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS" for more information.
USE OF LEVERAGE
The Fund intends to use leverage representing not more than 33 1/3% of the
Fund's total assets. The Fund will borrow primarily using reverse repurchase
agreements. A reverse repurchase agreement is a form of collateralized borrowing
in which the Fund borrows money from a counterparty, generally for a period of
three months or less, at an agreed-upon rate of interest.
The use of leverage creates an opportunity for increased net income and
returns, but also creates certain risks for shareholders. As long as the rate of
return on the assets purchased with the proceeds of leverage exceeds the net
cost of borrowings, including the effects of any associated hedges, the
investment of the proceeds of the leverage will generate more return than will
be needed to offset such borrowing costs. If so, the excess will be available to
pay higher dividends to shareholders. If, however, the net cost of borrowings,
including the effects of any associated hedges, exceeds the rate of return on
the assets purchased with the proceeds of leverage, the return to shareholders
will be less than if the Fund had not used leverage.
Under current market conditions, in order to reduce the variability of
leverage borrowing costs from short-term reverse repurchase agreements, the Fund
intends to enter into interest rate swaps with the effect of fixing net
borrowing costs for longer periods of time. See "INVESTMENT POLICIES - Use of
Leverage" for more information.
RISK FACTORS
The following summarizes some of the matters that you should consider
before investing in the Fund. Please refer to the "RISK FACTORS" section of the
Prospectus for a more detailed discussion of the following risks.
No Operating History. The Fund is a newly organized, diversified,
closed-end management investment company and has no operating history.
Market Discount Risk. The shares of closed-end management investment
companies such as the Fund frequently trade at a discount from their net asset
value.
Interest Rate Risk. The prices of bonds tend to fall as interest rates
rise. Interest rate risk is the risk that the bonds in the Fund's portfolio will
decline in value because of increases in market interest rates. A decline in the
prices of the bonds owned by the Fund would cause a decline in the net asset
value of the Fund, which could adversely affect the trading price of the Fund's
Common Shares. Securities that have longer maturities tend to fluctuate more in
price in response to changes in market interest rates than securities with
shorter maturities.
The Fund's use of leverage, as described below, may tend to increase the
Fund's interest rate risk.
Credit Risk. Credit risk is the risk that one or more bonds in the Fund's
portfolio will (1) decline in price due to deterioration of the issuer's or
underlying pool's financial condition or other events or (2) fail to pay
interest or principal when due. The Fund will invest at least 80% of its total
assets in investment grade quality bonds that are (1) issued or guaranteed by
the U.S. government or any agency or instrumentality thereof, (2) rated within
the four highest investment grades by a least one rating agency or (3) bonds
that are unrated but judged to be of comparable quality by the Adviser. The Fund
may invest up to 20% of its total assets in bonds that are below investment
grade quality or are unrated. The prices of these lower grade bonds are more
sensitive to negative developments, such as a general economic downturn or an
increase in delinquencies in the pool of underlying mortgages that secure an
MBS, than are the prices of higher grade securities. Bonds of below investment
grade quality are predominantly speculative with respect to the issuer's or
pool's capacity to pay interest and repay principal when due and therefore
involve a greater risk of default.
Under normal market conditions, the Fund will invest to a significant
degree in subordinated classes of MBS, including Non-Agency RMBS and CMBS. Such
subordinated classes are subject to a greater degree of non-payment than are
senior classes of the same issuer or Agency MBS. In addition, under certain
market conditions, the market for subordinated classes of MBS may not be as
liquid as the market for other fixed income securities.
Prepayment Risk. For certain types of MBS, prepayments of principal may be
made at any time. Prepayment rates are influenced by changes in current interest
rates and a variety of economic, geographic, social and other factors and cannot
be predicted with certainty.
During periods of declining mortgage interest rates, prepayments on MBS
generally increase. If interest rates in general also decline, the amounts
available for reinvestment by the Fund during such periods are likely to be
reinvested at lower interest rates than the Fund was earning on the MBS that
were prepaid. MBS may decrease in value as a result of increases in interest
rates and may benefit less than other fixed income securities from declining
interest rates because of the risk of prepayment. Under certain interest rate or
prepayment scenarios, the Fund may fail to recoup fully its investment in such
securities.
Bond Market Risk. The yield spreads of the Fund's portfolio securities, or
yield differentials between the Fund's portfolio securities and Treasury
securities with comparable maturities, may widen, causing the value of the
Fund's portfolio securities to underperform Treasury securities. The amount of
public information available about the MBS and ABS in the Fund's portfolio is
generally less than that for corporate equities or bonds, and the investment
performance of the Fund may therefore be more dependent on the analytical
capabilities of the Adviser than if the Fund were a stock fund or a corporate
bond fund. The secondary market for certain types of MBS and ABS may be less
well-developed or liquid than many other securities markets, which may adversely
affect the Fund's ability to sell its portfolio securities at attractive prices.
Economic Sector Risk. Under normal market conditions, the Fund will be
fully invested in Agency MBS, Non-Agency RMBS, CMBS and ABS. This may make the
Fund more susceptible to adverse economic, political or regulatory events that
affect the value of real estate, and increase the potential for fluctuation in
the net asset value of the Fund's Common Shares.
Leverage Risk. The use of leverage creates an opportunity for increased net
income and returns, but also creates certain risks for shareholders. The Fund's
leverage strategy may not be successful, and creates two major types of risks
for shareholders: (1) the likelihood of greater volatility in the net asset
value and market price of the Common Shares because the Fund may, with borrowed
money, invest in securities which lose value, thereby increasing the amount of
loss incurred by the investor, and (2) the possibility that net income will fall
if the Fund's borrowing costs from leverage exceed the income received or
capital appreciation realized by the Fund from any securities purchased with
borrowed money.
Interest Rate Transactions Risk. Under current market conditions, in order
to reduce the variability of leverage borrowing costs from short-term reverse
repurchase agreements, the Fund intends to enter into interest rate swaps with
the effect of fixing net borrowing costs for longer periods of time.
The value of the Fund's interest rate swaps could increase, decrease or
have a corresponding impact on the net asset value of the Fund. To the extent
there is a decline in interest rates, the value of the interest rate swap could
decrease, and could result in a decrease in the Fund's net asset value. In
addition, if the counterparty to an interest rate swap defaults, the Fund would
be obligated to make the payments that it had intended to avoid. Depending on
whether the Fund would be entitled to receive net payments from the counterparty
on the swap, which in turn would depend on the general state of short-term
interest rates and the returns on the Fund's portfolio securities at that point
in time, a default could adversely affect the net asset value of the Common
Shares.
Hedging Transactions. The Fund may employ a variety of other hedging
transactions, including interest rate and total rate of return swap
transactions, interest rate caps and floors, futures, options on securities and
futures, short sales, when-issued purchases and forward commitments. The hedging
transactions expected to be employed by the Fund involve certain risks, and
there can be no assurance that any such transaction used will succeed.
While the use of hedging transactions is intended to minimize the risk of
loss resulting from a decline in the value of portfolio securities covered by
the hedging transactions, these transactions will tend to limit any potential
gain that could result from an increase in the value of these securities. Such
transactions also are subject to the risk that, if the Adviser is incorrect in
its forecast of interest rates, market values or other economic factors
affecting such a transaction, the Fund would have been better off if it had not
entered into the transaction.
Anti-Takeover Provisions. The Fund's Articles of Incorporation (the
"Articles") include provisions that could limit the ability of other entities or
persons to acquire control of the Fund or convert the Fund to open-end status.
The provisions of the Articles described above could have the effect of
depriving shareholders of opportunities to sell their shares at a premium over
the then current market price of the shares.
You should carefully consider your ability to assume the foregoing risks as
well as those discussed under the heading "RISK FACTORS" before making an
investment in the Fund. The Statement of Additional Information for this
Prospectus also contains information about risks associated with an investment
in the Fund. An investment in the Fund is not appropriate for all investors.
INFORMATION REGARDING THE ADVISER AND SUBADVISER
The Adviser is a Delaware corporation and SEC registered investment
adviser. The Adviser's officers and employees have substantial experience in
originating, evaluating and investing in the securities in which the Fund
invests and in the use of hedging transactions. The Fund pays the Adviser an
aggregate monthly fee computed at the annual rate of 0.65% of the Fund's average
weekly net assets.
The Subadviser, a Delaware limited liability company and SEC registered
investment adviser, acts as the Fund's subadviser with respect to CMBS. The
Adviser pays the Subadviser an aggregate monthly fee based on the Fund's assets
invested in CMBS. See "MANAGEMENT OF THE FUND" for more information.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to make monthly distributions to the holders of its
Common Shares out of net investment income. It is expected that the first
dividend will be paid approximately 60 to 75 days after the date of the initial
issuance of the Common Shares, depending on market conditions. Capital gains, if
any, will be distributed at least annually. See "DIVIDENDS AND DISTRIBUTIONS"
for more information. Holders of Common Shares may elect to participate in a
Dividend Reinvestment Plan and have dividends and capital gains distributions
reinvested automatically in Common Shares. See "DIVIDEND REINVESTMENT PLAN" for
more information.
CUSTODIAN, TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
State Street Bank and Trust Company will serve as custodian for the
Fund. American Stock Transfer & Trust Company will serve as transfer agent,
dividend disbursing agent and registrar for the Fund. See "CUSTODIAN, TRANSFER
AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR" for more information.
FEE TABLE
Shareholder Transaction Expenses
Sales Load (as a percentage of the Purchase Price per Share)(1).......................____%
Dividend Reinvestment Plan Fees ............................................. 0%
Annual Expenses (as a percentage of net assets attributable to Common Shares)(2)
Management Fees(3)................................................................... 0.65%
Interest Payments on Borrowed Funds(4).............................................. ____%
Other Expenses (5) ................................................................. ____%
Total Annual Expenses ................................................................... ____%
(1)
(2) Amounts are based on estimated amounts for the Fund's current fiscal year.
(3) The Fund currently pays the Adviser a monthly fee at an annual rate of
0.65% based on the Fund's average weekly net assets. See "MANAGEMENT OF THE
FUND."
(4) "Interest payments on borrowed funds" assumes a net cost of borrowing at an
annual rate of 4.01% on borrowed funds. This is equal to the net sum of the
assumed cost of leverage financing through reverse repurchase agreements and the
interest rate swaps used to hedge leverage borrowing costs, as set forth in the
table below.
Leverage interest cost - reverse repurchase agreements 2.13%
Plus: Interest rate swap - "pay fixed rate" leg 3.91%
Minus: Interest rate swap - "receive floating rate" leg -2.03%
------
Equals: Net cost of borrowing 4.01%
=====
If the Fund did not use interest rate swaps to hedge leverage interest
expense, projected "Interest payments on borrowed funds" would be 0.93%.
(5) "Other Expenses" are based on estimated amounts for the current fiscal year,
and include, among other things, administration fees, legal fees, the
independent auditor's fees, printing costs and fees payable to the Directors
that are not "interested persons" of the Fund (as defined in the 1940 Act). The
Fund will also pay organizational costs of approximately $[ ] and offering
expenses estimated to be $[ ], which will be charged to the Fund's capital at
commencement of operations and are not included under "Other Expenses."
EXAMPLE:
CUMULATIVE EXPENSES PAID FOR THE PERIOD OF:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
An investor would pay the
following expenses on a
$1,000 investment, assuming
a 5% annual return
throughout the periods $_______ $_______ $_______ $_______
THE FOREGOING FEE TABLE AND EXAMPLE ARE INTENDED TO ASSIST INVESTORS IN
UNDERSTANDING THE COSTS AND EXPENSES THAT AN INVESTOR IN THE FUND WILL BEAR
DIRECTLY OR INDIRECTLY.
The Example set forth above assumes reinvestment of all dividends and
distributions at net asset value, payment of a _______% sales load and an annual
expense ratio of _____%. The table above and the assumption in the Example of a
5% annual return are required by SEC regulations applicable to all investment
companies. THE EXAMPLE SHOULD NOT BE CONSIDERED AS A REPRESENTATION OF PAST OR
FUTURE EXPENSES OR ANNUAL RATES OF RETURN. ACTUAL EXPENSES OR ANNUAL RATES OF
RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE. In
addition, while the Example assumes reinvestment of all dividends and
distributions at net asset value, participants in the Fund's Dividend
Reinvestment Plan may receive Common Shares purchased or issued at a price or
value different from net asset value. See "Dividend Reinvestment Plan."
THE FUND
The Fund is a recently organized, diversified, closed-end management
investment company. The Fund was organized as a Maryland corporation on May 17,
2002 and is registered as an investment company under the Investment Company Act
of 1940 (the "1940 Act"). As a recently-organized entity, the Fund has no
operating history. The Fund's principal office is located at One Liberty Plaza,
165 Broadway, 36th Floor, New York, NY 10006-1404. The Common Shares have been
approved for listing on the Exchange, subject to official notice of issuance,
under the symbol "_____."
The Fund is a closed-end investment company. These companies differ
from open-end investment companies (commonly referred to as "mutual funds") in
that closed-end investment companies have a fixed capital base, whereas open-end
companies issue securities redeemable at net asset value at any time at the
option of the shareholder and typically engage in a continuous offering of their
shares. Accordingly, open-end investment companies are subject to periodic asset
in-flows and out-flows that can make the management of liquidity more difficult.
Closed-end investment companies do not face the prospect of having to liquidate
portfolio holdings to satisfy redemptions at the option of shareholders or
having to maintain cash positions to meet the possibility of such redemptions.
USE OF PROCEEDS
The proceeds of this offering, after payment of underwriting discounts
and commissions and offering and organizational expenses that do not exceed
$0.03 per Common Share, are estimated to be $_____________ (assuming no exercise
of the over-allotment option described under "Underwriting"). The Adviser has
agreed to pay for all of the Fund's organizational expenses and offering
expenses (other than the sales load) that exceed $0.03 per Common Share.
The net proceeds of this offering will be fully invested in accordance
with the policies set forth under "INVESTMENT OBJECTIVES, POLICIES AND
RESTRICTIONS" within six months of the initial public offering. Pending such
investment, those proceeds may be invested in U.S. government securities or
high-quality, short-term money market instruments.
INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
INVESTMENT OBJECTIVES
The Fund's primary investment objective is to provide a high level of
current income by investing primarily in MBS that, in the opinion of the Fund's
Adviser, offer an attractive combination of credit quality, yield and maturity.
The Fund's secondary investment objective is to provide capital appreciation.
Based on the Adviser's market assessment, the Fund will invest primarily in MBS
that offer an attractive combination of credit quality, yield and maturity. The
Fund's objectives are fundamental and cannot be changed without the approval of
the holders of a majority of outstanding Common Shares. A "majority of the
outstanding" means (1) 67% or more of the Common Shares present at a meeting, if
the holders of more than 50% of the Common Shares are present or represented by
proxy, or (2) more than 50% of the Common Shares, whichever is less.
INVESTMENT POLICIES
Under normal market conditions, the Fund will invest at least 80% of
its total assets in MBS (debt instruments secured by mortgages on real
residential or commercial property) and may invest up to 20% of its total assets
in U.S. government securities, or cash or other short-term instruments. The Fund
may invest up to 10% of its total assets in ABS secured by pools of assets, such
as credit card receivables or automobile loans, that may not represent interests
in real estate. Under normal market conditions, the Fund will be fully invested
in Agency MBS, Non-Agency RMBS, CMBS, and ABS.
If current market conditions persist, the Fund expects its initial
portfolio composition, once it is fully invested, to be approximately invested
MBS as summarized in the table below.
% of Total Assets
Agency MBS 30%
Non-Agency RMBS 35%
CMBS 35%
---
100%
The actual portfolio composition at any point in time will reflect the
Adviser's assessment of market conditions and relative value between classes of
assets and individual securities.
Once the Fund is fully invested and under normal market conditions, the
Adviser expects the minimum allocation to any one of the above MBS categories
will be 15% of total assets, and the maximum allocation to any one of the above
MBS categories will be 50% of total assets.
Credit Quality. The Fund will invest at least 80% of its total assets
in securities that at the time of investment are investment grade quality.
Investment grade quality bonds are those that are (1) issued or guaranteed by
the U.S. government or any agency or instrumentality thereof, (2) rated within
the four highest investment grades by at least one rating agency (Baa or BBB or
better by Moody's, S&P or Fitch) or (3) bonds that are unrated but judged to be
of comparable quality by the Fund's Adviser. The Fund may invest up to 20% of
its total assets in securities that at the time of investment are below
investment grade, including securities rated Ba, BB or B by Moody's, S&P or
Fitch, or are unrated. Bonds of below investment grade quality are regarded as
having predominately speculative characteristics with respect to the issuer's
capacity to pay interest and repay principal, and are commonly referred to as
"junk bonds" and "high risk high yield bonds." The Fund may invest up to 5% of
total assets in unrated MBS that represent the lowest tier of subordination from
the cash flows of a pool of mortgage loans and that are considered to be of
credit quality below securities rated "B." The Fund will not invest in
securities that at the time of purchase are in default.
These credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security if a rating
agency or the Adviser downgrades its assessment of that security. In determining
whether to retain or sell a security that a rating agency or the Adviser has
downgraded, the Adviser may consider such factors as its assessment of the
credit quality of the security, the price at which the security could be sold
and the rating, if any, assigned to the security by other ratings agencies.
Please refer to the Appendix to this prospectus for more information in
connection with Moody's, S&P's and Fitch's ratings of bonds.
Investment Process. To evaluate, invest and manage the Fund's portfolio
in Agency MBS, Non-Agency RMBS and ABS, the Adviser utilizes proprietary
analytical methods in performing scenario analysis to forecast cash flows and
expected total returns under different interest rate assumptions. Simulation
analysis is also performed to provide a broader array of potential patterns of
return over different interest rate scenarios. Such analysis may be applied to
individual securities or to an entire portfolio. The Adviser also performs
relative value analysis of individual securities based on yield, credit rating,
average life, expected duration and option-adjusted spreads. Other
considerations in the Adviser's investment process include analysis of
fundamental economic trend, consumer borrowing trends, home price appreciation
and relevant regulatory developments.
The Fund's investments in CMBS are selected and managed by the
Subadviser. This relationship combines the fixed income expertise of the Adviser
with the extensive real estate resources of Lend Lease Real Estate Investments,
Inc. ("LLREI"). Property type, geographic concentration, security structure and
fundamental economic strength are considered when assessing the attractiveness
of potential CMBS investments. The Subadviser utilizes the 10 local offices of
LLREI in performing due-diligence on properties and property markets to which an
individual CMBS has exposure.
Prepayment Characteristics. Under normal market conditions, the Fund
will attempt to reduce portfolio prepayment risk by investing in MBS, such as
certain Non-Agency RMBS, whose returns may be enhanced by faster prepayments,
and also by investing in MBS, such as certain Agency MBS, whose returns may be
enhanced by slower prepayments.
Use of Leverage. The Fund intends to utilize leverage representing not
more than 33 1/3% of the Fund's total assets. The Fund will borrow funds
primarily using reverse repurchase agreements, although it may use other sources
of borrowing if these are deemed advantageous to shareholders. Based on the
Adviser's assessment of market conditions, the Adviser may increase or decrease
the amount of leverage used.
The Adviser believes that under normal market conditions for a
portfolio with a substantial allocation to U.S. government securities, reverse
repurchase agreements provide a low cost form of financing. A reverse repurchase
agreement is a form of collateralized borrowing. Under a reverse repurchase
agreement, the Fund borrows money from a counterparty, generally for a period of
three months or less, at an agreed-upon rate of interest to an agreed-upon
maturity date. To collateralize the borrowing, the Fund places liquid high grade
securities having a value not less than the borrowed amount in a segregated
account with the custodian of the counterparty. The collateral's market value is
re-evaluated daily, and the borrowing is subject to minimum margin requirements,
such that the Fund may be required to post additional collateral with the
counterparty if the market value of collateral falls below an agreed-upon amount
in relation to the amount of the borrowing. Any cash flows on the collateral
accrue to the benefit of the Fund.
Under the 1940 Act, the Fund generally is not permitted to borrow
unless immediately after the borrowing the value of the Fund's total assets is
at least 300% of the principal amount of such borrowing (i.e., such principal
amount may not exceed 33 1/3% of the Fund's total assets). In addition, the Fund
is not permitted to declare any cash dividend or other distribution on its
Common Shares unless, at the time of such declaration, the value of the Fund's
total assets, less liabilities other than the borrowings, is at least 300% of
such principal amount. If the Fund borrows, the Fund intends, to the extent
possible, to prepay all or a portion of the principal amount of the borrowing to
the extent necessary in order to maintain the required asset coverage. Failure
to maintain certain asset coverage requirements could result in an event of
default and could entitle the debt holders to elect a majority of the Fund's
Board of Directors.
Assuming that the Fund's borrowings will represent approximately 33
1/3% of the Fund's total assets and pay interest set by a combination of a
reverse repurchase agreement and an interest rate swap transaction at an annual
average rate of 4.01% of the amount borrowed, the income generated by the Fund's
portfolio (net of estimated expenses) must exceed 1.34% in order to cover such
interest payments and other expenses specifically related to the borrowings. Of
course, these numbers are merely estimates, used for illustration. Actual
borrowing costs may vary frequently and may be significantly higher or lower
than the rate estimated above.
The following table is designed to illustrate the effect of leverage on
total return, assuming investment portfolio total returns (comprised of income
and changes in the value of investments held in the Fund's portfolio) of -10%,
-5%, 0%, 5% and 10%. These assumed investment portfolio returns are hypothetical
figures and are not necessarily indicative of the investment portfolio returns
expected to be experienced by the Fund. The table further reflects borrowings
representing 33 1/3% of the Fund's total assets, a 7.85% yield on the Fund's
investment portfolio, net of expenses, and the Fund's currently projected annual
interest payment rate set by a combination of a reverse repurchase agreement and
an interest rate swap transaction of 4.01% of the amount borrowed. See "Leverage
Risks" below for more information.
------------------------------------------ ------------- ------------- ------------- ------------- -------------
Assumed Portfolio Total Return (10)% (5)% 0 % 5% 10%
------------------------------------------ ------------- ------------- ------------- ------------- -------------
------------------------------------------ ------------- ------------- ------------- ------------- -------------
Common Share Total Return (17.01%) (9.51%) (2.01%) 5.49% 12.99%
------------------------------------------ ------------- ------------- ------------- ------------- -------------
Common Share total return is composed to two elements - the dividends
paid by the Fund (the amount of which is largely determined by the net
investment income of the Fund after paying interest on borrowings) and gains or
losses on the value of the securities the Fund owns. The table assumes that the
Fund is more likely to suffer capital losses than to enjoy capital appreciation.
The Fund may also borrow money as a temporary measure for extraordinary
or emergency purposes, including the payment of dividends and the settlement of
securities transactions which otherwise might require untimely dispositions of
Fund securities.
Leverage Risks. The use of leverage is a speculative investment
technique and involves certain risks to shareholders. These include the
possibility of higher volatility of the net asset value and market price of the
Common Shares.
As long as the rate of return on the assets purchased with the proceeds
of leverage exceeds the net cost of borrowings, including the effects of any
associated hedges, the investment of the proceeds of the leverage will generate
more return than will be needed to offset such borrowing costs. If so, the
excess will be available to pay higher dividends to shareholders. If, however,
the net cost of borrowings, including the effects of any associated hedges,
exceeds the rate of return on the assets purchased with the proceeds of
leverage, the return to shareholders will be less than if the Fund had not
leveraged.
Any decline in the net asset value of the Fund's investments will be
borne entirely by shareholders. Therefore, if the market value of the Fund's
portfolio declines, the leverage will result in a greater decrease in the Fund's
net asset value than if the Fund were not leveraged. Such greater net asset
value decrease will also tend to cause a greater decline in the market price for
the Common Shares.
To the extent that the Fund is required or elects to prepay any
borrowings, the Fund may need to liquidate investments to fund such prepayments.
Liquidation at times of adverse economic conditions may result in capital loss
and reduce returns to shareholders. In addition, such prepayment would likely
result in the Fund seeking to terminate early all or a portion of any swap
transaction. Early termination of the swap could result in a termination payment
by the Fund. See "Interest Rate Transactions" below and "RISK FACTORS - LEVERAGE
RISKS" for more information.
Interest Rate Transactions. Under current market conditions, in order
to reduce the variability of leverage borrowing costs from short-term reverse
repurchase agreements, the Fund intends to enter into interest rate swaps with
the effect of fixing net borrowing costs for longer periods of time.
Interest rate swaps involve the exchange with another party of
commitments to pay or receive interest (e.g., an exchange of floating rate
payments for fixed rate payments) on a notional principal amount. The purchase
of an interest rate cap entitles the purchaser, to the extent that a specified
index exceeds a predetermined interest rate, to receive payments of interest on
a notional principal amount from the party selling such interest rate cap. The
purchase of an interest rate floor entitles the purchaser, to the extent that a
specified index falls below a predetermined interest rate, to receive payments
of interest on a notional principal amount from the party selling such interest
rate floor.
The use of interest rate swaps or other hedging instruments is a highly
specialized activity that involves investment techniques and risks different
from those associated with ordinary portfolio security transactions. Depending
on the state of interest rates in general, the Fund's use of interest rate swaps
could enhance or decrease the Fund's net income. To the extent there is a
decline in interest rates, the value of the interest rate swap could decline,
and could result in a decline in the Fund's net asset value. In addition, if
short-term interest rates are lower than the rate of payment on the interest
rate swap, this will reduce the performance of the Fund. If, on the other hand,
short-term interest rates are higher than the Fund's rate of payment on the
interest rate swap, this will enhance the performance of the Fund.
The Fund may enter into interest rate transactions to preserve a return
or spread on a particular investment or portion of its portfolio, to protect
against any increase in the price of securities the Fund anticipates purchasing
at a later date, to effectively fix the rate of interest that it pays on one or
more borrowings or series of borrowings or to manage the effective maturity or
interest rate sensitivity of its portfolio. The Fund would use these
transactions as a hedge and not as a speculative investment. Interest rate
transactions are subject to risks comparable to those described above with
respect to other hedging strategies.
The Fund may enter into interest rate swaps, caps and floors on either
an asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities, and will usually enter into interest rate swaps on a
net basis, i.e., the two payment streams are netted out, with the Fund receiving
or paying, as the case may be, only the net amount of the two payments.
Because these interest rate transactions are entered into for good
faith hedging purposes, and inasmuch as segregated accounts will be established
with respect to such transactions, the Adviser and the Fund believe such
obligations do not constitute senior securities and, accordingly, will not treat
them as being subject to its borrowing restrictions. The net amount of the
excess, if any, of the Fund's obligations over its entitlements, with respect to
each interest rate swap, will be accrued on a daily basis and an amount of cash,
U.S. government securities or other liquid high grade debt obligations having an
aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account by a custodian that satisfies the
requirements of the 1940 Act. The Fund also will establish and maintain such
segregated accounts with respect to its total obligations under any interest
rate swaps that are not entered into on a net basis and with respect to any
interest rate caps and floors that are written by the Fund.
The Fund will enter into interest rate transactions only with banks and
recognized securities dealers believed by the Adviser to present minimal credit
risks. If there is a default by the other party to such a transaction, the Fund
will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
The Fund's use of interest rate swaps could increase or decrease or
have a corresponding impact on the net asset value of the Fund. To the extent
there is a decline in interest rates, the value of the interest rate swap could
decline, and could result in a decline in the Fund's net asset value. In
addition, if the counterparty to an interest rate swap defaults, the Fund would
be obligated to make the payments that it had intended to avoid. Depending on
whether the Fund would be entitled to receive net payments from the counterparty
on the swap, which in turn would depend on the general state of short-term
interest rates and the returns on the Fund's portfolio securities at that point
in time, such default could adversely affect the performance of the Common
Shares. See "RISK FACTORS - INTEREST RATE TRANSACTION RISK" AND "RISK FACTORS -
HEDGING TRANSACTIONS" for more information.
Total Rate of Return Swap Transactions.
--------------------------------------
Total rate of return swap transactions are a form of interest rate swap
transaction, which involve the exchange with a counterparty of commitments to
pay or receive interest on a notional principal amount. In a total rate of
return swap, one party to the agreement will agree to pay a floating rate of
interest on a notional principal amount, in exchange for the other party's
agreement to pay the published total rate of return, including coupon, price and
other return components, of a bond index or mutually agreed upon basket of fixed
income securities. The Fund may use total rate of return swap transactions in
order to hedge anticipated future investments.
OTHER INVESTMENT POLICIES
Hedging Transactions. The Fund may engage in various transactions for
hedging purposes ("Hedging Transactions"), including interest rate swap
transactions, interest rate caps and floors, total rate of return swap
transactions (see previous discussion at "Interest Rate Transactions"), futures,
options on securities and futures, short sales, when-issued purchases and
forward commitments, among others.
Hedging Transactions may be used to preserve a return or spread on a
particular investment within the portfolio or its entire portfolio and to manage
the effective maturity or interest rate sensitivity of its portfolio. Hedging
Transactions may also be used to attempt to protect against possible declines in
the market value of the Fund's assets resulting from downward trends in the debt
securities markets (generally due to an increase in interest rates), to protect
any unrealized gains in the value of the Fund's portfolio securities, to
facilitate the sale of such securities, to establish a position in the
securities markets as a temporary substitute for purchasing particular
securities, or to protect against rising leverage costs due to an increase in
interest rates.
Any, all or none of these techniques may be used at any time. There is
no particular strategy that requires use of one technique rather than another.
Use of any particular Hedging Transaction is a function of the overall strategy
adopted by the Fund and market conditions. Further, Hedging Transactions may be
used by the Fund in the future as they are developed or deemed by the Board of
Directors of the Fund to be appropriate and in the best interest of
shareholders. The Fund may not be able to hedge some of its investments due to
the cost or lack of availability of a Hedging Transaction.
The Fund intends to use these transactions as a hedge against market
fluctuations and to manage the interest rate risk of the Fund's investments and
not as speculative investments. The Fund may also purchase and sell (or write)
options on securities or indices of securities and may purchase or sell futures
contracts or options on futures contracts. Please see "OTHER INVESTMENT
POLICIES" in the Statement of Additional Information for more information on
Hedging Transactions.
Futures Contracts and Related Options.
The Fund may buy or sell financial futures contracts or purchase
options on such futures as a hedge against anticipated interest rate changes. A
futures contract sale creates an obligation by the Fund, as seller, to deliver
the specified type of financial instrument called for in the contract at a
specified future time for a specified price or, in "cash settlement" futures
contracts, to pay to (or receive from) the buyer in cash the difference between
the price in the futures contract and the market price of the instrument on the
specified date, if the market price is higher (or lower, as the case may be).
Options on futures contracts are similar to options on securities except that an
option on a futures contract gives the purchaser the right for the premium paid
to assume a position in a futures contract (a long position if the option is a
call and a short position if the option is a put).
The Fund's use of futures and options on futures will in all cases be
consistent with applicable regulatory requirements and in particular the rules
and regulations of the Commodity Futures Trading Commission ("CFTC") with which
the Fund must comply in order not to be deemed a commodity pool within the
meaning and intent of the Commodity Exchange Act and the regulations promulgated
thereunder.
Typically, an investment in a futures contract requires the Fund to
deposit with the applicable exchange or other specified financial intermediary
as security for its obligations an amount of cash or other specified debt
securities which initially is 1% to 5% of the face amount of the contract and
which thereafter fluctuates on a periodic basis as the value of the contract
fluctuates. An investment in options involves payment of a premium for the
option without any further obligation on the part of the Fund.
Regulations of the CFTC applicable to the Fund currently require that
all of the Fund's futures and options on futures transactions constitute bona
fide Hedging Transactions or be undertaken incidental to the Fund's activities
in the securities markets. In accordance with CFTC regulations, the Fund may not
purchase or sell futures contracts or options thereon if immediately thereafter
the sum of the amounts of initial margin deposits on the Fund's existing futures
positions and premiums paid for options on futures would exceed 5% of the fair
market value of the Fund's total assets. The Adviser reserves the right to
comply with such different standards as may be established by CFTC rules and
regulations with respect to the purchase or sale of futures contracts or options
thereon.
Eurodollar Futures Contracts and Options on Futures Contracts.
The Fund may make investments in Eurodollar futures and options thereon
for hedging purposes and, in each case, in accordance with the rules and
regulations of the CFTC. Eurodollar futures and options thereon are U.S.
dollar-denominated futures contracts or options thereon which are linked to the
London Interbank Offered Rate ("LIBOR"). Eurodollar futures contracts enable
purchasers to obtain a fixed rate for the lending of funds and sellers to obtain
a fixed rate for borrowings. The Fund intends to use Eurodollar futures
contracts and options thereon to hedge against changes in LIBOR, to which many
interest rate swaps, short-term borrowings and floating rate securities are
linked, and which can affect the market prices of many short-term securities.
When the Fund enters into a futures contact it makes a deposit of initial margin
and thereafter will be required to pay or entitled to receive variation margin
in an amount equal to the change in the value of the contract from the preceding
day.
When-Issued and Forward Commitment Transactions.
The Fund may purchase securities on a "when-issued" basis and may
purchase or sell securities on a "forward commitment" basis in order to hedge
against anticipated changes in interest rates and prices and secure a favorable
rate of return. When such transactions are negotiated, the price, which is
generally expressed in yield terms, is fixed at the time the commitment is made,
but delivery and payment for the securities take place at a later date, which
can be a month or more after the date of the transaction. At the time the Fund
makes the commitment to purchase securities on a when-issued or forward
commitment basis, it will record the transaction and thereafter reflect the
value of such securities in determining its net asset value. At the time the
Fund enters into a transaction on a when-issued or forward commitment basis, a
segregated account consisting of cash or liquid securities equal to the value of
the when-issued or forward commitment securities will be established and
maintained with the custodian and will be marked to market daily. On the
delivery date, the Fund will meet its obligations from securities that are then
maturing or sales of the securities held in the segregated asset account and/or
from then available cash flow. When-issued securities and forward commitments
may be sold prior to the settlement date. If the Fund disposes of the right to
acquire a when-issued security prior to its acquisition or disposes of its right
to deliver or receive against a forward commitment, it can incur a gain or loss
due to market fluctuation. There is always a risk that the securities may not be
delivered and that the Fund may incur a loss or will have lost the opportunity
to invest the amount set aside for such transaction in the segregated asset
account. Settlements in the ordinary course are not treated by the Fund as
when-issued or forward commitment transactions and, accordingly, are not subject
to the foregoing limitations even though some of the risks described above may
be present in such transactions.
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions. The Fund's investment objectives
and the following investment restrictions are fundamental and cannot be changed
without the approval of the holders of a majority of the outstanding Common
Shares and, if issued, a majority of any outstanding preferred shares, voting as
separate classes, which means for each class the lesser of (a) more than 50% of
the outstanding shares of such class or (b) 67% or more of the shares
represented at a meeting where more than 50% of the outstanding shares of such
class are represented. All other investment policies or practices are considered
by the Fund not to be fundamental and, accordingly, may be changed without
shareholder approval. If a percentage restriction on investment or use of assets
set forth below is adhered to at the time a transaction is effected, later
changes in percentage resulting from changing market values will not be
considered a deviation from policy.
Diversification.
---------------
The Fund may not, with respect to 75% of its total assets, invest more
than 5% of the value of its total assets (taken at market value at the time of
purchase) in the outstanding securities of any one issuer, or own more than 10%
of the outstanding voting securities of any one issuer, in each case other than
securities issued or guaranteed by the U.S. government or any agency or
instrumentality thereof.
The Fund may not invest 25% or more of the value of its total assets in
the securities of any one issuer, other than securities issued or guaranteed by
the U.S. government or any agency or instrumentality thereof.
The Fund may not invest 25% or more of the value of its total assets in
securities of issuers engaged in any one industry, other than securities issued
or guaranteed by the U.S. government or any agency or instrumentality thereof.
For purposes of these restrictions, the Fund generally treats each pool
of assets backing an issue of MBS or ABS as the issuer, rather than the sponsor
or depositor of the pool.
Leverage and Senior Indebtedness.
--------------------------------
The Fund may not issue senior securities in the form of indebtedness or
borrow money (including on margin if marginable securities are owned), other
than for the temporary purposes permitted by the 1940 Act, in excess of 33 1/3%
of the Fund's total assets (including the proceeds of such senior securities
issued and money borrowed) or pledge its assets other than to secure such
issuances or borrowings or in connection with, to the extent permitted under the
1940 Act and consistent with the guidelines promulgated in Rel. 10666, good
faith hedging transactions, reverse repurchase agreements, when-issued and
forward commitment transactions and similar investment strategies. The Fund's
obligations under interest rate swaps maintained in accordance with the
guidelines in Rel. 10666 will not be treated as senior securities.
The Fund may not pledge, hypothecate, mortgage or otherwise encumber
its assets, except to secure issuances or borrowings permitted by the
restriction above. Collateral arrangements with respect to reverse repurchase
agreements or to margin for futures contracts and options are not deemed to be
pledges or other encumbrances for purposes of this restriction because the Fund
will comply with the guidelines in Rel. 10666, including the collateral
requirements.
Securities Lending.
------------------
The Fund may not make loans of money or property to any person, except
through loans of portfolio securities to qualified institutions, the purchase of
debt obligations in which the Fund may invest consistently with the Fund's
investment objectives and policies and investment restrictions or the temporary
investment in repurchase agreements with qualified institutions. The Fund will
not lend portfolio securities if, as a result, the aggregate of such loans
exceed 33 1/3% of the value of the Fund's total assets (including such loans).
Underwriting.
------------
The Fund may not underwrite the securities of other issuers, except to
the extent that in connection with the disposition of portfolio securities or
the sale of its own Common Shares the Fund may be deemed to be an underwriter.
Other Fundamental Investment Restrictions.
-----------------------------------------
The Fund may not invest for the purpose of exercising control over
management of any company.
The Fund may not purchase real estate or interests therein other than
MBS, ABS and similar instruments.
The Fund may not purchase or sell commodities or commodity contracts
except for hedging purposes.
The Fund may not, except in the case of short sales against the box,
make any short sale of securities, unless, after giving effect to such sale, the
market value of all securities sold short does not exceed 10% of the value of
the Fund's total assets and the Fund's aggregate short sale of a particular
class of securities does not exceed 25% of the then outstanding securities of
that class.
Non-Fundamental Investment Limitations. The following investment
limitations are not fundamental and may be changed by the Board of
Directors.
Quality of Investments.
The Fund will invest at least 80% of its total assets in bonds of
investment grade quality at the time of investment. Investment grade quality
means that such bonds are 1) issued or guaranteed by the U.S. government or any
agency or instrumentality thereof, 2) rated by at least one of the national
rating agencies within the four highest grades (Baa or BBB or better by Moody's,
S&P or Fitch), or 3) unrated but judged to be of comparable quality by the
Adviser. The Fund's credit quality investment restrictions apply only at the
time a security is purchased, and the Fund is not required to dispose of a
security if a rating agency or the Adviser downgrades its assessment of that
security. The Fund may invest up to 5% of total assets in unrated MBS that
represent the lowest tier of subordination from the cash flows of a pool of
mortgage loans and that are considered to be of credit quality below securities
rated "B." The Fund will not invest in securities that at the time of purchase
are in default.
Assets Secured by Interests in Real Estate.
------------------------------------------
The Fund will invest at least 80% of its total assets in MBS, which
for the purposes of this limitation, will be defined as debt instruments secured
by interests in real estate. Prior to a change, if any, of this policy, the Fund
will provide the shareholders with at least 60 days prior notice of such change
in accordance with Rule 35d-1(c) promulgated under the 1940 Act.
Other Assets.
------------
The Fund may invest up to 20% of its total assets in non-MBS securities
issued or guaranteed by the U.S. government or any agency or instrumentality
thereof that are not MBS or ABS or in cash and other short-term instruments,
including repurchase agreements.
Prohibited Investments.
----------------------
The Fund may not invest in corporate bonds or other corporate
indebtedness, except for instruments that are secured by interests in real
estate or other pools of assets and, therefore, are MBS or ABS or are guaranteed
by the U.S. government or any agency or instrumentality thereof. The Fund may
not invest in the following types of derivative MBS and ABS: interest-only and
principal-only classes of MBS and ABS; classes of MBS and ABS whose cash flows
are substantially interest-only or principal-only in nature; inverse floating
rate securities, and classes of floating rate MBS and ABS that carry a floating
rate of interest with a levered relationship to the index on which the floating
rate is based.
DESCRIPTION OF FUND INVESTMENTS
The discussion below describes the principal categories of securities
in which the Fund intends to invest.
AGENCY MBS
Agency MBS are securities that represent participations in, are secured
by or payable from, mortgage loans secured by real residential property. Agency
MBS include the following:
Agency Mortgage Pass-through Certificates. The agency mortgage
pass-through certificates in which the Fund will invest include those issued or
guaranteed by the Government National Mortgage Association ("GNMA", or "Ginnie
Mae"), the Federal National Mortgage Association ("FNMA", or "Fannie Mae"), and
the Federal Home Loan Mortgage Corporation ("FHLMC", or "Freddie Mac").
These mortgage pass-through certificates provide for the pass-through
to investors of their pro rata share of monthly payments (including any
prepayments) made by the individual borrowers on the pooled mortgage loans, net
of any fees paid to the guarantor of such securities and the servicer of the
underlying loans. GNMA, FNMA and FHLMC guarantee timely distributions of
interest and principal to shareholders.
GNMA is a wholly-owned corporate instrumentality of the U.S. Department
of Housing and Urban Development. The full faith and credit of the U.S.
government is pledged to payment of all amounts that may be required to be paid
under GNMA's guaranty. FNMA and FHLMC are federally chartered and privately
owned corporations created pursuant to the Federal National Mortgage Association
Charter Act of 1938 and the Emergency Home Finance Act of 1970, respectively.
The obligations of FNMA and FHLMC are obligations solely of those respective
corporations, and are not backed by the full faith and credit of the U.S.
government.
Agency Collateralized Mortgage Obligations ("Agency CMOs"). Agency CMOs
are debt obligations issued by GNMA, FNMA or FHLMC. CMOs, which may be Agency or
Non-Agency, are backed by mortgage pass-through securities (discussed above) and
are evidenced by a series of bonds or certificates issued in multiple "classes."
The principal and interest on the underlying mortgage assets may be allocated
among the several classes of a series of CMOs in many ways.
In a CMO, a series of bonds or certificates are issued in multiple
classes. Each class of CMO may be issued with a specific fixed or floating
coupon rate and has a stated maturity or final scheduled distribution date.
Principal prepayments on the underlying mortgage pass-through securities may
cause the CMOs to be retired substantially earlier than their stated maturities
or final scheduled distribution dates.
The principal of and interest on the underlying mortgage pass-through
securities may be allocated among the several classes of a CMO in many ways. As
a result of this allocation process, certain classes of a CMO may have more
predictable cash flows, while the cash flows of other classes may be less
predictable. CMO classes with less predictable cash flows will generally exhibit
more volatile market prices and yields.
Agency CMOs issued after 1991 have generally elected to be treated, for
federal income tax purposes, as a Real Estate Mortgage Investment Conduit (a
"REMIC"). An issuer of CMOs issued after 1991 must elect to be treated as a
REMIC or it will be taxable as a corporation under rules regarding taxable
mortgage pools.
NON-AGENCY RMBS
Non-Agency RMBS are debt obligations issued by private originators or
investors in residential mortgage loans. Non-Agency RMBS generally are issued as
CMOs, and are backed by pools of whole mortgage loans or by mortgage
pass-through certificates. Under normal market conditions, the Fund will invest
to a degree in subordinated Non-Agency RMBS.
Non-Agency RMBS generally are securitized in senior / subordinated
structures, or structured with one or more of the types of credit enhancement
described below under "CREDIT SUPPORT." In senior/subordinated structures, the
senior class investors have greater protection against potential losses on the
underlying mortgage loans or assets than the subordinated class investors, who
assume the first losses if there are defaults on the underlying loans. See "RISK
FACTORS - CREDIT RISKS" for more information.
CMBS
CMBS are multi-class debt or pass-through or pay-through securities
backed by a mortgage loan or pool of mortgage loans on commercial real estate,
such as industrial and warehouse properties, office buildings, retail space and
shopping malls, multifamily properties, hotels and motels, nursing homes, and
medical facilities. Assets underlying CMBS may relate to many properties, only a
few properties, or to a single property. Each commercial mortgage loan that
underlies a CMBS has certain distinct characteristics. Under normal market
conditions, the Fund will invest to a significant degree in subordinated CMBS.
Commercial mortgage loans are sometimes non-amortizing and often not
fully amortizing. At their maturity date, repayment of the remaining principal
balance or "balloon" is due and is repaid through the attainment of an
additional loan, the sale of the property or the contribution of additional
capital.
Unlike most single family residential mortgages, commercial real estate
loans often contain provisions that substantially reduce the likelihood that
they will be prepaid. The provisions generally impose significant prepayment
penalties on loans and, in some cases, there may be prohibitions on principal
prepayments for several years following origination.
Changing real estate markets may adversely affect both the value of the
underlying collateral and the borrower's ability to meet contractual
obligations, either of which may lead to delinquencies, defaults, modifications
or foreclosure that in turn may lead to the realization of losses in CMBS.
CMBS have been issued in public and private transactions by a variety
of public and private issuers. The Fund may from time to time purchase CMBS
directly from issuers in negotiated or non-negotiated transactions or from a
holder of such CMBS in the secondary market.
Commercial mortgage securitizations generally are senior/subordinated
structures. The senior class investors have greater protection against potential
losses on the underlying mortgage loans or assets than the subordinated class
investors who take the first loss if there are defaults on the underlying
commercial mortgage loans. Other protections, which may benefit all of the
classes including the subordinated classes, may include issuer guarantees,
additional subordinated securities, cross-collateralization,
over-collateralization and the equity in the underlying properties. See "RISK
FACTORS - CREDIT RISKS" for more information.
ABS
ABS, which may be real estate-related or non-real estate related, are
collateralized by pools of assets such as home equity loans and lines of credit,
credit card receivables, automobile loans, equipment receivables, and other
forms of indebtedness, leases or claims to identifiable cash flows.
Real estate-related ABS are secured by pools of loans generally secured
by property and buildings. Real estate-related ABS include issues secured by
second liens on residential property, commonly referred to as "home equity
loans" and "home equity lines-of-credit." Real estate-related ABS may also be
secured by other forms of residential dwellings such as manufactured housing and
by loans used to finance the building and establishment of franchise businesses.
Non-real estate-related ABS are secured by pools of loans, receivables,
leases or other forms of indebtedness or claims to identifiable cash flows which
are not secured by property or buildings. Investment in non-real estate-related
ABS will be limited to 10% of total assets.
ABS present certain risks that are not presented by MBS. ABS generally
do not have the benefit of the same type of security interest in the related
collateral, or may not be secured by a specific interest in real estate. See
"RISK FACTORS - CREDIT RISKS" for more information.
CREDIT SUPPORT
Many of the Non-Agency RMBS, CMBS and ABS in which the Fund will invest
are issued in a senior/subordinated structure. In these structures, the senior
class investors have greater protection against potential losses on the
underlying loans or assets than do the subordinated class investors.
In senior/subordinated structures, Non-Agency RMBS, CMBS and ABS are
often backed by a pool of assets representing the obligations of a number of
different parties. To lessen the effect of a failure by obligors on underlying
assets to make payments, such securities may contain elements of credit support.
Such credit support falls into two categories: (1) liquidity protection and (2)
protection against losses resulting from ultimate default by an obligor on the
underlying assets. Liquidity protection generally refers to the provision of
advances, typically by the entity administering the pool of assets, to ensure
that the pass-through of payments due on the underlying pool occurs in a timely
fashion. Protection against losses resulting from ultimate default enhances the
likelihood of ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained by the issuer or sponsor from
third parties (referred to herein as "third party credit support"), through
various means of structuring the transaction or through a combination of such
approaches. The Fund will not pay any additional fees for such credit support,
although the existence of credit support may increase the price the Fund pays
for a security.
MBS EXPECTED AVERAGE MATURITY AND STATED FINAL MATURITY
The stated final maturity of an MBS or ABS often corresponds to the
last scheduled payment of the longest maturity individual loan in the underlying
pool of assets. The expected average maturity of an MBS or ABS, often referred
to as Weighted Average Life, as described below, depends upon the expected
timing of all the return of principal from the security, which in turn depends
upon assumptions regarding the expected cash flow from the underlying pool,
including scheduled principal, prepayments and other factors that may affect
cash flow.
Weighted Average Life is a measure of expected average maturity for an
MBS or ABS that pays principal to investors over a period of time, rather than
on a single maturity date. It is equal to the projected weighted average time to
return of principal from the MBS or ABS, based upon assumptions regarding
prepayments and other factors that may affect cash flow.
The Adviser primarily intends to select securities that, at the time of
purchase, based upon the Adviser's assumptions regarding prepayments and other
factors, have a Weighted Average Life of less than 13 years.
MBS RATED BELOW INVESTMENT GRADE
The Fund may invest up to 20% of its total assets in MBS that at the
time of investment are below investment grade, including securities rated Ba, BB
or B by Moody's, S&P or Fitch, or that are unrated and of equivalent credit
quality. Bonds of below investment grade quality are regarded as having
predominately speculative characteristics with respect to the issuer's capacity
to pay interest and repay principal, and are commonly referred to as "junk
bonds" and "high risk high yield bonds." The Fund may invest up to 5% of total
assets in unrated MBS that represent the lowest tier of subordination from the
cash flows of a pool of mortgage loans and that are considered to be of credit
quality below securities rated "B." The Fund will not invest in securities that
at the time of purchase are in default.
Generally, lower rated or unrated securities of equivalent or lower
credit quality offer a higher return potential than higher rated securities but
involve greater volatility of price and greater risk of loss of income and
principal, including the possibility of a default or bankruptcy of the issuers
of such securities. Lower rated securities and unrated securities of equivalent
credit quality will likely have larger uncertainties or major risk exposure to
adverse conditions and are predominantly speculative, and may have limited
marketability.
U.S. GOVERNMENT SECURITIES
U.S. government securities include issues of the U.S. Treasury, such as
bills, certificates of indebtedness, notes and bonds, as well as obligations of
agencies and instrumentalities of the U.S. government. U.S. Treasury securities
are backed by the full faith and credit of the U.S. government. Obligations of
agencies and instrumentalities of the U.S. government often are not backed by
the full faith and credit of the U.S. government.
NEW TYPES OF INSTRUMENTS
Investors should note that new types of MBS and hedging instruments in
which the Fund may invest are developed and marketed from time-to-time and that,
consistent with its investment restrictions, the Fund expects to invest in those
securities and instruments that the Adviser believes may assist the Fund in
achieving its investment objectives. Investments in these securities and
instruments will be disclosed to shareholders in the Fund's annual, semi-annual
and other reports.
RISK FACTORS
An investment in the Fund is subject to a number of risks and special
considerations. The net asset value of the Fund's Common Shares will fluctuate
with and be affected by, among other things, credit risk, interest rate risk,
bond market risk, prepayment risk, leverage risk and risks associated with
interest rate swaps and other hedging transactions. In addition, an investment
in Common Shares will be subject to discount risk, economic sector risk and
inflation risk. Each of these risks is more fully described below.
RECENTLY ORGANIZED
The Fund is a recently organized, diversified, closed-end management
investment company and has no operating history.
DISCOUNT FROM NET ASSET VALUE
The shares of closed-end investment companies such as the Fund
frequently trade at a discount from their net asset values, but may trade at a
premium. The Fund cannot predict whether its Common Shares will trade at, above
or below net asset value. The value of the debt securities in the Fund's
investment portfolio and its net asset value will fluctuate, generally
inversely, with changes in interest rates. The possibility that Common Shares of
the Fund will trade at a discount from net asset value is a separate risk from
the risk that the Fund's net asset value will decrease. The Fund will employ
various hedging transactions to hedge against the negative fluctuations in net
asset value that may result from certain changes in interest rates. Market price
risk may be greater for investors who intend to sell their Common Shares in a
relatively short period after completion of this offering.
In an effort to reduce or eliminate a market value discount from net
asset value, the Fund may, in accordance with applicable law and subject to the
rights of holders of any preferred shares, repurchase Common Shares in the open
market or tender for Common Shares at net asset value as of the close of
business on the date that the tender offer ends, in either case, in amounts
deemed advantageous to the Fund and the holders of Common Shares. The Fund may
incur debt to finance repurchases, which poses certain risks to holders of
Common Shares. Any borrowings for this purpose will be subject to the asset
coverage requirements and borrowing restrictions of the 1940 Act and any
investment guidelines established in connection with preferred shares. There can
be no assurance that the Board of Directors will authorize such repurchases
and/or tender offers or that, if undertaken, such actions will result in an
improvement in the price of the Common Shares. See "DETERMINATION OF NET ASSET
VALUE" and "REPURCHASE OF COMMON SHARES AND CONVERSION TO OPEN-END STATUS" for
more information.
INTEREST RATE RISK
Interest rate risk is the risk that bonds, and the Fund's net assets,
will decline in value because of changes in interest rates. Generally, MBS will
decrease in value when interest rates rise and increase in value when interest
rates fall. This means that the net asset value of the Fund's Common Shares will
fluctuate with interest rate changes and the corresponding changes in the value
of the Fund's MBS holdings. The values of the longer-term bonds fluctuate more
in response to changes in interest rates than do the values of shorter-term
bonds. Conversely, the values of non-investment grade bonds are less likely than
those of investment grade bonds to fluctuate inversely with changes in interest
rates. The Fund's use of leverage, as described below, will tend to increase the
interest rate risk of the Fund's Common Shares.
INFLATION RISK
Inflation risk is the risk that the value of assets or income from
investments will be worth less in the future as inflation decreases the value of
money. As inflation increases, the real value of the Common Shares and
distributions can decline.
CREDIT RISK
Credit risk is the risk that one or more bonds in the Fund's portfolio
will (1) decline in price due to deterioration of the issuer's or underlying
pool's financial condition or other events or (2) fail to pay interest or
principal when due. The Fund will invest at least 80% of its total assets in
investment grade quality bonds 1) issued or guaranteed by the U.S. government or
any agency or instrumentality thereof, 2) rated BBB or Baa or higher by at least
one rating agency or 3) bonds that are unrated by judged to be of comparable
quality by the Adviser. The Fund may invest up to 20% of its total assets in
bonds that are rated BB, Ba or B or are unrated. The Fund may invest up to 5% of
total assets in unrated MBS that represent the lowest tier of subordination from
the cash flows of a pool of mortgage loans and that are considered to be of
credit quality below securities rated "B." The Fund will not invest in
securities that at the time of purchase are in default.
Under normal market conditions, the Fund will invest to a significant
degree in subordinated classes of MBS, including Non-Agency RMBS and CMBS, and
may invest in subordinated classes of ABS. Subordinated classes of MBS and ABS
are entitled to receive repayment of principal only after all such required
principal payments have been made to more senior classes, and also have
subordinated rights as to receipt of interest distributions. Such subordinated
classes are subject to a greater degree of non-payment than are senior classes
or MBS guaranteed by an agency or instrumentality of the U.S. government. In
addition, in certain market conditions, the market for subordinated classes of
MBS may not be as liquid as for other fixed income securities.
In general, lower rated MBS carry a greater degree of risks associated
with negative developments, such as a general economic downturn or an increase
in delinquencies in the pool of underlying mortgages that secure an MBS, than
higher grade MBS. Accordingly, the prices of these lower grade bonds are more
sensitive to negative developments than are the prices of higher grade
securities. Bonds of below investment grade quality are predominantly
speculative with respect to the issuer's or pool's capacity to pay interest and
repay principal when due and therefore involve a greater risk of default.
PREPAYMENT RISK
The investment characteristics of MBS and real estate-related ABS
differ from those of traditional debt securities. The major differences include
the fact that, on certain MBS and real estate related ABS, prepayments of
principal may be made at any time. Prepayment rates are influenced by changes in
current interest rates and a variety of economic, geographic, social and other
factors and cannot be predicted with certainty.
In periods of declining mortgage interest rates, prepayments on MBS and
real estate-related ABS generally increase. If interest rates in general also
decline, the amounts available for reinvestment by the Fund during such periods
are likely to be reinvested at lower interest rates than the Fund was earning on
the securities that were prepaid. Such securities may decrease more in value as
a result of increases in interest rates and may benefit less than other fixed
income securities from declining interest rates because of the risk of
prepayment.
In general, changes in both prepayment rates and interest rates will
change the total return of MBS and real estate related ABS. Under certain
interest rate or prepayment scenarios, the Fund may fail to recoup fully its
investment in such securities, even if the securities have been assigned the
highest rating by a ratings agency or are issued or guaranteed by the U.S.
government or one if its agencies or instrumentalities. The Fund may use hedging
techniques to attempt to mitigate this risk.
Unlike most single family residential mortgages, commercial real estate
mortgages often contain provisions that substantially reduce the likelihood that
they will be prepaid. The provisions generally impose significant prepayment
penalties on loans and, in some cases, there may be prohibitions on principal
prepayments for several years following origination.
Under normal market conditions, the Fund will attempt to reduce
portfolio prepayment risk by investing in MBS, such as certain Non-Agency RMBS,
whose returns may be enhanced by faster prepayments, and also investing in MBS,
such as certain Agency MBS, whose returns may be enhanced by slower prepayments.
BOND MARKET RISK
The value of debt securities tend to fall as interest rates rise. In
addition, such securities that have longer maturities tend to fluctuate more in
price in response to changes in market interest rates. A decline in the prices
of the portfolio securities owned by the Fund would cause a decline in the
Fund's net asset value, which in turn is likely to cause a corresponding in the
market price of the Common Shares.
Investing in MBS and ABS involves certain risks. The yield spreads of
the Fund's securities, or yield differentials between the Fund's securities and
Treasury or Agency securities with comparable maturities, may widen, causing the
Fund's assets to underperform Treasury and Agency securities. The amount of
public information available about the MBS and ABS in the Fund's portfolio is
generally less than that for corporate equities or bonds, and the investment
performance of the Fund may therefore be more dependent on the analytical
capabilities of the Adviser than if the Fund were a stock fund or corporate bond
fund. The secondary market for certain types of MBS and ABS may be less
well-developed or liquid than many other securities markets, which may adversely
affect the Fund's ability to sell its bonds at attractive prices.
ECONOMIC SECTOR RISK
Under normal market conditions, the Fund will be fully invested in
Agency MBS, Non-Agency RMBS, CMBS and ABS. The Fund invests primarily in debt
instruments secured by interests in real estate. This may make the Fund more
susceptible to adverse economic, political or regulatory occurrences that affect
real estate, and may increase the potential for fluctuation in the net asset
value of the Fund's Common Shares.
LEVERAGE RISK
The use of leverage creates an opportunity for increased net income and
returns, but also creates certain risks for shareholders. In borrowing, the Fund
will pay interest on borrowed money and may incur other transactions costs, and
will pledge some assets as collateral. Borrowing expenses can exceed the income
received or capital appreciation realized by the Fund from any securities
purchased with borrowed money.
The Fund's leverage strategy may not be successful, and creates certain
risks for shareholders. Any decline in the net asset value of the Fund's
investments will be borne entirely by shareholders. Therefore, if the market
value of the Fund's portfolio declines, the leverage will result in a greater
decrease in net asset value to shareholders than if the Fund were not leveraged.
Such greater net asset value decrease would also tend to cause a greater decline
in the market price for the Common Shares.
To the extent that the Fund is required or elects to prepay any
borrowings, the Fund may need to liquidate investments to fund such prepayments.
Liquidation at times of adverse economic conditions may result in capital loss
and reduce returns to shareholders. In addition, such prepayment would likely
result in the Fund seeking to terminate early all or a portion of any interest
rate swap transaction used to hedge leverage borrowing costs. Early termination
of the swap could result in a termination payment by the Fund.
In times of volatile markets, a drop in the value of the Fund's
portfolio securities may cause the Fund to violate agreed upon loan covenants.
This could result in a default under such loan agreements causing an early call
of a loan and/or the payment of penalties to the lender; thereby causing a loss
of income and/or principal to investors in the Fund. The Fund will only borrow
when the Adviser believes that such borrowings will benefit the Fund after
taking into account considerations such as interest income and possible gains or
losses upon liquidation.
INTEREST RATE TRANSACTION RISK
The Fund may enter into interest rate swap or cap transactions to
attempt to protect itself from increasing borrowing costs resulting from
increasing short-term interest rates. A decline in interest rates may result in
a decline in the value of the swap or cap which may result in a decline in the
net asset value of the Fund.
Interest rate swaps do not involve the delivery of securities or other
underlying assets or principal. Accordingly, the risk of loss with respect to
interest rate swaps is limited to the net amount of interest payments that the
Fund is contractually obligated to make. If the counterparty defaults, the Fund
would not be able to use the anticipated net receipts under the swap to offset
the rate of interest on borrowings. Depending on whether the Fund would be
entitled to receive net payments from the counterparty on the swap, which in
turn would depend on the general state of short-term interest rates and the
returns on the Fund's portfolio securities at that point in time, such default
could negatively impact the net asset value of the Fund's Common Shares.
Although this will not guarantee that the counterparty does not default, the
Fund will not enter into an interest rate swap with any counterparty that the
Adviser believes does not have the financial resources to honor its obligation
under the interest rate swap transaction. Further, the Adviser will monitor the
financial stability of a counterparty to an interest rate swap transaction in an
effort to protect the Fund against the risk of counterparty default. In
addition, at the time an interest rate swap reaches its scheduled termination
date, there is a risk that the Fund will not be able to obtain a replacement
transaction or that the terms of the replacement transaction will not be as
favorable as on the expiring transaction. If this occurs, it could impair the
performance of the Fund's Common Shares.
If the current net market value of an interest rate swap is negative to
the Fund and positive to the counterparty, the Fund will be required in most
instances under the terms of the swap agreement to pledge some assets as
collateral. The market of collateral that the Fund is required to post would
generally be equal to or greater than the net market value of the interest rate
swap, and the Fund could be exposed to additional margin requirements, depending
upon subsequent changes in the market value of the collateral and the net market
value of the interest rate swap.
Total Rate of Return Swap Transactions. Total rate of return swap
transactions involve risks that are similar to those of interest rate swaps, and
also involve additional risks. The total rate of return of a published index or
basket of bonds may exhibit substantial volatility. The total rate of return of
an index in any given period may be positive or negative, and if it is negative
and the Fund is receiving the total rate of return of that index in its part of
the swap agreement, the Fund would be required to make a payment to the
counterparty in addition to that required on the other, generally floating rate,
part of the swap agreement. Also, the index on which the swap is based may cease
to be published, or unusual market conditions in the basket of bonds on which
the swap is based may prevent the index total rate of return from being
calculated, in which case other provisions in the swap agreement may be invoked
which could cause the Fund to lose some of the anticipated benefit from the
swap, or otherwise reduce the Fund's return.
HEDGING TRANSACTIONS
The Fund may employ a variety of Hedging Transactions, including
interest rate swap transactions, interest rate caps and floors, total rate of
return swap transactions (see "INTEREST RATE TRANSACTION RISK" above), futures,
options on securities and futures, short sales, when-issued purchases and
forward commitments. The Hedging Transactions expected to be employed by the
Fund involve certain risks, and there can be no assurance that any such
transaction used will succeed. The principal risks relating to the use of
Hedging Transactions are: (a) possible imperfect correlation between changes in
the value of the hedging instrument and the changes in the market value of the
underlying securities; (b) possible lack of a liquid secondary market for
closing out or offsetting a hedging position; (c) losses on hedging positions
resulting from general movements in securities prices or interest rate movements
not anticipated by the Adviser, and (d) the possibility that the Fund could be
obligated to pay variation margin on a hedging position at a time when it would
be disadvantageous to do so.
While the use of Hedging Transactions should tend to minimize the risk
of loss resulting from a decline in the value of hedged portfolio securities,
these transactions will tend to limit any potential gain that could result from
an increase in the value of these securities. Such transactions also are subject
to the risk that, if the Adviser is incorrect in its forecast of interest rates,
market values or other economic factors affecting such a transaction, the Fund
would have been better off if it had not entered into the transaction. Please
refer to "ADDITIONAL RISK FACTORS" in the Statement of Additional Information
for more information on the risks associated with Hedging Transactions.
Futures Transactions. The variable degree of correlation between price
movements of futures contracts and price movements in the position being hedged
creates the possibility that losses on the hedge may be greater than gains in
the value of the Fund's position. In addition, futures and futures option
markets may not be liquid in all circumstances. As a result, in volatile
markets, the Fund may not be able to close out a transaction without incurring
losses substantially greater than the initial deposit. Although the contemplated
use of these contracts should tend to minimize the risk of loss due to a decline
in the value of the hedged position, at the same time they tend to limit any
potential gain which might result from an increase in the value of such
position. The ability of the Fund to hedge successfully will depend on the
Adviser's ability to forecast pertinent market movements, which cannot be
assured. Finally, the daily deposit requirements in futures contracts create an
ongoing greater potential financial risk than do options purchased by the Fund,
where the exposure is limited to the cost of the initial premium. Losses due to
hedging transactions will reduce net asset value. Income earned by the Fund from
its hedging activities generally will be treated as capital gains.
ANTI-TAKEOVER PROVISIONS
Certain anti-takeover provisions adopted by the Fund will make a change
in the Fund's business or management without the approval of the Board of
Directors more difficult and might have the effect of depriving shareholders of
an opportunity to sell their Common Shares at a premium above the prevailing
market price. For a discussion of these and other anti-takeover provisions see
"DESCRIPTION OF CAPITAL STOCK - ANTI-TAKEOVER PROVISIONS OF THE ARTICLES OF
INCORPORATION AND BY-LAWS."
DIVIDENDS AND DISTRIBUTIONS
Subject to market conditions, the Fund will seek to provide its
shareholders with a relatively stable level of dividends per share paid from net
investment income. The Board of Directors may, in its sole discretion, change
the Fund's current dividend policy in response to market or other conditions.
The Fund's ability to maintain a stable level of dividends is a function of the
yield generated by the Fund's investments, which depends on market conditions at
the time those investments are made and on the performance of those investments.
Capital gains, if any, will be distributed at least annually.
Shareholders may elect to participate in the Fund's dividend reinvestment plan.
See "DIVIDEND REINVESTMENT PLAN." "Net investment income", as used above,
includes all dividends, interest and other income earned by the Fund on its
portfolio holdings, net of the Fund's expenses. Monthly notices will be provided
in accordance with Section 19(a) of the 1940 Act. For a discussion of certain
possible restrictions on the Fund's ability to declare dividends on the Common
Shares see "INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS - INVESTMENT
POLICIES - Leverage and Borrowing."
The Fund will not be permitted to declare dividends or other
distributions with respect to the Common Shares or purchase Common Shares unless
at the time thereof the Fund meets certain asset coverage requirements,
including those imposed by the 1940 Act. Failure to pay dividends or other
distributions could result in the Fund ceasing to qualify as a regulated
investment company under the Internal Revenue Code.
PORTFOLIO TURNOVER
The Fund may engage in portfolio trading when considered appropriate,
but short-term trading will not be used as the primary means of achieving the
Fund's investment objectives. Although the Fund cannot accurately predict its
portfolio turnover rate, it is not expected to exceed 100% of the entire
portfolio annually under normal market conditions. However, there are no limits
on the rate of portfolio turnover, and investments may be sold without regard to
length of time held when, in the opinion of the Adviser, investment
considerations warrant such action. A higher turnover rate results in
correspondingly greater transactional expenses which are borne by the Fund. High
portfolio turnover may result in the realization of net short-term capital gains
by the Fund which, when distributed to shareholders, may be taxable as ordinary
income. See the Statement of Additional Information for more information on
taxation.
RECENT DEVELOPMENTS
As a result of the terrorist attacks on the World Trade Center and the
Pentagon on September 11, 2002, some of the U.S. securities markets were closed
for a four-day period. These terrorist attacks and related events have led to
increased short-term market volatility and may have long-term effects on U.S.
and world economies and markets. These long-term effects may include changes in
default rates, property values, rental income and access to insurance coverage.
These changes may lag behind general economic conditions. In the future,
disruptions of the financial markets could also impact interest rates, secondary
trading, ratings, credit risk, inflation and other factors relating to the
Common Shares.
Given the above-described investment risks inherent in the Fund,
investment in Common Shares of the Fund should not be considered a complete
investment program and is not appropriate for all investors. You should
carefully consider your ability to assume these risks before making an
investment in the Fund.
MANAGEMENT OF THE FUND
BOARD OF DIRECTORS
The management of the Fund, including general supervision of the duties
performed by the Adviser and Subadviser, is the responsibility of the Board of
Directors. See "DIRECTORS AND OFFICERS" in the Statement of Additional
Information for more information.
ADVISER
The Fund has engaged Hyperion Capital Management, Inc., a leading MBS
manager, to provide professional investment management for the Fund pursuant to
an Advisory Agreement dated ____________, 2002. The Adviser is a Delaware
corporation which was organized in February 1989. The Adviser is an SEC
registered investment adviser under the Investment Advisers Act of 1940, as
amended. The business address of the Adviser and its officers and directors is
One Liberty Plaza, 165 Broadway, 36th Floor, New York, New York 10006-1404.
Subject to the authority of the Board of Directors, the Adviser is responsible
for overall management of the Fund's business affairs. As of March 31, 2002, the
Adviser has $7.3 billion in assets under management. The Adviser's clients
include pensions, foundations and endowments, insurance companies and closed-end
mutual funds. In its investment process, the Adviser focuses on relative value
opportunities, particularly in the MBS and ABS markets.
The Adviser is a subsidiary of Hyperion Partners L.P., a Delaware
limited partnership ("Hyperion Partners"). The sole general partner of Hyperion
Partners is Hyperion Ventures L.P., a Delaware limited partnership ("Hyperion
Ventures"). Corporations owned principally by Lewis S. Ranieri, Salvatore A.
Ranieri and Scott A. Shay are the general partners of Hyperion Ventures. Lewis
S. Ranieri, a former Vice Chairman of Salomon Brothers Inc ("Salomon Brothers"),
is the Vice Chairman of the Board of the Adviser and Chairman of the Fund.
Messrs. Salvatore Ranieri and Shay are directors of the Adviser, but have no
other positions with either the Adviser or the Fund. Messrs. Salvatore Ranieri
and Shay are principally engaged in the management of the affairs of Hyperion
Ventures and its affiliated entities. Clifford E. Lai, the President of the
Fund, is an employee of the Adviser, and may be entitled, in addition to
receiving a salary from the Adviser, to receive a bonus based upon a portion of
the Adviser's profits, including any profit from a sale of the Adviser. Paul M.
Jacob and John H. Dolan, Vice Presidents of the Fund, Thomas F. Doodian,
Treasurer of the Fund, and Joseph Tropeano, Secretary of the Fund, are also
employees of the Adviser. The business address of Hyperion Partners and Hyperion
Ventures is 50 Charles Lindbergh Boulevard, Suite 500, Uniondale, New York
11553.
Mr. Salvatore A. Ranieri and Mr. Shay, as well as the owners of the limited
partners of Hyperion Ventures, all of whom hold a pro rata interest in Hyperion
Partners, have offered to sell their stock in the Adviser to an investment group
composed entirely of officers and directors of the Adviser, including Mr. Lewis
Ranieri (the "Transaction"). Mr. Lewis Ranieri will own [50%] of the Adviser,
and Messrs. Lai, Feeney and Dolan will each own more than 5% of the Adviser.
There is not anticipated to be any change in the day to day management structure
of the Adviser.
The Adviser provides advisory services to several other registered
investment companies which invest in MBS. Its management includes several
individuals with extensive experience in originating, evaluating and investing
in MBS, RMBS and ABS, and in using hedging techniques. Lewis S. Ranieri,
Chairman of the Adviser and Director of the Fund, was instrumental in the
development of the secondary MBS market and the creation and development of
secondary markets for conventional mortgage loans, CMOs and other
mortgage-related securities. While at Salomon Brothers, Mr. Ranieri directed
that firm's activities in the mortgage, real estate and U.S. Government
guaranteed areas. Clifford E. Lai, President and Director of the Adviser and
President of the Fund, was Managing Director and Chief Investment Strategist for
Fixed Income at First Boston Asset Management Corporation.
Portfolio Management. Mr. Paul M. Jacob is senior portfolio manager and
director of the Adviser and will be primarily responsible for the day-to-day
management of the Fund's portfolio. Mr. Jacob has been a senior portfolio
manager for the Adviser from 1993-1997 and from 1998-Present.
ADVISORY AGREEMENT
On ___________, 2002, the Board of Directors of the Fund, including
those persons identified as interested persons and a majority of the Directors
who are not parties to the Advisory Agreement or interested persons (as such
term is defined in the 1940 Act) of any such party (the "Disinterested
Directors"), approved the Advisory Agreement. At the time of the Board's
approval of the Advisory Agreement, ____________________ was an interested
person of the Fund. The Advisory Agreement was approved by _____________, the
sole shareholder of the Fund. The Advisory Agreement will continue in effect for
two years and then from year to year, but only so long as such continuation is
specifically approved at least annually by both (1) the vote of a majority of
the Board of Directors or the vote of a majority of the outstanding voting
securities of the Fund (as provided in the 1940 Act) and (2) by the vote of a
majority of the Disinterested Directors cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement may be terminated
at any time without the payment of any penalty, upon the vote of a majority of
the Board of Directors or a majority of the outstanding voting securities of the
Fund or by the Adviser, on 60 days' written notice by either party to the other.
The Agreement will terminate automatically in the event of its assignment (as
such term is defined in the 1940 Act and the rules thereunder).
Pursuant to the Advisory Agreement, the Fund has retained the Adviser
to manage the investment of the Fund's assets and to provide, with the
assistance of Lend Lease Hyperion Capital Advisors, L.L.C. (the "Subadviser"),
such investment research, advice and supervision, in conformity with the Fund's
investment objectives and policies, as may be necessary for the operations of
the Fund.
The Advisory Agreement provides, among other things, that the Adviser
will bear all expenses of its employees and overhead incurred in connection with
its duties under the Advisory Agreement, and will pay all salaries of the Fund's
directors and officers who are affiliated persons (as such term is defined in
the 1940 Act) of the Adviser. The Advisory Agreement provides that the Fund
shall pay to the Adviser a monthly fee for its services which is equal to 0.65%
per annum of the Fund's average weekly net assets, which, for purposes of
determining the Adviser's fee, shall be the average weekly value of the total
assets of the Fund, minus the sum of accrued liabilities (including accrued
expenses) of the Fund and any declared but unpaid dividends on the Common
Shares.
SUBADVISER
The Adviser has engaged the Subadviser to provide subinvestment
advisory services for investments in CMBS. The amount of the Fund's assets
allocated to the Subadviser is determined by the Adviser. The Subadviser, an SEC
registered investment adviser, is a Delaware limited liability company,
organized on June 2, 1995, and as of March 31, 2002, managed approximately $1.19
billion in CMBS. The business address of the Subadviser and its officers and
directors is One Liberty Plaza, 165 Broadway, 36th Floor, New York, New York
10006-1404.
The overall portfolio management strategy undertaken by the Subadviser
on behalf of the Fund is mutually determined by the Adviser and the Subadviser.
The execution of the management strategy is conducted under the general
supervision and direction of the Subadviser's investment committee.
The Subadviser is owned equally by Lend Lease Real Estate Investments,
Inc ("LLREI") and the Adviser and was formed for the purpose of managing
portfolios of CMBS. The Subadviser combines the fixed income expertise of the
Adviser with the extensive real estate resources of LLREI LLREI is an indirect
wholly-owned subsidiary of Lend Lease Corporation Limited, an integrated real
estate and financial services company established in 1958 as a New South Wales,
Australia corporation. Listed on the Australian and New Zealand stock exchanges,
Lend Lease Corporation Limited has substantial global interests operating in the
United States, the Asia-Pacific Region, South America and Europe, and also has a
market capitalization in excess of $3 billion as of December 31, 2001. As of
December 31, 2001, Lend Lease Corporation Limited's global real estate
investment management business has approximately $47 billion in real estate
assets under management on five continents.
LLREI is a full service investment adviser with experience in investing
and managing commercial real estate assets for institutional lenders and owners.
LLREI manages one of the largest portfolios in the United States of real estate
assets owned by pension plans and other tax exempt investors. LLREI has
substantial experience in the origination and servicing of whole loans, the
acquisition and resolution of troubled loans and the management of diverse real
estate related assets. LLREI is co-headquartered in New York, New York, and
Atlanta, Georgia and has 13 regional offices located throughout the United
States. The firm's regional operations are full service offices with valuation
professionals, asset managers, and acquisition and disposition specialists. The
business address of Lend Lease Real Estate is 3424 Peachtree Road., N.E., Suite
800, Atlanta, Georgia 30342-1152.
SUBADVISORY AGREEMENT
On ___________, 2002, the Board of Directors of the Fund, including a
majority of the Disinterested Directors, approved the Subadvisory Agreement. The
Subadvisory Agreement was approved by __________________, the sole shareholder
of the Fund. The Subadvisory Agreement contains the same provisions with respect
to continuation and termination as does the Advisory Agreement.
The Subadvisory Agreement provides, among other things, that the
Subadviser will bear all expenses of its employees and overhead incurred in
connection with its duties under the Subadvisory Agreement. The Subadvisory
Agreement provides that the Adviser shall pay to the Subadviser a monthly fee
for the Subadviser's services. The amount of this fee is equal to an annual
percentage of the portion of the Fund's average weekly value of the total assets
that are invested in CMBS. This annual percentage is determined by the credit
rating of the CMBS at the time of purchase, and ranges from 1.00% for unrated
CMBS to 0.13% for AAA/Aaa rated CMBS. The Adviser pays the Subadviser's fee out
of the fee that the Adviser receives from the Fund.
ADMINISTRATION AND SUBADMINISTRATION AGREEMENTS
The Fund has entered into an Administration Agreement with Hyperion
Capital Management, Inc. (the "Administrator"). The Administrator will perform
administrative services necessary for the operation of the Fund, including
maintaining certain books and records of the Fund, and preparing reports and
other documents required by federal, state, and other applicable laws and
regulations, and provides the Fund with administrative office facilities. For
these services, the Fund will pay a monthly fee at an annual rate of 0.20% of
its average weekly assets.
The Administrator has entered into a Sub-Administration Agreement with
State Street Bank and Trust Company (the "Subadministrator"). The
Subadministrator will perform administrative services necessary for the
operation of the Fund, including maintaining certain books and records of the
Fund, and preparing reports and other documents required by federal, state, and
other applicable laws and regulations. For these services, the Administrator
will pay a monthly fee at an annual rate of at least $___________.
DETERMINATION OF NET ASSET VALUE
The net asset value of the Common Shares will be computed based upon
the value of the Fund's portfolio securities and other assets. Net asset value
per Common Share will be determined as of the close of the Exchange no less
frequently than the second to the last business day of each week and the last
business day of each month. The Fund calculates net asset value per Common Share
by subtracting (i) the Fund's liabilities (including accrued expenses), (ii)
accumulated and unpaid dividends on any outstanding preferred shares, (iii) the
aggregate liquidation value any outstanding preferred shares and (iv) any
dividends payable on the Common Shares, from the Fund's total assets (the value
of the securities the Fund holds plus cash or other assets, including interest
accrued but not yet received) and dividing the result by the total number of
Common Shares outstanding. Please see the Statement of Additional Information
for more information.
REPURCHASE OF COMMON SHARES AND CONVERSION TO OPEN-END STATUS
REPURCHASE OF COMMON SHARES
Shares of closed-end investment companies often trade at a discount to
net asset value, and the Fund's Common Shares may also trade at a discount to
their net asset value. The market price of the Fund's Common Shares will be
determined by such factors as relative demand for and supply of Common Shares in
the market, the Fund's net asset value, general market and economic conditions
and other factors beyond the control of the Fund. Although shareholders will not
have the right to redeem their Common Shares, the Fund may take action to
repurchase Common Shares in the open market or make tender offers for its Common
Shares at net asset value. During a tender offer, the Fund will publish how
shareholders may readily ascertain the net asset value. For more information see
"REPURCHASE OF COMMON SHARES" in the Statement of Additional Information.
CONVERSION TO OPEN-END STATUS
The Fund's Board of Directors may elect to submit to the Fund's
shareholders at any time a proposal to convert the Fund to an open-end
investment company and in connection therewith to retire any outstanding
preferred shares, as would be required upon such conversion by the 1940 Act. In
determining whether to exercise its discretion to submit this proposal to
shareholders, the Board of Directors would consider all factors then relevant,
including the relationship of the market price of the Common Shares to net asset
value, the extent to which the Fund's capital structure is leveraged and the
possibility of releveraging, the spread, if any, between yields on high yield
high risk securities in the Fund's portfolio as compared to interest and
dividend charges on senior securities and general market and economic
conditions. In addition to any vote required by Maryland law, conversion of the
Fund to an open-end investment company would require the affirmative vote of the
holders of 75% of each class of the shares entitled to be voted on the matter.
Shareholders of an open-end investment company may require the company to redeem
their shares at any time (except in certain circumstances as authorized by or
under the 1940 Act) at their net asset value, less such redemption charges, if
any, as might be in effect at the time of redemption. If the Fund converted to
an open-end investment company, it could be required to liquidate portfolio
securities to meet requests for redemption, and the Common Shares would no
longer be listed on the Exchange. In the event the Fund converts to open-end
status, the Fund would only be able to borrow through bank borrowings within
certain limits and would not be allowed to issue preferred shares.
DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Plan, holders of Common Shares may elect to have
all distributions of dividends and capital gains automatically reinvested by
State Street Bank and Trust Company (the "Plan Agent") in Common Shares.
Pursuant to the Plan, shareholders who do not participate in the Plan will
receive all distributions in cash paid by check mailed directly to the
shareholder of record (or if the Common Shares are held in street or other
nominee name, then to the nominee) by the custodian, as dividend disbursing
agent.
The Plan Agent serves as agent for the shareholders in administering
the Plan. After the Fund declares a dividend or determines to make a capital
gain distribution, payable in cash or in shares, if (1) the market price is
lower than net asset value, the participants in the Plan will receive the
equivalent in Fund Common Shares valued at the market price determined as of the
time of purchase (generally, the payment date of the dividend or distribution);
or if (2) the market price of the Common Shares on the payment date of the
dividend or distribution is equal to or exceeds their net asset value,
participants will be issued Common Shares at the lower of net asset value or the
market price. If net asset value exceeds the market price of Common Shares on
the payment date or the Fund declares a dividend or other distribution payable
only in cash (i.e., if the Board of Directors precludes reinvestment in Fund
Common Shares for that purpose), the Plan agent will, as agent for the
participants, receive the cash payment and use it to buy Common Shares in the
open market, the Exchange or elsewhere, for the participants' accounts. If,
before the Plan Agent has completed its purchases, the market price exceeds the
net asset value of a Common Share, the average per share purchase price paid by
the Plan Agent may exceed the net asset value of Common Shares, resulting in
acquisition of fewer Common Shares than if the dividend or distribution had been
paid in Common Shares issued by the Fund. The Fund will not issue Common Shares
under the Plan below net asset value.
Participants in the Plan may withdraw from the Plan upon written notice
to the Plan Agent. When a participant withdraws from the Plan or upon
termination of the Plan as provided below, certificates for whole Common Shares
credited to his or her account under the Plan will be issued and a cash payment
will be made for any fraction of a Common Share credited to such account.
The Plan Agent maintains each shareholder's account in the Plan and
furnishes monthly written confirmations of all transactions in the accounts,
including information needed by shareholders for personal and tax records.
Common Shares in the account of each Plan participant will be held by the Plan
Agent in non-certificated form in the name of the participant, and each
shareholder's proxy will include those Common Shares purchased pursuant to the
Plan.
In the case of shareholders, such as banks, brokers or nominees, which
hold Common Shares for others who are the beneficial owners, the Plan Agent will
administer the Plan on the basis of the number of Common Shares certified from
time to time by the record shareholders as representing the total amount
registered in the record shareholder's name and held for the account of
beneficial owners who are participants in the Plan.
The Fund will not charge participants for reinvesting dividends or
capital gain distributions through the plan, except for certain brokerage
commissions, as described below. The Plan Agent's fees for the handling of the
reinvestment of dividends and distributions will be paid by the Fund. There will
be no brokerage commission charged with respect to Common Shares issued directly
by the Fund. However, each participant will pay a pro rata share of brokerage
commissions incurred with respect to the Plan Agent's open market purchases in
connection with the reinvestment of dividends and distributions.
Some brokers may automatically elect to receive cash on your behalf and
may reinvest that cash in additional Common Shares of the Fund for you. If you
wish for all dividends declared on your Common Shares of the Fund to be
automatically reinvested pursuant to the Plan, please contact your broker.
The automatic reinvestment of dividends and distributions will not
relieve participants of any federal income tax that may be payable on such
dividends or distributions. See "TAXATION-FEDERAL TAX TREATMENT OF HOLDERS OF
COMMON SHARES" in the Statement of Additional Information.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan as
applied to any dividend or distribution paid subsequent to written notice of the
change sent to all shareholders of the Fund at least 90 days before the record
date for the dividend or distribution. The Plan also may be amended or
terminated by the Plan Agent by at least 90 days' written notice to all
shareholders of the Fund. All correspondence concerning the Plan should be
directed to the Plan Agent at P.O. Box 366, Boston, MA 02101.
TAXATION
The Fund will distribute substantially all of its net investment income
and gains to shareholders. Such distributions are taxable as ordinary income or
capital gains to the shareholder. Shareholders may be proportionately liable for
taxes on income and gains of the Fund, but shareholders not subject to tax on
their income will not be required to pay tax on amounts distributed to them. The
Fund will inform shareholders of the amount and nature of the income or gains.
Please see the Statement of Additional Information for a more detailed
discussion of the federal income tax issues associated with the purchase of the
Fund's Common Shares.
DESCRIPTION OF CAPITAL STOCK
general
The Fund has authorized capital of 50,000,000 Common Shares, par value
$0.01 per share as of ___________, 2002. The Articles of Incorporation permit
the Board of Directors to classify and reclassify any unissued Common Shares and
to increase the authorized capital of the Fund. The Board of Directors may
create a class of preferred shares. Please see "PREFERRED SHARES" in the
Statement of Additional Information. The Common Shares and preferred shares if
issued, will be fully paid and nonassessable. There are no preemptive rights.
COMMON SHARES
The Fund has no present intention of offering any additional Common
Shares except through the Offering outlined in this Prospectus and pursuant to
the Dividend Reinvestment Plan. Other offerings of its Common Shares, if made,
will require approval by the Board of Directors. Any additional offering will be
subject to the requirements of the 1940 Act that shares may not be issued at a
price below the then current net asset value (exclusive of underwriting
discounts and commissions) except in connection with an offering to existing
shareholders or with the consent of a majority of the Fund's outstanding voting
securities. The rights of Common Shares with respect to dividends and
distributions are described under "RISK FACTORS - DIVIDENDS AND DISTRIBUTIONS."
Each Common Share is entitled to participate equally in the net distributable
assets of the Fund upon liquidation.
VOTING
On each matter submitted to a vote of the holders of the Common Shares,
each holder shall be entitled to one vote for each Common Share owned. Except as
noted in the Statement of Additional Information under "PREFERRED SHARES," the
Common Shares and the preferred shares will have equal voting rights of one vote
per share and vote together as a single class. Please see the Statement of
Additional Information for more information on how preferred shares affect the
voting rights of the holders of Common Shares.
The Fund is required by the rules of the Exchange to hold annual
meetings of shareholders. The first annual meeting of shareholders is scheduled
for April 2003.
ANTI-TAKEOVER PROVISIONS OF THE ARTICLES OF INCORPORATION
AND BY-LAWS
The Fund presently has provisions in its Articles of Incorporation and
By-Laws (commonly referred to as "anti-takeover" provisions) which may have the
effect of limiting the ability of other entities or a person to acquire control
of the Fund, to cause it to engage in certain transactions or to modify its
structure.
First, a Director may be removed from office only for cause by vote of
at least 75% of the shares entitled to be voted in an election of such Director.
Second, to authorize the Fund's conversion from a closed-end to an open-end
investment company, (a) the affirmative vote of the holders of at least 75% of
the shares entitled to vote on this matter and (b) the favorable vote of the
majority of the total number of Directors of the Fund will be required. Third,
the Board of Directors is classified into three classes, each with a term of
three years with only one class of Directors standing for election in any year.
Such classification may prevent replacement of a majority of the Directors for
up to a two year period. In addition, under the Articles of Incorporation, the
Fund has elected to be subject to provisions of the Maryland General Corporation
law that generally provide that certain mergers, consolidations, share
exchanges, asset sales, stock issuances, liquidations or dissolutions,
reclassification of securities or recapitalization and other transactions
("Business Combinations"), with a beneficial owner of 10% or more of the voting
power of a Maryland corporation (an "Interested Shareholder") or any affiliate
of an Interested Shareholder must be recommended by the Board of Directors and
approved by the affirmative vote of at least (i) 80% of the votes entitled to be
cast by outstanding shares of voting stock of the corporation and (ii) 66 2/3%
of the votes entitled to be cast by holders of voting stock other than voting
stock held by the Interested Shareholder who will (or whose affiliate will) be a
party to the Business Combination or by an affiliate or associate of the
Interested Shareholder, unless certain value and other standards are satisfied
or some other statutory exemption is available. The affirmative vote of at least
75% of the shares entitled to vote on the matter will be required to amend
Articles of Incorporation to change any of the foregoing provisions.
The percentage votes required under these provisions, which are greater
than the minimum requirements under Maryland law (absent the elections described
above) or under the 1940 Act, will make more difficult a change in the Fund's
business or management and may have the effect of depriving holders of Common
Shares of an opportunity to sell Common Shares at a premium over prevailing
market prices by discouraging a third party from seeking to obtain control of
the Fund in a tender offer or similar transaction. The Board of Directors,
however, has considered these anti-takeover provisions and believes they are in
the best interests of holders of Common Shares.
UNDERWRITING
The underwriters named below (the "Underwriters"), acting through
Raymond James & Associates, Inc., 880 Carillon Parkway, St. Petersburg, Florida
33716, and A.G. Edwards & Sons, Inc., One North Jefferson Avenue, St. Louis,
Missouri 63103, as their representatives (the "Representatives"), have severally
agreed, subject to the terms and conditions of the Underwriting Agreement with
the Fund and the Adviser (the "Underwriting Agreement"), to purchase from the
Fund the number of Common Shares set forth below opposite their respective
names.
Underwriter Number of Shares
----------- ----------------
Raymond James & Associates, Inc.
A.G. Edwards & Sons, Inc.
Total
===========
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions, including the absence of any
materially adverse change in the Fund's business and the receipt of certain
certificates, opinions and letters from the Fund and the Fund's attorneys and
independent accountants. The nature of the Underwriters' obligation is such that
they are committed to purchase all Common Shares offered hereby if any of the
Common Shares are purchased.
The Fund has granted to the Underwriters an option, exercisable for 45
days from the date of this prospectus, to purchase up to an aggregate of
__________ additional Common Shares to cover over-allotments, if any, at the
initial offering price. The Underwriters may exercise such option solely for the
purpose of covering over-allotments incurred in the sale of the Common Shares
offered hereby. To the extent that the Underwriters exercise this option, each
of the Underwriters will have a firm commitment, subject to certain conditions,
to purchase an additional number of Common Shares proportionate to such
Underwriter's initial commitment.
The Representatives have advised the Fund that the Underwriters propose
to offer some of the Common Shares directly to investors at the offering price
of $____ per Common Share, and may offer some of the Common Shares to certain
dealers at the offering price less a concession not in excess of $ ____ per
Common Share, and such dealers may reallow, a concession not in excess of $ ____
per Common Share on sales to certain other dealers. The Fund has agreed to pay
the Underwriters up to $____ in reimbursement of their expenses. The Common
Shares are offered by the Underwriters, subject to prior sale, when, as and if
delivered to and accepted by the Underwriters, and subject to their right to
reject orders in whole or in part.
The Fund intends to apply to list its Common Shares on the Exchange
under the symbol "[ ]." In order to meet the requirements for listing the Common
Shares on the Exchange, the Underwriters have undertaken to sell lots of 100 or
more Common Shares to a minimum of 2,000 beneficial owners. The minimum
investment requirement is [ ] Common Shares ($____). Prior to this offering,
there has been no public market for the Common Shares or any other securities of
the Fund. Consequently, the offering price for the Common Shares was determined
by negotiation among the Fund and the Representatives.
The Fund and the Adviser have each agreed to indemnify the several
Underwriters for or to contribute to the losses arising out of certain
liabilities, including liabilities under the Securities Act of 1933, as amended.
The Fund has agreed not to offer or sell any additional Common Shares
of the Fund, other than as contemplated by this prospectus, for a period of [ ]
days after the date of the Underwriting Agreement without the prior written
consent of the Representatives.
The Fund anticipates that the Representatives and certain other
Underwriters may from time to time act as brokers or dealers in connection with
the execution of its portfolio transactions after they have ceased to be
Underwriters and, subject to certain restrictions, may so act while they are
Underwriters.
Until the distribution of Common Shares is completed, rules of the SEC
may limit the ability of the Underwriters and certain selling group members to
bid for and purchase the Common Shares. As an exception to these rules, the
Underwriters are permitted to engage in certain transactions that stabilize the
price of the Common Shares. Such transactions may consist of short sales,
stabilizing transactions and purchases to cover positions created by short
sales. Short sales involve the sale by the Underwriters of a greater number of
Common Shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the Common Shares while
the offering is in progress.
The Underwriters also may impose a penalty bid. This occurs when a
particular Underwriter repays to the other Underwriters all or a portion of the
underwriting discount received by it because the Representatives have
repurchased shares sold by or for the account of such Underwriter in stabilizing
or short covering transactions.
These activities by the Underwriters may stabilize, maintain or
otherwise affect the market price of the Common Shares. As a result, the price
of the Common Shares may be higher than the price that otherwise might exist in
the open market. If these activities are commenced, they may be discontinued by
the Underwriters without notice at any time. These transactions may be effected
on the Exchange, or otherwise.
VALIDITY OF THE COMMON SHARES
The validity of the Common Shares offered hereby is being passed on for
the Fund by Sullivan & Worcester, LLP, Washington, D.C. Piper Marbury Rudnick &
Wolfe L.L.P. will opine on certain matters pertaining to Maryland law.
CUSTODIAN, TRANSFER AGENT, DIVIDEND
DISBURSING AGENT AND REGISTRAR
The Fund's securities and cash will be held by State Street
Corporation, whose principal business address is Two Avenue de Lafayette,
Boston, Massachusetts 02105, as custodian (the "Custodian") under a custodian
contract. Under the custodian contract, the Custodian is responsible for
determining the net asset value for the Fund and maintaining all accounting
records related thereto.
American Stock Transfer & Trust Company, whose principal business
address is 6201 15th Avenue, Brooklyn, New York 11219, serves as dividend
disbursing agent under the Plan and as transfer agent and registrar for the
Common Shares.
REPORTS TO SHAREHOLDERS
The Fund will send unaudited semiannual and audited annual reports to
its shareholders, including a list of investments held.
FURTHER INFORMATION
The Fund is subject to the informational requirements of the 1934 Act,
and the 1940 Act, and in accordance therewith will file reports and other
information with the SEC. Such reports and other information can be inspected
and copied at the public reference facilities maintained by the SEC at 450 Fifth
Street, Washington, D.C. 20549 and the SEC's regional offices at The Woolworth
Bldg., 233 Broadway, New York, New York 10279. Copies of such material can be
obtained from the Public Reference Section of the SEC at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. Such reports and other information
concerning the Fund may also be inspected at the offices of the Exchange.
TABLE OF CONTENTS
of the
STATEMENT OF ADDITIONAL INFORMATION
GENERAL INFORMATION .................................................2
ADDITIONAL INFORMATION ABOUT INVESTMENT POLICIES AND
FUND INVESTMENTS ........................................................2
DIRECTORS AND OFFICERS .......................................................5
COMPENSATION OF DIRECTORS ....................................................8
THE ADVISER, SUBADVISER AND ADMINISTRATOR ...................................10
PORTFOLIO TRANSACTIONS AND BROKERAGE ........................................14
DETERMINATION OF NET ASSET VALUE ............................................15
REPURCHASE OF COMMON SHARES .................................................16
PREFERRED SHARES ............................................................17
PORTFOLIO MATURITY AND TURNOVER .............................................20
TAXATION ....................................................................20
PERFORMANCE INFORMATION .................................................... 25
FINANCIAL STATEMENTS ........................................................36
..
APPENDIX A
RATINGS OF CORPORATE OBLIGATIONS
Standard & Poor's describes classifications of bonds as follows:
"AAA" Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
"AA" Debt rated "AA" has a strong capacity to pay interest and repay
principal and differs from the higher rated issues only by a small degree.
"A" Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
"BBB" Debt rated "BBB" is regarded as having an adequate capacity to
pay interest and repay principal. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
"BB," "B," "CCC," "CC," "C" Debt rated "BB," "B," "CCC," "CC" and "C"
is regarded, on balance, as predominantly speculative with respect to capacity
to pay interest and repay principal in accordance with the terms of the
obligation. "BB" indicates the lowest degree of speculation and "C" the highest
degree of speculation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposure to adverse conditions.
"C1" The rating "C1" is reserved for income bonds on which no interest
is being paid.
Fitch IBCA describes classifications of bonds as follows:
"AAA" ratings denote the highest credit quality and the lowest
expectation of credit risk. They are assigned only in case of exceptionally
strong capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
"AA" ratings denote a very high credit quality and a very low
expectation of credit risk. They indicate very strong capacity for timely
payment of financial commitments. This capacity is not significantly vulnerable
to foreseeable events.
"A" ratings denote a high credit quality and a low expectation of
credit risk. The capacity for timely payment of financial commitments is
considered strong. This capacity may, nevertheless, be more vulnerable to
changes in circumstances or in economic conditions than is the case for higher
ratings.
"BBB" ratings indicate good credit quality and that there is currently
a low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
"BB" ratings indicate speculative bonds and that there is a possibility
of credit risk developing, particularly as a result of adverse economic change
over time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment-grade.
"B" ratings indicate highly speculative bonds and that significant
credit risk is present, but a limited margin of safety remains. Financial
commitments are currently being met; however, capacity for continued payment is
contingent upon a sustained, favorable business and economic environment.
"CCC" and "C" ratings denote high default risk. Default is a real
possibility. Capacity for meeting financial commitments is solely reliant upon
sustained, favorable business or economic developments. A "CC" rating indicates
that default of some kind appears probable. "C" ratings signal imminent default.
Moody's Investors Service, Inc. describes classifications of bonds as follows:
-----------------------------------------------------------------------------
"Aaa" Bonds which are rated "Aaa" are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin, and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
"Aa" Bonds which are rated "Aa" are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
"A" Bonds which are rated "A" possess many favorable investment
attributes and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
"Baa" Bonds which are rated "Baa" are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
"Ba" Bonds which are rated "Ba" are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
"B" Bonds which are rated "B" generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
"Caa" Bonds which are rated "Caa" are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
"Ca" Bonds which are rated "Ca" represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
"C" Bonds which are rated "C" are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE FUND. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE AFFAIRS OF THE FUND SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
HOWEVER, IF ANY MATERIAL CHANGE OCCURS WHILE THIS PROSPECTUS IS REQUIRED BY LAW
TO BE DELIVERED, THIS PROSPECTUS WILL BE AMENDED OR SUPPLEMENTED ACCORDINGLY.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN
OFFER TO BUY, ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT
RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION
OF AN OFFER TO BUY IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL
The Hyperion Strategic Mortgage Income Fund, Inc.
4,000,000 Common Shares
TABLE OF CONTENTS
PROSPECTUS SUMMARY............................................................5
FEE TABLE....................................................................10
THE FUND.....................................................................11
USE OF PROCEEDS..............................................................11
INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS.............................12
DESCRIPTION OF FUND INVESTMENTS..............................................22
RISK FACTORS.................................................................27
MANAGEMENT OF THE FUND.......................................................34
REPURCHASE OF COMMON SHARES AND CONVERSION TO OPEN-END STATUS................38
DIVIDEND REINVESTMENT PLAN...................................................39
TAXATION.....................................................................40
DESCRIPTION OF CAPITAL STOCK.................................................41
UNDERWRITING.................................................................42
VALIDITY OF THE COMMON SHARES................................................44
CUSTODIAN, TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR...........44
REPORTS TO SHAREHOLDERS......................................................44
FURTHER INFORMATION..........................................................44
APPENDIX A...................................................................47
RATINGS OF CORPORATE OBLIGATIONS.............................................47
--------
1 Before deduction of offering expenses incurred by the Fund, estimated
to be $_______, including an aggregate of up to $125,000 to be paid to Raymond
James & Associates, Inc. as partial reimbursement for its expenses. Any offering
expenses over $0.03 per Common Share will be paid by the Adviser.
STATEMENT OF ADDITIONAL INFORMATION
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
One Liberty Plaza
165 Broadway, 36th Floor
New York, NY 10006-1404
(800) Hyperion
___________, 2002
THE INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT
COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE
REGISTRATION STATEMENT FILED WITH THE SEC IS EFFECTIVE. THIS PROSPECTUS IS NOT
AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
This Statement of Additional Information for The Hyperion Strategic
Mortgage Income Fund, Inc. (the "Fund"), relating specifically to the Fund's
prospectus (the "Prospectus"), consists of this cover page and the information
listed in the Table of Contents.
This Statement of Additional Information, which is not a prospectus,
supplements, and should be read in conjunction with, the Prospectus of the Fund
dated __________, 2002 and as supplemented from time to time. This Statement of
Additional Information is incorporated by reference in its entirety into the
Prospectus. This Statement of Additional Information does not include all
information that a prospective investor should consider before purchasing shares
of the Fund, and investors should obtain and read the Prospectus prior to
purchasing shares. A copy of the Prospectus may be obtained without charge by
calling or writing to the Fund at the telephone number or address set forth
above.
The Prospectus and this Statement of Additional Information are part of
the registration statement filed with the Securities and Exchange Commission
(the "Commission"), Washington, D.C., which includes additional information
regarding the Fund. The registration statement may be obtained from the
Commission upon payment of the fee prescribed, inspected at the Commission's
office at no charge or on the Commission's website at http://www.sec.gov.
TABLE OF CONTENTS
GENERAL INFORMATION........................................................2
ADDITIONAL INFORMATION ABOUT...............................................2
INVESTMENT POLICIES AND FUND INVESTMENTS...................................2
DIRECTORS AND OFFICERS.....................................................5
COMPENSATION OF DIRECTORS..................................................8
THE ADVISER, SUBADVISER AND ADMINISTRATOR..................................10
PORTFOLIO TRANSACTIONS AND BROKERAGE.......................................14
DETERMINATION OF NET ASSET VALUE...........................................15
REPURCHASE OF COMMON SHARES................................................16
PREFERRED SHARES...........................................................17
PORTFOLIO TURNOVER.........................................................20
TAXATION...................................................................20
PERFORMANCE INFORMATION....................................................25
FINANCIAL STATEMENTS.......................................................36
GENERAL INFORMATION
The Fund is a recently organized, diversified, closed-end management
investment company organized as a Maryland corporation on May ___, 2002. Much of
the information contained in this Statement of Additional Information expands on
subjects discussed in the Prospectus. Defined terms used in this document have
the same meanings as in the Prospectus. No investment in the Fund should be made
without first reading the Prospectus.
ADDITIONAL INFORMATION ABOUT
INVESTMENT POLICIES AND FUND INVESTMENTS
Most of the different types of securities in which the Fund may invest,
subject to its investment objectives, policies and restrictions, are described
in the Prospectus, under "INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS,"
"DESCRIPTION OF FUND INVESTMENTS" and "RISK FACTORS." Additional information
concerning certain of the Fund's investment policies and risks is set forth
below.
OTHER INVESTMENT POLICIES
Calls and Puts on Securities and Related Options. The Fund may
engage in various put and call transactions. The Fund may hedge through the use
of call and put options ("calls" and "puts") on U.S. government securities and
futures that are traded on U.S. securities exchanges and in U.S.
over-the-counter markets. The Fund would use these transactions as a hedge and
not as a speculative investment.
The Fund may purchase and sell calls on these securities or indices
thereof. Sales of calls will be "covered" while the call is outstanding (i.e.,
the Fund owns the securities subject to the call or other securities acceptable
for applicable escrow requirements). Some contracts are "cash settled" (i.e.,
the Fund pays the difference between the call and market price in cash when the
market price is higher). Cash-settled calls also may be covered. The Fund does
not intend to sell any cash-settled calls that are not covered. If a call sold
by the Fund is exercised, the Fund forgoes any possible profit from an increase
in the market price of the underlying security over the exercise price.
A put option gives the purchaser of the option the right to sell
and the writer, if the purchaser exercises his right, the obligation to buy the
underlying security at the exercise price during the option period. A call
option gives the purchaser of the option the right to buy and the writer, if the
purchaser exercises his right, the obligation to sell the underlying security at
the exercise price during the option period. The Fund is authorized to purchase
and sell exchange listed options and over-the-counter options ("OTC Options").
Listed options are issued by the Options Clearing Corporation ("OCC") which
guarantees the performance of the obligations of the parties to such options.
The Fund will engage in OTC Option transactions only with major U.S. government
securities dealers.
The writer of an option assumes an obligation to deliver or
purchase the underlying interest represented by the option upon the assignment
to him of an exercise notice. The writer is subject to being assigned an
exercise notice at any time after he has written the option until the option
expires or until he has closed out his position by the offsetting purchase of an
identical option. The Fund will not sell puts if, as a result, more than 50% of
the Fund's assets would be required to be segregated.
Short Sales. The Fund may, subject to investment restrictions (See
"INVESTMENT RESTRICTIONS" in the Prospectus for more information), engage in
short sale transactions for hedging purposes. When the Fund makes a short sale,
it generally must borrow the security sold short and deliver it to a
broker-dealer through which it made the short sale as collateral for its
obligation to deliver the security upon conclusion of the sale. The Fund may
have to pay a fee to borrow particular securities and is often obligated to pay
over any payments received on the borrowed securities. The Fund's obligation to
replace the borrowed security will generally be secured by collateral deposited
with the broker-dealer, usually cash, U.S. government securities or other highly
liquid securities similar to those borrowed. The Fund will also be required to
deposit similar collateral with its Custodian to the extent, if any, necessary
so that the value of both collateral deposits in the aggregate is at all times
equal to at least 100% of the current market value of the security sold short.
To the extent that the value of the collateral deposited by the Fund with its
Custodian does not equal 100% of the current market value of the security sold
short, in the view of the Commission, a senior security will be deemed to have
been created. Any senior security so created will be indebtedness and will be
subject to the Fund's fundamental investment restriction concerning aggregate
indebtedness. That restriction limits the aggregate amount of the Fund's senior
securities in the form of indebtedness to no more than 33 1/3% of the Fund's
total assets. Depending on arrangements made with the broker-dealer from which
it borrowed the security, the Fund may not receive any payments (including
interest) on its collateral deposited with the broker-dealer. To the extent the
Fund makes short sales of U.S. Treasury securities in lieu of futures, these
requirements to borrow securities and provide collateral may not apply.
The Fund may also make short sales "against the box." In this type
of short sale, at the time of the sale, the Fund owns or has the immediate and
unconditional right to acquire at no additional cost the identical security. In
that situation, any gain or loss on the short sale is offset by the
corresponding loss or gain on the long position.
Repurchase Agreements. The Fund may invest temporarily, without
limitation, in repurchase agreements, which are agreements pursuant to which
securities are acquired by the Fund from a third party with the commitment that
they will be repurchased by the seller at a fixed price on an agreed date. These
agreements may be made with respect to any of the portfolio securities in which
the Fund is authorized to invest. Repurchase agreements may be characterized as
loans by the Fund to the other party to the agreement that are secured by the
underlying securities. Repurchase agreements facilitate portfolio management and
allow the Fund to earn additional revenue. The Fund may enter into repurchase
agreements with (i) member banks of the Federal Reserve System having total
assets in excess of $500 million and (ii) securities dealers, provided that such
banks or dealers meet the creditworthiness standards established by the Adviser
("Qualified Institutions"). The Adviser will monitor the continued
creditworthiness of Qualified Institutions. The collateral will be marked to
market daily. Such agreements permit the Fund to keep all of its assets earning
interest while retaining flexibility in pursuit of investments of a longer-term
nature.
Reverse Repurchase Agreements. At the time the Fund enters into a reverse
repurchase agreement, it will establish and maintain a segregated account with
its own custodian containing liquid high grade securities having a value not
less than the repurchase price (including accrued interest). Under 1940 Act
Release No. 10666 ("Rel. 10666"), the SEC indicated that it would not raise the
question whether an instrument or arrangement was a senior security if cash or
marketable securities equal to 100% of the value of the obligation were
maintained in a segregated account to collateralize the obligation. The Fund
will follow the guidelines set forth in Rel. 10666 with respect to reverse
repurchase agreements. Accordingly, the Fund will not treat these agreements as
senior securities for purposes of its investment restrictions; these agreements
will affect asset coverage, however, because under the 1940 Act the liability to
repurchase the securities offsets the asset that results from the sale of
securities.
Lending of Securities. The Fund may lend its portfolio securities to
Qualified Institutions. By lending its portfolio securities, the Fund attempts
to increase its income through the receipt of interest on the loan. Any gain or
loss in the market price of the securities loaned that may occur during the term
of the loan will be for the account of the Fund.
The Fund will not lend portfolio securities if, as a result, the aggregate
of such loans and any borrowings exceed 33 1/3% of the value of the Fund's total
assets (including such loans). All relevant facts and circumstances, including
the creditworthiness of the Qualified Institution, will be monitored by the
Adviser, and will be considered in making decisions with respect to lending of
securities, subject to review by the Fund's Board of Directors. The Fund may pay
reasonable negotiated fees in connection with loaned securities, so long as such
fees are set forth in a written contract and their reasonableness is determined
by the Fund's Board of Directors.
ADDITIONAL RISK FACTORS
Options Transactions. The purchaser of an option risks losing his entire
investment in a short period of time. If an option is not sold while it has
remaining value, or if during the life of an option the underlying security does
not appreciate, in the case of a call option, or depreciate, in the case of a
put option, the purchaser of the option may lose his entire investment. On the
other hand, given the same market conditions, if the potential purchaser of a
call option purchases the underlying security directly instead of purchasing a
call option or if the potential purchaser of a put option decides not to
purchase the put option but to sell the underlying security, the potential
option purchaser might have less of a loss. An option purchaser does not have
the choice of "waiting out" an unexpected decrease or increase in the underlying
securities' price beyond the expiration date of the option. The more that an
option is out-of-the-money and the shorter its remaining term to expiration, the
greater the risk that a purchaser of the option will lose all or part of his
investment. Further, except where the value of the remaining life of an option
may be realized in the secondary market, for an option purchase to be
profitable, the market price of the underlying interest must exceed or be below
the exercise price by more than the premium and transaction costs paid in
connection with the purchase of the option and its sale or exercise.
The writer of an option assumes an obligation to deliver or purchase the
underlying interest represented by the option upon the assignment to him of an
exercise notice. The writer is subject to being assigned an exercise notice at
any time after he has written the option until the option expires or until he
has closed out his position by the offsetting purchase of an identical option.
The Fund's ability to close out its position as a writer or purchaser of an
exchange-listed option is dependent upon the existence of a liquid secondary
market on option exchanges. Among the possible reasons for the absence of a
liquid secondary market on an exchange are: (1) insufficient trading interest in
certain options; (2) restrictions on transactions imposed by an exchange; (3)
trading halts, suspensions or other restrictions imposed with respect to
particular classes or series of options or underlying securities; (4)
interruption of the normal operations on an exchange; (5) inadequacy of the
facilities of an exchange or OCC to handle current trading volume; or (6) a
decision by one or more exchanges to discontinue the trading of options (or a
particular class or series of options) in which event the secondary market on
that exchange (or in that class or series of options) would cease to exist,
although outstanding options on that exchange that had been listed by the OCC as
a result of trades on that exchange would generally continue to be exercisable
in accordance with their terms. OTC Options are purchased from or sold to
dealers or financial institutions which have entered into direct agreement with
the Fund. With OTC Options, such variables as expiration date, exercise price
and premium will be agreed upon between the Fund and the transacting dealer,
without the intermediation of a third party such as the OCC. If the transacting
dealer fails to make or take delivery of the securities underlying an option it
has written, in accordance with the terms of that option as written, the Fund
would lose the premium paid for the option as well as any anticipated benefit of
the transaction. OTC Options and their underlying securities may be considered
illiquid.
Short Sales. If the price of the security sold short increases between the
time of the short sale and the time the Fund replaces the borrowed security or
otherwise closes the short position, the Fund will incur a loss; conversely, if
the price declines, the Fund will realize a capital gain. Any gain will be
decreased, and any loss increased, by the transaction costs described above.
Although the Fund's gain is limited to the price at which it sold the security
short, its potential loss is theoretically unlimited. The projected offset to
this price risk within the portfolio is the market value gain of the similar
securities held by the Fund. However, changes in the value of the securities
sold short and of the portfolio securities may not correlate under some market
conditions.
DIRECTORS AND OFFICERS
The Directors and officers of the Fund, their addresses, their ages, their
principal occupations for at least the past five years and other information are
set forth below.
Position(s) Held with Number of
Fund and Term of Office Principal Occupation(s) Portfolios in Fund
Name, Address and Length of Time During Past 5 Years and Complex Overseen
and Age Served Other Directorships Held by Director by Director
-------------------------- ------------------------- ------------------------------------------------ --------------------
----------------------------------------------------- ---------------------------------------------------------------------
Interested Director
Clifford E. Lai* President President (since November 1998) of Hyperion 5
c/o One Liberty Plaza, Capital Management, Inc.
36th floor, New York, Elected Annually (March 1993-Present).
New York 10006-1404 Since May 2002
Age 48
John Dolan* Vice President Chief Investment Strategist (1998-Present)and
c/o One Liberty Plaza, Chief Investment Officer (since 2002) of 5
36th floor, New York, Elected Annually Hyperion Capital Management, Inc. Formerly
New York 10006-1404 Since May 2002 Managing Director at Bankers Trust
(1995-1997).
Age 48
Paul Jacob* Vice President Director and Senior Portfolio Manager, 5
c/o One Liberty Plaza, Hyperion Capital Management, Inc. (1993-1997
36th floor, New York, Elected Annually Since and 1998-Present).
New York 10006-1404 May 2002
Age 44
Thomas F. Doodian* Treasurer Director of Finance and Operations, Hyperion 5
c/o One Liberty Plaza, Capital Management, Inc. (July 1995-Present).
36th floor, New York, Elected Annually Treasurer of several investment companies
New York 10006-1404 Since May 2002 advised by Hyperion Capital Management, Inc.
(February 1998- Present).
Age 42
Joseph Tropeano* 5
c/o One Liberty Plaza, Secretary Vice President and Compliance Officer,
36th floor, New York, Hyperion Capital Management, Inc.
New York 10006-1404 Elected Annually (1993-Present); Assistant Secretary and
Since May 2000 Compliance Officer of several investment
Age 40 companies advised by Hyperion Capital
Management, Inc. (1994-Present); Assistant
Secretary and Compliance Officer, AIG Hyperion
Inc. (1994-Present); Secretary and Compliance
Officer, Lend Lease Hyperion Capital Advisors,
LLC (1995-Present); Secretary and Compliance
Officer of Lend Lease Hyperion High-Yield CMBS
Fund, Inc. (1998-Present). Formerly, Vice
President and Compliance Officer, Hyperion
Distributers, Inc. (1994-1998).
*........"Interested person" as defined in the Investment Company Act of 1940
(the "1940 Act"), because of affiliations with Hyperion Capital Management,
Inc., the Fund's Advisor and/or with the Fund.
INTERESTED PERSONS
COMMITTEES AND BOARD OF DIRECTORS' MEETINGS
The Fund has a standing Audit Committee currently consisting of
________________ and _________, all of whom are members of the Board of
Directors and are currently non-interested persons of the Fund. The principal
functions of the Fund's Audit Committee are to recommend to the Board the
appointment of the Fund's accountants, to review with the accountants the scope
and anticipated costs of their audit and to receive and consider a report from
the accountants concerning their conduct of the audit, including any comments or
recommendations they might want to make in that connection.
The Fund has a Nominating and a Compensation Committee. The Nominating and
Compensation Committees presently consist of ___________. The function of the
Nominating Committee is to recommend candidates for election to the Board as
independent directors. The Committee will consider nominees recommended by
stockholders. Such recommendations should be submitted in writing to the
Secretary of the Fund. The function of the Compensation Committee is to
determine the compensation paid to the independent directors. The Fund has an
Executive Committee. The Executive Committee presently consists of
_____________. The function of the Executive Committee is to approve dividends
for the Fund when the full Board of Directors cannot meet.
APPROVAL OF INVESTMENT ADVISORY AGREEMENT
The Board of Directors, including a majority of the Directors who are not
interested persons of the Fund as defined in the 1940 Act (the "Disinterested
Directors"), has the responsibility under the 1940 Act to approve the Fund's
Investment Advisory Agreement and Investment Subadvisory Agreement
(collectively, the "Agreements") for its initial term and annually thereafter at
a meeting called for the purpose of voting on such matters. The Agreements were
approved for an initial two-year term by the Fund's Directors, including a
majority of the Disinterested Directors, at a meeting held on _______, 2002. In
determining whether to approve the Agreements, the Directors reviewed the
materials provided by the Adviser and Subadviser and considered the following:
(1) the level of the management fees and estimated expense ratio of the Fund as
compared to competitive funds of a comparable size; (2) the nature and quality
of the services rendered by the Adviser and Subadviser, (3) anticipated benefits
derived by the Adviser and Subadviser from their relationship with the Fund, (4)
the costs of providing services to the Fund, and (5) the anticipated
profitability of the Fund to the Adviser and Subadviser. They also considered
that the Adviser agreed to pay all offering costs, other than the sales load,
that exceeded an amount equal to $0.03 per Common Share in connection with the
Fund's.
DIRECTOR OWNERSHIP
The following table sets forth, for each Director, the aggregate dollar
range of equity securities owned of the Fund as of ____________, 2002 and of all
funds overseen by each Director in the Fund Complex as of December 31, 2001. The
information as to beneficial ownership is based on statements furnished to the
Fund by each Director.
Aggregate Dollar Range of Equity Securities in
All Funds Overseen by Director or Nominee in
Dollar Range of Equity Family of Investment Companies
Name of Director Securities in the Fund
------------------------------- ----------------------------- -------------------------------------------------
None $ _____________
PRINCIPAL SHAREHOLDERS
To the knowledge of the Fund, as of _____________, 2002, no current
director of the Fund owned 1% or more of the outstanding Common Shares, and the
officers and Directors of the Fund owned, as a group, less than 1% of the Common
Shares.
As of _______________, 2002, no person, to the knowledge of the Fund, owned
beneficially more than 5% of the outstanding Common Shares.
COMPENSATION OF DIRECTORS*
Pension or Retirement Total Compensation
Benefits Accrued As From Fund and Fund
Part of Fund Expenses Complex** Paid to
Aggregate Directors
Compensation from
Name and Position Fund
----- ---- ----
* The information in this table is furnished for the period beginning May ____,
2002 and ending on December 31, 2002. ** The Hyperion fund complex consists of
five funds, including the Fund.
The Board of Directors consists of five members, at least 50% of whom
are not "interested persons" as defined in the 1940 Act. Under the Fund's
articles of incorporation (the "Articles of Incorporation") and the 1940 Act,
the holders of preferred shares, if any, will be entitled to elect two Directors
(both of whom are not "interested persons" as defined in the 1940 Act) with the
other Directors elected by the holders of the Common Shares (two of who are not
"interested persons" as defined in the 1940 Act); provided, however, that the
holders of the preferred shares will be entitled to elect as a class the
smallest number of additional Directors as shall be necessary to assure that a
majority of the Directors has been elected by the holders of the preferred
shares if the Fund fails to pay accumulated dividends on the preferred shares in
an amount equal to two full years of dividends. See "DESCRIPTION OF CAPITAL
STOCK - VOTING" in the Prospectus for more information. Election of Directors is
non-cumulative; accordingly, holders of a majority of the outstanding Common
Shares or a majority of the outstanding preferred shares may elect all of the
Directors who are subject to election by such class.
The Fund will pay each Director not affiliated with the Adviser or the
Subadviser a fee of $_______ per year plus $______ per Directors' meeting
attended, together with annual out-of-pocket expenses relating to attendance at
such meetings. In addition, the members of the Fund's Audit Committee, which
consists of the Fund's disinterested Directors, receive $_____ for each Audit
Committee meeting attended, other than meetings held on days on which there is
also a Directors' meeting.
The Fund's Articles of Incorporation limit the personal liability of
Directors and officers to the Fund and its shareholders to the fullest extent
permitted by Maryland law and the 1940 Act. Based upon Maryland law, the Fund's
Directors and officers have no liability to the Fund and its shareholders for
monetary damages except (a) for, and to the extent of, actual receipt of an
improper benefit in money, property or services, or (b) in respect of an
adjudication based upon a finding of active and deliberate dishonesty which was
material to the cause of action adjudicated. In accordance with the 1940 Act,
the Articles of Incorporation do not protect or purport to protect Directors and
officers against any liability to the Fund or its shareholders to which they
would be subject by reason of willful misfeasance, bad faith, gross negligence
or reckless disregard of duties involved in the conduct of such person's office.
In addition, the Fund's Articles of Incorporation provide that the Fund
will indemnify its Directors and officers against liabilities and expenses in
connection with the performance of their duties on behalf of the Fund to the
fullest extent permitted by Maryland law, subject to the applicable requirements
of the 1940 Act. Under Maryland law, the Fund is entitled (and, if the Director
or Officer is successful on the merits or otherwise, obligated) to indemnify
each Director or Officer in connection with any proceeding to which such
Director or officer is made a party by reason of service in his capacity as a
Director or officer, unless it is proved that (1) the act or omission of the
Director or officer was material to the cause of action adjudicated in the
proceeding and was committed in bad faith or was the result of active and
deliberate dishonesty, (2) the Director or officer actually received an improper
personal benefit in money, property or services, or (3) in the case of any
criminal proceeding, the Director or officer had reasonable cause to believe
that the act or omission was unlawful. The foregoing standards apply both as to
third party actions and derivative suits by or in the right of the Fund.
Indemnification may be against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by the Director or officer in connection
with the proceeding. If, however, the proceeding is one by or in the right of
the Fund, indemnification may not be made in respect of any proceeding in which
the Director or officer shall have been adjudged to be liable to the Fund. In
the view of the staff of the Commission, an indemnification provision is
consistent with the 1940 Act if it (1) precludes indemnification for any
liability, whether or not there is an adjudication of liability, arising by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties described in Section 17(h) and (i) of the 1940 Act ("disabling
conduct") and (2) sets forth reasonable and fair means for determining whether
indemnification shall be made; in the case of the Fund, "reasonable and fair
means" would include (1) a final decision on the merits by a court or other body
before whom the proceeding was brought that the person to be indemnified
("indemnitee") was not liable by reason of disabling conduct (including a
dismissal of insufficiency of evidence) and (2) a reasonable determination,
based upon a review of the facts, that the indemnitee was not liable by reason
of disabling conduct, by (a) the vote of a majority of a quorum of Directors who
are neither "interested persons" of the Fund as defined in Section 2(a)(19) of
the 1940 Act nor parties to the proceeding, or (b) a written opinion of
independent legal counsel.
The indemnification rights provided or authorized by the Articles of
Incorporation or applicable law are not exclusive of any other rights to which a
person seeking indemnification may be entitled. The Fund has also obtained
liability insurance at its expense for the benefit of its Directors and officers
which includes coverage for liability arising from the performance of their
duties on behalf of the Fund which is not inconsistent with the indemnification
provisions of the Articles of Incorporation and applicable law.
THE ADVISER, SUBADVISER AND ADMINISTRATOR
ADVISER
The Fund has engaged Hyperion Capital Management, Inc., a leading MBS
manager, to provide professional investment management for the Fund pursuant to
an Advisory Agreement dated ____________, 2002. The Adviser is a Delaware
corporation which was organized in February 1989. The Adviser is an SEC
registered investment adviser under the Investment Advisers Act of 1940, as
amended. The business address of the Adviser and its officers and directors is
One Liberty Plaza, 165 Broadway, 36th Floor, New York, New York 10006-1404.
Subject to the authority of the Board of Directors, the Adviser is responsible
for overall management of the Fund's business affairs. As of March 31, 2002, the
Adviser has $7.3 billion in assets under management. The Adviser's clients
include pensions, foundations and endowments, insurance companies and closed-end
mutual funds. In its investment process, the Adviser focuses on relative value
opportunities, particularly in the MBS and ABS markets.
The Adviser is a subsidiary of Hyperion Partners L.P., a Delaware
limited partnership ("Hyperion Partners"). The sole general partner of Hyperion
Partners is Hyperion Ventures L.P., a Delaware limited partnership ("Hyperion
Ventures"). Corporations owned principally by Lewis S. Ranieri, Salvatore A.
Ranieri and Scott A. Shay are the general partners of Hyperion Ventures. Lewis
S. Ranieri, a former Vice Chairman of Salomon Brothers Inc ("Salomon Brothers"),
is the Vice Chairman of the Board of the Adviser and Chairman of the Fund.
Messrs. Salvatore Ranieri and Shay are directors of the Adviser, but have no
other positions with either the Adviser or the Fund. Messrs. Salvatore Ranieri
and Shay are principally engaged in the management of the affairs of Hyperion
Ventures and its affiliated entities. Clifford E. Lai, the President of the
Fund, is an employee of the Adviser, and may be entitled, in addition to
receiving a salary from the Adviser, to receive a bonus based upon a portion of
the Adviser's profits, including any profit from a sale of the Adviser. Paul M.
Jacob and John H. Dolan, Vice Presidents of the Fund, Thomas F. Doodian,
Treasurer of the Fund, and Joseph Tropeano, Secretary of the Fund, are also
employees of the Adviser. The business address of Hyperion Partners and Hyperion
Ventures is 50 Charles Lindbergh Boulevard, Suite 500, Uniondale, New York
11553.
Mr. Salvatore A. Ranieri and Mr. Shay, as well as the owners of the limited
partners of Hyperion Ventures, all of whom hold a pro rata interest in Hyperion
Partners, have offered to sell their stock in the Adviser to an investment group
composed entirely of officers and directors of the Adviser, including Mr. Lewis
Ranieri (the "Transaction"). Mr. Lewis Ranieri will own [50%] of the Adviser,
and Messrs. Lai, Feeney and Dolan will each own more than 5% of the Adviser.
There is not anticipated to be any change in the day to day management structure
of the Adviser.
The Adviser provides advisory services to several other registered
investment companies which invest in MBS. Its management includes several
individuals with extensive experience in originating, evaluating and investing
in MBS, RMBS and ABS, and in using hedging techniques. Lewis S. Ranieri,
Chairman of the Adviser and Director of the Fund, was instrumental in the
development of the secondary MBS market and the creation and development of
secondary markets for conventional mortgage loans, CMOs and other
mortgage-related securities. While at Salomon Brothers, Mr. Ranieri directed
that firm's activities in the mortgage, real estate and U.S. Government
guaranteed areas. Clifford E. Lai, President and Director of the Adviser and
President of the Fund, was Managing Director and Chief Investment Strategist for
Fixed Income at First Boston Asset Management Corporation.
Portfolio Management. Mr. Paul M. Jacob is senior portfolio manager and
director of the Adviser and will be primarily responsible for the day-to-day
management of the Fund's portfolio. Mr. Jacob has been a senior portfolio
manager for the Adviser from 1993-1997 and from 1998-Present.
ADVISORY AGREEMENT
..........On ___________, 2002, the Board of Directors of the Fund, including
those persons identified as interested persons and a majority of the Directors
who are not parties to the Advisory Agreement or interested persons (as such
term is defined in the 1940 Act) of any such party (the "Disinterested
Directors"), approved the Advisory Agreement. At the time of the Board's
approval of the Advisory Agreement, ____________________ was an interested
person of the Fund. The Advisory Agreement was approved by _____________, the
sole shareholder of the Fund. The Advisory Agreement will continue in effect for
two years and then from year to year, but only so long as such continuation is
specifically approved at least annually by both (1) the vote of a majority of
the Board of Directors or the vote of a majority of the outstanding voting
securities of the Fund (as provided in the 1940 Act) and (2) by the vote of a
majority of the Disinterested Directors cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement may be terminated
at any time without the payment of any penalty, upon the vote of a majority of
the Board of Directors or a majority of the outstanding voting securities of the
Fund or by the Adviser, on 60 days' written notice by either party to the other.
The Agreement will terminate automatically in the event of its assignment (as
such term is defined in the 1940 Act and the rules thereunder).
Pursuant to the Advisory Agreement, the Fund has retained the Adviser to
manage the investment of the Fund's assets and to provide, with the assistance
of Lend Lease Hyperion Capital Advisors, L.L.C. (the "Subadviser"), such
investment research, advice and supervision, in conformity with the Fund's
investment objectives and policies, as may be necessary for the operations of
the Fund.
The Advisory Agreement provides, among other things, that the Adviser will
bear all expenses of its employees and overhead incurred in connection with its
duties under the Advisory Agreement, and will pay all salaries of the Fund's
directors and officers who are affiliated persons (as such term is defined in
the 1940 Act) of the Adviser. The Advisory Agreement provides that the Fund
shall pay to the Adviser a monthly fee for its services which is equal to 0.65%
per annum of the Fund's average weekly net assets, which, for purposes of
determining the Adviser's fee, shall be the average weekly value of the total
assets of the Fund, minus the sum of accrued liabilities (including accrued
expenses) of the Fund and any declared but unpaid dividends on the Common
Shares.
SUBADVISER
The Adviser has engaged the Subadviser to provide subinvestment advisory
services for investments in CMBS. The amount of the Fund's assets allocated to
the Subadviser is determined by the Adviser. The Subadviser, an SEC registered
investment adviser, is a Delaware limited liability company, organized on June
2, 1995, and as of March 31, 2002, managed approximately $1.19 billion in CMBS.
The business address of the Subadviser and its officers and directors is One
Liberty Plaza, 165 Broadway, 36th Floor, New York, New York 10006-1404.
The overall portfolio management strategy undertaken by the Subadviser on
behalf of the Fund is mutually determined by the Adviser and the Subadviser. The
execution of the management strategy is conducted under the general supervision
and direction of the Subadviser's investment committee.
The Subadviser is owned equally by Lend Lease Real Estate Investments, Inc
("LLREI") and the Adviser and was formed for the purpose of managing portfolios
of CMBS. The Subadviser combines the fixed income expertise of the Adviser with
the extensive real estate resources of LLREI LLREI is an indirect wholly-owned
subsidiary of Lend Lease Corporation Limited, an integrated real estate and
financial services company established in 1958 as a New South Wales, Australia
corporation. Listed on the Australian and New Zealand stock exchanges, Lend
Lease Corporation Limited has substantial global interests operating in the
United States, the Asia-Pacific Region, South America and Europe, and also has a
market capitalization in excess of $3 billion as of December 31, 2001. As of
December 31, 2001, Lend Lease Corporation Limited's global real estate
investment management business has approximately $47 billion in real estate
assets under management on five continents.
LLREI is a full service investment adviser with experience in investing and
managing commercial real estate assets for institutional lenders and owners.
LLREI manages one of the largest portfolios in the U.S. of real estate assets
owned by pension plans and other tax exempt investors. LLREI has substantial
experience in the origination and servicing of whole loans, the acquisition and
resolution of troubled loans and the management of diverse real estate related
assets. LLREI is co-headquartered in New York, New York, and Atlanta, Georgia
and has 13 regional offices located throughout the United States. The firm's
regional operations are full service offices with valuation professionals, asset
managers, and acquisition and disposition specialists. The business address of
Lend Lease Real Estate is 3424 Peachtree Road., N.E., Suite 800, Atlanta,
Georgia 30342-1152.
SUBADVISORY AGREEMENT
On ___________, 2002, the Board of Directors of the Fund, including a
majority of the Disinterested Directors, approved the Subadvisory Agreement. The
Subadvisory Agreement was approved by __________________, the sole shareholder
of the Fund. The Subadvisory Agreement contains the same provisions with respect
to continuation and termination as does the Advisory Agreement.
The Subadvisory Agreement provides, among other things, that the Subadviser
will bear all expenses of its employees and overhead incurred in connection with
its duties under the Subadvisory Agreement. The Subadvisory Agreement provides
that the Adviser shall pay to the Subadviser a monthly fee for the Subadviser's
services. The amount of this fee is equal to an annual percentage of the portion
of the Fund's average weekly value of the total assets that are invested in
CMBS. This annual percentage is determined by the credit rating of the CMBS at
the time of purchase, and ranges from 1.00% for unrated CMBS to 0.13% for
AAA/Aaa rated CMBS. The Adviser pays the Subadviser's fee out of the fee that
the Adviser receives from the Fund.
CODE OF ETHICS
The Fund, the Adviser and the Subadviser have adopted codes of ethics as
required under the 1940 Act. Subject to certain conditions and restrictions,
these codes permit personnel subject to the codes to invest in securities for
their own accounts, including securities that may be purchased, held or sold by
the Fund. Securities transactions by some of these persons may be subject to
prior approval. Securities transactions of certain personnel are subject to
quarterly reporting and review requirements. The codes are on public file with,
and are available from, the SEC.
The codes of ethics can be reviewed and copied at the Commission's Public
Reference Room ("PRR"), in Washington, D.C. Information on the operation of the
PRR may be obtained by calling the Commission at 1-202-942-8090. The codes of
ethics are also available on the EDGAR database on the Commission's Internet
site at http://www.sec.gov. Copies are also available (subject to a duplicating
fee) at the following E-mail address: ------------------ publicinfo@sec.gov, or
by writing the Commission's Public Reference Section, Washington, D.C.
20549-0102. ------------------
ADMINISTRATION AND SUBADMINISTRATION AGREEMENTS
The Fund has entered into an Administration Agreement with Hyperion Capital
Management, Inc. (the "Administrator"). The Administrator will perform
administrative services necessary for the operation of the Fund, including
maintaining certain books and records of the Fund, and preparing reports and
other documents required by federal, state, and other applicable laws and
regulations, and provides the Fund with administrative office facilities. For
these services, the Fund will pay a monthly fee at an annual rate of 0.20% of
its average weekly assets.
The Administrator has entered into a Sub-Administration Agreement with
State Street Bank and Trust Company (the "Subadministrator"). The
Subadministrator will perform administrative services necessary for the
operation of the Fund, including maintaining certain books and records of the
Fund, and preparing reports and other documents required by federal, state, and
other applicable laws and regulations. For these services, the Administrator
will pay a monthly fee at an annual rate of at least $___________.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Adviser and the Subadviser are responsible for decisions to buy and
sell securities and to effect Hedging Transactions for the Fund, to select
brokers and dealers to effect such transactions and to negotiate prices and any
brokerage commissions. The securities in which the Fund invests are traded
principally in the over-the-counter market. In the over-the-counter market,
securities are generally traded on a "net" basis with dealers acting as
principals for their own accounts without a stated commission, although the
price of the security usually includes a mark-up to the dealer. Securities
purchased in underwritten offerings generally include in the price a fixed
amount of compensation for the manager(s), underwriter(s) and dealer(s). The
Fund also may purchase certain money market instruments directly from an issuer,
in which case no commissions or discounts are paid. Purchases and sales of
securities on stock and futures exchanges are effected through brokers who
charge a commission for their services.
The Adviser and the Subadviser are responsible for effecting securities
transactions of the Fund and will do so in a manner deemed fair and reasonable
to shareholders of the Fund and not according to any formula. The primary
considerations for the Adviser and the Subadviser in selecting the manner of
executing securities transactions for the Fund will be prompt execution of
orders, the size and breadth of the market for the security, the reliability,
integrity and financial condition and execution capability of the firm, the size
of and difficulty in executing the order and the best net price. There are many
instances when, in the judgment of the Adviser and the Subadviser, more than one
firm can offer comparable execution services. In selecting among such firms,
consideration may be given to those firms which supply research and other
services in addition to execution services. However, it is not the policy of the
Adviser and the Subadviser, absent special circumstances, to pay higher
commissions to a firm because it has supplied such services.
The Adviser and the Subadviser are able to fulfill their obligations to
furnish a continuous investment program to the Fund without receiving such
information from brokers; however, they consider access to such information to
be an important element of financial management. Although such information is
considered useful, its value is not determinable, because it must be reviewed
and assimilated by the Adviser and the Subadviser and does not reduce the normal
research activities of the Adviser and the Subadviser in rendering investment
advice under the Advisory Agreement and the Subadvisory Agreement, respectively.
It is possible that the expenses of the Adviser and the Subadviser could be
materially increased if they attempted to purchase this type of information or
generate it through their own staff.
One or more of the other accounts which the Adviser or the Subadviser
may manage may own, from time to time, the same investments as the Fund.
Investment decisions for the Fund are made independently from those of such
other accounts; however, from time to time, the same investment decision may be
made for more than one company or account. When two or more companies or
accounts seek to purchase or sell the same securities, the securities actually
purchased or sold will be allocated among the companies and accounts on a good
faith equitable basis by the Adviser and the Subadviser in their discretion in
accordance with the accounts' various investment objectives. In some cases, this
system may adversely affect the price or size of the position obtainable for the
Fund. In other cases, however, the ability of the Fund to participate in volume
transactions may produce better execution for the Fund. It is the opinion of the
Board of Directors that this advantage, when combined with the other benefits
available due to the Adviser's and Subadviser's organization, outweighs any
disadvantages that may be said to exist from exposure to simultaneous
transactions.
Although the Advisory Agreement and the Subadvisory Agreement contain
no restrictions on portfolio turnover, it is not the Fund's policy to engage in
transactions with the objective of seeking profits from short-term trading. It
is expected that the annual portfolio turnover rate of the Fund will not exceed
_______% excluding securities having a maturity of one year or less. Higher
portfolio turnover results in increased Fund expenses, including dealer mark-ups
and other transaction costs on the sale of securities and on the reinvestment in
other securities.
DETERMINATION OF NET ASSET VALUE
The net asset value of the Common Shares will be computed based upon
the value of the Fund's portfolio securities and other assets. Net asset value
per Common Share will be determined as of the close of the Exchange no less
frequently than the second to the last business day of each week and the last
business day of each month. The Fund will calculate net asset value per Common
Share by subtracting (1) the Fund's liabilities (including accrued expenses),
(2) accumulated and unpaid dividends on any outstanding preferred shares, (3)
the aggregate liquidation value any outstanding preferred shares and (4) any
dividends payable on the Common Shares, from the Fund's total assets (the value
of the securities the Fund holds plus cash or other assets, including interest
accrued but not yet received) and dividing the result by the total number of
Common Shares outstanding.
Securities for which market quotations are readily available are valued
at market value, which is currently determined using the last reported sale
price or, if no sales are reported-as in the case of some securities traded
over-the-counter- the last reported bid price, except that certain U.S.
government securities are stated at the mean between the last reported bid and
asked prices.
..........The Fund will value MBS and other debt securities not traded in an
organized market on the basis of valuations provided by dealers or by a pricing
service, approved by the Board of Directors, which uses information with respect
to transactions in such securities, quotations from dealers, market transactions
in comparable securities, various relationships between securities and yield to
maturity in determining value. Debt securities having a remaining maturity of
sixty days or less when purchased and debt securities originally purchased with
maturities in excess of sixty days but which currently have maturities of sixty
days or less are valued at cost adjusted for amortization of premiums and
accretion of discounts. Any securities or other assets for which current market
quotations are not readily available are valued at their fair value as
determined in good faith under procedures established by and under the general
supervision and responsibility of the Board of Directors. A determination of
value by a pricing service to be used in calculating net asset value will be
deemed to be a fair value determination made in good faith by the Board of
Directors. While no single standard for determining fair value exists, as a
general rule, the current fair value of a security would appear to be the amount
which the Fund could expect to receive upon its current sale. Some but not
necessarily all of the general factors which may be considered in determining
fair value include: (1) the fundamental analytical data relating to the
investment; (2) the nature and duration of restrictions on disposition of the
securities; and (3) an evaluation of the forces which influence the market in
which these securities are purchased and sold. Without limiting or including all
of the specific factors which may be considered in determining fair value, some
of the specific factors include: type of security, financial statements of the
issuer, cost at date of purchase, size of holding, discount from market value,
value of unrestricted securities of the same class at the time of purchase,
special reports prepared by analysts, information as to any transaction or
offers with respect to the security, existence or merger proposals or tender
offers affecting the securities, price and extent of public trading in similar
securities of the issuer or comparable companies, and other relevant matters.
REPURCHASE OF COMMON SHARES
Several factors may cause the market price per share of the Common
Shares to be greater than or less than net asset value per share. Shares of
closed-end investment companies that invest primarily in fixed income securities
tend to trade on the basis of the market yield on their shares and, like the
prices of their underlying assets, the share prices of such funds tend to move
in an inverse relationship to changes in interest rates. Prices of high yield
high risk securities also fluctuate in response to general economic conditions
and business conditions affecting the specific industries in which the issuers
of such securities are engaged. Such changes in the values of portfolio
securities generally will not affect the amount of interest income earned on
such securities but they will affect the net asset value of the Fund. In
addition, shares of closed-end investment companies frequently trade at a
discount from net asset value, but in some cases trade at a premium. This
characteristic of shares of closed-end funds is a risk separate and distinct
from the risk that the Fund's net asset value may decrease. The market price of
the Fund's Common Shares also may be affected by trading volume of the Common
Shares, general market and economic conditions and other factors beyond the
control of the Fund.
The Board of Directors from time to time may, in the interests of the
Fund's shareholders, consider actions for the Fund to take to attempt to reduce
a market value discount. Subject to applicable law and restrictions with respect
to any preferred shares, such actions may include the repurchase of Common
Shares in the open market or the making of a tender offer at net asset value as
of the close of business on the date any such tender offer ends to all holders
of Common Shares, for a portion of the Common Shares. Any service fees incurred
in connection with a tender offer will not be deducted from the consideration
paid for the Common Shares. The Fund may incur debt to finance any repurchases
or tenders, subject to compliance with the 1940 Act, the Fund's fundamental
policy with respect to borrowings and the other limitations described under
"INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS" in the Prospectus. Interest
on any such borrowings will reduce the Fund's net income. Any failure by the
Fund to maintain certain asset coverage ratios would provide certain rights to
holders of any preferred shares which could affect negatively potential returns
on the Common Shares. See "PREFERRED SHARES."
There can be no assurance that any such repurchases and/or tenders
would cause the Common Shares to trade at a price equal to their net asset value
or reduce the spread between the market price and the net asset value of a
Common Share. Although the Board of Directors would not expect to authorize
Common Share repurchases and tenders unless it believes that such action would
have a favorable effect on the market price of the Common Shares, the
acquisition of Common Shares by the Fund will decrease the total assets of the
Fund and, therefore, could have the effect of increasing the Fund's expense
ratio. Because of the nature of the Fund's investment objectives, policies and
portfolio, the Adviser does not anticipate that repurchases and tenders should
interfere with the ability of the Fund to manage its investments in accordance
with its investment objectives, and does not anticipate any material difficulty
in disposing of portfolio securities to consummate Common Share repurchases and
tenders.
The Fund does not intend to effect repurchases or tender offers if (1)
such transactions would result in the delisting of the Common Shares by the
Exchange or impair the Fund's status as a regulated investment company under the
Internal Revenue Code; (2) the Fund would not be able to liquidate portfolio
securities in an orderly manner without creating a negative impact on the net
asset value of the Fund to the detriment of shareholders; or (3) there are
certain other events or conditions that would have a material adverse effect on
the Fund or its shareholders if Common Shares were repurchased. The Board of
Directors may modify these conditions in light of experience if it deems the
modifications to be in the best interests of shareholders.
If the Fund must liquidate portfolio securities to pay for the purchase of
Common Shares, the Fund may be required to sell portfolio securities for other
than investment purposes and may realize gains and losses. See "TAXATION -
FEDERAL INCOME TAX TREATMENT OF THE FUND."
PREFERRED SHARES
Although there is no present intention of doing so, the Fund may offer
preferred shares subject to market conditions, if it believes that leveraging
the Fund's capital structure through the issuance of preferred shares may
achieve benefits to holders of the Common Shares. There can be no assurance,
however, that preferred shares will be issued or that the terms of preferred
shares will be those that are currently anticipated.
The terms of the preferred shares, including the dividend rate, voting
rights, liquidation preference and redemption provisions, will be determined by
the Board of Directors (subject to applicable law and the Articles of
Incorporation) if and when they authorize an offering of preferred shares. The
preferred shares may be issued in one or more series and may provide for the
periodic redetermination of the dividend rate at relatively short intervals
through an auction or remarketing procedure. Such auction or remarketing
procedures with respect to preferred shares are expected to involve the payment
of fees by the Fund to its agents in connection with such procedures.
The discussion set forth below summarizes the currently anticipated terms
of the preferred shares.
DIVIDENDS AND DISTRIBUTIONS
To the extent permitted by applicable law, it is intended that the
preferred shares, if issued, will have a preference on dividends, which will be
paid first out of net investment income and short-term capital gains and then,
if necessary, out of long-term capital gains. See "TAXATION - FEDERAL INCOME TAX
INCOME TREATMENT OF THE FUND." Dividends on preferred shares will be cumulative
from the date on which such shares are originally issued (the "Original Issuance
Date") and will be payable, when, as and if declared by the Board of Directors.
Dividends will be paid to the holders of preferred shares on each dividend
payment date through a disbursing agent.
Unless at the time of the declaration, purchase or redemption referred to
in (i) through (iii) below (and after giving effect thereto) the Fund complies
with the applicable asset coverage requirements set forth in the 1940 Act, the
Fund may not (i) declare dividends on preferred shares, (ii) declare any other
distributions with respect to the preferred shares or purchase or redeem
preferred shares, or (iii) declare dividends or other distributions on the
Common Shares or purchase or redeem any Common Shares. See "INVESTMENT
OBJECTIVES, POLICIES AND RESTRICTIONS - INVESTMENT POLICIES - Leverage and
Borrowing" in the Prospectus for more information. MINIMUM LIQUIDITY LEVEL
The Fund will be required to have a specified amount of cash, U.S.
Government obligations or short term money market instruments (the "Deposit
Securities") with maturity dates not later than the day preceding the next
dividend payment date and have a value not less than the aggregate amount of
dividends to be paid on such dividend payment date on the outstanding preferred
shares, less the combined value of deposit securities irrevocably deposited for
the payment of dividends on the preferred shares.
MAINTENANCE OF RATING ON PREFERRED SHARES
If preferred shares are issued, the composition of the Fund's portfolio
will be maintained (the "Maintenance") so that the Fund will receive ratings of
AAA or aaa by any Rating Agency for the preferred shares. In connection with the
Maintenance, the Fund also will be required to meet the specified minimum
liquidity level described below. The Maintenance is designed to cause the Fund's
assets to be sufficiently diversified and of sufficient credit quality and
amount on an ongoing basis to maintain the ratings on the preferred shares. The
Maintenance is not prescribed by law, but will be implemented by the Fund to
receive the desired ratings on the preferred shares. See "Appendix A" of the
Prospectus. The Maintenance will provide a set of tests for portfolio
diversification and asset coverage that are different from the applicable
requirements under the 1940 Act (and may be more or less restrictive), but will
be the sole determinants in the rating of the preferred shares.
The Maintenance will seek to cause the value of certain specified assets of
the Fund to be sufficient, under certain adverse scenarios determined by the
Rating Agencies, to cover the aggregate liquidation preference for the
outstanding preferred shares, accumulated unpaid dividends (and certain
projected dividends) on the preferred shares and the Fund's liabilities. To
determine the Fund's compliance with the Maintenance, the market value of the
Fund's portfolio will be discounted by dividing the value of each security (or
category of securities) by a factor assigned by the Rating Agencies. The
discount factors applied will vary according to the type, credit quality and
liquidity of each security being valued. To the extent any of the Fund's assets
do not meet the Maintenance, such assets will not be included in determining
whether the discounted value of the Fund's portfolio complies with the
requirements of the Maintenance.
Upon any failure to maintain the required discounted value, the Fund will
seek to alter the composition of its portfolio to attain the required asset
coverage within the cure period specified by the Rating Agencies, and as a
result may incur additional transaction costs and possible losses and/or gains
on dispositions of portfolio securities. To the extent any such failure is not
cured in a timely manner, the holders of the preferred shares will acquire
certain rights, which may include the right to require redemption of certain of
the preferred shares by the Fund.
REDEMPTION, PURCHASE AND SALE OF PREFERRED SHARES BY THE FUND
The terms of the preferred shares may provide that (i) they are redeemable
at certain times, in whole or in part, at the original purchase price per
Preferred Share plus accrued dividends and redemption premium, if any, (ii) the
Fund may tender for or purchase preferred shares and (iii) the Fund may
subsequently resell any preferred shares so tendered for or purchased. The Fund
cannot predict what, if any, mandatory redemption requirements may be imposed by
a Rating Agency in connection with its ratings of the preferred shares. Any
redemption or purchase of preferred shares by the Fund will reduce the leverage
applicable to the Common Shares, while any resale of preferred shares by the
Fund will increase such leverage. See "Leverage and Borrowing."
LIQUIDATION RIGHTS
Upon a liquidation, dissolution or winding up of the Fund (whether
voluntary or involuntary), holders of preferred shares then outstanding will be
entitled to receive, out of the assets of the Fund available for distribution to
shareholders, after satisfying claims of creditors but before any distribution
of assets is made to holders of the Common Shares, a liquidation distribution in
an amount expected to equal the original purchase price per share plus an amount
equal to accumulated and unpaid dividends (whether or not earned or declared) to
the date of the final distribution. Unless and until payment in full has been
made to the holders of preferred shares of the liquidation distribution to which
they are entitled, no dividends or distributions will be made to holders of the
Common Shares.
VOTING
The discussion set forth below summarizes the voting rights of
shareholders, including the currently anticipated voting rights of shareholders
if an offering of preferred shares is consummated. Except as noted below, the
Common Shares and the preferred shares will have equal voting rights of one vote
per share and vote together as a single class. In elections of Directors, the
holders of the preferred shares, as a separate class, will vote to elect two
Directors. The holders of the Common Shares will vote to elect the remaining
Directors. In addition, during any period (hereinafter referred to as a "Voting
Period") that accumulated dividends payable on preferred shares in an amount
equal to two full years of dividends are unpaid on such preferred shares, voting
as a class, will be entitled to elect the smallest number of additional
Directors as shall be necessary to assure that a majority of the Directors has
been elected by the holders of such preferred shares.
The terms of office of all persons who are Directors of the Fund at the
time of the commencement of a Voting Period will continue, notwithstanding the
election by the holders of the preferred shares of the additional number of
Directors which such holders are entitled to elect. The persons elected by the
holders of preferred shares, together with the incumbent Directors elected by
the holders of the Common Shares, will constitute the duly elected Directors of
the Fund. When all accumulated and unpaid dividends have been paid or provided,
for, the terms of office of the additional Directors elected by the holders of
the preferred shares shall terminate.
The Common Shares and the preferred shares will vote as separate
classes on amendments to the Articles of Incorporation that would adversely
affect their respective rights as expressly set forth in the Articles of
Incorporation. In addition, so long as any preferred shares are outstanding, (1)
the Fund may not be voluntarily liquidated, dissolved, wound up, merged or
consolidated, and may not sell all or substantially all of its assets, without
the approval of at least a majority of the preferred shares and the Common
Shares, each voting as a separate class; (2) the adoption of any plan of
reorganization adversely affecting either the preferred shares or the Common
Shares will require the approval of a majority of the shares of each such class
so affected; (3) the approval of a majority of the preferred shares and the
Common Shares, each voting as a separate class, will be required to approve any
action requiring a vote of security holders under Section 13(a) of the 1940 Act,
including among other things, changes in its investment objectives or changes in
its investment restrictions, and (4) the approval of a majority of the preferred
shares, voting separately as a class, will be required to amend, alter, repeal
or affect materially and adversely any of the preferences, rights or powers of
holders of preferred shares, or increase or decrease the number of preferred
shares authorized to be issued. The Common Shares and the preferred shares also
will vote separately to the extent otherwise required under Maryland law or the
1940 Act as in effect from time to time.
For purposes of any rights of the holders of the preferred shares to
vote on any matter, whether such right is created by the Articles of
Incorporation, by statue or otherwise, a holder of a preferred share will not be
entitled to vote and such preferred share will not be deemed to be outstanding
for the purpose of voting or determining of preferred shares required to
constitute a quorum, if prior to or concurrently with a determination of
preferred shares entitled to vote or of preferred shares deemed outstanding for
quorum purposes, as the case may be, a notice of redemption of such Preferred
Share shall have been deposited in trust.
PORTFOLIO TURNOVER
The Adviser actively makes portfolio adjustments that reflect the Fund's
investment strategy, but does not trade securities for the Fund for the purpose
of seeking short-term profits. It will, however, change the Fund's securities,
regardless of how long they have been held, when it believes doing so will
further the Fund's investment objectives.
The Fund reserves full freedom with respect to portfolio turnover. In
periods when there are rapid changes in economic conditions or security price
levels or when the investment strategy is changed significantly, portfolio
turnover may be significantly higher than during times of economic and market
price stability, when the investment strategy remains relatively constant. A
high rate of portfolio turnover will result in increased transaction costs for
the Fund in the form of increased dealer spreads and brokerage commissions.
TAXATION
Set forth below is a discussion of certain U.S. federal income tax
issues concerning the Fund and the purchase, ownership and disposition of Fund
shares. This discussion does not purport to be complete or to deal with all
aspects of federal income taxation that may be relevant to shareholders in light
of their particular circumstances. This discussion is based upon current
provisions of the Internal Revenue Code, the Treasury regulations promulgated
thereunder and judicial and administrative ruling authorities, all of which are
subject to change, possibly with retroactive effect. Prospective investors
should consult their own tax advisers with regard to the federal tax
consequences of the purchase, ownership, or disposition of Fund shares, as well
as the tax consequences arising under the laws of any state, foreign country or
other taxing jurisdiction.
FEDERAL INCOME TAX TREATMENT OF THE FUND
The Fund has elected and intends to qualify to be treated as a
regulated investment company under the Internal Revenue Code. To qualify as a
regulated investment company, the Fund must, among other things, (a) derive in
each taxable year at least 90% of its gross income from dividends, interest,
payments with respect to securities loans and gains from the sale or other
disposition of stock, securities or foreign currencies, or other income derived
with respect to its business of investing in stock, securities or currencies
(including, but not limited to, gains from options, futures and forward
contracts), and (b) diversify its holdings so that, at the end of each quarter
of each taxable year, (i) at least 50% of the market value of the Fund's assets
is represented by cash, cash items, U.S. Government securities, securities of
other regulated investment companies and other securities, with such other
securities of any one issuer limited for the purposes of this calculation to an
amount not greater than 5% of the value of the Fund's total assets and 10% of
the outstanding voting securities of such issuer and (ii) not more than 25% of
the value of its total assets is invested in the securities of any one issuer
(other than U.S. government securities or the securities of other regulated
investment companies).
As a regulated investment company, in any fiscal year with respect to
which the Fund distributes at least 90% of its investment company taxable income
(which includes, among other items, dividends and interest but excludes net
long-term capital gains in excess of net short-term capital losses), the Fund
(but not its shareholders) generally will be relieved of U.S. federal income tax
on its net investment income and net capital gains (net long-term capital gains
in excess of the sum of net short-term capital losses and capital loss
carryovers from prior years, if any) that it distributes to shareholders. To the
extent the Fund retains its net capital gains for investment, it will be subject
under current tax rates to a federal income tax at a maximum effective rate of
35% on the amount retained. See "FEDERAL INCOME TAX TREATMENT OF HOLDERS OF
COMMON SHARES" below. Amounts not distributed on a timely basis in accordance
with a calendar year distribution requirement are subject to a nondeductible 4%
excise tax payable by the Fund. To avoid this tax, the Fund must distribute, or
be deemed to have distributed, during each calendar year at least an amount
equal to the sum of (1) 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (2) 98% of its capital gains in
excess of its capital losses (adjusted for certain ordinary losses) for the
twelve-month period ending on December 31 of the calendar year, and (3) all
ordinary income and capital gains for previous years that were not distributed
during such years. See "RISK FACTORS - DIVIDENDS AND DISTRIBUTIONS" in the
Prospectus.
If in any taxable year the Fund fails to qualify as a regulated
investment company under the Internal Revenue Code, the Fund will be taxed in
the same manner as an ordinary corporation, and distributions to its
shareholders will not be deductible by the Fund in computing its taxable income.
In the event of failure to qualify, the Fund's distributions, to the extent
derived from the Fund's current or accumulated earnings and profits, will
constitute dividends eligible for the corporate dividends received deduction,
subject to certain requirements which are taxable to shareholders as ordinary
income, even though those distributions might otherwise (at least in part) have
been treated in the shareholders' hands as long-term capital gains. In addition,
in the event the Fund fails to qualify for any year, it generally must pay out
its earnings and profits accumulated in that year less an interest charge to the
U.S. Treasury on 50% of such earnings and profits before it can again qualify as
a regulated investment company.
If the Fund does not meet the asset coverage requirements of the 1940
Act, the Fund will be required to suspend distributions to shareholders and/or
to any outstanding preferred shares until the asset coverage is restored. Such a
suspension of distributions could prevent the Fund from distributing 90% of its
investment company taxable income, as is required in order to qualify for
taxation as a regulated investment company, or cause the Fund to incur a tax
liability or a non-deductible 4% excise tax on its undistributed taxable income
(including gain), or both.
The Fund's portfolio may include zero coupon bonds. Zero coupon bonds
are original issue discount bonds which pay no current interest. Original issue
discount is the excess (if any) of the stated redemption price at maturity of a
debt instrument over the issue price of the instrument. Original issue discount
on a taxable obligation is required to be currently included in the income of
the holder of the obligation generally on a constant interest rate basis
resembling the economic accrual of interest. The tax basis of the holder of an
original issue discount debt instrument is increased by the amount of original
issue discount thereon properly included in the holder's gross income as
determined for federal income tax purposes. Current inclusion in gross income of
original issue discount on a taxable debt instrument is required, even though no
cash is received at the time the original issue discount is required to be
included in gross income. Because such income may not be matched by a
corresponding cash distribution to the Fund, the Fund may be required to borrow
money or dispose of other securities to be able to distribute all of its
investment company taxable income to the investors.
Certain of the Fund's investments, including transactions in foreign
currencies, forward contracts, options and futures contracts (including options
and futures contracts on foreign currencies), will be subject to special
provisions of the Internal Revenue Code that, among other things, may affect the
character of gains and losses realized by the Fund (i.e., may affect whether
gains or losses are ordinary or capital), accelerate recognition of income to
the Fund, defer Fund losses, or affect the determination of whether capital
gains and losses are characterized as long- term or short-term capital gains or
losses. These rules could therefore affect the character, amount and timing of
distributions to shareholders. These provisions may cause the Fund to recognize
income or gain without receiving cash with which to make distributions in
amounts necessary to satisfy the 90% and 98% distribution requirements for
avoiding income and excise taxes. The Fund will monitor its transactions and
will make the appropriate tax elections in order to mitigate the effect of these
rules and prevent disqualification of the Fund as a regulated investment company
and minimize the imposition of income and excise taxes.
FEDERAL INCOME TAX TREATMENT OF HOLDERS OF COMMON SHARES
For any period during which the Fund qualifies as a regulated
investment company for federal income tax purposes, dividends paid out of the
Fund's investment company taxable income to shareholders will be taxable as
ordinary income. It is expected that dividends received by corporate
shareholders will not be eligible for the dividends received deduction as the
Fund's income is expected to come from sources other than dividends from
domestic corporations. Distributions of net capital gains designated by the Fund
as "capital gain dividends," if any, are taxable as long-term capital gains,
regardless of how long the shareholder has held the Fund's shares. Capital gain
dividends are not eligible for the corporate dividends received deduction.
Dividends and distributions will be taxable to shareholders as if actually
distributed, even if they are reinvested in additional shares of the Fund.
Shareholders receiving distributions in the form of newly issued shares will
have a cost basis in each share received equal to the fair market value of a
share of the Fund on the distribution date. Shareholders receiving distributions
in the form of additional Common Shares purchased by the Plan Agent will be
treated for federal income tax purposes as receiving the amount of cash received
by the Plan Agent on their behalf. In general, the basis of such shares will
equal the price paid by the Plan Agent for such shares.
Generally, dividends paid by the Fund are treated as received in the
taxable year in which the distribution is made; however, any dividend declared
by the Fund in October, November or December of any calendar year, payable to
shareholders of record on a specified date in such a month and actually paid
during January of the following year, will be treated as received on December 31
of the year in which declared.
Any distribution by the Fund to a shareholder not made out of the
Fund's current and accumulated earnings and profits will be treated as a return
of capital to each shareholder, will reduce the basis of each Common Share with
respect to which it is distributed and will be subject to tax as capital gain to
the extent that the distribution exceeds the basis of the Common Share with
respect to which it is distributed. Investors should carefully consider the tax
implications of buying Common Shares just prior to a distribution, as the price
of shares purchased at such time may reflect the amount of the forthcoming
distribution which will, except in unusual circumstances, be taxable when
received.
After the close of each taxable year, the Fund will identify for its
shareholders the portions of its distributions that are attributable to capital
gains and to ordinary income.
The Internal Revenue Code permits certain miscellaneous itemized
deductions by individuals, including deductions of certain investment expenses,
only to the extent the aggregate of such deductions exceeds 2% of an
individual's federal adjusted gross income. The Internal Revenue Code treats
such expenses incurred by a regulated investment company as being indirectly
incurred by the shareholders of the regulated investment company. Shareholder
expenses of publicly offered regulated investment companies are exempted from
the application of the 2% floor. Thus, the limitation will not apply with
respect to indirect deductions through the Fund. There are no similar
limitations which could apply to corporate shareholders.
If the Fund suffers a net taxable loss in any taxable year, the holders
of Common Shares will not be permitted to utilize that loss on their federal
income tax returns.
A shareholder will realize gain or loss on the sale or exchange of
shares of the Fund in an amount equal to the difference between the
shareholder's adjusted basis in the shares sold or exchanged and the amount
realized on their disposition. Generally, a gain recognized by a shareholder on
the sale of shares held for more than one year will be taxable as a long-term
capital gain. If a shareholder holds shares primarily for sale to customers in
the ordinary course of business rather than for investment, any gain recognized
on the sale of those shares will be taxable as ordinary income. Any loss
recognized on a sale or exchange will be disallowed to the extent the shares
disposed of are replaced within a period of 61 days beginning 30 days before and
ending 30 days after the shares are disposed of. In such a case, the basis of
the shares acquired will be adjusted to reflect the disallowed loss. Any loss
recognized by a shareholder on a disposition of Fund shares held by the
shareholder for six months or less will be treated as a long-term capital loss
to the extent of any distributions of capital gain dividends received or treated
as having been received by the shareholder with respect to such shares.
Shareholders who acquire shares on multiple dates should consult their tax
advisors to determine how to allocate the cost of shares for basis purposes.
In general, federal withholding taxes at a 30% rate (or a lower rate
established by treaty) will apply to distributions to shareholders (except to
those distributions designated by the Fund as capital gain dividends) that are
nonresident aliens or foreign partnerships, trusts or corporations to the extent
that such income is not "effectively connected" with a U.S. trade or business
carried on by such shareholders. In contrast, interest income from direct
investment in the underlying assets of the Fund by such shareholders generally
would not be subject to such federal withholding taxes. Prospective foreign
investors should consult their tax advisers concerning the tax consequences to
them of an investment in Common Shares.
In the event the Fund retains any net capital gains, it may designate
such retained amounts as undistributed capital gains in a notice to its
shareholders. In the event such a designation is made, shareholders subject to
U.S. tax would include in income, as long-term capital gains, their
proportionate share of such undistributed amounts, but would be allowed a credit
or refund, as the case may be, for their proportionate share of the 35% tax paid
by the Fund. If the designation is made, for U.S. federal income tax purposes,
the tax basis of shares owned by a shareholder would be increased by an amount
equal to the difference between (i) the amount included in such shareholder's
income as long-term capital gains and (ii) such shareholder's proportionate
share of the 35% tax paid by the Fund.
BACKUP WITHHOLDING
The Fund may be required to withhold for U.S. federal income taxes a
percentage of all taxable distributions paid to shareholders who (i) fail to
properly provide the Fund with their correct taxpayer identification number,
(ii) fail to make required certifications or (iii) have been notified or with
respect to whom the Fund has been notified by the U.S. Internal Revenue Service
that distributions to such shareholder are subject to backup withholding.
Corporate shareholders and certain other shareholders specified in the Internal
Revenue Code are exempt from such backup withholding. Backup withholding is not
an additional tax. Any amounts withheld may be refunded or credited against the
shareholder's U.S. federal income tax liability.
Generally, dividends paid to nonresident aliens or foreign
partnerships, trusts or corporations that are subject to the 30% federal income
tax withholding described above under "Federal Income Tax Treatment of Holders
of Common Shares" are not subject to backup withholding. To avoid backup
withholding on capital gain dividends and gross proceeds from the sale of Common
Shares, such shareholders must provide a properly completed Internal Revenue
Service Form W-8BEN certifying their non-United States status.
OTHER TAXATION
The foregoing discussion is a general summary of a few of the current
federal income tax laws regarding the Fund and investors in the shares. The
discussion does not purport to deal with all of the federal income tax
consequences applicable to the Fund, or to all categories of investors who may
be subject to special rules (for example, foreign investors). Investors are
advised to consult their own tax advisors with respect to the application to
their own circumstances of the above-described general taxation rules and with
respect to the federal, state, local or foreign tax consequences to them of an
investment in the Common Shares and any proposed tax law changes.
PERFORMANCE INFORMATION
From time to time, the Fund may quote the Fund's total return,
aggregate total return or yield in advertisements or in reports and other
communications to shareholders. The Fund's performance will vary depending upon
market conditions, the composition of its portfolio and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of the Fund's performance in the future. In addition, because
performance will fluctuate, it may not provide a basis for comparing an
investment in the Fund with certain bank deposits or other investments that pay
a fixed yield for a stated period of time. Investors comparing the Fund's
performance with that of other investment companies should give consideration to
the quality and maturity of the respective investment companies' portfolio
securities.
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return figures will be computed
according to a formula prescribed by the SEC. The formula can be expressed as
follows:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment of $1000,
T = average annual total return,
N = number of years, and
ERV = Ending redeemable value of a hypothetical $1000
payment made at the beginning of a 1-, 5-, or 10-year
period at the end of a 1-, 5-, or 10-year period (or
fractional portion thereof), assuming reinvestment of
all dividends and distributions.
YIELD
Quotation of yield for the Fund will be based on all investment income
per share earned during a particular 30-day period (including dividends and
interest), less expenses accrued during the period ("Net Investment Income") and
will be computed by dividing Net Investment Income by the maximum offering price
per share on the last day of the period, according to the following formula:
A - B
2 [( --------- + 1)6 - 1]
CD
Where: A = dividends and interest earned during the period,
B = expenses accrued for the period (net of
reimbursements),
C = the average daily number of shares outstanding during
the period that were entitled to receive dividends, and
D = the maximum offering price per share on the last day
of the period.
In reports or other communications to shareholders or in advertising
materials, the Fund may compare its performance with that of (1) other
closed-end investment companies listed in the rankings prepared by
______________________, publications such as ____________________________ or
other industry or financial publications or (2) the ____________________________
and other relevant indices and industry publications. The Fund may also compare
the historical volatility of its portfolio to the volatility of such indices
during the same time periods. (Volatility is a generally accepted barometer of
the market risk associated with a portfolio of securities and is generally
measured in comparison to the stock market as a whole - the beta - or in
absolute terms - the standard deviation.)
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
In the opinion of the Adviser, the historical credit performance of
Non-Agency RMBS and CMBS has been superior to that of corporate bonds, as
evidenced by the ratio between credit rating upgrades and downgrades of prime
first mortgage Non-Agency RMBS, all Non-Agency RMBS, CMBS and corporate bonds
for the past one, five and ten years ended December 31, 2001, as set forth
below.
Ratio of Total Credit Rating Upgrades to Total Credit Rating Downgrades
for Prime First Mortgage Non-Agency RMBS, all Non-Agency RMBS, CMBS and
Corporate Bonds for One, Five and Ten Years Ended December 31, 2001
Prime First
Mortgage All Non-Agency
Non-Agency RMBS RMBS Corporate Bonds
CMBS
Last 1 Year 23.45 : 1 8.61 : 1 2.81 : 1 1 : 2.90
Last 5 Years 9.71 : 1 3.73 : 1 3.69 : 1 1 : 1.95
Last 10 Years 5.11 : 1 2.85 : 1 1.66 : 1 1 : 1.58
Sources: S&P ; Hyperion Capital Management, Inc.
Prime First Mortgage Non-Agency RMBS represent Non-Agency RMBS secured
by prime high quality first mortgages, primarily on owner-occupied single family
residential properties. All Non-Agency RMBS include Prime First Mortgage
Non-Agency RMBS, as well as Non-Agency RMBS secured by second mortgages, home
equity lines of credit, subprime mortgages, and other types of residential
mortgages not considered to be Prime quality first mortgages. The Fund intends,
under normal market conditions, to invest its Non-Agency RMBS allocation
primarily in Prime First Mortgage Non-Agency RMBS, although it may also invest
in other types of Non-Agency RMBS.
For the past 10 years, Prime First Mortgage Non-Agency RMBS, all
Non-Agency RMBS and CMBS have experienced more credit upgrades than downgrades.
Corporate bonds have experienced more downgrades than upgrades over the same
time period.
The upgrade / downgrade ratios shown in the table above have been
calculated as the total number of credit ratings upgrades reported by S&P over
the respective 1, 5 or 10-year period, divided by the total number of downgrades
for that period, expressed as a ratio.
Total Annual Credit Ratings Upgrades and Downgrades for
Prime First Mortgage Non-Agency MBS: 1992-2001
Total Upgrades Total Downgrades
1992 13 33
1993 27 29
1994 132 42
1995 74 40
1996 39 34
1997 95 30
1998 78 40
1999 121 17
2000 510 27
2001 516 22
Last 5 Years 1,320 136
Last 10 Years 1,605 314
Sources: S&P "Ratings Transitions 2001: U.S. RMBS Credit Ratings Show Continued
Resiliency", January 15, 2002; S&P, memorandum to Hyperion Capital Management,
Inc., April 15, 2002; Hyperion Capital Management, Inc.
Total Annual Credit Ratings Upgrades and Downgrades for
All Non-Agency MBS: 1992-2001
Total Upgrades Total Downgrades
1992 13 34
1993 27 31
1994 132 61
1995 74 55
1996 43 39
1997 96 56
1998 88 67
1999 132 29
2000 552 164
2001 551 64
Last 5 Years 1,419 380
Last 10 Years 1,708 600
Sources: S&P, "Ratings Transitions 2001: U.S. RMBS Credit Ratings Show Continued
Resiliency", January 15, 2002; S&P, memorandum to Hyperion Capital Management,
Inc., April 15, 2002; Hyperion Capital Management, Inc.
Total Annual Credit Ratings Upgrades and
Downgrades for CMBS: 1992-2001
Total Upgrades Total Downgrades
1992 0 7
1993 2 11
1994 2 26
1995 6 31
1996 3 57
1997 9 5
1998 38 7
1999 64 5
2000 88 22
2001 174 62
Last 5 Years 373 101
Last 10 Years 386 233
Sources: S&P, "Ratings Transitions 2001: CMBS Continues to Show Strong Credit
Performance", January 29, 2002; Hyperion Capital Management, Inc.
Estimated Total Annual Credit Ratings Upgrades and
Downgrades for Corporate Bonds: 1992-2001
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Total Total Total % of % of % of Total % Total Total
Investment Speculative Corp. Corp. Corp. Corp. of Corp. Corp. Corp.
Grade Grade Bond Bond Bond Bond Bonds Bond Bond
Corp. Corp. Issues Issues Issues Issues Down-graded Up-grades Down-grades
Bond Bond (on Jan. Up-graded Down-graded Down-graded = (5)+(6) = (4)x(3) = (7)x(3)
Issues Issues 1) = (1) During (except to "D"
(on Jan. 1) (on Jan. 1) + (2) Year down-grades
to "D")
1992 1,784 520 2,304 4.17% 5.86% 1.22% 7.08% 96 135
1993 1,971 577 2,548 3.96% 4.95% 0.47% 5.42% 101 126
1994 2,135 751 2,886 2.53% 4.12% 0.52% 4.64% 73 119
1995 2,444 870 3,314 3.71% 3.92% 0.91% 4.83% 123 130
1996 2,595 950 3,545 4.40% 2.93% 0.45% 3.38% 156 104
1997 2,803 1,066 3,869 3.88% 3.88% 0.57% 4.45% 150 150
1998 3,034 1,399 4,433 3.07% 5.55% 1.17% 6.72% 136 246
1999 3,151 1,772 4,923 2.52% 4.81% 2.01% 6.82% 124 237
2000 3,225 1,931 5,156 2.56% 5.74% 2.23% 7.97% 132 296
2001 3,314 1,968 5,282 2.52% 7.31% 3.46% 10.77% 133 386
Last 5
Years 675 1315
Last 10
Years
1,224 1,929
Sources: S&P, "Record Defaults in 2001 the Result of Poor Credit Quality And a
Weak Economy", Special Report: Ratings Performance 2001, February, 2002;
Hyperion Capital Management, Inc.
In the opinion of the Adviser, risk-adjusted returns on Agency MBS have
been superior to those of intermediate Treasury securities and corporate bonds
over the past 10 years ended March 31, 2002. Set forth below are the Sharpe
ratios for the 1-, 5- and 10-years on the Lehman Fixed Rate MBS Index, the
Lehman U.S. Treasury Intermediate Index, the Lehman Intermediate Corporate Index
and the Lehman U.S. Corporate High Yield Index.
Historical Sharpe Ratios for the Lehman Fixed Rate MBS Index, the Lehman
U.S. Treasury Intermediate Index, the Lehman Intermediate Corporate Index
and the Lehman U.S. Corporate High Yield Index: 1-, 5- and 10-Years Ended
March 31, 2002
Lehman U.S. Lehman Lehman U.S.
Lehman Fixed Treasury Intermediate Corporate High
Rate MBS Index Intermediate Corporate Index Yield Index
Index
Last 1 Year 0.46 0.15 0.26 -0.12
Last 5 Years 0.52 0.30 0.35 -0.12
Last 10 Years 0.41 0.28 0.33 0.19
Sources: Lehman Brothers Inc.; Hyperion Capital Management, Inc.; William P.
Sharpe, "The Sharpe Ratio", Journal of Portfolio Management, Fall 1994.
The Lehman Fixed Rate Index MBS represents the universe of
actively-traded fixed rate GNMA, FNMA and FHLMC MBS passthroughs with a minimum
current outstanding issue size of $150 million. This Index represents the
largest universe of collateralized fixed income securities in the U.S.
The Sharpe Ratio for a series of historical total returns on an asset,
portfolio or index, also known as the Ex-Post Sharpe Ratio, measures the average
historical average excess return per unit of historical variability of the
excess return. Excess returns are often calculated as the difference between the
historical returns of an asset portfolio or index and those of a short maturity
fixed income asset or index with very low risk.
The Historical Sharpe Ratios shown in the table above were calculated
based on historical quarterly returns on the respective indices, shown in the
table below. Excess returns on an index for a quarter were calculated as the
difference between the return of that Index and the return of the Lehman 3-month
U.S. Treasury Bellweather, also shown below. The Sharpe ratios in the table
above measure, for the respective index return series and time period, the
average quarterly excess return divided by the standard deviation of quarterly
excess returns.
Historical Quarterly Total Returns for the Lehman Fixed Rate MBS Index, the
Lehman U.S. Treasury Intermediate Index, the Lehman Intermediate Corporate
Index, the Lehman U.S. Corporate High Yield Index and the Lehman 3-month
U.S. Treasury Bellweather: For 10 Years Ended March 31, 2002
Lehman U.S. Lehman U.S.
Treasury Lehman Corporate High Lehman 3-month
Lehman Fixed Intermediate Intermediate Yield Index U.S. Treasury
Quarter Ended Rate MBS Index Index Corporate Index Bellweather
6/30/92 4.02% 3.89% 4.29% 2.75% 1.05%
9/30/92 2.98% 4.47% 4.52% 3.89% 1.00%
12/31/92 0.72% -0.36% -0.44% 0.97% -0.11%
3/31/93 2.96% 3.77% 4.83% 6.07% 0.79%
6/30/93 1.86% 1.98% 2.90% 4.21% 0.75%
9/30/93 0.96% 2.12% 2.80% 2.08% 0.81%
12/31/93 0.90% 0.15% 0.22% 3.79% 0.82%
3/31/94 -2.32% -1.86% -2.73% -1.94% 0.75%
6/30/94 -0.56% -0.55% -0.78% -0.33% 0.99%
9/30/94 0.87% 0.76% 1.03% 1.57% 1.13%
12/30/94 0.43% -0.11% -0.17% -0.30% 1.32%
3/31/95 5.24% 4.13% 5.33% 5.96% 1.51%
6/30/95 5.22% 4.70% 6.27% 6.09% 1.54%
9/30/95 2.10% 1.52% 2.05% 2.83% 1.43%
12/31/95 3.32% 3.38% 4.17% 3.10% 1.49%
3/31/96 -0.44% -0.71% -1.39% 1.77% 1.26%
6/30/96 0.80% 0.65% 0.48% 1.66% 1.32%
9/30/96 2.05% 1.71% 1.95% 4.00% 1.38%
12/31/96 2.88% 2.30% 2.92% 3.49% 1.33%
3/31/97 0.13% -0.07% -0.41% 1.12% 1.28%
6/30/97 3.79% 2.77% 3.47% 4.65% 1.38%
9/30/97 2.93% 2.57% 3.17% 4.54% 1.45%
12/31/97 2.37% 2.24% 1.92% 1.93% 1.30%
3/31/98 1.64% 1.51% 1.68% 3.36% 1.33%
6/30/98 1.72% 1.85% 1.99% 1.10% 1.34%
9/30/98 2.64% 4.85% 4.00% -4.55% 1.43%
12/31/98 0.80% 0.21% 0.41% 2.13% 1.12%
3/31/99 0.99% -0.37% 0.01% 1.85% 1.11%
6/30/99 -0.45% -0.18% -0.81% 0.34% 1.14%
9/30/99 0.93% 1.08% 0.70% -1.42% 1.28%
12/31/99 0.38% -0.11% 0.27% 1.63% 1.28%
3/31/00 1.38% 1.79% 1.24% -2.34% 1.35%
6/30/00 2.25% 1.80% 1.45% 1.15% 1.55%
9/30/00 3.23% 2.51% 3.21% 0.57% 1.52%
12/31/00 3.88% 3.81% 3.09% -5.24% 1.64%
3/31/01 2.73% 2.92% 4.04% 6.36% 1.53%
6/30/01 1.02% 0.37% 0.96% -2.29% 1.13%
9/30/01 4.21% 4.82% 4.05% -4.23% 1.08%
12/31/01 0.07% -0.11% 0.28% 5.78% 0.64%
3/31/02 0.99% -0.44% -0.26% 1.68% 0.43%
Source: Lehman Brothers Inc.
Historical Excess Quarterly Returns over the Lehman 3-month U.S. Treasury
Bellweather for the Lehman Fixed Rate MBS Index, the Lehman U.S. Treasury
Intermediate Index, the Lehman Intermediate Corporate Index, the Lehman U.S.
Corporate High Yield Index and the Lehman 3-month U.S. Treasury
Bellweather: For 10 Years Ended March 31, 2002
Lehman U.S. Lehman U.S.
Treasury Lehman Corporate High
Lehman Fixed Intermediate Intermediate Yield Index
Quarter Ended Rate MBS Index Index Corporate Index
6/30/92 2.97% 2.84% 3.24% 1.70%
9/30/92 1.98% 3.47% 3.52% 2.89%
12/31/92 0.83% -0.25% -0.33% 1.08%
3/31/93 2.17% 2.98% 4.04% 5.28%
6/30/93 1.11% 1.23% 2.15% 3.46%
9/30/93 0.15% 1.31% 1.99% 1.27%
12/31/93 0.08% -0.67% -0.60% 2.97%
3/31/94 -3.07% -2.61% -3.48% -2.69%
6/30/94 -1.55% -1.54% -1.77% -1.32%
9/30/94 -0.26% -0.37% -0.10% 0.44%
12/30/94 -0.89% -1.43% -1.49% -1.62%
3/31/95 3.73% 2.62% 3.82% 4.45%
6/30/95 3.68% 3.16% 4.73% 4.55%
9/30/95 0.67% 0.09% 0.62% 1.40%
12/31/95 1.83% 1.89% 2.68% 1.61%
3/31/96 -1.70% -1.97% -2.65% 0.51%
6/30/96 -0.52% -0.67% -0.84% 0.34%
9/30/96 0.67% 0.33% 0.57% 2.62%
12/31/96 1.55% 0.97% 1.59% 2.16%
3/31/97 -1.15% -1.35% -1.69% -0.16%
6/30/97 2.41% 1.39% 2.09% 3.27%
9/30/97 1.48% 1.12% 1.72% 3.09%
12/31/97 1.07% 0.94% 0.62% 0.63%
3/31/98 0.31% 0.18% 0.35% 2.03%
6/30/98 0.38% 0.51% 0.65% -0.24%
9/30/98 1.21% 3.42% 2.57% -5.98%
12/31/98 -0.32% -0.91% -0.71% 1.01%
3/31/99 -0.12% -1.48% -1.10% 0.74%
6/30/99 -1.59% -1.32% -1.95% -0.80%
9/30/99 -0.35% -0.20% -0.58% -2.70%
12/31/99 -0.90% -1.39% -1.01% 0.35%
3/31/00 0.03% 0.44% -0.11% -3.69%
6/30/00 0.70% 0.25% -0.10% -0.40%
9/30/00 1.71% 0.99% 1.69% -0.95%
12/31/00 2.24% 2.17% 1.45% -6.88%
3/30/01 1.20% 1.39% 2.51% 4.83%
6/30/01 -0.11% -0.76% -0.17% -3.42%
9/30/01 3.13% 3.74% 2.97% -5.31%
12/31/01 -0.57% -0.75% -0.36% 5.14%
3/31/02 0.56% -0.87% -0.69% 1.25%
Sources: Lehman Brothers Inc.; Hyperion Capital Management, Inc.
In the opinion of the Adviser, Agency MBS have outperformed
intermediate maturity Treasury securities and intermediate investment grade
corporate bonds during times of rising interest rate environments.
The table below shows historical annual total returns on Lehman Fixed
Rate MBS Index, the Lehman U.S. Treasury Index, the Lehman Corporate Investment
Grade Index, the Lehman Aggregate Index, the Lehman U.S. Treasury Intermediate
Index and the Lehman Intermediate Corporate Index for 10 years ended December
31, 2001.
Historical Annual Total Returns on Lehman Fixed Rate MBS Index, the Lehman
U.S. Treasury Index, the Lehman Corporate Investment Grade Index, the
Lehman Aggregate Index, the Lehman U.S. Treasury Intermediate Index and the
Lehman Intermediate Corporate Index: For 10 Years Ended December 31, 2001
Lehman Lehman U.S.
Lehman Fixed Lehman U.S. Corporate Treasury Lehman
Rate MBS Treasury Investment Lehman Intermed. Intermed.
Year Ended Index Index Grade Index Aggregate Index Corporate
10 Year Index Index
Treasury
12/31/92 6.56% 6.96% 7.21% 8.69% 7.40% 6.95% 8.20%
12/31/93 11.87% 6.84% 10.68% 12.16% 9.75% 8.22% 11.13%
12/31/94 (7.85)% -1.61% -3.38% -3.93% -2.92% -1.76% -2.66%
12/31/95 23.76% 16.80% 18.35% 22.25% 18.47% 14.42% 18.99%
12/31/96 0.10% 5.35% 2.70% 3.28% 3.63% 3.98% 3.97%
12/31/97 11.26% 9.49% 9.57% 10.23% 9.65% 7.69% 8.36%
12/31/98 12.87% 6.96% 10.03% 8.57% 8.69% 8.62% 8.29%
12/31/99 (8.43)% 1.86% -2.56% -1.96% -0.82% 0.41% 0.16%
12/31/00 14.45% 11.16% 13.52% 9.08% 11.63% 10.26% 9.27%
12/31/01 4.04% 8.22% 6.75% 10.31% 8.44% 8.16% 9.60%
Source: Lehman Brothers Inc.
In the opinion of the Adviser, currently, Agency MBS offers a yield
spread relative to Treasury that is above the 10-year average.
The table below shows the yields on the Lehman Fixed Rate MBS Index and
the Lehman U.S. Treasury Intermediate Index, as well as the yield spread between
the Indices, observed monthly for the 10 years ended April 30, 2002.
Historical Yields on the Lehman Fixed Rate MBS Index and the Lehman U.S.
Treasury Intermediate Index, and the Yield Spread Between the Lehman Fixed
Rate MBS Index and the Lehman U.S. Treasury Intermediate Index: Monthly,
for 10 Years Ended April 30, 2002
(1) (2) (3)
Lehman U.S.
Lehman Fixed Treasury
Rate MBS Index Intermediate Yield Spread
As of Index = (1) - (2)
5/31/92 7.88% 5.94% 1.94%
6/30/92 7.70% 5.63% 2.07%
7/31/92 7.59% 5.19% 2.40%
8/31/92 7.33% 5.01% 2.31%
9/30/92 7.24% 4.70% 2.54%
10/31/92 7.73% 5.27% 2.47%
11/30/92 7.78% 5.63% 2.15%
12/31/92 7.54% 5.37% 2.18%
1/31/93 7.24% 4.95% 2.29%
2/28/93 6.94% 4.66% 2.29%
3/31/93 6.92% 4.68% 2.23%
4/30/93 6.91% 4.56% 2.35%
5/31/93 6.91% 4.88% 2.03%
6/30/93 6.63% 4.59% 2.04%
7/31/93 6.65% 4.68% 1.98%
8/31/93 6.46% 4.38% 2.08%
9/30/93 6.55% 4.38% 2.17%
10/31/93 6.51% 4.44% 2.07%
11/30/93 6.81% 4.72% 2.08%
12/31/93 6.69% 4.73% 1.95%
1/31/94 6.44% 4.56% 1.88%
2/28/94 6.74% 5.16% 1.59%
3/31/94 7.60% 5.74% 1.86%
4/30/94 7.94% 6.16% 1.78%
5/31/94 7.99% 6.38% 1.61%
6/30/94 8.13% 6.53% 1.60%
7/31/94 7.85% 6.31% 1.54%
8/31/94 7.91% 6.43% 1.48%
9/30/94 8.36% 6.88% 1.48%
10/31/94 8.38% 7.08% 1.30%
11/30/94 8.66% 7.57% 1.09%
12/31/94 8.66% 7.73% 0.93%
1/31/95 8.36% 7.37% 0.99%
2/28/95 7.99% 6.90% 1.09%
3/31/95 8.03% 6.92% 1.11%
4/30/95 7.87% 6.72% 1.15%
5/31/95 7.27% 5.99% 1.28%
6/30/95 7.28% 5.93% 1.35%
7/31/95 7.40% 6.05% 1.34%
8/31/95 7.29% 5.98% 1.31%
9/30/95 7.21% 5.95% 1.26%
10/31/95 7.11% 5.74% 1.37%
11/30/95 6.93% 5.50% 1.43%
12/31/95 6.69% 5.32% 1.37%
1/31/96 6.63% 5.13% 1.50%
2/29/96 7.10% 5.63% 1.48%
3/31/96 7.35% 5.96% 1.40%
4/30/96 7.57% 6.22% 1.35%
5/31/96 7.70% 6.42% 1.28%
6/30/96 7.54% 6.29% 1.25%
7/31/96 7.62% 6.37% 1.25%
8/31/96 7.76% 6.51% 1.25%
9/30/96 7.54% 6.27% 1.26%
10/31/96 7.24% 5.91% 1.32%
11/30/96 7.03% 5.72% 1.31%
12/31/96 7.30% 6.03% 1.27%
1/31/97 7.27% 6.07% 1.20%
2/28/97 7.34% 6.20% 1.14%
3/31/97 7.68% 6.58% 1.10%
4/30/97 7.47% 6.40% 1.08%
5/31/97 7.39% 6.32% 1.07%
6/30/97 7.26% 6.21% 1.05%
7/31/97 6.91% 5.81% 1.10%
8/31/97 7.14% 6.09% 1.05%
9/30/97 6.96% 5.91% 1.05%
10/31/97 6.77% 5.71% 1.06%
11/30/97 6.83% 5.81% 1.01%
12/31/97 6.70% 5.70% 1.00%
1/31/98 6.52% 5.40% 1.12%
2/28/98 6.64% 5.60% 1.05%
3/31/98 6.68% 5.65% 1.03%
4/30/98 6.65% 5.65% 1.00%
5/31/98 6.58% 5.59% 0.99%
6/30/98 6.56% 5.53% 1.04%
7/31/98 6.58% 5.54% 1.04%
8/31/98 6.40% 5.04% 1.36%
9/30/98 6.03% 4.41% 1.61%
10/31/98 6.39% 4.41% 1.98%
11/30/98 6.37% 4.67% 1.70%
12/31/98 6.33% 4.68% 1.65%
1/31/99 6.23% 4.67% 1.56%
2/28/99 6.59% 5.25% 1.34%
3/31/99 6.55% 5.14% 1.41%
4/30/99 6.57% 5.20% 1.37%
5/31/99 6.83% 5.56% 1.28%
6/30/99 7.04% 5.65% 1.39%
7/31/99 7.30% 5.76% 1.54%
8/31/99 7.42% 5.87% 1.55%
9/30/99 7.22% 5.77% 1.45%
10/31/99 7.23% 5.91% 1.32%
11/30/99 7.34% 6.08% 1.26%
12/31/99 7.51% 6.34% 1.17%
1/31/00 7.83% 6.66% 1.18%
2/29/00 7.73% 6.58% 1.15%
3/31/00 7.65% 6.41% 1.23%
4/30/00 7.76% 6.61% 1.15%
5/31/00 7.88% 6.66% 1.22%
6/30/00 7.58% 6.35% 1.23%
7/31/00 7.58% 6.30% 1.28%
8/31/00 7.40% 6.13% 1.27%
9/30/00 7.31% 6.01% 1.31%
10/31/00 7.29% 5.96% 1.33%
11/30/00 7.09% 5.63% 1.47%
12/31/00 6.85% 5.21% 1.64%
1/31/01 6.59% 4.85% 1.73%
2/28/01 6.57% 4.67% 1.90%
3/31/01 6.57% 4.49% 2.07%
4/30/01 6.68% 4.67% 2.01%
5/31/01 6.63% 4.65% 1.98%
6/30/01 6.70% 4.67% 2.03%
7/31/01 6.37% 4.21% 2.16%
8/31/01 6.26% 4.07% 2.19%
9/30/01 5.93% 3.45% 2.48%
10/31/01 5.48% 3.05% 2.44%
11/30/01 6.08% 3.46% 2.62%
12/31/01 6.32% 3.67% 2.65%
1/31/02 6.20% 3.70% 2.51%
2/28/02 5.99% 3.62% 2.37%
3/31/02 6.37% 4.24% 2.13%
4/30/02 6.03% 3.75% 2.28%
Average Yield Spread over past five years = 1.53%.
Average Yield Spread over past ten years = 1.57%
Sources: Lehman Brothers Inc., Hyperion Capital Management, Inc.
Past performance is no guarantee of future results. The foregoing
charts are for illustrative purposes only and do not represent the past or
future performance of the Fund. Prospective investors should recognize that
future performance of the Fund will differ from that of the indexes referenced
in this section as such indexes are not (and will not be) subject to the same
investment restrictions and limitations imposed on the Fund by the Investment
Company Act of 1940 and the Internal Revenue Code, each of which may adversely
affect the Fund's performance.
FINANCIAL STATEMENTS
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP are the Fund's independent accountants
providing audit and tax return preparation and consultation services in
connection with the review of various SEC filings. The address of
PricewaterhouseCoopers LLP is 1177 Avenue of the Americas, New York, New York
10036. The Statement of Assets and Liabilities of the Fund as of _______, 2002
and the Statement of Operations of the Fund for the one day then ended included
in this Statement of Additional Information have been so included and are
attached to this Statement of Additional Information in reliance on the report
of Pricewaterhouse Coopers LLP, given on the authority of the firm as experts in
auditing and accounting.
PART C -- OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
(1) FINANCIAL STATEMENTS - The following financial statements have been
incorporated by reference into the Registration Statement as described
on page __ of the Statement of Additional Information:
(i) Statement of Assets and Liabilities as of _________, 2002;
(ii) Statement of Operations of the Fund for the one day then ended
________, 2002; and
(iii) Notes to Financial Statements ______, 2002.
Statements, schedules and historical information other than these
listed above have been omitted since they are either not applicable, or not
required or the required information is shown in the financial statements
or notes thereto.
(2) EXHIBITS
(A) Articles of Incorporation of The Hyperion Strategic Mortgage
Income Fund, Inc. dated May 17, 2002.
(B) By-laws.
(C) Not applicable
(D) To be filed by Amendment.
(E) To be filed by Amendment.
(F) Not applicable
(G) (1) Form of Advisory Agreement
between Registrant and Hyperion Capital Management, Inc.
(2) Form of Sub-Advisory Agreement between Hyperion Capital
Management, Inc. and Lend Lease Hyperion Capital Advisers,
L.L.C.
(H) To be filed by Amendment.
(I) Not applicable
(J) To be filed by Amendment.
(K)(1) To be filed by Amendment.
(2) To be filed by Amendment.
(3) To be filed by Amendment.
(L)(1) To be filed by Amendment.
(2) To be filed by Amendment.
(M) Not applicable
(N) To be filed by Amendment.
(O) Not applicable
(P) Not applicable
(Q) Not applicable
(R) To be filed by Amendment.
ITEM 25. MARKETING ARRANGEMENTS
See Exhibit (H) of Item 24(2) of this Registration Statement.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the expenses to be incurred in
connection with the issuance and distribution of securities described in this
Registration Statement:
Registration fees $ 5,520
National Association of Securities Dealers, Inc. fee $ 8,000
New York Stock Exchange listing fee $ 35,000
Printing (other than stock certificates) $ 200,000
Accounting fees and expenses $ 20,000
Legal fees and expenses $ 125,000
Underwriter expense reimbursement $ 125,000
Miscellaneous $ *
------
Total $ *
=====
* To be filed by amendment
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
None.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES (as of_____, 2002)
TITLE OF CLASS NUMBER OF RECORD HOLDERS
-------------- -------------
Common Stock _________
ITEM 29. INDEMNIFICATION
Under Registrant's Articles of Incorporation and By-Laws, the directors
and officers of Registrant will be indemnified to the fullest extent allowed and
in the manner provided by Maryland law and applicable provisions of the
Investment Company Act of 1940, including advancing of expenses incurred in
connection therewith. Indemnification shall not be provided to any officer or
director against any liability to the Registrant or its shareholders to which he
or she would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in the conduct of
his or her office.
Article 2, Section 405.2 of the Maryland General Corporation Law
provides that the Charter of a Maryland Corporation may limit the extent to
which directors or officers may be personally liable to the Corporation or its
shareholders for money damages in certain instances. The Registrant's Articles
of Incorporation provide that, to the fullest extent permitted by Maryland law,
as it may be amended or interpreted from time to time, no director or officer of
the Registrant shall be personally liable to the Registrant or its shareholders
for money damages. The Registrant's Articles of Incorporation also provide that
no amendment of the Registrant's Articles of Incorporation or repeal of any of
it's provisions shall limit or eliminate any of the benefits provided to
directors and officers in respect of any act or omission that occurred prior to
such amendment or repeal.
The Underwriting Agreement filed in response to Item 24 (2)(h) contains
provisions requiring indemnification of the Registrant's underwriters by the
Registrant.
Insofar as indemnification for liability arising under the Securities
Act of 1933, as amended (the "Act"), may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions, or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
The description of the business of Hyperion Capital Management, Inc.
and Lend Lease Hyperion Capital Advisers, L.L.C. is set forth under the caption
"MANAGEMENT OF THE FUND" in the Prospectus and "THE ADVISER, SUBADVISER AND
ADMINISTRATOR" in the Statement of Additional Information forming part of this
Registration Statement.
The information as to the Directors and officers of Hyperion Capital
Management, Inc. set forth in Hyperion Capital Management, Inc.'s Form ADV filed
with the Securities and Exchange Commission on _____, 2002 (File No. 801-34605)
and as amended through the date hereof is incorporated herein by reference. The
information as to the Directors and officers of Lend Lease Hyperion Capital
Advisers, L.L.C. set forth in Lend Lease Hyperion Capital Adviser's L.L.C. Form
ADV filed with the Securities and Exchange Commission on ______, 2002 (File No.
______) and as amended through the date hereof is incorporated herein by
reference.
ITEM 31. LOCATION OF ACCOUNTS AND RECORDS
Registrant: The Hyperion Strategic Mortgage Income Fund, Inc.
One Liberty Plaza, 165 Broadway, 36th Floor
New York, New York 10006-1404
Investment Adviser: Hyperion Capital Management, Inc.
One Liberty Plaza, 165 Broadway, 36th Floor
New York, New York 10006-1404
Investment Lend Lease Hyperion Capital Advisers, L.L.C.
Subadviser: One Liberty Plaza, 165 Broadway, 36th Floor
New York, New York 10006-1404
Transfer Agent for American Stock Transfer & Trust Company, Inc.
Common Stock: 6201 15th Avenue
Brooklyn, New York 11219
Custodian and Fund State Street Corp.
Accounting Agent: Two Avenue de Lafayette
Boston, Massachusetts 02105
ITEM 32. MANAGEMENT SERVICES
Not applicable.
ITEM 33. UNDERTAKINGS
(a) Registrant undertakes to suspend the offering of its shares until it
amends its Prospectus if:
(1) subsequent to the effective date of this Registration Statement,
the net asset value per share declines more than 10% from its net asset
value per share as of the effective date of the Registration Statement; or
(2) the net asset value increases to an amount greater than its net
proceeds as stated in the Prospectus.
(b) Registrant hereby undertakes:
(1) that for purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as part
of this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 497(h) under the
Securities Act shall be deemed to be part of this Registration Statement as of
the time it was declared effective.
(2) that for the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
(3) that for the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment shall be deemed to be a
new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(4) to supplement the prospectus, after the expiration of the
subscription period, to set forth the results of the subscription offer, the
transactions by underwriters during the subscription period, the amount of
unsubscribed securities to be purchased by underwriters, and the terms of any
subsequent reoffering thereof. Further, if any public offering by the
underwriters of the securities registered herein is to be made on terms
differing from those set forth on the cover page of the prospectus included in
this Registration Statement, the Registrant shall undertake to file a
post-effective amendment to set forth the terms of such offering.
(5) to send by first class mail or by other means designed to ensure
equally prompt delivery, within two business days of receipt of a written or
oral request, any Statement of Additional Information.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
and the Investment Company Act of 1940, as amended, the Registrant has duly
caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of New York, State of New
York on the 20th day of May, 2002.
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
By: /s/CLIFFORD E. LAI
--------------------------------------
CLIFFORD E. LAI
President
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed below by the following persons in
the capacities and on the date indicated. Each person whose signature appears
below hereby authorizes and appoints Clifford E. Lai as his attorney-in-fact to
sign and file on his behalf (individually and in each capacity stated below) any
and all pre- and post-effective amendments to this Registration Statement.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ CLIFFORD E. LAI President (Principal Executive
------------------------------------
CLIFFORD E. LAI Officer) May 20, 2002
/s/ JOHN H. DOLAN Vice-President May 20, 2002
------------------------------------
JOHN H. DOLAN
/s/ PAUL M. JACOB Vice-President May 20, 2002
------------------------------------
PAUL M. JACOB
/s/ THOMAS F. DOODIAN Treasurer (Principal Financial
------------------------------------
THOMAS F. DOODIAN and Accounting Officer) May 20, 2002
/s/ JOSEPH TROPEANO Secretary May 20, 2002
------------------------------------
JOSEPH TROPEANO
/s/ JOHN J. FEENEY, JR. Director May 20, 2002
------------------------------------
JOHN J. FEENEY, JR.
EXHIBIT INDEX
Exhibit No. Description of Exhibit
(A) Articles of Incorporation
(B) By-Laws
(G)(1) Form of Advisory Agreement between Registrant and
Hyperion Capital Management, Inc.
(2) Form of Sub-Advisory Agreement between Hyperion
Capital Management, Inc. and Lend Lease Hyperion
Capital Advisers, L.L.C.