S-11/A 1 x14736a5sv11za.htm AMENDMENT NO. 5 TO FORM S-11 S-11/A
Table of Contents

Registration No. 333-130256
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
AMENDMENT NO. 5
TO
FORM S-11
FOR REGISTRATION UNDER THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
 
Crystal River Capital, Inc.
(Exact name of registrant as specified in governing instruments)
 
Three World Financial Center, 200 Vesey Street, Tenth Floor
New York, New York 10281-1010
(212) 549-8400
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 
Daniel S. Kim, Esq.
Crystal River Capital, Inc.
c/o Hyperion Brookfield Asset Management, Inc.
Three World Financial Center, 200 Vesey Street, Tenth Floor
New York, New York 10281-1010
(212) 549-8400
(Name, address, including zip code, and telephone number, including area code, of agent for service)
Copies To:
     
Michael L. Zuppone, Esq.    David J. Goldschmidt, Esq.
Paul, Hastings, Janofsky & Walker LLP   Skadden, Arps, Slate, Meagher & Flom LLP
75 East 55th Street   Four Times Square
New York, New York 10022   New York, New York 10036
(212) 318-6000   (212) 735-3000
     Approximate date of commencement of sale of the securities to the public: As soon as practicable after this registration statement becomes effective.
     If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o                            
     If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o                            
     If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o                            
     If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.    o
 
CALCULATION OF REGISTRATION FEE
             
             
             
      Proposed Maximum      
Title of Securities     Aggregate Offering     Amount of
to be Registered     Price(1)     Registration Fee(2)
             
Common Stock, par value $0.001 per share
    $303,485,000     $32,473(3)
             
             
(1)  Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended.
 
(2)  Calculated in accordance with Rule 457(o) under the Securities Act of 1933.
 
(3)  A fee of $49,220 was paid on December 9, 2005.
     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 the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a) of the Securities Act of 1933, may determine.
 
 


Table of Contents

The information in this preliminary 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 declared effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

Subject to Completion, Dated July 24, 2006
(CRYSTAL RIVER CAPITAL) LOGO
 
9,100,000 Shares
Common Stock
________________________________________________________________________________
Crystal River Capital, Inc. is a Maryland corporation that invests in real estate-related securities, real estate loans and instruments and various other asset classes. We are externally managed and advised by Hyperion Brookfield Crystal River Capital Advisors, LLC, a wholly-owned subsidiary of Hyperion Brookfield Asset Management, Inc., and have retained Brookfield Crystal River Capital L.P. and Ranieri & Co., Inc. as sub-advisors.
This is our initial public offering. We are offering a total of 8,071,900 shares of our common stock in this offering and 1,028,100 shares of our common stock are being offered by the selling stockholders described in this prospectus. We will not receive any of the proceeds from the sale of shares of common stock by the selling stockholders. We have granted the underwriters the right to purchase up to 1,365,000 additional shares of our common stock to cover over-allotments.
We expect to qualify as a real estate investment trust, or REIT, for federal income tax purposes and will elect to be taxed as a REIT under the federal income tax laws for the taxable year ended December 31, 2005 and subsequent tax years.
We currently anticipate that the initial public offering price of our common stock will be between $26.00 and $29.00 per share. Prior to this offering, there has been no public market for our common stock. Our common stock has been approved for listing on the New York Stock Exchange under the symbol “CRZ,” subject to notice of issuance.
Shares of our common stock are subject to ownership limitations that we must impose in order to qualify and maintain our status as a REIT. Generally, no person may own more than 9.8% in value or in number of shares, whichever is more restrictive, of any class or series of the outstanding shares of our capital stock.
Investing in our common stock involves risks. See “Risk Factors” beginning on page 20 for a discussion of the following and other risks:
•  There are various conflicts of interest resulting from relationships among us, our manager, our sub-advisors and other parties, including those relating to the structure of the management agreement with our manager and other transactions with affiliated parties. Under the management agreement with our manager, our manager is entitled to receive a base management fee, which is not tied to the performance of our portfolio, and incentive compensation based on our portfolio’s performance, which may lead it to place emphasis on the short-term maximization of net income. This could result in increased risk to the value of our investment portfolio and decreased cash available for distributions to our stockholders.
 
•  The net proceeds from this offering are not committed to specific investments; we may allocate the net proceeds from this offering to investments with which you may not agree, and our failure to apply these proceeds effectively could cause our operating results and the value of our common stock to decline.
 
•  If we do not qualify as a REIT or fail to remain qualified as a REIT, we will be subject to income tax at regular corporate rates and could face substantial tax liability, which would reduce the amount of cash available for distribution to our stockholders and adversely affect the value of our common stock.
 
•  We have a limited operating history and our manager has no prior experience operating a REIT or a public company; therefore, our manager may not operate us successfully.
Neither the Securities and Exchange Commission 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.
         
    Per Share   Total
Public offering price
  $   $
Underwriting discounts and commissions
  $   $
Proceeds, before expenses, to Crystal River Capital, Inc. 
  $   $
Proceeds, before expenses, to the selling stockholders
  $   $
      The underwriters expect to deliver the shares to purchasers on or about                     , 2006.
Deutsche Bank Securities Wachovia Securities
Banc of America Securities LLC Credit Suisse UBS Investment Bank
A.G. Edwards RBC Capital Markets
The date of this prospectus is                     , 2006.


Table of Contents

TABLE OF CONTENTS
           
    Page
     
    1  
      1  
      4  
      6  
      8  
      10  
      11  
      11  
      13  
      14  
      14  
      15  
      16  
      17  
      18  
    20  
      20  
      33  
      43  
      48  
      51  
    55  
    56  
    57  
    58  
    60  
    62  
    64  
    66  
      66  
      67  
 
 Trends
    68  
      69  
      78  
      84  
      85  
      85  
      86  
      97  
    98  
      98  
      98  
      101  
      102  
      105  

i


Table of Contents

           
    Page
     
      107  
      116  
      116  
      117  
      120  
      123  
      123  
      124  
      128  
      130  
      132  
      133  
      133  
      135  
      135  
      136  
      136  
    137  
      137  
      138  
      141  
      142  
      143  
      143  
      148  
      149  
      150  
      154  
      155  
      159  
      159  
    163  
    165  
    168  
    174  
      174  
      174  
      174  
      175  
      175  
      177  
      177  
    180  
      180  
      180  
      180  
      181  

ii


Table of Contents

           
    Page
     
    182  
      182  
      182  
      183  
      183  
      183  
      184  
      184  
      184  
      185  
      186  
      187  
      187  
    189  
      189  
      192  
      195  
      199  
      202  
      203  
      203  
      204  
      204  
      206  
      206  
      207  
      207  
      208  
      209  
      210  
    211  
      214  
    215  
    215  
    215  
    F-1  
 EX-1.1: FORM OF UNDERWRITING AGREEMENT
 EX-23.1: CONSENT OF ERNST & YOUNG LLP

iii


Table of Contents

      No dealer, salesperson or other individual has been authorized to give any information or make any representations not contained in this prospectus in connection with the offering made by this prospectus. If given or made, such information or representations must not be relied upon as having been authorized by us or any of the underwriters. This prospectus does not constitute an offer to sell, or a solicitation of an offer to buy, any of our securities in any jurisdiction in which such an offer or solicitation is not authorized or in which the person making such offer or solicitation is not qualified to do so, or to any person to whom it is unlawful to make such offer or solicitation. Neither the delivery of this prospectus nor any sale made hereunder shall, under any circumstances, create an implication that there has not been any change in the facts set forth in this prospectus or in the affairs of our company since the date hereof.

iv


Table of Contents

PROSPECTUS SUMMARY
      This summary highlights the key aspects of this offering. It is not complete and may not contain all of the information that you should consider before making an investment in our common stock. You should read carefully the more detailed information set forth under “Risk Factors” and the other information included in this prospectus. Except where the context suggests otherwise, the terms “Crystal River,” “we,” “us” and “our” refer to Crystal River Capital, Inc. and its subsidiaries; “Hyperion Brookfield Crystal River” and “our Manager” refer to our external manager, Hyperion Brookfield Crystal River Capital Advisors, LLC; “Hyperion Brookfield” refers to Hyperion Brookfield Asset Management, Inc., the parent company of Hyperion Brookfield Crystal River; “Brookfield Sub-Advisor” refers to Brookfield Crystal River Capital L.P., a sub-advisor that has been retained by us and Hyperion Brookfield Crystal River; “Brookfield” refers to Brookfield Asset Management Inc., formerly known as Brascan Corporation, the indirect parent company of Hyperion Brookfield and Brookfield Sub-Advisor, together with its subsidiaries; and “Ranieri & Co.” refers to Ranieri & Co., Inc., another sub-advisor that has been retained by us and Hyperion Brookfield Crystal River. Unless indicated otherwise, the information in this prospectus assumes (i) the common stock to be sold in this offering is to be sold at $27.50 per share, which is the mid-point of the price range set forth on the front cover of this prospectus and (ii) no exercise by the underwriters, for whom Deutsche Bank Securities Inc. is acting as representative, of their option to purchase up to an additional 1,365,000 shares of our common stock solely to cover over-allotments, if any.  
Our Company
      We are a specialty finance company that was formed on January 25, 2005 by Hyperion Brookfield to invest in real estate-related securities, real estate loans and instruments and various other asset classes. We will elect and intend to qualify to be taxed as a REIT for federal income tax purposes. Our objective is to provide attractive returns to our investors through a combination of dividends and capital appreciation. To achieve this objective, we currently are investing primarily in residential mortgage-backed securities, or RMBS, and commercial mortgage-backed securities, or CMBS, whole mortgage loans, bridge loans, junior interests in mortgage loans known as B Notes and mezzanine loans. We also are investing in and intend to continue to invest in direct real estate interests and preferred equity interests in entities that own real estate, diversified asset-backed securities, or ABS, including aircraft and consumer obligations, and collateralized debt obligations, or CDOs. Finally, we intend to make selective debt and/or equity investments in certain alternative assets, which may include power generating facilities, timber and private equity funds managed by certain of our affiliates that invest in such assets, to diversify our portfolio and enhance our risk adjusted returns. We are externally managed and advised by Hyperion Brookfield Crystal River, a wholly-owned subsidiary of Hyperion Brookfield.  
 
      We currently target and expect to continue to target asset classes that provide consistent, stable risk-adjusted returns. We expect to continue to leverage our investments to enhance returns on our investments. We make portfolio allocation decisions based on various factors, including expected cash yield, relative value, risk-adjusted returns, current and projected credit fundamentals, current and projected macroeconomic considerations, current and projected supply and demand, credit and market risk concentration limits, liquidity, cost and availability of financing and hedging activities, as well as maintaining our REIT qualification and our exclusion from regulation under the Investment Company Act of 1940, which we refer to as the Investment Company Act. These factors place significant limits on the amount of certain of our targeted investments such as aircraft and consumer ABS, non-real estate-related CDOs and other equity investments that we may include in our portfolio.  

1


Table of Contents

      We intend to identify and invest in a diversified portfolio of assets that will compensate us appropriately for the credit risk associated with them. Our targeted asset classes and the principal investments we expect to make in each are as follows:
       
Asset Class   Principal Investments
     
Mortgage-Backed Securities, or MBS
   
 
 
— RMBS
  • Agency Adjustable Rate RMBS, or ARMS
    • Non-Agency ARMS
    • Non-Conforming Loans
    • Other RMBS
 
 
— CMBS
  • Investment Grade CMBS (Senior and Subordinated)
    • Below-Investment Grade CMBS (Rated and Non-Rated)
Mortgages and Other Real Estate Debt
  • Whole Mortgage Loans
    • Bridge Loans
    • B Notes
    • Mezzanine Loans
    • Land Loans
    • Construction Loans
    • Construction Mezzanine Loans
Commercial Real Estate
  • Direct Property Ownership
    • REIT Common and Preferred Stock Investments
    • Preferred Equity Investments
    • Joint Ventures
Other ABS
  • CDOs
    • Net Interest Margin Securities, or NIMs
    • Consumer ABS
    • Aircraft ABS
Alternative Assets
  • Hydroelectric, Gas- and Coal-Fired Power Generating Facilities
    • Timber
    • Other Equity Investments
      In addition, subject to maintaining our qualification as a REIT and the exclusion from regulation under the Investment Company Act, we may invest opportunistically in other types of investments within Hyperion Brookfield Crystal River’s core competencies, including investment grade corporate bonds and related derivatives, government bonds and related derivatives and other fixed income related instruments.
      We and our Manager believe that the most significant opportunities for out-performance exist between and within our target asset classes, as well as among individual securities. Our Manager will strive to identify and capitalize on relative value anomalies through the assessment of relationships between supply and demand, changes in interest rates and associated prepayment expectations, market volatility and investor trends. We and our Manager believe that, on a long-term basis, this investment approach will provide attractive risk-adjusted returns.

2


Table of Contents

      Our net interest income is generated primarily from the net spread, or difference, between the interest income we earn on our investment portfolio and the cost of our financing and hedging activities. Our net interest income will vary based upon, among other things, the difference between the interest rates earned on our various interest-earning assets and the borrowing costs of the liabilities used to finance those investments.
      As of March 31, 2006, we had a portfolio of approximately $2.9 billion consisting primarily of RMBS, as shown in the following chart:
                                                     
            Weighted Average    
                 
    Estimated   Percent of       Months       Constant
    Asset   Total       to   Yield to   Prepayment
Security Description   Value(1)   Investments   Coupon   Reset(2)   Maturity   Rate(3)
                         
    (In thousands)                
Commercial Real Estate Debt:
                                               
 
Below investment grade CMBS
  $ 292,854       10.2 %     5.05 %             9.59 %        
 
Real estate loans
    132,805       4.6       7.09               7.29          
                                     
 
Total Commercial Real Estate Debt
    425,659       14.8       5.54               8.87          
RMBS:
                                               
 
Non-Agency:
                                               
   
Senior prime 5/1 adjustable rate
    237,786       8.3       5.28       45.91       6.02       23.43 %
   
Junior prime
    153,906       5.4       6.57       24.47       16.01       24.39  
   
Subprime
    160,987       5.6       6.76       11.32       8.80       33.56  
 
Agency:
                                               
   
3/1 hybrid adjustable rate
    631,400       22.0       4.93       29.26       6.06       10.65  
   
5/1 hybrid adjustable rate
    1,203,308       41.9       4.91       47.69       5.79       14.80  
                                     
 
Total RMBS
    2,387,387       83.2       5.23       38.19       6.74       16.75  
CDO Preferred Stock
    4,707       0.2                                  
Other ABS:
                                               
 
Aircraft ABS
    51,048       1.8       5.21               7.22          
                                     
   
Total Investments
  $ 2,868,801       100.0 %     5.28 %             7.06 %        
                                     
 
(1)  All securities listed in this chart are carried at their estimated fair value other than real estate loans, which are carried at their cost. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition”.
 
(2)  Represents number of months before conversion to floating rate.
 
(3)  Represents the estimated percentage of principal that will be prepaid over the next 12 months based on historical principal paydowns.
     We have invested a substantial portion of our capital in Agency Adjustable Rate RMBS pending the full implementation of our diversified investment strategy. We currently expect the portion of our portfolio invested in non-RMBS investments to be in the range of 15% to 40% of our assets in an effort to create a more diversified, less correlated portfolio of investments, which may include investments in non-U.S. dollar denominated securities, within 12 months of the completion of this offering, subject to the availability of appropriate investment opportunities. However, our portfolio in its current form does not fully balance the interest rate or mark-to-market risks inherent in our RMBS investments, and we will not be able to eliminate all of our portfolio risk through asset allocation. Future dividends and capital appreciation are not guaranteed. Our investments will depend on prevailing market conditions and trends. We have not adopted any policy that establishes specific asset allocations among our targeted asset

3


Table of Contents

classes, and our targeted allocations will vary from time to time. As a result, we cannot predict the percentage of our assets that will be invested in each asset class or whether we will invest in other classes or investments. We generally expect to incur total leverage of up to five times the amount of our equity for most investments other than Agency Adjustable Rate RMBS, which we anticipate we generally will lever up to 15 times the amount of our equity allocated to this asset class. We currently expect our overall long-term average portfolio leverage to be three to five times the amount of our equity. We may change our investment strategy and policies and the percentage of assets that may be invested in each asset class, or in the case of securities, in a single issuer, without a vote of our stockholders.
      Because we will elect and intend to qualify to be taxed as a REIT and to operate our business so as to be exempt from regulation under the Investment Company Act, we are required to invest a substantial majority of our assets in qualifying real estate assets, such as agency RMBS, mortgage loans and other liens on and interests in real estate. Therefore, the percentage of our assets we may invest in other MBS, ABS, alternative assets and other types of instruments is limited, unless those investments comply with various federal income tax requirements for REIT qualification and the requirements for exclusion from Investment Company Act regulation.
      As of March 31, 2006, we had entered into master repurchase agreements with 12 counterparties and as of such date, we had outstanding obligations under repurchase agreements with 11 counterparties totaling approximately $2,384.4 million with a weighted average borrowing rate of 4.77%. In addition to repurchase agreements, we rely on credit facilities with multiple counterparties for capital needed to fund our other investments, including a $31.0 million unsecured revolving credit facility with Signature Bank, as administrative agent, that we entered into on March 1, 2006. On November 30, 2005, we closed our first CDO financing transaction. See “Business — Our Financing Strategy — Term Financing-CDOs.” We have no restriction on the amount of leverage that we may use.
      As of March 31, 2006, we had hedged a portion of the liabilities financing our investment portfolio by entering into a combination of one-, two-, three-, five- and ten-year interest rate swaps. The total notional par value of such swaps was approximately $1,436.0 million.
Summary Risk Factors
      An investment in shares of our common stock involves various risks. You should consider carefully the risks discussed below and under “Risk Factors” before purchasing our common stock.
  •  The net proceeds from this offering are not committed to specific investments; we may allocate the net proceeds from this offering to investments with which you may not agree, and our failure to apply these proceeds effectively could cause our operating results and the value of our common stock to decline.
 
  •  We have a limited operating history and our Manager, Hyperion Brookfield Crystal River, has no prior experience operating a REIT or a public company; therefore, our Manager may not operate us successfully.
 
  •  Our ability to achieve attractive risk-adjusted returns is dependent on our ability both to generate sufficient cash flow to pay an attractive dividend and to achieve capital appreciation, and we cannot assure you we will do either.
 
  •  We are dependent upon Hyperion Brookfield Crystal River and certain key personnel of Hyperion Brookfield Crystal River and may not find a suitable replacement if Hyperion Brookfield Crystal River terminates the management agreement or such key personnel are no longer available to us. We also rely on our sub-advisors and may not find suitable replacements if we or they terminate the sub-advisory agreements.

4


Table of Contents

  •  There are conflicts of interest in our relationship with Hyperion Brookfield Crystal River, which could result in decisions that are not in the best interests of our stockholders. Our management agreement with Hyperion Brookfield Crystal River was negotiated between related parties and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party. In addition, affiliates of Hyperion Brookfield Crystal River may sponsor or manage other investment vehicles in the future with an investment focus similar to our focus, which could result in us competing for access to the benefits that our relationship with Hyperion Brookfield Crystal River provides to us, including access to the senior management of Hyperion Brookfield Crystal River.
 
  •  Hyperion Brookfield and our sub-advisors are not contractually obligated to dedicate their time to us and may engage in other activities that compete with us, which may result in conflicts of interest that could cause our results of operations to be lower or result in increased risk to the value of our investment portfolio.
 
  •  There are conflicts of interest in our relationship with certain of our underwriters, which could result in decisions that are not in the best interests of our stockholders.
 
  •  Through our relationship with Brookfield Sub-Advisor, we expect to pursue and acquire investments from, and make investments in private equity funds advised by, Brookfield and its affiliates, which will result in conflicts of interest between us and Brookfield Sub-Advisor. Brookfield Sub-Advisor is not obligated to offer to us such investment opportunities and any decision to do so will be entirely within its discretion.
 
  •  Hyperion Brookfield Crystal River is entitled to receive a base management fee, which is not tied to the performance of our portfolio.
 
  •  Hyperion Brookfield Crystal River is entitled to incentive compensation based on our portfolio’s performance, which may lead it to place emphasis on the short-term maximization of net income. This could result in increased risk to the value of our investment portfolio and decreased cash available for distributions to our stockholders.
 
  •  We may not terminate the management agreement between us and Hyperion Brookfield Crystal River without cause until after December 31, 2008. Upon termination without cause after this initial term or upon a failure to renew the management agreement, we would be required to pay Hyperion Brookfield Crystal River a substantial termination fee. These and other provisions in our management agreement make termination without cause or non-renewal difficult and costly.
 
  •  As of March 31, 2006, greater than 63.0% of our investment portfolio consisted of Agency Adjustable Rate RMBS and greater than 19.0% of our investment portfolio consisted of Non-Agency RMBS, and we cannot assure you that we will be successful in achieving a more diversified portfolio that generates comparable or better returns. Even if we are successful in achieving a more diversified portfolio, it is likely that RMBS will remain a significant component of our portfolio.
 
  •  We may, consistent with our intention to qualify as a REIT and to maintain our exclusion from regulation under the Investment Company Act, change our investment strategy without stockholder consent, which could result in investments that are different, and possibly more risky, than the proposed investments and current portfolio we describe in this prospectus. Because we intend to continue to operate in such a manner to be excluded from regulation as an investment company under the Investment Company Act, the assets that we may acquire are limited by the provisions of the Investment Company Act and the rules and regulations promulgated thereunder. If we fail to acquire and maintain assets meeting the requirements to be excluded from regulation as an

5


Table of Contents

  investment company under the Investment Company Act, we would have to register as an investment company, which would adversely affect our business.
 
  •  We seek to enhance our potential returns by leveraging our investments, which may enhance returns but also may compound losses. We are not limited in the amount of leverage we may use. Our use of leverage may adversely affect our return on investments and may reduce cash available for distribution.
 
  •  Interest rate fluctuations may cause losses. The yields on our investments and the costs of our borrowings may be sensitive to changes in prevailing interest rates and changes in prepayment rates. Mismatches between the repricing or maturity dates of our assets and those of our financings may reduce or eliminate income derived from our investments or result in losses.
 
  •  Changes in prevailing interest rates will impact the value of our portfolio, which may not be mitigated by our hedging strategy. We do not hedge all of our exposure to changes in interest rates and prepayment rates, as there are practical limitations to our ability to insulate the portfolio from all of the negative consequences associated with changes in short-term interest rates while still seeking to provide an attractive net spread on our portfolio.
 
  •  Many of the assets in which we invest, such as MBS and interests in CDOs, are subject to the credit risk associated with the underlying loans and in the event of default of the borrower under such loans, the collateral securing the loans and any underlying or additional credit support may not be adequate to enable us to recover our full investment.
 
  •  Our charter and bylaws contain provisions that may inhibit potential takeover bids that you and other stockholders may consider favorable. The stock ownership limits that apply to REITs, as prescribed by the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, and that are contained in our charter, may restrict our business combination opportunities.
 
  •  The REIT qualification rules impose limitations on the types of investments and activities that we may undertake, including limitations on our use of hedging transactions and derivatives, and these limitations may, in some cases, preclude us from pursuing the most economically beneficial investment alternatives.
 
  •  If we fail to qualify as a REIT, we will be subject to income tax at regular corporate rates, which would reduce the amount of cash available for distribution to our stockholders and adversely affect the value of our stock.
 
  •  There may not be an active market for our common stock, which may cause our common stock to trade at a discount and make it difficult for you to sell our common stock.
 
  •  The market price and trading volume of our common stock may be volatile following this offering.
Our Formation and Structure
      We were organized on January 25, 2005 by Hyperion Brookfield, who may be deemed to be our promoter, and completed a private offering of our common stock in March 2005, in which we raised net proceeds of approximately $405.6 million. In our March 2005 private offering, Deutsche Bank Securities Inc. and Wachovia Capital Markets, LLC served as the initial purchasers/placement agents. In our March 2005 private offering, an indirect subsidiary of Brookfield purchased 800,000 shares, or 4.5% (assuming all outstanding options have vested and are exercised), of our common stock and certain of our executive officers, directors and members of our strategic advisory committee, and certain executive officers of Hyperion

6


Table of Contents

Brookfield Crystal River and Hyperion Brookfield that provide services to us collectively purchased 183,800 shares, or 1.0% (assuming all outstanding options have vested and are exercised), of our common stock. In addition, upon completion of our March 2005 private offering, we issued to Hyperion Brookfield Crystal River, and it subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us, 84,000 shares of restricted stock and we granted to Hyperion Brookfield Crystal River, and it subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us, options to purchase 126,000 shares of our common stock with an exercise price of $25.00 per share, representing in the aggregate approximately 1.2% of the outstanding shares of our common stock as of the date of this prospectus, assuming all outstanding options have vested and are exercised. Following completion of this offering, Hyperion Brookfield, Brookfield, Hyperion Brookfield Crystal River and their respective affiliates and employees who provide services to us, including our executive officers, members of our strategic advisory committee and certain of our directors, as well as our independent directors, will collectively own 1,105,800 shares of our common stock, representing 4.3% of our outstanding shares of common stock, and will have options to purchase an additional 130,000 shares of our common stock representing an additional 0.5% of our outstanding shares of common stock, in each case, assuming all outstanding options have vested and are exercised.

7


Table of Contents

      The following chart illustrates the organizational structure of our company after giving effect to this offering.
(FLOW CHART)
      On April 28, 2005, an indirect wholly-owned subsidiary of Brookfield acquired all of the capital stock in Hyperion Brookfield’s parent. As a result of such acquisition, an affiliate of Ranieri & Co. will share in additional payments, for a period of 15 years following the closing of that acquisition, totaling 20% of the base and incentive management fees and termination fees we pay to our Manager, net of sub-advisor fees.
Our Manager
      We are externally managed and advised by Hyperion Brookfield Crystal River, a wholly-owned subsidiary of Hyperion Brookfield formed on January 25, 2005 solely for the purpose of serving as our manager, whose officers consist of investment professionals and employees of

8


Table of Contents

Hyperion Brookfield or one or more of its affiliates. As of July 21, 2006, Hyperion Brookfield Crystal River had no employees and we and Hyperion Brookfield Crystal River had no independent officers and were entirely dependent on Hyperion Brookfield for the day-to-day management of our operations. While our directors periodically review our investment guidelines and our investment portfolio, other than any investments involving our affiliates or our sub-advisors’ affiliates or investments proposed by Brookfield Sub-Advisor, which they are required to review and approve prior to such investments being made, they do not review all of our proposed investments. Our officers, as employees of Hyperion Brookfield or one of its affiliates, have been delegated the responsibility to review and make investments consistent with our investment strategy as articulated by our strategic advisory committee. Hyperion Brookfield Crystal River did not have any experience managing a REIT prior to its entering into a management agreement with us and it currently does not provide management or other services to entities other than us. Prior to our formation, Hyperion Brookfield had no prior experience managing a REIT. However, Hyperion Brookfield has a successful 17-year history of acquiring and managing MBS and ABS through an investment philosophy predicated on the concept of relative value. Hyperion Brookfield was founded in 1989 by Lewis Ranieri, an MBS market pioneer and former Vice Chairman of Salomon Brothers, Inc. Today, Hyperion Brookfield employs approximately 85 professionals and is dedicated to providing investment management services for institutional clients and mutual funds through the management of core fixed income portfolios as well as separately managed portfolios of RMBS, CMBS and ABS. As of March 31, 2006, Hyperion Brookfield and its affiliates managed approximately $19.3 billion in assets for institutional clients, closed-end investment companies and CDOs.
      We believe our relationship with Hyperion Brookfield, our Manager and our sub-advisors provides us with substantial benefits in sourcing, underwriting and managing our investments. Our Manager is responsible for administering our business activities and day-to-day operations and uses the resources of Hyperion Brookfield to support our operations. These resources include:
  •  Investment sourcing;
 
  •  Investment process;
 
  •  Portfolio management resources;
 
  •  Portfolio management infrastructure; and
 
  •  Risk management.
As the parent company of our Manager, Hyperion Brookfield has an economic incentive to provide us with these services to the extent that their provision will increase the management fees that we pay to our Manager through our improved performance. However, Hyperion Brookfield is not contractually obligated to provide us with any of these services.
      We are able to draw upon the unique resources of two sub-advisors to enhance the management of our portfolio:
  •  Brookfield Sub-Advisor. For investments in mortgages and other real estate debt, real estate, hydroelectric, gas-and coal-fired power generating facilities and timber assets, we are able to draw upon a sub-advisory relationship with Brookfield Sub-Advisor. Through this relationship, we are able to access the resources of Brookfield, an asset manager focused on property, power and infrastructure assets with approximately $50.0 billion of assets under management as of March 31, 2006. Brookfield’s portfolio of high quality assets includes interests in approximately 70 commercial properties and 140 power generating plants.

9


Table of Contents

  •  Ranieri & Co. Our Manager utilizes Ranieri & Co. to provide guidance on macroeconomic trends, market trends in MBS and overall portfolio strategy. We expect that our relationship with Ranieri & Co. will continue to provide us with access to its relationships for investment and financing opportunities. Ranieri & Co is managed by Lewis Ranieri, whose leading role in the development of MBS has earned him recognition as a pioneer of the securitized mortgage market in the U.S.
      Our Manager and our sub-advisors have senior management teams with extensive experience in identifying and financing, hedging and managing RMBS, ABS, CMBS, real estate equity and mezzanine investments. Mr. Clifford Lai, our president and chief executive officer, is also the president and chief executive officer of Hyperion Brookfield, and leads Hyperion Brookfield’s CMBS team. Mr. John Dolan, our chief investment officer, is also the chief investment officer of Hyperion Brookfield and the leader of its RMBS/ABS team. Each has over 25 years of investment experience.
      Our board of directors has formed a strategic advisory committee to advise and consult with our board and our senior management team with respect to our investment policies, investment portfolio holdings, financing and leveraging strategies and investment guidelines. The members of the strategic advisory committee are Lewis Ranieri, who serves as chairman of the committee, Clifford Lai and John Dolan of Hyperion Brookfield and Bruce Flatt and Bruce Robertson of Brookfield. The committee reviews, discusses and makes recommendations on our overall investment strategy but does not approve individual investment opportunities or present investment opportunities to us or our Manager.
Our Business Strengths
      We have the following business strengths:
  •  Access to a top-ranked investment advisor with a superior track record;
 
  •  Access to complementary investment skills of leading sub-advisors;
 
  •  Experienced professionals and senior management team;
 
  •  Diversified investment strategy;
 
  •  Access to Hyperion Brookfield’s infrastructure;
 
  •  Relationships and deal flow of Hyperion Brookfield and our sub-advisors; and
 
  •  Alignment of interests of Hyperion Brookfield Crystal River and our stockholders.

10


Table of Contents

Hyperion Brookfield’s Historical Performance
      The following table sets forth Hyperion Brookfield’s historical investment performance with respect to its assets under management in its Enhanced MBS and high yield CMBS categories. These asset classes are those in which Hyperion Brookfield invests that are similar in nature to the assets in which we currently invest and intend to continue to invest. However, the investment returns shown below generally were obtained using much lower levels of financial leverage than what we intend to use. Past performance is not indicative of future results. In addition, this information is a reflection of Hyperion Brookfield’s historical performance and not a guarantee or prediction of the return that Hyperion Brookfield or Hyperion Brookfield Crystal River will achieve for us. The percentile rankings noted below reflect the performance of Hyperion Brookfield against other asset managers for the same period. For example, performance that is reflected in the 7th percentile means that Hyperion Brookfield’s performance ranked in the top 7% of all asset managers with that investment strategy for the period noted.
PSN Mortgage-Backed Universe — percentile rankings (as of 3/31/2006)
                                 
    Hyperion Enhanced   Hyperion High Yield
    MBS   CMBS
         
    Gross Return   Percentile   Gross Return   Percentile
                 
1 year
    3.04%       40       6.50%       1  
3 year
    4.41%       7       8.91%       1  
5 year
    6.32%       4       11.96%       1  
10 year
    7.96%       1              
Hyperion Brookfield obtained this information from Plan Sponsor Network, or PSN, which is a third-party investment manager database and is a division of Informa Investment Solutions. We and Hyperion Brookfield have not verified the accuracy of the information provided by PSN. All rates of return are annualized. Performance figures shown are gross of fees and do not take into account advisory fees or transaction costs. These costs reduced actual returns. Index returns do not reflect any management fees, transaction costs or expenses.
Management Agreement
      We have entered into a management agreement with Hyperion Brookfield Crystal River that provides for the day-to-day management of our operations in conformity with the policies and the investment guidelines that are approved and monitored by our board of directors. Hyperion Brookfield Crystal River’s role as manager is under the supervision and direction of our board of directors.
      The initial term of the management agreement expires on December 31, 2008 and will be automatically renewed for a one-year term each anniversary date thereafter. After the initial term, our independent directors will review our Manager’s performance annually and the management agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, or by the affirmative vote of the holders of at least a majority of the outstanding shares of our common stock, based upon unsatisfactory performance that is materially detrimental to us. A termination fee will be paid to our Manager upon such termination. We may also terminate the management agreement with 30 days’ prior written notice from our board of directors, without payment of a termination fee, for cause, as defined in the management agreement.
      Our Manager is not obligated to dedicate certain of its employees exclusively to us nor is it obligated to dedicate any specific portion of its time to our business. Moreover, none of our

11


Table of Contents

Manager’s employees are contractually dedicated to our Manager’s obligations to us under our management agreement.
      Our Manager is entitled to receive a base management fee from us, incentive compensation based on certain performance criteria, reimbursement of certain expenses and, a termination fee if we decide to terminate the management agreement without cause. We believe that the base management fee and incentive compensation that our Manager is entitled to receive are comparable to the base management fee and incentive compensation received by managers of comparable externally managed REITs. The following table summarizes the fees payable to our Manager pursuant to the management agreement:
     
Type   Description
     
Base management fee   1.50% per annum of our stockholders equity, defined as the aggregate net proceeds from sales of our equity securities plus retained earnings as of the end of the measurement period (without taking into account any non-cash equity compensation expense incurred in the current or prior periods), less amounts paid for repurchases of our capital stock. Payable monthly in arrears in cash.
Incentive management fee
  Quarterly fee equal to 25% of:
    • the amount by which our net income (before non-cash compensation expense and the incentive management fee) per share for such quarter exceeds an amount equal to:
         • the product of the weighted average price per share in our March 2005 private offering, this offering and any subsequent offerings of our common stock multiplied by the higher of:
           • 2.4375% and
           • 25% of the then applicable 10-year treasury note rate plus 0.50%,
    • multiplied by the weighted average number of shares of common stock outstanding during the quarter.
    The calculation is subject to adjustment for certain one-time charges and, with the approval of a majority of our independent directors, certain non-cash items.
    Payable quarterly in a combination of stock and cash, provided that at least 10% of any quarterly payment may be made in stock, subject to compliance with the REIT qualification rules.
Termination fee
  If we terminate the management agreement for cause, no termination fee is payable. If we terminate or fail to renew without cause, we will be required to pay a termination fee equal to two times the sum of the average annual base management fee and the average annual incentive management fee earned during the two 12-month periods immediately preceding the date of termination.
      In addition to the fees payable to our Manager discussed above, we will incur management fee expense related to the amortization of restricted stock and stock options issued or granted under our long term incentive plan. From March 15, 2005, the date we commenced operations, through December 31, 2005 and for the three months ended March 31, 2006, our Manager

12


Table of Contents

earned base management fees of approximately $4.8 million and $1.5 million, respectively. From March 15, 2005 to March 31, 2006, our Manager has not earned any incentive fees. There are no contractual limitations on our obligation to reimburse our Manager for third party expenses and our Manager may incur such expenses consistent with the grant of authority provided to it pursuant to the management agreement without any additional approval of our board of directors being required. Our Manager has waived its right to request reimbursement from us of third-party expenses that it incurs through June 30, 2006. We and our Manager have entered into sub-advisory agreements with each of Brookfield Sub-Advisor and Ranieri & Co., pursuant to which they provide advisory services to us in conjunction with our Manager’s service to us as our external manager. Our manager pays Brookfield Sub-Advisor an annual sub-advisory fee equal to 20% of the base management fee and incentive management fee that it receives from us and our manager pays Ranieri & Co. an annual sub-advisory fee of $100,000.
Our Distribution Policy
      Federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain. For more information, please see “Federal Income Tax Consequences of Our Qualification as a REIT.”
      To satisfy the requirements to qualify as a REIT and generally not be subject to federal income and excise tax, we intend to make regular quarterly distributions of all or substantially all of our REIT taxable income to holders of our common stock out of assets legally available therefor. Any future distributions we make will be at the discretion of our board of directors out of legally available funds and will depend upon, among other things, our earnings and financial condition, maintenance of our REIT status, applicable provisions of the Maryland General Corporation Law, or MGCL, and such other factors as our board of directors deems relevant.
      We anticipate that our distributions generally will be taxable as ordinary income to our stockholders, although a portion of the distributions may constitute a return of capital. We will furnish annually to each of our stockholders a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, return of capital, qualified dividend income or capital gain.
      On June 21, 2005, we declared a quarterly distribution of $0.25 per share of our common stock, payable on July 13, 2005, to stockholders of record as of June 30, 2005. We distributed total dividends of approximately $4.4 million from uninvested cash. In addition, on September 28, 2005, we declared a quarterly distribution of $0.575 per share of our common stock, payable on October 13, 2005, to stockholders of record as of September 30, 2005. In connection with such distribution, we distributed an aggregate of approximately $10.1 million. On December 23, 2005, we declared a quarterly distribution of $0.725 per share of our common stock, payable on December 30, 2005, to stockholders of record as of December 23, 2005. In connection with such distribution, we distributed an aggregate of approximately $12.7 million. On March 31, 2006, we declared a quarterly distribution of $0.725 per share of our common stock, payable on April 17, 2006, to stockholders of record as of March 31, 2006. In connection with such distribution, we distributed an aggregate of approximately $12.7 million. On June 23, 2006, we declared a quarterly distribution of $0.725 per share of our common stock, payable on July 21, 2006, to stockholders of record as of June 30, 2006. In connection with such distribution, we distributed an aggregate of approximately $12.7 million. All distributions through December 31, 2005 represented distributions of taxable earnings and profits; none represented a return of capital, and all distributions from and including October 13, 2005 were funded primarily from operating cash flows, and as necessary, to a lesser extent from the sale or repayment of our investments or from borrowings under our credit facilities or master repurchase agreements, and were not funded out of the offering

13


Table of Contents

proceeds from our March 2005 private offering. We cannot assure you that we will have sufficient cash available for future quarterly distributions at this level, or at all.
Operating and Regulatory Structure
      We intend to qualify and will elect to be taxed as a REIT for federal income tax purposes commencing with our taxable year ended on December 31, 2005. Our qualification as a REIT will depend upon our ability to meet, on a continuing basis, various complex requirements under the Internal Revenue Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels and the concentration of ownership of our capital stock. We believe that we were organized and have operated in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code, and that our intended manner of operation will enable us to continue to meet the requirements for qualification and taxation as a REIT.
      As a REIT, we generally will not be subject to federal income tax on the REIT taxable income that we distribute currently to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax at regular corporate rates. Even if we qualify for federal taxation as a REIT, we may be subject to some federal, state and local taxes on our income or property. Crystal River Capital TRS Holdings, Inc., our taxable REIT subsidiary, or TRS, will be a regular taxable corporation that will be subject to federal, state and local income tax on its income.
      In order to implement our investment strategy, subject to the limitations in the Internal Revenue Code on the total value of investments in TRSs and the amount of dividend income from TRSs, we will utilize TRSs in order to conduct any active businesses or make sales of assets which would not be appropriate for a REIT, hold assets that do not qualify as real estate assets under the Internal Revenue Code and engage in activities or make investments that would produce income that would not qualify as income from real estate assets.
Exclusion from Regulation Under the Investment Company Act
      We intend to continue to operate our business so as to be excluded from regulation under the Investment Company Act, as administered by the Securities and Exchange Commission, referred to as the Commission, and its Division of Investment Management, referred to as the Division. Because we conduct our business directly and through wholly-owned subsidiaries, we must ensure not only that we, but also each of our subsidiaries, qualify for an exclusion from regulation under the Investment Company Act.
      We are excluded from regulation under Section 3(c)(5)(C) of the Investment Company Act, a provision designed for companies that do not issue redeemable securities and are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. To qualify for this exemption, we will need to ensure that at least 55% of our assets consist of mortgage loans and other assets that are considered the functional equivalent of mortgage loans for purposes of the Investment Company Act, which we refer to as qualifying real estate assets, and that at least 80% of our assets consist of qualifying real estate assets and real estate-related assets. We do not intend to issue redeemable securities. We also may rely on an exclusion under Section 3(c)(6) of the Investment Company Act if, from time to time, we engage in our business through one or more majority-owned subsidiaries.
      We will treat our ownership interest in pools of whole loan RMBS, in cases in which we acquire the entire beneficial interest in a particular pool, as qualifying real estate assets based on no-action positions of the Division. As of March 31, 2006 such assets comprise in excess of 60.0% of our total assets. We generally do not expect our investments in CMBS and other

14


Table of Contents

RMBS investments to constitute qualifying real estate assets for the 55% test, unless such treatment is consistent with Division or Commission guidance. Instead, these investments generally will be classified as real estate-related assets for purposes of the 80% test. We do not expect that our investments in CDOs, ABS, credit default swaps and total return swaps will constitute qualifying real estate assets, although we may treat our interests in a CDO issuer that we determine is a “majority-owned subsidiary” and is excluded from Investment Company Act regulation under Section 3(c)(5)(C) of the Investment Company Act as qualifying real estate assets, consistent with Division or Commission guidance. Moreover, to the extent that these investments are not backed by mortgage loans or other interests in real estate, they will constitute miscellaneous assets, which can comprise no more than 20% of our assets. We treat our interests in an existing CDO, which is relying on the exclusion in Section 3(c)(7) of the Investment Company Act, as miscellaneous assets. See “Business — Exclusion from Regulation Under the Investment Company Act” for further information concerning our reliance on the Section 3(c)(5)(C) exclusion from Investment Company Act regulation. For purposes of the foregoing discussion “we” and “our” refer to Crystal River Capital, Inc. alone and not its subsidiaries.
Restrictions on Ownership of Our Common Stock
      In order to assist us in complying with the limitations on the concentration of ownership of REIT shares imposed by the Internal Revenue Code, our charter generally prohibits any stockholder from beneficially or constructively owning, applying certain attribution rules under the Internal Revenue Code, more than 9.8% in value or in number of shares, whichever is more restrictive, of any class or series of our capital stock. Our board of directors may, in its sole discretion, waive the 9.8% ownership limit with respect to a particular stockholder if it is presented with evidence satisfactory to it that such ownership will not then or in the future jeopardize our qualification as a REIT. Our charter also prohibits any person from, among other things:
  •  beneficially or constructively owning shares of our capital stock that would result in our being “closely held” under Section 856(h) of the Internal Revenue Code or otherwise cause us to fail to qualify as a REIT; and
 
  •  transferring shares of our capital stock if such transfer would result in our capital stock being owned by fewer than 100 persons.
      Our charter provides that any ownership or purported transfer of our capital stock in violation of the foregoing restrictions will result in the shares owned or transferred in such violation being automatically transferred to a charitable trust for the benefit of a charitable beneficiary, and the purported owner or transferee acquiring no rights in such shares. If a transfer to a charitable trust would be ineffective for any reason to prevent a violation of the restriction, the transfer that would have resulted in such violation will be void ab initio.

15


Table of Contents

THE OFFERING
Common stock offered by us 8,071,900 shares
 
Common stock offered by selling stockholders 1,028,100 shares
 
Common stock to be outstanding after this offering 25,595,400 shares(1)(2)
 
Use of proceeds The net proceeds to us from our sale of shares of common stock in this offering, after deducting the underwriting discounts and commissions and other estimated offering expenses, will be approximately $203.5 million. If the underwriters exercise their over-allotment option in full, we estimate that our net proceeds will be approximately $238.5 million. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.
 
We plan to invest the net proceeds of this offering in accordance with our investment objectives and strategies described in this prospectus.
 
New York Stock Exchange symbol “CRZ”
 
Trading This is our initial public offering. No public market currently exists for our common stock. Shares of our common stock issued to qualified institutional buyers in connection with our March 2005 private offering are eligible for trading in The PORTALsm Market.
 
Ownership and transfer
restrictions
In order to assist us in complying with the limitations on the concentration of ownership of a REIT imposed by the Internal Revenue Code, our charter generally prohibits any stockholder from beneficially or constructively owning more than 9.8% in value or in number of shares, whichever is more restrictive, of any class or series of the outstanding shares of our capital stock, subject to important exceptions.
 
(1)  Assumes the underwriters’ option to purchase up to an additional 1,365,000 shares of our common stock solely to cover over-allotments, if any, is not exercised.
(2)  Includes 17,400,000 shares of our common stock issued in our March 2005 private offering and 84,000 restricted shares of our common stock issued to Hyperion Brookfield Crystal River under our 2005 stock incentive plan in March 2005. Excludes 126,000 shares of common stock issuable upon exercise of options with an exercise price of $25.00 per share granted to Hyperion Brookfield Crystal River under our 2005 stock incentive plan in March 2005. These restricted shares and options vested or became exercisable in three equal annual installments beginning on March 15, 2006, the first anniversary of the closing date of our March 2005 private offering. As permitted by the awards, Hyperion Brookfield Crystal River allocated and transferred these shares and options to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield or their respective affiliates who provide services to us. Also includes an aggregate of 3,500 shares of restricted common stock issued to three of our independent directors under our stock incentive plan that they elected to receive in lieu of cash directors fees, which shares vested on the date of grant and an aggregate of 36,000 shares of restricted common stock that were issued to one of our independent directors and certain employees of Hyperion Brookfield who provide services to us in 2006 but excludes options to purchase 4,000 shares of our common stock granted to one of our independent directors on March 15, 2006. As of July 21, 2006, 32,162 of such 123,500 shares of restricted stock were no longer subject to forfeiture and options with respect to 43,328 shares of our common stock (out of 130,000 options) were exercisable. Does not include 1,495,250 shares of our common stock available for future issuance under our 2005 stock incentive plan (which includes 10,160 shares to be issued in respect of deferred stock units and restricted stock units issued to certain of our independent directors).

16


Table of Contents

Our Corporate Information
      Our offices, Hyperion Brookfield’s offices and Hyperion Brookfield Crystal River’s offices are located at Three World Financial Center, 200 Vesey Street, Tenth Floor, New York, New York 10281-1010, and our telephone number is 212-549-8400. We maintain an internet site at http://www.crystalriverreit.com which contains information concerning us and our subsidiaries. Information included or referred to on our website is not incorporated by reference or otherwise a part of this prospectus. Our website address is included in this prospectus as an inactive textual reference only.

17


Table of Contents

SUMMARY HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
      In the table below, we provide you with summary historical consolidated financial information of Crystal River Capital, Inc. We have prepared this information as of and for the period ended December 31, 2005 using our consolidated financial statements for the period ended December 31, 2005, which have been audited by Ernst & Young LLP, independent registered public accounting firm. We have prepared this information for the period ended March 31, 2005 and as of and for the three months ended March 31, 2006 using our unaudited consolidated financial statements for such periods. The financial statements for the period ended March 31, 2005 and as of and for the three months ended March 31, 2006 have not been audited. In the opinion of management, such financial statements have been prepared on the same basis as our audited consolidated financial statements and reflect all adjustments, consisting of normal accruals, necessary for a fair presentation of the data for such periods. Results for the period ended March 31, 2005 and for the three months ended March 31, 2006 are not necessarily indicative of results that may be expected for the entire year.
      When you read this summary historical consolidated financial information, it is important that you read along with it the historical consolidated financial statements and related notes, as well as the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are included in this prospectus.

18


Table of Contents

                             
    Period from       Period from
    March 15, 2005   Three Months   March 15, 2005
    (commencement of   Ended   (commencement
    operations) to   March 31,   of operations) to
    March 31, 2005   2006   December 31, 2005
             
    (In thousands, except share and per share data)
Consolidated Income Statement Data:
                       
Net interest income:
                       
 
Interest income
  $ 713     $ 41,078     $ 79,594  
 
Interest expense
    103       28,851       48,425  
                   
   
Net interest income
    610       12,227       31,169  
                   
Expenses:
                       
 
Management fees, related party(1)
    320       1,677       5,448  
 
Professional fees
    41       761       2,205  
 
Insurance expense
    13       91       250  
 
Other general and administrative expenses(2)
    309       236       533  
                   
   
Total expenses
    683       2,765       8,436  
                   
 
Income (loss) before other revenues
    (73 )     9,462       22,733  
Other revenues (expenses):
                       
 
Realized net loss on sale of real estate loans and securities available for sale
          (568 )     (521 )
 
Realized and unrealized gain (loss) on derivatives
    195       7,930       (2,497 )
 
Loss on impairment of available for sale securities
          (1,258 )     (5,782 )
 
Other
          (122 )     15  
                   
   
Total other revenues (expenses)
    195       5,982       (8,785 )
                   
Net income
  $ 122     $ 15,444     $ 13,948  
Net income per share — basic and diluted
  $ 0.01     $ 0.88     $ 0.80  
Weighted-average number of shares outstanding — basic and diluted
    17,487,500       17,495,082       17,487,500  
Cash dividends declared per common share
  $     $ 0.725     $ 1.55  
 
(1)  Includes $33, $222 and $627, respectively, of stock based compensation.
 
(2)  Includes $116 of stock based compensation for the three months ended March 31, 2006.
                 
    March 31, 2006   December 31, 2005
         
    (In thousands)
Consolidated Balance Sheet Data:
               
Total assets
  $ 3,023,321     $ 2,669,769  
Debt — Repurchase agreements
    2,384,415       1,994,287  
Debt — Collateralized debt obligations
    211,210       227,500  
Debt — Notes payable, related party
          35,000  
Stockholders’ equity
    383,173       381,429  

19


Table of Contents

RISK FACTORS
      An investment in our common stock involves a high degree of risk. Before making an investment decision, you should carefully consider the following risk factors, together with the other information contained in this prospectus. If any of the risks discussed in this prospectus occur, our business, financial condition, liquidity and results of operations could be materially and adversely affected. If this were to happen, the price of our common stock could decline significantly and you could lose all or a part of your investment.
Risks Related to Our Business and Investment Strategy
We have a limited operating history and limited experience as a REIT and we may not be able to successfully operate our business or generate sufficient revenue to make or sustain dividends to stockholders.
      We were recently organized and have a limited operating history and limited experience operating as a REIT. We are subject to all of the business risks and uncertainties associated with any new business, including the risk that we will not achieve our investment objectives and that the value of your investment could decline substantially. Our ability to achieve attractive risk-adjusted returns is dependent on our ability both to generate sufficient cash flow to pay an attractive dividend and to achieve capital appreciation, and we cannot assure you we will do either. There can be no assurance that we will be able to generate sufficient revenue from operations to pay our operating expenses and make or sustain dividends to stockholders.
We are dependent on Hyperion Brookfield Crystal River and our sub-advisors and may not find suitable replacements if Hyperion Brookfield Crystal River terminates the management agreement.
      We are externally managed by Hyperion Brookfield Crystal River. Most of our officers are employees of Hyperion Brookfield or certain of its affiliates. We have no separate facilities and are completely reliant on Hyperion Brookfield Crystal River, which has significant discretion as to the implementation of our operating policies and strategies. We are subject to the risk that Hyperion Brookfield Crystal River will terminate the management agreement, thereby triggering a termination of our sub-advisors, and that no suitable replacements will be found to manage us. We believe that our success depends to a significant extent upon the experience of Hyperion Brookfield Crystal River’s executive officers, whose continued service is not guaranteed. If Hyperion Brookfield Crystal River terminates the management agreement, we may not be able to execute our business plan and may suffer losses, which could materially decrease cash available for distribution to our stockholders.
Hyperion Brookfield Crystal River has limited prior experience managing a REIT and we cannot assure you that Hyperion Brookfield Crystal River’s past experience will be sufficient to successfully manage our business as a REIT.
      The federal income tax laws impose numerous constraints on the operations of REITs. Our Manager’s and its employees’ limited experience in managing a portfolio of assets under REIT and Investment Company Act constraints may hinder their ability to achieve our investment objective. In addition, maintaining our REIT qualification limits the types of investments we are able to make. Our investors are not acquiring an interest in any of Hyperion Brookfield’s other managed entities or Hyperion Brookfield Crystal River or their respective subsidiaries through this offering. We can offer no assurance that Hyperion Brookfield through Hyperion Brookfield Crystal River will replicate its historical success or its management team’s success in its previous endeavors, and we caution you that our investment returns could be substantially

20


Table of Contents

lower than the returns achieved by funds managed by Hyperion Brookfield or Hyperion Brookfield’s other endeavors.
We are dependent upon Hyperion Brookfield’s key personnel and the resources of our sub-advisors for our success and the departure of any of these key personnel or the elimination of resources of our sub-advisors could negatively impact our performance.
      We depend on the diligence, skill and network of business contacts of the senior management of Hyperion Brookfield, who direct the management activities of Hyperion Brookfield Crystal River, including Clifford Lai, John Dolan and John Feeney. The senior management of Hyperion Brookfield evaluates, negotiates, structures, closes and monitors our investments. Our continued success will depend on the continued service of the senior management team of Hyperion Brookfield. The departure of any of the senior managers of Hyperion Brookfield, or of a significant number of the investment professionals or principals of Hyperion Brookfield or Hyperion Brookfield Crystal River, could have a material adverse effect on our performance. In addition, we can offer no assurance that Hyperion Brookfield Crystal River will remain as our manager or that we will continue to have access to Hyperion Brookfield’s principals and professionals or their information and deal flow. We also depend on the resources of our sub-advisors in connection with sourcing and managing our investments and executing our investment strategy.
Our base management fee is payable regardless of our performance, which could lead to conflicts of interest with our Manager.
      Hyperion Brookfield Crystal River is entitled to receive a base management fee that is based on the amount of our equity (as defined in the management agreement), regardless of the performance of our portfolio. Hyperion Brookfield Crystal River’s entitlement to substantial non-performance based compensation might reduce its incentive to devote its time and effort to seeking investments that provide attractive risk-adjusted returns for our portfolio. This in turn could hurt our ability to make distributions to our stockholders.
Hyperion Brookfield Crystal River’s incentive fee may induce it to make certain investments, including speculative investments, that increase the risk of our investment portfolio.
      Hyperion Brookfield Crystal River’s entitlement to an incentive fee may cause it to invest in high risk investments. In addition to its base management fee, Hyperion Brookfield Crystal River is entitled to receive incentive compensation based entirely upon our achievement of targeted levels of net income. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on net income may lead Hyperion Brookfield Crystal River to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation. Investments with higher yield potential generally are riskier or more speculative. This could result in increased risk to the value of our investment portfolio.
The net proceeds from this offering are not committed to specific investments, Hyperion Brookfield Crystal River manages our portfolio pursuant to very broad investment guidelines and our board of directors does not approve each investment decision made by Hyperion Brookfield Crystal River, which may result in our making riskier investments with which you do not agree and which could cause our operating results and the value of our common stock to decline.
      The net proceeds from this offering are not committed to specific investments and Hyperion Brookfield Crystal River is authorized to follow very broad investment guidelines. While

21


Table of Contents

our directors periodically review our investment guidelines and our investment portfolio, other than any investments involving our affiliates or our sub-advisors’ affiliates or investments proposed by Brookfield Sub-Advisor, which they are required to review and approve prior to such investment being made, they do not review all of our proposed investments. In addition, in conducting periodic reviews, our directors may rely primarily on information provided to them by Hyperion Brookfield Crystal River or Brookfield Sub-Advisor. Furthermore, Hyperion Brookfield Crystal River and Brookfield Sub-Advisor may use complex strategies in structuring transactions for us and those transactions may be difficult or impossible to unwind. Subject to maintaining our REIT qualification and our exemption from regulation under the Investment Company Act, Hyperion Brookfield Crystal River has great latitude within the broad investment guidelines in determining the types of investments it makes for us.
      The failure of our management to apply these proceeds effectively could result in unfavorable returns, could have a material negative impact on our business, financial condition, liquidity and results of operations, could materially decrease cash available for distribution to our stockholders and could cause the value of our common stock to decline.
We may change our investment strategy and asset allocation without stockholder consent, which may result in riskier investments.
      We have not adopted a policy as to the amounts to be invested in each of our intended investments, including securities rated below investment grade. Subject to our intention to invest in a portfolio that allows us to qualify as a REIT and remain eligible for an exclusion from regulation as an investment company under the Investment Company Act, we may change our investment strategy or asset allocation, including the percentage of assets that may be invested in each class, or in the case of securities, in a single issuer, at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this prospectus. A change in our investment strategy may increase our exposure to interest rate risk, default risk and real estate market fluctuations, all of which could negatively affect the market price of our common stock and our ability to make distributions to you.
There are conflicts of interest in our relationship with Hyperion Brookfield Crystal River, which could result in decisions that are not in the best interests of our stockholders.
      We are entirely dependent on Hyperion Brookfield Crystal River for our day-to-day management and have no independent officers. Our chairman of the board, chief executive officer and president, chief financial officer, chief investment officer and executive vice president also serve as officers and/or directors of Hyperion Brookfield or certain of its affiliates. As a result, our management agreement with Hyperion Brookfield Crystal River was negotiated between related parties and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party.
      Termination of the management agreement with Hyperion Brookfield Crystal River without cause is difficult and costly. The management agreement provides that it may only be terminated without cause following the initial term expiring on December 31, 2008, annually upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of at least a majority of the outstanding shares of our common stock, based upon:
  •  unsatisfactory performance by Hyperion Brookfield Crystal River that is materially detrimental to us or

22


Table of Contents

  •  a determination that the management fee payable to Hyperion Brookfield Crystal River is not fair, subject to Hyperion Brookfield Crystal River’s right to prevent such a termination by accepting a mutually acceptable reduction of management fees.
Hyperion Brookfield Crystal River will be provided 180 days’ prior notice of any such termination and will be paid a termination fee equal to the amount of two times the sum of the average annual base management fee and the average annual incentive compensation earned by Hyperion Brookfield Crystal River during the two 12-month periods immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. These provisions may increase the effective cost to us of terminating the management agreement, thereby restricting our ability to terminate Hyperion Brookfield Crystal River without cause.
      The ability of Hyperion Brookfield and its officers and employees to engage in other business activities may reduce the time Hyperion Brookfield Crystal River spends managing us.
      The management compensation structure that we have agreed to with Hyperion Brookfield Crystal River may cause Hyperion Brookfield Crystal River to invest in potentially higher yielding investments. Investments with higher yield potential generally are riskier or more speculative. The compensation we pay Hyperion Brookfield Crystal River consists of both a base management fee that is not tied to our performance and an incentive management fee that is based entirely on our performance. The risk of the base management fee component is that it may not sufficiently incentivize Hyperion Brookfield Crystal River to generate attractive risk-adjusted returns for us. The risk of the incentive fee component is that it may cause Hyperion Brookfield Crystal River to place undue emphasis on the maximization of GAAP net income at the expense of other criteria, such as preservation of capital, in order to achieve a higher incentive fee. This could result in increased risk to the value of our investment portfolio. Subject to certain limitations, Hyperion Brookfield Crystal River will receive at least 10% of its incentive fee in the form of shares of our common stock, and, at Hyperion Brookfield Crystal River’s option, may receive up to 100% of its incentive fee in the form of shares of our common stock. Hyperion Brookfield Crystal River has agreed not to sell such shares prior to one year after the date such shares are issued. Hyperion Brookfield Crystal River has the right in its discretion to allocate these shares to its officers, employees and other individuals who provide services to us. However, any of these shares that Hyperion Brookfield Crystal River allocates will be subject to the same one-year restriction on sale. Any such shares received would have the benefit of registration rights.
Hyperion Brookfield and our sub-advisors are not contractually obligated to dedicate their time to us and may engage in other activities that compete with us, which may result in conflicts of interest that could cause our results of operations to be lower or result in increased risk to the value of our investment portfolio.
      The ability of Hyperion Brookfield, Brookfield Sub-Advisor and Ranieri & Co. and their respective officers and employees to engage in other business activities may result in conflicts of interest and, with respect to Brookfield Sub-Advisor and Ranieri & Co., may reduce the time they spend acting as a sub-advisor to us. In addition, the management compensation structure that we and our Manager have agreed to with Brookfield Sub-Advisor may cause Brookfield Sub-Advisor to source potentially higher yielding investments. Investments with higher yield potential generally are riskier or more speculative. The compensation our Manager pays Brookfield Sub-Advisor is equal to 20% of the base management fee and incentive management fees we pay to our Manager. In addition, for a 15 year period ending in April 2020, an affiliate of Ranieri & Co. will receive 20% of the base and incentive management fees and termination fees we pay to our Manager, net of sub-advisor fees. The base management fee is not tied to our performance and the incentive management fee is based entirely on our performance. The

23


Table of Contents

risk of the base management fee component is that it may not sufficiently incentivize Brookfield Sub-Advisor or Ranieri & Co. to generate attractive risk-adjusted returns for us in the investments that they source for us. The risk of the incentive fee component is that it may cause Brookfield Sub-Advisor or Ranieri & Co. to place undue emphasis on the maximization of GAAP net income at the expense of other criteria, such as preservation of capital, in order to achieve a higher incentive fee. This could result in increased risk to the value of our investment portfolio.
There are conflicts of interest in our relationship with certain of our underwriters, which could result in decisions that are not in the best interests of our stockholders.
      Deutsche Bank AG, an affiliate of Deutsche Bank Securities Inc., one of our underwriters, is a stockholder in our company and owns 400,000 shares of our common stock. Deutsche Bank AG will not be a selling stockholder in this offering, but may sell its shares in a future offering of our common stock. In addition, we have purchased and will likely purchase in the future agency RMBS and securities other than agency RMBS issued by affiliates of certain of the underwriters in this offering or underwritten by certain underwriters in this offering. As of March 31, 2006, an aggregate of approximately $257.0 million in carrying value, or 24.8%, of our portfolio invested in assets other than agency RMBS had been purchased from certain of the underwriters in this offering, including Deutsche Bank Securities Inc., Wachovia Capital Markets, LLC, Banc of America Securities LLC, Credit Suisse Securities (USA) LLC and UBS Securities LLC, and their respective affiliates, and approximately $246.7 million, or 13.4%, of our agency RMBS was purchased from certain of the underwriters in this offering, including Deutsche Bank Securities Inc., Credit Suisse Securities (USA) LLC and UBS Securities LLC, and their respective affiliates. We also have entered into master repurchase agreements with Deutsche Bank Securities Inc., Wachovia Capital Markets, LLC, Banc of America Securities LLC and affiliates of Credit Suisse Securities (USA) LLC that are unlimited in capacity, and we have entered into a master repurchase agreement with Wachovia Bank, N.A., an affiliate of Wachovia Capital Markets, LLC, with total capacity of $275.0 million. At March 31, 2006, $857.4 million was outstanding under these agreements. These repurchase agreements mature at various dates through August 2007. In addition, Deutsche Bank AG, Wachovia Bank, N.A. and an affiliate of Credit Suisse Securities (USA) LLC entered into 29 interest rate swaps with us that were outstanding at March 31, 2006 in an aggregate notional amount of $770.5 million. These swaps mature at various dates through March 2016. Deutsche Bank AG also entered into five credit default swaps with us that were outstanding at March 31, 2006 in an aggregate notional amount of $50.0 million and one currency swap with us that was outstanding at March 31, 2006 in the notional amount of Can$50.0 million. The credit default swaps mature through February 2042 and the currency swap matures in July 2016. Wachovia Capital Markets, LLC acted as exclusive structurer and placement agent for us in connection with our CDO 2005-1 Transaction and received a customary fee of approximately $3.6 million and reimbursement of approximately $26,000 of expenses in connection therewith. This transaction closed on November 30, 2005. These circumstances create a potential conflict of interest because these underwriters have interests in the successful completion of this offering beyond the underwriting discounts and commissions they will receive.
We may compete with existing and future investment vehicles for access to Hyperion Brookfield and our sub-advisors and their affiliates, which may reduce investment opportunities available to us.
      Brookfield currently sponsors one investment vehicle, Brascan Real Estate Finance Fund, and Hyperion Brookfield manages one investment vehicle, Brascan Adjustable Rate Trust, and at March 31, 2006, managed 19 client accounts with investment focuses that overlap our investment focus, and each may in the future sponsor or manage other investment vehicles that

24


Table of Contents

have overlapping focuses with our investment focus. Accordingly, we compete for access to the benefits that we expect our relationship with Hyperion Brookfield Crystal River and our sub-advisors and their affiliates to provide and to the time of their investment professionals to carry out and facilitate our investment activities. Our rights to participate in investment opportunities are subject to Hyperion Brookfield’s conflict of interest policy. Brookfield is not subject to Hyperion Brookfield’s conflict of interest policy and is not obligated to offer us any investment opportunities and any decision to do so will be entirely within its discretion. In addition, we may make investments that are senior or junior to participations in, or have rights and interests different from or adverse to, the investments made by other vehicles or accounts managed by Hyperion Brookfield or Brookfield. Our interests in such investments may conflict with the interests of such other vehicles or accounts in related investments at the time of origination or in the event of a default or restructuring of the investment. If a default occurs with respect to such an investment, Hyperion Brookfield Crystal River will advise our independent directors who will direct Hyperion Brookfield Crystal River with respect to the resolution or disposition of the investment.
Our investment portfolio is heavily concentrated in agency adjustable-rate RMBS and we cannot assure you that we will be successful in achieving a more diversified portfolio.
      As of March 31, 2006, more than 63.0% of our investment portfolio consisted of Agency Adjustable Rate RMBS. One of our key strategic objectives is to achieve a more diversified portfolio of investments that delivers attractive risk-adjusted returns. We cannot assure you that we will be successful in diversifying our investment portfolio and even if we are successful in diversifying our investment portfolio it is likely that approximately 70.0% of our fully leveraged assets will be MBS. If we are unable to achieve a more diversified portfolio, we will be particularly exposed to the investment risks that relate to investments in adjustable-rate MBS and we may suffer losses if investments in adjustable-rate MBS decline in value.
We leverage our investments, which may negatively affect our return on our investments and may reduce cash available for distribution.
      We intend to continue to leverage our investments through borrowings, generally through the use of warehouse facilities, bank credit facilities, repurchase agreements, secured loans, securitizations, including the issuance of CDOs, loans to entities in which we hold, directly or indirectly, interests in pools of assets, and other borrowings. We are not limited in the amount of leverage we may use. The percentage of leverage varies depending on our ability to obtain credit facilities and the lender’s and rating agencies’ estimate of the stability of the investments’ cash flow. Our return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions increase the cost of our financing relative to the income that can be derived from the assets acquired. Our debt service payments will reduce cash flow available for distributions to stockholders. We may not be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to foreclosure or sale to satisfy the obligations. We leverage certain of our assets through repurchase agreements. A decrease in the value of these assets may lead to margin calls which we will have to satisfy. We may not have the funds available to satisfy any such margin calls and may have to sell assets at a time when we might not otherwise choose to do so.
      Further, credit facility providers and warehouse facility providers may require us to maintain a certain amount of uninvested cash or to set aside unlevered assets sufficient to maintain a specified liquidity position which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.

25


Table of Contents

Our failure to manage future growth effectively may have a material negative impact on our business, financial condition and results of operations.
      Our ability to achieve our investment objective depends on our ability to grow, which depends, in turn, on the senior management team of Hyperion Brookfield and its ability to identify and invest in securities that meet our investment criteria. Accomplishing this result on a cost-effective basis is largely a function of Hyperion Brookfield’s structuring of our investment process, its ability to provide competent, attentive and efficient services to us and our access to financing on acceptable terms. Our ability to grow is also dependent upon Hyperion Brookfield’s ability to successfully hire, train, supervise and manage new employees. We may not be able to manage growth effectively or to achieve growth at all. Any failure to manage our future growth effectively could have a material negative impact on our business, financial condition and results of operations.
      When we obtain financing, lenders can impose restrictions on us that affect our ability to incur additional debt, our capability to make distributions to stockholders and our flexibility to determine our operating policies. Loan documents we have executed contain, and loan documents we may execute in the future may contain, negative covenants that limit, among other things, our ability to repurchase stock, distribute more than a certain amount of our funds from operations, and employ leverage beyond certain amounts. Some of our master repurchase agreements in effect as of July 21, 2006 contain negative covenants requiring us to maintain certain levels of net asset value, tangible net worth and available funds and comply with interest coverage ratios, leverage ratios and distribution limitations.
We may acquire investments from Hyperion Brookfield and Brookfield or their affiliates or otherwise participate in investments in which they have an interest or for which they have a related investment, which could result in conflicts of interest.
      We expect that we will continue to acquire investments from Hyperion Brookfield and Brookfield or their affiliates, make investments that finance their investments or make co-investments with them. These transactions are not and will not be the result of arm’s length negotiations and involve conflicts between our interests and the interest of Hyperion Brookfield and Brookfield and their affiliates in obtaining favorable terms and conditions. There can be no assurance that any procedural protections, such as obtaining market prices, other reliable indicators of fair market value and independent valuations or appraisals and the prior approval of our independent directors, will be sufficient to assure that the consideration we pay for these investments will not exceed their fair market value.
We operate in a highly competitive market for investment opportunities and we may not be able to identify and make investments that are consistent with our investment objectives.
      A number of entities compete with us to make the types of investments that we plan to make. We compete with other REITs, public and private funds, commercial and investment banks and commercial finance companies. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. Several other REITs have recently raised, or are expected to raise, significant amounts of capital, and may have investment objectives that overlap with ours, which may create competition for investment opportunities. Some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. We cannot assure you that the competitive pressures we face will not have a material negative impact on our business, financial condition and results of operations. Also, as a result of this competition, we may not

26


Table of Contents

be able to take advantage of attractive investment opportunities from time to time, and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective.
Failure to procure adequate capital and funding would negatively impact our results and may, in turn, negatively affect the market price of shares of our common stock and our ability to distribute dividends.
      We depend upon the availability of adequate funding and capital for our operations. As a REIT, we are required to distribute annually at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, to our stockholders and are therefore not able to retain significant amounts of our earnings for new investments. However, Crystal River Capital TRS Holdings, Inc., our TRS, is able to retain earnings for investment in new capital, subject to the REIT requirements which place a limitation on the relative value of TRS stock and securities owned by a REIT. The failure to secure acceptable financing could reduce our taxable income, as our investments would no longer generate the same level of net interest income due to the lack of funding or increase in funding costs. A reduction in our net income would reduce our liquidity and our ability to make distributions to our stockholders. We cannot assure you that any, or sufficient, funding or capital will be available to us in the future on terms that are acceptable to us. Therefore, in the event that we cannot obtain sufficient funding on acceptable terms, there may be a negative impact on the market price of our common stock and our ability to make distributions.
If we issue senior securities we will be subject to additional restrictive covenants and limitations on our operating flexibility, which could materially decrease cash available for distribution to our stockholders.
      If we decide to issue senior securities in the future, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Holders of senior securities may be granted specific rights, including but not limited to: the right to hold a perfected security interest in certain of our assets, the right to accelerate payments due under the indenture, rights to restrict dividend payments, and rights to require approval to sell assets. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock. We, and indirectly our stockholders, will bear the cost of issuing and servicing such securities.
We may not be able to successfully complete securitization transactions, which could inhibit our ability to grow our business and could negatively impact our results of operations.
      In addition to issuing senior securities to raise capital as described above, we may, to the extent consistent with the REIT requirements, seek to securitize certain of our portfolio investments to generate cash for funding new investments. This would involve creating a special-purpose vehicle, contributing a pool of our assets to the entity, and selling interests in the entity on a non-recourse basis to purchasers (whom we would expect to be willing to accept a lower interest rate to invest in investment grade loan pools). We would retain all or a portion of the equity in the securitized pool of portfolio investments. We have initially financed our investments with relatively short-term credit facilities and reverse repurchase arrangements. We use these short-term facilities to finance the acquisition of securities until a sufficient quantity of securities is accumulated, at which time we intend to refinance these facilities through a securitization, such as a CDO issuance, or other long-term financing. As a result, we are subject to the risk that we may not be able to acquire, during the period that our short-term facilities are available, a sufficient amount of eligible securities to maximize the efficiency of a

27


Table of Contents

CDO issuance. We also bear the risk that we may not be able to obtain short-term credit facilities or may not be able to renew any short-term credit facilities after they expire should we find it necessary to extend our short-term credit facilities to allow more time to seek and acquire the necessary eligible securities for a long-term financing. The inability to renew our short-term credit facilities may require us to seek more costly financing for our investments or to liquidate assets. In addition, conditions in the capital markets may make the issuance of a CDO impractical when we do have a sufficient pool of collateral. The inability to securitize our portfolio could hurt our performance and ability to grow our business. At the same time, the securitization of our portfolio investments might expose us to losses, as the residual portfolio investments in which we do not sell interests will tend to be riskier and more likely to generate losses.
We expect that the use of CDO financings with over-collateralization requirements may have a negative impact on our cash flow.
      The terms of our initial CDO financing, CDO 2005-1, required that the principal amount of assets must exceed the principal balance of the related bonds by a certain amount, which is commonly referred to as “over-collateralization.” We expect that the terms of CDOs that we may issue in the future generally will provide for over-collateralization and that, if certain delinquencies and/or losses exceed specified levels, which we will establish based on the analysis by the rating agencies (or any financial guaranty insurer) of the characteristics of the assets collateralizing the bonds, the required level of over-collateralization may be increased or may be prevented from decreasing as would otherwise be permitted if losses or delinquencies did not exceed those levels. Other tests (based on delinquency levels or other criteria) may restrict our ability to receive net income from assets collateralizing the obligations. We cannot assure you that the performance tests will be satisfied. In advance of completing negotiations with the rating agencies or other key transaction parties on our future CDO financings, we cannot assure you of the actual terms of the CDO delinquency tests, over-collateralization terms, cash flow release mechanisms or other significant factors regarding the calculation of net income to us. Failure to obtain favorable terms with regard to these matters may materially and adversely affect the availability of net income to us. If our assets fail to perform as anticipated, our over-collateralization or other credit enhancement expense associated with our CDO financings will increase.
An increase in our borrowing costs relative to the interest we receive on our assets may negatively affect our profitability, and thus our cash available for distribution to our stockholders.
      As our repurchase agreements and other short-term borrowings mature, we will be required either to enter into new borrowings or to sell certain of our investments at times when we might not otherwise choose to do so. An increase in short-term interest rates at the time that we seek to enter into new borrowings would reduce the spread between our returns on our assets and the cost of our borrowings. This would negatively affect our returns on our assets that are subject to prepayment risk, including our MBS, which might reduce earnings and, in turn, cash available for distribution to our stockholders.
We may not be able to renew the total return swaps that we enter into, which could adversely impact our leveraging strategy.
      In the future, we may leverage certain of our investments through the use of total return swaps, which are swaps in which the non-floating rate side is based on the total return of an equity or fixed income instrument with a life longer than the swap. We may wish to renew many of the swaps, which are for specified terms, as they mature. However, there is a limited

28


Table of Contents

number of providers of such swaps, and there is no assurance the initial swap providers will choose to renew the swaps, and, if they do not renew, that we would be able to obtain suitable replacement providers. Providers may choose not to renew our total return swaps for a number of reasons, including:
  •  increases in the provider’s cost of funding;
 
  •  insufficient volume of business with a particular provider;
 
  •  our desire to invest in a type of swap that the provider does not view as economically attractive due to changes in interest rates or other market factors; or
 
  •  our inability to agree with a provider on terms.
      Furthermore, our ability to invest in total return swaps, other than through a TRS, may be severely limited by the REIT qualification requirements because total return swaps are not qualifying assets and do not produce qualifying income for purposes of the REIT asset and income tests.
Hedging against interest rate exposure may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.
      Subject to maintaining our qualification as a REIT and our exemption from regulation under the Investment Company Act, we often pursue various hedging strategies to seek to reduce our exposure to losses from adverse changes in interest rates. Our hedging activity varies in scope based on the level and volatility of interest rates, the type of assets held, and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us because, among other things:
  •  interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;
 
  •  available interest rate hedges may not correspond directly with the interest rate risk for which protection is sought;
 
  •  the duration of the hedge may not match the duration of the related liability;
 
  •  the amount of income that a REIT may earn from hedging transactions (other than through TRSs) to offset interest rate losses is limited by federal tax provisions governing REITs;
 
  •  the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
 
  •  the party owing money in the hedging transaction may default on its obligation to pay.
      Our hedging activity may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders. We may utilize instruments such as forward contracts and interest rate swaps, caps, collars and floors and credit default swaps to seek to hedge against mismatches between the cash flows on our assets and the interest payments on our liabilities or fluctuations in the relative values of our portfolio positions, in each case resulting from changes in market interest rates. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may

29


Table of Contents

not be possible to hedge against an interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.
      The success of our hedging transactions will depend on Hyperion Brookfield Crystal River’s ability to correctly predict movements of interest rates. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss.
      In addition, by entering into derivative contracts in connection with hedging transactions, we could be required to fund cash payments in certain circumstances. These potential payments will be contingent liabilities and therefore may not appear on our balance sheet. Our ability to fund these contingent liabilities will depend on the liquidity of our assets and access to capital at the time, and the need to fund these contingent liabilities could adversely impact our financial condition.
Our failure to achieve adequate operating cash flow could reduce our cash available for distribution to our stockholders.
      As a REIT, we must distribute annually at least 90% of our REIT taxable income to our stockholders, determined without regard to the deduction for dividends paid and excluding net capital gain. Our ability to make and sustain cash distributions is based on many factors, including the return on our investments, operating expense levels and certain restrictions imposed by Maryland law. Some of the factors are beyond our control and a change in any such factor could affect our ability to pay future dividends, which may also have a negative impact on our stock price. No assurance can be given as to our ability to pay distributions.
Loss of Investment Company Act exclusion would adversely affect us and could cause a decline in the market price of our common stock and limit our ability to distribute dividends.
      Because registration as an investment company would significantly affect our ability to engage in certain transactions or to organize ourselves in the manner we are currently organized, we intend to maintain our qualification for certain exclusions from registration under the Investment Company Act. Since we conduct our business directly and through wholly-owned subsidiaries, we must ensure not only that we, but also that each of our subsidiaries, qualify for an exclusion or exemption from regulation under the Investment Company Act.
      For purposes of the ensuing discussion “we” and “our” refer to Crystal River Capital, Inc. alone and not its subsidiaries.
      We rely on the exclusion provided by Section 3(c)(5)(C) of the Investment Company Act (and potentially Section 3(c)(6) if, from time to time, we engage in business through one or more majority-owned subsidiaries).
      Section 3(c)(5)(C), as interpreted by the staff of the SEC, requires us to invest at least 55% of our assets in “mortgages and other liens on and interests in real estate”, referred to as qualifying real estate assets, and at least 80% of our assets in qualifying real estate assets plus real estate-related assets. We will treat our direct ownership interests in real property (held in the form of fee interests) and our whole mortgage loans as qualifying real estate assets. In

30


Table of Contents

addition, we will treat our ownership interest in pools of whole loan RMBS, in cases in which we acquire the entire beneficial interest in a particular pool, as qualifying real estate assets based on no-action positions of the Division.
      We also invest in other types of RMBS, CMBS, B Notes and mezzanine loans, which we will not treat as qualifying real estate assets for purposes of determining our eligibility for the exclusion provided by Section 3(c)(5)(C) unless such treatment is consistent with guidance provided by the Commission or the Division. We have not requested no-action or other interpretative guidance or applied for an exemptive order with respect to the treatment of such assets. In the absence of guidance of the Commission or the Division that otherwise supports the treatment of such investments as qualifying real estate assets, we will treat them, for purposes of determining our eligibility for the exclusion provided by Section 3(c)(5)(C), as real estate-related assets or miscellaneous assets, as appropriate.
      As of March 31, 2006, our investments in RMBS whole pool certificates comprise in excess of 60.0% of our assets, and coupled with our whole mortgage loan investments, comprise in excess of 64.0% of our assets. Such qualifying real estate assets, coupled with our real estate-related assets, comprise in excess of 89.0% of our assets as of March 31, 2006. We monitor our assets to ensure that at least 55% of our assets consist of qualifying real estate assets, and that at least 80% of our assets consist of qualifying real estate assets and real estate-related assets. We expect, when required due to the mix of our investments, to acquire pools of whole loan RMBS for compliance purposes. Investments in such pools may not represent an optimum use of our investable capital when compared to the available investments we target pursuant to our investment strategy.
      If we fail to satisfy the requirements provided in the Investment Company Act to preserve our exclusion from regulation under the Investment Company Act, we could be required to materially restructure our activities and to register as an investment company under the Investment Company Act, which could have a material adverse effect on our operating results. Further, if it were established that we were an unregistered investment company, there would be a risk that we would be subject to monetary penalties and injunctive relief in an action brought by the Commission, that we would be unable to enforce contracts with third parties and that third parties could seek to obtain rescission of transactions undertaken during the period it was established that we were an unregistered investment company.
Rapid changes in the values of our MBS and other real estate related investments may make it more difficult for us to maintain our qualification as a REIT or exclusion from regulation under the Investment Company Act, which may cause us to change our mix of portfolio investments which may not produce optimal returns consistent with our investment strategy.
      If the market value or income potential of our MBS and other real estate related investments declines as a result of increased interest rates, prepayment rates or other factors, we may need to increase our real estate investments and income and/or liquidate our non-qualifying assets in order to maintain our REIT qualification or exclusion from regulation under the Investment Company Act. If the decline in real estate asset values and/or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated if the assets that we need to sell in order to comply with the requirements for qualification as a REIT or to qualify for an exclusion from regulations under the Investment Company Act have no pre-existing trading market and cannot easily be sold. To the extent that the assets we need to sell are comprised of subordinated MBS, individually-negotiated loans, loan participations or mezzanine loans where there is no established trading market, we may have difficulty selling such investments quickly for their fair value. Accordingly, we may have to make investment decisions that we otherwise would not make absent the REIT and Investment Company Act considerations.

31


Table of Contents

We are highly dependent on communications and information systems operated by Hyperion Brookfield or by third parties, and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to pay dividends.
      Our business is highly dependent on communications and information systems, including all of Hyperion Brookfield’s proprietary analytical systems and models and certain third-party systems and models. Any failure or interruption of our systems or the systems operated by Hyperion Brookfield or by third parties on which we rely, as we experienced as part of system-wide interruptions following the September 11, 2001 terrorist attacks and the East Coast electrical power black-out in August 2003, could cause delays or other problems in our securities trading activities, including MBS trading activities, which could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to pay dividends.
We will be required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and furnish a report on our internal control over financial reporting as of the end of 2007.
      Based on current laws and regulations, we will be required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”) in 2007. Section 404 requires us to assess and attest to the effectiveness of our internal control over financial reporting and requires our independent registered public accounting firm to opine as to the adequacy of our assessment and effectiveness of our internal control over financial reporting. Our efforts to comply with Section 404 will result in us incurring significant expenses through 2007 that we estimate will exceed $500,000.
      Even with those expenditures, we may not receive an unqualified opinion from our independent registered public accounting firm in regards to our internal control over financial reporting. In connection with our financial statement audit for the period ended June 30, 2005, our independent registered public accounting firm identified four material weaknesses involving our internal control over financial reporting for the period March 15, 2005 (commencement of operations) to June 30, 2005. While we have remediated those material weaknesses as of December 31, 2005, we cannot assure you that we will not have material weaknesses in our internal control over financial reporting in the future. The existence of a material weakness in our internal control over financial reporting could result in errors in our financial statements that could require us to restate our financial statements, cause us to fail to meet our reporting obligations and cause investors to lose confidence in our reported financial information, all of which could lead to a decline in the trading price of our common stock.
Terrorist attacks and other acts of violence or war may affect the market for our common stock, the industry in which we conduct our operations and our profitability.
      The terrorist attacks on September 11, 2001 disrupted the U.S. financial markets, including the real estate capital markets, and negatively impacted the U.S. economy in general. Any future terrorist attacks, the anticipation of any such attacks, the consequences of any military or other response by the U.S. and its allies, and other armed conflicts could cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets and economy. The economic impact of these events could also adversely affect the credit quality of some of our loans and investments and the property underlying our ABS securities. Some of our loans and investments are more susceptible to the adverse effects discussed above than others, such as hotel loans, which may experience a significant reduction in occupancy rates following any future attacks. We may suffer losses as a result of the adverse impact of any future attacks and these losses may adversely impact our performance and revenues and may result in volatility of the value of our securities. A prolonged

32


Table of Contents

economic slowdown, a recession or declining real estate values could impair the performance of our investments and harm our financial condition, increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. We cannot assure you that there will not be further terrorist attacks against the United States or U.S. businesses, and we cannot predict the severity of the effect that such future events would have on the U.S. financial markets, the economy or our business. Losses resulting from these types of events are uninsurable.
      In addition, the events of September 11 created significant uncertainty regarding the ability of real estate owners of high profile assets to obtain insurance coverage protecting against terrorist attacks at commercially reasonable rates, if at all. With the enactment of the Terrorism Risk Insurance Act of 2002 (TRIA), and the subsequent enactment of the Terrorism Risk Insurance Extension Act of 2005, which extended TRIA through the end of 2007, insurers must make terrorism insurance available under their property and casualty insurance policies, but this legislation does not regulate the pricing of such insurance. The absence of affordable insurance coverage may adversely affect the general real estate lending market, lending volume and the market’s overall liquidity and may reduce the number of suitable investment opportunities available to us and the pace at which we are able to make investments. If the properties in which we invest are unable to obtain affordable insurance coverage, the value of those investments could decline and in the event of an uninsured loss, we could lose all or a portion of our investment.
Risks Related to Our Investments
Our real estate investments are subject to risks particular to real property, any of which could reduce our returns on such investments and limit our cash available for distribution to our stockholders.
      We own assets secured by real estate and may own real estate directly. Real estate investments will be subject to various risks, including:
  •  acts of God, including hurricanes, earthquakes, floods and other natural disasters, which may result in uninsured losses;
 
  •  acts of war or terrorism, including the consequences of terrorist attacks, such as those that occurred on September 11, 2001;
 
  •  adverse changes in national and local economic and market conditions;
 
  •  changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances;
 
  •  costs of remediation and liabilities associated with environmental conditions such as indoor mold; and
 
  •  the potential for uninsured or under-insured property losses.
      If any of these or similar events occurs, it may reduce our return from an affected property or investment and reduce or eliminate our ability to make distributions to stockholders.
The mortgage loans we invest in and the mortgage loans underlying the MBS and asset-backed securities we invest in are subject to delinquency, foreclosure and loss, which could result in losses to us.
      Commercial mortgage loans are secured by multifamily or commercial property and are subject to risks of delinquency and foreclosure, and risks of loss that are greater than similar

33


Table of Contents

risks associated with loans made on the security of single-family residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expense or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes in national, regional or local economic conditions and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances.
      Residential mortgage loans are secured by single-family residential property and are subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of factors, including a general economic downturn, acts of God, terrorism, social unrest and civil disturbances, may impair a borrower’s ability to repay its loans. ABS are bonds or notes backed by loans and/or other financial assets. The ability to repay these loans or other financial assets is dependant upon the income or assets of the borrower.
      In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our cash flow from operations. In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law.
      Foreclosure of a mortgage loan can be an expensive and lengthy process which could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan. RMBS evidence interests in or are secured by pools of residential mortgage loans and CMBS evidence interests in or are secured by a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, the MBS we invest in are subject to all of the risks of the underlying mortgage loans.
We may not be able to identify satisfactory alternative investments to successfully balance the interest rate or mark-to-market risk inherent in our RMBS investments, which could result in losses to us.
      As of March 31, 2006, greater than 63.0% of our investment portfolio consisted of Agency Adjustable Rate RMBS and greater than 19.0% of our investment portfolio consisted of Non-Agency RMBS. If we are not able to identify and acquire satisfactory alternative investments, our portfolio will be concentrated in a less diversified portfolio of RMBS investments. This would increase our dependence on these investments and increase our interest rate and mark-to-market risk inherent in RMBS investments, which could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to pay dividends.

34


Table of Contents

An increase in the yield spread of our assets may cause the market price of our common stock to drop.
      One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is the relative yield spread differential between the assets that we own and their valuation relative to comparable duration Treasuries. An increase in the yield spread differential could lower the book value of the assets which could lower the value of the common stock.
Our investments in CMBS generally are subordinated and could subject us to increased risk of losses.
      In general, losses on an asset securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit provided by the borrower, if any, and then by the “first loss” subordinated security holder and then by the “second loss” subordinated security holder. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit and any classes of securities junior to those in which we invest, we may not be able to recover all of our investment in the securities we purchase. In addition, if the underlying mortgage portfolio has been overvalued by the originator, or if the values subsequently decline and, as a result, less collateral is available to satisfy interest and principal payments due on the related MBS, the securities in which we invest may effectively become the “first loss” position behind the more senior securities, which may result in significant losses to us.
      The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments. A projection of an economic downturn, for example, could cause a decline in the price of lower credit quality securities because the ability of obligors of mortgages underlying MBS to make principal and interest payments or to refinance may be impaired. In this case, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities.
Our assets may include high yield and subordinated corporate securities that have greater risks of loss than secured senior loans and if those losses are realized, it could negatively impact our earnings, which could materially decrease cash available for distribution to our stockholders.
      Our assets may include high yield and subordinated securities that involve a higher degree of risk than long-term senior secured loans. First, the high yield securities may not be secured by mortgages or liens on assets. Even if secured, these high yield securities may have higher loan-to-value ratios than a senior secured loan. Furthermore, our right to payment and the security interest may be subordinated to the payment rights and security interests of the senior lender. Therefore, we may be limited in our ability to enforce our rights to collect these loans and to recover any of the loan balance through a foreclosure of collateral.
      Certain of these high yield and subordinated securities may have an interest only payment schedule, with the principal amount remaining outstanding and at risk until the maturity of the obligation. In this case, a borrower’s ability to repay its obligation may be dependent upon a liquidity event that will enable the repayment of the obligation.
      In addition to the above, numerous other factors may affect a company’s ability to repay its obligation, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. A deterioration in a company’s financial condition and prospects may be accompanied by deterioration in the collateral for the obligation. Losses in our high yield and

35


Table of Contents

subordinated securities could negatively impact our earnings, which could materially decrease cash available for distribution to our stockholders.
      High yield and subordinated securities from highly leveraged companies may have a greater risk of loss which, in turn, could materially decrease cash available for distribution to our stockholders.
      Leverage may have material adverse consequences to the companies in which we will hold investments. These companies may be subject to restrictive financial and operating covenants. The leverage may impair these companies’ ability to finance their future operations and capital needs. As a result, these companies’ flexibility to respond to changing business and economic conditions and to business opportunities may be limited. A leveraged company’s income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used. As a result, leveraged companies have a greater risk of loss. Losses on our investments could negatively impact our earnings, which could materially decrease cash available for distribution to our stockholders.
We may continue to invest in the equity securities of CDOs and such investments involve various significant risks, including that CDO equity receives distributions from the CDO only if the CDO generates enough income to first pay the holders of its debt securities and its expenses.
      We may continue to invest in the equity securities of CDOs. A CDO is a special purpose vehicle that purchases collateral (such as ABS) that is expected to generate a stream of interest or other income. The CDO issues various classes of securities that participate in that income stream, typically one or more classes of debt instruments and a class of equity securities. The equity is usually entitled to all of the income generated by the CDO after the CDO pays all of the interest due on the debt securities and its expenses. However, there will be little or no income available to the CDO equity if there are defaults by the issuers of the underlying collateral and those defaults exceed a certain amount. In that event, the value of our investment in the CDOs equity could decrease substantially. In addition, the equity securities of CDOs are generally illiquid, and because they represent a leveraged investment in the CDO’s assets, the value of the equity securities will generally have greater fluctuations than the values of the underlying collateral.
We may enter into warehouse agreements in connection with investments in the equity securities of CDOs structured for us and, if the investment in a CDO is not consummated, the warehoused collateral will be sold and we must bear any loss resulting from the purchase price of the collateral exceeding the sale price.
      In connection with future investment in CDOs that Hyperion Brookfield structures for us, we expect to enter into warehouse agreements with investment banks or other financial institutions, pursuant to which the institution initially will finance the purchase of the collateral that will be transferred to the CDO. Hyperion Brookfield will select the collateral. If the CDO transaction is not consummated, the institution would liquidate the warehoused collateral and we would have to pay any amount by which the original purchase price of the collateral exceeds its sale price, subject to negotiated caps, if any, on our exposure. In addition, regardless of whether the CDO transaction is consummated, if any of the warehoused collateral is sold before the consummation, we will have to bear any resulting loss on the sale. The amount at risk in connection with the warehouse agreements supporting our investments in CDOs generally is the amount that we have agreed to invest in the equity securities of the CDOs. Although we would expect to complete the CDO transaction within about three to nine months after the warehouse

36


Table of Contents

agreement is signed, we cannot assure you that we would in fact be able to complete any such transaction, or complete it within the expected time period.
We will lose money on our repurchase transactions if the counterparty to the transaction defaults on its obligation to resell the underlying security back to us at the end of the transaction term, or if the value of the underlying security has declined as of the end of that term or if we default on our obligations under the repurchase agreement.
      When we engage in a repurchase transaction, we generally sell securities to the transaction counterparty and receive cash from the counterparty. The counterparty is obligated to resell the securities back to us at the end of the term of the transaction, which is typically 30-90 days. Because the cash we receive from the counterparty when we initially sell the securities to the counterparty is less than the value of those securities (typically up to about 97% of that value), if the counterparty defaults on its obligation to resell the securities back to us we would incur a loss on the transaction equal to about 3% of the value of the securities (assuming there was no change in the value of the securities). We would also lose money on a repurchase transaction if the value of the underlying securities has declined as of the end of the transaction term, as we would have to repurchase the securities for their initial value but would receive securities worth less than that amount. Any losses we incur on our repurchase transactions could negatively impact our earnings, and thus decrease our cash available for distribution to our stockholders.
      If we default on one of our obligations under a repurchase transaction, the counterparty can terminate the transaction and cease entering into any other repurchase transactions with us. In that case, we would likely need to establish a replacement repurchase facility with another repurchase dealer in order to continue to leverage our portfolio and carry out our investment strategy. There is no assurance we would be able to establish a suitable replacement facility.
Investments in mezzanine loans involve greater risks of loss than senior loans secured by income producing properties.
      Investments in mezzanine loans take the form of subordinated loans secured by second mortgages on the underlying property or loans secured by a pledge of the ownership interests in the entity that directly or indirectly owns the property. These types of investments involve a higher degree of risk than a senior mortgage loan because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of the property owning entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is paid in full. As a result, we may not recover some or all of our investment, which could result in losses. In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal.
Increases in interest rates could negatively affect the value of our investments, which could result in reduced earnings or losses and negatively affect the cash available for distribution to our stockholders.
      We invest indirectly in mortgage loans by purchasing MBS. Under a normal yield curve, an investment in MBS will decline in value if long-term interest rates increase. Despite Fannie Mae, Freddie Mac or Ginnie Mae guarantees of certain of the MBS we own, those guarantees do not protect us from declines in market value caused by changes in interest rates. Declines in market

37


Table of Contents

value may ultimately reduce earnings or result in losses to us, which may negatively affect cash available for distribution to our stockholders.
      A significant risk associated with our investment in MBS is the risk that both long-term and short-term interest rates will increase significantly. If long-term rates increase significantly, the market value of these MBS would decline and the duration and weighted average life of the investments would increase. We could realize a loss if the securities were sold. At the same time, an increase in short-term interest rates would increase the amount of interest owed on the repurchase agreements we may enter into in order to finance the purchase of MBS.
      Market values of our investments may decline without any general increase in interest rates for a number of reasons, such as increases in defaults, increases in voluntary prepayments for those investments that are subject to prepayment risk, and widening of credit spreads.
We remain subject to losses on our mortgage portfolio despite the significant concentration of highly-rated MBS in our portfolio.
      A significant portion of our current assets are invested in MBS that either are agency-backed or are rated investment grade by at least one rating agency. While highly-rated MBS generally are subject to a lower risk of default than lower credit quality MBS and may benefit from third-party credit enhancements such as insurance or corporate guarantees, there is no assurance that such MBS will not be subject to credit losses. Furthermore, ratings are subject to change over time as a result of a number of factors, including greater than expected delinquencies, defaults or credit losses, or a deterioration in the financial strength of corporate guarantors, any of which may reduce the market value of such securities. Furthermore, ratings do not take into account the reasonableness of the issue price, interest rate risk, prepayment risk, extension risk or other risks associated with such MBS. As a result, while we attempt to mitigate our exposure to credit risk in our mortgage portfolio on a relative basis by focusing on highly-rated MBS, we cannot completely eliminate credit risk and remain subject to other risks to our investment portfolio that could cause us to suffer losses, which may harm the market price of our common stock.
Some of our portfolio investments are recorded at fair value as estimated by management and reviewed by our board of directors and, as a result, there is uncertainty as to the value of these investments.
      Some of our portfolio investments are in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded is not readily determinable. We value these investments quarterly at fair value as determined under policies approved by our board of directors. Because such valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. The value of our common stock could be adversely affected if our determinations regarding the fair value of these investments is materially higher than the values that we ultimately realize upon their disposal.
The value of investments denominated or quoted in international currencies may decrease due to fluctuations in the relative rates of exchange between the currencies of different nations and by exchange control regulations.
      If we make investments denominated or quoted in foreign currencies, our investment performance may be negatively affected by a devaluation of that currency. Further, our investment performance may be negatively affected by currency exchange rates because the

38


Table of Contents

U.S. Dollar value of investments denominated or quoted in another currency may increase or decrease in response to changes in the value of the currency in relation to the U.S. Dollar.
Declines in the market values of our investments may adversely affect periodic reported results and credit availability, which may reduce earnings and, in turn, cash available for distribution to our stockholders.
      A substantial portion of our assets are classified for accounting purposes as “available-for-sale.” Changes in the market values of those assets are directly charged or credited to stockholders’ equity. As a result, a decline in values may reduce the book value of our assets. Moreover, if the decline in value of an available-for-sale security is other than temporary, such decline will reduce earnings.
      All of our repurchase agreements are subject to bilateral margin calls in the event that the collateral securing our obligations under those facilities exceeds or does not meet our collateralization requirements. The analysis of sufficiency of collateralization is undertaken daily and the thresholds for adjustment range from $100,000 to $500,000. As of March 31, 2006, on a net basis, the fair value of the collateral, including restricted cash, securing our obligations under repurchase agreements exceeded the amount of such obligations by approximately $160.2 million.
      A decline in the market value of our assets may adversely affect us particularly in instances where we have borrowed money based on the market value of those assets. If the market value of those assets declines, the lender may require us to post additional collateral to support the loan. If we were unable to post the additional collateral, we would have to sell the assets at a time when we might not otherwise choose to do so. A reduction in credit available may reduce our earnings and, in turn, cash available for distribution to stockholders.
The lack of liquidity in our investments may harm our business.
      We have made investments and, subject to maintaining our REIT qualification and our exemption from regulation under the Investment Company Act, expect to make additional investments, in securities that are not publicly traded. A portion of these securities may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly traded securities. The illiquidity of our investments, such as subordinated MBS or investments in timber or power generating assets, may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. Moreover, we may face other restrictions on our ability to liquidate an investment in a business entity to the extent that we or Hyperion Brookfield Crystal River has or could be attributed with material non-public information regarding such business entity.
Failure to comply with negative covenants contained in our repurchase facilities agreements will limit available financing under these agreements.
      We obtain a significant portion of our funding through the use of repurchase facilities. Certain of our repurchase facility agreements include negative covenants, that if breached, may cause transactions to be terminated early. Except as noted below, the repurchase facility agreements do not include negative covenants other than those contained in the standard master repurchase agreement as published by the Bond Market Association. One of our master repurchase agreements provides that it may be terminated if, among other things, certain material decreases in net asset value occur, our chief executive officer ceases to be involved in the day-to-day operations of our Manager, we lose our REIT status or our Manager is

39


Table of Contents

terminated. An event of default or termination event under the standard master repurchase agreement or the additional provisions explained above would give our counterparty the option to terminate all repurchase transactions existing with us and make any amount due by us to the counterparty payable immediately. If we are required to terminate outstanding repurchase transactions and are unable to negotiate favorable terms of replacement financing, cash will be negatively impacted. This may reduce the amount of capital available for investing and/or may negatively impact our ability to distribute dividends. In addition, we may have to sell assets at a time when we might not otherwise choose to do so.
We may not be able to acquire eligible investments for a CDO issuance, or may not be able to issue CDO securities on attractive terms, which may require us to seek more costly financing for our investments or to liquidate assets.
      We intend to continue to acquire debt instruments and finance them on a non-recourse long-term basis, such as through the issuance of CDOs. During the period that we are acquiring these assets, we intend to finance our purchases through relatively short-term credit facilities. We use short-term warehouse lines of credit to finance the acquisition of instruments until a sufficient quantity is accumulated, at which time we may refinance these lines through a securitization, such as a CDO issuance, or other long-term financing. As a result, we are subject to the risk that we will not be able to acquire, during the period that our warehouse facility is available, a sufficient amount of eligible assets to maximize the efficiency of a CDO issuance. In addition, conditions in the capital markets may make the issuance of CDOs less attractive to us when we do have a sufficient pool of collateral. If we are unable to issue a CDO to finance these assets, we may be required to seek other forms of potentially less attractive financing or otherwise to liquidate the assets.
A prolonged economic slowdown, a recession or declining real estate values could impair the performance of our investments and harm our operating results.
      Many of our investments may be susceptible to economic slowdowns or recessions, which could lead to financial losses in our investments and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing investments and have a negative impact on our operating results.
We may be exposed to environmental liabilities with respect to properties to which we take title, which could impair the performance of our investments and harm our operating results.
      In the course of our business, we may take title to real estate, and, if we do take title, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation, and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.

40


Table of Contents

Our hedging transactions may not completely insulate us from interest rate risk.
      Subject to maintaining our qualification as a REIT, from time to time we engage in certain hedging transactions to limit our exposure to changes in interest rates and therefore may expose ourselves to risks associated with such transactions. We utilize instruments such as forward contracts and interest rate swaps, caps, collars and floors to seek to hedge against mismatches between the cash flows on our assets and the interest payments on our liabilities or fluctuations in the relative values of our portfolio positions, in each case resulting from changes in market interest rates. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to hedge against an interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.
      The success of our hedging transactions will depend on Hyperion Brookfield Crystal River’s ability to correctly predict movements of interest rates. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss.
Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities and involve risks and costs that could expose us to unexpected economic losses in the future.
      The cost of using hedging instruments increases as the period covered by the instrument increases and during periods of rising and volatile interest rates. We may increase our hedging activity and thus increase our hedging costs during periods when interest rates are volatile or rising and hedging costs have increased. We expect that from time to time, in addition to the interest rate swaps, credit default swaps and currency swaps into which we had entered as of March 31, 2006, we may in the future enter into forward contracts and cash flow swaps as part of our hedging strategy.
      In addition, hedging instruments involve risk since they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities. Consequently, there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then current market price. Although generally we will seek to reserve the right to terminate our hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot assure you that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.

41


Table of Contents

      Subject to maintaining our qualification as a REIT, part of our investment strategy involves entering into derivative contracts that could require us to fund cash payments in the future under certain circumstances, e.g., the early termination of the derivative agreement caused by an event of default or other early termination event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the derivative contract. The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. These economic losses will be reflected in our financial results of operations, and our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time, and the need to fund these obligations could negatively impact our financial condition.
Prepayment rates could negatively affect the value of our MBS, which could result in reduced earnings or losses and negatively affect the cash available for distribution to our stockholders.
      In the case of residential mortgage loans, there are seldom any restrictions on borrowers’ abilities to prepay their loans. Homeowners tend to prepay mortgage loans faster when interest rates decline. Consequently, owners of the loans have to reinvest the money received from the prepayments at the lower prevailing interest rates. Conversely, homeowners tend not to prepay mortgage loans when interest rates increase. Consequently, owners of the loans are unable to reinvest money that would have otherwise been received from prepayments at the higher prevailing interest rates. This volatility in prepayment rates may affect our ability to maintain targeted amounts of leverage on our mortgage-backed securities portfolio and may result in reduced earnings or losses for us and negatively affect the cash available for distribution to our stockholders.
      Despite Fannie Mae, Freddie Mac or Ginnie Mae guarantees of principal and interest related to certain of the MBS we own, those guarantees do not protect investors against prepayment risks.
Our Manager’s due diligence may not reveal all of an entity’s liabilities and may not reveal other weaknesses in its business, which could lead to investment losses.
      Before investing in a company, our Manager assesses the strength and skills of the company’s management and other factors that our Manager believes are material to the performance of the investment. In making the assessment and otherwise conducting customary due diligence, our Manager relies on the resources available to it and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly organized entities because there may be little or no information publicly available about the entities. There can be no assurance that our Manager’s due diligence processes will uncover all relevant facts or that any current or future investment will be successful and not result in investment losses.
We may not be able to relet or renew leases of properties held by us on terms favorable to us.
      We are subject to the risk that upon expiration of leases for space located at any income-producing property, the space may not be relet or, if relet, the terms of the renewal or reletting (including the cost of required renovations or concessions to tenants) may be less favorable than the expiring lease terms. Any of these situations may result in extended periods where there is a significant decline in revenues or no revenues generated by a property. If we are unable to relet or renew leases for all or substantially all of the space at any such properties, if the rental rates upon such renewal or reletting are significantly lower than expected, or if

42


Table of Contents

reserves for these purposes prove inadequate, we may be required to reduce or eliminate distributions to our stockholders.
Our insurance on our commercial real estate may not cover all losses.
      There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. Any uninsured loss could result in both loss of cash flow from and the asset value of the affected property.
Any investments in timber assets will expose us to special risks.
      We may invest in timber assets. The demand for and supply of standing timber continually fluctuates, which leads to significant volatility in timber prices. Availability of timber supplies is influenced by many factors, including changes in weather patterns and harvest strategies of industry participants, pest infestations and forest fires. Such factors will impact the volume of any timber assets we may harvest and, as is typical in the industry, we will not maintain insurance for any loss of standing timber as a result of natural disasters. The timber industry is subject to extensive environmental regulation, including protected species regulation, which may restrict timber harvesting from time to time and may lead to increased costs of harvesting, all of which will impact the performance of any timber assets in which we invest.
Any investments in power generation assets will expose us to special risks.
      We may invest in power generation assets. The demand for and supply of electricity continually fluctuates, which leads to significant volatility in electricity prices both intra-day and seasonally. Availability of electricity is influenced by many factors, including production strategies of industry participants that take into account the cost and volume of energy inputs such as coal, uranium or gas required to generate electricity relative to the market price of electricity, adverse weather variations which affect primarily hydroelectric facilities, equipment failures, the current regulatory environment and availability of transmission, all of which will impact the performance of any power generation assets in which we invest.
Risks Related to This Offering
There may not be an active market for our common stock, which may cause our common stock to trade at a discount and make it difficult to sell the common stock you purchase.
      Prior to this offering, there has been no public market for our common stock. The initial public offering price for our common stock will be determined by negotiations between the underwriters and us. We cannot assure you that the initial public offering price will correspond to the price at which our common stock will trade in the public market subsequent to this offering or that the price of our shares available in the public market will reflect our actual financial performance.
      Our common stock has been approved for listing, subject to notice of issuance, on the New York Stock Exchange under the symbol “CRZ.” Listing on the New York Stock Exchange will

43


Table of Contents

not ensure that an actual market will develop for our common stock. Accordingly, no assurance can be given as to:
  •  the likelihood that an actual market for our common stock will develop;
 
  •  the liquidity of any such market;
 
  •  the ability of any holder to sell shares of our common stock; or
 
  •  the prices that may be obtained for our common stock.
The market price and trading volume of our common stock may be volatile following this offering.
      Even if an active trading market develops for our common stock after this offering, the market price of our common stock may be highly volatile and be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. If the market price of our common stock declines significantly, you may be unable to resell your shares at or above the initial public offering price. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include:
  •  actual or anticipated variations in our quarterly operating results or distributions;
 
  •  changes in our earnings estimates or publication of research reports about us or the real estate or specialty finance industry;
 
  •  increases in market interest rates that lead purchasers of our shares of common stock to demand a higher yield;
 
  •  changes in market valuations of similar companies;
 
  •  adverse market reaction to any increased indebtedness we incur in the future;
 
  •  additions to, or departures of, Hyperion Brookfield’s key management personnel;
 
  •  actions by institutional stockholders;
 
  •  speculation in the press or investment community; and
 
  •  general market and economic conditions.
Broad market fluctuations could negatively impact the market price of our common stock.
      The stock market has experienced extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to ours and that have been unrelated to these companies’ operating performances. These broad market fluctuations could reduce the market price of our common stock. Furthermore, our operating results and prospects may be below the expectations of public market analysts and investors or may be lower than those of companies with comparable market capitalizations, which could lead to a material decline in the market price of our common stock.

44


Table of Contents

Future offerings of debt securities, which would rank senior to our common stock upon our liquidation, and future offerings of equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes of dividend and liquidating distributions, may cause a decline in the market price of our common stock.
      In the future, we may attempt to increase our capital resources by making offerings of debt or additional offerings of equity securities. Upon liquidation, holders of our debt securities and shares of preferred stock, if any, and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Our preferred stock, if issued, could have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. Sales of substantial amounts of our common stock (including shares of our common stock issued pursuant to our incentive plan), or the perception that these sales could occur, could cause a material decline in the price of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.
Your interest in us may be diluted if we issue additional shares.
      Existing stockholders and potential investors in this offering do not have preemptive rights to any common stock issued by us in the future. Therefore, investors purchasing shares in this offering may experience dilution of their equity investment if we sell additional common stock in the future, sell securities that are convertible into common stock or issue shares of common stock, including shares issued as incentive compensation under our management agreement, or options exercisable for shares of common stock.
Future sales of shares of our common stock may depress the price of our shares.
      We cannot predict the effect, if any, of future sales of our common stock or the availability of shares for future sales on the market price of our common stock. We agreed to file a shelf registration statement for the benefit of the holders of 17,400,000 shares of our common stock issued in the March 2005 private offering and not being sold in this offering (including 183,800 shares of our common stock that certain of our executive officers, directors and other parties related to Hyperion Brookfield and Brookfield purchased collectively in that offering) no later than December 10, 2005. In compliance with this agreement, we filed a resale shelf registration statement. We have also agreed to register 84,000 shares of restricted stock and 126,000 shares of common stock underlying options issued to Hyperion Brookfield Crystal River upon completion of our March 2005 private offering, which our Manager subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us, and any shares of common stock issued to Hyperion Brookfield Crystal River as incentive compensation under our management agreement. Our management agreement provides that 10% of Hyperion Brookfield Crystal River’s incentive compensation is to be paid in shares of our common stock (provided that under our management agreement, Hyperion Brookfield Crystal River may not receive payment of its incentive fee in shares of our common stock if such payment would result in Hyperion Brookfield Crystal River owning directly or indirectly through one or more subsidiaries more than 9.8% of our common stock) and the balance in cash. Hyperion Brookfield Crystal River may, in its sole discretion, elect to receive a greater percentage or all of its incentive compensation in the form of our common stock subject

45


Table of Contents

to certain ownership limitations. We also have issued an aggregate of 39,500 shares of restricted stock and options to purchase 4,000 shares of our common stock to certain of our officers and independent directors and certain employees of Hyperion Brookfield who provide services to us under our 2005 stock incentive plan and may issue up to an additional 1,495,250 shares of common stock pursuant to our 2005 stock incentive plan (which includes 10,160 shares to be issued in respect of deferred stock units issued to certain of our independent directors). Any sales of a substantial number of our shares in the public market, or the perception that sales might occur, may cause the market price of our shares to decline.
You should not rely on lock-up agreements in connection with the private placement or this offering to limit the amount of common stock sold into the market.
      We will agree with the underwriters not to offer to sell, contract to sell, or otherwise dispose of, loan, pledge or grant any rights with respect to any shares of our common stock, any options or warrants to purchase any shares of our common stock or any securities convertible into or exercisable for any of our common stock for a period of 180 days after the effective date of the registration statement of which this prospectus forms a part, subject to certain exceptions. Each of our executive officers and directors, members of our strategic advisory committee, Brookfield, Hyperion Brookfield, Hyperion Brookfield Crystal River, our sub-advisors and their respective affiliates, certain executive officers, directors and employees of and other individuals affiliated with Brookfield, Hyperion Brookfield, Hyperion Brookfield Crystal River, our sub-advisors and their respective affiliates have agreed not to offer, sell, pledge, contract to sell (including any short sale), grant any options to purchase or otherwise dispose of, or enter into any transaction that is designed to, or could be expected to, result in the disposition of any shares of our common stock or other securities convertible into or exchangeable or exercisable for shares of our common stock or derivatives of our common stock owned by these persons prior to this offering or common stock issuable upon exercise of options or warrants held by these persons for a period of 180 days after the effective date of the registration statement of which this prospectus forms a part without the prior written consent of Deutsche Bank Securities Inc.
      In addition, our stockholders who purchased shares in our March 2005 private offering and who are not our affiliates, who in the aggregate will own approximately 16,276,600 shares of our common stock immediately after this offering, have agreed, for a period of at least 60 days after the effective date of the registration statement of which this prospectus is a part, that they will not, without the prior written consent of Deutsche Bank Securities Inc., directly or indirectly offer to sell, sell or otherwise dispose of any shares of our common stock or any securities convertible into, or exercisable or exchangeable for, shares of our common stock or our other capital stock, other than the shares of our common stock sold by the selling stockholders in this offering.
      Pursuant to the registration rights agreement we entered into in connection with our March 2005 private offering, the stockholders who own common stock sold in that private offering and do not sell those shares in this offering have agreed, to the extent requested by us or an underwriter of our securities, not to sell any shares of our common stock or any securities convertible into or exchangeable or exercisable for our common stock owned by them for a period ending 60 days following the date of any underwritten offering made pursuant to the resale shelf registration statement that we filed concurrently with the initial filing of the registration statement of which this prospectus is a part, except in specified circumstances.
      The representative of the underwriters may, at any time, release all or a portion of the securities subject to the foregoing lock-up provisions. There are no present agreements between the underwriters and us or any of our executive officers, directors or stockholders releasing them or us from these lock-up agreements. However, we cannot predict the

46


Table of Contents

circumstances or timing under which the representative of the underwriters may waive these restrictions. If the restrictions under the lock-up agreements with members of our senior management, directors, members of our strategic advisory committee and an affiliate of Brookfield are waived or terminated, or upon expiration of a lock-up period, approximately 218,800 shares will be available for sale into the market at that time, subject only to applicable securities rules and regulations. These sales or a perception that these sales may occur could reduce the market price for our common stock.
We have not established a minimum distribution payment level and we cannot assure you of our ability to make distributions in the future.
      We expect to make quarterly distributions to our stockholders in amounts such that we distribute all or substantially all of our taxable income in each year, subject to certain adjustments. We have not established a minimum distribution payment level, and our ability to make distributions may be adversely affected by the risk factors described in this prospectus. All distributions will be made at the discretion of our board of directors out of legally available funds and will depend on our earnings, our financial condition, maintenance of our REIT status and other factors as our board of directors may deem relevant from time to time. We may not be able to make distributions in the future. In addition, some of our distributions may include a return of capital. To the extent that we decide to make distributions in excess of our current and accumulated tax earnings and profits, such distributions would generally be considered a return of capital for federal income tax purposes. A return of capital is not taxable, but it has the effect of reducing the holder’s basis in its investment.
An increase in market interest rates may cause a material decrease in the market price of our common stock.
      One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is our distribution rate as a percentage of our share price relative to market interest rates. If the market price of our common stock is based primarily on the earnings and return that we derive from our investments and income with respect to our investments and our related distributions to stockholders, and not from the market value of the investments themselves, then interest rate fluctuations and capital market conditions will likely affect the market price of our common stock. For instance, if market rates rise without an increase in our distribution rate, the market price of our common stock could decrease as potential investors may require a higher distribution yield on our common stock or seek other securities paying higher distributions or interest. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby reducing cash flow and our ability to service our indebtedness and pay distributions.
Investors in this offering will suffer immediate and substantial dilution.
      The initial public offering price of our common stock is substantially higher than what our net tangible book value per share will be immediately after this offering. Purchasers of our common stock in this offering will incur immediate dilution of approximately $4.83 in net tangible book value per share of our common stock, based on the mid-point of the price range for the shares to be sold in this offering.
Investing in our shares may involve an above average degree of risk.
      The investments we make in accordance with our investment objective may result in a higher amount of risk than alternative investment options and volatility or loss of principal. Our

47


Table of Contents

investments may be highly speculative and aggressive, and therefore, an investment in our shares may not be suitable for someone with lower risk tolerance.
Risks Related to Our Organization and Structure
Our charter and bylaws contain provisions that may inhibit potential takeover bids that you and other stockholders may consider favorable, and the market price of our common stock may be lower as a result.
      Our charter and bylaws contain provisions that may have an anti-takeover effect and inhibit a change in our board of directors. These provisions include the following:
  •  There are ownership limits and restrictions on transferability and ownership in our charter. In order to qualify as a REIT for each taxable year after 2005, not more than 50% of the value of our outstanding stock may be owned, directly or constructively, by five or fewer individuals during the second half of any calendar year and our shares must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months or during a proportionate part of a shorter taxable year. To assist us in satisfying these tests, our charter generally prohibits any person from beneficially or constructively owning more than 9.8% in value or number of shares, whichever is more restrictive, of any class or series of our outstanding capital stock, subject to important exceptions. These restrictions may:
  •  discourage a tender offer or other transactions or a change in the composition of our board of directors or control that might involve a premium price for our shares or otherwise be in the best interests of our stockholders; or
 
  •  result in shares issued or transferred in violation of such restrictions being automatically transferred to a trust for a charitable beneficiary and thereby resulting in a forfeiture of ownership of the additional shares.
  •  Our charter permits our board of directors to issue stock with terms that may discourage a third party from acquiring us. Our charter permits our board of directors to amend the charter without stockholder approval to increase the total number of authorized shares of stock or the number of shares of any class or series and to issue common or preferred stock having preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications, or terms or conditions of redemption as determined by our board of directors. Thus, our board of directors could authorize the issuance of stock with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of our shares might receive a premium for their shares over the then-prevailing market price of our shares.
 
  •  Maryland Control Share Acquisition Act. Maryland law provides that “control shares” of a corporation acquired in a “control share acquisition” will have no voting rights except to the extent approved by a vote of two-thirds of the votes eligible to be cast on the matter under the Maryland Control Share Acquisition Act. “Control shares” means voting shares of stock that, if aggregated with all other shares of stock owned by the acquiror or in respect of which the acquiror is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power: one-tenth or more but less than one-third, one-third or more but less than a majority, or a majority or more of all voting power. A “control share acquisition” means the acquisition of control shares, subject to certain exceptions.
 
     If voting rights or control shares acquired in a control share acquisition are not approved at a stockholders’ meeting or if the acquiring person does not deliver an acquiring person

48


Table of Contents

  statement as required by the Maryland Control Share Acquisition Act, then subject to certain conditions and limitations, the issuer may redeem any or all of the control shares for fair value. If voting rights of such control shares are approved at a stockholders’ meeting and the acquiror becomes entitled to vote a majority of the shares of stock entitled to vote, all other stockholders may exercise appraisal rights. Our bylaws contain a provision exempting acquisitions of our shares from the Maryland Control Share Acquisition Act. However, our board of directors may amend our bylaws in the future to repeal or modify this exemption, in which case any control shares of our company acquired in a control share acquisition will be subject to the Maryland Control Share Acquisition Act.
 
  •  Business Combinations. Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as:

  •  any person who beneficially owns ten percent or more of the voting power of the corporation’s shares; or
 
  •  an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of ten percent or more of the voting power of the then outstanding voting stock of the corporation.
 
    A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which such person otherwise would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by our board of directors.
 
    After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:
    •  eighty percent of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and
 
    •  two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder.
    These super-majority vote requirements do not apply if the corporation’s common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares.
 
    The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors prior to the time that the interested stockholder becomes an interested stockholder. Our board of directors has adopted a resolution which provides that any business combination between us and any other person is exempted from the provisions of the Act, provided that the business combination is first approved by the board of directors. This resolution, however, may be altered or repealed in whole or in part at any time. If this resolution is repealed, or the board of directors does not otherwise approve a business combination, this statute may

49


Table of Contents

  discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.

  •  Staggered board. Our board of directors is divided into three classes of directors. The current terms of the directors expire in 2006, 2007 and 2008. Directors of each class are chosen for three-year terms upon the expiration of their current terms, and each year one class of directors is elected by the stockholders. The staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interests of our stockholders.
 
  •  Our charter and bylaws contain other possible anti-takeover provisions. Our charter and bylaws contain other provisions that may have the effect of delaying, deferring or preventing a change in control of us or the removal of existing directors and, as a result, could prevent our stockholders from being paid a premium for their common stock over the then-prevailing market price.
Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit your recourse in the event of actions not in your best interests.
      Our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:
  •  actual receipt of an improper benefit or profit in money, property or services; or
 
  •  a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.
      In addition, our charter permits us to agree to indemnify our present and former directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify each present or former director or officer, to the maximum extent permitted by Maryland law, in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service to us. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.
Our access to confidential information may restrict our ability to take action with respect to some investments, which, in turn, may negatively affect the potential return to stockholders.
      We, directly or through Hyperion Brookfield, Hyperion Brookfield Crystal River or Brookfield may obtain confidential information about the companies in which we have invested or may invest. If we do possess confidential information about such companies, there may be restrictions on our ability to dispose of, increase the amount of, or otherwise take action with respect to an investment in those companies. Our management of investment funds could create a conflict of interest to the extent Hyperion Brookfield Crystal River is aware of inside information concerning potential investment targets. We have implemented compliance procedures and practices designed to ensure that inside information is not used for making investment decisions on behalf of the funds and to monitor funds invested. We cannot assure you, however, that these procedures and practices will be effective. In addition, this conflict and these procedures and practices may limit the freedom of Hyperion Brookfield Crystal River to make potentially profitable investments, which could negatively impact our operations. These limitations imposed by access to confidential information could therefore negatively affect the potential market price of our common stock and the ability to distribute dividends.

50


Table of Contents

Tax Risks
Complying with REIT requirements may cause us to forego otherwise attractive opportunities.
      To qualify as a REIT for federal income tax purposes, we must continually satisfy various tests regarding the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. In order to meet these tests, we may be required to forego investments we might otherwise make. This difficulty may be exacerbated by the illiquid nature of many of our non-real estate assets. Thus, compliance with the REIT requirements may hinder our investment performance.
Certain financing activities may subject us to U.S. federal income tax.
      We have not and currently do not intend to enter into any transactions that could result in us or a portion of our assets being treated as a “taxable mortgage pool” for federal income tax purposes. However, it is possible that in the future we may enter into transactions that will have that effect. If we enter into such a transaction at the REIT level, although the law on the matter is unclear, we might be taxable at the highest corporate income tax rate on a portion of the income arising from a taxable mortgage pool that is allocable to the percentage of our stock held by “disqualified organizations,” which are generally certain cooperatives, governmental entities and tax-exempt organizations that are exempt from unrelated business taxable income. Disqualified organizations are permitted to own our stock. Because this tax would be imposed on us, all of our investors, including investors that are not disqualified organizations, would bear a portion of the tax cost associated with the classification of us or a portion of our assets as a taxable mortgage pool.
      In addition, if we realize excess inclusion income and allocate it to stockholders, this income cannot be offset by losses of our stockholders. If the stockholder is a tax-exempt entity and not a disqualified organization, then this income would be fully taxable as unrelated business taxable income under Section 512 of the Internal Revenue Code. If the stockholder is a foreign person, it would be subject to U.S. federal income tax withholding on this income without reduction or exemption pursuant to any otherwise applicable income tax treaty.
Failure to qualify as a REIT would subject us to U.S. federal income tax, which would reduce the cash available for distribution to our stockholders.
      We operate in a manner that is intended to cause us to qualify as a REIT for federal income tax purposes. However, the federal income tax laws governing REITs are extremely complex, and administrative interpretations of the federal income tax laws governing qualification as a REIT are limited. Qualifying as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. While we operate in such a manner so as to qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.
      If we fail to qualify as a REIT in any calendar year and we do not qualify for certain statutory relief provisions, we would be required to pay federal income tax on our taxable income. We might need to borrow money or sell assets in order to pay that tax. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT and we do not qualify for certain statutory relief provisions, we no longer would be required to distribute substantially all of our REIT taxable income to our stockholders. Unless our failure to qualify as a

51


Table of Contents

REIT were excused under federal tax laws, we could not re-elect REIT status until the fifth calendar year following the year in which we failed to qualify.
Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our stockholders.
      In order to qualify as a REIT, we must distribute to our stockholders, each calendar year, at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than the sum of:
  •  85% of our ordinary taxable income for that year;
 
  •  95% of our capital gain net income for that year; and
 
  •  100% our undistributed taxable income from prior years.
      We intend to continue to distribute our net taxable income to our stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax. However, there is no requirement that domestic TRSs distribute their after-tax net income to their parent REIT or their stockholders and Crystal River Capital TRS Holdings, Inc., our TRS, may determine not to make any distributions to us.
      Our taxable income may substantially differ from our net income as determined based on generally accepted accounting principles, or GAAP, because, for example, realized capital losses will be deducted in determining our GAAP net income, but may not be deductible in computing our taxable income. In addition, we may invest in assets that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets, referred to as phantom income. Although some types of phantom income are excluded to the extent they exceed 5% of our REIT taxable income in determining the 90% distribution requirement, we will incur corporate income tax and the 4% nondeductible excise tax with respect to any phantom income items if we do not distribute those items on an annual basis. As a result of the foregoing, we may generate less cash flow than taxable income in a particular year. In that event, we may be required to use cash reserves, incur debt, or liquidate non-cash assets at rates or times that we regard as unfavorable in order to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax in that year.
Dividends payable by REITs do not qualify for the reduced tax rates.
      Legislation enacted in 2003 generally reduces the maximum tax rate for dividends payable to domestic stockholders that are individuals, trusts and estates to 15% (through 2008). Dividends payable by REITs, however, are generally not eligible for the reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.

52


Table of Contents

Ownership limitation may restrict change of control or business combination opportunities in which our stockholders might receive a premium for their shares.
      In order for us to qualify as a REIT for each taxable year after our 2005 taxable year, no more than 50% in value of our outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. “Individuals” for this purpose include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. In order to preserve our REIT qualification, our charter generally prohibits any person from directly or indirectly owning more than 9.8% in value or in number of shares, whichever is more restrictive, of any class or series of the outstanding shares of our capital stock.
      This ownership limitation could have the effect of discouraging a takeover or other transaction in which holders of our common stock might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests.
Our ownership of and relationship with our TRS will be limited and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.
      A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 20% of the value of a REIT’s assets may consist of stock or securities of one or more TRSs. A TRS will pay federal, state and local income tax at regular corporate rates on any income that it earns. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s length basis.
      Our TRS, Crystal River Capital TRS Holdings, Inc., as a domestic TRS, will pay federal, state and local income tax on its taxable income, and its after-tax net income is available for distribution to us but is not required to be distributed to us. The aggregate value of the TRS stock and securities owned by us should be less than 20% of the value of our total assets (including the TRS stock and securities). Furthermore, we monitor the value of our investments in TRSs for the purpose of ensuring compliance with the rule that no more than 20% of the value of our assets may consist of TRS stock and securities (which is applied at the end of each calendar quarter). In addition, we scrutinize all of our transactions with TRSs for the purpose of ensuring that they are entered into on arm’s length terms in order to avoid incurring the 100% excise tax described above. There can be no complete assurance, however, that we will be able to comply with the 20% limitation discussed above or to avoid application of the 100% excise tax discussed above.
Complying with REIT requirements may limit our ability to hedge effectively.
      The REIT provisions of the Internal Revenue Code substantially limit our ability to hedge MBS and related borrowings. Under these provisions, our annual gross income from qualifying and non-qualifying hedges, together with any other income not generated from qualifying real estate assets, cannot exceed 25% of our gross income. In addition, our aggregate gross income from non-qualifying hedges, fees, and certain other non-qualifying sources cannot exceed 5% of our annual gross income. As a result, we might have to limit our use of

53


Table of Contents

advantageous hedging techniques or implement those hedges through Crystal River Capital TRS Holdings, Inc. This could increase the cost of our hedging activities or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear.
The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing mortgage loans, that would be treated as sales for federal income tax purposes.
      A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were able to sell or securitize loans in a manner that was treated as a sale of the loans for federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans and may limit the structures we utilize for our securitization transactions even though such sales or structures might otherwise be beneficial to us.
      It may be possible to reduce the impact of the prohibited transaction tax and the holding of assets not qualifying as real estate assets for purposes of the REIT asset tests by conducting certain activities, holding non-qualifying REIT assets or engaging in CDO transactions through our TRSs, subject to certain limitations as described below. To the extent that we engage in such activities through TRSs, the income associated with such activities may be subject to full corporate income tax.
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our common stock.
      At any time, the federal, state or local income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new tax law, regulation or administrative interpretation, or any amendment to any existing tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, tax law, regulation or administrative interpretation.
If we make distributions in excess of our current and accumulated earnings and profits, those distributions will be treated as a return of capital, which will reduce the adjusted basis of your stock, and to the extent such distributions exceed your adjusted basis, you may recognize a capital gain.
      Unless you are a tax-exempt entity, distributions that we make to you generally will be subject to tax as ordinary income to the extent of our current and accumulated earnings and profits as determined for federal income tax purposes. Although all of the distributions we made through December 31, 2005 represented distributions of earnings and profits and none represented a return of capital, if the amount we distribute to you exceeds your allocable share of our current and accumulated earnings and profits, the excess will be treated as a return of capital to the extent of your adjusted basis in your stock, which will reduce your basis in your stock but will not be subject to tax. To the extent the amount we distribute to you exceeds both your allocable share of our current and accumulated earnings and profits and your adjusted basis, this excess amount will be treated as a gain from the sale or exchange of a capital asset.

54


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
      Some of the statements under “Prospectus Summary,” “Risk Factors,” “Distribution Policy,” “Business” and elsewhere in this prospectus constitute forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “goal,” “objective,” “potential,” “project,” “should,” “will” and “would” or the negative of these terms or other comparable terminology.
      The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, the performance of our portfolio and our business, financial condition, liquidity and results of operations may vary materially from those expressed, anticipated or contemplated in our forward-looking statements. You should carefully consider these risks before you invest in our common stock, along with the following factors that could cause actual results to vary from our forward-looking statements:
  •  the factors referenced in this prospectus, including those set forth under the sections captioned “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business;”
 
  •  general volatility of the securities markets in which we invest and the market price of our common stock;
 
  •  changes in our business strategy;
 
  •  availability, terms and deployment of capital;
 
  •  availability of qualified personnel;
 
  •  changes in our industry, interest rates, the debt securities markets or the general economy;
 
  •  increased rates of default and/or decreased recovery rates on our investments;
 
  •  increased prepayments of the mortgage and other loans underlying our mortgage-backed or other asset-backed securities;
 
  •  changes in governmental regulations, tax law and rates and similar matters;
 
  •  our expected financings and investments;
 
  •  the adequacy of our cash resources and working capital;
 
  •  changes in generally accepted accounting principles by standard-setting bodies;
 
  •  availability of investment opportunities in real estate-related and other securities; and
 
  •  the degree and nature of our competition.

55


Table of Contents

USE OF PROCEEDS
      We estimate that the net proceeds we will receive from the sale of 8,071,900 shares of our common stock in this offering will be approximately $203.5 million, or approximately $238.5 million if the underwriters fully exercise their over-allotment option of up to 1,365,000 shares, in each case assuming a public offering price of $27.50 per share, which is the mid-point of the range set forth on the cover of this prospectus, and after deducting underwriting discounts and commissions of approximately $15.0 million, or approximately $17.5 million if the underwriters fully exercise their over-allotment option of up to 1,365,000  shares, and estimated offering expenses of approximately $3.5 million payable by us.
      A $1.00 increase (decrease) in the assumed initial public offering price of $27.50 per share would increase (decrease) the net proceeds we will receive from this offering by $7.5 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
      We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.
      If a selling stockholder listed in this prospectus does not satisfy, or obtain a waiver of, all of the conditions required pursuant to the underwriting agreement, the underwriters will not buy shares of our common stock from such selling stockholder. We will issue and sell to the underwriters any shortfall in shares resulting from such a failure. For each 100,000 shares of common stock that selling stockholders do not sell, and that we issue, to the underwriters, we will receive additional net proceeds of approximately $2.6 million, assuming an initial public offering price of $27.50 per share, the mid-point of the range set forth on the cover page of this prospectus.
      We plan to invest the net proceeds of this offering and the proceeds, if any, from the exercise by the selling stockholders of options to purchase shares of our common stock in accordance with our investment objectives and strategies described in this prospectus.

56


Table of Contents

INSTITUTIONAL TRADING OF OUR COMMON STOCK
      There is no public trading market for our common stock. Shares of our common stock issued to qualified institutional buyers in connection with our March 2005 private offering are eligible for trading in The PORTALsm Market, or PORTAL, a subsidiary of The NASDAQ Stock Market, Inc., which permits secondary sales of eligible unregistered securities to qualified institutional buyers in accordance with Rule 144A under the Securities Act. The following table shows the high and low sales prices for our common stock for each quarterly period since our common stock became eligible for trading on PORTAL:
                 
    High Sales   Low Sales
    Price   Price
         
March 15, 2005 to March 31, 2005
    *       *  
April 1, 2005 to June 30, 2005
    *       *  
July 1, 2005 to September 30, 2005
    *       *  
October 1, 2005 to December 31, 2005
    *       *  
January 1, 2006 to March 31, 2006
    *       *  
April 1, 2006 to June 30, 2006
    *       *  
July 1, 2006 to July 21, 2006
    *       *  
 
To our knowledge, no trades of our common stock have occurred on PORTAL during this period.
     The information above regarding PORTAL prices may not be complete since we have access only to information regarding trades reported by our underwriters and not trades reported by other broker-dealers. Moreover, broker-dealers are not required to report all trades to PORTAL.
      As of July 21, 2006, we had 17,523,500 shares of our common stock issued and outstanding which were held by 16 holders of record. Cede & Co. is the holder of record for 17,400,000 of such shares and it holds such shares as nominee for The Depository Trust Company, which itself holds shares on behalf of approximately 600 beneficial owners of our common stock.

57


Table of Contents

DISTRIBUTION POLICY
      We will elect and intend to qualify to be taxed as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2005. Federal income tax law requires that a REIT distribute with respect to each year at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gain. If our cash available for distribution is less than 90% of our REIT taxable income, we could be required to sell assets or borrow funds in order to make distributions. Up to 20% of the value of a REIT’s assets may consist of investments in the securities of one or more TRSs. A domestic TRS, such as Crystal River Capital TRS Holdings, Inc., may retain its net income, and its earnings are subject to the 90% distribution requirement only to the extent the TRS actually distributes its earnings to the REIT. However, a foreign TRS generally is deemed to distribute its earnings to the REIT on an annual basis for federal income tax purposes, regardless of whether it actually distributes its earnings. For more information, please see “Federal Income Tax Consequences of Our Qualification as a REIT — Taxation of Our Company.”
      To satisfy the requirements to qualify as a REIT and generally not be subject to federal income and excise tax, we intend to make regular quarterly distributions of all or substantially all of our REIT taxable income to holders of our common stock out of assets legally available therefor. Any future distributions we make will be at the discretion of our board of directors out of legally available funds and will depend upon, among other things, our earnings and financial condition, maintenance of REIT status, applicable provisions of the MGCL and such other factors as our board of directors deems relevant. These results and our ability to pay distributions will be affected by various factors, including the net interest and other income from our portfolio, our operating expenses and any other expenditures. Although we do not anticipate earning a significant level of taxable income through our TRSs in comparison to our consolidated results of operations, if our TRSs generate taxable income, from time to time, in the discretion of management, such amounts, net of tax, may be distributed to us and, by extension, to our stockholders. For more information regarding risk factors that could materially adversely affect our earnings and financial condition, please see “Risk Factors” beginning on page 20.
      We anticipate that our distributions generally will be taxable as ordinary income to our stockholders, although a portion of the distributions may be designated by us as qualified dividend income or capital gain or may constitute a return of capital. To the extent that we decide to make distributions in excess of our current and accumulated earnings and profits for federal income tax purposes, such distributions would generally be considered a return of capital for federal income tax purposes. We will furnish annually to each of our stockholders a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, return of capital, qualified dividend income or capital gain. Income as computed for purposes of the foregoing tax rules will not necessarily correspond to our income as determined for financial reporting purposes.
      On June 21, 2005, we declared a quarterly distribution of $0.25 per share of our common stock, payable on July 13, 2005, to stockholders of record as of June 30, 2005. In connection with that distribution, we distributed an aggregate of approximately $4.4 million from uninvested cash. In addition, on September 28, 2005, we declared a quarterly distribution of $0.575 per share of our common stock, payable on October 13, 2005, to stockholders of record as of September 30, 2005. In connection with that distribution, we distributed an aggregate of approximately $10.1 million. On December 23, 2005, we declared a quarterly distribution of $0.725 per share of our common stock, payable on December 30, 2005, to stockholders of record as of December 23, 2005. In connection with that distribution, we distributed an aggregate of approximately $12.7 million. On March 31, 2006, we declared a quarterly distribution of $0.725 per share of our common stock, payable on April 17, 2006, to

58


Table of Contents

stockholders of record as of March 31, 2006. In connection with that distribution, we distributed an aggregate of approximately $12.7 million. On June 23, 2006, we declared a quarterly distribution of $0.725 per share of our common stock, payable on July 21, 2006, to stockholders of record as of June 30, 2006. In connection with that distribution, we distributed an aggregate of approximately $12.7 million. All distributions through December 31, 2005 represented distributions of taxable earnings and profits; none represented a return of capital, and all distributions from and including October 13, 2005 were funded primarily from operating cash flows, and as necessary, to a lesser extent from the sale or repayment of our investments or from borrowings under our credit facilities or master repurchase agreements, and were not funded out of the offering proceeds from our March 2005 private offering. We believe that REIT taxable income for the year will be sufficient for our April 17, 2006 and July 21, 2006 distributions to be taxable as a dividend and not a return of capital. We cannot assure you that we will have sufficient cash available for future quarterly distributions at this level, or at all. See “Risk Factors.”

59


Table of Contents

CAPITALIZATION
      The following table sets forth (1) our actual cash and capitalization at March 31, 2006 and (2) our cash and capitalization as adjusted to reflect the effects of the sale of our common stock in this offering at an assumed initial public offering price of $27.50 per share, which is the mid-point of the range set forth on the cover of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us and the application of the net proceeds as described in “Use of Proceeds.” You should read this table together with “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this prospectus.
                 
    As of March 31, 2006
     
        As
    Actual(1)   Adjusted(2)
         
    (In thousands)
Assets:
               
Cash and cash equivalents
  $ 21,906     $ 225,400  
             
Debt:
               
Debt — Repurchase agreements
  $ 2,384,415     $ 2,384,415  
Debt — Collateralized debt obligations
    211,210       211,210  
             
Total debt
  $ 2,595,625     $ 2,595,625  
Stockholders’ equity:
               
Common stock, par value $0.001 per share; 500,000,000 shares authorized, 17,519,500 shares outstanding — actual and 25,591,400 shares outstanding — as adjusted
  $ 18     $ 26  
Preferred stock, par value $0.001 per share; 100,000,000 shares authorized, no shares outstanding — actual and as adjusted
           
Additional paid-in capital
    406,665       610,151  
Accumulated other comprehensive loss
    (13,090 )     (13,090 )
Declared dividends in excess of earnings
    (10,420 )     (10,420 )
             
Total stockholders’ equity
  $ 383,173     $ 586,667  
             
 
(1)  Includes 84,000 shares of restricted stock issued to Hyperion Brookfield Crystal River upon completion of our March 2005 private offering which it subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us. Does not include options to purchase 126,000 shares of our common stock that we granted to Hyperion Brookfield Crystal River upon completion of our March 2005 private offering which were subsequently reallocated and transferred to certain persons who provide services to us. As of March 15, 2006, 27,996 shares of such restricted stock were no longer subject to forfeiture. The remaining shares and options will vest or become exercisable in equal installments on March 15, 2007 and March 15, 2008. Includes an aggregate of 3,500 shares of common stock issued to three of our independent directors under our 2005 stock incentive plan and 32,000 shares of restricted stock issued to one of our independent directors and certain employees of Hyperion Brookfield who provide services to us in 2005 and 2006 but does not include options to purchase 4,000 shares of our common stock granted to one of our independent directors in 2006 and does not include 4,000 shares of restricted stock issued in June 2006 to an employee of Hyperion Brookfield who provides services to us or 1,495,250 shares of our common stock available for future issuance under our 2005 stock incentive plan (which includes 10,160 shares to be issued in respect of deferred stock units issued to certain of our independent directors). See “Management — 2005 Long-Term Incentive Plan.”

60


Table of Contents

(2)  Assumes 8,071,900 shares will be sold in this offering at an initial public offering price of $27.50 per share, which is the mid-point of the range set forth on the cover of this prospectus, for net proceeds of approximately $203.5 million after deducting the estimated underwriting discounts and commissions of approximately $15.0 million and estimated offering expenses of approximately $3.5 million.
 
     A $1.00 increase (decrease) in the assumed initial public offering price of $27.50 per share would increase (decrease) each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization by $7.5 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
 
     If a selling stockholder listed in this prospectus does not satisfy, or obtain a waiver of, all of the conditions required pursuant to the underwriting agreement, the underwriters will not buy shares of our common stock from such selling stockholder. We will issue and sell to the underwriters any shortfall in shares resulting from such a failure. For each 100,000 shares of common stock that selling stockholders do not sell, and that we issue, to the underwriters, it would increase each of cash and cash equivalents, additional paid in capital, total stockholders’ equity and total capitalization by $2.6 million, assuming an initial public offering price of $27.50 per share, the mid-point of the range set forth on the cover page of this prospectus.

61


Table of Contents

DILUTION
      Purchasers of our common stock offered in this prospectus will experience immediate and substantial dilution of the net tangible book value of their common stock from the initial public offering price. Our net tangible book value as of March 31, 2006 was approximately $376.8 million, or $21.51 per share of our common stock. Net tangible book value per share represents the amount of our total tangible assets, which excludes deferred financing costs, minus our total liabilities, divided by the shares of our common stock that were outstanding on March 31, 2006. After giving effect to the sale of 8,071,900 shares of our common stock in this offering at an assumed initial public offering price of $27.50 per share, which is the mid-point of the range set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our as adjusted net tangible book value on March 31, 2006 would have been approximately $580.3 million, or $22.67 per share. This amount represents an immediate increase in net tangible book value of $1.16 per share to our existing stockholders and an immediate dilution in as adjusted net tangible book value of $4.83 per share to new investors who purchase our common stock in this offering at an assumed initial public offering price per share of $27.50. The following table shows this immediate per share dilution:
         
Assumed initial public offering price per share
  $ 27.50  
Net tangible book value per share on March 31, 2006, before giving effect to this offering
  $ 21.51  
Increase in net tangible book value per share attributable to this offering
  $ 1.16  
As adjusted net tangible book value per share on March 31, 2006, after giving effect to this offering
  $ 22.67  
Dilution in as adjusted net tangible book value per share to new investors
  $ 4.83  
      A $1.00 increase (decrease) in the assumed initial public offering price of $27.50 per share would increase (decrease) our increase in net tangible book value per share attributable to this offering by $0.29 per share, the as adjusted net tangible book value per share on March 31, 2006, after giving effect to this offering by $0.29 per share and the dilution in as adjusted net tangible book value per share to new investors in this offering by $0.29 per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
      If a selling stockholder listed in this prospectus does not satisfy, or obtain a waiver of, all of the conditions required pursuant to the underwriting agreement, the underwriters will not buy shares of our common stock from such selling stockholder. We will issue and sell to the underwriters any shortfall in shares resulting from such a failure. For each 100,000 shares of common stock that selling stockholders do not sell, and that we issue, to the underwriters, it would increase (decrease) our increase in net tangible book value per share attributable to this offering by $0.01 per share, the as adjusted net tangible book value per share on March 31, 2006, after giving effect to this offering by $0.01 per share and the dilution in as adjusted net tangible book value per share to new investors in this offering by $0.01 per share, assuming an initial public offering price of $27.50 per share, the mid-point of the range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
      The discussion and table above include 116,000 shares of our common stock subject to restricted stock awards, 28,662 of which shares of restricted stock are no longer subject to forfeiture, and an aggregate of 3,500 shares of restricted stock issued to three of our independent directors under our stock incentive plan, which shares vested on the date of issue.

62


Table of Contents

      The following table summarizes, as of March 31, 2006, the differences between the average price per share paid by our existing stockholders and by new investors purchasing shares of common stock in this offering at an assumed initial public offering price of $27.50 per share, which is the mid-point of the range set forth on the cover page of this prospectus, before deducting underwriting discounts and commissions and estimated offering expenses payable by us in this offering:
                                         
    Shares Purchased(1)   Total Consideration    
            Average Price
    Number   Percent   Amount   Percent   Per Share
                     
Existing stockholders(2)
    17,519,500       68.5 %   $ 435,000,000       66.2 %   $ 24.83  
New investors in this offering
    8,071,900       31.5       221,977,250       33.8       27.50  
                               
Total
    25,591,400             $ 656,977,250               25.67  
                               
 
(1)  Assumes no exercise of the underwriters’ option to cover over-allotments and does not include 130,000 shares of our common stock issuable upon exercise of outstanding options (options with respect to 43,328 of such shares have vested as of the date of this prospectus).
 
(2)  Includes 84,000 shares of restricted stock (27,996 of such shares of restricted stock are no longer subject to forfeiture) issued to Hyperion Brookfield Crystal River upon completion of our March 2005 private offering for which no consideration was paid. Also includes an aggregate of 3,500 shares of restricted stock issued to three of our independent directors under our 2005 stock incentive plan, which shares vested on the date of issue, for which no consideration was paid, and an aggregate of 32,000 shares of restricted stock (666 of such shares of restricted stock are no longer subject to forfeiture) issued to one of our executive officers and one of our independent directors on March 15, 2006, for which no consideration was paid.
     If the underwriters fully exercise their over-allotment option, the number of shares of common stock held by existing holders will be reduced to 65.0% of the aggregate number of shares of common stock outstanding after this offering, and the number of shares of common stock held by new investors will be increased to 9,436,900, or 35.0%, of the aggregate number of shares of common stock outstanding after this offering.

63


Table of Contents

SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
      In the table below, we provide you with selected historical consolidated financial information of Crystal River Capital, Inc. We have prepared this information as of and for the period ended December 31, 2005 using our consolidated financial statements for the period ended December 31, 2005. The consolidated financial statements for the period ended December 31, 2005 have been audited by Ernst & Young LLP, independent registered public accounting firm. We have prepared this information for the period ended March 31, 2005 and as of and for the three months ended March 31, 2006 using our unaudited consolidated financial statements for such periods. The financial statements for the period ended March 31, 2005 and as of and for the three months ended March 31, 2006 have not been audited. In the opinion of management, such financial statements have been prepared on the same basis as our audited consolidated financial statements and reflect all adjustments, consisting of normal accruals, necessary for a fair presentation of the data for such periods. Results for the period ended March 31, 2005 and for the three months ended March 31, 2006 are not necessarily indicative of results that may be expected for the entire year.
      When you read this selected historical consolidated financial information, it is important that you read along with it the historical consolidated financial statements and related notes, as well as the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are included in this prospectus.

64


Table of Contents

                             
    Period from       Period from
    March 15, 2005   Three months   March 15, 2005
    (commencement   ended   (commencement
    of operations)   March 31,   of operations)
    to March 31, 2005   2006   to December 31, 2005
             
    (In thousands, except share and per share data)
Consolidated Income Statement Data:
                       
Net interest income:
                       
 
Interest income
  $ 713     $ 41,078     $ 79,594  
 
Interest expense
    103       28,851       48,425  
                   
   
Net interest income
    610       12,227       31,169  
                   
Expenses:
                       
 
Management fees, related party(1)
    320       1,677       5,448  
 
Professional fees
    41       761       2,205  
 
Insurance expense
    13       91       250  
 
Other general and administrative expenses(2)
    309       236       533  
                   
   
Total expenses
    683       2,765       8,436  
                   
 
Income before other revenues (expenses)
    (73 )     9,462       22,733  
Other revenues (expenses):
                       
 
Realized net loss on sale of real estate loans and securities available for sale
          (568 )     (521 )
 
Realized and unrealized gain (loss) on derivatives
    195       7,930       (2,497 )
 
Loss on impairment of available for sale securities
          (1,258 )     (5,782 )
 
Other
          (122 )     15  
                   
   
Total other revenues (expenses)
    195       5,982       (8,785 )
                   
Net income
  $ 122     $ 15,444     $ 13,948  
Net income per share — basic and diluted
  $ 0.01     $ 0.88     $ 0.80  
Weighted-average number of shares outstanding — basic and diluted
    17,487,500       17,495,082       17,487,500  
Cash dividends declared per common share
  $     $ 0.725     $ 1.55  
 
(1)  Includes $33, $222 and $627, respectively, of stock based compensation.
 
(2)  Includes $116 of stock based compensation for the three months ended March 31, 2006.
                 
    March 31, 2006   December 31, 2005
         
    (In thousands)
Consolidated Balance Sheet Data:
               
Total assets
  $ 3,023,321     $ 2,669,769  
Debt — Repurchase agreements
    2,384,415       1,994,287  
Debt — Collateralized debt obligations
    211,210       227,500  
Debt — Notes payable, related party
          35,000  
Stockholders’ equity
    383,173       381,429  

65


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
      The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this prospectus.
Overview
      We are a specialty finance company formed on January 25, 2005 by Hyperion Brookfield, who may be deemed to be our promoter, to invest in real estate-related securities and various other asset classes. We commenced operations in March 2005. We will elect and intend to qualify to be taxed as a REIT for federal income tax purposes. We invest in financial assets and intend to construct an investment portfolio that is leveraged where appropriate to seek to achieve attractive risk-adjusted returns and that is structured to comply with the various federal income tax requirements for REIT status and to qualify for an exclusion from regulation under the Investment Company Act. Our current focus is on the following asset classes:
  •  Real estate-related securities, principally RMBS and CMBS;
 
  •  Whole mortgage loans, bridge loans, B Notes and mezzanine loans; and
 
  •  Other ABS, including CDOs, and consumer ABS.
      We completed a private offering of 17,400,000 shares of our common stock in March 2005 in which we raised net proceeds of approximately $405.6 million. We have fully invested the proceeds from the March 2005 private offering and, as of March 31, 2006, have a portfolio of RMBS and other alternative investments of approximately $2.9 billion. We are externally managed by Hyperion Brookfield Crystal River. Hyperion Brookfield Crystal River is a wholly-owned subsidiary of Hyperion Brookfield.
      We earn revenues and generate cash through our investments. We use a substantial amount of leverage to seek to enhance our returns. We finance each of our investments with different degrees of leverage. The cost of borrowings to finance our investments comprises a significant portion of our operating expenses. Our net income will depend, in large part, on our ability to control this particular operating expense in relation to our revenues.
      A variety of industry and economic factors may impact our financial condition and operating performance. These factors include:
  •  interest rate trends,
 
  •  rates of prepayment on mortgages underlying our MBS,
 
  •  competition, and
 
  •  other market developments.
      In addition, a variety of factors relating to our business may also impact our financial condition and operating performance. These factors include:
  •  our leverage,
 
  •  our access to funding and borrowing capacity,
 
  •  our borrowing costs,
 
  •  our hedging activities,

66


Table of Contents

  •  the market value of our investments, and
 
  •  REIT requirements and the requirements to qualify for an exemption from regulation under the Investment Company Act.
Our Business Model
      Our net interest income is generated primarily from the net spread, or difference, between the interest income we earn on our investment portfolio and the cost of our borrowings and hedging activities. Our net interest income will vary based upon, among other things, the difference between the interest rates earned on our various interest-earning assets and the borrowing costs of the liabilities used to finance those investments. Other than our investments in RMBS, we generally attempt to match fund our assets in order to match the maturity of the investments with the maturity of the financing sources used to make such investments. Although we do not match fund agency ARMS due to their average 30 year maturities, we utilize interest rate swaps to hedge much of our interest rate exposure in our other MBS investments. In CDO financings, match funding is more likely as the cash flows from the collateral pool pays the interest on the debt securities issued by the CDO and interest rate swaps are utilized to convert fixed interest obligations to floating rate obligations inherent in the instruments comprising the collateral pool.
      We anticipate that, for any period during which our assets are not match-funded, such assets could reprice more slowly than the corresponding liabilities. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income. Increases in these rates could tend to decrease our net income and the market value of our assets, and could possibly result in operating losses for us or limit or eliminate our ability to make distributions to our stockholders.
      The yield on our assets may be affected by a difference between the actual prepayment rates and our projections. Prepayments on loans and securities may be influenced by changes in market interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. To the extent we have acquired assets at a premium or discount, a change in prepayment rates may impact our anticipated yield. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain assets.
      In periods of declining interest rates, prepayments on our investments, including our RMBS, will likely increase. If we are unable to reinvest the proceeds of such prepayments at comparable yields, our net interest income may suffer. In periods of rising interest rates, prepayment rates on our investments, including our RMBS, will likely slow, causing the expected lives of these investments to increase. This may cause our net interest income to decrease as our borrowing and hedging costs rise while our interest income on those assets remain constant.
      While we use hedging to mitigate some of our interest rate risk, we do not hedge all of our exposure to changes in interest rates and prepayment rates, as there are practical limitations to our ability to insulate the portfolio from all of the negative consequences associated with changes in short-term interest rates while still seeking to provide an attractive net spread on our portfolio.
      In addition, our returns will be affected by the credit performance of our non-agency investments. If credit losses on our investments or the loans underlying our investments increase, it may have an adverse affect on our performance.

67


Table of Contents

      Hyperion Brookfield Crystal River is entitled to receive a base management fee that is based on the amount of our equity (as defined in the management agreement), regardless of the performance of our portfolio. Accordingly, the payment of our management fee is a fixed cost and will not decline in the event of a decline in our profitability and may lead us to incur losses.
Trends
      We believe the following trends may also affect our business:
      Rising interest rate environment — interest rates have recently increased and we believe that interest rates may continue to increase. With respect to our existing MBS portfolio, which is heavily concentrated in 3/1 and 5/1 hybrid adjustable rate RMBS, we believe that such interest rate increases should result in decreases in our net interest income, as there is a timing mismatch between the reset dates on our MBS portfolio and the financing of these investments. We currently have invested and intend to continue to invest in hybrid adjustable-rate RMBS which are based on mortgages with interest rate caps. The financing of these RMBS is short term in nature and does not include the benefit of an interest rate cap. This mismatch should result in a decrease in our net interest income if rates increase sharply after the initial fixed rate period and our interest cost increases more than the interest rate earned on our RMBS due to the related interest rate caps. With respect to our existing and future floating rate investments, we believe such interest rate increases should result in increases in our net interest income because our floating rate assets are greater in amount than the related liabilities. Similarly, we believe such an increase in interest rates should generally result in an increase in our net interest income on future fixed rate investments made by us because our fixed rate assets would be greater in amount than our liabilities. However, we would expect that our fixed rate assets would decline in value in a rising interest rate environment and our net interest spreads on fixed rate assets could decline in a rising interest rate environment to the extent they are financed with floating rate debt. We have engaged in interest rate swaps to hedge a significant portion of the risk associated with increases in interest rates. However, because we do not hedge 100% of the amount of short-term financing outstanding, increases in interest rates should result in a decline in the value of our portfolio, net of hedges. Similarly, decreases in interest rates should result in an increase in the value of our portfolio.
      Flattening yield curve — short term interest rates have been increasing at a greater rate than longer term interest rates. For example, between March 31, 2005 and March 31, 2006, the yield on the three-month U.S. treasury bill increased by 184 basis points, while the yield on the three-year U.S. treasury note increased by only 90 basis points. With respect to our MBS portfolio, we believe that a continued flattening of the shape of the yield curve should result in decreases in our net interest income, as the financing of our MBS investments is usually shorter in term than the fixed rate period of our MBS portfolio, which is heavily weighted towards 3/1 and 5/1 hybrid adjustable rate RMBS. Similarly, we believe that a steepening of the shape of the yield curve should result in increases in our net interest income. A flattening of the shape of the yield curve results in a smaller gap between the rate we pay on the swaps and rate we receive. Furthermore, a continued flattening of the shape of the yield curve should result in a decrease in our hedging costs, since we pay a fixed rate and receive a floating rate under the terms of our swap agreements. Similarly, a steepening of the shape of the yield curve should result in an increase in our hedging costs.
      Prepayment rates — as interest rates increase, we believe that prepayment rates are likely to fall. Prepayment rates generally increase when interest rates fall and decrease when interest rates rise, but changes in prepayment rates are difficult to predict. Prepayment rates also may be affected by other factors, including, without limitation, conditions in the housing and financial markets, general economic conditions and the relative interest rates on adjustable-rate and fixed-rate mortgage loans. Because we believe that interest rates are likely to continue to

68


Table of Contents

increase, we believe that MBS prepayment rates are likely to fall. If interest rates begin to fall, triggering an increase in prepayment rates, our current portfolio, which is heavily weighted towards hybrid adjustable-rate mortgages, would cause decreases in our net interest income relating to our MBS portfolio.
      Competition — we expect to face increased competition for our targeted investments. However, we expect that the size and growth of the market for these investments will continue to provide us with a variety of investment opportunities. In addition, we believe that bank lenders will continue their historical lending practices, requiring low loan-to-value ratios and high debt service coverages, which will provide opportunities to lenders like us to provide corporate mezzanine financing.
      For a discussion of additional risks relating to our business see “Risk Factors” and “— Quantitative and Qualitative Disclosures About Risk.”
Critical Accounting Policies
      Our financial statements are prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. These accounting principles require us to make some complex and subjective decisions and assessments. Our most critical accounting policies involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments upon which our financial statements are based were reasonable at the time made based upon information available to us at that time. We rely on the experience of Hyperion Brookfield Crystal River’s management and its analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. See Note 2 to the consolidated financial statements for a complete discussion of our accounting policies. Under different conditions, we could report materially different amounts arising under these critical accounting policies. We have identified our most critical accounting policies to be the following:
Investment Consolidation
      For each investment we make we evaluate the underlying entity that issued the securities we acquired or to which we made a loan in order to determine the appropriate accounting. We refer to guidance in Statement of Financial Accounting Standards (SFAS) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS 140“), and FASB Interpretation No. (FIN) 46R, Consolidation of Variable Interest Entities, in performing our analysis. FIN 46R addresses the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which voting rights are not effective in identifying an investor with a controlling financial interest. An entity is subject to consolidation under FIN 46R if the investors either do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity’s activities, or are not exposed to the entity’s losses or entitled to its residual returns (“variable interest entities” or “VIEs”). Variable interest entities within the scope of FIN 46R are required to be consolidated by their primary beneficiary. The primary beneficiary of a VIE is determined to be the party that absorbs a majority of the entity’s expected losses, its expected returns, or both.
      Our ownership of the subordinated classes of CMBS from a single issuer gives us the right to control the foreclosure/workout process on the underlying loans (“Controlling Class CMBS”). FIN 46R has certain scope exceptions, one of which provides that an enterprise that holds a variable interest in a qualifying special-purpose entity (“QSPE”) does not consolidate that entity unless that enterprise has the unilateral ability to cause the entity to liquidate. SFAS 140 provides the requirements for an entity to be considered a QSPE. To

69


Table of Contents

maintain the QSPE exception, the trust must continue to meet the QSPE criteria both initially and in subsequent periods. A trust’s QSPE status can be impacted in future periods by activities by its transferor(s) or other involved parties, including the manner in which certain servicing activities are performed. To the extent our CMBS investments were issued by a trust that meets the requirements to be considered a QSPE, we record the investments at the purchase price paid. To the extent the underlying trusts are not QSPEs, we follow the guidance set forth in FIN 46R as the trusts would be considered VIEs.
      We have analyzed the governing pooling and servicing agreements for each of our subordinated class CMBS and RMBS and believe that the terms are industry standard and are consistent with the QSPE criteria. However, given uncertainty with respect to QSPE treatment due to ongoing review by accounting standard setters (including the FASB’s project to amend SFAS 140 and the recently added FASB project on servicer discretion in a QSPE), potential actions by various parties involved with the QSPE, as discussed above, as well as varying and evolving interpretations of the QSPE criteria under SFAS 140, we have also analyzed the investments as if the trusts are not qualifying. Using the fair value approach to compute expected losses and expected residual returns, we have concluded that we would not be the primary beneficiary under FIN 46R of any of the underlying trusts.
      The primary difference between the fair value method, which we utilized in our analysis, and the cash flow method is the difference in the yield curves used to discount projected cash flow outcomes. The fair value method uses multiple yield curves, representing possible interest rate environments at the time the cash is distributable, while the cash flow method uses only the current yield curve on the evaluation date. We believe that the fair value method, in which we apply a discount to correct for differences in payments, more clearly reflects the risks of ownership to the portfolio as it states the market value risk that the company incurs under various interest rate scenarios, factoring in the long repayment period and the timing of cash flows. There are no differences in the projected cash flows used under the fair value method and the cash flow method. In computing cash flows, we identified various combinations of interest rate and credit scenarios and computed cash flows for each of the tranches of a particular security for each scenario. These cash flow scenarios are discounted based on the prevalent interest rate and weighted by probability of occurrence to arrive at an expected value. Lastly, the risks absorbed by the variable holders are then compared to the risks absorbed by all of the security’s classes.
      The non-investment grade and unrated tranches of the CMBS owned by us provide credit support to the more senior classes of the related commercial securitizations. Cash flow from the underlying mortgages generally is allocated first to the senior tranches, with the most senior tranches having a priority right to the cash flow. Any remaining cash flow is allocated, generally, among the other tranches in order of their relative seniority. To the extent there are defaults and unrecoverable losses on the underlying mortgages resulting in reduced cash flows, the remaining CMBS classes will bear such losses in order of their relative subordination.
      We are aware that on April 13, 2006, FASB Staff Position, FIN 46(R)-6, Determining the Variability to be Considered In Applying FASB Interpretation No. 46(R) (the “Staff Position”) was issued. The Staff Position will result in us excluding interest rate risk as a variable when we perform our FIN 46 analysis to determine the expected losses and residual returns and which party, if any, is the primary beneficiary in our Controlling Class CMBS and RMBS investments.
      We considered the guidance identified above by the Staff Position, and note that our Controlling Class CMBS and RMBS investments have both senior and subordinate interests. We believe that the subordination is substantively consistent with the discussion in the footnote to paragraph 13 of FIN 46(R)-6 because our junior tranche investments absorb expected losses prior to the senior interests not held by us. Further, because we hold the most junior tranche in

70


Table of Contents

the Controlling Class CMBS and RMBS investments, the amount of subordination in relation to the overall expected losses is significant.
      We believe that under FIN 46(R)-6, credit risk will be determined to be substantive given the design of the Controlling Class CMBS and RMBS investments. Therefore, evaluation of whether we are the primary beneficiary in accordance with FIN 46(R)-6 will be based upon credit risk assumptions and will not include interest rate risk. Application of FIN 46(R)-6 without the inclusion of interest rate risk to the Controlling Class CMBS and RMBS investments will result in our being the primary beneficiary as greater than 50% of the losses and residual returns will typically be allocated to us. We would be required to consolidate the Controlling Class CMBS and RMBS investments’ assets, liabilities and results of operations in our financial statements.
      FIN 46(R)-6 is required to be prospectively applied to entities in which we first become involved after July 1, 2006, and would be applied to all existing entities with which we are involved if and when a “reconsideration event” (as described in FIN 46) occurs.
      For illustrative purposes, we have presented the following pro forma balance sheet as of March 31, 2006 and pro forma statement of income for the period March 15, 2005 (commencement of operations) to December 31, 2005 and for the three months ended March 31, 2006 as if the Controlling Class CMBS and RMBS investments had been consolidated under FIN 46(R)-6 as of the beginning of each period presented.
Crystal River Capital, Inc.
Pro Forma Balance Sheet
March 31, 2006
(In thousands)
(Unaudited)
         
Total assets
  $ 28,484,310 (1)
       
Total liabilities
    2,640,148  
Minority interest in CMBS and RMBS entities
    25,460,989 (1)
Total stockholders’ equity
    383,173  
       
Total liabilities and stockholders’ equity
  $ 28,484,310  
       
 
(1)  Crystal River obtained from the respective trustees copies of the collateral balances as of March 31, 2006 for each of the CMBS and RMBS pools in which it owns an investment in the Controlling Class ($25,778,720) and subtracted the fair value of its investments as of such date ($317,731) to derive the minority interest in CMBS and RMBS entities as of March 31, 2006 ($25,460,989).

71


Table of Contents

Crystal River Capital, Inc.
Pro Forma Income Statement
For the period March 15, 2005 (commencement of operations)
to December 31, 2005
(In thousands)
(Unaudited)
         
Interest income
  $ 734,702 (2)
       
Total expenses
    56,861  
       
Income before other revenue (expenses) and minority interest
    677,841  
Total other revenue (expenses)
    (8,785 )
       
Income before minority interest
    669,056  
Minority interest in CMBS and RMBS entities
    (655,108 )(2)
       
Net income
  $ 13,948  
       
 
(2)  Crystal River obtained from the respective trustees copies of the interest income balances for the period March 15, 2005 to December 31, 2005 for each of the CMBS and RMBS pools in which it owns an investment in the Controlling Class ($665,294) and subtracted the interest income for its investments for such period ($10,186) to derive the interest income of $655,108. Such amount also represents the minority interest in CMBS and RMBS entities as we have no contractual right to such interest income.
Crystal River Capital, Inc.
Pro Forma Income Statement
For the Three Months Ended March 31, 2006
(In thousands)
(Unaudited)
         
Interest income
  $ 348,889 (3)
       
Total expenses
    31,616  
       
Income before other revenue and minority interest
    317,273  
Total other revenue
    5,982  
       
Income before minority interest
    323,255  
Minority interest in CMBS and RMBS entities
    307,811 (3)
       
Net income
  $ 15,444  
       
 
(3)  Crystal River obtained from the respective trustees copies of the interest income balances for the three months ended March 31, 2006 for each of the CMBS and RMBS pools in which it owns an investment in the Controlling Class ($313,315) and subtracted the interest income for its investments for such period ($5,504) to derive the interest income of $307,811. Such amount also represents the minority interest in CMBS and RMBS entities as we have no contractual right to such interest income.
     The financing structures that we offer to our borrowers on certain of our loans involve the creation of entities that could be deemed VIEs and, therefore, could be subject to FIN 46R. We have evaluated these entities and have concluded that none of them are VIEs that are subject to consolidation under FIN 46R.

72


Table of Contents

Revenue Recognition
      The most significant source of our revenue comes from interest income on our securities and loan investments. Interest income on loans and securities investments is recognized over the life of the investment using the effective interest method. Mortgage loans will generally be originated or purchased at or near par value and interest income will be recognized based on the contractual terms of the debt instrument. Any loan fees or acquisition costs on originated loans will be deferred and recognized over the term of the loan as an adjustment to the yield. Interest income on MBS is recognized on the effective interest method as required by EITF 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. Under EITF 99-20, management estimates, at the time of purchase, the future expected cash flows and determines the effective interest rate based on these estimated cash flows and our purchase prices. Subsequent to the purchase and on a quarterly basis, these estimated cash flows are updated and a revised yield is calculated based on the current amortized cost of the investment. In estimating these cash flows, there are a number of assumptions that are subject to uncertainties and contingencies. These include the rate and timing of principal payments (including prepayments, repurchases, defaults and liquidations), the pass through or coupon rate and interest rate fluctuations. In addition, interest payment shortfalls have to be estimated due to delinquencies on the underlying mortgage loans and the timing and magnitude of credit losses on the mortgage loans underlying the securities. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact management’s estimates and our interest income. When current period cash flow estimates are lower than the previous period and fair value is less than an asset’s carrying value, we will write down the asset to fair market value and record an impairment charge in current period earnings.
      Through its extensive experience in investing in MBS, Hyperion Brookfield has developed models based on historical data in order to estimate the lifetime prepayment speeds and lifetime credit losses for pools of mortgage loans. The models are based primarily on loan characteristics, such as loan-to-value ratios (LTV), credit scores, loan type, loan rate, property type, etc., and also include other qualitative factors such as the loan originator and servicer. For credit losses, the models also assume a certain level of stress to prevailing employment rates and housing prices. Once the models have been used to project the base case prepayment speeds and to project the base case cumulative loss, those outputs are used to create yield estimates and to project cash flows.
      Since mortgage assets amortize over long periods of time (i.e., 30 years in the case of RMBS assets or 10 years in the case of CMBS assets), the expected lifetime prepayment experience and the expected lifetime credit losses projected by the models are subject to modification in light of actual experience assessed from time to time. For each of the purchased mortgage pools, our Manager tracks the actual monthly prepayment experience and the monthly loss experience, if any. To the extent that the actual performance trend over a 6-12 month period of time does not reasonably approximate the expected lifetime trend, in consideration of the seasoning of the asset, our Manager will make adjustments to the assumptions and revise yield estimates and projected cash flows.
      The following hypothetical example reflects the impact of a change in the historical prepayment experience:
  Assumptions:
  Price = 101.75% of par
  Current Face = $1,000,000
  Investment at cost =$1,017,500

73


Table of Contents

                             
Constant            
Prepayment            
Rate   Yield   Annual Income   Percent Difference
             
  6%       5.54 %   $ 57,129.30       14 %
  15%       5.09 %   $ 52,481.09       5 %
  20%       4.85 %   $ 49,978.37       0 %
  40%       3.97 %   $ 40,754.16       (18 )%
  60%       3.06 %   $ 31,394.35       (37 )%
Loan Loss Provisions
      We purchase and originate mezzanine loans and commercial mortgage loans to be held as long-term investments. We evaluate each of these loans for possible impairment on a quarterly basis. Impairment occurs when it is deemed probable that we will not be able to collect all amounts due according to the contractual terms of the loan. Upon determination of impairment, we will establish a reserve for loan losses and a corresponding charge to earnings through the provision for loan losses. Significant judgments are required in determining impairment, which include assumptions regarding the value of the real estate or partnership interests that secure the mortgage loans.
Valuations of MBS and ABS
      Our MBS and ABS have fair values as determined with reference to price estimates provided by independent pricing services and dealers in the securities. Different judgments and assumptions used in pricing could result in different presentations of value.
      When the fair value of an available-for-sale security is less than its amortized cost for an extended period, we consider whether there is an other-than-temporary impairment in the value of the security. If, in our judgment, an other-than-temporary impairment exists, the cost basis of the security is written down to the then-current fair value, and the unrealized loss is transferred from accumulated other comprehensive loss as an immediate reduction of current earnings (as if the loss had been realized in the period of other-than-temporary impairment). The determination of other-than-temporary impairment is a subjective process, and different judgments and assumptions could affect the timing of loss realization.
      We consider the following factors when determining an other-than-temporary impairment for a security or investment:
  •  The length of time and the extent to which the market value has been less than the amortized cost;
 
  •  Whether the security has been downgraded by a rating agency; and
 
  •  Our intent to hold the security for a period of time sufficient to allow for any anticipated recovery in market value.
      Periodically, all available for sale securities are evaluated for other than temporary impairment in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”), and Emerging Issues Task Force No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Financials Assets (“EITF 99-20”). An impairment that is an “other than temporary impairment” is a decline in the fair value of an investment below its amortized cost attributable to factors that indicate the decline will not be recovered over the investment’s remaining life. Other than temporary impairments result in reducing the security’s carrying value to its fair value through

74


Table of Contents

the statement of income, which also creates a new carrying value for the investment. We compute a revised yield based on the future estimated cash flows as described in “— Revenue Recognition” above. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the changes in interest rates.
      The determination of other-than-temporary impairment is made at least quarterly. If we determine an impairment to be other than temporary we will need to realize a loss that would have an impact on future income. At December 31, 2005, our overall intent was to replace lower-coupon Agency ARMS with higher yielding securities. In evaluating which securities were to be sold, we considered:
  •  the length of the time to reset (we were interested in selling Agency ARMS that were 5/1 hybrids);
 
  •  securities whose value had declined by more than an immaterial amount; and
 
  •  securities that could be replaced with a security carrying a higher coupon rate.
      In our analysis at December 2005, we established as thresholds:
  •  45 months remaining to rate reset;
 
  •  market price declines in excess of 1.50%; and
 
  •  securities bearing a coupon rate under 4.80%.
      These criteria were established based on our Manager’s review of our investment portfolio and its determination that these criteria provided a pool of securities to be sold that would produce an acceptable proportionate increase in income yield for our portfolio. Two mitigating factors that we considered in evaluating the foregoing criteria were whether a security was subject to a reverse repurchase agreement with a sufficiently distant settlement date that would preclude such a sale in the near term, for practical, hedging and economic reasons, and whether we agreed with the quoted market value for such securities. With the passage of time, as we periodically review the performance of our portfolio, our investment strategy in light of market conditions and our liquidity requirements and available sources of liquidity, the criteria we utilize to determine impairment under SFAS 115 may change. At any measurement date, securities that satisfy all of our impairment criteria that we do not intend to hold until we recover their amortized cost or until maturity would be deemed to be other than temporarily impaired.
      Under the guidance provided by SFAS 115, a security is impaired when its fair value is less than its amortized cost and we do not intend to hold that security until we recover its amortized cost or until its maturity. Based on the foregoing parameters, we identified nine individual securities that were determined to be impaired under the guidance provided by SFAS 115. As of December 31, 2005, we intended and had the ability to hold the remaining Agency ARMS and Non-Agency RMBS with fair values less than their respective amortized cost to allow sufficient time for the anticipated recovery of amortized cost, which could be the maturity date of the underlying debt securities. Through March 31, 2006, we had sold five of the nine Agency ARMS, realizing a loss of $0.9 million on the sale during the three months ended March 31, 2006. Through June 2006, we have sold three of the four remaining impaired Agency ARMS.
      For the period March 15, 2005 (commencement of operations) to December 31, 2005 and the three months ended March 31, 2006, we recognized an impairment charge of approximately $5.8 million and $1.3 million, respectively, in respect of other-than-temporary impairment on certain of our assets. We have net unrealized holding losses on our available-for-sale securities of approximately $36.5 million as of March 31, 2006, none of which we believe to be other-than-temporary.

75


Table of Contents

Repurchase Agreements
      In certain circumstances, we have financed the purchase of securities from a counterparty through a repurchase agreement with the same counterparty pursuant to which we pledge the purchased securities. Currently, we record the acquisition of these securities as assets and the related borrowing under repurchase agreements as financing liabilities on our consolidated balance sheet with changes in the fair value of the securities being recorded as a component of other comprehensive income in stockholders’ equity. Interest income earned on the securities and interest expense incurred on the repurchase obligations are reported separately on our consolidated income statement. As of March 31, 2006 we had 44 such transactions that were outstanding, and our March 31, 2006 balance sheet included approximately $883.3 million of such securities and approximately $868.6 million of such repurchase agreement liabilities.
      It has come to our attention and to the attention of other market participants, as well as our repurchase agreement counterparties, that SFAS 140 may require a different accounting treatment for such transactions. Under SFAS 140, transactions in which we acquire securities from a counterparty that are financed through a repurchase agreement with the same counterparty will not qualify as a purchase by us if we are not able to conclude that the securities purchased have been legally isolated from the counterparty. If the acquisitions do not qualify as a purchase of securities under SFAS 140, we would not be permitted to include the securities purchased and repurchase agreements on a gross basis on our balance sheet. Additionally, we would not be able to report on a gross basis on our income statement the related interest income earned and interest expense incurred. Instead, we would be required to present the net investment on our balance sheet together with an embedded derivative with the corresponding change in fair value of the derivative being recorded in our income statement. The value of the derivative would reflect not only changes in the value of the underlying securities, but also changes in the value of the underlying credit provided by the counterparty. Although we believe our accounting for these transactions is appropriate, we will continue to evaluate our position as the interpretation of this issue among industry participants and standard setters evolves.
Accounting For Derivative Financial Instruments and Hedging Activities
      Our policies permit us to enter into derivative contracts, including interest rate swaps and interest rate swap forwards, as a means of mitigating our interest rate risk on forecasted interest expense associated with the benchmark rate on forecasted rollover/reissuance of repurchase agreements, or hedged items, for a specified future time period. We currently intend to use interest rate derivative instruments to mitigate interest rate risk rather than to enhance returns.
      At March 31, 2006, we were a party to 46 interest rate swaps with a notional par value of approximately $1,436.0 million and an intrinsic gain of approximately $25.4 million. We entered into these interest rate swaps to seek to mitigate our interest rate risk for the specified future time period, which is defined as the term of the swap contracts. Based upon the market value of these interest rate swap contracts, our counterparties may request additional margin collateral or we may request additional collateral from our counterparties to ensure that appropriate margin account balance is maintained at all times through the expiration of the contracts.
      At March 31, 2006, we were a party to one currency swap with a notional par value of approximately Can$50.0 million and an intrinsic gain of approximately $0.9 million. We entered into this currency swap to seek to mitigate our currency risk for the specified future time period, which is defined as the term of the swap contract. Based upon the market value of this currency swap contract, our counterparty may request additional margin collateral or we may

76


Table of Contents

request additional collateral from our counterparty to ensure that appropriate margin account balance is maintained at all times through the expiration of the contract.
      As of March 31, 2006, we had 11 credit default swaps, or CDS, with a notional par value of $105.0 million and an intrinsic gain of approximately $1.1 million. The fair value of the CDS depends on a number of factors, primarily premium levels, which are dependent on interest rate spreads. The CDS contracts are valued using internally developed and tested market-standard pricing models which calculate the net present value of differences between future premiums on currently quoted market CDS and the contractual futures premiums on our CDS contracts.
      We account for derivative and hedging activities in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, or SFAS 133. SFAS 133 requires recognizing all derivative instruments as either asset or liabilities in the balance sheet at fair value. The accounting for changes in fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivatives instruments that are designated and qualify as hedging instruments, we must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. We have no fair value hedges or hedges of a net investment in foreign operations.
      For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings (for example, in “interest expense” when the hedged transactions are interest cash flows associated with floating-rate debt). The remaining gain (loss) on the derivative instrument in excess of the cumulative changes in the present value of future cash flows of the hedged item, if any, is recognized in the realized and unrealized gain (loss) on derivatives in current earnings during the period of change. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in realized and unrealized gain (loss) on derivatives in the current earnings during the period of change. Income and/or expense from interest rate swaps are recognized as a net adjustment to interest expense. We account for income and expense from interest rate swaps on an accrual basis over the period to which the payment and/or receipt relates.
Share-Based Payment
      We account for share-based compensation issued to members of our board of directors, our Manager and certain of our senior executives using the fair value based methodology in accordance with SFAS No. 123R, Accounting for Stock Based Compensation. We do not have any employees, although we believe that members of our Board of Directors are deemed to be employees for purposes of interpreting and applying accounting principles relating to share-based compensation. We record as compensation costs the restricted common stock that we issued to members of our board of directors at fair value as of the grant date and we amortize the cost into expense over the three-year vesting period using the straight-line method. We recorded compensation costs for restricted common stock and common stock options that we issued to our Manager and that were reallocated to employees of our Manager and its affiliates that provide services to us at fair value as of the grant date and we remeasure the amount on subsequent reporting dates to the extent that the restricted common stock and or common stock options are unvested. Unvested restricted common stock is valued using appraised value. Unvested common stock options are valued using a Binomial pricing model and assumptions based on observable market data for comparable companies. We amortize compensation

77


Table of Contents

expense related to the restricted common stock and common stock options that we granted to our Manager using the graded vesting attribution method in accordance with SFAS No. 123R.
      Because we remeasure the amount of compensation costs associated with the unvested restricted common stock and unvested common stock options that we issued to our Manager and certain of our senior executives as of each reporting period, our share-based compensation expense reported in our statements of operations will change based on the fair value of our common stock and this may result in earnings volatility.
      As of March 31, 2006, aggregate share-based compensation, including the effects of remeasurement through March 31, 2006, totaled approximately $3.4 million and consisted of approximately $3.1 million related to the grant of restricted common stock and deferred stock units and approximately $0.3 million related to the grant of common stock options. Since inception and through March 31, 2006, we have expensed share-based compensation totaling approximately $1.0 million. As of March 31, 2006, scheduled amortization of unamortized share-based compensation, excluding the impact of future remeasurement, for the remainder of calendar 2006 and for calendar 2007, 2008 and 2009, is approximately $0.9 million, $1.1 million, $0.4 million and $0.1 million, respectively. As of March 31, 2006, substantially all our share-based compensation is subject to remeasurement and a $1 increase in the price of our common stock increases our future share-based compensation expense by approximately $0.1 million in the aggregate over calendar 2006, 2007 and 2008. As of March 31, 2006, the fair value of outstanding vested and unvested options to purchase our common stock, based upon the assumed public offering price of $27.50 per share, was $0.2 million and $0.3 million, respectively, based on 130,000 outstanding stock options.
Income Taxes
      We operate in a manner that we believe will allow us to be taxed as a REIT and, as a result, we do not expect to pay substantial corporate-level income taxes. Many of the requirements for REIT qualification, however, are highly technical and complex. If we were to fail to meet these requirements and do not qualify for certain statutory relief provisions, we would be subject to federal income tax, which could have a material adverse impact on our results of operations and amounts available for distributions to our stockholders. In addition, Crystal River TRS Holdings, Inc., our TRS, is subject to corporate-level income taxes.
Financial Condition
      All of our assets at March 31, 2006 were acquired with the net proceeds of approximately $405.6 million from our March 2005 private offering of 17,400,000 shares of our common stock and our use of leverage.
Mortgage-Backed Securities
      Some of our mortgage investment strategy involves buying higher coupon, higher premium bonds, which takes on more prepayment risk (particularly call or shortening risk) than lower dollar-priced strategies. However, we believe that the potential benefits of this strategy include higher income, wider spreads, and lower hedging costs due to the shorter option-adjusted duration of the higher coupon security.

78


Table of Contents

      The table below summarizes our MBS investments at March 31, 2006:
                 
    RMBS   CMBS
         
    (In thousands)
Amortized cost
  $ 2,419,394     $ 298,424  
Unrealized gains
    2,166       2,343  
Unrealized losses
    (34,173 )     (7,913 )
             
Fair value
  $ 2,387,387     $ 292,854  
      As of March 31, 2006, the RMBS and CMBS in our portfolio were purchased at a net discount to their par value and our portfolio had a weighted-average amortized cost of 97% and 67% of face amount, respectively. The RMBS and CMBS were valued below par at March 31, 2006 because we are investing in lower-rated bonds in the credit structure. Certain of the securities held at March 31, 2006 are valued below cost. We do not believe any such securities are other than temporarily impaired at March 31, 2006.
      Our MBS holdings were as follows at March 31, 2006:
                                                     
            Weighted Average    
                 
    Estimated   Percent of       Months       Constant
    Asset   Total       to   Yield to   Prepayment
    Value(1)   Investments   Coupon   Reset(2)   Maturity   Rate(3)
                         
    (In thousands)                
RMBS:
                                               
 
Non-Agency:
                                               
   
Senior prime 5/1 adjustable rate
  $ 237,786       8.3 %     5.28 %     45.91       6.02 %     23.43 %
   
Junior prime
    153,906       5.4       6.57       24.47       16.01       24.39  
   
Subprime
    160,987       5.6       6.76       11.32       8.80       33.56  
 
Agency:
                                               
   
3/1 hybrid adjustable rate
    631,400       22.0       4.93       29.26       6.06       10.65  
   
5/1 hybrid adjustable rate
    1,203,308       41.9       4.91       47.69       5.79       14.80  
                                     
Total RMBS
    2,387,387       83.2       5.23       38.19       6.74       16.75  
CMBS:
                                               
 
Below investment grade CMBS
    292,854       10.2       5.05               9.59          
 
(1)  All securities listed in this chart are carried at their estimated fair value.
 
(2)  Represents number of months before conversion to floating rate.
 
(3)  Represents the estimated percentage of principal that will be prepaid over the next 12 months based on historical principal paydowns.

79


Table of Contents

     The table below summarizes the credit ratings of our MBS investments at March 31, 2006:
                 
    RMBS   CMBS
         
    (In thousands)
AAA
  $ 2,072,493     $  
AA
           
A
    48,882        
BBB
    81,552       129,070  
BB
    101,438       85,094  
B
    65,054       42,842  
Not rated
    17,968       35,848  
             
Total
  $ 2,387,387     $ 292,854  
      Actual maturities of RMBS are generally shorter than stated contractual maturities, as they are affected by the contractual lives of the underlying mortgages, periodic payments of principal, and prepayments of principal. The stated contractual final maturity of the mortgage loans underlying our portfolio of RMBS ranges up to 30 years, but the expected maturity is subject to change based on the prepayments of the underlying loans. As of March 31, 2006, the average final contractual maturity of the mortgage portfolio is 2035.
      The constant prepayment rate, or CPR, attempts to predict the percentage of principal that will be prepaid over the next 12 months based on historical principal paydowns. As interest rates rise, the rate of refinancings typically declines, which we believe may result in lower rates of prepayment and, as a result, a lower portfolio CPR.
      As of March 31, 2006, some of the mortgages underlying our RMBS had fixed interest rates for the weighted-average lives of approximately 38.2 months, after which time the interest rates reset and become adjustable. The average length of time until contractual maturity of those mortgages as of March 31, 2006 was 29 years.
      After the reset date, interest rates on our hybrid adjustable rate RMBS securities float based on spreads over various LIBOR indices. These interest rates are subject to caps that limit the amount the applicable interest rate can increase during any year, known as an annual cap, and through the maturity of the applicable security, known as a lifetime cap. The weighted average lifetime cap for the portfolio is an increase of 4.35%; the weighted average maximum increases and decreases are 1.77%. Additionally, the weighted average maximum increases and decreases for agency hybrid RMBS in the first year that the rates are adjustable are 2.88%.
      The following table summarizes our RMBS and our CMBS according to their estimated weighted average life classifications as of March 31, 2006:
                                   
    RMBS   CMBS
         
        Amortized       Amortized
Weighted Average Life   Fair Value   Cost   Fair Value   Cost
                 
    (In thousands)
Less than one year
  $ 1,410     $ 1,451     $     $  
Greater than one year and less than five years
    1,204,884       1,227,140              
Greater than five years
    1,181,093       1,190,803       292,854       298,424  
                         
 
Total
  $ 2,387,387     $ 2,419,394     $ 292,854     $ 298,424  
      The estimated weighted-average lives of the MBS in the tables above are based upon prepayment models obtained through subscription-based financial information service providers.

80


Table of Contents

The prepayment model considers current yield, forward yield, steepness of the yield curve, current mortgage rates, the mortgage rate of the outstanding loan, loan age, margin and volatility.
      The actual weighted-average lives of the MBS in our investment portfolio could be longer or shorter than the estimates in the table above depending on the actual prepayment rates experienced over the lives of the applicable securities and are sensitive to changes in both prepayment rates and interest rates.
Other Fixed Income Securities
      At March 31, 2006, we classified certain short-term non-MBS as available-for-sale. These investments were reported at fair value. These investments are periodically reviewed for other-than-temporary impairment, but their contractual lives are short term in nature.
Equity Securities
      Our investment policies allow us to acquire equity securities, including common and preferred shares issued by other real estate investment trusts. At March 31, 2006, we held two investments in equity securities.
      These investments above are classified as available for sale and thus carried at fair value on our balance sheet with changes in fair value recognized in accumulated other comprehensive income until realized.
Real Estate Loans
      At March 31, 2006, our real estate loans are reported at cost. These investments are periodically reviewed for impairment. As of March 31, 2006, there was $0 of impairment in our real estate loans.
Interest and Principal Paydown Receivable
      At March 31, 2006, we had interest and principal paydown receivable of approximately $25.1 million, of which approximately $0.8 million related to interest that had accrued on securities prior to our purchase of such securities. The total interest and principal paydown receivable amount consisted of approximately $23.6 million relating to our MBS and approximately $1.5 million relating to other investments.
Hedging Instruments
      There can be no assurance that our hedging activities will have the desired beneficial impact on our results of operations or financial condition. Moreover, no hedging activity can completely insulate us from the risks associated with changes in interest rates and prepayment rates. We generally intend to hedge as much of the interest rate risk as Hyperion Brookfield Crystal River determines is in the best interests of our stockholders, after considering the cost of such hedging transactions and our desire to maintain our status as a REIT. Our policies do not contain specific requirements as to the percentages or amount of interest rate risk that our manager is required to hedge.
      As of March 31, 2006, we had engaged in interest rate swaps and interest rate swap forwards as a means of mitigating our interest rate risk on forecasted interest expense associated with repurchase agreements for a specified future time period, which is the term of the swap contract. An interest rate swap is a contractual agreement entered into by two

81


Table of Contents

counterparties under which each agrees to make periodic payments to the other for an agreed period of time based upon a notional amount of principal. Under the most common form of interest rate swap, a series of payments calculated by applying a fixed rate of interest to a notional amount of principal is exchanged for a stream of payments similarly calculated but using a floating rate of interest. This is a fixed-floating interest rate swap. We hedge our floating rate debt by entering into fixed-floating interest rate swap agreements whereby we swap the floating rate of interest on the liability we are hedging for a fixed rate of interest. An interest rate swap forward is an interest rate swap based on an interest rate to be set at an agreed future date. As of March 31, 2006, we were a party to interest rate swaps with maturities ranging from April 2006 to March 2016 with a notional par amount of approximately $1,436.0 million. Under the swap agreements in place at March 31, 2006, we receive interest at rates that reset periodically, generally every three months, and pay a rate fixed at the initiation of and for the life of the swap agreements. The current market value of interest rate swaps is heavily dependent on the current market fixed rate, the corresponding term structure of floating rates (known as the yield curve) as well as the expectation of changes in future floating rates. As expectations of future floating rates change, the market value of interest rate swaps changes. Based on the daily market value of those interest rate swaps and interest rate swap forward contracts, our counterparties may request additional margin collateral or we may request additional collateral from our counterparties to ensure that an appropriate margin account balance is maintained at all times through the maturity of the contracts. At March 31, 2006, the unrealized gain on interest rate swap contracts was $25.4 million due to an increase in prevailing market interest rates.
      As of March 31, 2006, we had engaged in credit default swaps, or CDS, in order to add credit exposure synthetically (by writing protection) that we were not able to access in the cash market. The current CDS holdings offered a more attractive leveraged return than the underlying cash instruments.
      While so far we have only taken synthetic long positions (by writing protection) we may find it attractive to hedge our credit exposure by entering into synthetic short positions (by buying protection) at some point in the future.
      As of March 31, 2006, we were a party to 11 credit default swaps with maturities ranging from February 2035 to July 2043 with a notional par amount of $105.0 million. At March 31, 2006, the unrealized gain on credit default swap contracts was $1.1 million due to an increase in the creditworthiness of the underlying securities.
      As of March 31, 2006, we had engaged in currency swaps as a means of mitigating our currency risk under one of our real estate loans that was denominated in Canadian dollars. As of March 31, 2006, we were a party to one currency swap with a maturity of July 2016 with a notional par amount of Can$50.0 million. The current market value of currency swaps is heavily dependent on the current currency exchange rate and the expectation of changes in future currency exchange rates. As expectations of future currency exchange rates change, the market value of currency swaps changes. Based on the daily market value of those currency swaps, our counterparties may request additional margin collateral or we may request additional collateral from our counterparties to ensure that an appropriate margin account balance is maintained at all times through the maturity of the contracts. At March 31, 2006, the unrealized gain on currency swap contracts was $0.9 million due to a weakening of the Canadian dollar versus the United States dollar.
Liabilities
      We have entered into repurchase agreements to finance some of our purchases of RMBS. These agreements are secured by our RMBS and bear interest rates that have historically moved in close relationship to LIBOR. As of March 31, 2006, we had established 17 borrowing

82


Table of Contents

relationships with various investment banking firms and other lenders. As of March 31, 2006, we were utilizing 12 of those relationships.
      At March 31, 2006, we had outstanding obligations under repurchase agreements with 11 counterparties totaling approximately $2,384.4 million with weighted-average current borrowing rates of 4.77% all of which have maturities of between seven and 504 days. We intend to seek to renew these repurchase agreements as they mature under the then-applicable borrowing terms of the counterparties to the repurchase agreements. At March 31, 2006, the repurchase agreements were secured by MBS and real estate loans and cash with an estimated fair value of approximately $2,559.7 million and had weighted-average maturities of 51 days. The net amount at risk, defined as fair value of the collateral, including restricted cash, minus repurchase agreement liabilities and accrued interest expense, with all counterparties was approximately $160.2 million at March 31, 2006. One of the repurchase agreements is a $275.0 million master repurchase agreement with Wachovia Bank, that has a two year term with a one year renewal option. The Wachovia Bank master repurchase agreement provides for the purchase, sale and repurchase of, commercial and residential mortgage loans, commercial mezzanine loans, B Notes, participation interests in the foregoing, commercial mortgage-backed securities and other mutually agreed upon collateral and bears interest at the varying rates over LIBOR based upon the type of asset included in the repurchase obligation.
      In certain circumstances, we have financed the purchase of securities from a counterparty through a repurchase agreement with the same counterparty pursuant to which we pledge the purchased securities. Currently, we record the acquisition of these securities as assets and the related borrowing under repurchase agreements as financing liabilities on our consolidated balance sheet with changes in the fair value of the securities being recorded as a component of other comprehensive income in our stockholders’ equity. Interest income earned on the securities and interest expense incurred on the repurchase obligations are reported separately on our consolidated income statement. As of March 31, 2006 we had 44 such transactions that were outstanding, and our March 31, 2006 balance sheet included approximately $883.3 million of such securities and approximately $868.6 million of such repurchase agreement liabilities.
      It has come to our attention and to the attention of other market participants, as well as our repurchase agreement counterparties, that SFAS 140 may require a different accounting treatment for such transactions. Under SFAS 140, transactions in which we acquire securities from a counterparty that are financed through a repurchase agreement with the same counterparty will not qualify as a purchase by us if we are not able to conclude that the securities purchased have been legally isolated from the counterparty. If the acquisitions do not qualify as a purchase of securities under SFAS 140, we would not be permitted to include the securities purchased and repurchase agreements on a gross basis on our balance sheet. Additionally, we would not be able to report on a gross basis on our income statement the related interest income earned and interest expense incurred. Instead, we would be required to present the net investment on our balance sheet together with an embedded derivative with the corresponding change in fair value of the derivative being recorded in our income statement. The value of the derivative would reflect not only changes in the value of the underlying securities, but also changes in the value of the underlying credit provided by the counterparty. Although we believe our accounting for these transactions is appropriate, we will continue to evaluate our position as the interpretation of this issue among industry participants and standard setters evolves.
Stockholders’ Equity
      Stockholders’ equity at March 31, 2006 was approximately $383.2 million and included $36.5 million of unrealized losses on securities available for sale and $23.4 million of unrealized

83


Table of Contents

and realized gains on cash flow hedges presented as a component of accumulated other comprehensive loss.
Results of Operations For the Period March 15, 2005 (commencement of operations) to December 31, 2005
Summary
      Our net income for the period was $13.9 million or $0.80 per weighted-average basic and diluted share outstanding.
Net Interest Income
      Net interest income for the period was $31.2 million. Gross interest income of $79.6 million primarily consisted of $71.9 million of interest income from MBS, $3.6 million of interest income from real estate loans and $2.3 million of interest income from ABS. Interest expense of $48.4 million consisted primarily of $43.2 million related to repurchase agreements and $3.2 million related to interest rate swaps.
Expenses
      Expenses for the period totaled $8.4 million, which consisted primarily of base management fees of approximately $4.8 million, amortization of approximately $0.6 million related to restricted stock and options granted to our Manager, professional fees of $2.2 million and start-up costs of $0.3 million.
      Our Manager has waived its right to request reimbursement from us of third-party expenses that it incurs through June 30, 2006, which amount otherwise would have been required to be reimbursed. The management agreement with Hyperion Brookfield Crystal River, which was negotiated before our business model was implemented, provides that we will reimburse our Manager for certain third party expenses that it incurs on our behalf, including rent and utilities. Hyperion Brookfield incurs such costs and did not allocate any such expenses to our Manager in 2005 or in the first quarter of 2006 as our Manager’s use of such services were deemed to be immaterial. In 2007, Hyperion Brookfield will reevaluate whether any such rent and utility costs will be allocated to our Manager and if so, we will be responsible for reimbursing such costs allocable to our operations absent any further waiver of reimbursement by our Manager. There are no contractual limitations on our obligation to reimburse our Manager for third party expenses and our Manager may incur such expenses consistent with the grant of authority provided to it pursuant to the management agreement without any additional approval of our board of directors being required. In addition, our Manager may defer our reimbursement obligation from any quarter to a future period; provided, however, that we will record any necessary accrual for any such reimbursement obligations when required by generally accepted accounting principles and our Manager has advised us that it will promptly invoice us for such reimbursements consistent with sound financial accounting policies.
Other Revenues (Expenses)
      Other revenues (expenses) for the period totaled approximately $(8.8) million, which consisted primarily of $2.5 million of realized and unrealized losses on derivatives, $0.5 million of realized net losses on the sale of real estate loans and securities available for sale and $5.8 million of losses on impairment of securities available for sale.

84


Table of Contents

Results of Operations For the Three Months Ended March 31, 2006
Summary
      Our net income for the period was $15.4 million or $0.88 per weighted-average basic and diluted share outstanding.
Net Interest Income
      Net interest income for the period was $12.2 million. Gross interest income of $41.1 million primarily consisted of $36.8 million of interest income from MBS, $2.6 million of interest income from real estate loans and $1.0 million of interest income from ABS. Interest expense of $28.9 million consisted primarily of $25.7 million related to repurchase agreements and $2.9 million related to CDOs, which was partially offset by $0.6 million of interest income from interest rate swaps.
Expenses
      Expenses for the period totaled $2.8 million, which consisted primarily of base management fees of approximately $1.5 million, amortization of approximately $0.2 million related to restricted stock and options granted to our Manager and professional fees of $0.8 million.
      Our Manager has waived its right to request reimbursement from us of third-party expenses that it incurs through June 30, 2006, which amount otherwise would have been required to be reimbursed. The management agreement with Hyperion Brookfield Crystal River, which was negotiated before our business model was implemented, provides that we will reimburse our Manager for certain third party expenses that it incurs on our behalf, including rent and utilities. Hyperion Brookfield incurs such costs and did not allocate any such expenses to our Manager in 2005 or in the first quarter of 2006 as our Manager’s use of such services were deemed to be immaterial. In 2007, Hyperion Brookfield will reevaluate whether any such rent and utility costs will be allocated to our Manager and if so, we will be responsible for reimbursing such costs allocable to our operations absent any further waiver of reimbursement by our Manager. There are no contractual limitations on our obligation to reimburse our Manager for third party expenses and our Manager may incur such expenses consistent with the grant of authority provided to it pursuant to the management agreement without any additional approval of our board of directors being required. In addition, our Manager may defer our reimbursement obligation from any quarter to a future period; provided, however, that we will record any necessary accrual for any such reimbursement obligations when required by generally accepted accounting principles and our Manager has advised us that it will promptly invoice us for such reimbursements consistent with sound financial accounting policies.
Other Revenues (Expenses)
      Other revenues (expenses) for the period totaled approximately $6.0 million, which consisted primarily of $7.9 million of realized and unrealized gains on derivatives, which was offset in part by $0.6 million of realized net losses on the sale of securities available for sale and a $1.3 million loss on impairment of securities available for sale.
Results of Operations For the Period March 15, 2005 (commencement of operations) to March 31, 2005
Summary
      Our net income for the period was $0.1 million or $0.01 per weighted-average basic and diluted share outstanding.

85


Table of Contents

Net Interest Income
      Net interest income for the period was $0.6 million which primarily consisted of $0.5 million of interest income from MBS.
Expenses
      Expenses for the period totaled $0.7 million, which consisted primarily of base management fees of approximately $0.3 million and start-up costs of $0.3 million.
Liquidity and Capital Resources
      We held cash and cash equivalents of approximately $21.9 million at March 31, 2006, which excludes restricted cash of approximately $63.1 million that is used to collateralize certain of our repurchase facilities.
      Our operating activities provided net cash of approximately $8.5 million for the three months ended March 31, 2006 primarily as a result of net income of $15.4 million, impairment of available for sale securities of $1.3 million, and a net increase in accounts payable and accrued liabilities, due to Manager and interest payable of approximately $3.0 million, offset in part by non-cash unrealized gains on derivatives of $7.6 million non-cash, accretion of discount on assets of $2.0 million and increases in interest receivable of $2.8 million.
      Our operating activities provided net cash of approximately $30.3 million during the period March 15, 2005 (commencement of operations) to December 31, 2005 primarily as a result of net income of $13.9 million, impairment of available for sale securities of $5.8 million, unrealized loss on derivatives of $2.6 million and the excess of interest expense payments that were recognized but not yet paid over interest income receipts that were recognized but not yet received.
      Our investing activities used net cash of $292.8 million for the three months ended March 31, 2006 primarily from the purchase of securities available for sale of $595.5 million and the funding or purchase of real estate loans totaling $6.9 million, partially offset by receipt of principal paydowns on securities available for sale and real estate loans of approximately $111.7 million and $198.3 million of proceeds from the sale of securities available for sale and real estate loans.
      Our investing activities used net cash of $2,619.7 million during the period March 15, 2005 (commencement of operations) to December 31, 2005 primarily from the purchase of securities available for sale of $2,772.9 million and the funding or purchase of real estate loans totaling $174.9 million, partially offset by receipt of principal paydowns on securities available for sale of approximately $297.1 million and $32.2 million of proceeds from the sale of real estate loans.
      Our financing activities provided net cash of $284.8 million for the three months ended March 31, 2006 primarily from the net proceeds from borrowings under repurchase agreements, including with related parties, of $390.1 million, partially offset by principal repayments on CDOs of $16.3 million, repayment of a note payable to a related party of $35.0 million and $52.8 million of restricted cash used to collateralize certain financings.
      Our financing activities provided net cash of $2,610.9 million during the period March 15, 2005 (commencement of operations) to December 31, 2005 primarily from the issuance of common stock, net of offering costs, of $405.6 million, net proceeds from CDO issuances of $227.5 million, net proceeds from borrowings under repurchase agreements of $1,977.9 million and net proceeds of $35.0 million from borrowings under a note payable to a related party,

86


Table of Contents

partially offset by dividends paid to stockholders of $27.1 million and $18.5 million of restricted cash used to collateralize certain financings.
      Our source of funds as of March 31, 2006, excluding our March 2005 private offering, consisted of net proceeds from repurchase agreements totaling approximately $2,384.4 million with a weighted-average current borrowing rate of 4.77%, which we used to finance the acquisition of securities available for sale. We expect to continue to borrow funds in the form of repurchase agreements. As of March 31, 2006 we had established 17 borrowing arrangements with various investment banking firms and other lenders, 12 of which were in use on March 31, 2006. Increases in short-term interest rates could negatively impact the valuation of our mortgage-related assets, which could limit our borrowing ability or cause our lenders to initiate margin calls. Amounts due upon maturity of our repurchase agreements will be funded primarily through the rollover/reissuance of repurchase agreements and monthly principal and interest payments received on our mortgage-backed securities.
Off-Balance Sheet Arrangements
      As of March 31, 2006, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 31, 2006, we had outstanding commitments to fund real estate construction loans of $24.1 million, and as of such date, advances of $20.8 million had been made under these commitments.
Contractual Obligations and Commitments
      As of March 15, 2005, we had entered into a management agreement with Hyperion Brookfield Crystal River. Hyperion Brookfield Crystal River is entitled to receive a base management fee, incentive compensation, reimbursement of certain expenses and, in certain circumstances, a termination fee, all as described in the management agreement. Such fees and expenses do not have fixed and determinable payments. The base management fee is payable monthly in arrears in an amount equal to 1/12 of our equity (as defined in the management agreement) times 1.50%. Hyperion Brookfield Crystal River uses the proceeds from its management fee in part to pay compensation to its officers and employees who, notwithstanding that certain of them also are our officers, receive no cash compensation directly from us. Hyperion Brookfield Crystal River will receive quarterly incentive compensation in an amount equal to the product of: (a) 25% of the dollar amount by which (i) our net income (determined in accordance with GAAP) and before non-cash equity compensation expense and before incentive compensation, for the quarter per common share (based on the weighted average number of common shares outstanding for the quarter) exceeds (ii) an amount equal to (A) the weighted average of the price per share of the common shares in the March 2005 private offering and the prices per common shares in any subsequent offerings by us (including this offering), in each case at the time of issuance thereof, multiplied by (B) the greater of (1) 2.4375% and (2) 0.50% plus one-fourth of the Ten Year Treasury Rate for such quarter, multiplied by (b) the weighted average number of shares of common stock outstanding during the quarter; provided, that the foregoing calculation of incentive compensation shall be adjusted to exclude one-time events pursuant to changes in GAAP, as well as non-cash charges after discussion between Hyperion Brookfield Crystal River and our independent directors and approval by a majority of our independent directors in the case of non-cash charges. In accordance with the management agreement, our Manager and the independent members of our board of directors have agreed to adjust the calculation of the Manager’s incentive fee to exclude non-cash adjustments required by SFAS 133 relating to the valuation of interest rate swaps, currency swaps and credit default swaps. See note 10 to our March 31, 2006 unaudited consolidated financial statements included elsewhere herein.

87


Table of Contents

      As of March 31, 2006, we had outstanding commitments to fund real estate construction loans of $24.1 million, and as of such date, advances of $20.8 million had been made under these commitments.
      The following table presents certain information regarding our debt obligations as of March 31, 2006:
                   
        Weighted-Average
        Maturity of Repurchase
Repurchase Agreement Counterparties   Amount at Risk(1)   Agreement in Days
         
    (In thousands)
Banc of America Securities LLC
  $ 16,483       29  
Bear, Stearns & Co. Inc. 
    20,554       30  
Credit Suisse First Boston LLC
    6,849       60  
Deutsche Bank Securities Inc. 
    3,171       26  
Greenwich Capital Markets, Inc. 
    10,162       47  
Lehman Brothers Inc. 
    36,005       23  
Merrill Lynch, Pierce, Fenner & Smith Incorporated
    5,199       24  
Morgan Stanley & Co. Incorporated
    11,445       32  
Trilon International, Inc. 
    2,480       45  
Wachovia Capital Markets, LLC
    14,267       53  
Wachovia Bank, National Association
    33,627       504  
             
 
Total
  $ 160,242       51  
             
 
(1)  Equal to the fair value of collateral, including restricted cash, minus repurchase agreement liabilities and accrued interest expense.
     We purchase securities on a trade date that is prior to the related settlement date. As of March 31, 2006, we owed $5.5 million for our purchase of securities on or prior to March 31, 2006 that settled after March 31, 2006.
      The repurchase agreements for our repurchase facilities generally do not include substantive provisions other than those contained in the standard master repurchase agreement as published by the Bond Market Association. As noted below, some of our master repurchase agreements that were in effect as of July 21, 2006 contain negative covenants requiring us to maintain certain levels of net asset value, tangible net worth and available funds and comply with interest coverage ratios, leverage ratios and distribution limitations. One of our master repurchase agreements provides that it may be terminated if, among other things, certain material decreases in net asset value occur, our chief executive officer ceases to be involved in the day-to-day operations of our Manager, we lose our REIT status or our Manager is terminated. Generally, if we violate one of these covenants, the counterparty to the master repurchase agreement has the option to declare an event of default, which would accelerate the repurchase date. If such option is exercised, then all of our obligations would come due, including either purchasing the securities or selling the securities, as the case may be. The counterparty to the master repurchase agreement, if the buyer in such transaction, for example, will be entitled to keep all income paid after the exercise, which will be applied to the aggregate unpaid repurchase price and any other amounts owed by us, and we are required to deliver any purchased securities to the counterparty.
      Our master repurchase agreement with Banc of America Securities LLC contains a restrictive covenant that requires our net asset value to be no less than the higher of

88


Table of Contents

  •  the NAV Floor (defined below) and
 
  •  50% of our net asset value as of December 31 of the prior year.
      For 2006, the “NAV Floor” is $250.0 million. For all future periods, the NAV Floor is equal to the higher of
  •  the NAV Floor and
 
  •  50% of our net asset value,
in each case as of December 31 of the prior year.
      Our master repurchase agreements with Credit Suisse First Boston, LLC and Credit Suisse First Boston, (Europe) Limited each contain a restrictive covenant that would trigger an event of default if our net asset value declines:
  •  by 30% or more from the highest net asset value in the preceding 12-month period then ending,
 
  •  by 20% or more from the highest net asset value in the preceding three-month period then ending,
 
  •  by 15% or more from the highest net asset value in the preceding one-month period then ending, or
 
  •  by 50% or more from the highest net asset value since the date of the master repurchase agreement
or, if we or our Manager receive redemption notices that will result in an net asset value drop to the foregoing levels or below $175.0 million.
      Our master repurchase agreement with Wachovia Bank, National Association contains the following restrictive covenants:
  •  We may not permit the ratio of the sum of adjusted EBITDA (as defined in the master repurchase agreement) to interest expense to be less than 1.25 to 1.00.
 
  •  We may not permit our debt to equity ratio to be greater than 10:1.
 
  •  We may not declare or make any payment on account of, or set apart assets for, a sinking or other analogous fund for the purchase, redemption, defeasance, retirement or other acquisition of any of our equity interests, or make any other distribution in respect thereof, either directly or indirectly, whether in cash or property or in our obligations, except, so long as there is no default, event of default or “Margin Deficit” that has occurred and is continuing. We may (i) make such payments solely to the extent necessary to preserve our status as a REIT and (ii) make additional payments in an amount equal to 100% of funds from operations. A Margin Deficit occurs when the aggregate market value of all the purchased securities subject to all repurchase transactions in which a party is acting as buyer is less than the buyer’s margin amount for all transactions, which is the amount obtained by application of the buyer’s margin percentage to the repurchase price. The margin percentage is a percentage agreed to by the buyer and seller or the percentage obtained by dividing the market value of the purchased securities on the purchase date by the purchase price on the purchase date.
 
  •  Our tangible net worth may not be less than the sum of $300.0 million plus the proceeds from all equity issuances, net of investment banking fees, legal fees, accountants’ fees, underwriting discounts and commissions and other customary fees and expenses that we actually incur.
 
  •  We may not permit the amount of our cash and cash equivalents at any time to be less than $10.0 million during the first year following the closing date of the master

89


Table of Contents

  repurchase agreement or less than $15.0 million after the first year following the closing date, in either case after giving effect to any requested repurchase transaction.

      We intend to continue to make regular quarterly distributions of all or substantially all of our REIT taxable income to holders of our common stock. In order to maintain our qualification as a REIT and to avoid corporate-level income tax on the income we distribute to our stockholders, we are required to distribute at least 90% of our REIT taxable income (which includes net short-term capital gains) on an annual basis. This requirement can impact our liquidity and capital resources. On June 21, 2005, we declared a quarterly distribution of $0.25 per share of our common stock, payable on July 13, 2005, to stockholders of record as of June 30, 2005. In connection with that distribution, we distributed an aggregate of approximately $4.4 million from uninvested cash. In addition, on September 28, 2005, we declared a quarterly distribution of $0.575 per share of our common stock, payable on October 13, 2005, to stockholders of record as of September 30, 2005. In connection with such distribution, we distributed an aggregate of approximately $10.1 million. On December 23, 2005, we declared a quarterly distribution of $0.725 per share of our common stock, payable on December 30, 2005, to stockholders of record as of December 23, 2005. In connection with such distribution, we distributed an aggregate of approximately $12.7 million. On March 31, 2006, we declared a quarterly distribution of $0.725 per share of our common stock, payable on April 17, 2006, to stockholders of record as of March 31, 2006. In connection with such distribution, we distributed an aggregate of approximately $12.7 million. On June 23, 2006, we declared a quarterly distribution of $0.725 per share of our common stock, payable on July 21, 2006, to stockholders of record on June 30, 2006. In connection with such distribution, we distributed an aggregate of approximately $12.7 million. All distributions through December 31, 2005 represented distributions of taxable earnings and profits; none represented a return of capital, and all distributions from and including October 13, 2005 were funded primarily from operating cash flows, and as necessary, to a lesser extent from the sale or repayment of our investments or from borrowings under our credit facilities or master repurchase agreements, and were not funded out of the offering proceeds from our March 2005 private offering.
      For our short-term (one year or less) and long-term liquidity, which includes investing and compliance with collateralization requirements under our repurchase agreements (if the pledged collateral decreases in value or in the event of margin calls created by prepayments of the pledged collateral), we also rely on the cash flow from operations, primarily monthly principal and interest payments to be received on our mortgage-backed securities, cash flow from the sale of securities as well as any primary securities offerings authorized by our board of directors.
      Based on our current portfolio, leverage rate and available borrowing arrangements, including our $275.0 million master repurchase facility with Wachovia Bank, we believe that the net proceeds of this offering together with existing equity capital, combined with the cash flow from operations and the utilization of borrowings, will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements such as to fund our investment activities, pay fees under our management agreement, fund our distributions to stockholders and for general corporate expenses. However, an increase in prepayment rates substantially above our expectations could cause a temporary liquidity shortfall due to the timing of the necessary margin calls on the financing arrangements and the actual receipt of the cash related to principal paydowns. If our cash resources are at any time insufficient to satisfy our liquidity requirements, we may have to sell debt or additional equity securities. If required, the sale of MBS or real estate loans at prices lower than their carrying value would result in losses and reduced income. Although we have achieved a leverage rate within our targeted leverage range as of March 31, 2006, we have additional capacity to leverage our equity further should the need for additional short-term (one year or less) liquidity arise.

90


Table of Contents

      Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements in excess of our borrowing capacity under our $275.0 million master repurchase facility with Wachovia Bank will be subject to obtaining additional debt financing and equity capital. We may increase our capital resources by making public offerings of equity securities, possibly including classes of preferred stock, common stock, commercial paper, medium-term notes, CDOs, collateralized mortgage obligations and senior or subordinated notes. Such financing will depend on market conditions for capital raises and for the investment of any proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock.
      We generally seek to borrow between four and eight times the amount of our equity. At March 31, 2006, our total debt was approximately $2,595.6 million, which represented a leverage ratio of approximately 6.8 times. If our leverage ratio at March 31, 2006 were eight times our equity, our total debt would have been approximately $3,065.4 million, which represents an additional $469.8 million of borrowing.
REIT Taxable Income
      REIT taxable income is calculated according to the requirements of the Internal Revenue Code, rather than GAAP. The following table reconciles GAAP net income to REIT taxable income for the period March 15, 2005 (commencement of operations) to December 31, 2005 (in thousands):
             
GAAP net income
  $ 13,948  
Adjustments to GAAP net income:
       
 
Net tax adjustments related to organization costs
    320  
 
Net tax adjustments related to grant of restricted stock
    554  
 
Net tax adjustments related to grant of options
    73  
 
Net tax adjustments related to discount accretion and premium amortization
    210  
 
Book derivative income in excess of tax income
    4,390  
 
Capital loss limitations
    2,228  
 
Impairment losses not deductible for tax purposes
    5,782  
       
   
Net adjustments to GAAP net income
    13,557  
       
Estimated REIT taxable income
  $ 27,505  
       

91


Table of Contents

      The following table reconciles GAAP net income to REIT taxable income for the three months ended March 31, 2006 (in thousands):
             
GAAP net income
  $ 15,444  
Adjustments to GAAP net income:
       
 
Net tax adjustments related to organization costs
    (6 )
 
Net tax adjustments related to grant of restricted stock
    (420 )
 
Net tax adjustments related to grant of options
    40  
 
Net tax adjustments related to discount accretion and premium amortization
    200  
 
Book derivative income in excess of tax income
    (7,568 )
 
Capital loss limitations
    1,174  
 
Impairment losses not deductible for tax purposes
    1,258  
       
   
Net adjustments to GAAP net income
    (5,322 )
       
Estimated REIT taxable income
  $ 10,122  
       
      We believe that the presentation of our REIT taxable income is useful to investors because it demonstrates to investors the minimum amount of distributions we must make in order to maintain our qualification as a REIT and not be obligated to pay federal and state income taxes. However, beyond our intent to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification, we do not expect that the amount of distributions we make will necessarily correlate to our REIT taxable income. Rather, we expect to determine the amount of distributions we make based on our cash flow and what we believe to be an appropriate and competitive dividend yield relative to other specialty finance companies and mortgage REITs. REIT taxable income will not necessarily bear any close relation to cash flow. Accordingly, we do not consider REIT taxable income to be a reliable measure of our liquidity although the related distribution requirement can impact our liquidity and capital resources. Moreover, there are limitations associated with REIT taxable income as a measure of our financial performance over any period. As a result, REIT taxable income should not be considered as a substitute for our GAAP net income as a measure of our financial performance.
Inflation
      Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions are determined by our board of directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and or fair market value without considering inflation.
Quantitative and Qualitative Disclosures About Market Risk
      As of March 31, 2006, the primary component of our market risk was interest rate risk, as described below. While we do not seek to avoid risk completely, we do believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.

92


Table of Contents

Interest Rate Risk
      We are subject to interest rate risk in connection with most of our investments and our related debt obligations, which are generally repurchase agreements of limited duration that are periodically refinanced at current market rates. We mitigate this risk through utilization of derivative contracts, primarily interest rate swap agreements.
Yield Spread Risk
      Most of our investments are also subject to yield spread risk. The majority of these securities are fixed rate securities, which are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the market, as based on their credit relative to U.S. Treasuries. An excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher or “wider” spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value these securities. Under these conditions, the value of our real estate securities portfolio would tend to decrease. Conversely, if the spread used to value these securities were to decrease or “tighten,” the value of our real estate securities would tend to increase. Such changes in the market value of our real estate securities portfolio may affect our net equity or cash flow either directly through their impact on unrealized gains or losses on available-for-sale securities by diminishing our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.
Effect on Net Interest Income
      We fund our investments with short-term borrowings under repurchase agreements. During periods of rising interest rates, the borrowing costs associated with those investments tend to increase while the income earned on such investments could remain substantially unchanged. This results in a narrowing of the net interest spread between the related assets and borrowings and may even result in losses.
      On March 31, 2006, we were party to 46 interest swap contracts. The following table summarizes the expiration dates of these contracts and their notional amounts (in thousands):
         
Expiration Date   Notional Amount
     
April 2006
  $ 30,000  
October 2006
    5,000  
November 2006
    10,000  
February 2007
    70,000  
March 2007
    70,000  
April 2007
    38,000  
May 2007
    20,000  
August 2007
    65,000  
October 2007
    55,000  
November 2007
    85,000  
January 2008
    55,000  
February 2008
    95,000  
March 2008
    136,000  
April 2008
    130,000  
May 2008
    20,000  
October 2008
    60,000  
November 2008
    100,000  

93


Table of Contents

         
Expiration Date   Notional Amount
     
January 2009
    10,000  
April 2009
    10,000  
July 2009
    15,000  
August 2009
    10,000  
October 2009
    15,000  
January 2010
    15,000  
February 2010
    20,000  
March 2010
    52,500  
April 2010
    30,000  
August 2010
    10,000  
January 2011
    30,000  
December 2013
    53,499  
June 2015
    14,000  
October 2015
    40,000  
January 2016
    42,000  
March 2016
    25,000  
       
TOTAL
  $ 1,435,999  
       
      Hedging techniques are partly based on assumed levels of prepayments of our fixed-rate and hybrid adjustable-rate RMBS. If prepayments are slower or faster than assumed, the life of the RMBS will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns.
Extension Risk
      We invest in RMBS, some of which have interest rates that are fixed for the first few years of the loan (typically three, five, seven or ten years) and thereafter reset periodically on the same basis as adjustable-rate RMBS. We compute the projected weighted-average life of our RMBS based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgages. In general, when a fixed-rate or hybrid adjustable-rate residential mortgage-backed security is acquired with borrowings, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related RMBS. This strategy is designed to protect us from rising interest rates because the borrowing costs are fixed for the duration of the fixed-rate portion of the related residential mortgage-backed security.
      However, if prepayment rates decrease in a rising interest rate environment, the life of the fixed-rate portion of the related RMBS could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed after the end of the hedging instrument while the income earned on the RMBS would remain fixed. This situation may also cause the market value of our RMBS to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.

94


Table of Contents

Hybrid Adjustable-Rate RMBS Interest Rate Cap Risk
      We also invest in hybrid adjustable-rate RMBS which are based on mortgages that are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the security’s interest yield may change during any given period. However, our borrowing costs pursuant to our repurchase agreements will not be subject to similar restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings could increase without limitation by caps, while the interest-rate yields on our hybrid adjustable-rate RMBS would effectively be limited by caps. This problem will be magnified to the extent we acquire hybrid adjustable-rate RMBS that are not based on mortgages which are fully indexed. In addition, the underlying mortgages may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in our receipt of less cash income on our hybrid adjustable-rate RMBS than we need in order to pay the interest cost on our related borrowings. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would harm our financial condition, cash flows and results of operations.
Interest Rate Mismatch Risk
      We intend to continue to fund a substantial portion of our investments with borrowings that, after the effect of hedging, have interest rates based on indices and repricing terms similar to, but of somewhat shorter maturities than, the interest rate indices and repricing terms of our investments. Thus, we anticipate that in most cases the interest rate indices and repricing terms of our mortgage assets and our funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. Therefore, our cost of funds would likely rise or fall more quickly than would our earnings rate on assets. During periods of changing interest rates, such interest rate mismatches could negatively impact our financial condition, cash flows and results of operations. To mitigate interest rate mismatches, we may utilize hedging strategies discussed above.
      Our analysis of risks is based on management’s experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in this prospectus.
Prepayment Risk
      Prepayments are the full or partial repayment of principal prior to the original term to maturity of a mortgage loan and typically occur due to refinancing of mortgage loans. Prepayment rates for existing RMBS generally increase when prevailing interest rates fall below the market rate existing when the underlying mortgages were originated. In addition, prepayment rates on adjustable-rate and hybrid adjustable-rate RMBS generally increase when the difference between long-term and short-term interest rates declines or becomes negative. Prepayments of RMBS could harm our results of operations in several ways. Some adjustable-rate mortgages underlying our adjustable-rate RMBS may bear initial “teaser” interest rates that are lower than their “fully-indexed” rates, which refers to the applicable index rates plus a margin. In the event that such an adjustable-rate mortgage is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, the holder of the related residential mortgage-backed security would have held such security while it was less profitable and lost the opportunity to receive interest at the fully-indexed rate over the expected life of the adjustable-rate residential mortgage-backed security. Additionally, we currently own mortgage assets that were purchased at a premium. The prepayment of such assets at a rate faster than anticipated would result in a

95


Table of Contents

write-off of any remaining capitalized premium amount and a consequent reduction of our net interest income by such amount. Finally, in the event that we are unable to acquire new mortgage assets to replace the prepaid assets, our financial condition, cash flow and results of operations could be negatively impacted.
Effect on Fair Value
      Another component of interest rate risk is the effect changes in interest rates will have on the market value of our assets. We face the risk that the market value of our assets will increase or decrease at different rates than that of our liabilities, including our hedging instruments. We primarily assess our interest rate risk by estimating the duration of our assets and the duration of our liabilities. Duration essentially measures the market price volatility of financial instruments as interest rates change. We generally calculate duration using various financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities.
      The following interest rate sensitivity analysis is measured using an option-adjusted spread model combined with a proprietary prepayment model. We shock the curve up and down 100 basis points and analyze the change in interest rates, prepayments and cash flows through a Monte Carlo simulation. We then calculate an average price for each scenario which is used in our risk management analysis.
      The following sensitivity analysis table shows the estimated impact on the fair value of our interest rate-sensitive investments, repurchase agreement liabilities, CDO liabilities and swaps, at March 31, 2006, assuming rates instantaneously fall 100 basis points and rise 100 basis points:
                         
    Interest Rates       Interest Rates
    Fall 100       Rise 100
    Basis Points   Unchanged   Basis Points
             
    (Dollars in thousands)
Mortgage assets and other securities available for sale(1)
                       
Fair value
  $ 2,802,216     $ 2,735,996     $ 2,660,343  
Change in fair value
  $ 66,220     $ 0     $ (75,653 )
Change as a percent of fair value
    2.42 %     0.00 %     (2.77 )%
 
Real estate loans
                       
Fair value
  $ 136,648     $ 132,805     $ 129,269  
Change in fair value
  $ 3,843     $ 0     $ (3,536 )
Change as a percent of fair value
    2.89 %     0.00 %     (2.66 )%
 
Repurchase agreements(2)
                       
Fair value
  $ (2,384,415 )   $ (2,384,415 )   $ (2,384,415 )
Change in fair value
    n/m       n/m       n/m  
Change as a percent of fair value
    n/m       n/m       n/m  
 
CDO liabilities
                       
Fair value
  $ (211,251 )   $ (211,210 )   $ (209,750 )
Change in fair value
  $ (41 )     0     $ 1,460  
Change as a percent of fair value
    (0.19 )%     0.00 %     0.69 %
 
Designated and undesignated interest rate swaps
                       
Fair value
  $ (2,722 )   $ 25,387     $ 52,378  
Change in fair value
  $ (28,109 )   $ 0     $ 26,991  
Change as a percent of notional value
    (1.96 )%     0.00 %     1.88 %

96


Table of Contents

                         
    Interest Rates       Interest Rates
    Fall 100       Rise 100
    Basis Points   Unchanged   Basis Points
             
    (Dollars in thousands)
Designated and undesignated credit default swaps
                       
Fair value
  $ 1,043     $ 1,050     $ 1,054  
Change in fair value
  $ (7 )   $ 0     $ 4  
Change as a percent of notional value
    (0.01 )%     0.00 %     0.00 %
 
Designated and undesignated foreign currency swap
                       
Fair value
  $ (2,526 )   $ 933     $ 4,182  
Change in fair value
  $ (3,459 )   $ 0     $ 3,249  
Change as a percent of notional value
    (7.44 )%     0.00 %     6.99 %
 
(1)  The fair value of other available-for-sale investments that are sensitive to interest rate changes are included.
 
(2)  The fair value of the repurchase agreements would not change materially due to the short-term nature of these instruments.
n/m = not meaningful
     It is important to note that the impact of changing interest rates on fair value can change significantly when interest rates change beyond 100 basis points from current levels. Therefore, the volatility in the fair value of our assets could increase significantly when interest rates change beyond 100 basis points. In addition, other factors impact the fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, in the event of changes in actual interest rates, the change in the fair value of our assets would likely differ from that shown above, and such difference might be material and adverse to our stockholders.
Risk Management
      To the extent consistent with maintaining our REIT status, we seek to manage our interest rate risk exposure to protect our portfolio of RMBS and other mortgage securities and related debt against the effects of major interest rate changes. We generally seek to manage our interest rate risk by:
  •  monitoring and adjusting, if necessary, the reset indices and interest rates related to our MBS and our borrowings;
 
  •  attempting to structure our borrowing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;
 
  •  using derivatives, financial futures, swaps, options, caps, floors and forward sales, to adjust the interest rate sensitivity of our MBS and our borrowings; and
 
  •  actively managing, on an aggregate basis, the interest rate indices, interest rate adjustment periods, and gross reset margins of our MBS and the interest rate indices and adjustment periods of our borrowings.

97


Table of Contents

BUSINESS
Our Company
      We were organized on January 25, 2005 by Hyperion Brookfield, who may be deemed to be our promoter, and completed a private offering of our common stock in March 2005, in which we raised net proceeds of approximately $405.6 million. In our March 2005 private offering, Deutsche Bank Securities Inc. and Wachovia Capital Markets, LLC served as the initial purchasers/placement agents. In our March 2005 private offering, an indirect subsidiary of Brookfield purchased 800,000 shares, or 4.5% (assuming all outstanding options have vested and are exercised), of our common stock and certain of our executive officers, directors and members of our strategic advisory committee, and certain executive officers of Hyperion Brookfield Crystal River and Hyperion Brookfield that provide services to us collectively purchased 183,800 shares, or 1.0% (assuming all outstanding options have vested and are exercised), of our common stock. In addition, upon completion of our March 2005 private offering, we issued to Hyperion Brookfield Crystal River, and it subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us, 84,000 shares of restricted stock and we granted to Hyperion Brookfield Crystal River, and it subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us, options to purchase 126,000 shares of our common stock with an exercise price of $25.00 per share, representing in the aggregate approximately 1.2% of the outstanding shares of our common stock as of the date of this prospectus, assuming all outstanding options have vested and are exercised. Following completion of this offering, Hyperion Brookfield, Brookfield, Hyperion Brookfield Crystal River and their affiliates, including our executive officers, members of our strategic advisory committee and certain of our directors, as well as our independent directors, will collectively own 1,105,800 shares of our common stock, representing 4.3% of our outstanding shares of common stock, and will have options to purchase an additional 130,000 shares of our common stock representing an additional 0.5% of our outstanding shares of common stock, in each case, assuming all outstanding options have vested and are exercised.
      We currently target and expect to continue to target asset classes that provide consistent, stable risk-adjusted returns. We expect to continue to leverage our investments to enhance returns on our investments. We make portfolio allocation decisions based on various factors, including expected cash yield, relative value, risk-adjusted returns, current and projected credit fundamentals, current and projected macroeconomic considerations, current and projected supply and demand, credit and market risk concentration limits, liquidity, cost and availability of financing and hedging activities, as well as maintaining our REIT qualification and our exclusion from regulation under the Investment Company Act. These factors place significant limits on the amount of certain of our targeted investments such as aircraft and consumer ABS, non-real estate-related CDOs and other equity investments that we may include in our portfolio.
Our Manager
      We are externally managed and advised by Hyperion Brookfield Crystal River, a wholly-owned subsidiary of Hyperion Brookfield formed on January 25, 2005 solely for the purpose of serving as our manager, whose officers consist of investment professionals and employees of Hyperion Brookfield or one or more of its affiliates. As of July 21, 2006, Hyperion Brookfield Crystal River had no employees and we and Hyperion Brookfield Crystal River had no independent officers and were entirely dependent on Hyperion Brookfield for the day-to-day management of our operations. While our directors periodically review our investment

98


Table of Contents

guidelines and our investment portfolio, other than any investments involving our affiliates or our sub-advisors’ affiliates or investments proposed by Brookfield Sub-Advisor, which they are required to review and approve prior to such investment being made, they do not review all of our proposed investments. Our officers, as employees of Hyperion Brookfield or one of its affiliates, have been delegated the responsibility to review and make investments consistent with our investment strategy as articulated by our strategic advisory committee. Hyperion Brookfield Crystal River did not have any experience managing a REIT prior to its entering into a management agreement with us and it currently does not provide management or other services to entities other than us. Prior to our formation, Hyperion Brookfield had no prior experience managing a REIT. However, Hyperion Brookfield has a successful 17-year history of acquiring and managing MBS and ABS through an investment philosophy predicated on the concept of relative value. Hyperion Brookfield was founded in 1989 by Lewis Ranieri, an MBS market pioneer and former Vice Chairman of Salomon Brothers, Inc. Today, Hyperion Brookfield employs approximately 85 professionals and is dedicated to providing investment management services for institutional clients and mutual funds through the management of core fixed income portfolios as well as separately managed portfolios of RMBS, CMBS and ABS. As of March 31, 2006, Hyperion Brookfield and its affiliates managed approximately $19.3 billion in assets for institutional clients, closed-end investment companies and CDOs.
      We and our Manager believe that the most significant opportunities for out-performance exist between and within our target asset classes, as well as among individual securities. Our Manager will strive to identify and capitalize on relative value anomalies through the assessment of relationships between supply and demand, changes in interest rates and associated prepayment expectations, market volatility and investor trends. We and our Manager believe that, on a long-term basis, this investment approach will provide attractive risk-adjusted returns.
      We are able to draw upon the unique resources of two sub-advisors to enhance the management of our portfolio:
  •  Brookfield Sub-Advisor. For investments in mortgages and other non-commercial real estate financing instruments, commercial real estate, hydroelectric, gas- and coal-fired power generating facilities, timber assets and certain other asset classes, we are able to draw upon a sub-advisory relationship with Brookfield Sub-Advisor. Through this relationship, we are able to access the resources of Brookfield, an asset manager focused on property, power and infrastructure assets with approximately $50.0 billion of assets under management as of March 31, 2006. Brookfield’s portfolio of high quality assets includes interests in approximately 70 commercial properties and 140 power generating plants.
 
  •  Ranieri & Co. Our Manager utilizes Ranieri & Co. to provide guidance on macroeconomic trends, market trends in MBS and overall portfolio strategy. We expect that our relationship with Ranieri & Co. will continue to provide us with access to its relationships for investment and financing opportunities. Ranieri & Co is managed by Lewis Ranieri, whose leading role in the development of MBS has earned him recognition as a pioneer of the securitized mortgage market in the U.S.
      We believe our relationship with Hyperion Brookfield, our Manager and our sub-advisors provides us with substantial benefits in sourcing, underwriting and managing our investments. Our Manager is responsible for administering our business activities and day-to-day operations and uses the resources of Hyperion Brookfield to support our operations. We believe that our management agreement and sub-advisory agreements provides us access to broad referral networks, experience in capital markets, credit analysis, debt structuring, hedging and asset management, as well as corporate operations and governance. Our Manager, together with our sub-advisors, has well-respected, established portfolio management resources for each of our

99


Table of Contents

targeted asset classes and an extensive, mature infrastructure supporting those resources. Our Manager’s and our sub-advisors’ portfolio management resources and infrastructure are fully scalable to service our company’s activities. We also expect to benefit from our Manager’s comprehensive risk management, which addresses not only the risks of portfolio loss, such as risks relating to price volatility, position sizing and leverage, but also the operational risks such as execution of transactions, clearing of transactions, recording of transactions, and monitoring of positions that can have major adverse impacts on investment programs.
      Our Manager and our sub-advisors have senior management teams with extensive experience in identifying and financing, hedging and managing RMBS, ABS, CMBS, real estate equity and mezzanine investments. Mr. Clifford Lai, our president and chief executive officer is also the president and chief executive officer of Hyperion Brookfield, and leads Hyperion Brookfield’s CMBS team. Mr. John Dolan, our chief investment officer, is also the chief investment officer of Hyperion Brookfield and the leader of its RMBS/ ABS team. Each has over 25 years of investment experience.
      Our board of directors has formed a strategic advisory committee to advise and consult with our board and our senior management team with respect to our investment policies, investment portfolio holdings, financing and leveraging strategies and investment guidelines. The members of the strategic advisory committee are Lewis Ranieri, who serves as chairman of the committee, Clifford Lai and John Dolan of Hyperion Brookfield and Bruce Flatt and Bruce Robertson of Brookfield. The committee reviews, discusses and makes recommendations on our overall investment strategy but does not approve individual investment opportunities or present investment opportunities to us or our Manager.
      Our Manager is not obligated to dedicate certain of its employees exclusively to us nor is it obligated to dedicate any specific portion of its time to our business. Moreover, none of our Manager’s employees are contractually dedicated to our Manager’s obligations to us under our management agreement.

100


Table of Contents

Our Portfolio
      As of March 31, 2006, we had a portfolio of approximately $2.9 billion consisting primarily of RMBS, as shown in the following chart:
                                                     
            Weighted Average    
        Percent of       Constant
    Estimated   Total       Months to   Yield to   Prepayment
Security Description   Asset Value(1)   Investments   Coupon   Reset(2)   Maturity   Rate(3)
                         
    (In thousands)                
Commercial Real Estate Debt:
                                               
 
Below investment grade CMBS
  $ 292,854       10.2 %     5.05 %             9.59 %        
 
Real estate loans
    132,805       4.6       7.09               7.29          
                                     
 
Total Commercial Real Estate Debt
    425,659       14.8       5.54               8.87          
RMBS:
                                               
 
Non-Agency:
                                               
   
Senior prime 5/1 adjustable rate
    237,786       8.3       5.28       45.91       6.02       23.43 %
   
Junior prime
    153,906       5.4       6.57       24.47       16.01       24.39  
   
Subprime
    160,987       5.6       6.76       11.32       8.80       33.56  
 
Agency:
                                               
   
3/1 hybrid adjustable rate
    631,400       22.0       4.93       29.26       6.06       10.65  
   
5/1 hybrid adjustable rate
    1,203,308       41.9       4.91       47.69       5.79       14.80  
                                     
 
Total RMBS
    2,387,387       83.2       5.23       38.19       6.74       16.75  
CDO Preferred Stock
    4,707       0.2                                  
Other ABS:
                                               
 
Aircraft ABS
    51,048       1.8       5.21               7.22          
                                     
   
Total Investments
  $ 2,868,801       100.0 %     5.28 %             7.06 %        
                                     
 
(1)  All securities listed in this chart are carried at their estimated fair value other than real estate loans, which are carried at their cost. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition”.
 
(2)  Represents number of months before conversion to floating rate.
 
(3)  Represents the estimated percentage of principal that will be prepaid over the next 12 months based on historical principal paydowns.
     We have invested a substantial portion of our capital in Agency Adjustable Rate RMBS pending the full implementation of our diversified investment strategy. We currently expect the portion of our portfolio invested in non-RMBS investments to be in the range of 15% to 40% of our assets in an effort to create a more diversified, less correlated portfolio of investments, which may include investments in non-U.S. dollar denominated securities, within 12 months of the completion of this offering, subject to the availability of appropriate investment opportunities. However, our portfolio in its current form does not fully balance the interest rate or mark-to-market risks inherent in our RMBS investments, and we will not be able to eliminate all of our portfolio risk through asset allocation. Future dividends and capital appreciation are not guaranteed. Our investments will depend on prevailing market conditions and trends. We have not adopted any policy that establishes specific asset allocations among our targeted asset classes, and our targeted allocations will vary from time to time. As a result, we cannot predict the percentage of our assets that will be invested in each asset class or whether we will invest in other classes or investments. We generally expect to incur total leverage of up to five times the amount of our equity for most investments other than Agency Adjustable Rate RMBS, which we anticipate we generally will lever up to 15 times the amount of our equity allocated to

101


Table of Contents

this asset class. We currently expect our overall long-term average portfolio leverage to be three to five times the amount of our equity. We may change our investment strategy and policies and the percentage of assets that may be invested in each asset class, or in the case of securities, in a single issuer, without a vote of our stockholders.
      Because we will elect and intend to qualify to be taxed as a REIT and to operate our business so as to be exempt from regulation under the Investment Company Act, we are required to invest a substantial majority of our assets in qualifying real estate assets, such as agency RMBS, mortgage loans and other liens on and interests in real estate. Therefore, the percentage of our assets we may invest in other MBS, ABS, alternative assets and other types of instruments is limited, unless those investments comply with various federal income tax requirements for REIT qualification and the requirements for exclusion from Investment Company Act regulation.
      As of March 31, 2006, we had entered into master repurchase agreements with 12 counterparties and as of such date, we had outstanding obligations under repurchase agreements with 11 counterparties totaling approximately $2,384.4 million with a weighted average borrowing rate of 4.77%. In addition to repurchase agreements, we rely on credit facilities with multiple counterparties for capital needed to fund our other investments, including a $31 million unsecured revolving credit facility with Signature Bank, as administrative agent, that we entered into on March 1, 2006. On November 30, 2005, we closed our first CDO financing transaction. See “Business — Our Financing Strategy — Term Financing-CDOs.” We have no restriction on the amount of leverage that we may use.
      As of March 31, 2006, we had hedged a portion of the liabilities financing our investment portfolio by entering into a combination of one-, two-, three-, five- and ten-year interest rate swaps. The total notional par value of such swaps was approximately $1,436.0 million.
Our Business Strengths
Access to a Top-Ranked Investment Advisor with a Superior Track Record
      Hyperion Brookfield has a long history of excellent investment performance across MBS and ABS sectors and consistently has been recognized as one of the top investment advisors in these sectors. Hyperion Brookfield’s investment performance track record is discussed below under “Hyperion Brookfield’s Historical Performance.” From the firm’s inception in 1989 as a specialty MBS manager, Hyperion Brookfield has focused on subordinated RMBS, CMBS and ABS securities. As a result, it has developed substantial resources and proprietary technology to support its investment activities. The collective experience of the firm’s senior investment professionals includes investing in whole loans, structuring and rating RMBS transactions, selling and purchasing subordinated RMBS, CMBS and ABS, conducting originator and servicer reviews, as well as the modeling of cash flows and the valuation of excess spread. In the last five years, Hyperion Brookfield’s and its affiliates’ assets under management have grown from approximately $4.5 billion to approximately $19.3 billion as of March 31, 2006.
      We believe that Hyperion Brookfield’s specialization in collateralized securities differentiates it from its peers. We believe that its stringent investment process, extensive experience in specialized sub-sectors and ability to access securities for its clients give it clear and distinct competitive advantages in the market. As a participant in the market for over ten years, Hyperion Brookfield has substantial scale and a wealth of historical data.

102


Table of Contents

Access to Complementary Investment Skills of Leading Sub-Advisors
      Brookfield has over 25 years of experience operating and investing in real estate, hydroelectric, gas-and coal-fired power generating facilities and timber assets and, as of March 31, 2006 had approximately $50.0 billion of assets under management. Based on its long history of ownership within these asset classes and high transaction volume, we believe that Brookfield, as an owner/operator, has developed the specialized internal resources and expertise to properly evaluate opportunities in these asset classes and to manage them post-acquisition. We expect that Brookfield will, from time to time, through Brookfield Sub-Advisor, originate debt and equity investment opportunities and provide us with the opportunity to acquire assets from its extensive portfolio, to finance Brookfield portfolio assets and to co-invest with Brookfield in assets that meet our investment objectives.
      Lewis Ranieri has been a dominant presence in real estate finance and capital markets for the last 30 years and has high level access to major residential and commercial real estate industry participants. He will continue to provide advice and insights into market developments and economic trends that draw from his unique position and knowledge of the industry.
Experienced Professionals and Senior Management Team
      The experience of Hyperion Brookfield Crystal River’s approximately 30 asset management professionals together with its sub-advisors provides us with investment opportunities across all of our target asset classes. Clifford Lai, our president and chief executive officer, and John Dolan, our chief investment officer, lead Hyperion Brookfield’s CMBS and RMBS/ ABS teams, respectively, and each has over 25 years of investment experience. The remainder of Hyperion Brookfield Crystal River’s asset management professionals have an average of 13 years of investment experience.
      Crystal River’s strategic advisory committee, chaired by Lewis Ranieri, advises and consults with our board of directors and our officers with respect to the formulation and execution of our investment policies, financing and leveraging strategies and investment guidelines, as well as our investment portfolio holdings. The other members of the investment strategy committee are Clifford Lai and John Dolan of Hyperion Brookfield and Bruce Flatt and Bruce Robertson of Brookfield. Our board of directors consists of Bruce Robertson, who also serves as chairman of the board, Rodman Drake, Janet Graham, Harald Hansen, Clifford Lai, William Paulsen and Louis Salvatore. We believe our strategic advisory committee and our board of directors provides us with a competitive advantage through their experience, financial industry contacts and investment ideas.
Diversified Investment Strategy
      Subject to the availability of attractive investment opportunities, we expect that our MBS portfolio will be comprised of RMBS, CMBS and home equity ABS, thereby providing investors with diversification across MBS asset classes. In addition, we intend to complement our investments in MBS with a variety of other alternative asset classes to attempt to enhance returns to our stockholders and to reduce the overall risk of our portfolio in order to achieve a lower correlation of risk compared to MBS, although no assurances may be given as to the composition of our investment portfolio at any time. We expect to add further diversification and enhance the return of our core portfolio of real estate-related securities and loans by investing in alternative assets including commercial real estate, timber, and hydroelectric, gas- and coal-fired power generating facilities. Historically, these alternative assets have had a low correlation of return compared to MBS and other real estate loans. We believe that our affiliation with Hyperion Brookfield and our sub-advisors offers an attractive opportunity to invest in these alternative assets and leverage their expertise for our stockholders. The

103


Table of Contents

percentage of assets that we may invest in higher-yielding fixed income asset classes is limited unless those investments comply with various federal income tax requirements for REIT qualification and the requirements for exclusion from Investment Company Act regulation.
Access to Hyperion Brookfield’s Infrastructure
      We have access to Hyperion Brookfield’s portfolio management infrastructure, which includes a comprehensive, sophisticated systems platform that has been developed through a combination of proprietary and third-party models and systems, based on Hyperion Brookfield’s broad investment experience. Through its extensive experience in investing in these financial products, Hyperion Brookfield has developed models based on historical data in order to estimate the lifetime prepayment speeds and lifetime credit losses for pools of mortgage loans. The models are based primarily on loan characteristics, such as loan-to-value ratios (LTV), credit scores, loan type, loan rate, property type, etc., and also include other qualitative factors such as the loan originator and servicer. For credit losses, the models also assume a certain level of stress to prevailing employment rates and housing prices. Once the models have been used to project the base case prepayment speeds and to project the base case cumulative loss, those outputs are used to create yield estimates and to project cash flows. In addition, we benefit from existing detailed policies and procedures for risk management, operations, transaction processing and recording, credit analysis, accounting, technology systems, legal and compliance and internal audit. We believe that an established infrastructure is crucial to the success of a complex investment vehicle such as a REIT. These systems directly support and are completely integrated with Hyperion Brookfield Crystal River’s portfolio management functions. Although as the parent company of our Manager, Hyperion Brookfield has an economic incentive to provide us with access to these systems to the extent that their provision will increase the management fees that we pay to our Manager through our improved performance, Hyperion Brookfield is not contractually obligated to provide us with access to any of these systems.
Relationships and Deal Flow of Hyperion Brookfield and Our Sub-Advisors
      Investing in our targeted asset classes is highly competitive, and our Manager competes with many other investment managers for profitable investment opportunities in these areas. We believe that the combined and complementary strengths of Hyperion Brookfield and our sub-advisors in this regard give us a competitive advantage over other asset managers. We intend to capitalize on the deal-sourcing opportunities that we believe Hyperion Brookfield, Brookfield Sub-Advisor and Ranieri & Co. each bring to us as a result of their investment experience in our targeted asset classes, record of past successes and personal networks of contacts in the financial community, including real estate investors, investment banks, lenders and other financial intermediaries and sponsors. Hyperion Brookfield currently sources many of its investments, and we expect Hyperion Brookfield, Brookfield Sub-Advisor and Ranieri & Co. to source many of our investments, through their close relationships with a large and diverse group of financial intermediaries that each of them has developed over the course of the last several years through their prior investing and financing transactions with other industry participants.
      Brookfield and its affiliates currently source investments through the relationships they have created as a longstanding investor and operator in mortgages and other real estate debt, real estate, hydroelectric, gas- and coal-fired power generating facilities and timber sectors. With access to Brookfield management teams located in offices throughout North America, we believe that Brookfield Sub-Advisor is well positioned to identify, evaluate and manage investment opportunities for us in both the United States and Canada.

104


Table of Contents

Alignment of Interests of Hyperion Brookfield Crystal River and Our Stockholders
      Our Manager, Hyperion Brookfield Crystal River, has agreed to receive at least 10% of its incentive management fee under our management agreement in shares of our common stock and has also generally agreed not to transfer those shares prior to one year after the date they are paid, subject to certain ownership limitations. In addition, we issued to our Manager 84,000 shares of restricted stock and we granted to our Manager options to purchase 126,000 shares of our common stock, with an exercise price equal to $25.00 per share, representing in the aggregate approximately 1.2% of the outstanding shares of our common stock on a fully-diluted basis. On March 15, 2006, one-third of these shares of restricted stock and the shares underlying the options vested or became exercisable, and the remainder will vest or become exercisable in equal annual installments on March 15, 2007 and March 15, 2008. These shares and options were subsequently transferred to certain of our Manager’s officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us. We believe this investment provides an incentive for Hyperion Brookfield Crystal River to operate our company with a view towards maximizing returns to our stockholders.
Our Formation and Structure
      We were organized on January 25, 2005 by Hyperion Brookfield, who may be deemed to be our promoter, and completed a private offering of our common stock in March 2005, in which we raised net proceeds of approximately $405.6 million. In our March 2005 private offering, Deutsche Bank Securities Inc. and Wachovia Capital Markets, LLC served as the initial purchasers/placement agents. In our March 2005 private offering, an indirect subsidiary of Brookfield purchased 800,000 shares, or 4.5% (assuming all outstanding options have vested and are exercised), of our common stock and certain of our executive officers, directors and members of our strategic advisory committee, and certain executive officers of Hyperion Brookfield Crystal River and Hyperion Brookfield that provide services to us collectively purchased 183,800 shares, or 1.0% (assuming all outstanding options have vested and are exercised), of our common stock. In addition, upon completion of our March 2005 private offering, we issued to Hyperion Brookfield Crystal River, and it subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us, 84,000 shares of restricted stock and we granted to Hyperion Brookfield Crystal River, and it subsequently transferred to certain of its officers and employees, certain of our directors and other individuals associated with Hyperion Brookfield or Brookfield and their respective affiliates who provide services to us, options to purchase 126,000 shares of our common stock with an exercise price of $25.00 per share, representing in the aggregate approximately 1.2% of the outstanding shares of our common stock as of the date of this prospectus, assuming all outstanding options have vested and are exercised. Following completion of this offering, Hyperion Brookfield, Brookfield, Hyperion Brookfield Crystal River and their respective affiliates and employees who provide services to us, including our executive officers, members of our strategic advisory committee and certain of our directors, as well as our independent directors, will collectively own 1,105,800 shares of our common stock, representing 4.3% of our outstanding shares of common stock, and will have options to purchase an additional 130,000 shares of our common stock representing an additional 0.5% of our outstanding shares of common stock, in each case, assuming all outstanding options have vested and are exercised.

105


Table of Contents

      The following chart illustrates the organizational structure of our company after giving effect to this offering.
(CRYSTAL RIVER GRAPHIC)
      On April 28, 2005, an indirect wholly-owned subsidiary of Brookfield acquired all of the capital stock in Hyperion Brookfield’s parent. As a result of such acquisition, an affiliate of Ranieri & Co. will share in additional payments, for a period of 15 years following the closing of that acquisition, totaling 20% of the base and incentive management fees and termination fees we pay to our Manager, net of sub-advisor fees.

106


Table of Contents

Our Investment Strategy
Relative Value Philosophy
      Hyperion Brookfield Crystal River’s and our strategic advisory committee’s investment strategy is consistent with Hyperion Brookfield’s investment philosophy, which is predicated on the concept of relative value. Hyperion Brookfield believes the most significant opportunities for out-performance exist between and within sectors, as well as among individual securities. The investment process begins with a macroeconomic assessment of the market. Included in the market assessment is the analysis of the interest rate environment, the phase of the real estate cycle, consumer credit trends, supply and demand relationships, as well as a review of any recently released or pending economic data. Hyperion Brookfield seeks to determine the relative merits of sectors by combining the analysis of historical relationships with the firm’s anticipated outlook for the market. Portfolio managers evaluate developments in each sector, along with current offerings, recent transactions and market clearing levels and yield spread levels to provide a relative value outlook. The portfolio manager will closely examine yield spread histories between sectors, credit spread histories within sectors, fundamental credit, and option-adjusted spread analyses to examine call features and options. Hyperion Brookfield’s analytical platform is designed not only to identify technical and fundamental changes in various yield relationships, but also to quantify whether such changes in relative value are temporary, and therefore represent an investment opportunity, or are more permanent. This analysis is utilized to determine optimal areas to allocate credit risk in the portfolio across sectors and maturities and to maximize yield and total return expectations. The portfolio manager will analyze the risks of the various sectors, specifically, the outlook for delinquencies, housing affordability, consumer debt, collateral value appreciation, and loss severities for residential and commercial property. Hyperion Brookfield’s investment philosophy has historically been successful at identifying and exploiting relative value opportunities over a complete market cycle.
      The most important component of Hyperion Brookfield’s relative value investment strategy is security selection, a process that is the result of both quantitative and qualitative inputs, as well as the experience of the portfolio managers. Members of the investment team, utilizing Hyperion Brookfield’s proprietary analytics, determine the relative strengths of various securities based on applicable criteria such as issuer, issue, vintage, credit rating, structure, and geographic exposure. The security selection process focuses on four primary areas: the analysis of credit strength, the analysis of security structure, the determination of relative value, and a surveillance function. The analysis of credit strength entails the assessment of such attributes as a security’s loan-to-value ratio, vintage and issuer. Security structure involves the comprehensive examination of a security’s structural attributes such as senior/subordinated, single asset, conduit, large loan, as well as its yield maintenance provisions and prepayment lock-outs. After these first two analyses, the relative value of a security versus other candidates is determined through the evaluation of such aspects as yield spread, liquidity, and subordination levels. Finally, after purchase, a surveillance function begins that uses such analytical tools as Hyperion Brookfield’s proprietary credit filters and shortfall model to determine whether a security continues to perform as expected.
      Our objective is to provide attractive returns to our investors through a combination of dividends and capital appreciation. To achieve this objective, we opportunistically invest in a diversified investment portfolio of real estate securities and various other asset classes. We believe that this strategy permits us to be opportunistic and invest in those assets that generate attractive risk-adjusted returns, subject to maintaining our REIT status and exclusion from regulation under the Investment Company Act. Accordingly, we have not adopted policies that require us to establish or maintain any specific asset allocations, and our targeted allocations will vary from time to time as determined by our board of directors.

107


Table of Contents

      We benefit from the full range of experience and depth of resources developed by Hyperion Brookfield and its affiliates in managing approximately $19.3 billion of assets as of March 31, 2006. We believe this experience allows us to create a diversified portfolio that will provide attractive returns to investors. We rely on Hyperion Brookfield’s expertise in identifying assets within our target asset classes that will have limited price volatility risk, yet will provide consistent, stable margins. We expect to make portfolio allocation decisions based on various factors, including expected cash yield, relative value, risk-adjusted returns, current and projected credit fundamentals, current and projected macroeconomic considerations, current and projected supply and demand, credit and market risk concentration limits, liquidity, cost of financing and financing availability, as well as maintaining our REIT qualification and exclusion from regulation under the Investment Company Act.
      Because we will elect and intend to qualify to be taxed as a REIT and to operate our business so as to be excepted from regulation under the Investment Company Act, we are required to invest a substantial majority of our assets in qualifying real estate assets, such as certain types of MBS and loans secured by mortgages on real estate. Therefore, the percentage of our assets we may invest in ABS, leveraged finance instruments and other types of instruments will be limited, unless those investments comply with various federal income tax requirements for REIT qualification and the requirements for an exemption from regulation under the Investment Company Act.
Our Target Asset Classes
      Our targeted asset classes and the principal investments we expect to make in each are as follows:
       
Asset Class   Principal Investments
     
MBS
   
 
 
— RMBS
  • Agency ARMS
    • Non-Agency ARMS
    • Non-Conforming Loans
    • Other RMBS
 
 
— CMBS
  • Investment Grade CMBS (Senior and Subordinated)
    • Below-Investment Grade CMBS (Rated and Non-Rated)
 
Mortgages and Other Real Estate Debt
  • Whole Mortgage Loans
    • Bridge Loans
    • B Notes
    • Mezzanine Loans
    • Land Loans
    • Construction Loans
    • Construction Mezzanine Loans
 
Commercial Real Estate
  • Direct Property Ownership
    • REIT Common and Preferred Stock Investments
    • Preferred Equity Investments
    • Joint Ventures

108


Table of Contents

     
Asset Class   Principal Investments
     
Other ABS   • CDOs
    • NIMs
    • Consumer ABS
    • Aircraft ABS
 
Alternative Assets
  • Hydroelectric, Gas- and Coal-Fired Power Generating Facilities
    • Timber
    • Other Equity Investments
      In addition, subject to maintaining our qualification as a REIT and the exclusion from regulation under the Investment Company Act, we may invest opportunistically in other types of investments within Hyperion Brookfield Crystal River’s core competencies, including investment grade corporate bonds and related derivatives, government bonds and related derivatives and other fixed income related instruments.
      We and our Manager believe that the most significant opportunities for out-performance exist between and within our target asset classes, as well as among individual securities. Our Manager will strive to identify and capitalize on relative value anomalies through the assessment of relationships between supply and demand, changes in interest rates and associated prepayment expectations, market volatility and investor trends. We and our Manager believe that, on a long-term basis, this investment approach will provide attractive risk-adjusted returns.
      Our net interest income is generated primarily from the net spread, or difference, between the interest income we earn on our investment portfolio and the cost of our borrowings and hedging activities. Our net interest income will vary based upon, among other things, the difference between the interest rates earned on our various interest-earning assets and the borrowing costs of the liabilities used to finance those investments.
      Although we intend to focus on the investments described above, our investment decisions depend on prevailing market conditions. We have not adopted any policy that establishes specific asset allocations among our targeted asset classes. As a result, we cannot predict the percentage of our assets that will be invested in each asset class or whether we will invest in other classes or investments. Our board of directors will not review all of our proposed investments, but will review our portfolio at least quarterly and will review our investment strategy and policies at least annually. We may change our investment strategy and policies and the percentage of assets that may be invested in each asset class, or in the case of securities, in a single issuer, without a vote of our stockholders.
      The following discusses the principal investments we have made and that we expect to make.
Residential Mortgage-Backed Securities
      We intend to continue to invest in Agency and Non-Agency MBS. Agency MBS are securities that represent participations in, are secured by or payable from, mortgage loans secured by real residential property. These securities include, but are not limited to:
  •  Agency mortgage pass-through certificates, which are securities issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac; and
 
  •  Agency CMOs, which are debt obligations issued by Ginnie Mae, Fannie Mae or Freddie Mac that are backed by mortgage pass-through securities and are evidenced by a series

109


Table of Contents

  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.

      Non-Agency MBS are debt obligations issued by private originators of 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. Non-Agency RMBS generally are securitized in senior and subordinated structures, or structured with one or more of the types of credit enhancement. In senior and subordinated structures, the senior class investors have greater protection against potential losses on the underlying mortgage loans or assets than subordinated class investors, who assume the first losses if there are defaults on the underlying loans. We expect to enter into interest rate swaps, futures, options or other strategies to reduce the impact of changes in interest and financing rates for these investments.
      ARMS have interest rates that reset periodically, typically every six or 12 months. Because the interest rates on ARMS adjust periodically based on market conditions, ARMS tend to have interest rates that do not significantly deviate from current market rates. This, in turn, can cause ARMS to have less price sensitivity to interest rates.
      Hybrid ARMS have interest rates that have an initial fixed period (typically two, three, five, seven or ten years) and thereafter reset at regular intervals in a manner similar to traditional ARMS. Prior to the first interest rate reset date, hybrid ARMS have a price sensitivity to interest rates similar to that of a fixed-rate mortgage with a maturity equal to the period prior to the first reset date. After the first interest rate reset date occurs, the price sensitivity of a hybrid ARM resembles that of a non-hybrid ARM in that it does not significantly deviate from current market rates. However, because many hybrid ARMS are structured with a relatively short initial fixed interest rate period, even during that fixed rate period, the price sensitivity of hybrid ARMS may be low.
      The investment characteristics of pass-through RMBS differ from those of traditional fixed-income securities. The major differences include the payment of interest and principal on the RMBS, as described above, and the possibility that principal may be prepaid on the RMBS at any time due to prepayments on the underlying mortgage loans. These differences can result in significantly greater price and yield volatility than is the case with traditional fixed-income securities. On the other hand, the guarantees on agency RMBS by Fannie Mae, Freddie Mac and, in the case of Ginnie Mae, the U.S. government, provide reasonable assurance that the investor will be ultimately repaid the principal face amount of the security.
      Mortgage prepayments are affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage, and other social and demographic conditions. Generally, prepayments on pass-through RMBS increase during periods of falling mortgage interest rates and decrease during periods of stable or rising mortgage interest rates. Reinvestment of prepayments may occur at higher or lower interest rates than the original investment, thus affecting the yield on our portfolio.
      We currently leverage our investments in agency ARMS in the range of up to 15 times the amount of our equity allocated to this asset class. We leverage our other RMBS investments in the range of 0 to 5 times the amount of our equity allocated to the asset class.
      As of March 31, 2006, we had approximately $2,387.4 million in RMBS with a weighted average coupon rate of 5.23%.

110


Table of Contents

Commercial Mortgage-Backed Securities
      We invest in CMBS which are secured by, or evidence ownership interests in, a single commercial mortgage loan, or a partial or entire pool of mortgage loans secured by commercial properties. These securities may be senior, subordinated, investment grade or non-investment grade. We expect the majority of our CMBS investments to be rated by at least one nationally recognized rating agency, and to consist of securities that are part of a capital structure or securitization where the rights of such class to receive principal and interest are subordinated to senior classes but senior to the rights of lower rated classes of securities. We generally intend to invest in CMBS that will yield high current interest income and where we consider the return or principal to be likely. We intend to acquire CMBS from private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, finance companies, investment banks and other entities. We expect to enter into interest rate swaps, futures, options or other strategies to reduce the impact of changes in interest and financing rates for these investments.
      The yields on CMBS depend on the timely payment of interest and principal due on the underlying mortgage loans and defaults by the borrowers on such loans may ultimately result in deficiencies and defaults on the CMBS. In the event of a default, the trustee for the benefit of the holders of CMBS has recourse only to the underlying pool of mortgage loans and, if a loan is in default, to the mortgaged property securing such mortgage loan. After the trustee has exercised all of the rights of a lender under a defaulted mortgage loan and the related mortgaged property has been liquidated, no further remedy will be available. However, holders of relatively senior classes of CMBS will be protected to a certain degree by the structural features of the securitization transaction within which such CMBS were issued, such as the subordination of the relatively more junior classes of the CMBS.
      We currently leverage our investments in CMBS in the range of 0 to 5 times the amount of our equity allocated to the asset class. As of March 31, 2006, we had approximately $292.9 million in CMBS with a weighted average coupon rate of 5.05%.
Whole Mortgage Loans and Bridge Loans
      We may originate or purchase whole loans secured by first mortgages which provide long-term mortgage financing to commercial property developers and owners that generally have maturity dates ranging from three to ten years. We also may originate or purchase first mortgage loans that provide interim or bridge financing until permanent mortgage financing can be obtained. The maturity dates on bridge loans are generally less than five years. In some cases, we may originate and fund a first mortgage loan with the intention of selling the senior tranche and retaining the B Note or mezzanine loan tranche. As of December 31, 2005, we had originated 100% of the aggregate principal amount of whole mortgage loans and bridge loans that we held.
      We currently expect to leverage our investments in whole mortgage loans and bridge loans in the range of 0 to 8 times the amount of our equity allocated to such assets. As of March 31, 2006, we had approximately $97.1 million in whole loans with a weighted average coupon rate of 6.18%.

111


Table of Contents

Commercial Real Estate Subordinated Loans
      We intend to continue to invest in commercial real estate subordinated loans, which we refer to as B Notes, that may be rated by at least one nationally recognized rating agency. A B Note is typically a privately negotiated loan that is:
  •  secured by a first mortgage on a single large commercial property or group of related properties; and
 
  •  subordinated to an A Note secured by the same first mortgage on the same property.
      The subordination of a B Note typically is evidenced by an inter-creditor agreement with the holder of the related A Note.
      B Notes share certain credit characteristics with subordinated CMBS, in that both reflect an interest in a first mortgage and are subject to more credit risk with respect to the underlying mortgage collateral that the corresponding senior securities or the A Notes, as the case may be. As opposed to a typical CMBS secured by a large pool of mortgage loans, B Notes typically are secured by a single property, and the associated credit risk is concentrated in that single property. B Notes also share certain credit characteristics with second mortgages, in that both are subject to more credit risk with respect to the underlying mortgage collateral than the corresponding first mortgage or the A Note, as the case may be. We intend to acquire B Notes in negotiated transactions with the originators, as well as in the secondary market.
      We currently expect to leverage our investments in B Notes in the range of 0 to 4 times the amount of our equity allocated to such assets. As of March 31, 2006, we had approximately $9.0 million in B Notes with a coupon rate of 8.24%.
Mezzanine Loans
      We may originate or purchase mezzanine loans which are subordinated to a first mortgage loan on a property and are senior to the borrower’s equity in the property. These loans are made to the owner of the property and are secured by pledges of ownership interests in the property and/or the property owner. The mezzanine lender can foreclose on the pledge interests and thereby succeed to ownership of the property subject to the lien of the first mortgage. As of March 31, 2006, we had originated 100% of the aggregate principal amount of mezzanine loans that we held.
      We currently expect to leverage our investments in mezzanine loans in the range of 0 to 3 times the amount of our equity allocated to such assets. As of March 31, 2006, we had $6.0 million in mezzanine loans with a coupon rate of 10.11%.
Construction Loans and Construction Mezzanine Loans
      We also may originate, or acquire participations in, construction or rehabilitation loans on commercial properties that generally provide 85% to 90% of total project costs and are secured by first lien mortgages. Alternatively, we may make mezzanine loans to finance construction or rehabilitation where our security is subordinate to the first lien mortgage. Construction loans generally would provide us with fees and interest income at risk adjusted rates and potentially a percentage of net operating income or gross revenues from the property, payable to us on an ongoing basis, and a percentage of any increase in value of the property, payable upon maturity or refinancing of the loan. As of March 31, 2006, we had originated approximately 65.5% of the aggregate principal amount of commercial loans and construction mezzanine loans that we held.

112


Table of Contents

      We currently expect to leverage our investments in construction loans and construction mezzanine loans in the range of 0 to 4 times the amount of our equity allocated to such assets. As of March 31, 2006, we had approximately $20.7 million in construction loans with a weighted average coupon rate of 10.58%.
Direct Real Property Ownership
      We also may make direct investments in income-producing commercial real estate either within or outside the United States. Such investments may include office, multi-family residential, retail and industrial properties. We may acquire ownership of commercial property that we will own and operate or otherwise acquire controlling and non-controlling interests in commercial property through joint ventures and similar arrangements.
      We currently expect to leverage our direct real estate investments in the range of 3 to 8 times the amount of our equity allocated to such assets. As of March 31, 2006, we had $0 of direct investments in any real property.
Preferred Equity Investments
      We may make preferred equity investments in entities that directly or indirectly own income-producing commercial real estate. These preferred equity investments are not secured, but holders have priority relative to common equity holders on cash flow distributions and proceeds of capital events. In addition, preferred holders can often enhance their position and protect their equity position with lender-type covenants that limit the entity’s activities and grant us the right to control the property after default subject to the lien of the first mortgage.
      We currently expect to leverage our preferred equity investments in the range of 0 to 5 times the amount of our equity allocated to such assets. As of March 31, 2006, we had $0 in preferred equity investments.
REIT Common and Preferred Stock Investments
      We may invest in public and private issuances of common and preferred stock issued by REITs.
      We currently expect to leverage our investments in REIT preferred stock in the range of 0 to 3 times the amount of our equity allocated to such assets, subject to applicable margin requirements. As of March 31, 2006, we had $0 of investments in REIT common stock or REIT preferred stock.
Net Interest Margin Securities
      We may invest in NIMS, which are notes that are payable from and secured by excess cash flow that is generated by MBS or home equity loan-backed securities, or HELs, after paying the debt service, expenses and fees on such securities. The excess cash flow represents all or a portion of a residual that is generally retained by the originator of the MBS or HELs. Because the residual is illiquid, the originator will monetize the position by securitizing the residual and issuing a NIM, usually in the form of a note that is backed by the excess cash flow generated in the underlying securitization. In other words, a NIM represents the securitization of the excess cash flow (or excess stream of income) in a senior security backed by a pool of mortgages or HELs. NIMs may be more sensitive to increases in interest rates and a weaker economy than the underlying ABS or MBS securities.

113


Table of Contents

      We currently expect to leverage our investments in NIMs in the range of 2 to 4 times the amount of our equity allocated to such assets. As of March 31, 2006, had $0 of investments in NIMs.
Consumer Asset-Backed Securities
      We expect to continue to invest in investment grade and non-investment grade consumer ABS. Consumer ABS are generally securities for which the underlying collateral consists of assets such as home equity loans, credit card receivables and auto loans. Aircraft ABS are generally collateralized by aircraft leases. Issuers of consumer and aircraft ABS generally are special purpose entities owned or sponsored by banks and finance companies, captive finance subsidiaries of non-financial corporations or specialized originators such as credit card lenders.
      We expect that a significant amount of the consumer and aircraft ABS that we hold at any time will be rated between A1/A- and B1/B+ and will have an explicit rating from at least one nationally-recognized statistical rating agency.
      We currently leverage our investments in consumer ABS in the range of 0 to 15 times the amount of our equity allocated to such assets. As of March 31, 2006, we had approximately $51.0 million in aircraft ABS.
Collateralized Debt Obligations
      We may continue to invest in the debt and equity tranches of CDOs to gain exposure to corporate bonds, ABS and other instruments. Because of Hyperion Brookfield’s experience in structuring and managing CDOs, we believe we have a competitive advantage in analyzing investment opportunities in CDOs.
      In general, CDOs are issued by special purpose vehicles that hold a portfolio of debt obligation securities. The CDO vehicle issues tranches of debt securities of different seniority, and equity to fund the purchase of the portfolio. The debt tranches are typically rated based on collateral quality, diversification and structural subordination. The equity securities issued by the CDO vehicle are the “first loss” piece of the CDO vehicle’s capital structure, but they are also generally entitled to all residual amounts available for payment after the CDO vehicle’s obligations to the debt holders have been satisfied. Some CDO vehicles are “synthetic,” in which the credit risk to the collateral pool is transferred to the CDO vehicle by means of a credit derivative such as a credit default swap.
      We currently expect to leverage our investments in CDOs in the range of 1 to 3 times the amount of our equity allocated to such assets. As of March 31, 2006, we had approximately $4.7 million in preferred equity of CDOs.
Power and Timber
      We intend to make investments in income-producing timber and power generation assets. These investments may be in the form of either debt or equity interests. We may acquire these investments directly or participate with others through the syndication of debt positions, or in partnerships with other investors in equity ownership. These investments may be made in Brookfield’s major geographic focus, namely, the United States and Canada, or elsewhere. Investments in power generation may relate to electricity generating facilities, such as hydroelectric, gas- or coal-fired power generating facilities. Investments in timber may be through freehold or leasehold interests, and will vary with respect to timber type, including hardwood and softwood, and age distribution.

114


Table of Contents

      We currently expect to leverage our power and timber investments in the range of 0 to 8 times the amount of our equity allocated to such assets. As of March 31, 2006, we had $0 of investments in power or timber.
Other Equity Investments
      To a lesser extent, subject to maintaining our qualification as a REIT, we also may invest from time to time in equity securities, which may or may not be related to real estate. These investments may include direct purchases of private equity as well as purchases of interests in private equity funds. We will follow a value-oriented investment approach and focus on the anticipated future cash flows generated by the underlying business, discounted by an appropriate rate to reflect both the risk of achieving those cash flows and the alternative uses for the capital to be invested. We will also consider other factors such as the strength of management, the liquidity of the investment, the underlying value of the assets owned by the issuer, and prices of similar or comparable securities.
      We currently expect to hold all, or at least a significant portion, of our other equity investments through our TRS. To the extent that we do so, the income from such investments will be subject to corporate income tax.
      We currently expect to leverage our other equity investments in the range of 0 to 3 times the amount of our equity allocated to such assets. As of March 31, 2006, we had $0 of other equity investments.
Other Investments
      As discussed above, we may invest opportunistically in other types of investments within Hyperion Brookfield’s core competencies, including those discussed below.
      High Yield Corporate Bonds, Investment Grade Corporate Bonds and Related Derivatives. High yield corporate bonds are debt obligations of corporations and other non-governmental entities rated below Baa or BBB. Investment grade corporate bonds are debt obligations of corporations and other non-governmental entities rated Baa and BBB or higher. To the extent we invest in these bonds, we expect that a material amount of the holdings will not be secured by mortgages or liens on assets. A substantial portion of the investment grade corporate bonds we hold may have an interest-only payment schedule, with the principal amount staying outstanding and at risk until the bond’s maturity.
      Government Bonds and Related Derivatives. We may invest in bonds issued or guaranteed by the U.S. government or any instrumentality thereof, as well as bonds of major non-U.S. governments and their instrumentalities. We may invest in these bonds both for cash management purposes and as part of hedging and arbitrage strategies that involve the use of interest rate derivatives, such as swaps, options, caps, floors and futures.
      Other Fixed Income-Related Instruments. We may engage in the purchase and sale of derivative instruments, such as exchange-listed and over-the-counter put and call options on securities, financial futures, equity indices, and other financial instruments, either as outright investments, for hedging purposes or in connection with other strategies.
      We likely will hold at least some of the corporate bonds, government bonds and derivative instruments in which we invest for strategic purposes through our TRS. To the extent that we do so, the income from such bonds and instruments will be subject to corporate income tax.

115


Table of Contents

Investment Sourcing
      We recognize that investing in our targeted asset classes is highly competitive, and that Hyperion Brookfield Crystal River will compete with many other investment managers for profitable investment opportunities in these areas. Accordingly, we believe the ability to identify and source such opportunities is very important to our success, and distinguishes us from many REITs with a similar focus to ours. We think that the combined and complementary strengths of Hyperion Brookfield and Brookfield Sub-Advisor in this regard give us a competitive advantage over such REITs.
      Hyperion Brookfield currently sources many of its investments, and Hyperion Brookfield Crystal River sources many of our investments, through Hyperion Brookfield’s close relationships with a large and diverse group of financial intermediaries, ranging from major investment banks and brokerage firms to specialty dealers and financial sponsors. On a combined basis, these firms extensively cover our targeted asset classes. Hyperion Brookfield also sources many investments from traditional sources, using proprietary deal screening procedures and credit analytics.
      Brookfield has over 25 years of experience operating and investing in real estate, hydroelectric, gas-and coal-fired power generating facilities and timber assets. Based on its long history of ownership within these asset classes and its high transaction volume, we believe that Brookfield, as an owner/operator, has developed the specialized internal resources and expertise to properly evaluate opportunities in these asset classes and to manage them. We expect that Brookfield will, from time to time, through Brookfield Sub-Advisor, provide us with the opportunity to acquire assets from its extensive portfolio, to finance Brookfield’s and its affiliates’ portfolio assets and to co-invest with Brookfield and its affiliates in assets that meet our investment objective.
Investment Process
      To evaluate, invest and manage our investments in RMBS, Other ABS and Real Estate, Hyperion Brookfield Crystal River utilizes Hyperion Brookfield’s 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. Hyperion Brookfield Crystal River also performs relative value analyses of individual securities based on yield, credit rating, average life, expected duration and option-adjusted spreads. Other considerations in Hyperion Brookfield Crystal River’s investment process include analysis of fundamental economic trends, suitability for investment by a REIT, consumer borrowing trends, home price appreciation and relevant regulatory developments.
      Our investments in real estate assets and other alternative asset classes will be recommended and, if approved by our board of directors, closed and managed by Brookfield Sub-Advisor.
      To evaluate, invest and manage investments in real estate, Brookfield Sub-Advisor, through its affiliates, will utilize its experience and strong track record as an operator of commercial properties. Relying on Brookfield’s local presence in offices in the United States, Canada, Brazil and the United Kingdom, we expect that Brookfield Sub-Advisor is well positioned to underwrite and analyze real estate investments throughout North America, including the analysis of market conditions and building specific issues (including lease and structural analysis). Other considerations in the investment process will include valuation and analyses of economic conditions and demographic trends as well as supply and demand considerations.

116


Table of Contents

      To evaluate, invest and manage investments in hydroelectric, gas- and coal-fired power generating facilities, Brookfield Sub-Advisor, through its affiliates, will utilize its experience as an owner and operator of hydroelectric, gas- and coal-fired power generating facilities. With Brookfield’s operations in Canada, the United States and Brazil, we expect that Brookfield Sub-Advisor is well-positioned to underwrite and analyze investment opportunities in these regions including an analysis of current market conditions and property specific issues, such as in the case of hydro-electric generating facilities, structural assessments of dams and generating facilities, water flows and water storage capability, water use agreements, and turbines. Other considerations in the investment process include, but are not limited to, an analysis of market supply and demand, and an evaluation of the relative competitiveness of the sources of supply in the market, including but not limited to, as applicable, nuclear, coal-fired, gas-fired, hydroelectric, wind and emerging alternative forms of electricity generation.
      Brookfield, through its affiliates, owns and manages timber operations in Canada, the United States and Brazil. Relying on Brookfield’s presence in these markets, we believe that Brookfield Sub-Advisor has the capability to underwrite and analyze investment opportunities for us. Considerations in the investment process include but are not limited to, the forest density, age and species distribution, growth rates, which can vary by species and geographic region, proximity to and depth of markets, and anticipated harvesting and silviculture costs.
Hyperion Brookfield’s Historical Performance
      Hyperion Brookfield has a successful 17-year history of acquiring and managing MBS and ABS through an investment philosophy predicated on the concept of relative value, an investment philosophy that involves a macroeconomic assessment of the fixed income markets to determine the relative attractiveness of investment sectors and sub-sectors, by taking into account the effect of changes in yield relationships and various factors that indicate that they may be temporary and represent an investment opportunity. See “Business — Our Investment Strategy — Relative Value Philosophy” for further information regarding the concept of relative value. Hyperion Brookfield was founded in 1989 by Lewis Ranieri, an MBS market pioneer and former Vice Chairman of Salomon Brothers, Inc. As of June 30, 2006, Hyperion Brookfield employed approximately 85 professionals. Hyperion Brookfield is dedicated to providing investment management services for institutional clients and mutual funds through the management of core fixed income portfolios as well as separately managed portfolios of RMBS, CMBS and ABS.
      As of March 31, 2006, Hyperion Brookfield and its affiliates managed approximately $19.3 billion in assets for more than 80 institutional clients, including Crystal River, four closed-end investment companies and three CDOs. Hyperion Brookfield’s four managed closed-end investment companies include two NYSE-listed funds, The Hyperion Strategic Mortgage Income Fund and Hyperion Total Return Fund.
      The following table sets forth Hyperion Brookfield’s historical investment performance with respect to its assets under management in its Enhanced MBS and high yield CMBS categories. These asset classes are those in which Hyperion Brookfield invests that are similar in nature to the assets in which we currently invest and intend to continue to invest. As of March 31, 2006, Enhanced MBS and high yield CMBS comprised 16% of Hyperion Brookfield’s assets under management, or AUM, and approximately 29.5% of our investment portfolio, or 81.7% of our portfolio not invested in Agency ARMS as of that date. However, the investment returns shown below generally were obtained using much lower levels of financial leverage than what we intend to use. Past performance is not indicative of future results. In addition, this information is a reflection of Hyperion Brookfield’s historical performance and not a guarantee or prediction of the return that Hyperion Brookfield or Hyperion Brookfield Crystal River will achieve for us. The percentile rankings noted below reflect the performance of Hyperion Brookfield against other

117


Table of Contents

asset managers for the same period. For example, performance that is reflected in the 7th percentile means that Hyperion Brookfield’s performance ranked in the top 7% of all asset managers with that investment strategy for the period noted.
PSN Mortgage-Backed Universe — percentile rankings (as of 3/31/2006)
                                 
    Hyperion Enhanced   Hyperion High Yield
    MBS   CMBS
         
    Gross       Gross    
    Return   Percentile   Return   Percentile
                 
1 year
    3.04 %     40       6.50 %     1  
3 year
    4.41 %     7       8.9 %     1  
5 year
    6.32 %     4       11.96 %     1  
10 year
    7.96 %     1              
 
Hyperion Brookfield obtained this information from Plan Sponsor Network, or PSN, which is a third-party investment manager database and is a division of Informa Investment Solutions. We and Hyperion Brookfield have not verified the accuracy of the information provided by PSN. All rates of return are annualized. Performance figures shown are gross of fees and do not take into account advisory fees or transaction costs. These costs reduced actual returns. Index returns do not reflect any management fees, transaction costs or expenses.
     The following tables set forth Hyperion Brookfield’s investment track record for a composite of its accounts managed in its High Yield CMBS and Enhanced MBS strategies, which are similar to our CMBS and Non-Agency RMBS investments, respectively. No selective periods of performance have been used. Valuations and returns are computed and stated in U.S. dollars. The returns are computed using time-weighted total rates of return. A time-weighted rate of return eliminates the distorting effects created by inflows of new money and is the most common method used to compare the returns of investment managers. The effect of varying cash inflows is eliminated by assuming a single investment at the beginning of a period and measuring the growth or loss of market value to the end of that measurement period. Leverage has not been employed. Accounting is based on trade date. Accrued income is calculated for all fixed income securities which have been held at any time during the month. The daily interest accrual is computed and accumulated as an income flow on each day that the security is held. Accrual accounting recognizes all revenues and expenses in the period they are incurred. Unlike cash accounting, the transaction may not always occur when the physical cash is received. Cash flows generated from contributions and withdrawals are accumulated as capital flows at the end of the day on which they occur. Past performance is not indicative of future results. In addition, this information is a reflection of Hyperion Brookfield’s historical performance and not a guarantee or prediction of the return that Hyperion Brookfield or Hyperion Brookfield Crystal River will achieve for us.
      Hyperion Brookfield’s High Yield CMBS strategy is to invest primarily in commercial mortgage-backed securities, rated below-investment grade, with the objective of outperforming the Lehman High Yield CMBS Index, which is comprised of below-investment grade rated CMBS securities. The Index data has been taken from published sources. Index performance returns do not reflect management fees or expenses. Performance results are presented before management and custodial fees but after all trading commissions. All returns are represented gross of withholding taxes.

118


Table of Contents

Hyperion Brookfield High Yield CMBS Composite
Performance Disclosures
                                                                 
    Gross Rate   Net Rate of   Benchmark       Composite   Composite   % of   Total Firm
    of Return(1)   Return(2)   Return   Number of   Dispersion(4)   Assets   Firm   AUM
Year   (%)   (%)   (%)   Portfolios(3)   (%)   ($ millions)   AUM(5)   ($ millions)
                                 
1Q 2006
    0.04       (0.05 )     0.66       1       0       178       1       19,262  
2005
    8.80       8.41       12.95       1       0       178       1       17,619  
2004
    16.62       16.20       16.70       1       0       164       1       12,920  
2003
    4.25       3.83       3.61       1       0       140       2       8,869  
2002
    24.72       24.18       24.42       1       0       135       2       8,156  
2001
    11.11       10.61       11.14       1       0       128       2       7,076  
2000
    18.58       18.05       22.44       1       0       115       2       5,705  
1999
    0.95       0.59       3.44       2       0.28       126       3       4,673  
1998
    (6.38 )     (6.71 )     (9.89 )     2       0.43       104       2       5,211  
3/1997-12/1997(6)
    14.38       14.18       22.83       2       1.36       101       2       6,493  
 
(1)  Gross performance results are presented before management and custodial fees but after all trading commissions.
 
(2)  Net performance is calculated using the fee schedule of the portfolios comprising the composite.
 
(3)  Number of portfolios or accounts invested only in Hyperion Brookfield’s High Yield CMBS strategy. In accordance with the Global Investment Performance Standards, performance disclosures do not include any portfolio or account partially invested in such strategy, including Crystal River.
 
(4)  The composite dispersion is calculated on a high-low basis by averaging monthly dispersion in the composite for each calendar year. Dispersion is the mathematical difference between returns on multiple portfolios. A lower dispersion means that there was a lower variance among the performance of the multiple portfolios, while a higher dispersion indicates larger variance among the various portfolio returns.
 
(5)  AUM refers to Hyperion Brookfield’s assets under management.
 
(6)  April 1997 is the inception date of the Hyperion Brookfield High Yield CMBS Composite. For periods of less than one year, returns are not annualized.
     Hyperion Brookfield’s Enhanced MBS strategy is to invest primarily in credit sensitive MBS — specifically, Non-Agency MBS and real estate-related asset-backed securities — with the objective of capitalizing on relative value opportunities and outperforming the Lehman MBS Index, which is an unmanaged index comprised of fixed-rate securities backed by pools of mortgages that are rated investment grade or higher. The Index data has been taken from published sources. Index performance returns do not reflect management fees or expenses. Performance results are presented before management and custodial fees but after all trading commissions. All returns are represented gross of withholding taxes.

119


Table of Contents

Hyperion Brookfield Enhanced MBS Composite
Performance Disclosures
                                                                 
    Gross Rate   Net Rate of   Benchmark   Number   Composite   Composite   % of   Total Firm
    of Return(1)   Return(2)   Return(3)   of   Dispersion(4)   Assets   Firm   AUM
Year   <