AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 18, 2002
SECURITIES ACT FILE NO. 333-88788
INVESTMENT COMPANY ACT FILE NO. 811-21102
=========================================================================
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. 2 [X]
POST-EFFECTIVE AMENDMENT NO. __ [ ]
AND/OR
REGISTRATION STATEMENT UNDER
THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 2 [X]
(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 $5,520**
========================================================================
(*) Estimated solely for the purpose of computing the registration fee
pursuant to Rule 457.
(**) Previously paid.
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
Securities and Exchange Commission 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 July 18, 2002
PROSPECTUS
4,000,000 Shares
[HYPERION LOGO]
The Hyperion Strategic Mortgage Income Fund, Inc.
$15.00 per share
--------------
Investment Objectives. The Hyperion Strategic Mortgage Income Fund, Inc.
(the "Fund") is a newly organized, diversified, closed-end management investment
company.
o 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.
o The Fund's secondary investment objective is to provide capital
appreciation.
Portfolio Contents. Under normal market conditions, the Fund:
o will invest at least 80% of its total assets in MBS, securities backed
by interests in real estate,
o may invest up to 20% of its total assets in U.S. government
securities, or cash or other short-term instruments, and
o 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.
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.
(continued on following page)
---------------
Per Share Total
Price to Public.................... $ 15.00 $__
Sales Load......................... $ 0.75 $__
Proceeds, before expenses, to the $ 14.25 $__
Fund*..............................
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* Before deduction of expenses for issuance and distribution to be incurred by
the Fund, estimated to be $522,520. Any offering expenses over $0.03 per
Common Share will be paid by the Adviser. The underwriters expect to deliver
Common Shares to purchasers on or about ____, 2002.
---------------
Raymond James A.G. Edwards & Sons, Inc.
Advest, Inc. H&R Block Financial Advisors, Inc.
Charles Schwab & Co., Inc. Fahnestock & Co. Inc.
Ferris, Baker Watts J.J.B. Hilliard, W.L. Lyons, Inc.
Incorporated
Janney Montgomery Scott Legg Mason Wood Walker
LLC Incorporated
McDonald Investments Inc. Ryan, Beck & Co.
Including the Gruntal Division
SWS Securities Wedbush Morgan Securities
July ______, 2002
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.
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.
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 "HSM."
Investing in the Common Shares of the Fund involves certain risks. See
"Risk Factors" beginning on page __ of this prospectus before buying any of
these Common Shares. 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.
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 July ______, 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, including
the Statement of Additional Information.
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.
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.
The Fund................................... The Fund is a recently organized,
diversified, closed-end
management investment company.
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 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 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
securities are securities
o issued or guaranteed by the
U.S. government or any agency
or instrumentality thereof,
o rated within the four highest
investment grades by at least
one rating agency (Baa3, BBB-
or better by Moody's Investor
Service, Inc. ("Moody's"),
Standard & Poor's Ratings Group
("S&P") or Fitch IBCA, Inc.
("Fitch")) or
o unrated but judged to be of
comparable quality by the
Adviser. The Fund may invest
up to 20% of its total assets
in securities that at the
time of investment are below
investment grade quality,
including securities rated Ba,
BB or B by Moody's, S&P or
Fitch, or that are unrated.
Securities of non-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." 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.
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.
Under normal market conditions,
the Fund will invest to a
significant degree in
subordinated classes of MBS,
including Non-Agency RMBS and
CMBS.
The Fund may employ a variety of
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.
Please see the discussion of
hedging transactions below.
Once fully invested, the initial
portfolio composition is expected
to consist of 35% CMBS, which
generally have maturities of
10-years, and of 65% Agency MBS
and Non-Agency RMBS, which
generally have maturities of
30-years. Certain Agency MBS and
Non-Agency RMBS may have
maturities shorter than 30-years.
It is expected that approximately
30% of the Fund's assets will
initially have 10-year maturities
and that 60% will have maturities
of 30 years, with the balance in
MBS with shorter maturities.
(Note that both Agency MBS and
Non-Agency RMBS pay principal
over the life of the securities,
so that the 30-year maturities
represent the final payment on
the securities, rather than the
date on which the entire
principal is paid-off.)
The Fund cannot assure you that
it will achieve its investment
objectives. See "Investment
Objectives, Policies and
Restrictions" 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.
Exchange Listing........................... The Common Shares have been
approved for listing on the
New York Stock Exchange,
subject to notice of issuance.
The trading or "ticker" symbol
of the Common Shares is "HSM."
Due to this exchange listing,
the Fund may sometimes be
referred to in public
communications as a "closed-end
fund" or "fund."
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.
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.
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.
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.
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
securities 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)
unrated but judged to be of
comparable quality by the
Adviser. The Fund may invest up
to 20% of its total assets in
securities that at the time of
investment are below investment
grade quality or are unrated. The
prices of non-investment grade
quality securities 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.
Non-investment grade quality
securities are regarded as having
predominantly speculative
characteristics with respect to
the issuer's or pool's capacity
to pay interest and repay
principal when due and as a
result 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
or 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 or
decrease, with 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, which are
further discussed under the
heading "Risk Factors" (as well
as the other risks discussed
therein), 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)....................................... 5.00%
Dividend Reinvestment Plan Fees........................ 0%
Annual Expenses (as a percentage of
net assets attributable to Common
Shares) (1)
Management Fees(2).................. 0.65%
Interest Payments on Borrowed
Funds(3)............................ 0.93%
Other Expenses(4)................... 0.35%
----
Total Annual Expenses............... 1.93%
====
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(1) Amounts are based on estimated amounts for the Fund's current fiscal year.
(2) The Fund intends to pay 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."
(3) Assumes a net cost of borrowing at an annual rate of 1.94% on borrowed
funds in an amount equal to 32% of the Fund's total assets.
(4) "Other Expenses" are based on estimated amounts for the current fiscal year,
and include, among other things, administration fees at an annual rate of
0.20% to the Adviser see "Administration and Subadministration Agreements,"
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 bear offering costs estimated to be
$522,520, which will be charged to the Fund's capital at commencement of
operations and are not included under "Other Expenses." Any offering
expenses over $0.03 per share will be paid by the Adviser.
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............ $69 $108 $149 $264
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 5.00% sales load and an annual
expense ratio of 1.93%. 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 "HSM."
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 the sales load and offering
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 for 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 (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 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 in MBS as
summarized in the table below.
of Total Assets
Agency MBS........ 30%
Non-Agency RMBS... 35%
CMBS.............. 35%
ABS............... 0%
---
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 securities 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 (Baa3 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 may invest up to 20% of its total
assets in securities that at the time of investment are below investment grade
quality, including securities rated Ba, BB or B by Moody's, S&P or Fitch, or
that are unrated. Securities of non-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.
Please see "Management of the Fund--Subadviser." This joint venture 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 11 regional 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.
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 3.23% of the amount borrowed, the income generated by the Fund's
portfolio (net of estimated expenses) must exceed 1.08% 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 3.23% of the amount borrowed. See "Leverage
Risks" below for more information.
Assumed Portfolio Total Return (10)% (5)% 0% 5% 10%
Common Share Total Return... (16.61)% (9.11)% (1.61)% 5.89% 13.39%
Common Share total return is composed of 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. For example,
to assume total return of 0%, the Fund must assume that the interest it receives
on its debt security investments is entirely offset by losses in the value of
those bonds.
Subject to the asset coverage rules, 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, 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 to the Fund,
with a resulting decrease in net asset value or market price. 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 that satisfies
the requirements of the 1940 Act will be identified by memo entry in the Fund's
accounting records or maintained in a segregated account by a custodian. 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, with 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 operator 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. At the time the
Fund enters into a futures contract or options transaction, a segregated account
consisting of cash or liquid securities equal to the net amount of the excess,
if any, of the Fund's obligations over its entitlements that satisfies the
requirements of the 1940 Act may be identified by memo entry in the Fund's
accounting records or maintained in a segregated account by a custodian.
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 that satisfies the requirements of the 1940 Act
may be identified by memo entry in the Fund's accounting records or maintained
in a segregated account by a custodian. 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 issuers of ABS
securities (including MBS) or 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.
Concentration of Securities
The Fund will concentrate its investments in MBS, which is considered to be
a subset of the ABS industry.
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 SEC 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 SEC 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 SEC 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 (Baa3 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 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 quality, including securities rated Ba, BB
or B by Moody's, S&P or Fitch, or that are unrated and of comparable credit
quality. Securities of non-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 comparable 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 comparable 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 and that the Board of Directors deems
appropriate and in the best interests of shareholders. 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 shareholders. The Fund may incur debt to
finance repurchases, which poses certain risks to shareholders. Any borrowings
for this purpose will be subject to the asset coverage requirements and
borrowing restrictions of the 1940 Act and, if preferred shares are issued by
the Fund, 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 debt securities 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 securities 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 securities (1) issued or guaranteed by the U.S.
government or any agency or instrumentality thereof, (2) rated BBB- or Baa3 or
higher by at least one rating agency or (3) unrated but judged to be of
comparable quality by the Adviser. The Fund may invest up to 20% of its total
assets in securities 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 decline
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 will invest 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 decrease in value of the Fund's investments will be
borne entirely by shareholders as a corresponding decline in the Fund's net
asset value. Therefore, if the market value of the Fund's portfolio decreases,
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 to the Fund,
with a corresponding decline in the Fund's net asset value. 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 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 Investment Advisory Agreement (the "Advisory Agreement") dated June 18, 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 May 31,
2002, the Adviser has $6.1 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 Holdings, Inc. ("HHI"). LSR Capital
HCM, L.L.C. ("LSR") owns 61.75% of HHI. Lewis S. Ranieri is the managing member
of LSR.
Lewis S. Ranieri, a former Vice Chairman of Salomon Brothers Inc ("Salomon
Brothers"), is the Chairman of the Board of the Adviser and Chairman and
Director of the Fund. Mr. Andrew Carter is Vice Chairman of the Adviser, but
does not serve on the Adviser's Board of Directors. Clifford E. Lai, the
President of the Fund, is the President and a Director 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. Mr. John Feeney is a
Director and Managing Director, Marketing of the Adviser. Mr. John H. Dolan is a
Director and Managing Director, Chief Investment Officer of the Adviser and Vice
President of the Fund. Thomas F. Doodian, Treasurer of the Fund, and Joseph
Tropeano, Secretary of the Fund, are also employees 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 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 was Managing Director and Chief Investment
Strategist for Fixed Income at First Boston Asset Management Corporation.
Portfolio Management. Mr. John H. Dolan, Director and chief investment
officer of the Adviser, will be primarily responsible for the day-to-day
management of the Fund's portfolio. Mr. Dolan was recently appointed to chief
investment officer of the Adviser and has served as chief investment strategist
of the Adviser since 1998. Formerly, Mr. Dolan was managing director at Bankers
Trust.
Advisory Agreement
On June 18, 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, Lewis S. Ranieri was an interested person of the Fund. The
Advisory Agreement was approved by Hyperion Capital Management, Inc., 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 year to year
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, pursuant to an Investment Subadvisory
Agreement (the "Subadvisory Agreement") dated June 18, 2002. 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 May 31, 2002, managed
approximately $1.29 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 headquartered in Atlanta, Georgia and has 11
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
LLREI is 3424 Peachtree Road., N.E., Suite 800, Atlanta, Georgia 30326.
Subadvisory Agreement
On June 18, 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 Hyperion Capital Management, Inc., 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 Fund and the Administrator have 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 $110,000.
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, less all liabilities.
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, if the Fund has issued preferred shares, the retirement of 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 Dividend Reinvestment Plan (the "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 higher of net asset value or 95% of the market
price. This discount reflects savings in underwriting and other costs that the
Fund otherwise would incur to raise additional capital. 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, and no shares of preferred stock. The Articles of Incorporation
permit the Board of Directors to classify and reclassify any unissued Common
Shares and to increase or decrease 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 authorized and 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, if authorized and issued, 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 may 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 a change in the Fund's business or
management more difficult 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....................
Advest, Inc.................................
H&R BLOCK Financial Advisors, Inc...........
Charles Schwab & Co., Inc...................
Fahnestock & Co., Inc.......................
Ferris, Baker Watts Inc.....................
J.J.B. Hilliard, W.L. Lyons, Inc............
Janney Montgomery Scott LLC.................
Legg Mason Wood Walker, Incorporated........
McDonald Investments, Inc., a KeyCorp Company
Ryan, Beck & Co., LLC.......................
SWS Securities, Inc.........................
Wedbush Morgan Securities...................
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
$15.00 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 $125,000 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's Common Shares have been approved for listing on the Exchange
under the symbol "HSM." 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 100 Common Shares ($1,500). 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 180 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 Rudnick LLP,
Baltimore, Maryland, 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 Bank and Trust
Company, 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................................. 3
Additional Information About Investment Policies and
Fund 3
Investments.......................................
Directors and Officers.............................. 5
Compensation of Directors........................... 10
The Adviser, Subadviser and Administrator........... 11
Portfolio Transactions and Brokerage................ 12
Determination of Net Asset Value.................... 12
Repurchase of Common Shares......................... 13
Preferred Shares.................................... 14
Portfolio Maturity and Turnover..................... 16
Taxation............................................ 16
Performance Information............................. 19
Financial Statements................................ 26
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.
---------------
TABLE OF CONTENTS
Prospectus Summary............... 5
Fee Table........................ 9
The Fund......................... 9
Use of Proceeds.................. 10
Investment Objectives, Policies
and 10
Restrictions...................
Description of Fund Investments.. 17
Risk Factors..................... 20
Management of the Fund........... 24
Repurchase of Common Shares and
Conversion to Open-end Status.. 27
Dividend Reinvestment Plan....... 27
Taxation......................... 28
Description of Capital Stock..... 28
Underwriting..................... 29
Validity of the Common Shares.... 31
Custodian, Transfer Agent,
Dividend 31
Disbursing Agent and Registrar.
Reports to Shareholders.......... 31
Further Information.............. 31
Appendix A-- Ratings of Corporate
Obligations.................... 33
The Table of Contents for the Statement of Additional Information is found on
page ___ .
---------------
Until August 19, 2002 (25 days after the date of this Prospectus), all
dealers that buy, sell or trade the common shares, whether or not participating
in this offering, may be required to deliver a Prospectus. This is in addition
to the dealers' obligation to deliver a Prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.
================================================================================
4,000,000 Common Shares
The Hyperion Strategic
Mortgage Income Fund, Inc.
---------------
PROSPECTUS
---------------
Raymond James
A.G. Edwards & Sons, Inc.
Advest, Inc.
H&R Block Financial
Advisors, Inc.
Charles Schwab & Co., Inc.
Fahnestock & Co. Inc.
Ferris, Baker Watts
Incorporated
J.J.B. Hilliard, W.L. Lyons, Inc.
Janney Montgomery Scott LLC
Legg Mason Wood Walker
Incorporated
McDonald Investments Inc.
Ryan, Beck & Co.
Including the Gruntal Division
SWS Securities
Wedbush Morgan Securities
July ____, 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. The Prospectus and the Statement of
Additional Information are not an offer to sell these securities and are not
soliciting an offer to buy these securities in any jurisdiction where the offer
or sale is not permitted.
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
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 Investment Policies and
Fund 2
Investments.......................................
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 17, 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 ("SEC 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 SEC 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
Lewis S. Ranieri* Chairman and Director, Chairman and Chief Executive Officer 4
c/o One Liberty Plaza, Member of the Executive of Ranieri & Co., Inc. (since
1988);
36th floor, New York, Committee President of LSR Hyperion Corp., a
New York 10006-1404 general partner of the limited
Elected for Three Year partnership that is the general
Age 55 Term/Director since partner of Hyperion Partners L.P.
June 2002 ("Hyperion Partners") (since
1988); Director and Chairman of the
Board of Hyperion Capital Management,
Inc. (since June 2002); Director and
Vice Chairman of the Board of Hyperion
Capital Management, Inc.(from November
1998 through June 2002) Director and
Chairman of the Board of Hyperion
Capital Management, Inc. (1989-November
1998); Director and President of
Hyperion Funding II Corp., the general
partner of a limited partnership
that is the general partner of Hyperion
Partners II, L.P. (Hyperion Partners
II); Chairman and President of
various other direct and indirect
subsidiaries of Hyperion Partners
(since 1989) and Hyperion Partners
II (since 1995); Chairman of the
Board (1989-December 1998 and June 2002
through present) and/or Director
(since 1989) of several investment
companies (4) advised by Hyperion
Capital Management, Inc. or by its
affiliates.
Formerly, Director and Chairman of
Bank United Corp., and Director of
Bank United (1988-2001); Director
of Lend Lease Hyperion Mortgage
Opportunity Fund, Inc. (formerly,
Equitable Real Estate Hyperion
Mortgage Opportunity Fund, Inc.)
and Lend Lease Hyperion High Yield
Commercial Mortgage Fund, Inc.
(formerly, Equitable Real Estate
Hyperion High Yield Commercial
Mortgage Fund, Inc.) (1995-1999).
----------
* "Interested person" as defined in the 1940 Act, because of affiliations with Hyperion Capital Management, Inc.,
the Fund's Advisor.
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
----------- ------------ ----------------------------
Leo M. Walsh, Jr. Director, Chairman of Director and/or Trustee of several 5
c/o One Liberty Plaza, the Audit Committee, investment companies (3) advised by
36th floor, New York, Member of Nominating Hyperion Capital Management, Inc. or
New York 10006-1404 and Compensation by its affiliates (1989- Present);
Committees Financial Consultant for Medco
Age 69 Health Solutions, Inc. (formerly
Elected for Three Year Merck-Medco Managed Care LLC)
Term/Director since (1994-Present); Director of Lend
June 2002 Lease Hyperion Mortgage Opportunity
Fund, Inc. (formerly, Equitable
Real Estate Hyperion Mortgage
Opportunity Fund, Inc.) and Lend Lease
Hyperion High Yield CMBS Fund, Inc.
(formerly, Equitable Real Estate
Hyperion High Yield Commercial
Mortgage Fund, Inc.) (1999-Present).
Rodman L. Drake Director, Member of the Co-Founder, Baringo Capital LLC 4
c/o One Liberty Plaza, Audit Committee, (2002-Present); Director and/or
36th floor, New York, Chairman of Nominating Trustee of several investment
New York 10006-1404 and Compensation companies (3) advised by Hyperion
Committees Capital Management, Inc.
Age 59 (1989-Present); Director,
Elected for Two Year Hotelevision, Inc. (1999-Present);
Term/Director since Director, Parsons Brinckerhoff, Inc.
June 2002 (1995-Present); Director, Absolute
Quality Inc. (2000- Present);
Trustee of Excelsior Funds (3)
(1994-Present).
Formerly, President, Continuation
Investments Group Inc. (1997-2002);
Co-Chairman of KMR Power
Corporation (1993-1997); President,
Mandrake Group (1993-1997).
Harry E. Petersen, Jr. Director, Member of the Senior Consultant to Cornerstone
c/o One Liberty Plaza, Audit, Compensation, Equity Advisors, Inc. (1998-
36th floor, New York, Nominating and Present); Director and/or Trustee of
New York 10006-1404 Executive Committees several investment companies (3)
advised by Hyperion Capital
Age 77 Elected for Two Year Management, Inc. or by its
Term/Director since affiliates (1992-Present).
June 2002
Formerly, Senior Consultant to
Potomac Babson Inc. (1995-1998);
Director of Equitable Real Estate
Hyperion Mortgage Opportunity Fund,
Inc. and Equitable Real Estate
Hyperion High Yield Commercial
Mortgage Fund, Inc. (1995-1997);
Director of Lexington Corporate
Properties, Inc. (1993-1997).
Robert F. Birch Director, Member of the Chairman and President, New America 5
c/o One Liberty Plaza, Audit, Nominating, High Income Fund (1992- Present);
36th floor, New York, Compensation and Chairman of the Board and
New York 10006-1404 Executive Committees Co-Founder, The China Business
Group, Inc. (1996- Present);
Age 66 Elected for One Year Director of Brandywine Funds (2)
Term/Director since (2001-Present).
June 2002
Formerly, Director and Strategic
Planning Consultant, Dewe Rogerson,
Ltd. (1994-1998)
Clifford E. Lai* President President (since November 1998) of 5
c/o One Liberty Plaza, Hyperion Capital Management, Inc.
36th Floor, New York, Elected Annually Since (March 1993-Present); President (since
New York 10006-1404 May 2002 June 1997) of Hyperion 2002 Term
Trust, Inc. and Hyperion 2005
Age 48 Investment Grade Opportunity
Term Trust, Inc. (Senior Vice
President from April 1993 to
June 1997); President (since
October 1995) of The Hyperion
Total Return Fund, Inc.;
Director and Chairman of the
Board (since October 2000) of
the Lend Lease Hyperion
High-Yield CMBS Fund, Inc.
Formerly, President (December 1999-October
2000) of the Lend Lease Hyperion
High-Yield CMBS Fund, Inc.;
Senior Vice President (November
1998-December 1999) of the Lend
Lease Hyperion High-Yield
Commercial Mortgage Fund,
Inc.; Senior Vice President
(September 1995-November
1998) of the Equitable Real
Estate Hyperion High-Yield
Commercial Mortgage Fund, Inc.
John H. Dolan* Vice President Chief Investment Strategist (1998- 5
c/o One Liberty Plaza, Present) and Chief Investment
36th Floor, New York, Elected Annually Since Officer (since 2002) of Hyperion
New York 10006-1404 May 2002 Capital Management, Inc. Formerly
Managing Director at Bankers Trust
Age 48 (1995-1997).
Patricia A. Sloan* Vice President Consultant (2000-Present) and 5
c/o One Liberty Plaza Managing Director (1988-2000) of
36th Floor, New York, Elected Annually Since Ranieri & Co., Inc.; Secretary,
New York 10006-1404 June 2002 Director and/or Trustee of several
investment companies (3) advised by
Age 58 Hyperion Capital Management, Inc.
or by its affiliates (1989-Present).
Thomas F. Doodian* Treasurer Formerly, Vice President of CS First 5
c/o One Liberty Plaza, Boston MBS Trader, Business Unit
36th Floor, New York, Elected Annually Since Controller (1984-1994). Director of
New York 10006-1404 May 2002 Finance and Operations, Hyperion
Capital Management, Inc. (July
Age 43 1995-Present). Treasurer of several
investment companies advised by Hyperion
Capital Management, Inc. (February
1998-Present).
Joseph Tropeano* Secretary Vice President and Compliance 5
c/o One Liberty Plaza, Officer, Hyperion Capital
36th Floor, New York, Elected Annually Since Management, Inc. (1993-Present);
New York 10006-1404 May 2002 Assistant Secretary and 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 Distributors, 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 Adviser and/or with the Fund.
Interested Person
Mr. Ranieri serves as Chairman of the Board and Director of the Adviser. As
a result of his service with the Advisor and his ownership in the corporation
that owns the Adviser (please see "Management of the Fund" in the Prospectus for
more information), the Fund considers Mr. Ranieri to be an "interested person"
of the Fund within the meaning of Section 2(a)(19) of the 1940 Act.
Committees and Board of Directors' Meetings
The Fund has a standing Audit Committee currently consisting of Messrs.
Walsh, Drake, Petersen and Birch, all of whom are members of the Board of
Directors and are currently non-interested persons of the Fund. Mr. Walsh
currently serves as Chairman of the Audit Committee. The principal functions of
the Fund's Audit Committee are to recommend to the Board the appointment of the
Fund's independent accountants, to review with the independent accountants the
scope and anticipated costs of their audit and to receive and consider a report
from the independent accountants concerning their conduct and the results of the
audit, including any comments or recommendations they might want to make in that
connection.
The Fund has Nominating and Compensation Committees, which presently
consist of Messrs. Walsh, Drake, Petersen and Birch. Mr. Drake currently serves
as Chairman of the Nominating and Compensation Committees. 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 Messrs.
Birch, Petersen and Ranieri. 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 Agreements
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 June 18, 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
(including the amount and nature of fees paid by shareholders); (2) the nature
and quality of the services rendered by the Adviser and Subadviser (including
the supervision of the Fund's third party service providers), (3) anticipated
benefits derived by the Adviser and Subadviser from their relationship with the
Fund (including the compensation the Adviser will receive as administrator of
the Fund), (4) the costs of providing services to the Fund and the economies of
scale that the Adviser has received as a result of managing three other funds in
the Fund's complex, 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 considering the Agreements, the Board of Directors did not identify any
single factor as controlling. Since the Board of Directors serve on the Boards
of three other funds in the Fund's complex, which are advised by the same
Adviser, the Board of Directors are continually reviewing the Adviser's
investment staff and portfolio management process. Based on their evaluation of
all material factors discussed above and assisted by the advice of independent
counsel, the Board of Directors, including the Disinterested Directors,
concluded that the Agreements are fair and reasonable.
Director Ownership
The following table sets forth, for each Director, the aggregate dollar
range of equity securities owned of the Fund as of July 15, 2002 and of all
funds overseen by each Director in the Fund Complex as of November 30, 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
Dollar Range of Equity by Direfctor or Nominee in Family
Name of Director Securities in the Fund of Investment Companies
------------------- ------------------------ --------------------------------
Lewis Ranieri...... None $50,001 - $100,000
Leo M. Walsh, Jr... None Over $100,000
Rodman L. Drake.... None $10,001 - $50,000
Harry E. Petersen, Jr None $1 - $10,000
Robert F. Birch.... None $50,001 - $100,000
Principal Shareholders
To the knowledge of the Fund, as of July 15, 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.
Prior to the commencement of the Fund's public offering, 100% of the Fund's
outstanding Common Shares were owned by the Adviser.
COMPENSATION OF DIRECTORS*
Total
Pension or Compensation
Retirement Estimated From Fund
Benefits Annual and Fund
Aggregate Accrued As Benefits Complex**
Compensation Part of Fund Upon Paid to
Name and Position from Fund Expenses Retirement Directors
--------------------- --------------- ------------ ------------ -----------
Lewis Ranieri...... None None None None
Leo M. Walsh, Jr... $ 7,000 None None $ 29,000
Rodman L. Drake.... $ 7,000 None None $ 26,500
Harry E. Petersen, Jr $ 7,000 None None $ 26,500
Robert F. Birch.... $ 7,000 None None $ 29,000
----------
* The information in this table is furnished for the period beginning June 18,
2002 and ending on November 30, 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 $10,000 per year plus $1,000 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 $750 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 June 18, 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 May 31, 2002, the Adviser has
$6.1 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.
Subadviser
The Adviser has engaged the Subadviser to provide subinvestment advisory
services for investments in CMBS, pursuant to a Subadvisory Agreement dated June
18, 2002. 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
May 31, 2002, managed approximately $1.29 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.
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 Fund and the Administrator have 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 $110,000.
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
100% 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, less all liabilities.
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, market conventions regarding prepayment assumptions
for 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. A determination of value by a pricing service to be used
in calculating net asset value will be deemed to be determined at market value.
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. 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 and described below.
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 November 30 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 or aggregate
total return 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.
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-
Non-Agency Agency Corporate
RMBS RMBS CMBS Bonds
----------- -------- ------ --------
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. S&P reports an
upgrade to downgrade ratio for "All RMBS." Included in the "All RMBS" data are
bonds backed by residential mortgage loans to sub-prime borrowers, as well as to
prime borrowers. This "All RMBS" series includes sub-sets of data on prime first
mortgage non-agency RMBS, sub-prime Non- Agency RMBS, and other 2nd lien
home-equity securities. The S&P "All RMBS" Upgrade to Downgrade ratios are
listed as "All Non-Agency RMBS".
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.
Corporate bonds are interest bearing or discounted debt obligations issued
by corporations.
Total Annual Credit Ratings Upgrades and Downgrades for
Prime First Mortgage Non-Agency MBS: 1992-2001
Total Total
Upgrades 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 Total
Upgrades 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 Total
Upgrades 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
(5)
% of Corp.
(1) Bond (7)
Total (2) (4) Issues (6) Total %
Investment Total (3) % of Corp. Down- % of Corp. of (9)
Grade Speculative Total Corp. Bond graded Bond Corp. (8) Total Corp.
Corp. Grade Bond Issues Up- (except Issues Bonds Total Corp. Bond
Bond Corp. Bond Issues graded down- Down- Down- Bond Down-
Issues Issues (on Jan. 1) During grades graded graded Up-grades grades
(on Jan. 1) (on Jan. 1) = (1) + (2) Year to "D") to "D" =(5)+(6) = (4) x (3) = (7) x (3)
------------------------------------------------ ----------- ----------- ----------------------------------
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 1,315
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 U.S.
Lehman Fixed Rate Treasury Lehman Intermediate Corporate High
MBS Index Intermediate Index Corporate Index Yield 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.
Treasuries are interest bearing or discounted debt obligations of the U. S.
government; intermediate signifies a maturity of three to 10 years. Investment
grade corporate bonds are rated "BBB" or higher by nationally recognized rating
agencies such as Moody's, S & P and Fitch, generally signifying a high credit
worthiness of the bond. High yield or "junk bonds" are regarded as having
speculative characteristics with respect to the issuer's obligation to pay
interest and repay principal.
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 Lehman Lehman Lehman Lehman
Fixed Rate U.S. Treasury Intermediate U.S. Corporate 3-month
MBS Intermediate Corporate High Yield U.S. Treasury
Quarter Ended Index Index Index 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 Lehman Lehman Lehman
Fixed Rate U.S. Treasury Intermediate U.S. Corporate
MBS Intermediate Corporate High
Quarter Ended Index Index Index Yield 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
Lehman Corporate U.S. Lehman
Fixed Rate Lehman Investment Lehman Treasury Intermed.
10 Year MBS U.S. Treasury Grade Aggregate Intermed. Corporate
Year Ended Treasury Index Index Index Index Index Index
------------ --------------------- ------------- ---------- ---------- --------- --------
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)
Lehman Lehman
Fixed Rate U.S. Treasury (3)
MBS Intermediate Yield Spread
As of Index 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, is the Fund's independent accountants providing
financial statements audit and tax return preparation services, including audit
related reviews 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 July 10, 2002 included in this
Statement of Additional Information has been so included in reliance on the
report of PricewaterhouseCoopers LLP, given on the authority of the firm as
experts in auditing and accounting.
The Hyperion Strategic Mortgage Income Fund, Inc.
Statement of Assets and Liabilities
July 10, 2002
Assets:
Cash..................................................... $ 100,000
---------------------
Total assets................................... 100,000
Commitments (Notes 1 and 2).............................. ----------------------
Net Assets (7,018 shares of $.01 par value common shares issued and outstanding;
50,000,000 shares authorized)............................ $ 100,000
======================
Net Asset Value Per Share $ 14.25
======================
----------------------------------------------------------
Notes to Financial Statement
1. The Fund
The Hyperion Strategic Mortgage Income Fund, Inc. (the "Fund") was incorporated
as a Maryland corporation on May 17, 2002, and has had no operations to date
other than matters relating to its organization and registration as a
diversified, closed-end, management investment company under the Investment
Company Act of 1940, as amended, and the sale and issuance of 7,018 of its
common shares for $100,000 to Hyperion Capital Management, Inc. (the "Adviser").
Organization expenses relating to the Fund incurred and to be incurred,
estimated at $6,000, will be borne by the Adviser. Offering costs, estimated at
$523,000, will be paid from the proceeds of the offering and will be charged to
the Fund's capital at the time of the issuance of such shares. However, any
offering costs over $0.03 per share will be borne by the Adviser.
2. Investment Advisory Agreements and Affiliated Transactions
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.
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" and an affiliate of
the Adviser), 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 Adviser is responsible for any fees due to the
Subadviser.
The Fund has entered into an Administration Agreement with Hyperion Capital
Management, Inc. (the "Administrator"). The Administrator entered into a
sub-administration agreement with a third party. The Administrator and
subadministrator 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 providing the Fund with administrative
office facilities. For these services, the Fund pays to the Administrator a
monthly fee at an annual rate of 0.20% of the Fund's average weekly net assets.
The Administrator is responsible for any fees due the subadministrator.
Certain officers and/or directors of the Fund are officers and/or directors of
the Advisor, Administrator and Subadviser.
Report of Independent Accountants
To the Board of Directors and Shareholder of
The Hyperion Strategic Mortgage Income Fund, Inc.:
In our opinion, the accompanying statement of assets and liabilities presents
fairly, in all material respects, the financial position of The Hyperion
Strategic Mortgage Income Fund, Inc. (the "Fund) at July 10, 2002, in conformity
with accounting principles generally accepted in the United States of America.
This financial statement is the responsibility of the Fund's management; our
responsibility is to express an opinion on this financial statement based on our
audit. We conducted our audit of this financial statement in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statement is free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statement, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
July 15, 2002
PART C -- OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
(1) FINANCIAL STATEMENTS - The Statement of Assets and Liabilities as of July
10, 2002 and the supporting notes have been included in the Registration
Statement.
Statements, schedules and historical information other than 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) (1) Articles of Incorporation of The Hyperion Strategic
Mortgage Income Fund, Inc. dated May 17, 2002.*
(2) Certificate of Correction to Articles of Incorporation
dated May 22, 2002.**
(B) By-laws.*
(C) Not applicable
(D) (1) Stock Certificate
(2) Seed Capital Agreement
(E) Terms and Conditions of Dividend Reinvestment Plan.**
(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) (1) To be filed by amendment.
(2) Master Agreement Among Underwriters
(3) Selected Dealer Agreement
(I) Not applicable
(J) Form of Custodian Agreement between Registrant and State
Street Bank and Trust Company.
(k) (1) Form of Registrar and Transfer Agent Agreement between
Registrant and American Stock Transfer & Trust Company.
(2) Form of Administration Agreement between Registrant and
Hyperion Capital Management, Inc.
(3) Form of Subadministration Agreement between Hyperion
Capital Management, Inc. and State Street Bank and
Trust Company.
(L) (1) To be filed by amendment.
(2) To be filed by amendment.
(M) Not applicable
(N) Consent of Pricewaterhouse Coopers LLP
(O) Not applicable
(P) Not applicable
(Q) Not applicable
(R) (1) Code of Ethics for The Hyperion Strategic Mortgage Income
Fund, Inc.**
(2) Code of Ethics for Hyperion Capital Management, Inc.**
(3) Code of Ethics for Lend Lease Hyperion Capital
Advisors, LLC.**
* Filed with Registrant's Registration Statement on Form N-2 on May 22, 2002
(File No. 333-88788).
** Filed with Registrant's Pre-Effective Amendment No. 1 to its Registration
Statement on Form N-2 on June 20, 2002.
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 $ 7,000
Legal fees and expenses $ 122,000
Underwriter expense reimbursement $ 125,000
Miscellaneous $ 20,000
------------
Total $ 522,520
===========
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
None.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES (as of July 15, 2002)
TITLE OF CLASS NUMBER OF RECORD HOLDERS
-------------- -------------
Common Stock 1
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 expand or 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 its 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 July 9, 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 July 17, 2002 (File
No. 801-49350) 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 Bank and Trust Company
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 Pre-Effective Amendment No. 2 to the 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 17th day of July, 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 Pre-Effective Amendment No. 2 to the Registration Statement has been signed
below by the following persons in the capacities and on the date indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ CLIFFORD E. LAI President (Principal Executive
------------------------------------
CLIFFORD E. LAI Officer) July 17, 2002
/s/ LEWIS S. RANIERI** Chairman and Director July 17, 2002
------------------------------------
LEWIS S. RANIERI
/s/ ROBERT F. BIRCH** Director July 17, 2002
------------------------------------
ROBERT F. BIRCH
/s/ RODMAN L. DRAKE** Director July 17, 2002
------------------------------------
RODMAN L. DRAKE
/s/ HARRY E. PETERSEN, JR.** Director July 17, 2002
----------------------------
HARRY E. PETERSEN, JR.
/s/ LEO M. WALSH, JR.** Director July 17, 2002
------------------------------------
LEO M. WALSH, JR.
/s/ JOHN H. DOLAN* Vice-President July 17, 2002
------------------------------------
JOHN H. DOLAN
/s/ PATRICIA A. SLOAN** Vice President July 17, 2002
------------------------------------
PATRICIA A. SLOAN
/s/ THOMAS F. DOODIAN* Treasurer (Principal Financial
------------------------------------
THOMAS F. DOODIAN and Accounting Officer) July 17, 2002
/s/ JOSEPH TROPEANO* Secretary July 17, 2002
------------------------------------
JOSEPH TROPEANO
* Signed pursuant to Power of Attorney in Registrant's Registration Statement on
Form N-2 filed on May 22, 2002.
** Signed pursuant to Power of Attorney in Registrant's Pre-Effective Amendment
No. 1 to its Registration Statement on Form N-2 filed on June 20, 2002.
EXHIBIT INDEX
Exhibit No. Description of Exhibit
(D)(1) Stock Certificate
(2) Seed Capital Agreement
(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)(2) Master Agreement Among Underwriters
(3) Selected Dealer Agreement
(J) Form of Custodian Agreement between Registrant
and State Street Bank and Trust Company.
(k)(1) Form of Registrar and Transfer Agent Agreement
between Registrant and American Stock Transfer
& Trust Company.
(2) Form of Administration Agreement between
Registrant and Hyperion Capital Management, Inc.
(3) Form of Subadministration Agreement between
Hyperion Capital Management, Inc. and State
Street Bank and Trust Company.
(N) Consent of PricewaterhouseCoopers LLP