S-11 1 ds11.htm FORM S-11 Form S-11
Table of Contents

As filed with the Securities and Exchange Commission on July 17, 2009

Registration Statement No. 333-                

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-11

FOR REGISTRATION

UNDER

THE SECURITIES ACT OF 1933

OF CERTAIN REAL ESTATE COMPANIES

 

 

Ladder Capital Realty Finance Inc

(Exact name of registrant as specified in its governing instruments)

 

 

600 Lexington Avenue, 23rd Floor

New York, New York 10022

(212) 715-3170

(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)

 

 

Pamela McCormack, Esq.

General Counsel

c/o Ladder Capital Realty Finance Manager LLC

600 Lexington Avenue, 23rd Floor

New York, New York 10022

(212) 715-3174

(Name, Address, including Zip Code, and Telephone Number, including Area Code, of Agent for Service)

 

 

Copies to:

 

Larry Medvinsky, Esq.

Anthony A. Lopez III, Esq.

Clifford Chance US LLP

31 West 52nd Street

New York, New York 10019

Tel: (212) 878-8000

Fax: (212) 878-8375

 

Valerie Ford Jacob, Esq.

Paul D. Tropp, Esq.

Fried, Frank, Harris, Shriver & Jacobson LLP

One New York Plaza

New York, New York 10004

Tel: (212) 859-8000

Fax: (212) 859-4000

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the Securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box:  ¨

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.  ¨

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.  ¨

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.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer  ¨

   Accelerated filer  ¨    Non-accelerated filer  x    Smaller Reporting Company  ¨
      (Do not check if a smaller reporting company)   

CALCULATION OF REGISTRATION FEE

 

Title of Each Class of Securities to be Registered   Proposed Maximum
Aggregate Offering Price(1) (2)
  Amount
of Registration Fee(1)

Common Stock, par value $0.01 per share

  $400,000,000   $22,320

 

(1)   Estimated solely for purposes of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended.

 

(2)   Includes the offering price of common stock that may be purchased by the underwriters upon the exercise of their overallotment option.

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, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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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 we are not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to Completion, Dated July 17, 2009

             Shares

Ladder Capital Realty Finance Inc

Common Stock

We are a newly organized commercial real estate finance corporation that has been formed to primarily originate, acquire and manage a diversified portfolio of commercial real estate first mortgage loans secured by income-producing properties. To a lesser extent, we expect to invest in senior classes of investment grade commercial mortgage-backed securities and originate and acquire other commercial real estate-related debt instruments. We will be externally managed and advised by Ladder Capital Realty Finance Manager LLC, or our Manager, which is an affiliate and indirect subsidiary of Ladder Capital Finance Holdings LLC, or Holdings. Holdings is a specialty finance company that provides a comprehensive set of financing solutions to the commercial real estate industry and which has an investment strategy substantially similar to ours.

This is our initial public offering and no public market currently exists for our common stock. We are offering          shares of our common stock. We expect the initial public offering price of our common stock to be $     per share. We intend to apply to have our common stock listed on the New York Stock Exchange, or the NYSE, under the symbol “LCG.”

Concurrently with the completion of this offering, Ladder Capital Realty Finance Holdings LLC, or the Ladder Investor, an affiliate of our Manager, will acquire $         million of our common stock (         shares) and $         million of our common units of limited partnership interest in our operating partnership, or OP units (         OP units), in a private placement, at a price per share/unit equal to the initial public offering price, for an aggregate investment equal to 20% of the gross proceeds raised in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement.

We are a Maryland corporation that intends to elect and qualify to be taxed as a real estate investment trust, or REIT, for U.S. federal income tax purposes, commencing with our taxable year ending December 31, 2009. To assist us in qualifying as a REIT, stockholders are generally restricted from owning more than 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of common or capital stock. We expect our board of directors to waive this ownership limitation in order to allow the Ladder Investor and its affiliates, including our Manager, to own up to         % by value or number of shares, whichever is more restrictive, of our outstanding shares of common or capital stock. In addition, our charter contains various other restrictions on the ownership and transfer of our common stock.

 

      Per Share    Total

Public offering price

   $                    $                

Underwriting discounts and commissions

   $    $

Proceeds, before expenses, to us

   $    $

We have granted the underwriters an option to purchase up to an additional          shares from us at the public offering price, less underwriting discounts and commissions, to cover overallotments, if any, within 30 days of the date of this prospectus.

Investing in our common stock involves risks. See “Risk factors” beginning on page 28 of this prospectus for a discussion of the following and other risks:

 

 

We have no operating history and may not be able to operate our business successfully or generate sufficient cash flow to make or sustain distributions to our stockholders.

 

We have not identified any specific assets. Therefore, you will not be able to evaluate the allocation of the net proceeds of this offering and the concurrent private placement or the economic merits of our portfolio.

 

We may change our investment, leverage, financing and operating strategies, policies or procedures without stockholder consent, which may adversely affect the market value of our common stock and our ability to make distributions to our stockholders.

 

There are various conflicts of interest in our relationship with Holdings and its affiliates, including our Manager, which could result in decisions that are not in the best interests of our stockholders.

 

We are dependent on our Manager and its affiliates and their key personnel and we may not find a suitable replacement if they become unavailable to us.

 

Maintenance of our exemption from registration under the Investment Company Act of 1940, as amended, and our qualification as a REIT imposes significant limits on our operations.

 

Our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available for distribution to our stockholders.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed on the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters are offering the shares of our common stock as set forth under “Underwriting.” Delivery of the shares of our common stock will be made on or about         , 2009.

 

J.P. Morgan   Wells Fargo Securities

 

        , 2009


Table of Contents

Table of contents

 

     Page

Prospectus summary

   1

The offering

   27

Risk factors

   28

Forward-looking statements

   74

Use of proceeds

   76

Distribution policy

   77

Capitalization

   78

Management’s discussion and analysis of financial condition and results of operations

   79

Business

   104

Our management

   133

Our manager and the management agreement

   144

Principal stockholders

   158

Certain relationships and related transactions

   159

Description of capital stock

   163

Shares eligible for future sale

   168

Certain provisions of the Maryland General Corporation Law and our charter and bylaws

   170

The operating partnership agreement

   175

U.S. federal income tax considerations

   178

ERISA considerations

   204

Underwriting

   205

Legal matters

   210

Experts

   211

Where you can find more information

   212

Index to the balance sheet of Ladder Capital Realty Finance Inc

   F-1

You should rely only on the information contained in this prospectus, or in any free writing prospectus prepared by us. We have not, and the underwriters have not, authorized any other person to provide you with different or additional information. If anyone provides you with different or additional information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus and any free writing prospectus prepared by us is accurate only as of their respective dates or on the date or dates which are specified in these documents. Our business, financial condition, liquidity, results of operations and prospects may have changed since those dates.

Until             , 2009 (25 days after the date of this prospectus), all dealers that effect transactions in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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Market data

Certain market and industry data used in this prospectus has been obtained from independent industry sources and publications, including Commercial Mortgage Alert, John B. Levy & Company, Inc., Mortgage Bankers Association, Property & Portfolio Research, Inc., Trepp, LLC, the Federal Deposit Insurance Corporation and the Federal Reserve, as well as from research reports prepared for other purposes. We have not independently verified the data obtained from these sources, and we cannot assure you of the accuracy or completeness of the data.

These industry sources disclaim any and all liability with respect to this prospectus in the event any information, commentary, analysis, opinions, advice, recommendations or forecasts in such material prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses. Any forecasts prepared by such sources are based on data (including third party data), models, and experience of various professionals, and are based on various assumptions, all of which are subject to change without notice. Additionally, these industry sources reserve the right to make changes at any time, without notice, to any modeling used in their forecasts contained in this prospectus. The industry sources did not review any third party data provided to them for genuineness or accuracy, and do not represent or endorse the accuracy or reliability of any such data.

Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and additional uncertainties regarding other forward-looking statements in this prospectus.

The information provided by these industry sources should not be construed to sponsor, endorse, offer or promote an investment, nor does it constitute any representation or warranty, express or implied, regarding the advisability of an investment or the legality of an investment under appropriate laws.

 

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Prospectus summary

This summary highlights some of the information in this prospectus. It does not contain all of the information that you should consider before investing 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 “company,” “we,” “us,” and “our” refer to Ladder Capital Realty Finance Inc, a Maryland corporation, together with its consolidated subsidiaries, including Ladder Capital Realty Finance LP, a Delaware limited partnership, which we refer to as “our operating partnership” and, similarly, references to “our assets” refer primarily to assets of our operating partnership and its subsidiaries; “our Manager” refers to Ladder Capital Realty Finance Manager LLC, a newly-formed Delaware limited liability company, our external manager; “our Advisor” refers to Ladder Capital Finance LLC, a Delaware limited liability company; “the Ladder Capital Group” refers to Ladder Capital Finance Holdings LLC, which we refer to as Holdings, together with its direct and indirect subsidiaries (other than us), including our Manager; “the Ladder Investor” refers to Ladder Capital Realty Finance Holdings LLC, an affiliate of our Manager; “Class B units” refers to the Class B units of limited partnership interest in our operating partnership held by our Manager; and “OP units” refers to common units of limited partnership interest in our operating partnership. Unless indicated otherwise, the information in this prospectus assumes (1) the common stock to be sold in this offering is sold at $             per share, (2) a $             million investment will be made by the Ladder Investor in a private placement to be completed concurrently with the completion of this offering, and (3) the underwriters do not exercise their overallotment option to purchase up to an additional              shares of our common stock.

Our company

We are a newly organized commercial real estate finance corporation that has been formed to primarily originate, acquire and manage a diversified portfolio of commercial real estate first mortgage loans secured by income-producing properties. To a lesser extent, we expect to invest in senior classes of investment grade commercial mortgage-backed securities, or senior CMBS, and originate and acquire other commercial real estate-related debt instruments. We expect that over time most of our investment activity will take the form of first mortgage originations. However, we may initially allocate a significant portion of our net proceeds to senior CMBS designed to opportunistically take advantage of the Term Asset Backed Securities Loan Facility, or the TALF. We collectively refer to the assets that we intend to originate, acquire and manage as our target assets.

Our objective is to protect and preserve capital in a manner that provides for attractive risk-adjusted returns to our investors over the long term through dividends and capital appreciation. We intend to achieve this objective by selectively originating, acquiring and managing a diversified portfolio of our target assets designed to generate attractive risk-adjusted returns across a variety of market conditions and economic cycles. We believe that the current lack of liquidity in the commercial real estate, financial and credit markets presents significant opportunities for us to selectively originate high quality first mortgage loans to strong sponsors on attractive terms and that these conditions should persist for a number of years. We intend to build our business on a foundation of market knowledge combined with a disciplined credit and due diligence culture that is designed to protect and preserve capital. Our management team has implemented a similar business model to ours in the past. We believe that the flexibility of our investment strategy, combined with our expertise in our target assets and our long-term, primary focus on newly originated first mortgage loans, should enable us to achieve our objective.

We will be externally managed and advised by Ladder Capital Realty Finance Manager LLC, or our Manager, which is an affiliate and the indirect subsidiary of Holdings. Holdings is a specialty finance company that provides a comprehensive set of financing solutions to the commercial real estate industry. Holdings was

 

 

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formed by our senior management team in October 2008. Since its inception, our senior management team has been executing an investment strategy for Holdings substantially similar to ours and has been developing a pipeline of transactions that we expect to directly benefit from following the completion of this offering and the concurrent private placement.

Our Manager will originate, acquire and manage a diverse portfolio of real estate and real estate-related assets through a fully-integrated commercial mortgage loan origination platform with in-house origination, underwriting, structuring, financing, asset management, risk management and disposition capabilities. Our Manager will be comprised of an experienced team of senior managers, the core of whom have worked together previously in the commercial real estate industry, originating, underwriting, acquiring, structuring, managing and securitizing a diverse portfolio of commercial real estate mortgages, real estate and real estate-related assets through various economic cycles and market conditions. Our management team will be led by Brian Harris, our Chief Executive Officer, and will include Greta Guggenheim, our President, Marc Fox, our Chief Operating Officer, Robert Perelman, our Head of Asset Management, Pamela McCormack, our General Counsel and Head of Transaction Management, and             , our Chief Financial Officer. Brian Harris has over 23 years of experience in the real estate and financial markets and has managed multi-billion dollar proprietary commercial real estate lending platforms and commercial real estate portfolios for over 11 years at UBS Securities LLC, or UBS; Dillon Read Capital Management, or DRCM, a wholly-owned subsidiary of UBS; and Credit Suisse Securities (USA) LLC, or Credit Suisse.

We will commence operations upon completion of this offering and the concurrent private placement to Ladder Capital Realty Finance Holdings LLC, or the Ladder Investor. We are organized as a Maryland corporation and intend to elect and qualify to be taxed as a real estate investment trust, or REIT, for U.S. federal income tax purposes, commencing with our taxable year ending December 31, 2009. We generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute all of our taxable income to stockholders and maintain our intended qualification as a REIT. We will conduct substantially all of our operations though our operating partnership, of which we are the sole general partner. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the 1940 Act.

About the Ladder Capital Group

Our Manager is an indirect subsidiary of Holdings, a privately-held company that commenced operations in October 2008. Holdings, together with its direct and indirect subsidiaries, which is referred to herein as the Ladder Capital Group, is a vertically-integrated, full-service commercial real estate finance and investment management company with an investment strategy substantially similar to ours that originates, underwrites, structures, acquires, manages and distributes commercial real estate mortgages and other real estate debt instruments. Since its inception, our senior management team has been executing an investment strategy for Holdings substantially similar to ours and has been developing a pipeline of transactions that we expect to directly benefit from upon the completion of this offering and the concurrent private placement.

The Ladder Capital Group has several key and strategic investors, including TowerBrook Capital Partners L.P., a private equity firm with approximately $5.0 billion of capital under management, and GI International, L.P., or GI Partners, a private equity firm with approximately $3.7 billion of capital under management and with significant prior experience in the commercial real estate industry and the formation of public REITs, including Digital Realty Trust, Inc. In addition, Brian Harris has personally invested $25 million in Holdings. The Chairman of Holdings is Alan Fishman, who has a long and distinguished career having held positions at several large financial institutions. Over the last ten years, Mr. Fishman has served as President and Chief Executive Officer of ContiFinancial Corp., Chief Executive Officer of Independence Community Bank (including briefly as President of Sovereign Bancorp following its acquisition of Independence Community Bank) and Chairman of Meridian Capital Group LLC, one of the largest commercial real estate mortgage

 

 

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brokers in the United States. In September of 2008, Mr. Fishman was appointed as Chief Executive Officer of Washington Mutual and its holding company for a brief period immediately preceding its merger with JPMorgan Chase. The Ladder Capital Group operates out of New York and currently employs 17 professionals.

In late September/early October 2008, during an unprecedented period of market illiquidity and volatility, Holdings successfully raised $611.6 million of equity capital and obtained a $300 million secured term credit facility from Wells Fargo Securities, LLC, an affiliate of one of our underwriters. Thereafter, Holdings also obtained four additional short-term secured term funding lines from other financial institutions. As of June 30, 2009, 70% of Holdings’ committed equity has been drawn, leaving the remaining $183.5 million available to be deployed to support future investments, including the purchase of $             million of our common stock (             shares) and $             million of OP units (             OP units) in a private placement to be completed concurrently with this offering.

Beginning with its commencement of operations in October 2008, Holdings’ initial focus was on the origination and acquisition of income-producing commercial real estate first mortgage loans. However, in November 2008, the senior management team at Holdings observed that the market for CMBS experienced substantial turmoil resulting in market price declines for CMBS at all rating levels. As a result of such price declines, the yields on the most highly rated classes of CMBS were much higher than the returns that the senior management team at Holdings expected could be earned by originating or acquiring first mortgage loans and related instruments. In that environment, the senior management team at Holdings determined that the price of AAA-rated CMBS backed by large and diverse pools of commercial mortgage loans represented a better short-term investment than originating and acquiring first mortgage loans. In view of the attractive risk-adjusted returns the senior management team believed to be available in the CMBS market, the senior management team at Holdings has focused primarily on investing in the most senior classes (A-1 through A-4) of AAA-rated CMBS. From November 2008 through June 2009, Holdings acquired $679.4 million of CMBS securities. During the same time period, Holdings sold $50.5 million of CMBS securities, resulting in approximately $7.9 million of realized gains. As of June 30, 2009, Holdings’ CMBS portfolio had a weighted average unlevered yield to scheduled maturity of 8.45% and a weighted average term to scheduled maturity of 2.24 years (each measured as of the date of acquisition of the applicable CMBS). In addition to the CMBS securities, from November 2008 through June 2009, Holdings also acquired $26.8 million in interest only securities and a $16.0 million senior participation interest in a first mortgage loan at a discounted price of $14.6 million.

 

On July 7, 2009, Holdings entered into an agreement to acquire FirstCity Bank of Commerce, a Florida state-chartered bank, which we refer to herein as the Ladder Capital Bank. In connection with this acquisition, which is currently anticipated to close on or before December 31, 2009, Holdings intends to submit an application to qualify itself as a bank holding company under the Bank Holding Company Act of 1956. The acquisition is subject to a number of conditions, including stockholder approval, regulatory approvals, satisfaction of certain financial covenants and other customary closing conditions. Upon the completion of the merger, the Ladder Capital Bank is expected to primarily focus on the origination of high quality, low leverage first mortgage commercial loans. If the acquisition of the Ladder Capital Bank is completed, the senior management team at Holdings will serve as the senior executives of the Ladder Capital Bank. However, Holdings intends to retain the operational banking team currently employed by the Ladder Capital Bank as well as hire new additional banking personnel, including a Chief Credit Officer and Head of Retail Banking, allowing the senior management team at Holdings to focus primarily on loan originations. There is no guarantee as to whether, when or on what terms this acquisition will take place.

 

 

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Our Manager

We will be externally managed and advised by Ladder Capital Realty Finance Manager LLC, a newly-formed Delaware limited liability company. Pursuant to the terms of a management agreement between our Manager and us, our Manager will be responsible for administering our business activities and day-to-day operations and will provide us with our management team and appropriate support personnel. Pursuant to an advisory agreement between our Manager and Ladder Capital Finance LLC, or our Advisor, our Manager will directly benefit from the highly experienced personnel and resources of the Ladder Capital Group necessary for the implementation and execution of our investment strategy. We do not expect to have any employees. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. The Ladder Capital Group will not be obligated to dedicate any of its other executive officers or personnel exclusively to us. In addition, none of the Ladder Capital Group, its executive officers and other personnel, including our executive officers supplied to us by the Ladder Capital Group (other than our Chief Financial Officer), will be obligated to dedicate any specific portion of its or their time to our company. Our Manager will be subject to the supervision and oversight of our board of directors.

Our Manager will be comprised of an experienced team of senior managers led by Brian Harris and will include Greta Guggenheim, Marc Fox, Robert Perelman, Pamela McCormack and our Chief Financial Officer. Brian Harris and Greta Guggenheim initially began working together at Credit Suisse from 1996 through 1999 and then later worked together at UBS/DRCM from August 2000 until August 2007. In addition, a substantial number of Holdings’ employees worked together previously at UBS/DRCM where they established a track record of originating, underwriting, acquiring, structuring, managing and securitizing a diverse portfolio of commercial real estate mortgages, real estate and real estate-related assets. Between 2002 and 2006, the commercial real estate group at UBS/DRCM, headed by Brian Harris, generated adjusted total revenues of between $230 million and $295 million per year. Adjusted total revenue figures shown below represent gross revenues (comprised of trading revenues and fees, interest income and realized profits) of the commercial real estate group at UBS/DRCM for the years shown, net of financing and hedging costs, realized losses, impairments and mark-to-market adjustments, where applicable. Adjusted total revenue figures do not include deductions for compensation, overhead allocations and other expenses.

Historical data of the UBS/DRCM Commercial Real Estate Group led by Brian Harris(1)

 

(dollars in millions)    2002    2003(3)    2004(3)    2005    2006(4)
 

Adjusted total revenues(2)

   $249.8    $294.2    $275.0    $285.4    $233.6
 

 

(1)  

This data is unaudited and has not been independently verified. None of UBS, DRCM or any of their respective affiliates represents or warrants as to, or assumes any liability for, the accuracy or use of this data. None of UBS, DRCM or any of their respective affiliates makes any representation or warranty that this data is accurate or suitable for use in connection with this prospectus or in connection with your investment in our common stock.

 

(2)  

Adjusted total revenue figures shown above represent gross revenues (comprised of trading revenues and fees, interest income and realized profits) of the commercial real estate group at UBS/DRCM for the years shown, net of financing and hedging costs, realized losses, impairments and mark-to-market adjustments, where applicable. Adjusted total revenue figures do not include deductions for compensation, overhead allocations and other expenses.

 

(3)  

A portion of the 2003 and 2004 revenues (estimated by Brian Harris and members of his management team at such times to be approximately $46 million in the aggregate) relates to realization on equity investments in property acquired or occupied by UBS.

 

(4)  

The revenue figure for 2006 reflects revenue generated while the business was part of UBS Investment Bank and DRCM. The transition of the business out of UBS Investment Bank occurred on June 5, 2006.

This historical data is a reflection of certain aspects of the past performance of Brian Harris and his management team at UBS/DRCM and is not intended to be indicative of, or a guarantee or prediction of, the revenues that we or our management team may generate in the future. Similar data for the commercial real estate group at UBS/DRCM is not available for periods subsequent to the departure of Brian Harris and

 

 

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his management team from UBS/DRCM. Therefore, there is no information or representation as to the actual performance of UBS/DRCM’s commercial real estate asset portfolio (if any) in 2007 and 2008, nor can there be any assurance as to how the UBS/DRCM commercial real estate asset portfolio would have performed if managed during this volatile and turbulent period by Brian Harris and his management team. Although we intend to employ a similar investment strategy to that used by Brian Harris and his management team at UBS/DRCM, certain aspects of our business strategy differ from that model. We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes. Accordingly, to qualify as a REIT, we must comply with requirements regarding the composition and values of our assets, our sources of income and the amounts we distribute to our stockholders in a manner different from UBS/DRCM. Further, we expect to actively manage our portfolio in a manner so as to avoid registration under the 1940 Act. This will impose limitations on our activity which were not imposed at UBS/DRCM. We also expect to operate with significantly less leverage than did the commercial real estate group at UBS/DRCM. In contrast to the financial results of the commercial real estate group at UBS/DRCM where revenues from securitizations comprised the majority of revenues in the above table for the 2005 and 2006 calendar years and were a significant contribution in other periods, we expect to have significantly less revenue from securitizations as the securitization market may remain effectively closed for the near future. A portion of the adjusted total revenues of the commercial real estate group at UBS/DRCM reflect returns derived from investments in real estate equity. Our current plan is to invest in little, if any, real estate equity. Further, the UBS/DRCM team had more personnel than our Manager currently has and not all of the management team at UBS/DRCM during the periods indicated above are members of our management team. The historical data above also does not take into account management or advisory fees or similar transaction costs which reduce actual revenues. We will pay our Manager a base management fee and incentive distribution and we expect to incur certain transaction costs with respect to the origination, acquisition, financing and management of our assets. Accordingly, the historical data of Brian Harris and his management team at UBS/DRCM are not indicative of the performance of our strategy and we can offer no assurance that our Manager will replicate its historical performance as presented in this prospectus. See “Risk factors—Risks related to our company—Our Manager may not be able to replicate the prior business model used by certain members of our management team and available data for the prior business model is limited.”

Our Manager’s competitive strengths

We believe our business possesses a number of characteristics distinguishing us from our competitors, including:

Experienced management team

Our senior management team, which is comprised of Brian Harris, our Chief Executive Officer, Greta Guggenheim, our President, Marc Fox, our Chief Operating Officer, Robert Perelman, our Head of Asset Management, Pamela McCormack, our General Counsel and Head of Transaction Management, and             , our Chief Financial Officer, is highly experienced in real estate investing and finance and has significant experience in the commercial real estate sector. The core of our management team have worked together during both volatile and stable market conditions and have established a track record of acquiring and managing commercial real estate debt and real estate-related assets, generating what we believe to have been consistently attractive annual returns. For more information about our management team and their track record, see “—About the Ladder Capital Group,” “Our management—Our directors, director nominees and executive officers” and “Our Manager and the management agreement.” We expect that the extensive experience of the members of our management team in the commercial real estate industry will provide us with the ability to effectively deploy our capital in a manner that we believe will provide for attractive risk-adjusted returns but with a focus on capital preservation and protection.

 

 

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Access to the Ladder Capital Group’s long-standing relationships

The market for our target assets is competitive and we may compete with many other participants for investment opportunities. We believe our Manager’s ability to identify attractive opportunities will distinguish us from many of our competitors. We intend to capitalize on the Ladder Capital Group’s origination platform, structuring expertise and market insight into the commercial real estate sector. The Ladder Capital Group and its strategic investors have established numerous relationships with well-recognized real estate owners, investors, lenders and brokers, including leading investment banks, commercial banks, insurance companies, nationally recognized commercial mortgage brokers and other financial institutions. We expect to benefit from these long-standing relationships across the real estate industry and expect such relationships to help us continue to grow and maintain our pipeline and to generate attractive opportunities that may not be available to many of our competitors or to the general market.

Proven access to capital raising

In late September/early October 2008, during an unprecedented period of market illiquidity and volatility, Holdings successfully raised $611.6 million of equity capital and obtained a $300 million secured term credit facility from Wells Fargo Securities, LLC, an affiliate of one of our underwriters. Thereafter, Holdings also obtained four additional short-term secured term funding lines from other financial institutions which had approximately $113.3 million outstanding in the aggregate as of June 30, 2009. We expect our management team to provide us with similar access to major financial institutions and to assist us in obtaining short-term lending facilities and long-term secured debt facilities.

Disciplined lending/strong credit culture

We will seek to maximize our risk-adjusted returns, and preserve and protect capital, through our Manager’s disciplined and credit-based approach. Our management team has long employed a disciplined approach to risk. Our management team expects to manage the credit and market risk of our company’s portfolio through a rigorous underwriting and loan closing process that includes numerous checks and balances to evaluate the risks and merits of each potential transaction. Our Manager will seek to protect and preserve capital by performing a comprehensive risk-reward analysis on each potential transaction, with a focus on relative values between real estate asset sectors, geographic markets and its position in the capital structure, as well as by creating a diversified portfolio of assets that it will actively manage. We expect to benefit from the Ladder Capital Group’s highly specialized, credit analysis techniques, such as its credit and collateral stratifications, stress assessments and asset management procedures for early detection of troubled and deteriorating assets.

Vertically-integrated commercial mortgage loan origination platform

The Ladder Capital Group has a vertically-integrated commercial mortgage loan origination platform that allows it to manage and control the loan process from origination through closing with personnel highly experienced in credit, underwriting, structuring, capital markets and asset management. As a real estate lender, the Ladder Capital Group has a strong credit culture stemming from the extensive experience of its seasoned management team and the team’s in-depth understanding of commercial real estate markets. Through our Manager, we intend to utilize the Ladder Capital Group’s vertically-integrated commercial mortgage loan origination platform to identify, assess and manage risks associated with each opportunity we pursue. In addition, we believe that our access to this platform will allow us to quickly and efficiently execute opportunities we deem desirable.

 

 

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Structuring flexibility

Our Manager’s ability to provide a wide range of financing products and its ability to customize financing structures to meet borrowers’ needs is one of our key business strengths. In particular, we will seek to be a full-service provider of commercial real estate financing solutions, financing primarily the most senior capital positions as well as selectively making mezzanine loans and financing participation and subordinate interests. We believe that our Manager’s experience in creating the loan structures we intend to offer, including its expertise in structuring intercreditor agreements, participation agreements and servicing arrangements that can protect our rights, mitigate losses and enhance returns, will help us offer innovative and customized financing solutions to borrowers and produce attractive risk-adjusted returns. In addition, we expect to benefit from our Manager’s independent, segregated loan origination, underwriting, legal due diligence and asset management functions, which we expect will assist us in producing and managing commercial real estate financial products reflecting our disciplined approach to risk.

No legacy issues

Unlike many of our competitors, we are a newly-formed entity that will not be burdened by distressed legacy commercial real estate assets. We believe we will have a competitive advantage relative to other existing comparable commercial real estate lenders because neither we nor our Manager or its affiliates have a legacy portfolio of lower-return or problem assets that could potentially dilute the attractive returns we believe are available in the current liquidity-challenged environment and/or distract our management team. In addition, we will be an independent “pure-play” commercial real estate finance corporation. As a new business, our portfolio of target assets will consist of newly acquired and newly priced assets and we will not have any preexisting assets or legacy exposures, other than those we decide to purchase following this offering, to distract and monopolize our management team’s time and attention. At the completion of this offering and the concurrent private placement, we do not expect to have any adverse credit exposure to, nor our performance to be negatively impacted by, previously purchased assets.

Alignment of the Ladder Capital Group and our Manager’s interests

We have taken steps to structure our relationship with the Ladder Capital Group and our Manager so that our interests and those of the Ladder Capital Group and our Manager are closely aligned. The Ladder Investor has agreed to purchase $         million of our common stock (         shares) and $         million of OP units (         OP units) in a concurrent private placement, at a price per share/unit equal to the initial public offering price, for an aggregate investment equal to 20% of the gross proceeds raised in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement. The Ladder Investor has agreed to an 18-month lock-up with us with respect to the securities that they purchase in the concurrent private placement. In addition, we will grant shares of restricted common stock to our Manager under our 2009 equity incentive plan, equal to     % of the number of shares that we issue in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement, which will vest ratably on an annual basis over a three-year period commencing on the first anniversary of the completion of this offering and the concurrent private placement. We believe that the significant investment in us by the Ladder Investor, as well as our Manager’s incentive distribution structure and our 2009 equity incentive plan, will align our interests with those of our Manager, which will create an incentive to maximum returns for our stockholders.

 

 

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Market opportunity

We believe there is an unprecedented market opportunity for well capitalized commercial real estate lenders to originate attractively priced loans with strong credit fundamentals on high quality income-producing real estate. This opportunity, which we expect to persist for several years, is the result of a substantial decline in the aggregate balance sheet capacity of commercial real estate lenders amidst a backlog of over $1.8 trillion of maturing commercial real estate loans that will need to be refinanced from 2009 through 2012.

According to the Federal Reserve, the volume of commercial and multifamily mortgage debt outstanding grew by over 60% from the beginning of 2004 through the end of 2008 to $3.5 trillion. This growth was fueled by rising commercial real estate property values, a strong economy and an abundance of debt and equity capital. As the market expanded, commercial real estate values rose to levels higher than the underlying real estate fundamentals justified due to overly optimistic underwriting projections, the willingness of certain commercial real estate investors to accept lower rates of return (known as “cap rate compression”) and extremely high leverage levels. During this period, financing terms became increasingly favorable to borrowers as lenders aggressively underwrote loans to drive fee income from “originate-to distribute” securitization programs that transferred credit risk from lenders’ balance sheets to investors.

In February 2007, severe credit problems in the subprime residential mortgage market led to a re-examination of credit standards across all financing markets, including commercial real estate. In April 2007, in order to better reflect inherent risks, Moody’s Investors Service modified its models that determine how ratings to commercial mortgage-backed bonds are assigned. This shift led to a long-term structural change in the commercial real estate lending market, and investors reacted by requiring tighter underwriting standards. Commercial real estate lenders became saddled with billions of dollars of more loosely underwritten loans that were originally targeted for distribution to investors via securitizations. These loans either had to be held by the lenders or sold at a loss due to a substantial downward repricing; either option required lenders to hold additional capital and limited the lenders’ capacity to originate new commercial real estate loans. As a result, a widespread lack of liquidity developed in the commercial real estate market, which caused a dramatic rise in the cost of credit.

Amidst the ongoing commercial real estate pricing correction, many traditional commercial lenders have ceased or significantly decreased lending due to diminished balance sheet capacity and, in some cases, as a result of having been acquired or having entered bankruptcy. For instance, banks which are significant providers of commercial mortgages are experiencing significant stress. According to the Federal Reserve, as of July 10, 2009, 53 depository institutions with more than $37 billion in combined assets have failed in 2009. In 2008, 25 depository institutions with approximately $372 billion in combined assets failed, as compared to 2007 in which only three banks with approximately $2.6 billion in combined assets failed.

As a result, underwriting standards have tightened dramatically and the availability of credit has plummeted. An April 2009 Federal Reserve survey reported that over 65% of domestic banks have further tightened their lending standards for commercial real estate loans. The April 2009 reading of commercial real estate underwriting standards exceeds underwriting standards reported at any time between July 1990 and October 2007.

Additionally, CMBS is not currently a major source of liquidity for the commercial real estate sector as the credit contraction has virtually shut down the market. We believe that while the number and activity levels of market participants will be substantially lower than levels of the past five years, the lending opportunities will be vast. According to Property and Portfolio Research estimates, over $1.8 trillion of commercial real estate debt will mature from 2009 through 2012, with over $400 billion maturing in each of these years. We believe well capitalized lenders may now be highly selective while originating loans with strong credit fundamentals and historically wide spreads in this environment.

 

 

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Our investment strategy

Our objective is to protect and preserve capital in a manner that provides for attractive risk-adjusted returns to our investors over the long term through dividends and capital appreciation. We intend to achieve this objective by selectively originating, acquiring and managing a diversified portfolio of our target assets designed to generate attractive risk-adjusted returns across a variety of market conditions and economic cycles. We believe that the flexibility of our investment strategy, combined with our expertise in our target assets and our long-term, primary focus on newly originated first mortgage loans, should enable us to achieve our objective.

We expect our Manager to take advantage of long-term structural changes in the real estate lending market by originating and acquiring high quality income-producing commercial real estate mortgage loans and other real estate debt instruments at attractive spreads from high quality sponsors and low loan-to-value assumptions. To a much lesser extent, we also expect our Manager to seek to capitalize on opportunities created by the lack of liquidity in the real estate market and to take advantage of opportunistic pricing dislocations created by distressed sellers or distressed capital structures where a lender or holder of a loan or security is in a compromised situation due to balance sheet constraints, the relative size of its portfolio, the magnitude of nonperforming loans and/or regulatory/rating agency issues driven by potential capital adequacy or concentration issues.

In pursuing investment opportunities with attractive risk-reward profiles, we expect that our Manager will incorporate its views of the current and future economic environment, its outlook for real estate in general and particular asset classes, and its assessment of the risk-reward profile derived from its underwriting and cash flow analysis, including taking into account relative valuation, supply and demand fundamentals, the level of interest rates, the shape of the yield curve, prepayment rates, financing and liquidity, real estate prices, delinquencies, default rates, recovery of various sectors and vintage of collateral. In general, our Manager will employ a “bottom-up,” fundamental approach to asset and security valuation. All investment decisions will be made so that we maintain our qualification as a REIT and our exemption from registration under the 1940 Act.

In order to capitalize on the changing sets of investment opportunities that may be present in the various points of an economic cycle, we may expand or refocus our investment strategy by emphasizing investments in different parts of the capital structure and different sectors of real estate. Our investment strategy may be amended from time to time, if recommended by our Manager and approved by our board of directors. We will not seek stockholder approval when amending our investment strategy.

Our target assets

 

 

First mortgage loans: fixed and floating loans secured by first mortgage liens on income-producing commercial real estate that provide short-, medium- or long- term mortgage financing to commercial property owners generally having maturity dates ranging from one to ten years; and

 

 

Senior participation interests in first mortgage loans: a senior participation interest in an underlying first mortgage loan on commercial real estate, or A-Note, created by virtue of a participation or similar agreement to which the originator of the loan is a party, along with one or more participants, the performance of which depends upon the performance of the underlying loan. If the underlying borrower defaults, the participant typically has no recourse against the originator of the loan.

We expect that over time most of our investment activity will take the form of first mortgage originations.

 

 

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To a lesser extent, we will originate, acquire and manage:

 

 

CMBS: securities that are collateralized by a single commercial mortgage or a pool of commercial mortgage loans, including:

 

   

investment grade CMBS, which are rated BBB- (or Baa3) or higher,

   

below investment grade CMBS, which are rated lower than BBB- (or Baa3), and

   

unrated CMBS.

We do not generally expect to otherwise acquire below investment grade or unrated CMBS, provided that below investment grade CMBS and unrated CMBS may be retained in connection with a sale or securitization of our first mortgage loans. For the first two to three quarters following the completion of this offering and the concurrent private placement, we intend to deploy a significant portion of the net proceeds from these offerings (resulting in a greater percentage of our overall portfolio of target assets than we expect to have within approximately 12 months following the completion of this offering and the concurrent private placement) to acquire senior CMBS to opportunistically take advantage of the TALF. We expect the CMBS we acquire during this initial period to be the most senior priority by subordination with respect to vintages from 2008 and earlier and investment grade with respect to more recent vintages. Additionally, until other appropriate uses for the net proceeds of this offering and the concurrent private placement can be identified, we may invest in senior CMBS with short duration.

Non-core assets: We expect a relatively small portion of our investment activity will take the form of:

 

 

First mortgage loan financing: loans made to holders of commercial real estate first mortgage loans that are secured by such first mortgage loans. The performance of first mortgage loan financing will depend upon the performance of the underlying real estate collateral;

 

 

B–Notes: 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 ANote secured by the same first mortgage on the same property or group; and

 

 

Mezzanine loans: loans made to commercial property owners that are secured by pledges of the borrower’s ownership interests in the property and/or the property owner, subordinate to whole loans secured by first or second mortgage liens on the property and senior to the borrower’s equity in the property.

In addition to our target assets described above, we may also make limited purchases in certain other real estate-related assets, including corporate bank debt, corporate bonds, preferred equity interests, term loans and revolving or syndicated credit facilities, real estate assets related to corporate divestitures and other real estate-related debt.

Because we intend to elect and qualify to be taxed as a REIT and intend to operate our business so as to be excluded from regulation under the 1940 Act, we will be required to invest a substantial portion of our assets in qualifying real estate assets, such as whole loans secured by mortgages. Therefore, our ability to acquire certain assets will be limited, unless the assets are structured to comply with various U.S. federal income tax requirements for REIT qualification and the requirements for exclusion from the 1940 Act registration.

 

 

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Leverage policies/financing strategy

We intend to employ prudent leverage, to the extent available, to fund the origination and acquisition of our target assets and to increase potential returns to our stockholders. Although we are not required to maintain any particular leverage ratio, the amount of leverage we will deploy for particular target assets will depend upon our Manager’s assessment of a variety of factors, which may include the anticipated liquidity and price volatility of the target assets in our portfolio, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and commercial mortgage markets, our outlook for the level, slope, and volatility of interest rates, the credit quality of our target assets, the collateral underlying our target assets, and our outlook for asset spreads relative to the London Interbank Offer Rate, or the LIBOR, curve. Our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our indebtedness policy at any time. We intend to use leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.

Initially, we intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. With respect to other U.S. Government programs, to the extent we expect to utilize them at all, we would utilize such amount of non-recourse leverage up to the amount permitted under the guidelines of the applicable program. When market conditions allow, we intend to finance our first mortgage loans in part through the issuance of AAA-rated CMBS, which we expect should be eligible to be purchased by investors who are able to borrow under the TALF, while retaining the subordinate securities in our portfolio. There can be no assurance that we will be able to utilize the TALF or any other U.S. Government programs successfully or at all. See “Management’s discussion and analysis of financial condition and results of operations—Recent regulatory developments” for a description of the TALF and other U.S. Government programs. We will also seek to obtain financings, including secured term loans or revolving facilities, traditional repurchase or other secured credit facilities and other private funding sources. In addition, when market conditions allow, we expect to reduce the principal risk associated with our origination and investment activities through securitizations, syndications, participations and, to the extent consistent with maintaining our qualification as a REIT, other sales of portions of our assets, and we may choose to enhance our returns through the prudent use of higher leverage, with an emphasis on using term financings, including through the creation of securitization vehicles. We may also seek to raise further equity capital or issue debt securities in order to fund our future activities.

Subject to maintaining our qualification as a REIT, we intend to utilize derivative financial instruments (or hedging instruments), including interest rate swap agreements, interest rate cap agreements, interest rate swaptions, puts and calls on securities or indices of securities, exchange traded derivatives, U.S. Treasury securities and options on U.S. Treasury securities, and interest rate floors, in an effort to hedge the interest rate risk associated with the financing of our portfolio of target assets. Specifically, we will seek to hedge part of our exposure to potential interest rate mismatches between the interest we earn on our assets and our borrowing costs caused by fluctuations in short-term interest rates. In utilizing leverage and interest rate hedges, our objectives will be to improve risk-adjusted returns and, where possible, to lock in, on a long-term basis, a spread between the yield on our assets and the cost of our financing.

 

 

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Investment process

Our Manager will focus on the origination and select acquisition of income-producing commercial real estate first mortgage loans. Our Manager will be responsible for each stage of our investment process, which will include: (1) sourcing deals from the brokerage community and directly from real estate owners, operators, developers and investors; (2) performing due diligence with respect to underwriting the investment; (3) undertaking risk management with respect to individual loans and our aggregate portfolio; (4) executing the closing of a loan investment; and (5) analyzing ongoing capital markets and asset management options.

In addition, our Manager will be responsible for sourcing and screening other investment opportunities, assessing investment suitability, conducting interest rate and prepayment analysis, evaluating cash flow and collateral performance, reviewing legal structure, servicer and originator information and structuring investments, as appropriate. Upon identification of an investment opportunity, the investment will be screened and monitored by our Manager to determine its impact on maintaining our REIT qualification and our exemption from registration under the 1940 Act. Once a potential investment has been identified, our Manager will perform financial, operational, credit and legal due diligence to assess the risks of the investment. Our Manager will analyze our target assets and conduct follow-up due diligence as part of the underwriting process. As part of this process, the key factors which our Manager will consider include, but are not limited to, documentation, debt-to-income ratio, loan-to-value ratios and property valuation. The evaluation process will also include relative value analyses based on yield, credit rating, average life, expected duration, option-adjusted spreads, prepayment assumptions and credit exceptions. Other considerations in our investment process will include analysis of fundamental economic trends and relevant regulatory developments.

In evaluating the merits of any particular proposed investment, our Manager will also evaluate the diversification of our portfolio of assets. Prior to making a final investment decision, our Manager will determine whether it expects that a target asset would cause our portfolio of assets to be too heavily concentrated with, or cause too much risk exposure to, any one borrower, real estate sector, geographic region, source of cash flow for payment or other issues. If our Manager determines that a proposed investment presents excessive concentration risk, it may determine not to acquire an otherwise attractive asset on our behalf.

Our Manager will have an investment committee that will initially be chaired by Brian Harris and will also include Greta Guggenheim, Pamela McCormack and our Chief Financial Officer. Our Manager’s investment committee will make investment, financing, asset management and disposition decisions on our behalf. The investment committee will periodically review our portfolio and its compliance with our target asset guidelines, and our asset management team will provide our board of directors a report at the end of each quarter in conjunction with its review of our quarterly results. For a description of our target asset guidelines, please see “Business—Target asset guidelines.” All of our investments will require the approval of our Manager’s investment committee. In addition, any investment in excess of 10% of our equity will require the approval of the risk and underwriting committee of our board of directors, which consists of Brian Harris, Jonathan Bilzin, Howard Park and              and             , two of our independent directors, acting by an 80% supermajority vote. Any investment in excess of 20% of our equity will require the approval of our board of directors. From time to time, as it deems appropriate or necessary, the risk and underwriting committee of our board of directors and our board of directors will also review our portfolio and its compliance with our target asset guidelines and the appropriateness of our target asset guidelines and strategies. For a description of our risk and underwriting committee, please see “Our management—Risk and underwriting committee.”

 

 

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Asset management

We consider active asset management to be an integral part of successfully managing commercial real estate debt. Our Manager, through the Ladder Capital Group, has a dedicated, in-house asset management team comprised of experienced professionals who will provide us with critical oversight. Our Manager’s asset management team will monitor all assets in our portfolio and work closely with borrowers to assist in maximizing performance of our assets. With respect to our mortgage assets, our Manager’s asset management team will review and monitor annual budgets on a quarterly basis for any variance, directing follow-up and other questions back to the borrower. In addition we also review monthly remittance reports to ensure that our mortgage loan servicers strictly adhere to the servicing standards set forth in the applicable servicing agreements. Loan modifications, asset recapitalizations and other variations to a borrower’s business plan or budget will generally be vetted through our Manager’s asset management team with a recommended course of action presented for approval to our Manager’s investment committee, our risk and underwriting committee or our board of directors, as applicable. With respect to our CMBS, our Manager’s asset management team will review monthly remittance reports to ensure that the master and special servicers and trustee strictly adhere to the servicing standards set forth in the applicable pooling and servicing agreements. Quarterly portfolio management reports will generally be prepared by our Manager’s asset management team to assist us with internal risk management and all materials will be submitted to our Manager’s investment committee, risk and underwriting committee and board of directors for review on a quarterly basis. Our focus and value creation will be centered on careful asset specific and market surveillance, rigid enforcement of loan and security rights, and timely sale of underperforming positions. One of the key determinants in the underwriting process is the evaluation of potential exit strategies. Our Manager’s asset management team will monitor each asset and review the potential disposition strategies on a regular basis in order to position assets to realize appreciated values and maximize returns.

Risk management

To the extent consistent with maintaining our REIT qualification, we will seek to manage risk exposure to protect our portfolio of assets against the effects of prepayments, defaults, interest rate volatility, credit spread movements and liquidity risks. Our efforts to manage risk will focus on monitoring our portfolio and managing the financing, interest rate, credit, prepayment and convexity (the measure of the sensitivity of the duration of a debt instrument to changes in interest rates) risks associated with a portfolio of our target assets. See “Business—Investment process—Risk management.” We intend to engage in a variety of interest rate management techniques that seek on one hand to mitigate the economic effect of interest rate changes on the values of, and returns on, some of our assets, and on the other hand to help us achieve our risk management objective.

Summary risk factors

An investment in shares of our common stock involves various risks. You should consider carefully the risks discussed below and under the heading “Risk factors” beginning on page 28 of this prospectus before purchasing our common stock. If any of these risks occur, our business, financial condition, liquidity, results of operations, prospects and ability to make distributions to our stockholders could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you may lose some or all of your investment.

 

 

We have no operating history and may not be able to operate our business successfully or generate sufficient cash flow to make or sustain distributions to our stockholders.

 

 

We have not yet identified any specific assets for our portfolio and, therefore, you will not be able to evaluate the allocation of the net proceeds of this offering and the concurrent private placement or the economic merits of our portfolio before making an investment decision with respect to our common stock.

 

 

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We are dependent on our Manager and its affiliates and their key personnel who provide services to us through the management agreement and the advisory agreement, and we may not find a suitable replacement if the management agreement or the advisory agreement is terminated, or if key personnel leave or otherwise become unavailable to us, which could have a material adverse effect on our performance.

 

 

There are various conflicts of interest in our relationship with Holdings and its affiliates, including our Manager, which could result in decisions that are not in the best interests of our stockholders, including that our executive officers (other than our Chief Financial Officer) are also executive officers of Holdings and/or its affiliates, which may result in conflicts between their duties to us and them.

 

 

We will compete with current and future investment entities affiliated with our Manager and the Ladder Capital Group, including Ladder Capital Bank, if acquired, for access to the benefits that our relationship with the Ladder Capital Group provides to us, including access to investment opportunities.

 

 

The management agreement with our Manager and the partnership agreement of our operating partnership were not negotiated on an arm’s-length basis and may not be as favorable to us as if they had been negotiated with unaffiliated third parties.

 

 

The management agreement may be difficult and costly for us to terminate, which may adversely affect our inclination to end our relationship with our Manager.

 

 

The manner of determining the base management fee may not sufficiently incentivize our Manager to maximize risk-adjusted returns on our portfolio since it is based on our stockholders’ equity and not on our performance.

 

 

The Class B units may induce our Manager to acquire certain assets, including speculative assets, which could result in increased risk to the value of our portfolio.

 

 

Our board of directors will approve very broad target asset guidelines for our Manager and will not approve each investment and financing decision made by our Manager unless required by our target asset guidelines.

 

 

We operate in a highly competitive market for investment opportunities and competition may limit our ability to acquire desirable target assets and could also affect the pricing of these assets.

 

 

Our Manager may be not be able to replicate the prior business model used by certain members of our management team and available data for the prior business model is limited.

 

 

We may change our investment, leverage, financing and operating strategies, policies or procedures without stockholder consent, which may adversely affect the market value of our common stock and our ability to make distributions to our stockholders.

 

 

We may allocate the net proceeds from this offering and the concurrent private placement in a manner with which you may not agree.

 

 

Difficult conditions in the markets for mortgages and mortgage-related assets as well as the broader financial markets have resulted in a significant contraction in liquidity for mortgages and mortgage-related assets, which may adversely affect the value of the assets that we intend to originate or acquire.

 

 

The commercial mortgage and other commercial real estate-related loans that we will purchase, and the commercial mortgage loans underlying the CMBS in which we may invest, are subject to the ability of the commercial property owner to generate net income from operating the property as well as the risks of delinquency, foreclosure and loss, which could result in losses to us.

 

 

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Our access to financing may be limited and thus our ability to maximize our returns may be adversely affected.

 

 

We intend to leverage the acquisition of our target assets and are not limited in the amount of leverage we may use. Our use of leverage may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.

 

 

Interest rate fluctuations could significantly decrease our results of operations and cash flows and the market value of our assets.

 

 

There can be no assurance that the actions of the U.S. Government, the Federal Reserve, the U.S. Treasury and related bodies to stabilize the financial markets, including the establishment of the TALF and similar programs, or market response to those actions, will achieve the intended effect, or that our business will benefit from these actions, or that further government or market developments will not materially and adversely impact us.

 

 

Downgrades of legacy CMBS and/or changes in the rating methodology and assumptions for future CMBS issuances may decrease the availability of the TALF to finance CMBS.

 

 

We may enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.

 

 

Hedging against interest rate exposure may adversely affect our earnings and could reduce our cash available for distribution to our stockholders.

 

 

As a lending institution, we may be subject to “lender liability” claims.

 

 

If our Manager overestimates the yields or incorrectly prices the risks of our investments, we may experience losses.

 

 

An increase in prepayment rates may adversely affect the value of our portfolio.

 

 

We have not established a minimum distribution payment level and we may be unable to generate sufficient cash flows from our operations to make distributions to our stockholders at any time in the future.

 

 

Our Manager is a newly-formed entity and has no experience managing a REIT and limited experience managing a portfolio of assets in the manner necessary to maintain our exemption under the 1940 Act, which may hinder its ability to achieve our business objectives or result in the loss of our qualification as a REIT.

 

 

Maintenance of our exemption from registration under the 1940 Act and our qualification as a REIT imposes significant limits on our operations.

 

 

Our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available for distribution to our stockholders.

 

 

Complying with REIT requirements may cause us to forego otherwise attractive investment or hedging opportunities and/or liquidate attractive investments.

 

 

If we have substantial non-cash taxable income, we may have to sell assets, borrow funds or make taxable stock distributions to satisfy the REIT requirement that we distribute 90% of our taxable income. This distribution requirement will limit our ability to retain earnings and thereby replenish or increase capital for operations.

 

 

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Our organizational structure

We were organized as a Maryland corporation on June 30, 2009. We will conduct substantially all of our operations through our operating partnership, of which we are the sole general partner. We anticipate that our operating partnership will in turn conduct its business through separate subsidiaries which will hold different combinations of our target assets classes.

The following chart shows our anticipated structure and ownership of our company after giving effect to this offering and the concurrent private placement to the Ladder Investor:

LOGO

 

(1)   Includes (i)              shares of common stock and              OP units to be sold to the Ladder Investor in the concurrent private placement and (ii)              restricted shares of common stock issued to our Manager under our 2009 equity incentive plan upon completion of this offering and the concurrent private placement. Excludes (i) up to              shares of our common stock that may be issued by us upon exercise of the underwriters’ over allotment option, (ii)              shares of our common stock issuable upon an exchange of OP units to be outstanding upon completion of this offering and the concurrent private placement (excluding OP units held by us) and (iii)              shares of our common stock reserved for future issuance under our 2009 equity incentive plan.

 

(2)   Our operating partnership has issued Class B units to our Manager. See “Our Manager and the management agreement—Management agreement—Incentive distribution and allocation.”

 

(3)   Our taxable REIT subsidiary.

 

(4)   We expect that our wholly-owned and majority-owned subsidiaries will rely on certain specified exemptions from regulation under the 1940 Act.

 

 

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Management agreement

We will be externally managed and advised by Ladder Capital Realty Finance Manager LLC, a newly-formed Delaware limited liability company. We expect to benefit from the personnel, relationships and experience of our Manager’s executive team and other personnel and investors of the Ladder Capital Group. See “Our management—Our directors, director nominees and executive officers” for biographical information regarding these individuals. We do not expect to have any employees. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. The Ladder Capital Group will not be obligated to dedicate any of its other executive officers or personnel exclusively to us. In addition, none of the Ladder Capital Group, its executive officers and other personnel, including our executive officers supplied to us by the Ladder Capital Group (other than our Chief Financial Officer), will be obligated to dedicate any specific portion of its or their time to our company. Our Manager will be subject to the supervision and oversight of our board of directors.

We will enter into a management agreement with our Manager effective upon the closing of this offering. Pursuant to the management agreement, our Manager will implement our investment strategy and perform certain services for us, subject to the supervision and oversight of our board of directors. Our Manager will be responsible for, among other duties, (1) performing all of our day-to-day functions; (2) determining our investment strategy and guidelines in conjunction with our board of directors; (3) sourcing, analyzing and executing investments, asset sales and financings; (4) performing asset management duties; and (5) performing financial and accounting management services. In addition, our Manager will have an investment committee that will oversee compliance with our investment strategy and guidelines, investment portfolio holdings and financing strategy. The initial term of the management agreement will end three years after the closing of this offering and the concurrent private placement, with automatic one-year renewal terms that end on the anniversary of the closing of this offering and the concurrent private placement.

The following table summarizes the fees and expense reimbursements that we will pay to our Manager, the Class B units held by our Manager, and the equity awards to be awarded to our Manager:

 

Type    Description

Base management fee

   1.50% of our stockholders’ equity per annum and calculated and payable quarterly in arrears in cash. For purposes of calculating the base management fee, our stockholders’ equity means: (1) the sum of (a) the net proceeds from all issuances of our equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus (b) our retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less (2) any amount that we pay to repurchase our common stock since inception. Our stockholders’ equity also excludes (1) any unrealized gains and losses and other non-cash items that have impacted stockholders’ equity as reported in our financial statements prepared in accordance with accounting principles generally accepted in the United States, or GAAP, and (2) one-time events pursuant to changes in GAAP, and certain non-cash items not otherwise described above, in each case after discussions between our Manager and our independent directors and approval by a majority of our independent directors. As a result, our stockholders’ equity, for purposes of calculating the base management fee, could be greater or less than the amount of stockholders’ equity shown on our financial statements.

 

 

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Type    Description
  

Except for Class B units, we will treat issuances of limited partner interests of our operating partnership other than to us as equity securities for purposes of calculating the base management fee.

 

Incentive distribution and allocation

  

Our operating partnership has issued Class B units to our Manager to provide an incentive to our Manager to enhance the value of our common stock. Under the partnership agreement of our operating partnership, the Class B units owned by our Manager entitle it to receive an incentive allocation and distribution (which we refer to as the incentive distribution), until redeemed, in an amount equal to 20% of the dollar amount by which Core Earnings (as defined in the partnership agreement of our operating partnership), on a rolling four-quarter basis and before the incentive distribution for the current quarter, exceeds the product of (1) the weighted average of the issue price per share of all of our offerings multiplied by the weighted average number of shares of common stock outstanding in such quarter and (2) 8%.

   For the initial four quarters following this offering, Core Earnings will be calculated on the basis of each of the previously completed quarters on an annualized basis. Core Earnings for the initial quarter will be calculated from the settlement date of this offering on an annualized basis. Core Earnings is a non-GAAP measure and is defined as GAAP net income (loss) excluding non-cash equity compensation expense, unrealized gains, losses or other non-cash items recorded in the period, regardless of whether such items are included in other comprehensive income or loss, or in net income. The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between our Manager and our independent directors and after approval by a majority of our independent directors.
   Any net loss incurred by us in a given quarter or quarters will be offset against any net income earned by us in future quarters for purposes of calculating the incentive distribution in such future quarters. For example, if we experience a net loss of $20.0 million in the fourth quarter of a fiscal year and a net loss of $20.0 million in the first quarter of the following fiscal year (for a cumulative net loss of $40.0 million in those two quarters), but then earn net income of $25.0 million in the second quarter and $25.0 million in the third quarter, then our $25.0 million of net income in the second quarter would be reduced to zero, and no incentive distribution would be payable for the second quarter, and our $25.0 million of net income in the third quarter would be reduced by the remaining $15.0 million of net loss to $10.0 million for purposes of calculating the incentive distribution for the third quarter.
   Our Manager may elect to receive all or a portion of its incentive distribution in the form of our common stock or OP units, subject to

 

 

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Type    Description
   the approval of a majority of our independent directors and all applicable New York Stock Exchange, or NYSE, rules and securities laws; provided, that under our management agreement, our Manager may not receive payment of its incentive distribution in shares of our common stock if such payment would result in our Manager owning directly or indirectly through one or more subsidiaries shares of our common stock in excess of the ownership limitation applicable to it. To the extent such distribution is paid in shares of our common stock or OP units, the number of shares of our common stock or OP units to be received by our Manager will be based on the average of the closing prices of the shares of our common stock on any national securities exchange over the ten consecutive trading days immediately preceding the issuance of such OP units.

Expense reimbursement

   We will reimburse operating expenses related to us incurred by our Manager, including expenses relating to legal, accounting, financial, due diligence and other services, as well as expenses associated with a dedicated Chief Financial Officer and, if provided by our Manager, a dedicated Compliance Officer. We will not reimburse our Manager for the salaries and compensation of its other personnel. Our reimbursement obligation is not subject to any dollar limitation. We may be required to pay our pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of our Manager and its affiliates required for our operations. Expenses will be reimbursed monthly in cash.

Termination fee

  

Termination fee will be equal to three times the average annual base management fee during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. The termination fee will be payable upon termination of the management agreement by us without cause or by our Manager if we materially breach the management agreement.

 

In addition, if the management agreement is terminated under circumstances pursuant to which we are obligated to pay a termination fee to our Manager, our operating partnership will redeem, concurrently with such termination, the Class B units for an amount equal to three times the average annual distributions paid in respect of the Class B units during the 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. If the management agreement is terminated under circumstances where we are not obligated to pay a termination fee to our Manager, then our operating partnership will redeem all of the Class B units for $100.

Incentive plan

   Prior to the completion of this offering and the concurrent private placement, we will adopt an equity incentive plan. Our 2009 equity incentive plan will include provisions for grants of restricted common stock and other equity based awards to our directors or officers or any

 

 

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Type    Description
   personnel of our Manager and the Ladder Capital Group who provide services to us. We will grant shares of restricted common stock to our Manager under our 2009 equity incentive plan, equal to         % of the number of shares that we issue in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement, which will vest ratably on an annual basis over a three-year period commencing on the first anniversary of the completion of this offering and the concurrent private placement. See “Our management—Executive and director compensation—2009 equity incentive plan.”

Advisory agreement

Our Manager will enter into an advisory agreement with our Advisor effective upon the closing of this offering and the concurrent private placement. Pursuant to the advisory agreement, our Manager will be provided with access to, among other things, the Ladder Capital Group’s portfolio management, asset valuation, risk management and asset management services as well as administration services addressing legal, compliance, investor relations and information technologies necessary for the performance of our Manager’s duties in exchange for a fee representing our Manager’s allocable cost for these services. The fee paid by our Manager pursuant to the advisory agreement shall not constitute a reimbursable expense under the management agreement.

Conflicts of interest

We are subject to the following conflicts of interest relating to the Ladder Capital Group and its affiliates, including our Manager:

Conflicts with the Ladder Capital Group

 

 

Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. As a result, these persons will have a conflict of interest with respect to our agreements and arrangements with our Manager and other affiliates of the Ladder Capital Group, which were not negotiated at arm’s length, and their terms may not have been as favorable to us as if they had been negotiated at arm’s length with an unaffiliated third party.

 

 

Other than our Chief Financial Officer who will be exclusively dedicated to our company, our other executive officers will not be required to devote a specific amount of time to our affairs. Accordingly, we will compete with the Ladder Capital Group and any of its current and future programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired, for the time and attention of these officers in connection with our business. In particular, as of June 30, 2009, Holdings, which has an investment strategy substantially similar to ours, has $183.5 million of undrawn committed equity available to be deployed to support future investments, including the purchase of $             million of our common stock (             shares) and $             million of OP units (             OP units) in a private placement to be completed concurrently with this offering.

 

 

Brian Harris, who is our Chief Executive Officer and Chief Executive Officer of our Manager, owns an equity interest in Holdings, the parent entity of the Ladder Capital Group, which is the indirect parent company of our Manager. A portion of the remaining equity interest in Holdings is held by other

 

 

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    members of our management team and by entities affiliated with two of our directors. Therefore, Brian Harris and other members of our management team and certain of our directors have interests in our relationships with our Manager and the Ladder Capital Group that are different than the interests of our stockholders. In particular, Brian Harris and the other members of our management team and certain of our directors will have an interest in the financial success of the Ladder Capital Group, which may encourage them to support strategies that impact our company based upon these considerations.

 

 

We have not adopted a policy that expressly prohibits our directors, officers, security holders or affiliates from having a direct or indirect pecuniary interest in any asset to be acquired or disposed of by us or any of our subsidiaries or in any transaction to which we or any of our subsidiaries is a party or has an interest. Nor do we have a policy that expressly prohibits any such persons from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contains a conflict of interest policy that prohibits our directors, officers and employees from engaging in any transaction that involves an actual or apparent conflict of interest with us.

 

 

There will be conflicts of interest in allocating investment opportunities to us, the Ladder Capital Group and other programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group currently or in the future, including the Ladder Capital Bank, if acquired. For example, our management team currently manages Holdings, a specialty finance company that provides a comprehensive set of financing solutions to the commercial real estate industry and which has an investment strategy substantially similar to ours. Further, the profits incentive structure (also known as the “promote structure”) in the Ladder Capital Group or other future entities, including the Ladder Capital Bank, if acquired, could be more advantageous to our management team, which could incentivize them to allocate certain investment opportunities to other entities and/or affiliates of the Ladder Capital Group rather than to our company.

 

 

The Ladder Capital Group may in the future form or sponsor additional programs, funds, vehicles, managed accounts, ventures or other entities, in each case which could have overlapping investment objectives with ours. The Ladder Capital Group will compete with us, and such programs, funds, vehicles, managed accounts, ventures or other entities may compete with us, for investment opportunities. The Ladder Capital Group’s allocation policy may limit our ability to deploy the proceeds from this offering and the concurrent private placement in revenue-generating assets in the near term, which could have a material adverse effect on our results of operations and ability to make distributions to our stockholders.

Conflicts relating to our Manager

 

 

Our Manager may cause us to purchase assets from the Ladder Capital Group or make co-purchases alongside the Ladder Capital Group. Although our management agreement requires that investments in loans originated by and purchased from the Ladder Capital Group and investments in securities structured, issued or managed by the Ladder Capital Group must be approved by a majority of our independent directors, these transactions may not be the result of arm’s length negotiations and may involve conflicts between our interests and the interests of the Ladder Capital Group in obtaining favorable terms and conditions. Any fees paid by us to any affiliate of the Ladder Capital Group in connection with such investments or purchases or in connection with investments managed by it shall be deducted from the base management fee due to our Manager.

 

 

The management agreement provides that, in the absence of cause, it may only be terminated by us after the third anniversary of the closing of this offering and the concurrent private placement, upon the vote of two-thirds of our independent directors or the holders of a majority of our outstanding common stock, based upon unsatisfactory performance by our Manager that is materially detrimental to us or a determination that the compensation payable to our Manager under the management agreement is not fair, unless our Manager agrees to compensation that two-thirds of our independent directors determine

 

 

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    is fair. Upon any such termination by us, or upon termination by our Manager due to our material breach, we will be required to make a termination payment to our Manager equal to three times the average annual base management fee during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. In addition, our operating partnership will redeem concurrently with such termination, the Class B units for an amount equal to three times the average annual distributions paid in respect of the Class B units during the 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. These provisions may substantially restrict our ability to terminate the management agreement without cause, even if we believe our Manager’s performance is not satisfactory, and would cause us to incur substantial costs in connection with such a termination.

 

 

Our Manager does not assume any responsibility beyond the duties specified in the management agreement and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Our Manager’s liability is limited under the management agreement, and we have agreed to indemnify our Manager and its affiliates, including the Ladder Capital Group, with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts or omissions of such indemnified parties not constituting fraud, willful misconduct, gross negligence or reckless disregard of our Manager’s duties under the management agreement which has a material adverse effect on us. As a result, we could experience poor performance or losses for which our Manager would not be liable.

 

 

The manner of determining the base management fee may not sufficiently incentivize our Manager to maximize risk-adjusted returns on our portfolio since it is based on our stockholders’ equity and not on our performance.

 

 

Our Manager, as holder of the Class B units in our operating partnership, will be entitled to an incentive distribution based entirely on our financial performance. This feature of the Class B units may cause our Manager to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, to achieve such eligibility.

Resolution of potential conflicts of interest in allocation of investment opportunities

The Ladder Capital Group has adopted an allocation policy containing both subjective and objective procedures designed to manage potential conflicts of interest between its fiduciary obligations to us and its fiduciary obligations to any current and/or future programs, funds, vehicles, managed accounts, ventures or other entities that the Ladder Capital Group and/or our Manager own and/or manage with which we have an overlapping strategy. The objective of this policy is to ensure that investment opportunities are allocated in a fair and equitable manner among our company and such other current and/or future programs, funds, vehicles, managed accounts, ventures or other entities that the Ladder Capital Group and/or our Manager own and/or manage with which we have an overlapping strategy.

If the Ladder Capital Group and/or our Manager identify an investment opportunity in our target asset classes that is appropriate for us and any other programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by them, but the amount available is less than the amount sought by all of such programs, funds, vehicles, managed accounts, ventures or other entities, the Ladder Capital Group and/or our Manager will allocate the investment opportunity in accordance with the Ladder Capital Group’s allocation policy.

In the event that two such programs have simultaneous needs and/or claims on a given investment opportunity, the Ladder Capital Group and our Manager shall attempt to meet the obligations by allocating such investment opportunity based on need. In the event that is not practicable, the Ladder Capital Group and our Manager shall be required to use their best judgment to resolve the conflict in their sole discretion,

 

 

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usually through a sequential rotation. The Ladder Capital Group and our Manager have agreed that, until at least $300 million of the net proceeds of this offering and the concurrent private placement have been deployed by us into investments in first mortgage loans, they will allocate to our company at least two out of every three first mortgage loan opportunities that are identified as appropriate for our company. Thereafter, with respect to first mortgage loan originations, and at all times with respect to our other target assets, the Ladder Capital Group and our Manager have agreed that they will allocate to our company at least one of every two investment opportunities they source with respect to our other target assets.

Factors that will be considered in prioritizing an investment opportunity among programs, funds, vehicles, managed accounts, ventures or other entities will include the following:

 

 

whether the investment opportunity falls within the program’s investment objectives, policies and strategies;

 

 

availability of capital;

 

 

ability of a program to comply with the investment opportunity’s timing and sensitivities;

 

 

whether the transaction is complementary in terms of yield, credit quality and diversification to the program’s existing portfolio;

 

 

duration of the program’s outstanding need;

 

 

ability of the program to best exert control rights;

 

 

availability and terms of financing for such asset; and

 

 

in the event of sequential rotation, the aggregate dollars invested and number of previously closed transactions on behalf of the program.

The foregoing allocation procedures will also apply between us and any current or future programs, funds, vehicles, managed accounts, ventures or other entities that the Ladder Capital Group and/or our Manager own and/or manage with which we have an overlapping strategy, subject to any rights of first offer or similar rights.

The Ladder Capital Group and/or our Manager may make exceptions to these general policies when other circumstances make application of the policies inequitable or inapplicable.

Any transaction between us and the Ladder Capital Group not specifically permitted by our management agreement or the advisory agreement must be approved by a majority of our independent directors. In particular, our management agreement will permit us to purchase loans originated by and purchased from the Ladder Capital Group or in securities structured, issued or managed by the Ladder Capital Group, provided that we obtain prior approval of a majority of our independent directors.

The Ladder Capital Group and/or our Manager may in the future change then-existing, or adopt additional, conflicts of interest resolution policies and procedures designed to support the equitable allocation and to prevent the preferential allocation of investment opportunities among entities with overlapping investment objectives.

Our independent directors will periodically review our Manager’s and the Ladder Capital Group’s compliance with these conflicts of interest and allocation provisions.

 

 

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Operating and regulatory structure

REIT qualification

We intend to elect to qualify as a REIT commencing with our taxable year ending on December 31, 2009. Our qualification as a REIT depends upon our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Internal Revenue Code of 1986, as amended, or 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 diversity of ownership of our shares of common stock. We believe that we have been organized 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 meet the requirements for qualification and taxation as a REIT.

So long as we qualify as a REIT, we generally will not be subject to U.S. federal income tax on our taxable income that we distribute currently to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lost our REIT qualification. Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income or property.

1940 Act exemption

We intend to conduct our operations so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are U.S. Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.

We are organized as a holding company that conducts its businesses primarily through our operating partnership and its wholly-owned subsidiaries. Both our company and our operating partnership intend to conduct their operations so that they comply with the 40% test. The securities issued to our operating partnership by any wholly-owned or majority-owned subsidiaries that we may form in the future that are excepted from the definition of “investment company” based on Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities our operating partnership may own, may not have a value in excess of 40% of the value of our operating partnership’s total assets on an unconsolidated basis. We will monitor our holdings to ensure continuing and ongoing compliance with this test. In addition, we believe neither our company nor our operating partnership will be considered an investment company under Section 3(a)(1)(A) of the 1940 Act because we will not engage primarily or hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through our operating partnership’s wholly-owned subsidiaries, our company and our operating partnership will be primarily engaged in the non-investment company businesses of these subsidiaries.

If the value of securities issued by our subsidiaries that are excepted from the definition of “investment company” by Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities we own, exceeds 40% of our total assets on an unconsolidated basis, or if one or more of such subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either

 

 

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(1) to substantially change the manner in which we conduct our operations to avoid being required to register as an investment company or (2) to register as an investment company under the 1940 Act, either of which could have an adverse effect on us and the market price of our securities. If we were required to register as an investment company under the 1940 Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), portfolio composition, including restrictions with respect to diversification and industry concentration, and other matters.

Distribution policy

U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. We generally intend over time to pay regular quarterly dividends in an amount equal to our taxable income. Any distributions we make to our stockholders will be at the discretion of our board of directors and will depend upon, among other things, our actual results of operations and liquidity. 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. For more information, see “Distribution policy.”

Restrictions on ownership of our common stock

To assist us in complying with the limitations on the concentration of ownership of a REIT imposed by the Internal Revenue Code, our charter prohibits, with certain exceptions, any stockholder from beneficially or constructively owning, applying certain attribution rules under the Internal Revenue Code, more than 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of common stock, or 9.8% by value or number of shares, whichever is more restrictive, of our outstanding 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. We expect our board of directors to waive this ownership limit in order to allow the Ladder Investor and its affiliates, including our Manager, to own up to             % by value or number of shares, whichever is more restrictive, of our outstanding shares of common or capital stock.

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.

In addition, our charter provides that any ownership or purported transfer of our capital stock in violation of the foregoing restrictions will result in the shares so owned or transferred 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 resulting in such violation will be void from the time of such purported transfer.

 

 

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Our corporate information

Our principal executive offices are located at 600 Lexington Avenue, 23rd Floor, New York, New York 10022 and our telephone number is (212) 715-3170. We maintain a website at                         . The information contained on or connected to our website is not incorporated by reference into, and you must not consider the information to be a part of, this prospectus.

 

 

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The offering

 

Common stock offered by us

             shares (plus up to an additional              shares of our common stock that we may issue and sell upon the exercise of the underwriters’ overallotment option).

 

Common stock to be outstanding after this offering and the concurrent private placement

             shares(1)

 

Use of proceeds

We intend to deploy the net proceeds of this offering and the concurrent private placement predominantly in our target assets. For the first two to three quarters following the completion of this offering and the concurrent private placement, we intend to deploy a significant portion of the net proceeds from these offerings (resulting in a greater percentage of our overall portfolio of target assets than we expect to have within approximately 12 months following the completion of this offering and the concurrent private placement) to acquire senior CMBS to opportunistically take advantage of the TALF. We expect the CMBS we acquire during this initial period to be the most senior priority by subordination with respect to vintages from 2008 and earlier and investment grade with respect to more recent vintages. We expect that over time most of our investment activity will take the form of first mortgage originations. Until other appropriate uses can be identified, our Manager may invest the proceeds of this and any future offerings in interest-bearing, short-term investments, including money market accounts and senior CMBS with short duration, that are consistent with our intention to qualify as a REIT. See “Use of proceeds.”

 

Proposed NYSE symbol

“LCG.”

 

(1)   Includes (i)          shares of common stock to be sold to the Ladder Investor in the concurrent private placement and (ii)                      restricted shares of common stock issued to our Manager under our 2009 equity incentive plan upon completion of this offering and the concurrent private placement. Excludes (i) up to          shares of our common stock that may be issued by us upon exercise of the underwriters’ over allotment option, (ii)          shares of our common stock reserved for future issuance under our 2009 equity incentive plan and (iii)          shares of our common stock issuable upon an exchange of OP units to be outstanding upon completion of this offering and the concurrent private placement (excluding OP units held by us).

 

 

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Risk factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. If any of the following risks occur, our business, financial condition, liquidity and/or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you may lose some or all of your investment. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. Please refer to the section entitled, “Forward-looking statements.”

Risks related to our relationship with our Manager

We are dependent on our Manager and its affiliates and their key personnel who provide services to us through the management agreement and the advisory agreement, and we may not find a suitable replacement if the management agreement or the advisory agreement is terminated, or if key personnel leave or otherwise become unavailable to us, which could have a material adverse effect on our performance.

We do not expect to have any employees and we are completely reliant on our Manager to provide us with investment and advisory services. We expect to benefit from the personnel, relationships and experience of our Manager’s executive team and other personnel and investors of the Ladder Capital Group and expect to benefit from their established pipeline of transactions. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. Our Manager will have significant discretion as to the implementation of our investment and operating policies and strategies. Accordingly, we believe that our success will depend to a significant extent upon the efforts, experience, diligence, skill and relationships of the executive officers and key personnel of our Manager. The executive officers and key personnel of our Manager will evaluate, negotiate, close and monitor our portfolio. Our success will depend on their continued service.

In addition, we offer no assurance that our Manager will remain our investment manager or that we will continue to have access to our Manager’s principals and professionals. The initial term of our management agreement with our Manager, and the advisory agreement between our Manager and our Advisor only extends until the third anniversary of the closing of this offering and the concurrent private placement, with automatic one-year renewals thereafter. If the management agreement and the advisory agreement are terminated and no suitable replacement is found to manage us, our ability to execute our business plan will be negatively impacted.

There are various conflicts of interest in our relationship with Holdings and its affiliates, including our Manager, which could result in decisions that are not in the best interests of our stockholders, including that our executive officers (other than our Chief Financial Officer) are also executive officers of Holdings and/or its affiliates, which may result in conflicts between their duties to us and them.

We are subject to conflicts of interest arising out of our relationship with Holdings and its affiliates, including our Manager and members of our management team. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. Our Manager and executive officers may have conflicts between their duties to us and their duties to, and interests in, the Ladder Capital Group and its affiliates and the programs, funds, vehicles, managed accounts and ventures owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired. The Ladder Capital Group will not be obligated to dedicate any of its other executive officers or personnel exclusively to us. In addition, none of the Ladder Capital Group, its executive officers and other personnel, including our executive officers supplied to us by the Ladder Capital Group (other than our Chief Financial Officer), will be obligated to dedicate any specific portion of its or their time to our company. As a result, these individuals will have competing interest for their business time and attention. Our Manager will be subject to the supervision and oversight of our board of directors.

 

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Further, if and when there are turbulent conditions in the real estate markets or distress in the credit markets or other times when we will need focused support and assistance from our Manager, the attention of our Manager’s personnel and our executive officers and the resources of the Ladder Capital Group may also be required by the programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired. In such situations, we may not receive the level of support and assistance that we may receive if we were internally managed or if we were not managed by our Manager and we will compete with the Ladder Capital Group, its existing programs, funds, vehicles, managed accounts and ventures or other entities, including the Ladder Capital Bank, if acquired, in the future for the time and attention of these officers (other than our Chief Financial Officer who will be exclusively dedicated to us).

Concurrently with the completion of this offering and the concurrent private placement, the Ladder Investor will acquire a significant ownership interest in us and our Manager will be granted restricted shares of common stock under our 2009 equity incentive plan. The Ladder Investor has agreed to an 18-month lock-up with us with respect to the securities that it purchases in the concurrent private placement. To the extent that the Ladder Investor or our Manager sells some of these shares, our Manager’s interests may be less aligned with our interests.

In the future, we may enter into additional transactions with the Ladder Capital Group. In particular, we may purchase assets from the Ladder Capital Group or make co-purchases alongside the Ladder Capital Group. Even though transactions not specifically permitted by our management agreement will require approval by a majority of independent directors, such transactions may not be the result of arm’s length negotiations and may involve conflicts between our interests and the interests of the Ladder Capital Group in obtaining favorable terms and conditions. In addition, our management agreement provides that a majority of our directors must approve any purchase of or investment in any loan originated by the Ladder Capital Group or any purchase of or investment in any security structured, issued or managed by the Ladder Capital Group. There can be no assurance that any procedural protections will be sufficient to assure that these transactions will be made on terms that will be at least as favorable to us as those that we or, if acquired, the Ladder Capital Bank, would have obtained in an arm’s length transaction.

We will compete with current and future investment entities affiliated with our Manager and the Ladder Capital Group, including Ladder Capital Bank, if acquired, for access to the benefits that our relationship with the Ladder Capital Group provides to us, including access to investment opportunities.

We will be competing with the Ladder Capital Group and the programs, funds, vehicles, managed accounts, ventures or other entities that the Ladder Capital Group may form or sponsor in the future, including Ladder Capital Bank, if acquired, for access to the benefits that our relationship with the Ladder Capital Group provides to us, including access to investment opportunities. There will be conflicts of interest in allocating investment opportunities to us, the Ladder Capital Group and future programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired. For example, the Ladder Capital Group currently has, and, if acquired, the Ladder Capital Bank will have, overlapping investment objectives with us and therefore may compete with us for investment opportunities. In addition, there is no restriction on the Ladder Capital Group from forming, sponsoring, owning and/or managing additional investment entities that have overlapping investment objectives with ours and could compete with us for additional opportunities. The activities of programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired, could restrict our ability to pursue certain asset acquisitions or take other actions related to our business. The Ladder Capital Group’s allocation policy may limit our ability to deploy the proceeds from this offering and the concurrent private placement in revenue-generating assets in the near term, which could have a material adverse effect on our results of operations and ability to make distributions to our stockholders.

Moreover, we cannot assure you that our Manager will allocate the most attractive opportunities to us. The Ladder Capital Group and our Manager will be subject to certain allocation policies, subject to change, in

 

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their discretion, in allocating investment opportunities among us, the Ladder Capital Group and future programs, funds, vehicles, managed accounts, ventures or other entities it owns and/or manages, including Holdings and the Ladder Capital Bank, if acquired, but we cannot assure you that such allocation policies will have beneficial or equitable outcomes. See “Our Manager and the management agreement—Resolution of potential conflicts of interest in allocation of investment opportunities.” Members of our management team (other than our Chief Financial Officer) also manage Holdings, a specialty finance company that provides a comprehensive set of financing solutions to the commercial real estate industry and which has an investment strategy substantially similar to ours, and they may also in the future hold positions with other programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired. These multiple responsibilities may create conflicts of interest for these individuals if they are presented with opportunities that may benefit us and their other affiliates. In addition, there is a risk that the profits incentive structure (also known as the “promote structure”) in the Ladder Capital Group or other future entities, including the Ladder Capital Bank, if acquired, is more advantageous to our management team, which could incentivize them to allocate certain investment opportunities to other entities rather than to our company. In determining which opportunities to allocate to us and to their other affiliates, these individuals will consider the investment strategy and guidelines of each entity. Because we cannot predict the precise circumstances under which future potential conflicts may arise, we intend to address potential conflicts on a case-by-case basis. You will not have the opportunity to evaluate the manner in which any conflicts of interest involving the Ladder Capital Group, its affiliates, and our company are resolved before making your investment. For more information on these potential conflicts of interest, see “Our Manager and the management agreement—Conflicts of interest.”

We do not have a policy that expressly prohibits our directors, officers, security holders or affiliates from having a direct or indirect pecuniary interest in any transaction to which we or any of our subsidiaries has an interest or engaging for their own account in business activities of the types conducted by us.

We do not have a policy that expressly prohibits our directors, officers, security holders or affiliates from having a direct or indirect pecuniary interest in any asset to be acquired or disposed of by us or any of our subsidiaries or in any transaction to which we or any of our subsidiaries is a party or has an interest. Nor do we have a policy that expressly prohibits any such persons from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contains a conflict of interest policy that prohibits our directors, officers and employees from engaging in any transaction that involves an actual or apparent conflict of interest with us. In addition, our management agreement with our Manager does not prevent our Manager and its affiliates from engaging in additional management or investment opportunities, some of which could compete with us.

The management agreement with our Manager and the partnership agreement of our operating partnership were not negotiated on an arm’s-length basis and may not be as favorable to us as if they had been negotiated with unaffiliated third parties.

Our management agreement with our Manager and the partnership agreement of our operating partnership were negotiated between related parties and their terms, including fees payable to our Manager and the terms of the Class B units held by our Manager, may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we may choose not to enforce, or to enforce less vigorously, our rights under the management agreement or the partnership agreement because of our desire to maintain our ongoing relationship with our Manager. Our Manager maintains a contractual as opposed to a fiduciary relationship with us. Our management agreement with our Manager does not prevent our Manager and its affiliates from engaging in additional management or investment opportunities, some of which will compete with us. The ability of our Manager and its officers and employees to engage in other business activities may reduce the time our Manager spends managing us.

 

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The management agreement may be difficult and costly for us to terminate, which may adversely affect our inclination to end our relationship with our Manager.

Termination of the management agreement with our Manager by us without cause is difficult and costly. The term “cause” is limited to those circumstances described under “Our Manager and the management agreement—Management agreement.” The management agreement provides that, in the absence of cause, it may only be terminated by us after the third anniversary of the closing of this offering and the concurrent private placement, upon the vote of at least two-thirds of our independent directors or by a vote of the holders of a majority of the outstanding shares of our common stock, based upon: (1) our Manager’s unsatisfactory performance that is materially detrimental to us, or (2) a determination that the management fees payable to our Manager are not fair, subject to our Manager’s right to prevent termination based on unfair fees by accepting a reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager will be provided 180 days prior notice of any such termination. Additionally, upon a termination by us without cause (or upon a termination by our Manager due to our material breach), the management agreement provides that we will pay our Manager a termination payment equal to three times the average annual base management fee during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. In addition, our operating partnership will redeem concurrently with such termination, the Class B units for an amount equal to three times the average annual distributions paid in respect of the Class B units during the 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. These provisions may substantially restrict our ability to terminate the management agreement without cause and would cause us to incur substantial costs in connection with such a termination.

Our Manager is only contractually committed to serve us until the third anniversary of the closing of this offering and the concurrent private placement. Thereafter, the management agreement is renewable on an annual basis; provided, however, that our Manager may terminate the management agreement annually upon 180 days prior notice. If the management agreement is terminated and no suitable replacement is found to manage us, our ability to execute our business plan will be negatively impacted.

The manner of determining the base management fee may not sufficiently incentivize our Manager to maximize risk-adjusted returns on our portfolio since it is based on our stockholders’ equity and not on our performance.

Our Manager is entitled to receive a base management fee that is based on the amount of our stockholders’ equity (as defined in the management agreement) at the end of each quarter, regardless of our performance. Our stockholders’ equity for the purposes of calculating the base management fee is not the same as, and could be greater than, the amount of stockholders’ equity shown on our consolidated financial statements. The possibility exists that significant base management fees could be payable to our Manager for a given quarter despite the fact that we could experience a net loss during that quarter. Our Manager’s entitlement to such significant nonperformance-based compensation may not provide sufficient incentive to our Manager to devote its time and effort to source and maximize risk-adjusted returns on our portfolio, which could, in turn, adversely affect our ability to make distributions to our stockholders and the market price of our common stock. In addition, in calculating the base management fee, unrealized gains and losses are excluded which could incentivize our Manager to sell appreciated assets and keep non-performing assets even though it may not be in our best interest to do so.

The Class B units may induce our Manager to acquire certain assets, including speculative assets, which could result in increased risk to the value of our portfolio.

Our Manager, as holder of the Class B units in our operating partnership, will be entitled to an incentive distribution based entirely on our financial performance. This feature of the Class B units may cause our Manager to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, to achieve higher incentive fees. Assets with higher yield potential are generally riskier or more speculative. In addition, our Manager may have a conflict of interest in deciding upon

 

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whether to sell any assets at a gain, thereby increasing the incentive return on its Class B units, or to hold such assets based on its long-term value. These factors could result in increased risk to the value of our portfolio. In addition, in calculating the incentive fee, unrealized gains or losses are excluded, which could incentivize our Manager to sell appreciated assets and keep non-performing assets even though it may not be in our best interest to do so.

Our board of directors will approve very broad target asset guidelines for our Manager and will not approve each investment and financing decision made by our Manager unless required by our target asset guidelines.

Our Manager will be authorized to follow very broad target asset guidelines. Our board of directors will periodically review our target asset guidelines and our portfolio but will not, and will not be required to, review all of our proposed investments, except that any investment in excess of 10% of our equity will require the approval of the risk and underwriting committee of our board of directors, acting by an 80% supermajority vote, and any investment in excess of 20% of our equity will require the approval of our board of directors. In conducting periodic reviews, our board of directors may rely primarily on information provided to them by our Manager. Furthermore, our Manager may use complex strategies, and transactions entered into by our Manager may be costly, difficult or impossible to unwind by the time they are reviewed by our board of directors. Our Manager will have great latitude within the broad parameters of our target asset guidelines in determining the types and amounts of target assets it may decide are attractive to us, which could result in returns that are substantially below expectations or that result in losses, which would materially and adversely affect our business operations and results. Further, decisions made and investments and financing arrangements entered into by our Manager may not fully reflect the best interests of our stockholders.

Our target asset guidelines will generally not limit the amount of equity that may be deployed in any type of our target assets. In addition, our target asset guidelines may be changed from time to time by our board of directors without the approval of our stockholders.

Our Manager’s and the Ladder Capital Group’s liability is limited under the management agreement, and we have agreed to indemnify our Manager against certain liabilities. As a result, we could experience poor performance or losses for which our Manager would not be liable.

Pursuant to the management agreement, our Manager will not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Under the terms of the management agreement, our Manager, its officers, members, managers, directors, personnel, any person controlling or controlled by our Manager and any person providing sub-advisory services to our Manager will not be liable to us, any subsidiary of ours, our stockholders or partners or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the management agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the management agreement. In addition, we have agreed to indemnify our Manager, its officers, stockholders, members, managers, directors, personnel, any person controlling or controlled by our Manager and any person providing sub-advisory services to our Manager with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our Manager not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties, performed in good faith in accordance with and pursuant to the management agreement.

Our Manager’s failure to make investments on favorable terms that satisfy our investment strategy or to perform its responsibilities under the management agreement and otherwise generate attractive risk-adjusted returns initially and consistently from time to time in the future would materially and adversely affect us.

Our ability to achieve our investment objectives depends on our ability to grow, which depends, in turn, on our Manager’s personnel and their ability to make investments on favorable terms that satisfy our

 

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investment strategy and otherwise generate attractive risk-adjusted returns initially and consistently from time to time in the future. Accomplishing this result is also a function of our Manager’s ability to execute our financing strategy on favorable terms. Our ability to grow is also dependent upon our Manager’s relationships and its ability to successfully hire, train, supervise and manage its personnel. We may not be able to achieve any growth at all or to manage any future growth effectively, which would materially and adversely affect us.

We do not own the Ladder Capital name, but we may use the name pursuant to a license agreement with Holdings. Use of the name by other parties or the termination of our license agreement may harm our business.

We have entered into a license agreement with Holdings pursuant to which it has granted us a non-exclusive, royalty-free license to use the name “Holdings.” Under this agreement, we have a right to use this name for so long as Ladder Capital Realty Finance Manager LLC serves as our Manager pursuant to the management agreement. The Ladder Capital Group will retain the right to continue using the “Ladder Capital” name. We will further be unable to preclude the Ladder Capital Group from licensing or transferring the ownership of the “Ladder Capital” name to third parties, some of whom may compete with us. Consequently, we will be unable to prevent any damage to goodwill that may occur as a result of the activities of the Ladder Capital Group or others. Furthermore, in the event that the license agreement is terminated, we will be required to change our name and cease using the name. Any of these events could disrupt our recognition in the market place, damage any goodwill we may have generated and otherwise harm our business. The license agreement will terminate concurrently with the termination of the management agreement.

Risks related to our company

We have no operating history and may not be able to operate our business successfully or generate sufficient cash flow to make or sustain distributions to our stockholders.

We were organized on June 30, 2009 and have no operating history. We have no assets and will commence operations only upon completion of this offering and the concurrent private placement. We cannot assure you that we will be able to operate our business successfully or implement our operating policies and strategies as described in this prospectus. In addition, our company is subject to all of the customary business risks and uncertainties associated with any new business, including the risk that it will not achieve its objectives and, as a result, the value of our common stock could decline substantially. Our ability to achieve attractive total returns to our stockholders is dependent on our ability both to generate sufficient cash flow to pay attractive distributions 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 distributions to stockholders. The results of our operations will depend on several factors, including the availability of opportunities for the acquisition of target assets, the level and volatility of interest rates, the availability of adequate short and long-term financing, conditions in the financial markets and general economic conditions.

We may change our investment, leverage, financing and operating strategies, policies or procedures without stockholder consent, which may adversely affect the market value of our common stock and our ability to make distributions to our stockholders.

Our board of directors determines our operational policies and may amend or revise our policies, including our policies with respect to our acquisitions, dispositions, growth, operations, indebtedness, capitalization and dividends, or approve transactions that deviate from these policies, without a vote of, or notice to, our stockholders. We may change our target asset guidelines and investment, leverage, financing and operating strategies at any time without the consent of our stockholders, which could result in our making investments that are different in type from, and possibly riskier than, the investments contemplated in this

 

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prospectus. Operational policy changes or changes in our target asset guidelines and investment, leverage, financing and operating strategies may increase our exposure to interest rate risk, default risk, financing risk and real estate market fluctuations, which could adversely affect the market credit risk, price of our common stock and our ability to make distributions to our stockholders. In addition, our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without approval of our stockholders, if it determines that it is no longer in our best interests to qualify as a REIT.

We operate in a highly competitive market for investment opportunities and competition may limit our ability to acquire desirable target assets and could also affect the pricing of these assets.

We operate in a highly competitive market for investment opportunities. Our profitability depends, in large part, on our ability to acquire our target assets at attractive prices. In acquiring our target assets, we will compete with other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, financial institutions, governmental bodies and other entities, including other programs, funds, vehicles, managed accounts, ventures and other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired. We may also compete with companies that partner with and/or receive financing from the U.S. Government, including TALF and PPIP participants. Many of our competitors are substantially larger and have considerably greater financial, technical, marketing and other resources than we do. Several other companies, including 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 additional competition for investment opportunities. Some competitors may have a lower cost of funds and access to funding sources that may not be available to us, such as funding from the U.S. Government, if we are not eligible to participate in programs established by the U.S. Government. Many of our competitors are not subject to the operating constraints associated with REIT tax compliance or maintenance of an exemption from the 1940 Act. 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. If the Ladder Capital Bank is acquired, the Ladder Capital Group may also be subject to regulations in relation to owning and operating a bank that many of our competitors may not face. Furthermore, competition for our target assets may lead to the price of such assets increasing, which may further limit our ability to generate desired returns. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, desirable investments in our target assets may be limited in the future and we may not be able to take advantage of attractive investment opportunities from time to time, as we can provide no assurance that we will be able to identify and make investments that are consistent with our investment objectives.

Our Manager may not be able to replicate the prior business model used by certain members of our management team and available data for the prior business model is limited.

Our company is a new product for the Ladder Capital Group and is the Ladder Capital Group’s first REIT. Although we intend to employ a similar investment strategy to that used by Brian Harris and his management team at UBS/DRCM, certain aspects of our strategy differ from that model. We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes. Accordingly, to qualify as a REIT, we must comply with requirements regarding the composition and values of our assets, our sources of income and the amounts we distribute to our stockholders in a manner different from UBS/DRCM. Further, we expect to actively manage our portfolio in a manner so as to avoid registration under the 1940 Act. This will impose limitations on our activity which were not imposed at UBS/DRCM. We also expect to operate with significantly less leverage than did the commercial real estate group at UBS/DRCM. In contrast to the commercial real estate group at UBS/DRCM, we expect to have significantly less revenue from securitizations as the securitization market may remain effectively closed for the near future. A portion of the adjusted total revenues of the commercial real estate group at UBS/DRCM reflect returns derived from investments in real estate equity. Our current plan is to invest in little, if any, real estate equity. Further, the UBS/DRCM

 

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team had more personnel than our Manager currently has and not all of the management team at UBS/DRCM during the periods indicated above are members of our management team. The UBS/DRCM historical data included in this prospectus also does not take into account management or advisory fees or similar transaction costs which reduce actual revenues. We will pay our Manager a base management fee and incentive distribution and we expect to incur certain transaction costs with respect to the origination, acquisition, financing and management of our assets. Because similar data is not available for periods subsequent to the departure of Brian Harris and his management team from UBS/DRCM, there is no information or representation as to the actual performance of UBS/DRCM’s commercial real estate asset portfolio (if any) in 2007 and 2008, nor can there be any assurance as to how the UBS/DRCM commercial real estate asset portfolio would have performed if managed during this volatile and turbulent period by Brian Harris and his management team. In addition, the UBS/DRCM commercial real estate group operated in more favorable credit environments than the challenging economic environment we currently face. Accordingly, the historical data of Brian Harris and his management team at UBS/DRCM included in this prospectus are not indicative of the performance of our strategy and we can offer no assurance that our Manager will replicate the UBS/DRCM commercial real estate asset portfolio or its historical performance as presented in this prospectus. The past performance of programs, funds, vehicles, managed accounts or other entities currently or previously owned and/or managed by the Ladder Capital Group, its affiliates, our senior management team and/or Brian Harris are not predictive of our company’s future performance.

Our ability to generate returns for our stockholders through our investment, financing and operating strategies is subject to then existing market conditions, and we may make significant changes to these strategies in response to changing market conditions.

We have been formed to protect and preserve capital in a manner that provides for attractive risk-adjusted returns to our stockholders over the long term through dividends and capital appreciation. To achieve this goal, we will initially focus primarily on the origination and acquisition of income-producing commercial real estate first mortgage loans and, to a lesser extent, CMBS, participation interests in mortgage loans, mezzanine loans and subordinate interests in mortgage loans. In the future, to the extent that market conditions stabilize and we have sufficient capital to do so, we may expand our business focus to other targeted asset classes.

However, as the market evolves, our board of directors may determine that the commercial real estate market does not offer the potential for attractive risk-adjusted returns for an investment strategy that is consistent with our intention to elect and qualify to be taxed as a REIT and to operate in a manner to maintain our exemption from registration under the 1940 Act. For example, if our board of directors believes it would be advisable for us to be a more active seller of loans and securities, our board of directors may determine that we should conduct such business through a taxable REIT subsidiary, or TRS, or that we should cease to maintain our REIT qualification. In addition, if our board of directors believes the maintenance our exemption under the 1940 Act imposes undue limitations on our ability to generate attractive risk-adjusted returns to our stockholders, our board of directors may approve the wind down of our assets and liquidation of our business.

We are highly dependent on information systems 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 make distributions to our stockholders.

Our business is highly dependent on communications and information systems of the Ladder Capital Group. Any failure or interruption of the Ladder Capital Group’s systems could cause delays or other problems in our securities 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 make distributions to our stockholders.

 

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We will be subject to the requirements of the Sarbanes-Oxley Act of 2002, which may be costly and challenging.

Our management will be required to deliver a report that assesses the effectiveness of our internal controls over financial reporting, pursuant to Section 302 of the Sarbanes-Oxley Act as of December 31 subsequent to the year in which our registration statement becomes effective. Section 404 of the Sarbanes-Oxley Act requires our independent registered public accounting firm to deliver an attestation report on management’s assessment of, and the operating effectiveness of, our internal controls over financial reporting in conjunction with their opinion on our audited financial statements as of the same date. Substantial work on our part is required to implement appropriate processes, document the system of internal control over key processes, assess their design, remediate any deficiencies identified and test their operation. This process is expected to be both costly and challenging. We cannot give any assurances that material weaknesses will not be identified in the future in connection with our compliance with the provisions of Sections 302 and 404 of the Sarbanes-Oxley Act. The existence of any material weakness described above would preclude a conclusion by management and our independent auditors that we maintained effective internal control over financial reporting. Our management may be required to devote significant time and incur significant expense to remediate any material weaknesses that may be discovered and may not be able to remediate any material weaknesses in a timely manner. The existence of any material weakness in our internal control over financial reporting could also 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 stockholders to lose confidence in our reported financial information, all of which could lead to a decline in the trading price of our common stock.

We have limited experience in making critical accounting estimates, and our financial statements may be materially affected if our estimates prove to be inaccurate.

Financial statements prepared in accordance with GAAP require the use of estimates, judgments and assumptions that affect the reported amounts. Different estimates, judgments and assumptions reasonably could be used that would have a material effect on the financial statements, and changes in these estimates, judgments and assumptions are likely to occur from period to period in the future. Significant areas of accounting requiring the application of management’s judgment include, but are not limited to (1) assessing the adequacy of the allowance for loan losses and (2) determining the fair value of investment securities. These estimates, judgments and assumptions are inherently uncertain, and, if they prove to be wrong, then we face the risk that charges to income will be required. In addition, because we have limited operating history in some of these areas and limited experience in making these estimates, judgments and assumptions, the risk of future charges to income may be greater than if we had more experience in these areas. Any such charges could significantly harm our business, financial condition, results of operations and the price of our securities. See “Management’s discussion and analysis of financial condition and results of operations—Critical accounting policies—Use of estimates” for a discussion of the accounting estimates, judgments and assumptions that we believe are the most critical to an understanding of our business, financial condition and results of operations.

Terrorist attacks and other acts of violence or war may affect the real estate industry generally and our business, financial condition and results of operations.

We cannot predict the severity of the effect that potential future terrorist attacks would have on us. We may suffer losses as a result of the adverse impact of any future attacks and these losses may adversely impact our performance and may cause the market value of our shares of common stock to decline or be more volatile. A prolonged economic slowdown, a recession or declining real estate values could impair the performance of our assets and harm our financial condition and results of operations, increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. Losses resulting from these types of events may not be fully insurable.

 

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The events of September 11, 2001 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, or the TRIA, and the subsequent enactment of the Terrorism Risk Insurance Program Reauthorization Act of 2007, which extended the TRIA through the end of 2014, 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 opportunities available to us and the pace at which we are able to acquire assets. If the properties underlying our interests are unable to obtain affordable insurance coverage, the value of our interests could decline, and in the event of an uninsured loss, we could lose all or a portion of our assets.

Risks related to our portfolio

We have not yet identified any specific assets for our portfolio and, therefore, you will not be able to evaluate the allocation of the net proceeds of this offering and the concurrent private placement or the economic merits of our portfolio before making an investment decision with respect to our common stock.

We have not yet identified any specific assets for our portfolio and, therefore, you will not be able to evaluate our portfolio before making an investment decision with respect to our common stock. Additionally, our portfolio will be selected by our Manager and our stockholders will not have input into decisions regarding our portfolio. Both of these factors will increase the uncertainty, and thus the risk, of investing in shares of our common stock.

For the first two to three quarters following the completion of this offering and the concurrent private placement, we intend to deploy a significant portion of the net proceeds from these offerings (resulting in a greater percentage of our overall portfolio of target assets than we expect to have within approximately 12 months following the completion of this offering and the concurrent private placement) to acquire senior CMBS to opportunistically take advantage of the TALF. We expect the CMBS we acquire during this initial period to be the most senior priority by subordination with respect to vintages from 2008 and earlier and investment grade with respect to more recent vintages. Until other appropriate uses can be identified, our Manager may invest the proceeds of this and any future offerings in interest-bearing, short-term investments, including money market accounts and senior CMBS with short duration, that are consistent with our intention to qualify as a REIT. These investments are expected to provide a lower net return than we will seek to achieve from our target assets. See “Use of proceeds.” Our Manager intends to conduct due diligence with respect to each origination and/or acquisition and suitable investment opportunities may not be immediately available. We cannot assure you that we will be able to identify assets that meet our investment objectives, that our Manager’s due diligence processes will uncover all relevant facts regarding such assets, that we will be successful in consummating any investment opportunities we identify or that one or more investments we may purchase using the net proceeds of this offering and the concurrent private placements will yield attractive risk-adjusted returns. Our inability to do any of the foregoing likely would materially and adversely affect our business, financial condition, liquidity and results of operations, cash flows and our ability to make distributions to our stockholders.

We may allocate the net proceeds from this offering and the concurrent private placement in a manner with which you may not agree.

We will have significant flexibility in deploying the net proceeds of this offering and the concurrent private placements. You will be unable to evaluate the manner in which the net proceeds of these offerings will be deployed or the economic merit of our target assets and, as a result, we may use the net proceeds to invest in assets with which you may not agree. The failure of our management to apply these proceeds effectively or find assets that meet our investment criteria in sufficient time or on acceptable terms could result in unfavorable returns, could cause a material adverse effect on our business, financial condition, liquidity and

 

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results of operations. Because assets we expect to acquire may experience periods of illiquidity, we may lose profits or be prevented from earning capital gains if we cannot sell mortgage-related assets at an opportune time.

We bear the risk of being unable to dispose of our target assets at advantageous times or in a timely manner because mortgage-related assets generally experience periods of illiquidity, including the recent period of delinquencies and defaults with respect to commercial mortgage loans. The lack of liquidity may result from the absence of a willing buyer or an established market for these assets, as well as legal or contractual restrictions on resale or the unavailability of financing for these assets. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which may cause us to incur losses.

If our Manager overestimates the yields or incorrectly prices the risks of our assets, we may experience losses.

Our Manager will value our potential assets based on yields and risks, taking into account estimated future losses on the mortgage loans and the underlying collateral included in the securitization’s pools, and the estimated impact of these losses on expected future cash flows and returns. Our Manager’s loss estimates may not prove accurate, as actual results may vary from estimates. In the event that our Manager underestimates the asset level losses relative to the price we pay for a particular asset, we may experience losses with respect to such assets.

Difficult conditions in the markets for mortgages and mortgage-related assets as well as the broader financial markets have resulted in a significant contraction in liquidity for mortgages and mortgage-related assets, which may adversely affect the value of the assets that we intend to originate or acquire.

Our results of operations will be materially affected by conditions in the markets for mortgages and mortgage-related assets as well as the broader financial markets and the economy generally. In recent years, significant adverse changes in financial market conditions have resulted in a deleveraging of the entire global financial system and the forced sale of large quantities of mortgage-related and other financial assets. As a result of these conditions, many traditional mortgage investors have suffered severe losses in their mortgage portfolios and several major market participants have failed or been impaired, resulting in a significant contraction in market liquidity for mortgage-related assets. This illiquidity has negatively affected both the terms and availability of financing for most mortgage-related assets, including our target assets, and has resulted in these assets trading at significantly lower prices compared to recent periods. Further increased volatility and deterioration in the markets for mortgages and mortgage-related assets as well as the broader financial markets may adversely affect the performance and market value of our target assets. Furthermore, if these conditions persist, institutions from which we may seek financing for our target assets may become insolvent or tighten their lending standards, which could make it more difficult for us to obtain financing on favorable terms or at all. Our profitability may be adversely affected if we are unable to obtain cost-effective financing for our target assets.

The commercial mortgage and other commercial real estate-related loans that we will purchase, and the commercial mortgage loans underlying the CMBS in which we may invest, are subject to the ability of the commercial property owner to generate net income from operating the property as well as the risks of 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 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, or NOI, of the property is reduced, the borrower’s ability to repay the loan may be impaired. NOI of

 

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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 including the credit and securitization markets, 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, costs of remediation and liability associated with environmental conditions, the potential for uninsured property losses, changes in governmental rules, regulations and fiscal policies, including environmental legislation and the related costs of compliance, acts of God, terrorism, social unrest and civil disturbances.

Most commercial mortgage loans underlying CMBS are effectively non-recourse obligations of the sponsor, meaning that there is no recourse against the sponsor’s assets other than the underlying collateral. In the event of any default under a mortgage or other real-estate related 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 or other loan, which could have a material adverse effect on our cash flow from operations. In the event of the bankruptcy of a mortgage or other real-estate related loan borrower, the 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 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 that could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan. CMBS evidence interests in or are secured by a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, the CMBS we purchase are subject to all of the risks of the underlying mortgage loans.

Certain interim loans will involve a greater risk of loss than traditional mortgage loans.

We may originate and acquire interim loans secured by first lien mortgages on commercial real estate that provide interim financing to borrowers seeking short-term capital for the acquisition or transition (for example, lease up and/or rehabilitation) of commercial real estate generally having a maturity of three years or less. Such a borrower under an interim loan has usually identified a transitional asset that has been under-managed and/or is located in a recovering market. If the market in which the asset is located fails to recover according to the borrower’s projections, or if the borrower fails to improve the quality of the asset’s management and/or the value of the asset, the borrower may not receive a sufficient return on the asset to satisfy the interim loan, and we bear the risk that we may not recover some or all of our initial expenditure.

In addition, borrowers usually use the proceeds of a long-term mortgage loan to repay an interim loan. We may therefore be dependent on a borrower’s ability to obtain permanent financing to repay our interim loan, which could depend on market conditions and other factors. Interim loans are also subject to risks of borrower defaults, bankruptcies, fraud, losses and special hazard losses that are not covered by standard hazard insurance. In the event of any default under interim loans held by us, we bear the risk of loss of principal and non-payment of interest and fees to the extent of any deficiency between the value of the mortgage collateral and the principal amount and unpaid interest of the interim loan. To the extent we suffer such losses with respect to our interim loans, the value of our company and the price of our shares of common stock may be adversely affected.

We may not control the special servicing of the mortgage loans included in the CMBS in which we may invest and, in such cases, the special servicer may take actions that could adversely affect our interests.

With respect to each series of the CMBS in which we may invest, overall control over the special servicing of the related underlying mortgage loans will be held by a “directing certificate-holder” or a “controlling class

 

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representative,” which is appointed by the holders of the most subordinate class of CMBS in such series (except in the case of TALF-financed CMBS, where TALF rules prohibit control by investors in a subordinate class once the principal balance of that class is reduced to less than 25% of its initial principal balance as a result of both actual realized losses and “appraisal reduction amounts”). We may not have the right to appoint the directing certificate-holder. In connection with the servicing of the specially serviced mortgage loans, the related special servicer may, at the direction of the directing certificate-holder, take actions with respect to the specially serviced mortgage loans that could adversely affect our interests. However, the special servicer is not permitted to take actions that are prohibited by law or violate the applicable servicing standard or the terms of the mortgage loan documents.

As a lending institution, we may be subject to “lender liability” claims.

In recent years, a number of judicial decisions have upheld the right of borrowers to sue lending institutions on the basis of various evolving legal theories, collectively termed “lender liability.” Generally, lender liability is founded on the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has assumed a degree of control over the borrower resulting in the creation of a fiduciary duty owed to the borrower or its other creditors or stockholders. We cannot assure prospective investors that such claims will not arise or that we will not be subject to significant liability if a claim of this type did arise.

An increase in prepayment rates may adversely affect the value of our portfolio.

The value of our assets may be affected by prepayment rates on mortgage and other real estate-related loans. If we acquire mortgage-related securities, we anticipate that the underlying mortgages will prepay at a projected rate generating an expected yield. If we purchase assets at a premium to par value, when borrowers prepay their mortgage loans faster than expected, the corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will have to amortize the related premium on an accelerated basis. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their mortgage loans slower than expected, the decrease in corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will not be able to accrete the related discount as quickly as originally anticipated. Prepayment rates on loans are influenced by changes in market interest rates and a variety of economic, geographic and other factors beyond our control. Consequently, such prepayment rates cannot be predicted with certainty and no strategy can completely insulate us from prepayment or other such risks. In periods of declining interest rates, prepayment rates on mortgage and other real estate-related loans generally increase. If interest rates decline at the same time, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the yields on the assets that were prepaid. In addition, the market value of the assets may, because of the risk of prepayment, benefit less than other fixed income securities from declining interest rates. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments. A portion of our assets requires prepayment fees if the security or loan is prepaid.

The lack of liquidity in our portfolio may adversely affect our business.

The illiquidity of our real estate loans and assets, other than certain of our CMBS, may make it difficult for us to sell such assets if the need or desire arises. Many of the securities we purchase will not be registered under the relevant securities laws, resulting in a prohibition against their transfer, sale, pledge or their disposition except in a transaction that is exempt from the registration requirements of, or otherwise in accordance with, those laws. In addition, certain assets such as B-Notes, mezzanine loans and interim and other loans are also particularly illiquid due to their short life, their potential unsuitability for securitization and the greater difficulty of recovery in the event of a borrower’s default. As a result, we expect many of our assets will be illiquid and if we are required to liquidate all or a portion of our portfolio quickly, we may

 

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realize significantly less than the value at which we have previously recorded our investments. Further, we may face other restrictions on our ability to liquidate an investment in a business entity to the extent that we or our Manager has or could be attributed with material, non-public information regarding such business entity. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations and financial condition.

Our portfolio may be concentrated and will be subject to risk of default.

While we intend to diversify our portfolio of assets in the manner described in this prospectus, we are not required to observe specific diversification criteria, except as may be set forth in the target asset guidelines adopted by our board of directors. Therefore, our target assets may at times be concentrated by the sponsor as well as in certain property types that are subject to higher risk of foreclosure, or secured by properties concentrated in a limited number of geographic locations. To the extent that our portfolio is concentrated in any one region or type of asset, downturns relating generally to such region or type of asset may result in defaults on a number of our assets within a short time period, which may reduce our net income and the value of our common stock and accordingly reduce our ability to make distributions to our stockholders.

We may experience a decline in the fair value of our assets.

A decline in the fair market value of our assets may require us to recognize an “other-than-temporary” impairment, or OTTI, against such assets under GAAP if we were to determine that, with respect to any assets in unrealized loss positions, we do not have the ability and intent to hold such assets to maturity or for a period of time sufficient to allow for recovery to the amortized cost of such assets. If such a determination were to be made, we would recognize unrealized losses through earnings and write down the amortized cost of such assets to a new cost basis, based on the fair value of such assets on the date they are considered to be other-than-temporarily impaired. Such impairment charges reflect non-cash losses at the time of recognition; subsequent disposition or sale of such assets could further affect our future losses or gains, as they are based on the difference between the sale price received and adjusted amortized cost of such assets at the time of sale.

Some of our portfolio investments will be recorded at fair value and, as a result, there will be uncertainty as to the value of these investments. Furthermore, our determinations of fair value may have a material impact on our financial condition, liquidity and results of operations.

We expect that the value of some of our investments may not be readily determinable. We will value these investments quarterly at fair value, as determined in accordance with Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” or SFAS No. 157. Because such valuations are subjective, the fair value of certain of our assets may fluctuate over short periods of time and our determinations of fair value may differ materially from the values that would have been used if a ready market for these assets existed. Our determinations of fair value may have a material impact on our earnings, in the case of impaired loans and other assets, trading securities and available-for-sale securities that are subject to OTTI, or our accumulated other comprehensive income/(loss) in our stockholders’ equity, in the case of available-for-sale securities that are subject only to temporary impairments. Accordingly, the value of our common stock could be adversely affected by our determinations regarding the fair value of our investments, whether in the applicable period or in the future.

In many cases, our determination of the fair value of our investments will be based on valuations provided by third-party dealers and pricing services. Valuations of certain of our assets are often difficult to obtain or unreliable. In general, dealers and pricing services heavily disclaim their valuations. Dealers may claim to furnish valuations only as an accommodation and without special compensation, and so they may disclaim any and all liability for any direct, incidental or consequential damages arising out of any inaccuracy or incompleteness in valuations, including any act of negligence or breach of any warranty. Depending on the

 

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complexity and illiquidity of an asset, valuations of the same asset can vary substantially from one dealer or pricing service to another. Higher valuations of our investments will have the effect of increasing the amount of the base management fee we pay to our Manager and increasing the incentive return on the Class B units held by our Manager. Therefore, conflicts of interest exist to the extent that our Manager is involved in the determination of the fair value of our investments. Additionally, our results of operations for a given period could be adversely affected if our determinations regarding the fair value of these investments were materially higher than the values that we ultimately realize upon their disposal. The valuation process has been particularly challenging recently as market events have made valuations of certain assets more difficult, unpredictable and volatile.

A prolonged economic slowdown, a lengthy or severe recession or continued declining real estate values could impair our investments and harm our operations.

We believe the risks associated with our business will be more severe during periods of economic slowdown or recession if these periods are accompanied by declining real estate values such as during the current period. Declining real estate values will likely reduce the level of new mortgage and other real estate-related loan originations since borrowers often use appreciation in the value of their existing properties to support the purchase or investment in additional properties. Borrowers may also be less able to pay principal and interest on our loans if the value of real estate weakens. Further, declining real estate values significantly increase the likelihood that we will incur losses on our loans in the event of default because the value of our collateral may be insufficient to cover our cost on the loan. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income from loans in our portfolio as well as our Manager’s ability to originate/acquire, sell and securitize loans, which would materially and adversely affect our results of operations, financial condition, liquidity and business and our ability to make distributions to our stockholders.

Our investments in subordinate loans, subordinate participation interests in loans and subordinate CMBS are generally subject to losses.

We may acquire subordinate loans, subordinate participation interests in loans and subordinate CMBS. In the event a borrower defaults on a loan and lacks sufficient assets to satisfy our loan, we may suffer a loss of principal or interest. In the event a borrower declares bankruptcy, we may not have full recourse to the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy the loan. In addition, certain of our loans may be subordinate to other debt of the borrower. If a borrower defaults on our loan or on debt senior to our loan, or in the event of a borrower bankruptcy, our loan will be satisfied only after the senior debt is paid in full. Where debt senior to our loan exists, the presence of intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies and control decisions made in bankruptcy proceedings relating to borrowers.

In general, losses on a mortgaged property 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, if any, then by the holder of a mezzanine loan or B-Note, if any, then by the “first loss” subordinated security holder (generally, the “B-Piece” buyer) and then by the holder of a higher-rated security. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit, mezzanine loans or B-Notes, and any classes of securities junior to those in which we may invest, we will 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 mortgage-backed securities, the securities in which we may 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 the mortgage-backed securities to make principal and interest payments may be

 

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impaired. In such event, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities.

An economic downturn could increase the risk of loss on our subordinate CMBS. The prices of lower credit-quality securities, such as the subordinate CMBS in which we plan to invest, are generally less sensitive to interest rate changes than more highly rated securities, but are more sensitive to actual or perceived adverse economic downturns or individual property developments. An economic downturn or a projection of an economic downturn could cause a decline in the price of lower credit quality securities because the ability of obligors of mortgages underlying CMBS to make principal and interest payments or to refinance may be impaired. In such event, existing credit support to a securitized structure may be insufficient to protect us against loss of our principal on these securities.

Our first mortgage loan financings are subject to the ability of the commercial property owner to generate net income from operating the property as well as the risks of delinquency, foreclosure and loss, which could result in losses to us, and our rights with respect to the first mortgage loans would be adversely affected if the holder of the commercial real estate first mortgage loan fails to exercise its rights or fails to notify us of a default or other adverse action relating to the underlying real estate collateral.

Our target assets include first mortgage loan financings which are loans made to holders of commercial real estate first mortgage loans that are secured by such first mortgage loans. The performance of first mortgage loan financing will depend upon the performance of the underlying real estate collateral. In particular, 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 risks associated with loans made on the security of single-family residential property. The ability of a borrower under a first mortgage loan 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 NOI of the property is reduced, the borrower’s ability to repay the loan may be impaired and should the borrower default on the first mortgage loan, the holders of the commercial real estate first mortgage loans may be unable to repay the first mortgage loan financing and accordingly we may lose all or substantially all of our investment. In addition, in the event of the bankruptcy of the borrower under the first mortgage loan, we may not have full recourse to the assets of the holder of the commercial real estate mortgage loan, or the assets of the holder of the commercial real estate mortgage loan may not be sufficient to satisfy our first mortgage loan financing.

While we have certain rights with respect to the real estate collateral underlying a first mortgage loan, the holder of the commercial real estate first mortgage loans may fail to exercise its rights with respect to a default or other adverse action relating to the underlying real estate collateral or fail to promptly notify us of such an event which would adversely affect our ability to enforce our rights. In addition, foreclosure of a mortgage loan can be an expensive and lengthy process that could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan. Accordingly, we may face greater risks from our first loan financings than if we had made a first loan directly to a borrower.

The B-Notes we may retain or invest may be subject to additional risks relating to the privately negotiated structure and terms of the transaction, which may result in losses to us.

We may originate or acquire B-Notes. A B-Note is a mortgage loan typically (i) secured by a first mortgage on a single large commercial property or group of related properties and (ii) subordinated to an A-Note secured by the same first mortgage on the same collateral. As a result, if a borrower defaults, there may not be sufficient funds remaining for B-Note owners after payment to the A-Note owners. B-Notes reflect similar credit risks to comparably rated CMBS. However, since each transaction is privately negotiated, B-Notes can vary in their structural characteristics and risks. For example, the rights of holders of B-Notes to control the process following a borrower default may be limited in certain investments. We cannot predict the terms of each B-Note investment. Further, B-Notes typically are secured by a single property, and so reflect the increased risks associated with a single property compared to a pool of properties. B-Notes also are less

 

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liquid than CMBS, thus we may be unable to dispose of underperforming or non-performing investments. The higher risks associated with our subordinate position in our B-Note investments could subject us to increased risk of losses and may limit our ability to make distributions to our stockholders.

We may make loans to owners of net leased properties and these loans may generate losses.

We may make loans to owners of net leased real estate assets. A net lease requires the tenant to pay, in addition to the fixed rent, some or all of the property expenses that normally would be paid by the property owner. The value of our investments and the income from our investments in loans to owners of net leased properties, if any, will depend upon the ability of the applicable tenant to meet its obligations to maintain the property under the terms of the net lease. If a tenant fails or becomes unable to so maintain a property, the borrower would have difficulty making its required loan payments to us. In addition, under many net leases the owner of the property retains certain obligations with respect to the property, including among other things, the responsibility for maintenance and repair of the property, to provide adequate parking, maintenance of common areas and compliance with other affirmative covenants in the lease. If the borrower were to fail to meet these obligations, the applicable tenant could abate rent or terminate the applicable lease, which may result in a loss of capital invested in, and anticipated profits from, the property to the borrower and the borrower would have difficulty making its required loan payments to us. In addition, the borrower may find it difficult to lease property to new tenants that may have been suited to the particular needs of a former tenant.

We may make preferred equity investments which involve a greater risk of loss than traditional debt financing.

Preferred equity investment is subordinate to debt financing and is not secured. Should the issuer default on our investment, we would only be able to proceed against the entity that issued the preferred equity in accordance with the terms of the preferred security, and not any property owned by the entity. Furthermore, in the event of bankruptcy or foreclosure, we would only be able to recoup our capital after any lenders to the entity are paid. As a result, we may not recover some or all of our capital, which could result in losses.

Our investments in corporate bank debt and debt securities of commercial real estate operating or finance companies will be subject to the specific risks relating to the particular company and to the general risks of investing in real estate-related loans and securities, which may result in significant losses.

We may purchase corporate bank debt and debt securities of commercial real estate operating or finance companies. These investments will involve special risks relating to the particular company, including its financial condition, liquidity, results of operations, business and prospects. In particular, the debt securities are often non-collateralized and may also be subordinated to its other obligations. We may purchase debt securities of companies that are not rated or are rated non-investment grade by one or more rating agencies. Investments that are not rated or are rated non-investment grade have a higher risk of default than investment grade rated assets and therefore may result in losses to us. We have not adopted any limit on such investments.

These investments will also subject us to the risks inherent with real estate-related assets referred to in this prospectus, including the risks described with respect to commercial properties and similar risks, including:

 

 

risks of delinquency and foreclosure, and risks of loss in the event thereof;

 

the dependence upon the successful operation of, and net income from, real property;

 

risks generally incident to interests in real property; and

 

risks specific to the type and use of a particular property.

These risks may adversely affect the value of our interests in commercial real estate operating and finance companies and the ability of the issuers thereof to make principal and interest payments in a timely manner, or at all, and could result in significant losses.

 

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Investments in non-conforming and non-investment grade rated loans or securities involve increased risk of loss.

Our investments may not conform to conventional loan standards applied by traditional lenders and either will not be rated or will be rated as non-investment grade by the rating agencies. The non-investment grade ratings for these assets typically result from the overall leverage of the loans, the lack of a strong operating history for the properties underlying the loans, the borrowers’ credit history, the properties’ underlying cash flow or other factors. As a result, these investments will have a higher risk of default and loss than investment grade rated assets. Any loss we incur may be significant and may reduce distributions to our stockholders and adversely affect the market value of our shares of common stock. There are no limits on the percentage of unrated or non-investment grade rated assets we may hold in our portfolio.

Any credit ratings assigned to our investments will be subject to ongoing evaluations and revisions and we cannot assure you that those ratings will not be downgraded.

Some of our investments may be rated by Moody’s Investors Service, Fitch Ratings or Standard & Poor’s Investors Service, Inc., or S&P. Any credit ratings on our investments are subject to ongoing evaluation by credit rating agencies, and we cannot assure you that any such ratings will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. If rating agencies assign a lower-than-expected rating or reduce or withdraw, or indicate that they may reduce or withdraw, their ratings of our investments in the future, the value of these investments could significantly decline, which would adversely affect the value of our portfolio and could result in losses upon disposition or the failure of borrowers to satisfy their debt service obligations to us. Further, if rating agencies reduce the ratings on assets that we intended to finance through the TALF, such assets would no longer be eligible collateral that could be financed through the TALF.

Our mezzanine and other subordinate loan assets will involve greater risks of loss than senior loans secured by income-producing properties.

We may acquire mezzanine and other subordinate loans, which take the form of subordinate loans secured by second mortgages on the underlying property or loans secured by a pledge of the ownership interests of either the entity owning the property or a pledge of the ownership interests of the entity that owns the interest in the entity owning the property. These types of assets involve a higher degree of risk than a long-term senior mortgage loan secured by income-producing real property, because the loan 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 initial expenditure. In addition, mezzanine loans may have higher loan-to-value ratios than first mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal. Significant losses related to our mezzanine loans would result in operating losses for us and may limit our ability to make distributions to our stockholders.

Interest rate fluctuations could reduce our ability to generate income and may cause losses.

Changes in interest rates will affect our net interest income, which is the difference between the interest income we earn on our interest-earning assets and the interest expense we incur in financing these assets. Changes in the level of interest rates also may affect our ability to originate and acquire assets, the value of our assets and our ability to realize gains from the disposition of assets. Changes in interest rates may also affect borrower default rates. In a period of rising interest rates, our interest expense could increase, while the interest we earn on our fixed rate debt instruments do not change, adversely affecting our profitability. Our operating results depend in large part on differences between the income from our assets, net of credit losses, and our financing costs. We anticipate that for any period during which our assets are not match-

 

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funded, the income from such assets may respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates may significantly influence our net income. Increases in these rates will tend to decrease our net income and the market value of our fixed rate assets. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for us.

Liability relating to environmental matters may impact the value of properties that we may acquire or the properties underlying our investments.

Under various U.S. federal, state and local laws, an owner or operator of real property may become liable for the costs of removal of certain hazardous substances released on its property. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances.

The presence of hazardous substances may adversely affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of a property underlying one of our debt instruments becomes liable for removal costs, the ability of the owner to make payments to us may be reduced, which in turn may adversely affect the value of the relevant mortgage asset held by us and our ability to make distributions to our stockholders.

If we acquire any properties by foreclosure or otherwise, the presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs, thus harming our financial condition. The discovery of material environmental liabilities attached to such properties could have a material adverse effect on our results of operations and financial condition and our ability to make distributions to our stockholders.

Our real estate assets are subject to risks particular to real property, which may adversely affect our returns from certain assets and our ability to make distributions to our stockholders.

We expect to own originate and/or acquire debt instruments secured by real estate and may own real estate directly in the future, either through direct investments or upon a default of mortgage or other real estate-related loans. Real estate investments are subject to various risks, including:

 

 

acts of God, including 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.

Risks related to financing

Our access to financing may be limited and thus our ability to maximize our returns may be adversely affected.

We intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to

 

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incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. With respect to other U.S. Government programs, to the extent we utilize them at all, we would expect to utilize such amount of non-recourse leverage up to the amount permitted under the guidelines of the applicable program. We will also seek to obtain financings, including secured term loans or revolving facilities, traditional repurchase or other secured credit facilities and other private funding sources. The percentage of leverage we employ will vary depending on our Manager’s assessment of a variety of factors, which may include the anticipated liquidity and price volatility of the target assets in our portfolio, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and commercial mortgage markets, our outlook for the level, slope, and volatility of interest rates, the credit quality of our target assets, the collateral underlying our target assets, and our outlook for asset spreads relative to the LIBOR curve.

When market conditions allow, we expect to reduce the principal risk associated with our origination and investment activities through securitizations, syndications, participations and, to the extent consistent with maintaining our qualification as a REIT, other sales of portions of our assets, and we may choose to enhance our returns through the prudent use of higher leverage, with an emphasis on using term financings, including through the creation of securitization vehicles. We may also seek to raise further equity capital or issue debt securities in order to fund our future activities.

Our access to financing will depend upon a number of factors over which we have little or no control, including:

 

 

general market conditions;

 

 

the market’s view of the quality of our assets;

 

 

the market’s perception of our growth potential;

 

 

the market’s perception of the success or failure of the government initiatives;

 

 

our eligibility to participate in and access capital from programs established by the U.S. Government;

 

 

our current and potential future earnings and cash distributions; and

 

 

the market price of the shares of our common stock.

The current dislocation and weakness in the capital and credit markets could adversely affect one or more lenders and could cause one or more lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing. In addition, if regulatory capital requirements imposed on our private lenders change, they may be required to limit, or increase the cost of, financing they provide to us. In general, this could potentially increase our financing costs and reduce our liquidity or require us to sell assets at an inopportune time or price.

Under current market conditions, structured financing arrangements are generally unavailable, which has also limited borrowings under warehouse and repurchase agreements that are intended to be refinanced by such financings. Consequently, depending on market conditions at the relevant time, we may have to rely more heavily on additional equity issuances, which may be dilutive to our stockholders, or on less efficient forms of debt financing that require a larger portion of our cash flow from operations, thereby reducing funds available for our operations, future business opportunities, cash distributions to our stockholders and other purposes. We cannot assure you that we will have access to such equity or debt capital on favorable terms (including, without limitation, cost and term) at the desired times, or at all, which may cause us to curtail our asset acquisition activities and/or dispose of assets, which could negatively affect our results of operations.

 

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We intend to leverage the acquisition of our target assets and are not limited in the amount of leverage we may use. Our use of leverage may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.

We do not have a formal policy limiting the amount of debt we incur and our governing documents contain no limitation on the amount of leverage we may use.

We may significantly increase the amount of leverage we utilize at any time without approval of our board of directors. In addition, we may leverage individual assets at substantially higher levels. Incurring substantial debt could subject us to many risks that, if realized, would materially and adversely affect us, including the risk that:

 

 

our cash flow from operations may be insufficient to make required payments of principal of and interest on the debt or we may fail to comply with all of the other covenants contained in the debt, which is likely to result in (i) acceleration of such debt (and any other debt containing a cross-default or cross-acceleration provision) that we may be unable to repay from internal funds or to refinance on favorable terms, or at all, (ii) our inability to borrow unused amounts under our financing arrangements, even if we are current in payments on borrowings under those arrangements and/or (iii) the loss of some or all of our assets to foreclosure or sale;

 

 

our debt may increase our vulnerability to adverse economic and industry conditions with no assurance that yields will increase with higher financing costs;

 

 

we may be required to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing funds available for operations, future business opportunities, stockholder distributions or other purposes; and

 

 

we are not able to refinance debt that matures prior to the asset it was used to finance on favorable terms, or at all.

Our board of directors may change our leverage policies at any time without the consent of our stockholders, which could result in a portfolio with a different risk profile.

Any bank credit facilities and repurchase agreements that we may use in the future to finance our assets may require us to provide additional collateral or pay down debt.

We may utilize bank credit facilities (including term loans and revolving facilities) and repurchase agreements to finance our assets if they become available on acceptable terms. In the event we utilize such financing arrangements, they would involve the risk that the market value of our assets pledged or sold by us to the provider of the bank credit facility or the repurchase agreement counterparty may decline in value, in which case the lender may require us to provide additional collateral or to repay all or a portion of the funds advanced. We may not have the funds available to repay our debt at that time, which would likely result in defaults unless we are able to raise the funds from alternative sources, which we may not be able to achieve on favorable terms or at all. Posting additional collateral would reduce our liquidity and limit our ability to leverage our assets. If we cannot meet these requirements, the lender could accelerate our indebtedness, increase the interest rate on advanced funds and terminate our ability to borrow funds from them, which could materially and adversely affect our financial condition and ability to implement our business plan. In addition, in the event that the lender files for bankruptcy or becomes insolvent, our loans may become subject to bankruptcy or insolvency proceedings, thus depriving us, at least temporarily, of the benefit of these assets. Such an event could restrict our access to bank credit facilities and increase our cost of capital. The providers of bank credit facilities and repurchase agreement financing may also require us to maintain a certain amount of cash or set aside assets sufficient to maintain a specified liquidity position that 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 and prospects could deteriorate rapidly.

 

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There can be no assurance that we will be able to utilize bank credit facilities or repurchase agreements in the future on favorable terms, or at all. Furthermore, any bank or credit facility we enter into will be subject to conditions and covenants. To the extent we breach a covenant or cannot satisfy a condition, such facility may not be available to us, which could limit our ability to pursue our strategy.

Interest rate fluctuations could significantly decrease our results of operations and cash flows and the market value of our assets.

Our primary interest rate exposures will relate to the yield on our assets and the financing cost of our debt, as well as our interest rate swaps that we utilize for hedging purposes. Changes in interest rates will affect our net interest income, which is the difference between the interest income we earn on our interest-earning assets and the interest expense we incur in financing these assets. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for us. Changes in the level of interest rates also may affect our ability to purchase assets, the value of our investments and our ability to realize gains from the disposition of assets. Changes in interest rates may also affect borrower default rates. Our operating results depend in large part on differences between the income from our investments net of credit losses, and our financing costs.

To the extent that our financing costs will be determined by reference to floating rates, such as LIBOR or a Treasury index, plus a margin, the amount of which will depend on a variety of factors, including, without limitation, (i) for collateralized debt, the value and liquidity of the collateral, and for non-collateralized debt, our credit, (ii) the level and movement of interest rates and (iii) general market conditions and liquidity. In a period of rising interest rates, our interest expense on floating rate debt would increase, while any additional interest income we earn on our floating rate assets may not compensate for such increase in interest expense, the interest income we earn on our fixed rate assets would not change, the duration and weighted average life of our fixed rate assets would increase and the market value of our fixed rate assets would decrease. Similarly, in a period of declining interest rates, our interest income on floating rate assets would decrease, while any decrease in the interest we are charged on our floating rate debt may not compensate for such decrease in interest income and interest we are charged on our fixed rate debt would not change. We anticipate that for any period during which our assets are not match-funded, the income from such assets may respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates may significantly influence our net income. Increases in these rates will tend to decrease our net income and the market value of our fixed rate assets. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for us. Any such scenario could materially and adversely affect us.

Lenders may require us to enter into restrictive covenants relating to our operations, which may inhibit our ability to grow our business and increase revenues.

If or when we obtain debt financing, lenders (especially in the case of bank credit facilities) may impose restrictions on us that would affect our ability to incur additional debt, make certain investments or acquisitions, reduce liquidity below certain levels, make distributions to our stockholders, redeem debt or equity securities and impact our flexibility to determine our operating policies and investment strategies. For example, our loan documents may contain negative covenants that limit, among other things, our ability to repurchase our shares of common stock, distribute more than a certain amount of our net income or funds from operations to our stockholders, employ leverage beyond certain amounts, sell assets, engage in mergers or consolidations, grant liens, and enter into transactions with affiliates. If we fail to meet or satisfy any of these covenants, we would be in default under these agreements, and our lenders could elect to declare outstanding amounts due and payable, terminate their commitments, require the posting of additional collateral and enforce their interests against existing collateral. We may also be subject to cross-default and acceleration rights and, with respect to collateralized debt, the posting of additional collateral and foreclosure rights upon default. Further, this could also make it difficult for us to satisfy the qualification requirements necessary to maintain our status as a REIT for U.S. federal income tax purposes. A default and resulting repayment acceleration could significantly reduce our liquidity, which could require us

 

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to sell our assets to repay amounts due and outstanding. This could also significantly harm our business, financial condition, results of operations and ability to make distributions, which could cause the value of our capital stock to decline. A default could also significantly limit our financing alternatives such that we would be unable to pursue our leverage strategy, which could adversely affect our returns.

In the event non-recourse long-term securitizations become available to us in the future, such structures may expose us to risks which could result in losses to us.

Since the bankruptcy of Lehman Brothers in September 2008, the securitization markets have been largely closed to new securitizations. In the event the securitization markets reopen, market participants may demand terms and procedures for securitizations that are different from the terms and procedures that prevailed before the securitization markets closed. In the event the securitization markets reopen, we may utilize non-recourse long-term securitizations of our mortgage loans, especially loan originations, if and when they become available. Prior to any such financing, we may seek to finance these mortgage loans with relatively short-term facilities until a sufficient portfolio is accumulated. As a result, we would be subject to the risk that we would not be able to acquire, during the period that any short-term facilities are available, sufficient eligible assets to maximize the efficiency of a securitization. We also would bear the risk that we would not be able to obtain new short-term facilities or would not be able to renew any short-term facilities after they expire should we need more time to seek and acquire sufficient eligible assets for a securitization. In addition, conditions in the capital markets, including the current unprecedented volatility and disruption in the capital and credit markets, may not permit a non-recourse securitization at any particular time or may make the issuance of any such securitization less attractive to us even when we do have sufficient eligible assets. While we would intend to retain the unrated equity component of securitizations and, therefore, still have exposure to the riskiest component of such securitizations, our inability to enter into such securitizations would increase our overall exposure to risks associated with direct ownership of such investments, including the risk of default. Our inability to refinance any short-term facilities would also increase our risk because borrowings thereunder would likely be recourse to us as an entity. If we are unable to obtain and renew short-term facilities or to consummate securitizations to finance our assets on a long-term basis, we may be required to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price.

Furthermore, we understand that the U.S. Government and various regulators are considering proposals, which would require entities sponsoring securitizations to maintain credit exposure to the underlying assets. Depending upon the nature of any proposals that get enacted, we may face incremental risks associated with securitization activity.

The use of securitization financings with over-collateralization requirements may have a negative impact on our cash flow.

We expect that the terms of any future securitizations we may issue will generally provide that the principal amount of assets must exceed the principal balance of the related bonds by a certain amount, commonly referred to as “over-collateralization.” We anticipate that the securitization terms will provide that, if certain delinquencies or losses exceed the specified levels 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 securitization financings we cannot assure you of the actual terms of the securitization delinquency tests, over-collateralization terms, cash flow release mechanisms or other significant factors regarding the calculation of net income to us. Given the recent collapse of the securitization market, rating agencies may depart from historic practices for securitization financings, making them more difficult and costly for 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

 

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assets fail to perform as anticipated, over-collateralization or other credit enhancement expense associated with our securitization financings will increase.

We may purchase the equity securities of collateralized debt obligations, or CDOs, and such instruments involve significant risks, including that CDO equity receives distributions from the CDO only if the CDO generates enough income to first pay all debt service obligations on its indebtedness and its expenses.

We may purchase equity securities of CDOs, including CDOs structured by our Manager. A CDO is a special purpose vehicle that purchases collateral (such as real estate-related securities and loans) 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 its debt service obligations on its indebtedness and its expenses. However, there will be little or no income available to the CDO equity if there are defaults by the obligors under the underlying collateral and those defaults exceed a certain amount. In that event, the value of our investment in the CDO equity could decrease substantially or be eliminated. In addition, the equity of a CDO is generally illiquid, which is especially the case under current market conditions, and, because it represents a leveraged investment in a CDO’s assets, the value of the CDO equity will generally have greater fluctuations than will the values of the underlying collateral.

Any warehouse facilities that we may obtain in the future may limit our ability to acquire assets, and we may incur losses if the collateral is liquidated.

In the event that securitization financings become available, we may utilize, if available, warehouse facilities pursuant to which we would accumulate mortgage loans in anticipation of a securitization financing, which assets would be pledged as collateral for such facilities until the securitization transaction is consummated. In order to borrow funds to acquire assets under any future warehouse facilities, we expect that our lenders thereunder would have the right to review the potential assets for which we are seeking financing. We may be unable to obtain the consent of a lender to acquire assets that we believe would be beneficial to us and we may be unable to obtain alternate financing for such assets. In addition, no assurance can be given that a securitization structure would be consummated with respect to the assets being warehoused. If the securitization is not consummated and we are unable to meet the financial obligations associated with a warehouse facility, the lender could liquidate the warehoused collateral and we would then have to pay any amount by which the original purchase price of the collateral assets exceeds its sale price, subject to negotiated caps, if any, on our exposure. In addition, regardless of whether the securitization is consummated, if any of the warehoused collateral is sold before the consummation, we would have to bear any resulting loss on the sale.

Currently, we have no warehouse facilities in place, and no assurance can be given that we will be able to obtain one or more warehouse facilities in the future on favorable terms, or at all. Furthermore, any warehouse facility we enter into will be subject to conditions and covenants. To the extent we breach a covenant or cannot satisfy a condition, such warehouse facility may not be available to us, which could limit our ability to pursue our strategy.

If a counterparty to our repurchase transactions 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, we will lose money on our repurchase transactions.

When we engage in repurchase transactions, we will generally sell securities to lenders (i.e., repurchase agreement counterparties) and receive cash from the lenders. The lenders will be obligated to resell the same securities back to us at the end of the term of the transaction. Because the cash we will receive from the lender when we initially sell the securities to the lender is less than the value of those securities (this difference is the haircut), if the lender defaults on its obligation to resell the same securities back to us we would incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in

 

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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. Further, if we default on one of our obligations under a repurchase transaction, the lender will be able to terminate the transaction and cease entering into any other repurchase transactions with us. We expect that our repurchase agreements will contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our other agreements could also declare a default. If a default occurs under any of our repurchase agreements and the lenders terminate one or more of our repurchase agreements, we may need to enter into replacement repurchase agreements with different lenders. There can be no assurance that we will be successful in entering into such replacement repurchase agreements on the same terms as the repurchase agreements that were terminated or at all. Any losses we incur on our repurchase transactions could adversely affect our earnings and thus our cash available for distribution to our stockholders.

Our use of repurchase agreements to finance our CMBS may give our lenders greater rights in the event that either we or a lender files for bankruptcy, including to repudiate our repurchase agreements.

In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the U.S. Bankruptcy Code, the effect of which, among other things, would be to allow the lender under the applicable repurchase agreement to avoid the automatic stay provisions of the U.S. Bankruptcy Code and to foreclose on the collateral agreement without delay. In the event of the insolvency or bankruptcy of a lender during the term of a repurchase agreement, the lender may be permitted, under applicable insolvency laws, to repudiate the contract, and our claim against the lender for damages may be treated simply as an unsecured creditor. In addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970, or an insured depository institution subject to the Federal Deposit Insurance Act, our ability to exercise our rights to recover our securities under a repurchase agreement or to be compensated for any damages resulting from the lender’s insolvency may be further limited by those statutes. These claims would be subject to significant delay and, if and when received, may be substantially less than the damages we actually incur. Therefore, our use of repurchase agreements to finance our portfolio assets exposes our pledged assets to risk in the event of a bankruptcy filing by either a lender or us.

If one or more of our Manager’s executive officers are no longer employed by our Manager, financial institutions providing any financing arrangements we may have may not provide future financing to us, which could materially and adversely affect us.

If financial institutions that we seek to finance our assets require that one or more of our Manager’s executive officers continue to serve in such capacity and if one or more of our Manager’s executive officers are no longer employed by our Manager, it may constitute an event of default and the financial institution providing the arrangement may have acceleration rights with respect to outstanding borrowings and termination rights with respect to our ability to finance our future investments with that institution. If we are unable to obtain financing for our accelerated borrowings or for our future investments under such circumstances, we could be materially and adversely affected.

 

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Risks related to U.S. Government programs

There can be no assurance that the actions of the U.S. Government, the Federal Reserve, the U.S. Treasury and related bodies to stabilize the financial markets, including the establishment of the TALF and similar programs, or market response to those actions, will achieve the intended effect, or that our business will benefit from these actions, or that further government or market developments will not materially and adversely impact us.

In response to the severe dislocation in the credit markets, the U.S. Treasury and the Federal Reserve jointly announced the establishment of the TALF that is designed to increase credit availability and support economic activity by facilitating renewed securitization activities. Under the TALF, the Federal Reserve Bank of New York, or the FRBNY, provides non-recourse loans to borrowers to fund their purchase of eligible assets. In June 2009, the Federal Reserve made available up to $100 billion of TALF loans to finance purchases of CMBS created on or after January 1, 2009 and, on July 16, 2009, certain high-quality CMBS issued before January 1, 2009, or legacy CMBS, became eligible collateral under the TALF. However, the FRBNY may limit the volume of TALF loans secured by legacy CMBS, and is in the process of finalizing other requirements that will apply to legacy CMBS.

There can be no assurance that the TALF or other U.S. Government actions or programs will have a beneficial impact on the financial markets, including on current extreme levels of volatility, nor can there be any assurance that we will be eligible to participate in any programs established by the U.S. Government such as the TALF or, if we are eligible, that we will be able to utilize them successfully or at all. In addition, because the programs are designed, in part, to restart the market for certain of our target assets, the establishment of these programs may result in increased competition for attractive opportunities in certain of our target assets. It is also possible that our competitors may utilize the programs which would provide them with attractive debt and equity capital funding from the U.S. Government. In addition, the U.S. Government, the Federal Reserve, the U.S. Treasury and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. We cannot predict whether or when such actions may occur, and such actions could have a dramatic impact on our business, results of operations and financial condition.

Downgrades of legacy CMBS and/or changes in the rating methodology and assumptions for future CMBS issuances may decrease the availability of the TALF to finance CMBS.

On May 26, 2009, S&P, which rates a substantial majority of CMBS issuances, issued a request for comment regarding its proposed changes to its methodology and assumptions for rating CMBS, and in so doing indicated that the proposed changes would result in downgrades of a considerable amount of CMBS (including super-senior tranches). Specifically, S&P indicated that “it is likely that the proposed changes, which represent a significant change to the criteria for rating high investment-grade classes, will prompt a considerable amount of downgrades in recently issued (2005-2008 vintage) CMBS.” S&P noted that its preliminary findings indicate that approximately 25%, 60%, and 90% of the most senior tranches (by count) within the 2005, 2006, and 2007 vintages, respectively, may be downgraded. The current TALF guidelines issued by the FRBNY indicate that in order to be eligible for the TALF, legacy CMBS must not have a rating below the highest investment-grade rating category from any TALF CMBS-eligible rating agency, which includes S&P. Other rating agencies may take similar actions with regard to their ratings of CMBS. As a result, downgrades of legacy CMBS may limit substantially the availability of the TALF for legacy CMBS. Further, changes to the methodology and assumptions in rating CMBS by rating agencies, including S&P’s proposed changes, may decrease the amount or availability of new issue CMBS rated in the highest investment-grade rating category. Our investment strategy includes seeking to obtain financing through the TALF and so, to the extent that fewer assets are available to receive TALF financing, our operations and financial results could be negatively impacted.

 

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The terms and conditions of the TALF may change, which could adversely affect our investments.

The terms and conditions of the TALF, including asset and borrower eligibility, could be changed at any time. Any such modifications may adversely affect the market value of any of our assets financed through the TALF and otherwise or our ability to obtain additional TALF financing. The TALF is scheduled to expire on December 31, 2009, unless extended. If the TALF is prematurely discontinued or reduced while our assets financed through the TALF are still outstanding, there may be no market for these assets and the market value of these assets would be adversely affected. We intend to seek to enhance the returns on a portion of our commercial mortgage loans, especially loan originations, by securitizing the senior portion, expected to be equivalent to AAA-rated CMBS, while retaining the subordinate securities in our portfolio to the extent that TALF financing would be available for buyers of these AAA-rated CMBS. The TALF eligible asset requirements could be changed at any time. As a result, there can be no assurance that our intended securitizations would benefit from TALF financing for AAA-rated CMBS.

There is no assurance that we will be able to obtain any TALF loans.

The TALF is be operated by the FRBNY. The FRBNY has complete discretion regarding the extension of credit under the TALF and is under no obligation to make any loans to us even if we meet all of the applicable criteria. Requests for TALF loans may surpass the amount of funding authorized by the Federal Reserve and the U.S. Treasury, resulting in an early termination of the TALF. Depending on the demand for TALF loans and the general state of the credit markets, the Federal Reserve and the U.S. Treasury may decide to modify the terms and conditions of the TALF. Such actions may adversely affect our ability to obtain TALF loans and use the loan leverage to enhance returns, and may otherwise affect expected returns on our investments.

We could lose our eligibility as a TALF borrower, which would adversely affect our ability to fulfill our investment objectives.

Any U.S. company is permitted to participate in the TALF, provided, that it maintains an account relationship with a primary dealer. A U.S. company, as defined for the purposes of the TALF, excludes certain entities that are controlled by a non-U.S. government or are managed by an investment manager controlled by a non-U.S. government. For these purposes, an entity controls a company if, among other things, such entity owns, controls, or holds with power to vote 25% or more of a class of voting securities, or total equity, of the company. The application of these rules under the TALF is not clear. For instance, it is uncertain how a change of control subsequent to a stockholders’ purchase of shares of common stock which results in such stockholder being owned or controlled by a non-U.S. government will be treated for purposes of the 25% limitation.

If for any reason we are deemed not to be eligible to participate in the TALF, all of our outstanding TALF loans will become immediately due and payable and we will not be eligible to obtain future TALF loans.

The terms and conditions of the PPIP have not been finalized and there is no assurance that the final terms will enable us to benefit from the PPIP.

While the U.S. Treasury and the Federal Deposit Insurance Corporation, or the FDIC, have released a summary of proposed terms and conditions for the PPIP, they have not released the final terms and conditions governing these programs. The existing proposed terms and conditions do not address the specific terms and conditions relating to: (1) the guaranteed debt to be issued by participants in the Legacy Loans Program, (2) the debt financing from the U.S. Treasury in the Legacy Securities Program and (3) the warrants that the U.S. Treasury will receive under both programs. In addition, the U.S. Treasury and the FDIC have reserved the right to modify the proposed terms of the PPIP.

Investors in the Legacy Loans Program must be pre-qualified by the FDIC. The FDIC has complete discretion regarding the qualification of investors in the Legacy Loans Program and is under no obligation to approve our participation even if it meets all of the applicable criteria. Requests for funding under the PPIP may surpass the amount of funding authorized by the Federal Reserve and the U.S. Treasury, resulting in an early

 

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termination of the PPIP. In addition, under the terms of the Legacy Securities Program, the U.S. Treasury has the right to cease funding of committed but undrawn equity capital and debt financing to a specific fund participating in the Legacy Securities Program in its sole discretion. Furthermore, on June 3, 2009, the FDIC announced that the development of the Legacy Loans Program will continue, but that a previously planned pilot sale of assets by banks targeted for June 2009 will be postponed. On July 8, 2009, the Treasury announced that it will invest up to $30 billion in equity and debt issued by PPIFs established under the Legacy Securities Program. When the final terms and conditions are released, there is no assurance that the PPIP will provide a benefit to us. If we are unable to participate in or benefit from the PPIP, we may be limited in our ability to obtain capital and debt financing on similar terms and such actions may adversely affect our ability to purchase eligible assets and may otherwise affect expected returns on our assets.

We may not be able to acquire sufficient amounts of assets to obtain financing under the TALF consistent with our investment strategy.

Assets to be used as collateral for TALF loans must meet strict eligibility criteria with respect to characteristics such as issuance date, maturity, and credit rating and with respect to the origination date of the underlying collateral. These restrictions may limit the availability of eligible assets, and we may be unable to acquire sufficient amounts of assets to obtain financing under the TALF consistent with our investment strategy. In the Legacy Loans Program, eligible financial institutions must consult with the FDIC before offering an asset pool for sale and there is no assurance that a sufficient number of eligible financial institutions will be willing to participate as sellers in the Legacy Loans Program. Once an asset pool has been offered for sale by an eligible financial institution, the FDIC will determine the amount of leverage available to finance the purchase of the asset pool. There is no assurance that the amount of leverage available to finance the purchase of eligible assets will be acceptable to us. The asset pools will be purchased through a competitive auction conducted by the FDIC. The auction process may increase the price of these eligible asset pools. Even if we submit the highest bid on an eligible asset pool at a price that is acceptable to us, the selling financial institution may refuse to sell us the eligible asset pool at that price. These factors may limit the availability of eligible assets, and we may be unable to acquire sufficient amounts of assets to obtain financing under the Legacy Loans Program consistent with our investment strategy.

Our ability to transfer any assets we may purchase using TALF funding, to the extent available to us, is restricted.

Our assets purchased using TALF funding will be pledged to the FRBNY as collateral for the TALF loans. If we sell or transfer any of these assets, we must either repay the related TALF loan or obtain the consent of the FRBNY to assign our obligations under the related TALF loan to the applicable assignee. The FRBNY in its discretion may restrict or prevent us from assigning our TALF loan obligations to a third party, including a third party that meets the criteria of an eligible borrower. In addition, the FRBNY will not consent to any assignments after the termination date for making new loans, which is December 31, 2009, unless extended by the Federal Reserve.

These restrictions may limit our ability to trade or otherwise dispose of our investments, and may adversely affect our ability to take advantage of favorable market conditions and make distributions to stockholders.

We may need to surrender eligible TALF assets to repay TALF loans at maturity.

Each TALF loan must be repaid within three to five years. We intend to purchase CMBS that do not mature within the term of the TALF loan. If we do not have sufficient funds to repay interest and principal on the related TALF loan at maturity and if these assets cannot be sold for an amount equal to or greater than the amount owed on such loan, we must surrender the assets to the FRBNY in lieu of repayment. If we are forced to sell any assets to repay a TALF loan, we may not be able to obtain a favorable price. If we default on our obligation to pay a TALF loan and the FRBNY elects to liquidate the assets used as collateral to secure such TALF loan, the proceeds from that sale will be applied, first, to any enforcement costs, second, to unpaid principal and, finally, to unpaid interest. Under the terms of the TALF, if assets are surrendered to

 

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the FRBNY in lieu of repayment, all assets that collateralize that loan must be surrendered. In these situations, we would forfeit any equity that we held in these assets.

FRBNY consent is required to exercise our voting rights on the collateral.

As a requirement of the TALF, we must agree not to exercise or refrain from exercising any voting, consent or waiver rights under any TALF collateral without the consent of the FRBNY. During the continuance of a collateral enforcement event, the FRBNY will have the right to exercise voting rights in the collateral.

We will be dependent on the activities of our primary dealers.

To obtain TALF loans, we must execute a customer agreement with at least one primary dealer which will act on our behalf under the agreement with the FRBNY. The primary dealer will submit aggregate loan request amounts on behalf of its customers in the form and manner specified by the FRBNY. Each primary dealer is required to apply its internal customer identification program and due diligence procedures to each borrower and represent that each borrower is an eligible borrower for purposes of the TALF, and to provide the FRBNY with information sufficient to describe the dealer’s customer risk assessment methodology. These customer agreements may impose additional requirements that could affect our ability to obtain TALF loans. Each primary dealer is expected to have relationships with other TALF borrowers, and a primary dealer may allocate more resources toward assisting other borrowers with whom it has other business dealings. Primary dealers are also responsible for distributing principal and interest after receipt thereof from The Bank of New York Mellon, as custodian for the TALF. Once funds or collateral are transferred to a primary dealer or at the direction of a primary dealer, neither the custodian nor the FRBNY has any obligation to account for whether the funds or collateral are transferred to the borrower. We will therefore be exposed to bankruptcy risk of our primary dealers.

Termination of a customer agreement may adversely affect our related TALF borrowings.

In certain circumstances, a primary dealer may have the right to terminate its customer agreement with respect to any TALF loans made through such primary dealer and force us to find another primary dealer with respect to such loans, transfer the loan to another eligible borrower under the TALF, or to repay the loan or surrender the collateral to the FRBNY. In such circumstances, we may not realize our anticipated return on the assets used as collateral for such TALF loans.

We may be adversely affected if one of our investors has been previously rejected for the TALF.

Primary dealers may require us to represent under our customer agreements with them that neither we nor any person that holds an ownership interest in us has previously had a loan request under the TALF rejected by the FRBNY. We may not be able to determine if one of our investors has previously had a loan request under the TALF rejected by the FRBNY. A failure to comply with this representation may expose us to liability to the primary dealer. An inability to make this representation and warranty may prevent us from participating in the TALF.

We will be subject to interest rate risk, which can adversely affect our net income.

We expect interest rates on fixed rate TALF loans will be set at a premium over the then-current three-year or five-year LIBOR swap rate. All CMBS TALF loans must be fixed rate loans. As a result, we may be exposed to (1) timing risk between the dates on which payments are received on assets financed through the TALF and the dates on which interest payments are due on the TALF loans and (2) asset/liability repricing risk, due to differences in the dates and indices on which floating rates on the financed assets and on the related TALF loans are reset.

 

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Our ability to receive the interest earnings on assets used as collateral for TALF loans may be limited, which could significantly reduce our anticipated returns and materially negatively impact our results of operations and our ability to make or sustain distributions to our stockholders.

Interest payments that are received from the assets used as collateral for a TALF loan must be applied to pay interest on the related TALF loan before any interest payments can be distributed to us. To the extent there are interest payments from the collateral in excess of the required interest payment on the related TALF Loan, the amount of such excess interest that will be distributed to us will be limited. For example, for a five-year TALF loan, the excess of interest distributions from the collateral over the TALF loan interest payable will be remitted to us only until such excess equals 25% per annum of the haircut amount in the first three loan years, 10% in the fourth loan year, and 5% in the fifth loan year, and the remainder of such excess will be applied to the related TALF loan principal. Our ability to benefit from the excess interest could have a material adverse effect on our results of operation.

We may be required to use our earnings to keep the TALF loans current. If the interest on the collateral pledged to support a TALF loan is not sufficient to cover the interest payment on such loan, we will have a grace period of 30 days to make the interest payment. If the loan remains delinquent after the grace period, the FRBNY will enforce its rights to the collateral.

To the extent that proceeds from our TALF assets are received by the TALF custodian prior to the monthly date on which they are distributed to the borrowers, such proceeds will be held by the custodian and all interest earned on such proceeds will be retained by the FRBNY. If such proceeds were immediately distributed to the borrowers, the borrowers would be able to invest such proceeds in short-term investments and the income from such investments would be available to distribute to stockholders.

Under certain conditions, we may be required to provide full recourse for TALF loans or to make indemnification payments.

To participate in the TALF, we must execute a customer agreement with a primary dealer authorizing it, among other things, to act as our agent under TALF and to act on our behalf under the agreement with the FRBNY and with The Bank of New York Mellon as administrator and as the FRBNY’s custodian of the CMBS. Under such agreements, we will be required to represent to the primary dealer and to the FRBNY that, among other things, we are an eligible borrower and that the CMBS that we pledge meet the TALF eligibility criteria. The FRBNY will have full recourse to us for repayment of the loan for any breach of these representations. Further, the FRBNY may have full recourse to us for repayment of a TALF loan if the eligibility criteria for collateral under the TALF are considered continuing requirements and the pledged collateral no longer satisfies such criteria. In addition, we will be required to pay to our primary dealers fees under the customer agreements and to indemnify our primary dealers for certain breaches under the customer agreements and to indemnify the FRBNY and its custodian for certain breaches under the agreement with the FRBNY. Payments made to satisfy such full recourse requirements and indemnities could have a material adverse effect on our net income and our distributions to our stockholders, including any proceeds of this offering and the concurrent private placement that we have not yet invested in CMBS or distributed to our stockholders.

Risks related to hedging

We may enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.

Subject to maintaining our qualification as a REIT, part of our strategy will involve entering into hedging transactions that could require us to fund cash payments in certain circumstances (such as the early termination of the hedging instrument 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 hedging instrument). These potential payments will be contingent liabilities and therefore may not appear

 

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in our financial statements. 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 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 adversely impact our financial condition.

Hedging against interest rate exposure may adversely affect our earnings and could reduce our cash available for distribution to our stockholders.

Subject to maintaining our qualification as a REIT, we intend to pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates. Our hedging activity will vary 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;

 

 

due to a credit loss or other factors, 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 hedging transactions that satisfy certain requirements of the Internal Revenue Code or that are done through a TRS) to offset interest rate losses is limited by U.S. federal tax provisions governing REITs;

 

 

the credit quality of the hedging counterparty 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 hedging counterparty owing money in the hedging transaction may default on its obligation to pay.

In addition, we may fail to recalculate, readjust and execute hedges in an efficient manner.

Any hedging activity in which we engage may materially and adversely affect our results of operations and cash flows. Therefore, while we may enter into such transactions seeking 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 or liabilities being hedged may vary materially. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio positions or liabilities 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 therefore may involve risks and costs that could result in material losses.

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. 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 hedging transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international

 

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requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in its 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 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 significant losses.

If we fail to qualify for hedge accounting treatment, our operating results may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction.

We intend to record derivative and hedging transactions in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” or SFAS No. 133. Under these standards, we may fail to qualify for hedge accounting treatment for a number of reasons, including if we use instruments that do not meet the SFAS No. 133 definition of a derivative (such as short sales), we fail to satisfy SFAS No. 133 hedge documentation and hedge effectiveness assessment requirements or our instruments are not highly effective. If we fail to qualify for hedge accounting treatment, our operating results may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction or item.

We may enter into derivative contracts that could expose us to contingent liabilities in the future.

Subject to maintaining our qualification as a REIT, we may enter 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 may materially and adversely affect our results of operations and cash flows.

Increased regulatory oversight of derivatives could adversely affect our hedging activities.

The Obama administration recently proposed a significant restructuring of the U.S. financial regulatory system. Among other things, the proposed reforms would increase regulatory oversight of financial derivatives. We expect to use derivative arrangements to hedge against changes in interest rates and, subject to our intention to continue to qualify as a REIT, to manage credit risk. Increased regulation of financial derivatives may make our hedging strategy more expensive to execute and reduce its effectiveness.

Accounting rules for certain of our transactions are highly complex and involve significant judgment and assumptions. Changes in accounting interpretations or assumptions could impact our consolidated financial statements.

Accounting rules for transfers of financial assets, securitization transactions, consolidation of variable interest entities, or VIEs, and other aspects of our anticipated operations are highly complex and involve significant judgment and assumptions. These complexities could lead to a delay in preparation of financial information and the delivery of this information to our stockholders. Changes in accounting interpretations or assumptions could impact our consolidated financial statements, result in a need to restate our financial results and affect our ability to timely prepare our consolidated financial statements. Our inability to timely prepare our consolidated financial statements in the future would likely adversely affect our stock price significantly.

 

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Risks related to our common stock

Investing in our common stock may involve a high degree of risk.

The assets we purchase in accordance with our investment objectives may result in a high amount of risk when compared to alternative investment options and volatility or loss of principal. Our assets may be highly speculative and aggressive, and therefore an investment in our common stock may not be suitable for someone with lower risk tolerance.

There is no public market for our common stock and a market may never develop, which could cause our common stock to trade at a discount and make it difficult for holders of our common stock to sell their shares.

Our shares of common stock are newly-issued securities for which there is no established trading market. We intend to apply to have our common stock listed on the NYSE under the trading symbol “LCG.” However, there can be no assurance that an active trading market for our common stock will develop, or if one develops, be maintained. Accordingly, no assurance can be given as to the ability of our stockholders to sell their common stock or the price that our stockholders may obtain for their common stock.

Even if an active trading market develops, the market price of our common stock may be highly volatile and could be subject to wide fluctuations after this offering and may fall below the offering price. Some of the factors that could negatively affect the market price of our common stock include:

 

 

our actual or projected operating results, financial condition, cash flows and liquidity, or changes in business strategy or prospects;

 

 

actual or perceived conflicts of interest with our Manager or the Ladder Capital Group and individuals, including our executive officers;

 

 

equity issuances by us, or share resales by our stockholders, or the perception that such issuances or resales may occur;

 

 

actual or anticipated accounting problems;

 

 

changes in our earnings estimates or publication of research reports about us or the real estate industry;

 

 

changes in market valuations of similar companies;

 

 

adverse market reaction to any increased indebtedness we incur in the future;

 

 

additions to or departures of our Manager’s or the Ladder Capital Group’s key personnel;

 

 

speculation in the press or investment community;

 

 

our failure to meet, or the lowering of, our earnings’ estimates or those of any securities analysts;

 

 

increases in market interest rates, which may lead investors to demand a higher distribution yield for our common stock, if we have begun to make distributions to our stockholders, and would result in increased interest expenses on our debt;

 

 

changes in the credit markets;

 

 

failure to maintain our REIT qualification or exemption from the 1940 Act;

 

 

actions by our stockholders;

 

 

price and volume fluctuations in the stock market generally; and

 

 

general market and economic conditions, including the current state of the credit and capital markets.

 

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Market factors unrelated to our performance could also negatively impact the market price of our common stock. One of the factors that investors may consider in deciding whether to buy or sell our common stock is our distribution rate as a percentage of our stock price relative to market interest rates. If market interest rates increase, prospective investors may demand a higher distribution rate or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and conditions in the capital markets can affect the market value of our common stock. For instance, if interest rates rise, it is likely that the market price of our common stock will decrease as market rates on interest-bearing securities increase.

Common stock eligible for future sale may have adverse effects on our share price.

We cannot predict the effect, if any, of future sales of our common stock, or the availability of shares for future sales, on the market price of our common stock. The market price of our common stock may decline significantly when the restrictions on resale (or lock up agreements) by certain of our stockholders lapse, particularly in relation to securities purchased in the concurrent private placement. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock.

After the completion of this offering and the concurrent private placement, we may issue additional restricted common stock and other equity based awards under our 2009 equity incentive plan. We may also issue from time to time additional shares of common stock and securities convertible into, or exchangeable or exercisable for, common stock in subsequent public offerings or private placements to acquire new assets or for other purposes. We are not required to offer any such shares or securities to existing stockholders on a preemptive basis. Therefore, it may not be possible for existing stockholders to participate in such future share or security issuances, which may dilute the existing stockholders’ interests in us.

We have not established a minimum distribution payment level and we may be unable to generate sufficient cash flows from our operations to make distributions to our stockholders at any time in the future.

We are generally required to distribute to our stockholders at least 90% of our taxable income each year for us to qualify as a REIT under the Internal Revenue Code, which requirement we currently intend to satisfy through quarterly distributions of all or substantially all of our REIT taxable income in such year, subject to certain adjustments. We have not established a minimum distribution payment level and our ability to pay distributions may be adversely affected by a number of factors, including the risk factors described in this prospectus. If we make distributions from uninvested offering proceeds, which would generally be considered to be a return of capital for tax purposes, our future earnings and cash available for distribution may be reduced from what they otherwise would have been. All distributions will be made at the discretion of our board of directors and will depend on various factors, including our earnings, our financial condition, our liquidity, our debt and preferred stock covenants, maintenance of our REIT qualification, applicable provisions of the Maryland General Corporation Law, or MGCL, and other factors as our board of directors may deem relevant from time to time. We believe that a change in any one of the following factors could adversely affect our results of operations and impair our ability to pay distributions to our stockholders:

 

 

the profitability of how we deploy the net proceeds of this offering and the concurrent private placement;

 

 

our ability to make profitable investments;

 

 

margin calls or other expenses that reduce our cash flow;

 

 

defaults in our asset portfolio or decreases in the value of our portfolio; and

 

 

the fact that anticipated operating expense levels may not prove accurate, as actual results may vary from estimates.

 

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A change in any of these factors could affect our ability to make distributions. As a result, no assurance can be given that we will be able to make distributions to our stockholders at any time in the future or that the level of any distributions we do make to our stockholders will achieve a market yield or increase or even be maintained over time, any of which could materially and adversely affect us.

In addition, distributions that we make to our stockholders will generally be taxable to our stockholders as ordinary income. However, a portion of our distributions may be designated by us as long-term capital gains to the extent that they are attributable to capital gain income recognized by us or may constitute a return of capital to the extent that they exceed our earnings and profits as determined for tax purposes. A return of capital is not taxable, but has the effect of reducing the basis of a stockholder’s investment in our shares of common stock.

Future offerings of debt or equity securities, which would rank senior to our common stock, may adversely affect the market price of our common stock.

If we decide to issue debt or equity securities in the future, which would rank senior to our common stock, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. 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 and may result in dilution to owners of our common stock. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity 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 will bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.

Market interest rates may have an effect on the trading value of our shares.

One of the factors that investors may consider in deciding whether to buy or sell our shares is our distribution rate as a percentage of our share price relative to market interest rates. If market interest rates increase, prospective investors may demand a higher distribution rate or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and capital market conditions can affect the market value of our shares. For instance, if interest rates rise, it is likely that the market price of our shares will decrease as market rates on interest-bearing securities, such as bonds, increase.

Risks related to our organization and structure

Certain provisions of Maryland law could inhibit changes in control.

Certain provisions of the MGCL may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then-prevailing market price of our common stock. We are subject to the “business combination” provisions of the MGCL that, subject to limitations, prohibit certain business combinations (including a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our then outstanding voting capital stock or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting capital stock) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder. After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our board of directors and approved by the affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding shares of our voting capital stock; and (2) two-thirds of the votes entitled to be cast by holders of voting capital stock of the corporation other than shares held by the interested stockholder with

 

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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 our 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. These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our board of directors has by resolution exempted business combinations (1) between us and any other person, provided that such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person and (2) between us and the Ladder Capital Group).

The “control share” provisions of the MGCL provide that “control shares” of a Maryland corporation (defined as shares which, when aggregated with other shares controlled by the stockholder (except solely by virtue of a revocable proxy)), entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquirer of control shares, our officers and our personnel who are also our directors. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that this provision will not be amended or eliminated at any time in the future.

The “unsolicited takeover” provisions of the MGCL permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement takeover defenses, some of which (for example, a classified board) we do not yet have. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under the circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize a premium over the then current market price. Our charter contains a provision whereby we have elected to be subject to the provisions of Title 3, Subtitle 8 of the MGCL relating to the filling of vacancies on our board of directors. See “Certain provisions of the Maryland General Corporation Law and our charter and bylaws—Business combinations” and “—Control share acquisitions.”

Our authorized but unissued shares of common and preferred stock may prevent a change in our control.

Our charter authorizes us to issue additional authorized but unissued shares of common or preferred stock. In addition, our board of directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number of shares of stock of any class or series that we have authority to issue and classify or reclassify any unissued shares of common or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board of directors may establish a series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for our shares of common stock or otherwise be in the best interest of our stockholders.

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 present and former directors and officers to us and our stockholders for money damages to the maximum extent permitted under Maryland law. Under Maryland law, our present and former directors and officers will not have any liability to us and our stockholders for money damages other than liability resulting from:

 

 

actual receipt of an improper benefit or profit in money, property or services; or

 

 

active and deliberate dishonesty by the director or officer that was established by a final judgment as being material to the cause of action adjudicated.

 

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Our charter authorizes us to indemnify our 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 and 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 pay or reimburse the defense costs incurred by our present and former directors and officers without requiring a preliminary determination of their ultimate entitlement to indemnification.

Our charter contains provisions that make removal of our directors difficult, which could make it difficult for our stockholders to effect changes to our management.

Our charter provides that, subject to the rights of any series of preferred stock, a director may be removed only for cause upon the affirmative vote of at least two-thirds of the votes entitled to be cast generally in the election of directors. Vacancies may be filled only by a majority of the remaining directors in office, even if less than a quorum. These requirements make it more difficult to change our management by removing and replacing directors and may prevent a change in control of our company that is in the best interests of our stockholders.

We are the sole general partner of our operating partnership and could become liable for the debts and other obligations of our operating partnership beyond the amount of our initial expenditure.

We are the sole general partner of our operating partnership, Ladder Capital Realty Finance LP, and upon the consummation of this offering and the concurrent private placement will own         % of the OP units in our operating partnership. As the sole general partner, we are liable for our operating partnership’s debts and other obligations. Therefore, if our operating partnership is unable to pay its debts and other obligations, we will be liable for such debts and other obligations beyond the amount of our expenditure for ownership interests in our operating partnership. These obligations could include unforeseen contingent liabilities and could materially and adversely affect our financial condition, liquidity, results of operations and business and our ability to make distributions to our stockholders.

Ownership limitations 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 2009, 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. 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 the outstanding shares of our capital stock or more than 9.8% in value or in number of shares, whichever is more restrictive, of the outstanding shares of our common 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. We expect our board of directors to waive this ownership limitation in order to allow Ladder Investor and its affiliates, including our Manager, to own up to             % by value or number of shares, whichever is more restrictive, of our outstanding shares of common or capital stock.

 

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Risks related to our taxation as a REIT and 1940 Act exemption

Our Manager is a newly-formed entity and has no experience managing a REIT and limited experience managing a portfolio of assets in the manner necessary to maintain our exemption under the 1940 Act, which may hinder its ability to achieve our business objectives or result in the loss of our qualification as a REIT.

The REIT rules and regulations under the Internal Revenue Code are highly technical and complex, and the failure to comply with these rules and regulations in a timely manner could prevent us from qualifying as a REIT or could force us to pay unexpected taxes and penalties. Our Manager is a newly-formed entity with no experience managing a portfolio of assets under these complex rules and regulations. Our Manager’s officers and employees have limited experience operating a REIT and operating a business in compliance with the numerous technical restrictions and limitations set forth in the Internal Revenue Code applicable to REITs. In addition, our Manager will be required to develop and implement substantial control systems and procedures in order for us to qualify and maintain our qualification as a public REIT. As a result, we cannot assure you that we will be able to successfully operate as a REIT or comply with rules and regulations applicable to REITs, which would substantially reduce our earnings and may reduce the market value of our common stock.

In addition, in order to maintain our exemption from registration under the 1940 Act, the assets in our portfolio will be subject to certain restrictions, which will limit our operations meaningfully. Our Manager and its affiliates, including the Ladder Capital Group, have limited experience managing a portfolio in the manner necessary to maintain our exemption from registration under the 1940 Act, and no experience managing a public company under the constraints imposed by the 1940 Act. Furthermore, as a public company we will be subject to periodic and current reporting requirements under applicable regulations of the SEC. Failure to comply properly with SEC regulations and requirements could hinder our ability to operate as a public company.

Maintenance of our exemption from registration under the 1940 Act imposes significant limits on our operations.

We intend to conduct our operations so as not to become regulated as an investment company under the 1940 Act. Because we are a holding company that will conduct its businesses primarily through our operating partnership and its wholly-owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis, which we refer to as the 40% test. This requirement limits the types of businesses in which we may engage through our subsidiaries.

The determination of whether an entity is a majority-owned subsidiary of our company is made by us. The 1940 Act defines a majority-owned subsidiary of a person as a company 50% or more of the outstanding voting securities of which are owned by such person, or by another company which is a majority-owned subsidiary of such person. The 1940 Act further defines voting securities as any security presently entitling the owner or holder thereof to vote for the election of directors of a company. We treat companies in which we own at least a majority of the outstanding voting securities as majority-owned subsidiaries for purposes of the 40% test. We have not requested the Securities and Exchange Commission, or the SEC, to approve our treatment of any company as a majority-owned subsidiary and the SEC has not done so. If the SEC were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.

We expect Ladder Realty I LLC and certain other subsidiaries that we may form in the future to rely upon the exemption from registration as an investment company under the 1940 Act pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities “primarily engaged in the business of

 

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purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exemption generally requires that at least 55% of these subsidiaries’ assets must be comprised of qualifying assets and at least 80% of each of their portfolios must be comprised of qualifying assets and real estate-related assets under the 1940 Act. Qualifying assets for this purpose include commercial mortgage loans (including interim loans) and certain B-Notes and mezzanine loans that satisfy the conditions set forth in recent SEC staff no-action letters, or the Relevant No-Action Letter Conditions. We intend to treat as real estate-related assets A-Notes, CMBS, B-Notes and mezzanine loans that do not satisfy the Relevant No-Action Letter Conditions, debt and equity securities of companies primarily engaged in real estate businesses and securities issued by pass-through entities of which substantially all of the assets consist of qualifying assets and/or real estate-related assets.

We will organize a special purpose subsidiary for the purpose of borrowing under the TALF and we may in the future organize additional special purpose subsidiaries that would borrow under the TALF. We expect that these TALF subsidiaries will rely on Section 3(c)(7) for their 1940 Act exemption and, therefore, our operating partnership’s interest in each of these TALF subsidiaries would constitute an “investment security” for purposes of determining whether our operating partnership passes the 40% test. We may in the future organize one or more TALF subsidiaries that seek to rely on the 1940 Act exemption provided to certain structured financing vehicles by Rule 3a-7. Any such TALF subsidiary would need to be structured to comply with any guidance that may be issued by the Division of Investment Management of the SEC on the restrictions contained in Rule 3a-7. In certain circumstances, compliance with Rule 3a-7 may require, among other things, that the indenture governing the TALF subsidiary include limitations on the types of assets the subsidiary may sell or acquire out of the proceeds of assets that mature, are refinanced or otherwise sold, on the period of time during which such transactions may occur, and on the level of transactions that may occur. We expect that the aggregate value of our operating partnership’s interests in TALF subsidiaries that seek to rely on Rule 3a-7 will comprise less than 20% of our operating partnership’s (and, therefore, our company’s) total assets on an unconsolidated basis.

In light of the requirements of Rule 3a-7, our ability to manage assets held in a special purpose subsidiary that complies with Rule 3a-7 will be limited and we may not be able to purchase or sell assets owned by that subsidiary when we would otherwise desire to do so, which could lead to losses.

Qualification for exemption from registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of our subsidiaries to invest directly in mortgage-backed securities that represent less than the entire ownership in a pool of mortgage loans, debt and equity tranches of securitizations and certain asset-backed securities, or ABS, and real estate companies or in assets not related to real estate.

There can be no assurance that the laws and regulations governing the 1940 Act status of REITs, including the Division of Investment Management of the SEC providing more specific or different guidance regarding these exemptions, will not change in a manner that adversely affects our operations. To the extent that the SEC staff provides more specific guidance regarding any of the matters bearing upon such exclusions, we may be required to adjust our strategy accordingly. Any additional guidance from the SEC staff could provide additional flexibility to us, or it could further inhibit our ability to pursue the strategies we have chosen. If we or our subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either to (a) change the manner in which we conduct our operations to avoid being required to register as an investment company, (b) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (c) register as an investment company, any of which could negatively affect the value of our common stock, the sustainability of our business model, and our ability to make distributions which could have an adverse effect on our business and the market price for our shares of common stock.

 

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Our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available for distribution to our stockholders.

We have been organized and we intend to operate in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ending December 31, 2009. We have not requested and do not intend to request a ruling from the Internal Revenue Service, or the IRS, that we qualify as a REIT. The U.S. federal income tax laws governing REITs are complex. The complexity of these provisions and of the applicable U.S. Treasury Department regulations that have been promulgated under the Internal Revenue Code, or Treasury Regulations, is greater in the case of a REIT that, like us, holds its assets through a partnership, and judicial and administrative interpretations of the U.S. federal income tax laws governing REIT qualification are limited. To qualify as a REIT, we must meet, on an ongoing basis, various tests regarding the nature of our assets and our income, the ownership of our outstanding shares, and the amount of our distributions. Our ability to satisfy the asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Moreover, new legislation, court decisions or administrative guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. Thus, while we intend to operate so that we will 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. These considerations also might restrict the types of assets that we can acquire in the future.

If we fail to qualify as a REIT in any taxable year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income, and distributions to our stockholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money or sell assets in order to pay our taxes. 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, we no longer would be required to distribute substantially all of our net taxable income to our stockholders. In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT until the fifth calendar year following the year in which we failed to qualify.

Complying with REIT requirements may cause us to forgo otherwise attractive investment opportunities.

To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts that we distribute to our stockholders and the ownership of our stock. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make or cause us to liquidate certain attractive investments and otherwise limit our ability to engage in certain hedging strategies.

Complying with REIT requirements may cause us to forego hedging strategies and/or liquidate otherwise attractive investments.

To qualify as a REIT, we must ensure that at the end of each calendar quarter, at least 75% of the value of our total assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and certain kinds of mortgage-backed securities. The remainder of our investment in securities (other than government securities and qualified REIT real estate assets) generally

 

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cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total securities can be represented by securities of one or more TRSs, such as Ladder Realty (TRS) Inc. See “U.S. federal income tax considerations—Asset tests” If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences.

REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt or sell assets to make such distributions.

In order to qualify as a REIT, we must distribute to our stockholders, each calendar year, at least 90% of our REIT taxable income (including certain items of non-cash 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 are subject to U.S. 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 a minimum amount specified under U.S. federal income tax laws. We intend to distribute our net income to our stockholders in a manner that will satisfy the REIT 90% distribution requirement and to avoid the 4% nondeductible excise tax.

Our taxable income may substantially exceed our net income as determined by GAAP or differences in timing between the recognition of taxable income and the actual receipt of cash may occur. For example, we may be required to accrue interest and discount income on mortgage loans, CMBS, and other types of debt securities or interests in debt securities before we receive any payments of interest or principal on such assets. We may also acquire distressed debt instruments that are subsequently modified by agreement with the borrower either directly or pursuant to our involvement in the Legacy Loans Program or other similar programs recently announced by the federal government. If the amendments to the outstanding debt are “significant modifications” under the applicable Treasury Regulations, the modified debt may be considered to have been reissued to us at a gain in a debt-for-debt exchange with the borrower, with gain recognized by us to the extent that the principal amount of the modified debt exceeds our cost of purchasing it prior to modification. We may be required under the terms of the indebtedness that we incur, whether to private lenders or pursuant to government programs, to use cash received from interest payments to make principal payment on that indebtedness, with the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our stockholders.

As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, (iv) make a taxable distribution of our shares as part of a distribution in which stockholders may elect to receive shares or (subject to a limit measured as a percentage of the total distribution) cash or (v) use cash reserves, in order to comply with the REIT distribution requirements and to avoid corporate income tax and the 4% nondeductible excise tax. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could adversely affect the value of our common stock.

Even if we qualify as a REIT, we may face tax liabilities that reduce our cash flow.

Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, franchise, property and transfer taxes,

 

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including mortgage recording taxes. See “U.S. federal income tax considerations—Taxation of REITs in general.” In addition, any TRSs we own, such as Ladder Realty (TRS) Inc., will be subject to U.S. federal, state and local corporate taxes. In order to meet the REIT qualification requirements, or to avoid the imposition of a 100% tax that applies to certain gains derived by a REIT from sales of inventory or property held primarily for sale to customers in the ordinary course of business, we may hold some of our assets through taxable subsidiary corporations, including TRSs. Any taxes paid by such subsidiary corporations would decrease the cash available for distribution to our stockholders.

Our qualification as a REIT and exemption from U.S. federal income tax with respect to certain assets may be dependent on the accuracy of legal opinions or advice rendered or given or statements by the issuers of assets that we acquire, and the inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax.

When purchasing securities, we may rely on opinions or advice of counsel for the issuer of such securities, or statements made in related offering documents, for purposes of determining whether such securities represent debt or equity securities for U.S. federal income tax purposes, and also to what extent those securities constitute REIT real estate assets for purposes of the REIT asset tests and produce income which qualifies under the 75% REIT gross income test. In addition, when purchasing the equity tranche of a securitization, we may rely on opinions or advice of counsel regarding the qualification of the securitization for exemption from U.S. corporate income tax and the qualification of interests in such securitization as debt for U.S. federal income tax purposes. The inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax.

Certain financing activities may subject us to U.S. federal income tax and increase the tax liability of our stockholders, and may limit the manner in which we effect securitizations.

We may enter into transactions that could result in us, our operating partnership or a portion of our assets being treated as a “taxable mortgage pool” for U.S. federal income tax purposes. Specifically, we may securitize mortgage loans or CMBS in which we may invest and such securitizations, to the extent structured as other than a real estate mortgage investment conduit, or REMIC, would likely result in us owning interests in a taxable mortgage pool. Rather than holding equity interests in such a taxable mortgage pool securitization through our operating partnership, we would likely enter into such transactions through a qualified REIT subsidiary of one or more subsidiary REITs formed by our operating partnership. In effect we will be precluded from selling to outside investors equity interests in such securitizations or from selling any debt securities issued in connection with such securitizations that might be considered equity for U.S. federal income tax purposes in order to ensure that such entity remains a qualified REIT subsidiary. We will be taxed at the highest U.S. federal corporate income tax rate on any “excess inclusion income” arising from a taxable mortgage pool that is allocable to the percentage of our shares held in record name by “disqualified organizations,” which are generally certain cooperatives, governmental entities and tax-exempt organizations that are exempt from tax on unrelated business taxable income. To the extent that common stock owned by “disqualified organizations” is held in record name by a broker/dealer or other nominee, the broker/dealer or other nominee would be liable for the U.S. federal corporate income tax on the portion of our excess inclusion income allocable to the common stock held by the broker/dealer or other nominee on behalf of the disqualified organizations. We expect that disqualified organizations will own our stock. Because this tax generally would be imposed on us, all of our investors, including investors that are not disqualified organizations, generally will bear a portion of the tax cost associated with the classification of us or a portion of our assets as a taxable mortgage pool. A regulated investment company, or RIC, or other pass-through entity owning our common stock in record name will be subject to tax at the highest U.S. federal corporate tax rate on any excess inclusion income allocated to their owners that are disqualified organizations.

In addition, if we realize excess inclusion income and allocate it to our stockholders, this income cannot be offset by net operating losses of our stockholders. If the stockholder is a tax-exempt entity and not a disqualified organization, then this income is fully taxable as unrelated business taxable income under

 

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Section 512 of the Internal Revenue Code. If the stockholder is a foreign person, excess inclusion income 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. If the stockholder is a REIT, a RIC, common trust fund or other pass-through entity, our allocable share of our excess inclusion income could be considered excess inclusion income of such entity. Accordingly, such investors should be aware that it is likely that a portion of our income may be considered excess inclusion income in the future. Finally, if a subsidiary REIT of our operating partnership through which we held taxable mortgage pool securitizations, were to fail to qualify as a REIT, our taxable mortgage pool securitizations will be treated as separate taxable corporations for U.S. federal income tax purposes that could not be included in any consolidated U.S. federal corporate income tax return and that could prevent us from meeting the REIT asset tests.

The failure of mortgage loans or CMBS subject to a repurchase agreement or a mezzanine loan to qualify as a real estate asset would adversely affect our ability to qualify as a REIT.

We intend to enter into repurchase agreements under which we will nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that we will be treated for U.S. federal income tax purposes as the owner of the assets that are the subject of repurchase agreements and that the repurchase agreements will be treated as secured lending transactions notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the assets during the term of the repurchase agreement, in which case we could fail to qualify as a REIT.

In addition, we may acquire mezzanine loans, which are loans secured by equity interests in a partnership or limited liability company that directly or indirectly owns real property. In Revenue Procedure 2003-65, the IRS provided a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in the Revenue Procedure, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests, and interest derived from the mezzanine loan will be treated as qualifying mortgage interest for purposes of the REIT 75% gross income test. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. We may acquire mezzanine loans that may not meet all of the requirements for reliance on this safe harbor. In the event we own a mezzanine loan that does not meet the safe harbor, the IRS could challenge such loan’s treatment as a real estate asset for purposes of the REIT asset and income tests, and if such a challenge were sustained, we could fail to qualify as a REIT.

We may choose to make distributions in our own stock, in which case you may be required to pay income taxes in excess of the cash dividends you receive.

We may distribute taxable dividends that are payable in cash and shares of our common stock at the election of each stockholder. Under IRS Revenue Procedure 2009-15, up to 90% of any such taxable dividend for 2009 could be payable in our stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current or accumulated earnings and profits for U.S. federal income tax purposes. As a result, U.S. stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. Accordingly, U.S. stockholders receiving a distribution of our shares may be required to sell shares received in such distribution or may be required to sell other stock or assets owned by them, at a time that may be disadvantageous, in order to satisfy any tax imposed on such distribution. If a U.S. stockholder sells the stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock, by withholding or disposing of part of the shares in such distribution and using the proceeds of such disposition to satisfy the withholding tax imposed. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, such sale may put downward pressure on the trading price of our common stock.

 

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Further, while Revenue Procedure 2009-15 applies only to taxable dividends payable by us in cash or stock in 2009, it is unclear whether and to what extent we will be able to pay taxable dividends in cash and stock in later years. Moreover, various tax aspects of such a taxable cash/stock dividend are uncertain and have not yet been addressed by the IRS. No assurance can be given that the IRS will not impose additional requirements in the future with respect to taxable cash/stock dividends, including on a retroactive basis, or assert that the requirements for such taxable cash/stock dividends have not been met.

We may be required to report taxable income for certain investments in excess of the economic income we ultimately realize from them.

We may acquire debt instruments in the secondary market for less than their face amount. The amount of such discount will generally be treated as “market discount” for U.S. federal income tax purposes. Accrued market discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made, unless we elect to include accrued market discount in income as it accrues. Principal payments on certain loans are made monthly, and consequently accrued market discount may have to be included in income each month as if the debt instrument were assured of ultimately being collected in full. If we collect less on the debt instrument than our purchase price plus the market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions.

Similarly, some of the CMBS that we acquire may have been issued with original issue discount. We will be required to report such original issue discount based on a constant yield method and will be taxed based on the assumption that all future projected payments due on such CMBS will be made. If such CMBS turns out not to be fully collectible, an offsetting loss deduction will become available only in the later year that uncollectability is provable.

Finally, in the event that any debt instruments or CMBS acquired by us are delinquent as to mandatory principal and interest payments, or in the event payments with respect to a particular debt instrument are not made when due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectability. Similarly, we may be required to accrue interest income with respect to subordinate mortgage-backed securities at its stated rate regardless of whether corresponding cash payments are received or are ultimately collectable. In each case, while we would in general ultimately have an offsetting loss deduction available to us when such interest was determined to be uncollectible, the utility of that deduction could depend on our having taxable income in that later year or thereafter.

Although our use of TRSs may be able to partially mitigate the impact of meeting the requirements necessary to maintain our qualification as a REIT, our ownership of and relationship with our TRSs is limited and a failure to comply with the limits would jeopardize our REIT qualification 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 hold assets and earn income that would not be qualifying assets or income if held or earned directly by a 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 25% of the value of a REIT’s assets may consist of securities of one or more TRSs. 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.

TRSs, such as Ladder Realty (TRS) Inc., that we form will pay U.S. federal, state and local income tax on their taxable income, and their after-tax net income will be available for distribution to us but is not required to be distributed to us, unless necessary to maintain our REIT qualification. While we will be monitoring the aggregate value of the securities of our TRSs and intend to conduct our affairs so that such securities will represent less than 25% of the value of our total assets, there can be no assurance that we will be able to comply with the TRS limitation in all market conditions.

 

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Dividends payable by REITs do not qualify for the reduced tax rates on dividend income from regular corporations, which could adversely affect the value of our shares.

The maximum U.S. federal income tax rate for certain qualified dividends payable to U.S. stockholders that are individuals, trusts and estates is 15% (through 2010). Dividends payable by REITs, however, are generally not eligible for the reduced rates and therefore may be subject to a 35% maximum U.S. federal income tax rate on ordinary income. Although the reduced U.S. federal income tax rate applicable to dividend income from regular corporate dividends 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 shares of REITs, including our shares.

Liquidation of our assets may jeopardize our REIT qualification.

To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our assets to repay obligations to our lenders, we may be unable to comply with these requirements, thereby jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as inventory or property held primarily for sale to customers in the ordinary course of business.

Complying with REIT requirements may limit our ability to hedge effectively.

The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generate from transactions intended to hedge our interest rate risk will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if the instrument hedges interest rate risk on liabilities used to carry or acquire real estate assets, and such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that do not meet these requirements will generally constitute nonqualifying income for purposes of both the REIT 75% and 95% gross income tests. See “U.S. federal income tax considerations—Gross income tests—Hedging transactions.” As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRS would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRS will generally not provide any tax benefit, except for being carried forward against future taxable income in the TRS.

The share ownership limits that apply to REITs, as prescribed by the Internal Revenue Code and by our charter, may inhibit market activity in shares of our common stock and restrict our business combination opportunities.

In order for us to qualify as a REIT for each taxable year after 2009, not more than 50% in value of our outstanding shares of stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year, and at least 100 persons must beneficially own our stock during at least 335 days of a taxable year of 12 months, or during a proportionate portion of a shorter taxable year. To help insure that we meet the tests, our charter restricts the acquisition and ownership of shares of our stock. Our charter, with certain exceptions, authorizes our board of directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person may own more than 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of common stock, or 9.8% by value or number of shares, whichever is more restrictive, of our outstanding capital stock. Our board of directors may grant such an exemption to such limitations in its sole discretion, subject to such conditions, representations and undertakings as it may determine. These ownership limits could delay or prevent a transaction or a change in control of our company that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.

 

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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 U.S. 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 as inventory or primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell or securitize loans in a manner that was treated as a sale of the loans as inventory for U.S. federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans, other than through a TRS, and we may be required to limit the structures we use for our securitization transactions, even though such sales or structures might otherwise be beneficial for us.

We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of shares of our common stock.

At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be changed, possibly with retroactive effect. We cannot predict if or when any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective or whether 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, U.S. federal income tax law, regulation or administrative interpretation.

Your investment has various tax risks.

Although the provisions of the Internal Revenue Code generally relevant to an investment in shares of our common stock are described in “U.S. federal income tax considerations,” we urge you to consult your tax advisor concerning the effects of U.S. federal, state, local and foreign tax laws to you with regard to an investment in shares of our common stock.

Rapid changes in the values of our other real estate-related investments may make it more difficult for us to maintain our qualification as a REIT or exemption from the 1940 Act.

If the market value or income potential of 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 exemption from the 1940 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 by the illiquid nature of any non-qualifying assets that we may own. We may have to make investment decisions that we otherwise would not make absent the REIT and 1940 Act considerations.

 

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Forward-looking statements

We make forward-looking statements in this prospectus that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “contemplate,” “aim,” “continue,” “intend,” “should,” “may,” “would,” “will” or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking:

 

 

changes in economic conditions generally, changes in our industry and changes in the commercial finance and the real estate markets specifically;

 

 

use of proceeds of this offering and the concurrent private placement;

 

 

our business and investment strategy;

 

 

our projected operating results;

 

 

actions and initiatives of the U.S. Government, including the establishment of the TALF and the PPIP, and changes to U.S. Government policies and execution and impact of these actions, initiatives and policies;

 

 

our ability to obtain and maintain financing arrangements, including securitizations;

 

 

financing and advance rates for our target assets;

 

 

our expected leverage;

 

 

our expected target assets and general volatility of the markets for our target assets;

 

 

interest rate mismatches between our target assets and our borrowings used to fund such investments;

 

 

changes in interest rates and the market value of our target assets;

 

 

changes in prepayment rates on our target assets;

 

 

effects of hedging instruments on our target assets;

 

 

rates of default or decreased recovery rates on our target assets;

 

 

the degree to which our hedging strategies may or may not protect us from interest rate volatility;

 

 

impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters;

 

 

our ability to maintain our qualification as a REIT for U.S. federal income tax purposes;

 

 

our ability to maintain our exemption from registration under the 1940 Act;

 

 

availability of investment opportunities in mortgage-related and real estate-related instruments and other securities;

 

 

availability of qualified personnel;

 

 

estimates relating to our ability to make distributions to our stockholders in the future;

 

 

the degree and nature of our competition;

 

 

our dependence on our Manager and inability to find a suitable replacement in a timely manner, or at all, if we or our Manager were to terminate the management agreement;

 

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changes in the relationships among, or the business or investment objectives and strategies of, and conflicts of interest among, our company, the Ladder Capital Group and/or our Manager;

 

 

market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy;

 

 

prepayments of the mortgage and other loans underlying our mortgage-backed or other asset backed securities; and

 

 

changes in governmental regulations, tax law and rates and similar matters.

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. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described in this prospectus under the headings “Prospectus summary,” “Risk factors,” “Management’s discussion and analysis of financial condition and results of operations” and “Business.” If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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Use of proceeds

We are offering              shares of our common stock at the anticipated public offering price of $             per share. We estimate that our net proceeds from the initial public offering of shares of our common stock will be approximately $             million, after deducting the underwriting discounts and commissions and the estimated offering and organizational expenses of approximately $             million (or, if the underwriters exercise their overallotment option in full, approximately $             million, after deducting the underwriting discounts and commissions and the estimated offering and organizational expenses of approximately $             million).

Concurrently with the completion of this offering, the Ladder Investor will acquire $             million of our common stock (             shares) and $             million of OP units (             OP units) in a private placement, at a price per share/unit equal to the initial public offering price, for an aggregate investment equal to 20% of the gross proceeds raised in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement. The shares of our common stock to be sold to the Ladder Investor in the private placement will be sold at the initial public offering price.

We intend to deploy the net proceeds of this offering and the concurrent private placement predominantly in our target assets.

For the first two to three quarters following the completion of this offering and the concurrent private placement, we intend to deploy a significant portion of the net proceeds from these offerings (resulting in a greater percentage of our overall portfolio of target assets than we expect to have within approximately 12 months following the completion of this offering and the concurrent private placement) to acquire senior CMBS to opportunistically take advantage of the TALF. We expect the CMBS we acquire during this initial period to be the most senior priority by subordination with respect to vintages from 2008 and earlier and investment grade with respect to more recent vintages. We expect that over time most of our investment activity will take the form of first mortgage originations. Until other appropriate uses can be identified, our Manager may invest the proceeds of this and any future offerings in interest-bearing, short-term investments, including money market accounts and senior CMBS with short duration, that are consistent with our intention to qualify as a REIT.

 

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Distribution policy

We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ending December 31, 2009. U.S. 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 and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. 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 to pay cash dividends or we may make a portion of the required dividend in the form of a taxable stock dividend or dividend of debt securities. We will generally not be required to pay dividends with respect to activities conducted through any TRS. For more information, see “U.S. federal income tax considerations — Taxation of REITs in general.”

To satisfy the requirements to qualify as a REIT and generally not be subject to U.S. federal income and excise tax, we intend to make regular quarterly distributions of all or substantially all of our taxable income to holders of our common stock out of assets legally available therefor. The timing and amount of any dividends we pay to holders of our common stock , including our initial distribution, will be at the discretion of our board of directors and will depend upon various factors, including our actual and projected results of operations, financial condition, liquidity and business, our debt and preferred stock covenants, funding or margin requirements under securitizations, secured and unsecured borrowing agreements, maintenance of our REIT qualification, applicable provisions of the MGCL and such other factors as our board of directors deems relevant. Our results of operations, financial condition, cash flows and liquidity will, in turn, be affected by various factors, including the net interest and other income from our portfolio, our operating expenses and any other expenditures. Depending on market conditions and our results of operations, financial condition and liquidity, our board of directors may determine to pay a percentage of our dividends in shares of common stock in order to retain additional liquidity to further enhance our ability to take advantage of opportunities and protect against market uncertainties. For more information regarding risk factors that could materially adversely affect our results of operations, financial condition, cash flows, liquidity, business and prospects, see “Risk factors.”

We anticipate that our dividends generally will be taxable as ordinary income to our stockholders, although a portion of the dividends may be designated by us as qualified dividend income or capital gain or may constitute a return of capital or excess inclusion income. We will furnish annually to each of our stockholders a statement setting forth dividends paid during the preceding year and their characterization as ordinary income, return of capital, qualified dividend income or capital gain. For more information, see “U.S. federal income tax considerations—Taxation of taxable U.S. stockholders.”

 

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Capitalization

The following table sets forth:

(1) our actual capitalization at July 13, 2009; and

(2) our capitalization on an as adjusted basis to reflect the effect of (i) the sale of              shares of our common stock in this offering at the initial public offering price of $             per share after deducting underwriting discounts and commissions and estimated offering and organizational expenses payable by us and (ii) the concurrent private placement of              shares of our common stock to the Ladder Investor at a price per share/unit equal to the initial public offering price.

 

July 13, 2009      
(dollars in thousands)    Actual    As Adjusted(1)(2)
 

Equity

     

Stockholder’s equity:

     

Common stock, par value $0.01 per share; 1,000 shares authorized, and 1,000 shares issued and outstanding, actual and              shares authorized and              shares issued and outstanding, as adjusted(3)

   $     10    $                        

Preferred stock, par value $0.01 per share; no shares authorized and no shares issued and outstanding, actual and              shares authorized and no shares issued and outstanding, as adjusted

     

Additional paid-in-capital

   990   
    

Total stockholder’s equity

   $1,000    $                        
    

Noncontrolling interest in our operating partnership

     

Total equity

   $1,000    $                        
 

 

(1)   Assumes              shares of common stock will be sold in this offering,             shares of common stock and              OP units will be sold in the concurrent private placement at the initial public offering price for aggregate net proceeds of approximately $             million and              restricted shares of common stock will be issued to our Manager under our 2009 equity incentive plan upon completion of this offering and the concurrent private placement.

 

(2)   Does not include the underwriters’ overallotment option to purchase up to              additional shares of our common stock.

 

(3)   Does not include              shares of our common stock issuable upon an exchange of OP units to be outstanding upon completion of this offering and the concurrent private placement (excluding OP units held by us) and              shares of our common stock reserved for issuance under our 2009 equity incentive plan.

 

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Management’s discussion and analysis of financial

condition and results of operations

Overview

We are a newly organized commercial real estate finance corporation that has been formed to primarily originate, acquire and manage a diversified portfolio of commercial real estate first mortgage loans secured by income-producing properties. To a lesser extent, we expect to invest in senior CMBS and originate and acquire other commercial real estate-related debt instruments. We expect that over time most of our investment activity will take the form of first mortgage originations. However, we may initially allocate a significant portion of our net proceeds to senior CMBS designed to opportunistically take advantage of the TALF. We collectively refer to the assets that we intend to originate, acquire and manage as our target assets.

Our objective is to protect and preserve capital in a manner that provides for attractive risk-adjusted returns to our investors over the long term through dividends and capital appreciation. We intend to achieve this objective by selectively originating, acquiring and managing a diversified portfolio of our target assets designed to generate attractive risk-adjusted returns across a variety of market conditions and economic cycles. We believe that the current lack of liquidity in the commercial real estate, financial and credit markets presents significant opportunities for us to selectively originate high quality first mortgage loans to strong sponsors on attractive terms and that these conditions should persist for a number of years. We intend to build our business on a foundation of market knowledge combined with a disciplined credit and due diligence culture that is designed to protect and preserve capital. Our management team has implemented a similar business model to ours in the past. We believe that the flexibility of our investment strategy, combined with our expertise in our target assets and our long-term, primary focus on newly originated first mortgage loans, should enable us to achieve our objective.

We will be externally managed and advised by Ladder Capital Realty Finance Manager LLC, or our Manager, which is an affiliate and the indirect subsidiary of Holdings. Holdings is a specialty finance company that provides a comprehensive set of financing solutions to the commercial real estate industry. Holdings was formed by our senior management team in October 2008. Since its inception, our senior management team has been executing an investment strategy for Holdings substantially similar to ours and has been developing a pipeline of transactions that we expect to directly benefit from following the completion of this offering and the concurrent private placement.

We will commence operations upon completion of this offering and the concurrent private placement to the Ladder Investor. We are organized as a Maryland corporation and intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes, commencing with our taxable year ending December 31, 2009. We generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute all of our taxable income to stockholders and maintain our intended qualification as a REIT. We will conduct substantially all of our operations though our operating partnership, of which we are the sole general partner. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration under the 1940 Act.

Factors which may influence results of operations

We expect that the results of our operations will be affected by a number of factors and will primarily depend on, among other things, the ability of the borrowers of our capital to service their debt as it is due and payable, our ability to actively and effectively service any sub-performing and non-performing loans we may have from time to time in our portfolio, the level of our net interest income, the market value of our assets and the supply of, and demand for, commercial mortgage loans, commercial real estate debt, CMBS and other of our target assets which we may acquire. Our net interest income, which reflects the

 

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amortization of purchase premiums and the accretion of purchase discounts, varies primarily as a result of changes in market interest rates, prepayment rates and prepayment speeds, as measured by the Constant Prepayment Rate, or CPR, on our target assets and the ability of our borrowers to make scheduled interest payments. Interest rates and prepayment rates vary according to the type of investment, conditions in the financial markets, creditworthiness of our borrowers, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers whose mortgage loans are held directly by us or are included in our CMBS.

Market Conditions. Since March 2007, the market for commercial real estate whole loans and CMBS has been severely negatively impacted by the general deleveraging of the global economy and attendant economic recession. As a result of these conditions, several major financial institutions involved in the real estate debt markets have failed or been impaired, resulting in a significant contraction in available liquidity. We expect that pressure on financial institutions will continue to mount as delinquencies, loan loss reserves and charge-offs increase. Many financial institutions will need to sell assets and raise capital as they seek to improve their balance sheets and attain the approval of regulators. We expect that the number of failed institutions and troubled assets will eventually surpass levels seen in the early 1990s.

The confluence of these various forces has combined to force an industry-wide restructuring that is just beginning to emerge. We believe that one of the outcomes of this restructuring will be a reduced number of lenders healthy enough to underwrite new financing opportunities. Further, those healthy institutions will be operating under new capitalization standards which we expect will dramatically reduce the amount of leverage available to commercial real estate market participants. For example, we expect that financial institutions will need to significantly deleverage. We believe that the industry restructuring will result in fewer competitors with lower capital capacity.

This illiquidity has negatively affected both the terms and availability of financing for commercial real estate whole loans and CMBS. In general, different types of financing have been affected to varying degrees, with some sources generally being unavailable, and others being available but at a high cost and other more onerous provisions. As a result, we believe that the current economic downturn and corresponding credit crisis have produced an attractive environment to selectively originate real estate-related debt instruments with attractive risk-adjusted return profiles.

We believe that market conditions will cause us to adjust our investment and financing strategies over time as new opportunities emerge and risk profiles of our business change. Except as set forth above, we are not aware of any material trends or uncertainties, other than national economic conditions affecting mortgage loans, mortgage-backed securities and real estate, generally, that may reasonably be expected to have a material impact, favorable or unfavorable, on revenues or income from the acquisition of real estate-related assets, other than those referred to in this prospectus.

Credit Risk. One of our strategic focuses is acquiring assets which we believe to be of high credit quality. We believe this strategy will generally keep our credit losses and financing costs low. We expect to be subject to varying degrees of credit risk in connection with our target assets. Our Manager will seek to mitigate this risk by seeking to acquire high quality assets, with appropriate targeted returns given anticipated and unanticipated losses and by deploying a comprehensive review and asset selection process and by careful ongoing monitoring of acquired assets. Nevertheless, unanticipated credit losses could occur which could adversely impact our operating results.

Changes in Fair Value of Our Assets. It is our business strategy to hold our target assets as long-term investments. As such, we expect that our CMBS will be carried at their fair value, as available-for-sale securities in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt or Equity Securities,” or SFAS No. 115, with temporary changes in fair value recorded through accumulated other comprehensive income/(loss), a component of stockholders’ equity, rather than through earnings. As a result, we do not expect that temporary changes in the fair value of the assets will normally impact our operating results. However, at least on a quarterly basis, we will assess both our ability

 

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and intent to continue to hold such assets as long-term investments. As part of this process, we will monitor our target assets for OTTI. A change in our ability and/or intent to continue to hold any of our investment securities as well as a determination that impairment is more than temporary, could result in our recognizing an impairment charge or realizing losses upon the sale of such securities.

Changes in Market Interest Rates. With respect to our proposed business operations, increases in interest rates, in general, may over time cause:

 

  (i)   the interest expense associated with our borrowings to increase;

 

  (ii)   the value of our mortgage loans, CMBS and other securities and loans to decline;

 

  (iii)   coupons on our adjustable-rate mortgage loans, CMBS and other securities and loans to reset, although on a delayed basis, to higher interest rates;

 

  (iv)   to the extent applicable under the terms of our investments, prepayments on our mortgage loans, CMBS and other securities and loans to slow, thereby slowing the amortization of our purchase premiums and the accretion of our purchase discounts; and

 

  (v)   to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase if we are paying a fixed rate of interest (otherwise the value will decrease).

Conversely, decreases in interest rates, in general, may over time cause:

 

  (i)   to the extent applicable under the terms of our investments, prepayments on our mortgage loans, CMBS and other securities and loans to increase, thereby accelerating the amortization of our purchase premiums and the accretion of our purchase discounts;

 

  (ii)   the interest expense associated with our borrowings to decrease;

 

  (iii)   the value of our mortgage loan, CMBS and other securities and loans to increase;

 

  (iv)   to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease if we are paying a fixed rate of interest (otherwise the value will increase); and

 

  (v)   coupons on our adjustable-rate mortgage loans, CMBS and other securities and loans to reset, although on a delayed basis, to lower interest rates.

Size of Portfolio. The size of our portfolio is, as measured by the aggregate principal balance of our commercial mortgage loans, other commercial real estate-related debt instruments and other assets we own, also a key revenue driver. Generally, as the size of our portfolio grows, the amount of interest income we receive increases. A larger portfolio, however, may result in increased expenses as we may incur additional interest expense to finance the origination or purchase of our assets.

Recent regulatory developments

To combat the trends discussed above under “—Factors which may influence results of operations—Market conditions” and to protect the financial system and the broader economy from further erosion, the U.S. Government has enacted several policies designed to enhance liquidity in the financial system. Set forth below is a summary of U.S. Government programs that may have an impact on our business and our assessment of their anticipated impact.

Housing and Economic Recovery Act of 2008

In response to general market instability and, more specifically, the financial conditions of Fannie Mae and Freddie Mac, on July 30, 2008, the Housing and Economic Recovery Act of 2008, or the HERA, established a

 

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new regulator for Fannie Mae and Freddie Mac, the U.S. Federal Housing Finance Agency, or the FHFA. On September 7, 2008, the U.S. Treasury, the FHFA, and the U.S. Federal Reserve announced a comprehensive action plan to help stabilize the financial markets, support the availability of mortgage finance and protect taxpayers. Under the HERA, among other things, the FHFA has been appointed as conservator of both Fannie Mae and Freddie Mac, allowing the FHFA to control the actions of the two government sponsored enterprises, or GSEs, without forcing them to liquidate, which would be the case under receivership. Beginning in 2010, the GSEs will gradually start to reduce their portfolios. In addition, in an effort to further stabilize the U.S. mortgage market, the U.S. Treasury took three additional actions. First, it entered into a preferred stock purchase agreement with each of the GSEs, pursuant to which $100 billion (subsequently increased to $200 billion) will be available to each GSE. Second, it established a new secured credit facility, the GSECF, available to each of Fannie Mae and Freddie Mac (as well as Federal Home Loan Banks) through December 31, 2009, when other funding sources are unavailable. Third, it established a purchase program for agency-backed residential mortgage-backed securities, or Agency RMBS, under which the U.S. Treasury may purchase Agency RMBS in the open market; this program will also expire on December 31, 2009. Although the U.S. Government has committed capital to Fannie Mae and Freddie Mac, there can be no assurance that these actions will be adequate for their needs. These uncertainties lead to questions about the future of the GSEs in their current form, or at all.

Temporary Guarantee Program for Money Market Fund

In an effort to stabilize the money market fund industry, the U.S. Treasury on September 19, 2008 announced the establishment of the $50 billion Temporary Guarantee Program for Money Market Funds, or the Temporary Guarantee Program, through which U.S. Treasury guarantees the share price of any publicly offered eligible money market mutual fund—both retail and institutional—that applies for and pays a fee to participate in the program. The temporary measure will enable the Exchange Stabilization Fund, established in 1934 as part of the Gold Reserve Act, to insure the holdings of any publicly offered money market mutual fund for both retail and institutional clients. The current termination date for the Temporary Guarantee Program is September 18, 2009.

At the same time that the Temporary Guarantee Program was introduced, the Federal Reserve created the Money Market Investor Funding Facility to help increase liquidity for certain money market instruments held by money market funds by providing up to $600 billion for their purchase. This facility is set to expire on October 30, 2009, but may be extended. In addition, the Federal Reserve established the Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, which makes non-recourse advances to eligible borrowers to finance the purchase of eligible asset backed commercial paper from eligible money market funds. This program is set to expire on February 1, 2010, but may be extended.

Money market funds are a vital source of short-term liquidity in the financial markets. Money market funds provide for repurchase agreement financing by lending cash versus collateral, such as debt issued by the U.S. Treasury and Agency RMBS, for short periods of time. Pressure on asset prices in the credit markets has recently caused several money market funds to come under pressure from a pricing and redemption standpoint. We believe this insurance program has helped ease this pressure over time and has allowed lending capacity offered by money market funds to return to more normal levels. As we expect to rely on short-term borrowing in the form of repurchase agreements as a source to fund the purchase of some of our target assets, we believe that this action should positively impact us by stabilizing a significant source of our anticipated borrowings.

The end results of these initiatives cannot be determined at this time due to the relative uncertainty surrounding the plans. However, it is not unreasonable to assume that the guaranty program for money market funds referred to above, as well as the other initiatives described above, could increase the availability of lending in the credit markets.

 

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Capital Assistance Program and bank stress tests

On February 25, 2009, the U.S. Treasury and federal banking agencies released details regarding the Capital Assistance Program, or the CAP. The CAP has two elements: (1) a forward looking stress test to determine if any major bank requires an additional capital buffer, and (2) access to preferred shares convertible into common equity from the government as a bridge to private capital in the future. Nineteen banks with risk weighted assets exceeding $100 billion have been stress tested under various economic assumptions relating to further contractions in the U.S. economy and further declines in housing prices and increases in unemployment. The most recent stress tests were completed on April 24, 2009 and shared confidentially with the institutions subject to the test. The results were made public on May 7, 2009.

The Term Asset Backed Securities Loan Facility

In response to the severe dislocation in the credit markets, the U.S. Treasury and the Federal Reserve jointly announced the establishment of the TALF on November 25, 2008. The TALF is designed to increase credit availability and support economic activity by facilitating renewed securitization activities. Under the initial version of the TALF the FRBNY makes non-recourse loans to borrowers to fund their purchase of ABS collateralized by certain assets such as student loans, auto loans and leases, floor plan loans, credit card receivables, receivables related to residential mortgage services advances, equipment loans and leases and loans guaranteed by the Small Business Administration, or the SBA. Under the TALF, the FRBNY announced its intention to lend up to $200 billion to certain holders of TALF-eligible ABS. Any U.S. company that owns TALF eligible ABS may borrow from the FRBNY under the TALF, provided that the company maintains an account relationship with a primary dealer and enters into a TALF-specific customer agreement with such primary dealer. The TALF is scheduled to expire on December 31, 2009, but may be extended.

On March 23, 2009, the U.S. Treasury announced preliminary plans to expand the TALF to include, among other securities, CMBS that are rated AAA. On May 1, 2009, the Federal Reserve published the terms for the expansion of TALF to new issue CMBS and announced that, beginning on June 16, 2009, up to $100 billion of TALF loans will be available to finance purchases of eligible CMBS. The Federal Reserve stated that, to be eligible for TALF funding, the following conditions must be satisfied with respect to the new issue CMBS:

 

 

The CMBS must be collateralized by first-priority mortgage loans or participations therein that are current in payment at the time of securitization;

 

 

The underlying mortgage loans must be fixed rate loans that do not provide for interest-only payments during any part of their term;

 

 

The underlying mortgage loans must be secured by one or more income-generating commercial properties located in the United States or one of its territories;

 

 

95% or more of the dollar amount of the credit exposures underlying the CMBS must be exposures that are originated by U.S.-organized entities or institutions or U.S. branches or agencies of foreign banks;

 

 

As of the TALF loan subscription date, at least 95% of the properties, by related loan principal balance, must be located in the United States or one of its territories;

 

 

The CMBS must be issued on or after January 1, 2009 and the underlying mortgage loans must have been originated on or after July 1, 2008;

 

 

The underwriting must be prepared generally on the basis of then-current in-place, stabilized and recurring net operating income and then-current property appraisals;

 

 

The CMBS collateralizing the TALF borrowing must have a credit rating in the highest long-term investment-grade rating category, without the benefit of third party credit support, from at least two CMBS eligible national rating agencies and must not have a credit rating below the highest investment

 

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grade rating category from any CMBS eligible national rating agency or have been placed on review or watch for downgrade by any CMBS eligible national rating agency; and

 

 

The CMBS must entitle its holders to payments of principal and interest (that is, must not be an interest-only or principal-only security);

 

 

The CMBS must bear interest at a pass-through rate that is fixed or based on the weighted average of the underlying fixed mortgage rates;

 

 

The CMBS collateralizing the TALF borrowing must not be junior to other securities with claims on the same pool of loans; and

 

 

Control over the servicing of the underlying mortgage loans must not be held by investors in a subordinate class of the CMBS once the principal balance of that class is reduced to less than 25% of its initial principal balance as a result of both actual realized losses and “appraisal reduction amounts.”

On May 19, 2009, the Federal Reserve announced that certain high quality legacy CMBS, including CMBS issued before January 1, 2009, would become eligible collateral under the TALF starting on July 16, 2009. The Federal Reserve stated that, to be eligible for TALF funding, the following conditions must be satisfied with respect to legacy CMBS:

 

 

The CMBS must be senior in payment priority to all other interests in the underlying pool of commercial mortgages;

 

 

The security for each mortgage loan must include a mortgage or similar instrument on a fee or leasehold interest in one or more income-generating commercial properties;

 

 

The CMBS must entitle its holders to payments of principal and interest (that is, must not be an interest-only or principal-only security);

 

 

As of the TALF loan subscription date, at least 95% of the properties securing the underlying mortgage loans, by related loan principal balance, must be located in the United States or one of its territories;

 

 

The CMBS collateralizing the TALF borrowing must have a credit rating in the highest long-term investment-grade rating category, without the benefit of third party credit support, from at least two CMBS eligible national rating agencies and must not have a credit rating below the highest investment grade rating category from any CMBS eligible national rating agency or have been placed on review or watch for downgrade by any CMBS eligible national rating agency;

 

 

The CMBS must bear interest at a pass-through rate that is fixed or based on the weighted average of the underlying fixed mortgage rates;

 

 

The CMBS must not be issued by an agency or instrumentality of the United States or a government-sponsored enterprise (as discussed further below); and

 

 

Each CMBS must evidence an interest in a trust fund consisting of fully-funded mortgage loans and not other CMBS, other securities or interest rate swap or cap instruments or other hedging instruments. A participation or other ownership interest in such a loan will be considered a mortgage loan and not a CMBS or other security if, following a loan default, the ownership interest is senior to or pari passu with all other interests in the same loan in right of payment of principal and interest.

The initial subscription date was June 16, 2009 for newly issued CMBS and July 16, 2009 for legacy CMBS. The subscription and settlement cycle for newly issued and legacy CMBS will occur in the latter part of each month. However, on June 4, 2009, the Federal Reserve announced that it may not start lending against residential mortgage-back securities, or RMBS, under the TALF. The Federal Reserve stated that it was still in the process of assessing the feasibility and potential impact of such a program for legacy RMBS, which would pose a significant administrative burden.

 

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The Federal Reserve also described the following terms for new issue and legacy CMBS collateralized TALF loans:

 

 

Each TALF loan secured by CMBS will have a three-year maturity or five-year maturity, at the election of the borrower;

 

 

A three-year TALF loan will bear interest at a fixed rate per annum equal to 100 basis points over the three-year LIBOR swap rate. A five-year TALF loan is expected to bear interest at a fixed rate per annum equal to 100 basis points over the five-year LIBOR swap rate;

 

 

The amount of the TALF loan for each legacy CMBS will be the lesser of the dollar purchase price on the trade date or the market prices as of the loan subscription date less, in either case, the base dollar haircut (from par). The market price of any legacy CMBS must not exceed 100%;

 

 

The base dollar for each CMBS with an average life of five years or less will be 15%. For CMBS with average lives beyond five years, base dollar will increase by one percentage point for each additional year of average life beyond five years. No newly issued CMBS may have an average life beyond ten years;

 

 

Any remittance of principal on the CMBS must be used immediately to reduce the principal amount of the TALF loan in proportion to the TALF advance rate. In addition, for five-year TALF loans, the excess of CMBS interest distributions over the TALF loan interest payable will be remitted to the borrower only until such excess equals 25% per annum of the haircut amount in the first three loan years, 10% in the fourth loan year, and 5% in the fifth loan year, and the remainder of such excess will be applied to TALF loan principal. For a three-year TALF loan relating to Legacy CMBS, such excess will be remitted to the borrower in each loan year until it equals 30% per annum of the haircut amount, with the remainder applied to loan principal;

 

 

The loans will be non-recourse to the borrower, unless the borrower breaches its representations, warranties or covenants;

 

 

The loans will be exempt from margin calls related to a decrease in the underlying collateral value;

 

 

The loans are pre-payable in whole or in part at the option of the borrower, and generally prohibit collateral substitutions;

 

 

A TALF borrower must agree not to exercise or refrain from exercising any voting, consent or waiver rights under a CMBS without the consent of the FRBNY;

 

 

The FRBNY will retain the right to reject any CMBS as TALF loan collateral based on its risk assessment, and will pay particular attention to CMBS mortgage pools with large historical losses, concentrations of loans that are delinquent, in special servicing or on servicer watch lists or concentrations of subordinated-priority mortgage loans, and CMBS mortgage pools that are not diversified with respect to loan size, geography, property type, borrower sponsorship and other characteristics; and

 

 

The FRBNY may limit the volume of TALF loans secured by legacy CMBS, and is considering whether to allocate such volume via an auction or other procedure.

Any U.S. company is eligible to borrow under the TALF, provided that it maintains an account relationship with a primary dealer. A U.S. company, as defined for the purposes of the TALF, excludes certain entities that are controlled by a non-U.S. government or are managed by an investment manager controlled by a non-U.S. government. For these purposes, a non-U.S. government controls a company if, among other things, such non-U.S. government owns, controls, or holds with power to vote 25% or more of a class of voting securities or total equity of, the company.

We are currently evaluating the TALF to determine whether and how it would be most appropriate and beneficial to us and our stockholders. The application of the eligibility rules under the TALF is not yet clear and, as a result, the degree to which we may participate in the program is unclear.

 

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We believe that the expansion of the TALF to include highly rated new issuance CMBS may provide us with attractively priced non-recourse term borrowings that we could use to purchase CMBS that are eligible for funding under this program. Once the legacy CMBS requirements are finalized, we believe that the TALF may also provide us with attractively priced non-recourse term financing for the acquisition of legacy CMBS. However, many legacy CMBS have had their ratings downgraded by at least one rating agency (or have been put on notice as being likely to be downgraded in the near future) as property values have declined during the current recession because a large amount of legacy CMBS are backed by whole loans that were originated during a period of time when property values were relatively high and economic fundamentals were relatively strong. These downgradings significantly reduce the quantity of legacy CMBS that are TALF eligible. Accordingly, unless the criteria for legacy CMBS eligibility change, we expect most of our TALF eligible CMBS investments will be in newly issued CMBS. There can be no assurance we will be able to utilize the TALF to finance the acquisition of legacy CMBS or that the financing terms will be attractive.

The Public-Private Investment Program

On March 23, 2009, the U.S. Treasury, in conjunction with the FDIC, and the Federal Reserve, announced the establishment of the PPIP. The PPIP is designed to encourage the transfer of certain illiquid legacy real estate-related assets off of the balance sheets of financial institutions, restarting the market for these assets and supporting the flow of credit and other capital into the broader economy. The PPIP is expected to have two primary components: the Legacy Securities Program and the Legacy Loans Program.

Under the Legacy Securities Program, legacy securities public-private investment funds, or Legacy Securities PPIFs, will be established to purchase from financial institutions certain CMBS that were originally rated in the highest rating category by one or more of the national recognized statistical rating organizations. The U.S. Treasury will invest up to 50% of the equity capital raised for each Legacy Securities PPIF and will also provide attractively priced secured non-recourse loans in an aggregate amount of up to 50% of the Legacy Securities PPIF’s total equity capital so long as the Legacy Securities PPIF’s private investors do not have voluntary withdrawal rights. In addition, the U.S. Treasury will consider requests for debt financing of up to 100% of a Legacy Securities PPIF’s total equity capital, subject to restrictions on asset level leverage, withdrawal rights, disposition priorities and other factors to be developed by the U.S. Treasury. Loans made by the U.S. Treasury to any Legacy Securities PPIF will accrue interest at an annual rate to be determined by the U.S. Treasury and will be payable in full on the date of termination of the Legacy Securities PPIF.

To the extent available to us, we may consider financing our CMBS portfolio with financings under the Legacy Securities Program. However, we do not anticipate that a substantial portion of our target assets will be financed through the Legacy Securities Program in the near term.

Under the Legacy Loans Program, legacy loan public-private investment funds, or Legacy Loan PPIFs, will be established to purchase troubled loans (including commercial mortgage loans) from insured depository institutions. In the loan sales, assets will be priced through an auction process to be established under the program. The Legacy Loan PPIF will be able to fund the asset purchase through the issuance of senior notes issued by the Legacy Loan PPIF. The notes will be collateralized by assets purchased by the Legacy Loan PPIF and guaranteed by the FDIC up to a 6.0 to 1.0 debt-to-equity ratio.

Legacy Loan PPIFs, through their investment manager, will control and manage their asset pools within parameters pre-established by the FDIC and the U.S. Treasury, with reporting to and oversight by the FDIC. Legacy Loan PPIFs must agree to waste, fraud and abuse protections and will be required to make certain representations, warranties and covenants regarding the conduct of their business and compliance with applicable law. They must also provide information to the FDIC in performance of its oversight role.

On June 3, 2009, the FDIC announced that the development of the Legacy Loans Program will continue, but that a previously planned pilot sale of assets by banks targeted for June 2009 will be postponed. In making the announcement, the FDIC noted that banks have been able to raise capital without having to sell assets through the Legacy Loans Program, which in the view of the FDIC reflects renewed investor confidence in

 

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our banking system. The FDIC also indicated that it will continue its work on the Legacy Loans Program and will be prepared to offer it in the future as what the FDIC characterized as “an important tool to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy,” although no specific timeframe for the program was announced. As a next step, the FDIC will test the funding mechanism contemplated by the Legacy Loans Program in a sale of receivership assets this summer. This funding mechanism draws upon concepts successfully employed by the Resolution Trust Corporation in the 1990s, which routinely assisted in the financing of asset sales through responsible use of leverage. To the extent available to us, we may consider financing our whole loan portfolio with financings under the Legacy Loans Program. However, we do not anticipate that a substantial portion of our target assets will be financed through the Legacy Loans Program in the near term.

Emergency Economic Stabilization Act of 2008 and the TARP

On October 3, 2008, President George Bush signed into law the EESA. The EESA provides the Secretary of the U.S. Treasury with the authority to establish a Troubled Asset Relief Program, or the TARP, to purchase from financial institutions up to $700 billion of residential or commercial mortgages and any securities, obligations or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, as well as any other financial instrument that the Secretary of the U.S. Treasury, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, upon transmittal of such determination, in writing, to the appropriate committees of the U.S. Congress. In addition, under the EESA, the U.S. Treasury Secretary has the authority to establish a program to guarantee, upon request of a financial institution, the timely payment of principal and interest on these financial assets.

Capital Purchase Program

The Capital Purchase Program, or the CPP, is a voluntary program designed to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. Under this program, the U.S. Treasury is authorized to purchase up to $250 billion of senior preferred shares in qualifying domestically-controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities.

Targeted Investment Program

The Targeted Investment Program, or the TIP, is intended to prevent significant market disruptions that could result from a loss of confidence in a particular financial institution. The U.S. Treasury will determine whether a financial institution is eligible for the program on a case by case basis based on a number of considerations.

Systemically Significant Failing Institutions Program

The Systemically Significant Failing Institutions Program, or the SSFIP, is intended to provide stability and prevent disruption to financial markets that could result from the failure of a systemically significant institution. The U.S. Treasury will consider whether an institution is systemically significant and at substantial risk of failure, and thereby eligible for the SSFIP, on a case by case basis based on a number of considerations.

Asset Guarantee Program

The Asset Guarantee Program, or the AGP, is designed to provide guarantees for assets held by systemically significant financial institutions that face a high risk of losing market confidence due in large part to a portfolio of distressed or illiquid assets. The U.S. Treasury will determine the eligibility of participants and the allocation of resources on a case-by-case basis. In a report to Congress, the U.S. Treasury stated that it

 

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may use this program in coordination with a broader guarantee involving one or more other U.S. Government agencies.

Hope for Homeowners Act of 2008

On July 30, 2008, the Hope for Homeowners Act of 2008, or the H4H Act, was signed into law. The H4H Act created a new, temporary, voluntary program within the Federal Housing Administration, or the FHA, to back FHA-insured mortgages to distressed borrowers. The Hope for Homeowners program, which is effective from October 1, 2008 through September 30, 2011, will enable certain distressed borrowers to refinance their mortgages into FHA insured loans.

Critical accounting policies

General

Our financial statements are prepared in accordance with GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. In accordance with SEC guidance, the following discussion addresses the accounting policies that we will apply based on our expectation of our initial operations. Our most critical accounting policies will 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 consolidated financial statements will be based will be reasonable at the time made and based upon information available to us at that time. Our critical accounting policies will be expanded over time as we fully implement our investment strategies. Those accounting policies that we initially expect to be most critical to an investor’s understanding of our financial results of operations and financial condition and require complex management judgment are discussed below.

Basis of presentation

Our consolidated balance sheet will include the accounts of our company and any consolidated subsidiaries in accordance with GAAP. All significant intercompany balances will be eliminated in consolidation.

We consolidate subsidiaries in which we hold, directly or indirectly, more than 50% of the voting rights or where we exercise control. We follow the equity method of accounting for joint ventures and investments in associated companies in which we hold between 20% and 50% of the voting rights and/or have significant influence. We also evaluate our investments in all entities to determine if we have primary beneficial interests in any entities deemed to be variable interest entities, or VIEs.

Use of estimates

We will make a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements to prepare consolidated financial statements in conformity with GAAP. These estimates and assumptions will be based on management’s best estimates and judgment. Management will evaluate its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. The current economic environment has increased the degree of uncertainty inherent in these estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ from those estimates.

Risks and uncertainties

In the normal course of business, we will encounter primarily two significant types of economic risk: credit risk and market risk. Credit risk is the risk of default on our loans and securities or derivative instruments that result from a borrower’s or derivative counterparty’s inability or unwillingness to make contractually

 

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required payments. Market risk reflects changes in the value of investments in loans and securities or derivative instruments due to changes in interest rates or other market factors, including the value of the collateral underlying loans and securities held by us.

Cash and cash equivalents

We define cash and cash equivalents as highly liquid investments with original maturities of three months or less at date of purchase. The carrying amounts of cash equivalents approximate their fair value.

Loans held-for-investment

We will initially focus on investing in first mortgage loans collateralized by commercial real estate or in whole loans. These loans will be evaluated to determine whether they should be held-for-investment or available-for-sale based upon management’s intent and ability to hold the loans for the foreseeable future. Loans held-for-investment will be recorded at amortized cost, or the outstanding unpaid principal balance of the loan, net of unamortized acquisition premiums or discounts and unamortized costs and fees directly associated with the origination or acquisition of the loan in accordance with Statement of Financial Accounting Standards No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases,” or SFAS No. 91. Loans classified as held-for-investment will be stated at the principal amount outstanding, net of deferred loan fees and costs in accordance with Statement of Financial Accounting Standards No. 65, “Accounting for Certain Mortgage Banking Activities,” or SFAS No. 65. We expect that interest income will be recognized using the interest method or a method that approximates a level rate of return over the loan term in accordance with SFAS No. 91. Net deferred loan fees, origination and acquisition costs will be recognized in interest income over the loan term as yield adjustment. We may purchase loans held-for-investment at a discount to face value where, at the acquisition date, we expect to collect less than the contractual amounts due under the terms of the loan based, at least in part, on our assessment of the credit quality of the borrower. In accordance with Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” or SFAS No. 140, loans acquired in a transfer are initially measured at fair value (in the aggregate, presumptively the price paid).

Loans classified as held-for-sale will be carried at the lower of cost or fair value. The amount by which cost exceeds fair value will be accounted for as a valuation allowance. The fair value of the loans will be evaluated quarterly. Changes in the valuation allowance will be included in earnings. We will determine fair value of loans held-for-sale by using current secondary market information for loans with similar terms and credit quality. If current secondary market information is not available, we will consider other factors in estimating fair value, including modeled valuations using assumptions management believes a reasonable market participant would use in valuing similar assets (assumptions may include loss rates, prepayment rates, interest rates and credit spreads). If fair value is lower than the amortized cost basis of a loan classified as held-for-sale, we will record a valuation allowance to write the loan down to fair value.

Allowance for loan losses

For loans classified as held-for-investment, we will evaluate the loans for possible impairment on a quarterly basis in accordance with Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended, or SFAS No. 114. 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 or, for loans acquired at a discount to face value, when it is deemed probable that we will not be able to collect all amounts estimated to be collected at the time of acquisition. Impairment will then be measured based on the present value of expected future cash flows discounted at the loan’s contractual effective rate or the fair value of the collateral, if the loan is collateral dependent. Upon measurement of impairment, we will establish a reserve for loan losses and a corresponding charge to net income. Significant judgments are

 

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required in determining impairment, including making assumptions regarding the value of the loan, the value of the underlying collateral and other provisions such as guarantees.

Investment securities

Our acquisition of securities are expected to initially consist primarily of CMBS that we expect to classify as either available-for-sale or held-to-maturity. Assets classified as available-for-sale will be carried at their fair value in accordance with SFAS No. 115 with changes in fair value initially recorded through accumulated other comprehensive income(loss), a component of stockholders’ equity. We do not intend to hold any of our securities for trading purposes; however, if our securities were classified as trading securities, there could be substantially greater volatility in our earnings, as changes in the fair value of securities classified as trading are recorded through earnings. Debt securities classified as held for investment will be stated at their amortized cost, net of deferred fees and costs, with income recognized using the effective interest method.

When the estimated fair value of an available-for-sale or held-to-maturity security is less than amortized cost, we will consider whether there is an other-than-temporary impairment, or OTTI, in the value of the security. A security impairment considered to be other-than-temporary will be recognized in earnings. For debt securities, an impairment will be considered other-than-temporary if (i) we intend to sell the security, (ii) if it is more likely than not that we will be required to sell the security before recovering its cost, or (iii) we do not expect to recover the security’s cost basis. An impairment is considered to other-than-temporary if the present value of cash flows expected to be collected from the debt security is than the amortized cost basis (i.e., credit loss). If we intend to sell an impaired debt security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the impairment is other-than-temporary and will be recognized currently in earnings equal to the entire difference between fair value and amortized cost. If a credit loss exists, but we do not intend to, nor is it more likely than not that we will be required to sell before recovery, the impairment is other-than-temporary and should be separated into (i) the estimated amount relating to the credit loss, and (ii) the amount relating to all other factors. Only the estimated credit loss amount is recognized currently in earnings, with the remainder of the loss recognized in other comprehensive income. For held-to-maturity securities, the portion of an other-than-temporary impairment not related to a credit loss will be recognized in a new category of other comprehensive income and amortized over the remaining life of the debt security as an increase in the security’s carrying amount. Estimating cash flows and determining whether there is other-than-temporary impairment require management to exercise judgment and make significant assumptions, including, but not limited to, assumptions regarding estimated prepayments, loss assumptions, and assumptions regarding changes in interest rates. As a result, actual impairment losses, and the timing of income recognized on these securities, could differ from reported amounts.

Fair value option

Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” or SFAS No. 159, permits entities to choose to measure many financial instruments and certain other items at fair value. Changes in fair value, along with transaction costs, would be reported through net income. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities. We do not anticipate that we will elect the fair value option for any qualifying financial assets or liabilities that are not otherwise required to be carried at fair value in our financial statements.

Valuation of financial instruments

Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” or SFAS 157, establishes a new framework for measuring fair value and expands related disclosures. SFAS No. 157 establishes a

 

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hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial instruments at fair values. SFAS No. 157 establishes market based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy under SFAS No. 157 are described below:

Level I —Quoted prices in active markets for identical assets or liabilities.

Level II —Prices are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.

Level III —Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.

Unobservable inputs reflect our own assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available. We anticipate that a significant portion of our assets, in the short- to medium-term, will fall in Level III in the valuation hierarchy.

Any changes to the valuation methodology will be reviewed by management to ensure the changes are appropriate. As markets and products develop and the pricing for certain products becomes more transparent, we will continue to refine our valuation methodologies. The methods used by us may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. We will use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.

In October 2008, the Financial Accounting Standards Board, or the FASB, issued FASB Staff Position 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” or FSP 157-3, in response to the deterioration of the credit markets. This FSP provides guidance clarifying how SFAS No. 157 should be applied when valuing securities in markets that are not active. The guidance provides an illustrative example that applies the objectives and framework of SFAS No. 157, utilizing management’s internal cash flow and discount rate assumptions when relevant observable data does not exist. It further clarifies how observable market information and market quotes should be considered when measuring fair value in an inactive market. It reaffirms the notion of fair value as an exit price as of the measurement date and that fair value analysis is a transactional process and should not be broadly applied to a group of assets. FSP 157-3 is effective upon issuance including prior periods for which financial statements have not been issued. We will apply the guidance in FSP 157-3 in determining the fair value of our financial instruments.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008, or EESA, was signed into law. Section 133 of the EESA mandated that the SEC conduct a study on mark-to-market accounting standards. The SEC provided its study to the U.S. Congress on December 30, 2008. Part of the recommendations within the study indicated that “fair value requirements should be improved through development of application and best practices guidance for determining fair value in illiquid or inactive markets.” As a result of this study and the recommendations therein, on April 9, 2009, the FASB issued FSP 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” or FSP 157-4. FSP 157-4 provides additional guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased when compared with normal market activity for the asset or liability (or similar assets or liabilities). FSP 157-4 gives specific factors to evaluate if there has been a decrease in normal market activity and if so, provides a methodology to analyze transactions or quoted prices and make necessary adjustments to fair value in accordance with SFAS No. 157. The objective is to determine the point within a range of fair

 

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value estimates that is most representative of fair value under current market conditions. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. We will apply the guidance in FSP 157-4 in determining the fair value of our financial instruments.

Securitizations

We may periodically enter into transactions in which we sell financial assets, such as commercial mortgage loans, CMBS and other assets. Upon a transfer of financial assets, we will sometimes retain or acquire senior or subordinate interests in the related assets. Gains and losses on such transactions will be recognized using the guidance in SFAS No. 140, which is based on a financial components approach that focuses on control. Under this approach, after a transfer of financial assets that meets the criteria for treatment as a sale—legal isolation, ability of transferee to pledge or exchange the transferred assets without constraint, and transferred control—an entity recognizes the financial and servicing assets it acquired or retained and the liabilities it has incurred, derecognizes financial assets it has sold, and derecognizes liabilities when extinguished. We will determine the gain or loss on sale of mortgage loans by allocating the carrying value of the underlying mortgage between securities or loans sold and the interests retained based on their fair values. The gain or loss on sale is the difference between the cash proceeds from the sale and the amount allocated to the securities or loans sold. From time to time, we may securitize mortgage loans we hold if such financing is available. These transactions will be recorded in accordance with SFAS No. 140 and will be accounted for as either a “sale” and the loans will be removed from our balance sheet or as a “financing” and will be classified as “securitized loans” on our balance sheet, depending upon the structure of the securitization transaction. SFAS No. 140 is a complex standard that may require us to exercise significant judgment in determining whether a transaction should be recorded as a “sale” or a “financing.”

Variable interest entities

For each investment we make, we will evaluate the underlying entity that issued the securities we acquired or to which we make a loan to determine whether such entity should be consolidated in our financial statements. A similar analysis will be performed for each entity with which we enter into an agreement for management, servicing or related services. In performing our analysis, we will refer to guidance in SFAS No. 140 and Financial Accounting Standards Board Interpretation No. 46R, “Consolidation of Variable Interest Entities,” or FIN 46R. 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. In VIEs, 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. VIEs 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. This determination can sometimes involve complex and subjective analyses.

Interest income recognition

We expect that interest income on our mortgage loans and AAA-rated CMBS will be accrued based on the actual coupon rate and the outstanding principal balance of such assets. Premiums and discounts will be amortized or accreted into interest income over the lives of the assets using the effective yield method, as adjusted for actual prepayments in accordance with SFAS No. 91.

Income recognition is generally suspended for debt instruments at the earlier of the date at which payments become 90 days past due or when, in our opinion, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed.

 

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We designate loans as non-performing at such time as: (1) the loan becomes 90 days delinquent or (2) the loan has a maturity default. All non-performing loans are placed on non-accrual status and income is recognized only upon actual cash receipt.

We classify loans as sub-performing if they are not performing in material accordance with their terms, but they do not qualify as nonperforming loans. The specific facts and circumstances of these loans may cause them to develop into non-performing loans should certain events occur in the normal passage of time, which we consider to be 90 days from the measurement date.

We expect that interest income on our CMBS rated below AAA, including unrated CMBS, will be recognized in accordance with Emerging Issues Task Force, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” or EITF 99-20. Pursuant to EITF 99-20, cash flows from a security are estimated applying assumptions used to determine the fair value of such security and the excess of the future cash flows over the investment are recognized as interest income under the effective yield method. We will review and, if appropriate, make adjustments to our cash flow projections at least quarterly and monitor these projections based on input and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in interest income recognized on, or the carrying value of, such CMBS.

In January 2009, the FASB issued FASB Staff Position, or FSP Emerging Issues Task Force No. 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20, or FSP EITF 99-20-1, which amends the impairment guidance in EITF Issue No 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets to achieve more consistent determination of whether an other-than-temporary impairment has occurred for beneficial interests in securitized financial assets. FSP EITF 99-20-1 is effective for interim and annual periods ending after December 15, 2008. The determination cannot be overcome by management judgment of the probability of collecting all cash flows previously projected. For debt securities that are not within the scope of FSP EITF 99-20-1, SFAS No. 115 continues to apply. The objective of other-than-temporary impairment analysis is to determine whether it is probable that the holder will realize some portion of the unrealized loss on an impaired security. Factors to consider when making an other-than-temporary impairment decision include information about past events, current conditions, reasonable and supportable forecasts, remaining payment terms, financial condition of the issuer, expected defaults, value of underlying collateral, industry analysis, sector credit rating, credit enhancement, and financial condition of guarantor. We anticipate that our CMBS assets will fall under the guidance of FSP EITF 99-20-1 and as such we will assess each security for OTTI in accordance with its guidance.

For whole loans purchased at a discount, we will apply the provisions of Statement of Position 03-3 “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” or SOP 03-3. SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. SOP 03-3 limits the yield that may be accreted (accretable yield) to the excess of the investor’s estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the investor’s initial investment in the loan. SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield, loss accrual, or valuation allowance. Subsequent increases in cash flows expected to be collected generally will be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected will be recognized as impairment.

 

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Incentive distribution (Class B limited partner interest)

Through Class B limited partner interests, our Manager can avail itself of the flow-through of capital gains realized by us. The Class B limited partner interests will be entitled to receive quarterly profit distributions based on our financial performance. We will record any distributions on Class B limited partner interests as an incentive distribution expense in the period when earned and when payment of such amounts has become probable and reasonably estimable in accordance with the partnership agreement. As these interests are speculative in nature and subject to future performance, no value was ascribed to the original issuance of these interests and no consideration was paid in exchange for these interests. These cash distributions will reduce the amount of cash available for distribution to our common unitholders in our operating partnership and to common stockholders.

Hedging instruments and hedging activities

We will apply the provisions of Statement of Financial Accounting Standards No. 133, as amended by Statement of Financial Accounting Standards No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the balance sheets and to measure those instruments at fair value. Additionally, the fair value adjustments will affect either other comprehensive income in stockholders’ equity until the hedged item is recognized in earnings or net income depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity.

In the normal course of business, we may use a variety of derivative financial instruments to manage, or hedge, interest rate risk. These derivative financial instruments must be effective in reducing our interest rate risk exposure in order to qualify for hedge accounting. When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, all changes in the fair value of the instrument are marked-to-market with changes in value included in net income for each period until the derivative instrument matures or is settled. Any derivative instrument used for risk management that does not meet the hedging criteria is marked-to-market with the changes in value included in net income.

Derivatives will be used for hedging purposes rather than speculation. We will determine their fair value in accordance with SFAS No. 157 and we will obtain quotations from a third party to facilitate the process in determining these fair values. If our hedging activities do not achieve our desired results, our reported earnings may be adversely affected.

Other comprehensive income (loss)

We will recognize the change in fair value of our securities available for sale as a component of “Other Comprehensive Income (Loss)” on our consolidated balance sheet. In accordance with SFAS No. 133, we will recognize the change in fair value, and realized gains and losses from the effective portion of our cash flow hedges as a component of “Other Comprehensive Income (Loss)” on our consolidated balance sheet. Realized gains and losses from the effective portion of the cash flow hedges will then be amortized as a component of interest expense on our income statement over the term of the related financing, using the constant interest method.

Stock based compensation

Stock based compensation will be accounted for using the fair value based method prescribed by Statement of Financial Accounting Standards No. 123R, “Accounting for Share Based Payments,” or SFAS No. 123R. Pursuant to SFAS 123R, we will recognize compensation cost related to share-based awards based upon their grant date fair value. The compensation cost related to share-based awards will be amortized on a straight-line basis over the requisite service period, which is generally the vesting period of the awards. Since the compensation cost related to share-based awards is measured based upon grant date fair value, the expense related to these awards recognized in future periods may differ from the expense recognized if the awards were periodically remeasured at fair value.

 

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Income taxes

Our financial results are generally not expected to reflect provisions for current or deferred income taxes. We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ending December 31, 2009. As long as we qualify as a REIT, we generally will not be subject to U.S. federal income tax on our net income to the extent we, among meeting other requirements, annually distribute our taxable income to our stockholders. To the extent that we distribute 90% but not all of our taxable income, we will be subject to regular corporate income tax on the portion of taxable income that we retain. However, the U.S. federal income tax laws governing REITs are complex. If we fail to qualify as a REIT in any taxable year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on all of our taxable income whether or not retained. We will monitor the impact of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement 109,” or FIN 48, which clarifies the accounting for uncertainty in income taxes recognized in our financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” when we begin operations.

Our TRS is subject to U.S. federal, state and local taxes.

Organization and offering costs

As of July 13, 2009, we have incurred organization and offering costs of approximately $400,000. Offering costs include underwriting, legal, accounting, printing and other costs incurred in connection with our stock offering and the concurrent private placement. All offering costs will be recorded as an offset to additional paid in capital, and all organization costs will be recorded as an expense. In the event the minimum offering is not sold to the public, we will have no obligation to reimburse Holdings for any organizational and offering costs.

Recent accounting pronouncements

On June 12, 2009, the FASB issued SFAS No. 166, which amends the derecognition guidance in SFAS No. 140. SFAS No. 166 eliminates the concept of a QSPE (Qualified Special Purpose Entity) and eliminates the exception from applying FIN 46R. Additionally, SFAS No. 166 clarifies that the objective of paragraph 9 of SFAS No. 140 is to determine whether a transferor has surrendered control over transferred financial assets. That determination must consider the transferor’s continuing involvements in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. SFAS No. 166 modifies the financial-components approach used in SFAS No. 140 and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. It defines the term “participating interest” to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale. Under SFAS No. 166, when the transfer of financial assets are accounted for as a sale, the transferor must recognize and initially measure at fair value all assets obtained and liabilities incurred as a result of the transfer. This includes any retained beneficial interest. The implementation of this standard materially effects the securitization process in general, as it eliminates off-balance sheet transactions when an entity retains any interest in or control over assets transferred in this process. However, we do not believe the implementation of this standard will materially effect our reporting as we have no legacy QSPEs and it is our intent to treat securitizations as financings. The effective date for SFAS No. 166 is January 1, 2010.

In conjunction with SFAS No. 166, FASB issued SFAS No. 167, which amends FIN 46R. SFAS No. 167 requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. The analysis identifies the primary beneficiary

 

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of a VIE as the enterprise that has both (i) the power to direct the activities that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity which could potentially be significant to the VIE. With the removal of the QSPE exemption, established QSPEs must be evaluated for consolidation under SFAS No. 167. This statement requires enhanced disclosures to provide users of financial statements with more transparent information about an enterprise’s involvement in a VIE. Further, SFAS No. 167 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE. If we were to treat securitizations as sales in the future, we will analyze the transactions under the guidelines of SFAS No. 167 for consolidation. The effective date for SFAS No. 167 is January 1, 2010. We are evaluating the effect, if any, the adoption of SFAS No. 166 and SFAS No. 167 will have on consolidation and the securitizations strategy.

Results of operations

As of July 13, 2009, we have not commenced any significant operations because we are in our organizational stage. We will not commence any significant operations until we have completed this offering and the concurrent private placement.

Liquidity and capital resources

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders and other general business needs. We will use significant cash to purchase our target assets, repay principal and interest on our borrowings, make distributions to our stockholders and fund our operations. Our primary sources of cash will generally consist of the net proceeds from this offering and the concurrent private placement, payments of principal and interest we receive on our portfolio of assets, cash generated from our operating activities and unused borrowing capacity under our debt financing sources.

We intend to employ prudent leverage, to the extent available, to fund the origination and acquisition of our target assets and to increase potential returns to our stockholders. Although we are not required to maintain any particular leverage ratio, the amount of leverage we will deploy for particular target assets will depend upon our Manager’s assessment of a variety of factors, which may include the anticipated liquidity and price volatility of the target assets in our portfolio, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and commercial mortgage markets, our outlook for the level, slope, and volatility of interest rates, the credit quality of our target assets, the collateral underlying our target assets, and our outlook for asset spreads relative to the LIBOR curve. Our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our indebtedness policy at any time. We intend to use leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.

Initially, we intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. With respect to other U.S. Government programs, to the extent we utilize them at all, we would expect to utilize such amount of non-recourse leverage up to the amount permitted under the guidelines of the applicable program. When market conditions allow, we intend to finance our first mortgage loans in part through the issuance of AAA-rated CMBS, which we expect should be eligible to be purchased by investors who are able to borrow under the TALF, while retaining the subordinate securities in our portfolio. There can be no assurance that we will be able to utilize the TALF or any other U.S. Government programs successfully or at all. See “—Recent regulatory developments” for a description of the TALF and other U.S. Government programs. We will also seek to

 

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obtain financings, including secured term loans or revolving facilities, traditional repurchase or other secured credit facilities and other private funding sources. In addition, when market conditions allow, we expect to reduce the principal risk associated with our origination and investment activities through securitizations, syndications, participations and, to the extent consistent with maintaining our qualification as a REIT, other sales of portions of our assets, and we may choose to enhance our returns through the prudent use of higher leverage, with an emphasis on using term financings, including through the creation of securitization vehicles. We may also seek to raise further equity capital or issue debt securities in order to fund our future activities.

While we generally intend to hold our target assets for the long-term, certain of our assets may be sold in order to manage our interest rate risk and liquidity needs, meet other operating objectives and adapt to market conditions. The timing and impact of future sales of our assets, if any, cannot be predicted with any certainty.

The sources of financing for our target assets are described below.

The Term Asset Backed Securities Loan Facility

In response to the severe dislocation in the credit markets, the U.S. Treasury and the Federal Reserve jointly announced the establishment of the TALF on November 25, 2008. For a description of the TALF, see “—Recent regulatory developments—The Term Asset Backed Securities Loan Facility.”

We believe that the expansion of the TALF to include highly rated new issuance CMBS may provide us with attractively priced non-recourse term borrowings that we could use to purchase CMBS that are eligible for funding under this program. Once the legacy CMBS requirements are finalized, we believe that the TALF may also provide us with attractively priced non-recourse term financing for the acquisition of legacy CMBS. However, there can be no assurance we will be able to utilize the TALF to finance the acquisition of legacy CMBS or that the financing terms will be attractive.

Securitizations, syndications and sales

We intend to seek to enhance the returns on a portion of our commercial mortgage loans, especially loan originations, through securitizations that may or may not be supported by the TALF. To the extent available, we intend to securitize the senior portion of certain of our mortgage loans expected to be equivalent to investment grade CMBS, while retaining the subordinate securities in our portfolio. In order to facilitate the securitization market, the TALF is currently expected to provide financing to buyers of AAA-rated CMBS. In addition, when market conditions allow, we expect to reduce the principal risk associated with our origination and investment activities through securitizations, syndications and participations of our assets.

Credit facilities

We may fund purchases of our assets with credit facilities (including term loans and revolving facilities), although we currently do not have commitments for any credit facilities. These financings may be collateralized or non-collateralized and may involve one or more lenders. We expect these credit facilities will typically have maturities ranging from two to five years and may accrue interest at either fixed or floating rates.

Warehouse facilities

We may use temporary financing mechanisms such as warehouse facilities to finance assets. We currently do not have commitments for any warehouse facilities. We may use warehouse facilities in connection with the structuring of securitization transactions. Prior to an expected securitization issuance, there is a period during which securities and assets are identified and acquired for potential inclusion in the securitization,

 

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known as a warehouse accumulation period. The warehouse provider purchases these securities and assets and holds them on its balance sheet. We would direct the acquisition of securities and assets by the warehouse provider during this period and would contribute cash and other collateral to be held in escrow by the warehouse provider to cover our share of losses should securities or assets need to be liquidated. Typically, we would share gains, including the net interest income earned during the warehouse period, and losses, if any, with the warehouse provider.

Repurchase agreements

We may finance a portion of our assets through the use of short-term repurchase agreements and other short-term financings. We currently do not have commitments for any repurchase agreements. Repurchase agreements will effectively allow us to borrow against loans and securities that we own. Under these agreements, we will sell our loans and securities to a counterparty and agree to repurchase the same loans and securities from the counterparty at a price equal to the original sales price plus an interest factor. We expect to account for these agreements as debt secured by the underlying assets. During the term of a repurchase agreement, we earn the principal and interest on the underlying assets net of interest to the counterparty.

Seller-provided financing

We believe that sellers of whole loans and existing CMBS will include investment banks that are reducing inventory of loans and bonds and mid-sized to small commercial banks that might be forced to liquidate inventory for liquidity and regulatory capital purposes. We believe that commercial banks and investment banks that are seeking to dispose of whole loans and CMBS may be a source of financing for our purchases of their securities.

Total return swaps

Subject to maintaining our REIT qualification, we may finance certain of our assets using total return swaps. Total return swaps allow an investor to gain exposure to an underlying loan without actually owning the loan. In these swaps, the total return (interest, fees and capital gains/losses on an underlying loan) is paid to an investor in exchange for a floating rate payment. The investor pays a fraction of the value of the total amount of the loan that is referenced in the swap as collateral posted with the swap counterparty. The total return swap is thus a leveraged purchase of the underlying loan.

Total return swaps may not be qualifying real estate assets for purposes of the REIT asset tests and income therefrom may not be qualifying income for purposes of the REIT income tests. We may enter into total return swaps through a TRS, which would limit our ability to enter into such transactions and could cause the income from such swaps to be subject to U.S. federal corporate income tax.

Other potential sources of financing

We may also seek to raise further equity capital or issue debt securities in order to fund our future investments. In addition, as the credit markets recover, we may choose to enhance our returns through the prudent use of higher leverage, with an emphasis on using term financings, including through the creation of securitization vehicles.

Contractual obligations and commitments

Prior to the completion of this offering and concurrent private placement, we will enter into a management agreement with our Manager. Our Manager will be entitled to receive a base management fee, incentive distribution and the reimbursement of certain expenses. See “Our Manager and the management agreement—Management agreement.” Our Manager will use the proceeds from its base management fee

 

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in part to pay compensation to its officers and personnel (other than our Chief Financial Officer) who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us.

Our operating partnership has issued Class B units to our Manager to provide an incentive to our Manager to enhance the value of our common stock. Under the partnership agreement of our operating partnership, the Class B units owned by our Manager entitle it to receive an incentive allocation and distribution, until redeemed, in an amount equal to 20% of the dollar amount by which Core Earnings (as defined in the partnership agreement of our operating partnership), on a rolling four-quarter basis and before the incentive distribution for the current quarter, exceeds the product of (1) the weighted average of the issue price per share of all of our offerings multiplied by the weighted average number of shares of common stock outstanding in such quarter and (2) 8%.

Our 2009 equity incentive plan will include provisions for grants of restricted common stock and other equity based awards to our directors or officers or any personnel of our Manager and the Ladder Capital Group who provide services to us. Concurrently with the closing of this offering and the private placement, we will grant          shares of restricted common stock to our Manager under our 2009 equity incentive plan, equal to         % of the number of shares that we issue in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement, which will vest ratably on an annual basis over a three-year period commencing on the first anniversary of the completion of this offering and the concurrent private placement. See “Our Management—Executive and director compensation—2009 equity incentive plan.”

We expect to enter into certain contracts that may contain a variety of indemnification obligations , principally with brokers, underwriters and counterparties to credit and repurchase agreements. The maximum potential future payment amount we could be required to pay under these indemnification obligations may be unlimited. In addition, we expect to enter into a license agreement with Holdings relating to the use of the Ladder name and logo.

Off-balance sheet arrangements

As of July 13, 2009, we do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured investment vehicles, SPEs or VIEs, established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide additional funding to any such entities.

Distribution policy

We intend to make regular quarterly distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. We generally intend over time to pay regular quarterly dividends in an amount equal to our taxable income. However, because we currently have no assets and will commence operations only upon completion of this offering and the concurrent private placement, we may not have a portfolio of assets that generate sufficient income to be distributed to our stockholders during the initial quarters following this offering. Our board of directors has the sole discretion to determine the timing, form and amount of any distributions to our stockholders, and the amount of such distributions may be limited until we have a portfolio of income-generating assets. For more information, see “Distribution policy.”

Inflation

Virtually all of our assets and liabilities will be interest rate sensitive in nature. As a result, interest rates and other factors may influence our performance far more so than does inflation. Changes in interest rates do

 

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not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions will be 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

We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we 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.

Credit risk management

Through our investment strategy, we will seek to limit our credit losses and reduce our financing costs. However, we retain the risk of potential credit losses on all of the commercial mortgage loans, other real estate-related debt instruments, and the mortgage loans underlying the CMBS we may originate or acquire. We seek to manage this risk through employment of our extensive due diligence and rigorous underwriting processes and standards and through the use of non-recourse financing, when and where available and appropriate, on a risk-adjusted basis which limits our exposure to credit losses to the specific pool of mortgages that are subject to the non-recourse financing as well as through the use of appropriate derivative financial instruments and other hedging strategies. In addition, with respect to any particular target asset, our Manager’s asset management team will evaluate, among other things, relative valuation, comparable analyses, supply and demand trends, shape of yield curves, prepayment rates, delinquency and default rates, recovery of various sectors and vintage of collateral. Following origination or acquisition of our target assets, our Manager’s asset management team will rigorously monitor our portfolio for early detection of any potential credit or legal risks that may be mitigated or resolved prior to impairing any given asset.

For whole loan origination and loan and equity investments, our Manager will perform: (i) property level underwriting, including an extensive review of property histories and current and projected revenue and expenses, as well as a comprehensive analysis of rent rolls, lease abstracts and credit of tenants; (ii) a market review, including a review of the existing/projected supply and demand characteristics of the particular market, including competitive property analysis, recent leases/trends, projected valuation compared to recent sales, and replacement cost analysis; (iii) sponsorship/borrower analysis, and (iv) cash flow analysis. In addition, credit risk will be addressed through our Manager’s ongoing surveillance.

Our Manager will also seek to reduce credit risk by performing credit fundamental analysis of potential assets. For AAA-rated CMBS acquired in the secondary market, our Manager will analyze the bond structure taking into account subordination, defeasance, cash flow and waterfall priority. Our Manager will determine which loans are required for the bond to pay on time and will determine the likelihood of that event occurring. Our Manager will also analyze the largest loans in the deal to estimate whether any defaults or liquidations of the underlying loans could breach the subordination level before the bond would be paid in full. Our Manager will also analyze various credit characteristics of the deal, such as delinquency, watch list, property type, specially serviced loans, defeasance and subordination.

Liquidity risk management

Liquidity risk is the risk of being unable to preserve stable, reliable, and cost-effective funding sources to meet all near-term and projected long-term financial obligations. In addition to the equity funding provided

 

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by our stockholders, we expect external funding sources will consist primarily of unsecured and secured financings provided by banking institutions, other financings that may become available to us under recently established U.S. Government programs such as the TALF, and the issuance of CMBS. It is our intention to structure our funding programs to allow for flexible usage as funds will be repaid and re-drawn as assets generate cash and as we make additional investments. The external funding programs are expected to include a mix of committed and uncommitted sources that will provide short- and long- term funding over the expected holding periods of our individual assets. Initially, we intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. With respect to other U.S. Government programs, to the extent we utilize them at all, we would expect to utilize such amount of non-recourse leverage up to the amount permitted under the guidelines of the applicable program. We will maintain a contingency funding plan and perform related analyses to ensure that liquidity is available on a continuous basis even during disruptions in the capital markets of the type experienced in recent years.

Interest rate risk

Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We will be subject to interest rate risk in connection with our assets and our related financing obligations. In general, we expect to originate or acquire our target assets through the net proceeds from this offering and the concurrent private placement, various financings, including borrowings under programs established by the U.S. Government, bank credit facilities (including term loans and revolving facilities), resecuritizations, securitizations and other structured financing agreements. We may mitigate interest rate risk through utilization of hedging instruments, primarily interest rate swap agreements. Interest rate swap agreements are intended to serve as a hedge against the impact of future fluctuations in interest rates.

Our exposure to interest rates will also be affected by our overall corporate leverage, which may vary depending on our mix of assets.

In the event of a significant rising interest rate environment and/or economic downturn, delinquencies and defaults could increase and result in loan losses to us, which could adversely affect our liquidity and operating results. Further, such delinquencies or defaults could have an adverse effect on the spreads between interest-earning assets and interest-bearing liabilities.

Interest rate effect on net interest income

Our operating results will depend in large part on differences between the income earned on our assets and our cost of borrowing and hedging activities. The cost of our borrowings will generally be based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase (1) while the yields earned on our leveraged fixed rate mortgage assets will remain static and (2) at a faster pace than the yields earned on our leveraged floating rate mortgage assets, which could result in a decline in our net interest spread and net interest margin. The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our target assets. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations.

Hedging techniques are partly based on assumed levels of prepayments of our target assets. If prepayments are slower or faster than assumed, the life of the investment 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.

 

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Interest rate cap risk

We may acquire floating rate mortgage assets. These are assets in which the mortgages are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the asset’s interest yield may change during any given period. However, our borrowing costs pursuant to our financing 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 floating rate mortgage assets would effectively be limited if we did not implement effective caps. In addition, floating rate mortgage assets 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 such assets than we would need 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 basis risk

We may fund a portion of our acquisition of mortgage loans and CMBS with borrowings that are based on LIBOR, while the interest rates on these assets may be indexed to LIBOR or another index rate, such as the one-year Constant Maturity Treasury, or the CMT, index, the Monthly Treasury Average, or the MTA, index, or the 11th District Cost of Funds Index, or the COFI. Accordingly, any increase in LIBOR relative to one-year CMT rates, MTA or COFI will generally result in an increase in our borrowing costs that may not be matched by a corresponding increase in the interest earnings on these assets. Any such interest rate index mismatch could adversely affect our profitability, which may negatively impact distributions to our stockholders. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above.

Our analysis of risks is based on our Manager’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 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

Prepayment risk is the risk that principal will be repaid at a different rate than anticipated, causing the return on an asset to be less than expected. As we receive prepayments of principal on our assets, premiums paid on such assets will be amortized against interest income. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the rate of return earned on the assets. Conversely, discounts on such assets are accreted into interest income. In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the rate of return earned on the assets.

Extension risk

Our Manager will compute the projected weighted-average life of our assets based on assumptions regarding the rate at which the borrowers will prepay the mortgages. If prepayment rates decrease in a rising interest rate environment, the life of the fixed rate assets could extend beyond the term of the interest 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 fixed rate assets would remain fixed. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.

Market risk

Real Estate Risk. Commercial mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which

 

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may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans or loans, as the case may be, which could also cause us to suffer losses.

Market Value Risk. Our fixed rate available-for-sale securities will be reflected at their estimated fair value, with the difference between amortized cost and estimated fair value reflected in accumulated other comprehensive income pursuant to SFAS No. 115. The estimated fair value of these securities fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of these securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would be expected to increase. As market volatility increases or liquidity decreases, the fair value of our assets may be adversely impacted. If we are unable to readily obtain independent pricing to validate our estimated fair value of the securities in our portfolio, the fair value gains or losses recorded in other comprehensive income may be adversely affected.

Risk management

To the extent consistent with maintaining our REIT qualification, we will seek to manage risk exposure to protect our portfolio of assets against the effects of prepayments, defaults, interest rate volatility, credit spread movements and liquidity risks. Our efforts to manage risk will focus on monitoring our portfolio and managing the financing, interest rate, credit, prepayment and convexity (the measure of the sensitivity of the duration of a debt instrument to changes in interest rates) risks associated with a portfolio of our target assets. We generally seek to manage this risk by:

 

 

attempting to structure our financing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;

 

 

using hedging instruments, primarily interest rate swap agreements but also financial futures, options, interest rate cap agreements, floors and forward sales to adjust the interest rate sensitivity of our portfolio and our borrowings;

 

 

using securitization financing to better match the maturity of our financing with the duration of our assets;

 

 

employing a disciplined credit and due diligence culture that is designed to protect and preserve capital; and

 

 

attempting to match the interest we earn on our assets and our borrowing costs caused by fluctuations in short-term interest rates.

 

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Business

Our company

We are a newly organized commercial real estate finance corporation that has been formed to primarily originate, acquire and manage a diversified portfolio of commercial real estate first mortgage loans secured by income-producing properties. To a lesser extent, we expect to invest in senior classes of investment grade commercial mortgage-backed securities, or senior CMBS, and originate and acquire other commercial real estate-related debt instruments. We expect that over time most of our investment activity will take the form of first mortgage originations. However, we may initially allocate a significant portion of our net proceeds to senior CMBS designed to opportunistically take advantage of the Term Asset Backed Securities Loan Facility, or the TALF. We collectively refer to the assets that we intend to originate, acquire and manage as our target assets.

Our objective is to protect and preserve capital in a manner that provides for attractive risk-adjusted returns to our investors over the long term through dividends and capital appreciation. We intend to achieve this objective by selectively originating, acquiring and managing a diversified portfolio of our target assets designed to generate attractive risk-adjusted returns across a variety of market conditions and economic cycles. We believe that the current lack of liquidity in the commercial real estate, financial and credit markets presents significant opportunities for us to selectively originate high quality first mortgage loans to strong sponsors on attractive terms and that these conditions should persist for a number of years. We intend to build our business on a foundation of market knowledge combined with a disciplined credit and due diligence culture that is designed to protect and preserve capital. Our management team has implemented a similar business model to ours in the past. We believe that the flexibility of our investment strategy, combined with our expertise in our target assets and our long-term, primary focus on newly originated first mortgage loans, should enable us to achieve our objective.

We will be externally managed and advised by Ladder Capital Realty Finance Manager LLC, or our Manager, which is an affiliate and the indirect subsidiary of Holdings. Holdings is a specialty finance company that provides a comprehensive set of financing solutions to the commercial real estate industry. Holdings was formed by our senior management team in October 2008. Since its inception, our senior management team has been executing an investment strategy for Holdings substantially similar to ours and has been developing a pipeline of transactions that we expect to directly benefit from following the completion of this offering and the concurrent private placement.

Our Manager will originate, acquire and manage a diverse portfolio of real estate and real estate-related assets through a fully-integrated commercial mortgage loan origination platform with in-house origination, underwriting, structuring, financing, asset management, risk management and disposition capabilities. Our Manager will be comprised of an experienced team of senior managers, the core of whom have worked together previously in the commercial real estate industry, originating, underwriting, acquiring, structuring, managing and securitizing a diverse portfolio of commercial real estate mortgages, real estate and real estate-related assets through various economic cycles and market conditions. Our management team will be led by Brian Harris, our Chief Executive Officer, and will include Greta Guggenheim, our President, Marc Fox, our Chief Operating Officer, Robert Perelman, our Head of Asset Management, Pamela McCormack, our General Counsel, Head of Transaction Management and Secretary, and             , our Chief Financial Officer. Brian Harris has over 23 years of experience in the real estate and financial markets and has managed multi-billion dollar proprietary commercial real estate lending platforms and commercial real estate portfolios for over 11 years at UBS Securities LLC, or UBS; Dillon Read Capital Management, or DRCM, a wholly-owned subsidiary of UBS; and Credit Suisse Securities (USA) LLC, or Credit Suisse.

We will commence operations upon completion of this offering and the concurrent private placement to Ladder Capital Realty Finance Holdings LLC, or the Ladder Investor. We are organized as a Maryland corporation and intend to elect and qualify to be taxed as a real estate investment trust, or REIT, for U.S.

 

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federal income tax purposes, commencing with our taxable year ending December 31, 2009. We generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute all of our taxable income to stockholders and maintain our intended qualification as a REIT. We will conduct substantially all of our operations though our operating partnership, of which we are the sole general partner. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the 1940 Act.

About the Ladder Capital Group

Our Manager is an indirect subsidiary of Holdings, a privately-held company that commenced operations in October 2008. Holdings, together with its direct and indirect subsidiaries, which is referred to herein as the Ladder Capital Group, is a vertically-integrated, full-service commercial real estate finance and investment management company with an investment strategy substantially similar to ours that originates, underwrites, structures, acquires, manages and distributes commercial real estate mortgages and other real estate debt instruments. Since its inception, our senior management team has been executing an investment strategy for Holdings substantially similar to ours and has been developing a pipeline of transactions that we expect to directly benefit from upon the completion of this offering and the concurrent private placement.

The Ladder Capital Group has several key and strategic investors, including TowerBrook Capital Partners L.P., a private equity firm with approximately $5.0 billion of capital under management, and GI International, L.P., or GI Partners, a private equity firm with approximately $3.7 billion of capital under management and with significant prior experience in the commercial real estate industry and the formation of public REITs, including Digital Realty Trust, Inc. In addition, Brian Harris has personally invested $25 million in Holdings. The Chairman of Holdings is Alan Fishman, who has a long and distinguished career having held positions at several large financial institutions. Over the last ten years, Mr. Fishman has served as President and Chief Executive Officer at ContiFinancial Corp., Chief Executive Officer of Independence Community Bank (including briefly as President of Sovereign Bancorp following its acquisition of Independence Community Bank) and Chairman of Meridian Capital Group LLC, one of the largest commercial real estate mortgage brokers in the United States. In September of 2008, Mr. Fishman was appointed as Chief Executive Officer of Washington Mutual and its holding company for a brief period immediately preceding its merger with JPMorgan Chase. The Ladder Capital Group operates out of New York and currently employs 17 professionals.

In late September/early October 2008, during an unprecedented period of market illiquidity and volatility, Holdings successfully raised $611.6 million of equity capital and obtained a $300 million secured term credit facility from Wells Fargo Securities, LLC, an affiliate of one of our underwriters. Thereafter, Holdings also obtained four additional short-term secured term funding lines from other financial institutions. As of June 30, 2009, 70% of Holdings’ committed equity has been drawn, leaving the remaining $183.5 million available to be deployed to support future investments, including the purchase of $             million of our common stock (         shares) and $             million of OP units (         OP units) in a private placement to be completed concurrently with this offering.

Beginning with its commencement of operations in October 2008, Holdings’ initial focus was on the origination and acquisition of income-producing commercial real estate first mortgage loans. However, in November 2008, the senior management team at Holdings observed that the market for CMBS experienced substantial turmoil resulting in market price declines for CMBS at all rating levels. As a result of such price declines, the yields on the most highly rated classes of CMBS were much higher than the returns that the senior management team at Holdings expected could be earned by originating or acquiring first mortgage loans and related instruments. In that environment, the senior management team at Holdings determined that the price of AAA-rated CMBS backed by large and diverse pools of commercial mortgage loans represented a better short-term investment than originating and acquiring first mortgage loans. In view of the attractive risk-adjusted returns the senior management team believed to be available in the CMBS

 

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market, the senior management team at Holdings has focused primarily on investing in the most senior classes (A-1 through A-4) of AAA-rated CMBS.

Certain performance data of Holdings described above is set forth in the following tables. This data is not a guarantee or prediction of the returns that we may achieve.

The table below sets forth certain performance data of Holdings through June 30, 2009. Holdings obtained $612.0 million of members’ capital commitments. Through June 30, 2009, Holdings had called and received $428.0 million in proceeds from such capital commitments and distributed $5.7 million back to its members. At June 30, 2009, total Holdings members’ capital was $447.0 million (including cumulative net income of $7.0 million and other comprehensive income of $18.5 million and net of $1.1 million of offering costs). Holdings also obtained additional funding from four secured debt facilities and the total debt outstanding was $325.0 million at June 30, 2009. The members’ capital and debt funding support total assets of $788 million at June 30, 2009. The majority of that asset base was comprised of a portfolio of highly rated CMBS with a fair value of $573.0 million that had a weighted average unlevered yield to scheduled maturity of 8.45% and a weighted average term to scheduled maturity of 2.24 years (each measured as of the date of acquisition of the applicable CMBS). In addition to the CMBS securities, from November 2008 through June 2009, Holdings also acquired $26.8 million of interest only securities and a $16.0 million participation interest in a first mortgage loan at a discounted price of $14.6 million.

Investors in Holdings do not pay management or incentive fees to Holdings or its management. Members of management purchased certain preferred interests in Holdings alongside the other investors in Holdings. The preferred interests entitle the holders thereof to a priority in a return of capital and a percentage of distributions in excess of the return of capital. In addition, members of management and certain persons in Holdings were granted common membership interests in Holdings.

Performance from Commencement of Operations to June 30, 2009

 

(dollars in millions)                       CMBS Investment Portfolio(2)
Entity   Date of
Commence-
ment of
Operations
  Total
Members’
Capital
Commitments
Obtained
  Total
Members’
Capital
Called and
Received(1)
  Total
Distributions
  Total
Members’
Capital(1)
  Total Debt
Outstanding(1)
  Total
Assets(1)
  Fair Value of
CMBS
Investments(1)
  Weighted
Average
Unlevered
Yield to
Scheduled
Maturity(3)
  Weighted
Average
Term to
Scheduled
Maturity(3)
                                         

Holdings

  10/6/08   $612   $428   $5.7   $447   $325   $788   $573   8.45%   2.24 Years
                                         

 

(1)  

As of June 30, 2009.

 

(2)  

Excludes data related to $26.8 million of interest only securities.

 

(3)  

Based on data as of the date of acquisition of each CMBS security.

 

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Table I set forth below presents the amount of capital raised by Holdings as well as certain other information for the period from commencement of operations of Holdings (October 6, 2008) through June 30, 2009.

Table I

Ladder Capital Finance Holdings LLC

 

(dollars in thousands)    Commencement to
December 31, 2008
    As of and
through
June 30,
2009
            

Capital commitments

   $609,550      $611,550

Invested capital(1)

   243,820      428,085

Commissions paid to Holdings and its affiliates from proceeds of offerings(2)

       

Offering and organizational costs(3)

   1,060      1,060

Cumulative net income (loss)

   (6,439   6,978

Net unrealized gain on investments

   1,730      18,500

Cumulative net income and net unrealized gain (loss)(4)

   $(4,709   $25,478

Distributions to Investors

        5,692

Leverage(4)

   0%      41%
            

 

(1)   Capital that has been called from investors in Series A Participating Preferred units through the end of the indicated period ($9.96 million of capital was called in December 2008 and received in January 2009 and is included in the amount shown in the “Commencement to December 31, 2008” column. Otherwise the invested capital amounts all represent capital called and received from investors within the noted timeframe). The initial closing on the Series A Participating Preferred units was on September 22, 2008 and the most recent closing occurred on April 15, 2009. Holdings is not currently in an active capital raising mode although it may consider additional capital contributions from new investors from time to time.

 

(2)   Holdings and its affiliates did not receive any commissions with respect to amounts raised nor was a placement agent engaged for the purpose of raising capital for Holdings.

 

(3)   Aggregate fees and expenses paid in connection with the offering.

 

(4)   Ratio of debt to fair value of total assets.

 

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Table II set forth below presents certain operating results of Holdings which has a very limited operating history. Because the time periods presented below represent only a portion of the initial investment period, these results are not indicative of expected returns upon stabilization of operations following the completion of the remaining capital drawdowns and the full investment of these funds. During the initial year of a typical commercial real estate finance firm, it is common for operational costs to exceed income for at least a portion of the year as investments are yet to be completed and income realized.

Table II

Ladder Capital Finance Holdings LLC

Aggregate Summary Historical Performance

 

(dollars in thousands)   

December 31, 2008

  

June 30, 2009

           

Gross assets

   $232,461    $787,988

Net assets(1)

   $228,782    $447,457
           

 

      From
Commencement
to December
31, 2008
    For the
Six Months
to June 30,
2009
 
              

Net interest income(2)

   $(117   $13,134   

Other gain (loss):

    

Net realized (loss) gain on investments

        7,849   

Total other gain (loss)

   (44   (22

Total expenses

   (6,278   (7,544
            

Net income (loss)

   $(6,439   $13,417   
            

Net unrealized gain on investments(3)

   1,730      18,500   
              

 

(1)   Total assets net of total liabilities.

 

(2)   Reflects interest income net of interest expense and certain other investment related expenses.

 

(3)   Represents a mark-to-market adjustment resulting from favorable changes in the fair-value of securities held for sale. This amount is not reflected on the income statement but instead appears on the balance sheet of Holdings as a component of “Accumulated Other Comprehensive Income” in the Members’ Capital section.

On July 7, 2009, Holdings entered into an agreement to acquire FirstCity Bank of Commerce, a Florida state-chartered bank, which we refer to herein as the Ladder Capital Bank. In connection with this acquisition, which is currently anticipated to close on or before December 31, 2009, Holdings intends to submit an application to qualify itself as a bank holding company under the Bank Holding Company Act of 1956. The acquisition is subject to a number of conditions, including stockholder approval, regulatory approvals, satisfaction of certain financial covenants and other customary closing conditions. Upon the completion of the merger, the Ladder Capital Bank is expected to primarily focus on the origination of high quality, low leverage first mortgage commercial loans. If the acquisition of the Ladder Capital Bank is completed, the senior management team at Holdings will serve as the senior executives of the Ladder Capital Bank. However, Holdings intends to retain the operational banking team currently employed by the Ladder Capital Bank as well as hire new additional banking personnel, including a Chief Credit Officer and Head of Retail Banking, allowing the senior management team at Holdings to focus primarily on loan originations. There is no guarantee as to whether, when or on what terms this acquisition will take place.

Our Manager

We will be externally managed and advised by Ladder Capital Realty Finance Manager LLC, a newly-formed Delaware limited liability company. Pursuant to the terms of a management agreement between our Manager and us, our Manager will be responsible for administering our business activities and day-to-day operations and will provide us with our management team and appropriate support personnel. Pursuant to an advisory agreement between our Manager and Ladder Capital Finance LLC, or our Advisor, our Manager

 

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will directly benefit from the highly experienced personnel and resources of the Ladder Capital Group necessary for the implementation and execution of our investment strategy. We do not expect to have any employees. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. The Ladder Capital Group will not be obligated to dedicate any of its other executive officers or personnel exclusively to us. In addition, none of the Ladder Capital Group, its executive officers and other personnel, including our executive officers supplied to us by the Ladder Capital Group (other than our Chief Financial Officer), will be obligated to dedicate any specific portion of its or their time to our company. Our Manager will be subject to the supervision and oversight of our board of directors.

Our Manager will be comprised of an experienced team of senior managers led by Brian Harris and will include Greta Guggenheim, Marc Fox, Robert Perelman, Pamela McCormack and                 , our Chief Financial Officer. Brian Harris and Greta Guggenheim initially began working together at Credit Suisse from 1996 through 1999 and then later worked together at UBS/DRCM from August 2000 until August 2007. In addition, a substantial number of Holdings’ employees worked together previously at UBS/DRCM where they established a track record of originating, underwriting, acquiring, structuring, managing and securitizing a diverse portfolio of commercial real estate mortgages, real estate and real estate-related assets. Between 2002 and 2006, the commercial real estate group at UBS/DRCM, headed by Brian Harris, generated adjusted total revenues of between $230 million and $295 million per year. Adjusted total revenue figures shown below represent gross revenues (comprised of trading revenues and fees, interest income and realized profits) of the commercial real estate group at UBS/DRCM for the years shown, net of financing and hedging costs, realized losses, impairments and mark-to-market adjustments, where applicable. Adjusted total revenue figures do not include deductions for compensation, overhead allocations and other expenses.

Historical data of the UBS/DRCM Commercial Real Estate Group led by Brian Harris(1)

 

(dollars in millions)    2002    2003(3)    2004(3)    2005    2006(4)
 

Adjusted total revenues(2)

   $249.8    $294.2    $275.0    $285.4    $233.6
 

 

(1)   This data is unaudited and has not been independently verified. None of UBS, DRCM or any of their respective affiliates represents or warrants as to, or assumes any liability for, the accuracy or use of this data. None of UBS, DRCM or any of their respective affiliates makes any representation or warranty that this data is accurate or suitable for use in connection with this prospectus or in connection with your investment in our common stock.

 

(2)   Adjusted total revenue figures shown above represent gross revenues (comprised of trading revenues and fees, interest income and realized profits) of the commercial real estate group at UBS/DRCM for the years shown, net of financing and hedging costs, realized losses, impairments and mark-to-market adjustments, where applicable. Adjusted total revenue figures do not include deductions for compensation, overhead allocations and other expenses.

 

(3)   A portion of the 2003 and 2004 revenues (estimated by Brian Harris and members of his management team at such times to be approximately $46 million in the aggregate) relates to realization on equity investments in property acquired or occupied by UBS.

 

(4)   The revenue figure for 2006 reflects revenue generated while the business was part of UBS Investment Bank and DRCM. The transition of the business out of UBS Investment Bank occurred on June 5, 2006.

This historical data is a reflection of certain aspects of the past performance of Brian Harris and his management team at UBS/DRCM and is not intended to be indicative of, or a guarantee or prediction of, the revenues that we or our management team may generate in the future. Similar data for the commercial real estate group at UBS/DRCM is not available for periods subsequent to the departure of Brian Harris and his management team from UBS/DRCM. Therefore, there is no information or representation as to the actual performance of UBS/DRCM’s commercial real estate asset portfolio (if any) in 2007 and 2008, nor can there be any assurance as to how the UBS/DRCM commercial real estate asset portfolio would have performed if managed during this volatile and turbulent period by Brian Harris and his management team. Although we intend to employ a similar investment strategy to that used by Brian Harris and his management team at UBS/DRCM, certain aspects of our business strategy differ from that model. We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes. Accordingly, to qualify as a

 

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REIT, we must comply with requirements regarding the composition and values of our assets, our sources of income and the amounts we distribute to our stockholders in a manner different from UBS/DRCM. Further, we expect to actively manage our portfolio in a manner so as to avoid registration under the 1940 Act. This will impose limitations on our activity which were not imposed at UBS/DRCM. We also expect to operate with significantly less leverage than did the commercial real estate group at UBS/DRCM. In contrast to the financial results of the commercial real estate group at UBS/DRCM where revenues from securitizations comprised the majority of revenues in the above table for the 2005 and 2006 calendar years and were a significant contribution in other periods, we expect to have significantly less revenue from securitizations as the securitization market may remain effectively closed for the near future. A portion of the adjusted total revenues of the commercial real estate group at UBS/DRCM reflect returns derived from investments in real estate equity. Our current plan is to invest in little, if any, real estate equity. Further, the UBS/DRCM team had more personnel than our Manager currently has and not all of the management team at UBS/DRCM during the periods indicated above are members of our management team. The historical data above also does not take into account management or advisory fees or similar transaction costs which reduce actual revenues. We will pay our Manager a base management fee and incentive distribution and we expect to incur certain transaction costs with respect to the origination, acquisition, financing and management of our assets. Accordingly, the historical data of Brian Harris and his management team at UBS/DRCM are not indicative of the performance of our strategy and we can offer no assurance that our Manager will replicate its historical performance as presented in this prospectus. See “Risk factors—Risks related to our company—Our Manager may not be able to replicate the prior business model used by certain members of our management team and available data for the prior business model is limited.”

Our Manager’s competitive strengths

We believe our business possesses a number of characteristics distinguishing us from our competitors, including:

Experienced management team

Our senior management team, which is comprised of Brian Harris, our Chief Executive Officer, Greta Guggenheim, our President, Marc Fox, our Chief Operating Officer, Robert Perelman, our Head of Asset Management, Pamela McCormack, our General Counsel and Head of Transaction Management, and             , our Chief Financial Officer, is highly experienced in real estate investing and finance and has significant experience in the commercial real estate sector. The core of our management team have worked together during both volatile and stable market conditions and have established a track record of acquiring and managing commercial real estate debt and real estate-related assets, generating what we believe to have been consistently attractive annual returns. For more information about our management team and their track record, see “—About the Ladder Capital Group,” “Our management—Our directors, director nominees and executive officers” and “Our Manager and the management agreement.” We expect that the extensive experience of the members of our management team in the commercial real estate industry will provide us with the ability to effectively deploy our capital in a manner that we believe will provide for attractive risk-adjusted returns but with a focus on capital preservation and protection.

Access to the Ladder Capital Group’s long-standing relationships

The market for our target assets is competitive and we may compete with many other participants for investment opportunities. We believe our Manager’s ability to identify attractive opportunities will distinguish us from many of our competitors. We intend to capitalize on the Ladder Capital Group’s origination platform, structuring expertise and market insight into the commercial real estate sector. The Ladder Capital Group and its strategic investors have established numerous relationships with well-recognized real estate owners, investors, lenders and brokers, including leading investment banks, commercial banks, insurance companies, nationally recognized commercial mortgage brokers and other financial institutions. We expect to benefit from these long-standing relationships across the real estate

 

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industry and expect such relationships to help us continue to grow and maintain our pipeline and to generate attractive opportunities that may not be available to many of our competitors or to the general market.

Proven access to capital raising

In late September/early October 2008, during an unprecedented period of market illiquidity and volatility, Holdings successfully raised $611.6 million of equity capital and obtained a $300 million secured term credit facility from Wells Fargo Securities, LLC, an affiliate of one of our underwriters. Thereafter, Holdings also obtained four additional short-term secured term funding lines from other financial institutions which had approximately $113.3 million outstanding in the aggregate as of June 30, 2009. We expect our management team to provide us with similar access to major financial institutions and to assist us in obtaining short-term lending facilities and long-term secured debt facilities.

Disciplined lending/strong credit culture

We will seek to maximize our risk-adjusted returns, and preserve and protect capital, through our Manager’s disciplined and credit-based approach. Our management team has long employed a disciplined approach to risk. Our management team expects to manage the credit and market risk of our company’s portfolio through a rigorous underwriting and loan closing process that includes numerous checks and balances to evaluate the risks and merits of each potential transaction. Our Manager will seek to protect and preserve capital by performing a comprehensive risk-reward analysis on each potential transaction, with a focus on relative values between real estate asset sectors, geographic markets and its position in the capital structure, as well as by creating a diversified portfolio of assets that it will actively manage. We expect to benefit from the Ladder Capital Group’s highly specialized, credit analysis techniques, such as its credit and collateral stratifications, stress assessments and asset management procedures for early detection of troubled and deteriorating assets.

Vertically-integrated commercial mortgage loan origination platform

The Ladder Capital Group has a vertically-integrated commercial mortgage loan origination platform that allows it to manage and control the loan process from origination through closing with personnel highly experienced in credit, underwriting, structuring, capital markets and asset management. As a real estate lender, the Ladder Capital Group has a strong credit culture stemming from the extensive experience of its seasoned management team and the team’s in-depth understanding of commercial real estate markets. Through our Manager, we intend to utilize the Ladder Capital Group’s vertically-integrated commercial mortgage loan origination platform to identify, assess and manage risks associated with each opportunity we pursue. In addition, we believe that our access to this platform will allow us to quickly and efficiently execute opportunities we deem desirable.

Structuring flexibility

Our Manager’s ability to provide a wide range of financing products and its ability to customize financing structures to meet borrowers’ needs is one of our key business strengths. In particular, we will seek to be a full-service provider of commercial real estate financing solutions, financing primarily the most senior capital positions as well as selectively making mezzanine loans and financing participation and subordinate interests. We believe that our Manager’s experience in creating the loan structures we intend to offer, including its expertise in structuring intercreditor agreements, participation agreements and servicing arrangements that can protect our rights, mitigate losses and enhance returns, will help us offer innovative and customized financing solutions to borrowers and produce attractive risk-adjusted returns. In addition, we expect to benefit from our Manager’s independent, segregated loan origination, underwriting, legal due diligence and asset management functions, which we expect will assist us in producing and managing commercial real estate financial products reflecting our disciplined approach to risk.

 

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No legacy issues

Unlike many of our competitors, we are a newly-formed entity that will not be burdened by distressed legacy commercial real estate assets. We believe we will have a competitive advantage relative to other existing comparable commercial real estate lenders because neither we nor our Manager or its affiliates have a legacy portfolio of lower-return or problem assets that could potentially dilute the attractive returns we believe are available in the current liquidity-challenged environment and/or distract our management team. In addition, we will be an independent “pure-play” commercial real estate finance corporation. As a new business, our portfolio of target assets will consist of newly acquired and newly priced assets and we will not have any preexisting assets or legacy exposures, other than those we decide to purchase following this offering, to distract and monopolize our management team’s time and attention. At the completion of this offering and the concurrent private placement, we do not expect to have any adverse credit exposure to, nor our performance to be negatively impacted by, previously purchased assets.

Alignment of the Ladder Capital Group and our Manager’s interests

We have taken steps to structure our relationship with the Ladder Capital Group and our Manager so that our interests and those of the Ladder Capital Group and our Manager are closely aligned. The Ladder Investor has agreed to purchase $             million of our common stock (         shares) and $             million of OP units (         OP units) in a concurrent private placement, at a price per share/unit equal to the initial public offering price, for an aggregate investment equal to 20% of the gross proceeds raised in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement. The Ladder Investor has agreed to an 18-month lock-up with us with respect to the securities that they purchase in the concurrent private placement. In addition, we will grant shares of restricted common stock to our Manager under our 2009 equity incentive plan, equal to         % of the number of shares that we issue in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement, which will vest ratably on an annual basis over a three-year period commencing on the first anniversary of the completion of this offering and the concurrent private placement. We believe that the significant investment in us by the Ladder Investor, as well as our Manager’s incentive distribution structure and our 2009 equity incentive plan, will align our interests with those of our Manager, which will create an incentive to maximum returns for our stockholders.

Market opportunity

We believe there is an unprecedented market opportunity for well capitalized commercial real estate lenders to originate attractively priced loans with strong credit fundamentals on high quality income-producing real estate. This opportunity, which we expect to persist for several years, is the result of a substantial decline in the aggregate balance sheet capacity of commercial real estate lenders amidst a backlog of over $1.8 trillion of maturing commercial real estate loans that will need to be refinanced from 2009 through 2012.

According to the Federal Reserve, the volume of commercial and multifamily mortgage debt outstanding grew by over 60% from the beginning of 2004 through the end of 2008 to $3.5 trillion. This growth was fueled by rising commercial real estate property values, a strong economy and an abundance of debt and equity capital. As the market expanded, commercial real estate values rose to levels higher than the underlying real estate fundamentals justified due to overly optimistic underwriting projections, the willingness of certain commercial real estate investors to accept lower rates of return (known as “cap rate compression”) and extremely high leverage levels. During this period, financing terms became increasingly favorable to borrowers as lenders aggressively underwrote loans to drive fee income from “originate-to distribute” securitization programs that transferred credit risk from lenders’ balance sheets to investors.

 

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Commercial and multifamily mortgage debt outstanding

LOGO

In February 2007, severe credit problems in the subprime residential mortgage market led to a re-examination of credit standards across all financing markets, including commercial real estate. In April 2007, in order to better reflect inherent risks, Moody’s Investors Service modified its models that determine how ratings to commercial mortgage-backed bonds are assigned. This shift led to a long-term structural change in the commercial real estate lending market, and investors reacted by requiring tighter underwriting standards. Commercial real estate lenders became saddled with billions of dollars of more loosely underwritten loans that were originally targeted for distribution to investors via securitizations. These loans either had to be held by the lenders or sold at a loss due to a substantial downward repricing; either option required lenders to hold additional capital and limited the lenders’ capacity to originate new commercial real estate loans. As a result, a widespread lack of liquidity developed in the commercial real estate market, which caused a dramatic rise in the cost of credit as illustrated by the increase in spread over swaps for 10-year AAA CMBS set forth in the table on the following page.

 

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10 year AAA CMBS spread over swaps

LOGO

Amidst the ongoing commercial real estate pricing correction, many traditional commercial lenders have ceased or significantly decreased lending due to diminished balance sheet capacity and, in some cases, as a result of having been acquired or having entered bankruptcy. For instance, banks which are significant providers of commercial mortgages are experiencing significant stress. According to the Federal Reserve as of July 10, 2009, 53 depository institutions with more than $37 billion in combined assets have failed in 2009. In 2008, 25 depository institutions with approximately $372 billion in combined assets failed, as compared to 2007 in which only three banks with approximately $2.6 billion in combined assets failed.

FDIC Problem Institutions (1999 – 1Q 2009)

LOGO

 

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As a result, underwriting standards have tightened dramatically and the availability of credit has plummeted. An April 2009 Federal Reserve survey reported that over 65% of domestic banks have further tightened their lending standards for commercial real estate loans. The April 2009 reading of commercial real estate underwriting standards exceeds underwriting standards reported at any time between July 1990 and October 2007.

Federal Reserve Loan Officer Survey – Underwriting Standards

LOGO

Additionally, CMBS is not currently a major source of liquidity for the commercial real estate sector as the credit contraction has virtually shut down the market.

CMBS issuance volumes through June 30, 2009

LOGO

 

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We believe that while the number and activity levels of market participants will be substantially lower than levels of the past five years, the lending opportunities will be vast. According to Property and Portfolio Research estimates, over $1.8 trillion of commercial real estate debt will mature over the next four years, with over $400 billion maturing in each of 2009 through 2012. We believe well capitalized lenders may now be highly selective while originating loans with strong credit fundamentals and historically wide spreads in this environment.

Annual Maturities

LOGO

Our investment strategy

Our objective is to protect and preserve capital in a manner that provides for attractive risk-adjusted returns to our investors over the long term through dividends and capital appreciation. We intend to achieve this objective by selectively originating, acquiring and managing a diversified portfolio of our target assets designed to generate attractive risk-adjusted returns across a variety of market conditions and economic cycles. We believe that the flexibility of our investment strategy, combined with our expertise in our target assets and our long-term, primary focus on newly originated first mortgage loans, should enable us to achieve our objective.

We expect our Manager to take advantage of long-term structural changes in the real estate lending market by originating and acquiring high quality income producing commercial real estate mortgage loans and other real estate debt instruments at attractive spreads from high quality sponsors and low loan-to-value assumptions. To a much lesser extent, we also expect our Manager to seek to capitalize on opportunities created by the lack of liquidity in the real estate market and to take advantage of opportunistic pricing dislocations created by distressed sellers or distressed capital structures where a lender or holder of a loan or security is in a compromised situation due to balance sheet constraints, the relative size of its portfolio, the magnitude of nonperforming loans and/or regulatory/rating agency issues driven by potential capital adequacy or concentration issues.

 

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In pursuing investment opportunities with attractive risk-reward profiles, we expect that our Manager will incorporate its views of the current and future economic environment, its outlook for real estate in general and particular asset classes, and its assessment of the risk-reward profile derived from its underwriting and cash flow analysis, including taking into account relative valuation, supply and demand fundamentals, the level of interest rates, the shape of the yield curve, prepayment rates, financing and liquidity, real estate prices, delinquencies, default rates, recovery of various sectors and vintage of collateral. In general, our Manager will employ a “bottom-up,” fundamental approach to asset and security valuation. All investment decisions will be made so that we maintain our qualification as a REIT and our exemption from registration under the 1940 Act.

In addition, in each financing transaction we undertake, our Manager will seek to control as much of the capital structure as possible. Our Manager will generally seek to accomplish this through the direct origination of first mortgage loans and other assets, which will be acquired with the intention of holding to maturity, or by selling some or all of the risk via syndication and securitization executions. By providing a single source of financing to a borrower, we intend to streamline the lending process, give greater certainty of execution to the borrower and retain the portion of the capital structure that we believe will generate attractive risk-adjusted returns.

In order to capitalize on the changing sets of investment opportunities that may be present in the various points of an economic cycle, we may expand or refocus our investment strategy by emphasizing investments in different parts of the capital structure and different sectors of real estate. Our investment strategy may be amended from time to time, if recommended by our Manager and approved by our board of directors. We will not seek stockholder approval when amending our investment strategy.

Our target assets

First mortgage loans.    We may originate or acquire fixed and floating rate loans secured by first mortgage liens on income-producing commercial real estate which provide short-, medium- or long- term mortgage financing to commercial property owners that generally have maturity dates ranging from one to ten years.

Fixed rate loans.    Fixed rate loans first mortgage loans are generally made to well-capitalized borrowers and secured by commercial real estate assets with, such loans typically have five- or ten-year balloon payment maturities. Interest rates on fixed rate loans are determined at initiation based on a U.S. Treasury bond with similar duration. As such loans are originated, we expect to hold such loans on our balance sheet that we expect will be supported by an asset-based lending facility to be provided to us by a third party. When and if the commercial real estate securitization markets return, we expect that we may pool fixed rate loans with other mortgages for sale into CMBS transactions and, upon the sale, repay the borrowings on the warehouse facility and recycle the equity capital used to originate or acquire these loans. Key drivers of returns in fixed rate loan products are the interest rates and the net interest margin.

Floating rate loans.    Floating rate loans are generally made to well-capitalized borrowers and secured by commercial real estate assets, such loans typically having one- to five-year maturities. Interest rates on floating rate loans are determined using an index such as the London Interbank Offer Rate, or LIBOR, or other base rate for establishing the interest rate for a relevant period. As such loans are originated, we expect to hold such loans on our balance sheet that we expect will be supported by an asset based lending facility to be provided to us by a third party. When and if the commercial real estate securitization markets return, we expect that we may pool floating rate loans with other mortgages for sale into CMBS transactions several times a year and, upon the sale, repay the borrowings on the warehouse facility and recycle the equity capital used to originate or acquire these loans. Key drivers of returns in floating rate loan products are the interest rates, fees, and net interest margin.

In some cases, we may originate and fund a first mortgage loan with the intention of selling the senior tranche and retaining the subordinated tranche, or a B-Note, or a mezzanine loan tranche. We may receive origination fees, extension fees, modification fees or similar fees in connection with our first mortgage loans.

 

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Senior participation interests in first mortgage loans.    A senior participation interest in an underlying first mortgage loan on commercial real estate, or A-Note, is created by virtue of a participation or similar agreement to which the originator of the loan is a party, along with one or more participants, the performance of which depends upon the performance of the underlying loan. If the underlying borrower defaults, the participant typically has no recourse against the originator of the loan.

We expect that over time most of our investment activity will take the form of first mortgage originations.

To a lesser extent, we will originate, acquire and manage CMBS:

Commercial mortgage-backed securities.    CMBS are securities which are collateralized by, or evidence ownership interests in, a mortgage loan secured by a single commercial property, or a partial or entire pool of mortgage loans secured by commercial properties. We may purchase investment grade CMBS, which are rated BBB- (or Baa3) or higher. We do not generally expect to otherwise acquire below investment grade CMBS, which are rated lower than BBB- (or Baa3), or unrated CMBS, provided that below investment grade CMBS and unrated CMBS may be retained in connection with a sale or securitization of our first mortgage loans. For the first two to three quarters following the completion of this offering and the concurrent private placement, we intend to deploy a significant portion of the net proceeds from these offerings (resulting in a greater percentage of our overall portfolio of target assets than we expect to have within approximately 12 months following the completion of this offering and the concurrent private placement) to acquire senior CMBS to opportunistically take advantage of the TALF. We expect the CMBS we acquire during this initial period to be the most senior priority by subordination with respect to vintages from 2008 and earlier and investment grade with respect to more recent vintages. Additionally, until other appropriate uses for the net proceeds of this offering and the concurrent private placement can be identified, we may invest in senior CMBS with short duration.

In general, we intend to purchase CMBS that we expect will yield high current interest income and where we consider the return of principal to be likely. The yields on CMBS depend on the timely payment of interest on, and principal of, the underlying mortgage loans. Defaults by the borrowers under such loans may ultimately result in deficiencies and defaults on the CMBS. In the event of a default by the issuer of the CMBS, the trustee for the benefit of the holders of the CMBS has recourse only to the underlying pool of mortgage loans and, if an underlying mortgage loan is in default, to the property securing such 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. Holders of senior classes of CMBS expect to 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 junior classes of the CMBS, although such protection is not absolute.

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. To the extent the market allows, we intend to finance our first mortgage loans in part through the issuance of AAA-rated CMBS, which we expect should be eligible to be purchased by investors who are able to borrow under the TALF, while retaining the subordinate securities in our portfolio. CMBS financed under the TALF may not be junior to other securities with claims on the same pool of underlying commercial mortgage loans, must have a credit rating in the highest long-term investment-grade rating category from at least two TALF CMBS-eligible rating agencies and must not have a credit rating below the highest investment-grade rating category from any TALF CMBS-eligible rating agency. There can be no assurance that we will be able to utilize the TALF or any other U.S. Government programs successfully or at all. See “Management’s discussion and analysis of financial condition and results of operations—Recent regulatory developments.”

Non-core assets:    We expect a relatively small portion of our investment activity will take the form of:

First mortgage loan financing.    Loans made to holders of commercial real estate first mortgage loans that are secured by such first mortgage loans. The performance of first mortgage loan financing will depend upon the performance of the underlying real estate collateral.

 

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B-Notes.    We may originate B-Notes or acquire them in negotiated transactions with other originators or in the secondary market. 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 or group. The subordination of a B-Note typically is evidenced by an inter-creditor agreement with the holder of the related A-Note. B-Notes are subject to more credit risk with respect to the underlying mortgage collateral than the corresponding A-Note. We may receive origination fees, extension fees, modification or similar fees in connection with our B-Notes.

Mezzanine loans.    We may originate or acquire mezzanine loans, which are loans made to commercial property owners that are secured by pledges of the borrower’s ownership interests in the property and/or the property owner. Because mezzanine loans are not directly secured by a mortgage on the subject property, they are effectively subordinate to whole loans secured by first or second mortgage liens on that property, but are senior to the borrower’s equity in the property. Upon default, the mezzanine lender can foreclose on the ownership interests pledged under the loan and thereby succeed to ownership of the property, subject to liens of the mortgage holders on the property. Mezzanine loans are subject to more credit risk that mortgage loans. We may receive origination fees, extension fees, modification or similar fees in connection with our mezzanine loans.

In addition, we may elect to collaborate with one or more other sources of capital to originate or acquire fixed rate, interim or mezzanine loans or invest in a special situation that would require an aggregate amount of capital that is either too large for us to provide alone or which we would not want to provide alone due to the impact such a transaction would have on the overall diversification of our portfolio. In such a case, we may choose to form a new subsidiary or form or otherwise invest in a joint venture vehicle or other entity to facilitate execution of such a transaction. The exact structure and terms of any such arrangement would be determined on a case-by-case basis.

Other commercial real estate-related investments

In addition to our target assets described above, subject to maintaining our qualification as a REIT, we may also make limited purchases in certain non-core assets, including corporate bank debt, corporate bonds, preferred equity interests, term loans and revolving or syndicated credit facilities, real estate assets related to corporate divestitures and other real estate-related debt.

Target asset guidelines

Our board of directors will adopt the following target asset guidelines:

 

 

no investment will be made that would cause us to fail to qualify as a REIT for U.S. federal income tax purposes;

 

 

no investment will be made that would cause us to be regulated as an investment company under the 1940 Act;

 

 

our portfolio will be predominantly in our target assets;

 

 

at least a majority of our assets (beginning with the 12-month anniversary of the completion of this offering and the concurrent private placement) will consist of first mortgage loans;

 

 

no investment will be made in land loans or “ground up” or other construction loans; and

 

 

until other appropriate uses can be identified, our Manager may invest the proceeds of this and any future offerings in interest-bearing, short-term investments, including money market accounts and senior CMBS with short duration, that are consistent with our intention to qualify as a REIT.

 

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For the first two to three quarters following the completion of this offering and the concurrent private placement, we intend to deploy a significant portion of the net proceeds from these offerings (resulting in a greater percentage of our overall portfolio of target assets than we expect to have within approximately 12 months following the completion of this offering and the concurrent private placement) to acquire senior CMBS to opportunistically take advantage of the TALF. We expect the CMBS we acquire during this initial period to be the most senior priority by subordination with respect to vintages from 2008 and earlier and investment grade with respect to more recent vintages. We expect that over time most of our investment activity will take the form of first mortgage originations.

Our target asset guidelines will generally not limit the amount of equity that may be deployed in any type of our target assets. In addition, our target asset guidelines may be changed from time to time by our board of directors without the approval of our stockholders.

Our investment decisions will depend on prevailing market conditions and may change over time in response to opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of our equity that will be invested in any of our target assets at any given time. We believe that the flexibility of our investment strategy, combined with our expertise in our target assets and our long-term focus on newly originated senior assets, will enable us to make distributions and achieve capital appreciation throughout changing interest rate and credit cycles and provide attractive risk-adjusted long-term returns to our stockholders under a variety of market conditions and economic cycles.

Leverage policies

We intend to employ prudent leverage, to the extent available, to fund the origination and acquisition of our target assets and to increase potential returns to our stockholders. Although we are not required to maintain any particular leverage ratio, the amount of leverage we will deploy for particular target assets will depend upon our Manager’s assessment of a variety of factors, which may include the anticipated liquidity and price volatility of the target assets in our portfolio, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and commercial mortgage markets, our outlook for the level, slope, and volatility of interest rates, the credit quality of our target assets, the collateral underlying our target assets, and our outlook for asset spreads relative to the LIBOR curve. Our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our indebtedness policy at any time. We intend to use leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.

Financing and hedging strategy

Initially, we intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. With respect to other U.S. Government programs, to the extent we utilize them at all, we would expect to utilize such amount of non-recourse leverage up to the amount permitted under the guidelines of the applicable program. When market conditions allow, we intend to finance our first mortgage loans in part through the issuance of AAA-rated CMBS, which we expect should be eligible to be purchased by investors who are able to borrow under the TALF, while retaining the subordinate securities in our portfolio. There can be no assurance that we will be able to utilize the TALF or any other U.S. Government programs successfully or at all. See “Management’s discussion and analysis of financial condition and results of operations—Recent regulatory developments” for a description of the TALF and other U.S. Government programs. We will also seek to obtain financings, including secured term loans or revolving facilities, traditional repurchase or other secured credit facilities

 

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and other private funding sources. In addition, when market conditions allow, we expect to reduce the principal risk associated with our origination and investment activities through securitizations, syndications, participations and, to the extent consistent with maintaining our qualification as a REIT, other sales of portions of our assets, and we may choose to enhance our returns through the prudent use of higher leverage, with an emphasis on using term financings, including through the creation of securitization vehicles. We may also seek to raise further equity capital or issue debt securities in order to fund our future activities.

The Term Asset-Backed Securities Loan Facility

In response to the severe dislocation in the credit markets, the U.S. Treasury and the Federal Reserve jointly announced the establishment of the TALF on November 25, 2008. The TALF is designed to increase credit availability and support economic activity by facilitating renewed securitization activities. Under the TALF, the Federal Reserve Bank of New York, or the FRBNY, provides non-recourse loans to borrowers to fund their purchase of eligible assets, which initially included certain ABS, but not RMBS or CMBS. On March 23, 2009, the U.S. Treasury announced preliminary plans to expand the TALF to include non-Agency RMBS and CMBS. On May 1, 2009, the Federal Reserve provided more of the details as to how TALF is to be expanded to CMBS and explained that beginning on June 16, 2009, up to $100 billion of TALF loans will be available to finance purchases of CMBS created on or after January 1, 2009. Additionally, on May 19, 2009, the Federal Reserve announced that legacy CMBS, would become eligible collateral under the TALF starting on July 16, 2009.

We believe that the expansion of the TALF to include highly rated new issuance CMBS may provide us with attractively priced non-recourse term borrowings that we could use to purchase CMBS that are eligible for funding under this program. Once the legacy CMBS requirements are finalized, we believe that the TALF may also provide us with attractively priced non-recourse term financing for the acquisition of legacy CMBS. However, there can be no assurance we will be able to utilize the TALF to finance the acquisition of legacy CMBS or that the financing terms will be attractive. See “Management’s discussion and analysis of financial condition and results of operations—Recent regulatory developments—The Term Asset Backed Securities Loan Facility.”

Securitizations, syndications and sales

We intend to seek to enhance the returns on a portion of our commercial mortgage loans, especially loan originations, through securitizations that may be supported by the TALF. To the extent available, we intend to securitize the senior portion of certain of our mortgage loans expected to be equivalent to investment grade CMBS, while retaining the subordinate securities in our portfolio. In order to facilitate the securitization market, the TALF is currently expected to provide financing to buyers of AAA-rated CMBS. In addition, when market conditions allow, we expect to reduce the principal risk associated with our origination and investment activities through securitizations, syndications and participations of our assets.

Credit facilities

We may fund purchases of our assets with credit facilities (including term loans and revolving facilities), although we currently do not have commitments for any credit facilities. These financings may be collateralized or non-collateralized and may involve one or more lenders. We expect these credit facilities will typically have maturities ranging from two to five years and may accrue interest at either fixed or floating rates.

Warehouse facilities

We may use temporary financing mechanisms such as warehouse facilities to finance assets. We currently do not have commitments for any warehouse facilities. We may use warehouse facilities in connection with the structuring of securitization transactions. Prior to an expected securitization issuance, there is a period during which securities and assets are identified and acquired for potential inclusion in the securitization, known as a warehouse accumulation period. The warehouse provider purchases these securities and assets

 

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and holds them on its balance sheet. We would direct the acquisition of securities and assets by the warehouse provider during this period and would contribute cash and other collateral to be held in escrow by the warehouse provider to cover our share of losses should securities or assets need to be liquidated. Typically, we would share gains, including the net interest income earned during the warehouse period, and losses, if any, with the warehouse provider.

Repurchase agreements

We may finance a portion of our assets through the use of short-term repurchase agreements and other short-term financings. We currently do not have commitments for any repurchase agreements. Repurchase agreements will effectively allow us to borrow against loans and securities that we own. Under these agreements, we will sell our loans and securities to a counterparty and agree to repurchase the same loans and securities from the counterparty at a price equal to the original sales price plus an interest factor. We expect to account for these agreements as debt secured by the underlying assets. During the term of a repurchase agreement, we earn the principal and interest on the underlying assets net of interest to the counterparty.

Seller-provided financing

We believe that sellers of whole loans and existing CMBS will include investment banks that are reducing inventory of loans and bonds and mid-sized to small commercial banks that might be forced to liquidate inventory for liquidity and regulatory capital purposes. We believe that commercial banks and investment banks that are seeking to dispose of whole loans and CMBS may be a source of financing for our purchases of their securities.

Total return swaps

Subject to maintaining our REIT qualification, we may finance certain of our assets using total return swaps. Total return swaps allow an investor to gain exposure to an underlying loan without actually owning the loan. In these swaps, the total return (interest, fees and capital gains/losses on an underlying loan) is paid to an investor in exchange for a floating rate payment. The investor pays a fraction of the value of the total amount of the loan that is referenced in the swap as collateral posted with the swap counterparty. The total return swap is thus a leveraged purchase of the underlying loan.

Total return swaps may not be qualifying real estate assets for purposes of the REIT asset tests and income therefrom may not be qualifying income for purposes of the REIT income tests. We may enter into total return swaps through a TRS, which would limit our ability to enter into such transactions and could cause the income from such swaps to be subject to U.S. federal corporate income tax.

Other potential sources of financing

We may also seek to raise further equity capital or issue debt securities in order to fund our future investments. In addition, as the credit markets recover, we may choose to enhance our returns through the prudent use of higher leverage, with an emphasis on using term financings, including through the creation of securitization vehicles.

Derivative financial instruments

Subject to maintaining our qualification as a REIT, we intend to utilize derivative financial instruments (or hedging instruments), including interest rate swap agreements, interest rate cap agreements, interest rate swaptions, puts and calls on securities or indices of securities, exchange traded derivatives, U.S. Treasury securities and options on U.S. Treasury securities, and interest rate floors, in an effort to hedge the interest rate risk associated with the financing of our portfolio of target assets. Specifically, we will seek to hedge part of our exposure to potential interest rate mismatches between the interest we earn on our assets and our borrowing costs caused by fluctuations in short-term interest rates. In utilizing leverage and interest rate

 

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hedges, our objectives will be to improve risk-adjusted returns and, where possible, to lock in, on a long-term basis, a spread between the yield on our assets and the cost of our financing.

Investment committee

Our Manager will have an investment committee that will initially be chaired by Brian Harris and will also include Greta Guggenheim, Pamela McCormack and our Chief Financial Officer. Our Manager’s investment committee will make investment, financing, asset management and disposition decisions on our behalf. The investment committee will periodically review our portfolio and its compliance with our target asset guidelines, and our asset management team will provide our board of directors a report at the end of each quarter in conjunction with its review of our quarterly results. For a description of our target asset guidelines, please see “—Target asset guidelines.” All of our investments will require the approval of our Manager’s investment committee. In addition, any investment in excess of 10% of our equity will require the approval of the risk and underwriting committee of our board of directors, which consists of Brian Harris, Jonathan Bilzin, Howard Park and                  and                 , two of our independent directors, acting by an 80% supermajority vote. Any investment in excess of 20% of our equity will require the approval of our board of directors. From time to time, as it deems appropriate or necessary, the risk and underwriting committee of our board of directors and our board of directors will also review our portfolio and its compliance with our target asset guidelines and the appropriateness of our target asset guidelines and strategies. For a description of our risk and underwriting committee, please see “Our management—Risk and underwriting committee.”

Investment process

The table below outlines the expected flow of our operations from asset origination to closing and asset management.

LOGO

Origination, due diligence and underwriting of loans

Our Manager will focus on the origination and select acquisition of income-producing commercial real estate first mortgage loans. Our Manager will be responsible for each stage of our loan origination and acquisition process, which will include: (1) sourcing deals from the brokerage community and directly from real estate owners, operators, developers and investors; (2) performing due diligence with respect to underwriting the investment; (3) undertaking risk management with respect to individual loans and our aggregate portfolio; (4) executing the closing of a loan investment; and (5) analyzing ongoing capital markets and asset management options.

The origination process typically begins when a loan broker visits a property and assembles an application “package” for submission to a loan originator. The loan broker’s visit is generally the first of many physical reviews of the property, which is usually checked several times by various parties to ensure that the building is safe, well-built and has the characteristics, qualities, and value represented by the borrower. If a loan

 

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originator is satisfied with the broker’s package, credit and background checks on all counterparties are conducted and a term sheet is delivered to the borrower. The term sheet generally outlines the interest rate and offered terms (maturity and amortization schedule) as well as various lending requirements (such as insurance, escrows, reserve requirements and lockbox requirements). The document generally states that the loan application or term sheet is contingent on a full underwriting confirming the value and characteristics of the property. If the borrower accepts, the underwriting process begins.

An underwriter’s role is to perform due diligence on a property and verify and expand upon the originator’s due diligence on investments. Our underwriters are expected to conduct and manage a thorough due diligence and underwriting process with respect to our loans.

The first step in the underwriting is generally a site and property inspection by an in-house or contracted underwriter with expertise in the particular property type and geographic region. The underwriter will also generally hire third parties to gather and analyze market data on rents, values, vacancy rates, supply, absorption, demographics and employment, including available “market color” that is not widely known by people outside of the relevant region and is generally obtained from colleagues and other contacts within the commercial real estate industry. These processes are often run in parallel with those of other third party vendors engaged to conduct specific, specialized due diligence. As part of the process, the underwriter will generally review and approve all summaries and reports prepared by third party vendors, which generally include: an independent MAI appraisal (which indicates that the appraisal has been issued by a Member of the American Appraisal Institute, a trade organization that monitors appraisers and holds them to a higher standard than appraisers who are merely licensed but do not belong to such an organization. Market practices generally require that either the property is “clean” before lending or that any risks identified are controlled) for an independent opinion of value as well as additional supporting property and market data; a property condition/engineering report typically issued by an approved licensed engineer and/or registered architect for an independent and specialized assessment of the safety and soundness of a property and that typically is intended to identify any issues that may warrant further investigation and provide an estimate of the cost to bring a property into good repair; environmental report(s), including a Phase I Environmental Assessment, from an environmental consulting firm to identify and evaluate potential environmental hazards including ground water pollution, polychlorinated biphenyl, lead paint, asbestos and/or radon gas; and agreed upon procedures completed by independent third-party accountants (where applicable).

In addition to conducting diligence on the property’s physical characteristics, the underwriter generally performs cash flow analyses. Such cash flow analyses are generally used to determine the ability of the property to generate cash, and they may include assessing current and historical data on the property’s rent roll, operating expenses, capital expenditures, reserves and lease structure; calculating the property’s NOI to estimate the building’s value by measuring the property’s ability to generate income after expenses but before taxes, depreciation and debt service; and calculating the property’s underwritten net cash flow to estimate the building’s ability to service its debt by adjusting the NOI to account for anticipated future income based on existing lease terms for increased rents and/or anticipated future expenses including tenant roll-over and replacement or repair of major building components.

As part of the cash flow analyses, the underwriter will generally look at all engineering reports for the cost to repair or remediate any deficiencies. In addition, just as underwriters generally use outside experts to evaluate the physical condition of the building, they also generally hire outside counsel to evaluate the various legal documents such as the leases, title, title insurance, opinion letters, tenant estoppels, organizational documents (for the borrower’s corporate structure), and other agreements and documents related to the property.

If the condition and value of a property and the cash flow it produces are strong enough to support the loan requested, and if the pricing of the loan appears profitable, the underwriter is expected to prepare a complete credit memorandum and asset summary to present the loan to our Manager’s investment committee.

 

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Origination, acquisition, due diligence and underwriting of other target assets

In addition, our Manager will be responsible for sourcing and screening other investment opportunities, assessing investment suitability, conducting interest rate and prepayment analysis, evaluating cash flow and collateral performance, reviewing legal structure, servicer and originator information and structuring investments, as appropriate. Upon identification of an investment opportunity, the investment will be screened and monitored by our Manager to determine its impact on maintaining our REIT qualification and our exemption from registration under the 1940 Act. Once a potential investment has been identified, our Manager will perform financial, operational, credit and legal due diligence to assess the risks of the investment. Our Manager will analyze our target assets and conduct follow-up due diligence as part of the underwriting process. As part of this process, the key factors which our Manager will consider include, but are not limited to, documentation, debt-to-income ratio, loan-to-value ratios and property valuation. Consideration is also given to other factors such as price of the pool, geographic concentrations and type of product. Our Manager will refine its underwriting criteria based upon actual loan portfolio experience and as market conditions and investor requirements evolve. The evaluation process will also include relative value analyses based on yield, credit rating, average life, expected duration, option-adjusted spreads, prepayment assumptions and credit exceptions. Other considerations in our investment process will include analysis of fundamental economic trends, suitability for investment by a REIT and relevant regulatory developments.

In evaluating the merits of any particular proposed investment, our Manager will also evaluate the diversification of our portfolio of assets. Prior to making a final investment decision, our Manager will determine whether it expects that a target asset would cause our portfolio of assets to be too heavily concentrated with, or cause too much risk exposure to, any one borrower, real estate sector, geographic region, source of cash flow for payment or other issues. If our Manager determines that a proposed investment presents excessive concentration risk, it may determine not to acquire an otherwise attractive asset on our behalf.

Risk management

Risk management is a significant component of our strategy to deliver consistent risk-adjusted returns to our stockholders. As part of our risk management strategy, our Manager will closely monitor our portfolio and actively manage the financing, interest rate, credit, prepayment and convexity risks associated with holding a portfolio of our target assets. In addition to evaluating the merits of any particular proposed acquisition, our Manager will evaluate the diversification of our portfolio of assets. Prior to making a final investment decision, our Manager will determine whether a target asset will cause our portfolio of assets to be too heavily concentrated with, or cause too much risk exposure to, any one borrower, real estate sector, geographic region, source of cash flow for payment or other issues. If our Manager determines that a proposed acquisition presents excessive concentration risk, it may determine not to acquire an otherwise attractive asset on our behalf. In addition, our Manager’s investment committee, our risk and underwriting committee or our board of directors, as applicable, will approve each transaction based on its size.

Transaction management.    Members of the transaction management team will generally be responsible for coordinating the use of and managing outside counsel and will generally work directly with originators and borrowers to manage, structure, negotiate and close all transactions, including reviewing documents and due diligence reports, consulting with outside counsel on significant business, credit and/or legal issues, as well as facilitating the funding and closing of all investments and dispositions, including through securitizations and other loan sales. Members of this team will also be expected to assist with whole or partial loan sales, support asset managers with post closing issues and coordinate with internal business control units to facilitate transactions.

Asset management.    We consider active asset management to be an integral part of successfully managing commercial real estate debt. Our Manager, through the Ladder Capital Group, has a dedicated, in-house

 

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asset management team comprised of experienced professionals who will provide us with critical oversight. Our Manager’s asset management team will monitor all assets in our portfolio and work closely with borrowers to assist in maximizing performance of our assets. With respect to our mortgage assets, our Manager’s asset management team will review and monitor annual budgets on a quarterly basis for any variance, directing follow-up and other questions back to the borrower. In addition we also review monthly remittance reports to ensure that our mortgage loan servicers strictly adhere to the servicing standards set forth in the applicable servicing agreements. Loan modifications, asset recapitalizations and other variations to a borrower’s business plan or budget will generally be vetted through our Manager’s asset management team with a recommended course of action presented for approval to our Manager’s investment committee, our risk and underwriting committee or our board of directors, as applicable. With respect to our CMBS, our Manager’s asset management team will review monthly remittance reports to ensure that the master and special servicers and trustee strictly adhere to the servicing standards set forth in the applicable pooling and servicing agreements. Quarterly portfolio management reports will generally be prepared by our Manager’s asset management team to assist us with internal risk management and all materials will be submitted to our Manager’s investment committee, risk and underwriting committee and board of directors for review on a quarterly basis. Our focus and value creation will be centered on careful asset specific and market surveillance, rigid enforcement of loan and security rights, and timely sale of underperforming positions. One of the key determinants in the underwriting process is the evaluation of potential exit strategies. Our Manager’s asset management team will monitor each asset and review the potential disposition strategies on a regular basis in order to position assets to realize appreciated values and maximize returns.

A primary responsibility of our Manager’s asset management team will be to interface with both the mortgage loan servicers and securities custodians engaged by it for loan level oversight and asset performance tracking. Specific responsibilities of our Manager’s asset management team include: coordinating cash processing and cash management for collections and distributions to our company through mortgage loan servicers and/or borrower lock box accounts that are set up to trap all cash flow from a mortgaged property; monitoring tax and insurance administration to ensure timely payments from funded escrows to appropriate authorities and maintenance or placement of applicable insurance coverages for mortgaged properties; assisting with escrow analysis to maintain appropriate balances in required accounts; monitoring Uniform Commercial Code administration for continued compliance with lien laws in various jurisdictions; assisting with reserve and draw management from pre-funded loan collateral reserve accounts, including monitoring draw requests for legitimacy and budget accuracy; coordinating and conducting site inspections and surveillance activities, including periodic analysis of financial statements, rent rolls, and operating statements; completing and continually updating asset summary reviews; and providing complete portfolio management reporting to ensure that borrowers remain compliant with the terms of their loans and remain on target for established budgets and business plans.

Market risk management.    Risk management is an integral component of our strategy to deliver returns to our stockholders. Because we will originate and/or acquire commercial real estate mortgage loans and other real estate debt instruments including CMBS, losses from prepayments, defaults, interest rate volatility, credit spread movement or other risks can meaningfully reduce or eliminate funds available for distribution to our stockholders. In addition, because we will employ financial leverage in funding our asset portfolio, mismatches in the maturities of our assets and liabilities can create risk in the need to continually renew or otherwise refinance our liabilities. Our net interest margin will be dependent upon a positive spread between the returns on our asset portfolio and our overall cost of funding. To minimize the risks to our portfolio, we intend to actively employ portfolio wide and asset-specific risk measurement and management processes in our daily operations together with our ongoing active asset management functions. Our Manager’s risk management tools include software and services licensed or purchased from third parties. We may manage spread volatility by shorting positions in an index that closely mimics the characteristics of the assets being held in long positions. In addition, we may attempt to mitigate risk by securitizing, syndicating or, to the extent consistent with maintaining our qualification as a REIT, otherwise selling portions of our assets.

 

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Credit risk management.    Through our investment strategy, we will seek to limit our credit losses and reduce our financing costs. However, we retain the risk of potential credit losses on all of the commercial mortgage loans, other real estate-related debt instruments, and the mortgage loans underlying the CMBS we may originate or acquire. We seek to manage this risk through employment of our extensive due diligence and rigorous underwriting processes and standards and through the use of non-recourse financing, when and where available and appropriate, on a risk-adjusted basis which limits our exposure to credit losses to the specific pool of mortgages that are subject to the non-recourse financing as well as through the use of appropriate derivative financial instruments and other hedging strategies. In addition, with respect to any particular target asset, our Manager’s asset management team will evaluate, among other things, relative valuation, comparable analyses, supply and demand trends, shape of yield curves, prepayment rates, delinquency and default rates, recovery of various sectors and vintage of collateral. Following origination or acquisition of our target assets, our Manager’s asset management team will rigorously monitor our portfolio for early detection of any potential credit or legal risks that may be mitigated or resolved prior to impairing any given asset.

Interest rate hedging.    Subject to maintaining our qualification as a REIT, we intend to engage in a variety of interest rate management techniques that seek on one hand to mitigate the economic effect of interest rate changes on the values of, and returns on, some of our assets, and on the other hand help us achieve our risk management objective. Under the U.S. federal income tax laws applicable to REITs, we generally will be able to enter into certain transactions to hedge indebtedness that we may incur, or plan to incur, to acquire or carry real estate assets, although our total gross income from interest rate hedges that do not meet this requirement and other non-qualifying income generally must not exceed 5% of our gross income.

We intend to utilize derivative financial instruments, including, among others, puts and calls on securities or indices of securities, interest rate swaps, interest rate caps, interest rate swaptions, exchange-traded derivatives, U.S. Treasury securities and options on U.S. Treasury securities and interest rate floors to hedge all or a portion of the interest rate risk associated with the financing of our portfolio. Specifically, we will seek to hedge our exposure to potential interest rate mismatches between the interest we earn on our assets and our borrowing costs caused by fluctuations in short-term interest rates. In utilizing leverage and interest rate hedges, our objectives will be to improve risk-adjusted returns and, where possible, to lock in, on a long-term basis, a favorable spread between the yield on our assets and the cost of our financing. We will rely on our Manager’s expertise to manage these risks on our behalf.

The U.S. federal income tax rules applicable to REITs, may require us to implement certain of these techniques through a TRS that is fully subject to U.S. federal, state and, if applicable, local corporate income tax.

Liquidity risk management.    Liquidity risk is the risk of being unable to preserve stable, reliable, and cost-effective funding sources to meet all near-term and projected long-term financial obligations. In addition to the equity funding provided by our stockholders, we expect external funding sources will consist primarily of unsecured and secured financings provided by banking institutions, other financings that may become available to us under recently established U.S. Government programs such as the TALF, and the issuance of CMBS. It is our intention to structure our funding programs to allow for flexible usage as funds will be repaid and re-drawn as assets generate cash and as we make additional investments. The external funding programs are expected to include a mix of committed and uncommitted sources that will provide short- and long- term funding over the expected holding periods of our individual assets. Initially, we intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. With respect to other U.S. Government programs, to the extent we utilize them at all, we would expect to utilize such amount of non-recourse leverage up to the amount permitted under the guidelines of the applicable program. We will maintain a contingency funding plan and perform related analyses to ensure that liquidity is available on a continuous basis even during disruptions in the capital markets of the type experienced in recent years.

 

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Regulatory

We will obtain applicable and/or federal licenses and/or “doing business” authorizations in most of the fifty states where we intend to conduct business, including in those jurisdictions where a license is required to participate in equity transactions or to purchase or sell commercial mortgage or mezzanine loans in the secondary market.

Policies with respect to certain other activities

If our board of directors determines that additional funding is required, we may raise such funds through additional offerings of equity or debt securities or the retention of cash flow (subject to provisions in the Internal Revenue Code concerning distribution requirements and the taxability of undistributed REIT taxable income) or a combination of these methods. In the event that our board of directors determines to raise additional equity capital, it has the authority, without stockholder approval, to issue additional common stock or preferred stock in any manner and on such terms and for such consideration as it deems appropriate, at any time.

In addition, to the extent available, we intend to borrow money to finance the acquisition of our assets. We intend to use traditional forms of financing, including securitizations, as well as financing that may be available to us through the TALF and other U.S. Government programs in the event that we are eligible pursuant to the terms and conditions of those programs. We also may utilize structured financing techniques, such as collateralized debt obligations, or CDOs, or other securitization vehicles, to create attractively priced non-recourse financing at an all-in borrowing cost that is lower than that provided by traditional sources of financing and that provide long-term, floating rate financing. Our target asset guidelines, the assets in our portfolio and our leverage policy are periodically reviewed by our board of directors as part of their supervision and oversight of our Manager.

We do not currently intend to offer equity or debt securities in exchange for property. We may, subject to gross income and asset tests necessary for REIT qualification, invest in the debt securities of other REITs or other entities engaged in real estate operating or financing activities, but not for the purpose of exercising control over such entities.

We may offer equity or debt securities in exchange for property or to repurchase or otherwise reacquire shares of our common stock. Subject to the percentage of ownership limitations and gross income tests necessary for REIT qualification, we may in the future purchase debt securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities. We do not intend that our investments in securities will require us to register as an investment company under the 1940 Act, and we intend to divest such securities before any such registration would be required.

We expect to engage in the purchase and sale of assets. Consistent with our target asset guidelines, we may in the future make loans to third parties in the ordinary course of business for investment purposes. We do not currently intend to underwrite the securities of other issuers.

We intend to make available to our shareholders our annual reports, including our audited financial statements. After this offering, we will become subject to the information reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Pursuant to those requirements, we will be required to file annual and periodic reports, proxy statements and other information, including audited financial statements, with the SEC.

Our board of directors may change any of these policies without prior notice to you or a vote of our stockholders.

 

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Operating and regulatory structure

REIT qualification

We intend to elect to qualify as a REIT commencing with our taxable year ending on December 31, 2009. Our qualification as a REIT depends upon our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Internal Revenue Code of 1986, as amended, or 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 diversity of ownership of our shares of common stock. We believe that we have been organized 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 meet the requirements for qualification and taxation as a REIT.

So long as we qualify as a REIT, we generally will not be subject to U.S. federal income tax on our taxable income that we distribute currently to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lost our REIT qualification. Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income or property.

1940 Act exemption

We intend to conduct our operations so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities,” among other things, are U.S. Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.

The determination of whether an entity is a majority-owned subsidiary of our company is made by us. The 1940 Act defines a majority-owned subsidiary of a person as a company 50% or more of the outstanding voting securities of which are owned by such person, or by another company which is a majority-owned subsidiary of such person. The 1940 Act further defines voting securities as any security presently entitling the owner or holder thereof to vote for the election of directors of a company. We treat companies in which we own at least a majority of the outstanding voting securities as majority-owned subsidiaries for purposes of the 40% test. We have not requested the SEC to approve our treatment of any company as a majority-owned subsidiary and the SEC has not done so. If the SEC were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.

We are organized as a holding company that conducts its businesses primarily through our operating partnership and its wholly-owned subsidiaries. Both our company and our operating partnership intend to conduct their operations so that they comply with the 40% test. The securities issued to our operating partnership by any wholly-owned or majority-owned subsidiaries that we may form in the future that are excepted from the definition of “investment company” based on Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities our operating partnership may own, may not have a value in excess of 40% of the value of our operating partnership’s total assets on an unconsolidated basis. We will monitor our holdings to ensure continuing and ongoing compliance with this test. In addition, we believe

 

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neither our company nor our operating partnership will be considered an investment company under Section 3(a)(1)(A) of the 1940 Act because we will not engage primarily or hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through our operating partnership’s wholly-owned subsidiaries, our company and our operating partnership will be primarily engaged in the non-investment company businesses of these subsidiaries.

If the value of securities issued by our subsidiaries that are excepted from the definition of “investment company” by Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities we own, exceeds 40% of our total assets on an unconsolidated basis, or if one or more of such subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either (1) to substantially change the manner in which we conduct our operations to avoid being required to register as an investment company or (2) to register as an investment company under the 1940 Act, either of which could have an adverse effect on us and the market price of our securities. If we were required to register as an investment company under the 1940 Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), portfolio composition, including restrictions with respect to diversification and industry concentration, and other matters.

We expect Ladder Realty I LLC to qualify for an exemption from registration under the 1940 Act as an investment company pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” In addition, certain other subsidiaries that we may form in the future also may qualify for the Section 3(c)(5)(C) exemption. This exemption generally requires that at least 55% of such subsidiaries’ assets must be comprised of qualifying assets and at least 80% of each of their portfolios must be comprised of qualifying assets and real estate-related assets under the 1940 Act. Qualifying assets for this purpose include commercial mortgage loans (including interim loans), and certain B-Notes and mezzanine loans that satisfy the conditions set forth in recent SEC staff no-action letters, or the Relevant No-Action Letter Conditions. We intend to treat as real estate-related assets A-Notes, CMBS, B-Notes and mezzanine loans that do not satisfy the Relevant No-Action Letter Conditions, debt and equity securities of companies primarily engaged in real estate businesses and securities issued by pass-through entities of which substantially all of the assets consist of qualifying assets and/or real estate-related assets. Although we intend to monitor our portfolio periodically and prior to each asset acquisition, there can be no assurance that we will be able to maintain this exemption from registration for these subsidiaries.

We will organize a special purpose subsidiary for the purpose of borrowing under the TALF and we may in the future organize additional special purpose subsidiaries that would borrow under the TALF. We expect that these TALF subsidiaries will rely on Section 3(c)(7) for their 1940 Act exemption and, therefore, our operating partnership’s interest in each of these TALF subsidiaries would constitute an “investment security” for purposes of determining whether our operating partnership passes the 40% test. We may in the future organize one or more TALF subsidiaries that seek to rely on the 1940 Act exemption provided to certain structured financing vehicles by Rule 3a-7. Any such TALF subsidiary would need to be structured to comply with any guidance that may be issued by the Division of Investment Management of the SEC on the restrictions contained in Rule 3a-7. We expect that the aggregate value of our operating partnership’s interests in TALF subsidiaries that seek to rely on Rule 3a-7 will comprise less than 20% of our operating partnership’s (and, therefore, our company’s) total assets on an unconsolidated basis.

In general, Rule 3a-7 exempts from the 1940 Act issuers that limit their activities as follows:

 

 

the issuer issues securities the payment of which depends primarily on the cash flow from “eligible assets,” which include many of the types of assets that we expect to acquire in our TALF fundings, that by their terms convert into cash within a finite time period;

 

 

any securities sold to the public are fixed income securities rated investment grade by at least one rating agency (fixed income securities which are unrated or rated below investment grade may be sold to

 

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institutional accredited investors and any securities may be sold to “qualified institutional buyers” and to persons involved in the organization or operation of the issuer);

 

 

the issuer acquires and disposes of eligible assets (1) only in accordance with the agreements pursuant to which the securities are issued, (2) so that the acquisition or disposition does not result in a downgrading of the issuer’s fixed income securities and (3) the eligible assets are not acquired or disposed of for the primary purpose of recognizing gains or decreasing losses resulting from market value changes; and

 

 

unless the issuer is issuing only commercial paper, the issuer appoints an independent trustee, takes reasonable steps to transfer to the trustee an ownership or perfected security interest in the eligible assets, and meets rating agency requirements for commingling of cash flows.

In addition, in certain circumstances, compliance with Rule 3a-7 may also require, among other things, that the indenture governing the subsidiary include additional limitations on the types of assets the subsidiary may sell or acquire out of the proceeds of assets that mature, are refinanced or otherwise sold, on the period of time during which such transactions may occur, and on the level of transactions that may occur. In light of the requirements of Rule 3a-7, our ability to manage assets held in a special purpose subsidiary that complies with Rule 3a-7 will be limited and we may not be able to purchase or sell assets owned by that subsidiary when we would otherwise desire to do so, which could lead to losses.

Qualification for exemption from registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of our subsidiaries that rely on Section 3(c)(5)(C) to invest directly in CMBS that represent less than the entire ownership in a pool of mortgage loans, debt and equity tranches of securitizations and certain ABS and real estate companies or in assets not related to real estate. To the extent that the SEC staff provides more specific guidance regarding any of the matters bearing upon such exclusions, we may be required to adjust our strategy accordingly. Any additional guidance from the SEC staff could provide additional flexibility to us, or it could further inhibit our ability to pursue the strategies we have chosen.

Competition

In acquiring our target assets, we will compete with other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, including the Ladder Capital Group, investment banking firms, financial institutions, governmental bodies and other entities, including other programs, funds, vehicles, managed accounts, ventures and other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired. See “—Market opportunity.” In addition, there are numerous REITs with similar business objectives, including a number that have been recently formed, and others may be organized in the future. These other REITs will increase competition for the available supply of mortgage assets suitable for purchase and origination. Many of our anticipated competitors are significantly larger than we are, have access to greater capital and other resources and may have other advantages over 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 we can. Current market conditions may attract more competitors, which may increase the competition for sources of financing. An increase in the competition for sources of funding could adversely affect the availability and cost of financing, and thereby adversely affect the market price of our common stock. See “—Market opportunity.”

In the face of this competition, we expect to have access to our Manager’s, our Advisor’s and the Ladder Capital Group’s professionals and their industry expertise, which may provide us with a competitive advantage and help us assess investment risks and determine appropriate pricing for certain potential assets. We expect that these relationships will enable us to compete more effectively for attractive investment opportunities. In addition, we believe that current market conditions may have adversely affected the financial condition of certain competitors. Thus, not having a legacy portfolio may also enable

 

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us to compete more effectively for attractive investment opportunities. However, we may not be able to achieve our business goals or expectations due to the competitive risks that we face. For additional information concerning these competitive risks, see “Risk factors—Risks related to our portfolio—We operate in a highly competitive market for investment opportunities and competition may limit our ability to acquire desirable target assets and could also affect the pricing of these assets.”

Staffing

We will be externally managed and advised by our Manager pursuant to the management agreement between our Manager and us. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. Upon completion of this offering, we will have no employees, other than our Chief Financial Officer. See “Our Manager and the management agreement—management agreement.”

Legal proceedings

Neither we nor, to our knowledge, our Manager is currently a party or subject to any legal proceedings which we or our Manager consider to be material.

 

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Our management

Our directors, director nominees and executive officers

Currently, we have two directors. Prior to the completion of this offering and the concurrent private placement, our board of directors is expected to be comprised of seven directors, including the independent director nominees named below who will become directors upon completion of this offering and the concurrent private placement. Of the seven directors, we expect that our board of directors will determine that each of them other than Brian Harris, Howard Park and Jonathan Bilzin will be considered independent in accordance with the requirements of the NYSE. Our bylaws provide that a majority of the entire board of directors may at any time increase or decrease the number of directors. However, unless our bylaws are amended, the number of directors may never be less than the minimum number required by the MGCL nor more than 15.

The following sets forth certain information with respect to our directors, director nominees, executive officers and other key personnel:

 

Name    Age    Position held with us
 

Brian R. Harris

   48    Chief Executive Officer and Director Nominee

Howard Park

   46    Director Nominee

Jonathan Bilzin

   36    Director Nominee
      Director Nominee*
      Director Nominee*
      Director Nominee*
      Director Nominee*

Greta Guggenheim

   50    President
      Chief Financial Officer

Marc Fox

   49    Chief Operating Officer and Interim Principal Accounting Officer

Pamela L. McCormack

   38    General Counsel, Head of Transaction Management and Secretary

Robert M. Perelman

   46    Managing Director and Head of Asset Management
 

 

*   Our board of directors will nominate a director that it determines will be considered an independent director under the NYSE independence standards.

 

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Set forth below is biographical information for our directors, director nominees and executive officers.

Our directors and director nominees

Brian Harris.    Brian Harris is our Chief Executive Officer and a director nominee. Mr. Harris is one of the co-founders of the Ladder Capital Group. Mr. Harris has been the Chief Executive Officer of Ladder Capital Finance Holdings LLC since October 2008 and Ladder Capital Realty Finance Manager LLC since June 2009. Mr. Harris has more than 23 years of experience in the real estate and financial markets. From March 1996 through April 1999, Brian Harris was the Head of Commercial Mortgage Trading at Credit Suisse Securities (USA) LLC, or Credit Suisse, responsible for managing all proprietary commercial real estate investment and trading activities. From June 1999 through May 2007, Mr. Harris managed commercial real estate activities for UBS Securities LLC, or UBS. Mr. Harris was a Managing Director and Head of Global Commercial Real Estate at UBS. Mr. Harris joined UBS in 1999 and remained there until he left to join Dillon Read Capital Management, or DRCM, a wholly owned subsidiary of UBS in early 2006. Mr. Harris managed UBS’s proprietary commercial real estate activities globally and was a Member of the Board of Directors of UBS Investment Bank from April 2003 through September 2005. From early 2006 through May 2007, Mr. Harris was a Managing Director and Senior Partner of DRCM, managing over $500 million of equity capital from UBS for DRCM’s commercial real estate activities globally. Prior to that, Mr. Harris also worked in the real estate groups at Lehman Brothers, Salomon Brothers, Smith Barney and Daiwa Securities. Mr. Harris earned a B.S. in Biology and an M.B.A. from The State University of New York at Albany.

Howard Park.    Howard Park is one of our director nominees. Since October 2008, he has served on the board of Ladder Capital Finance Holdings LLC. Mr. Park has also served as a Managing Director of GI International L.P., or GI Partners, a private equity firm based in Menlo Park, since March 2003. Mr. Park currently serves on the boards of Plum Healthcare, a leading operator of nursing facilities located throughout California, The Planet, a service provider that provides efficient connectivity to the internet and related technical support, and Telx Corporation, a service provider that provides collocation, technical support and related services in the United States. Mr. Park also served on the boards of PC Helps and The Duckhorn Wine Company. Mr. Park worked for SG Cowen Securities Corporation from September 1996 to October 2002 and Nomura Securities International, Inc. from October 1990 to September 1996, primarily in principal investments and leveraged finance. Mr. Park has extensive buyout experience in a diverse set of industries, including IT services, healthcare and financial services. Mr. Park has also worked at Booz Allen Hamilton as a strategy consultant from August 1988 to September 1990. He graduated cum laude from Rice University with a B.A. in Economics and earned an M.B.A. from the Amos Tuck School of Business at Dartmouth College.

Jonathan Bilzin.    Jonathan Bilzin is one of our director nominees. Since October 2008, he has served on the board of Ladder Capital Finance Holdings LLC. He is also a Senior Managing Director of TowerBrook Capital Partners L.P., or TowerBrook, a private equity firm, where he has worked since it its formation in March 2005. He serves on TowerBrook’s Investment Committee, Portfolio Committee and Risk Committee. From August 1999 until the formation of TowerBrook, Mr. Bilzin was a partner at Soros Private Equity Partners. From July 1994 until July 1997, Mr. Bilzin was a member of the Principal Investment Area and Real Estate Principal Investment Area of Goldman Sachs. Mr. Bilzin earned a B.A. from the University of Michigan and an M.B.A. from the Stanford Graduate School of Business. Mr. Bilzin serves as a director of Spheris Inc., Ironshore Inc., Sound Inpatient Physicians, Inc., Ladder Capital Finance Holdings LLC and Unison Holdings, LLC.

Our executive officers

Greta Guggenheim.    Greta Guggenheim is our President and one of our initial directors. Ms. Guggenheim is one of the co-founders of the Ladder Capital Group. Ms. Guggenheim has been President of Ladder Capital Finance Holdings LLC since October 2008 and Ladder Capital Realty Finance Manager LLC since June 2009. Ms. Guggenheim’s primary focus at the Ladder Capital Group is the management of the origination,

 

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underwriting, closing and asset management of new loan originations and acquisitions and the direct management of the employees dedicated to these functions. Ms. Guggenheim worked at UBS and DRCM from 2002 through 2007 as a Managing Director and the Head of the Investments/Originations Group. Ms. Guggenheim has 23 years of experience in the commercial real estate industry. Before joining UBS, Ms. Guggenheim worked as a senior originator and as a real estate investment banker at Credit Suisse and Bear Stearns. Ms. Guggenheim is also the Chairman of the board of directors and President of Guggenheim, Inc., a family holding company. Ms. Guggenheim earned a B.A. in Economics & Spanish Literature from Swarthmore College and an M.B.A. from The Wharton School of the University of Pennsylvania.

Marc Fox.    Marc Fox is our Chief Operating Officer and Interim Principal Accounting Officer. Mr. Fox has been Chief Financial Officer of Ladder Capital Finance Holdings LLC since November 2008 and Ladder Capital Realty Finance Manager LLC since June 2009. Mr. Fox joined the Ladder Capital Group from Capmark Financial Group Inc., or Capmark, a diversified company that provides financial services to investors in commercial real estate-related assets. From 1999 to 2007, Mr. Fox was Treasurer of Capmark, where he formulated and executed the capital market strategies. Mr. Fox was significantly involved in the formation of Capmark’s wholly-owned banking platform and debt management of Capmark Bank, a regulated industrial bank subsidiary of Capmark. Mr. Fox formerly worked in the Treasurer’s Office of General Motors Corporation. Mr. Fox earned a B.S. in Economics and an M.B.A. from The Wharton School of the University of Pennsylvania.

Pamela McCormack.    Pamela McCormack is our General Counsel, Head of Transaction Management and Secretary and one of our initial directors. Ms. McCormack is one of the co-founders of the Ladder Capital Group. Ms. McCormack has been General Counsel, Head of Transaction Management and Secretary of Ladder Capital Finance Holdings LLC since October 2008 and Ladder Capital Realty Finance Manager LLC since June 2009. Ms. McCormack joined UBS in 2003 as in-house counsel and later as an Executive Director and Head of Transaction Management. In that capacity, Ms. McCormack managed a team responsible for the structuring, negotiation and closing of all real estate investments globally. Ms. McCormack has over 12 years of experience in the commercial real estate industry. Prior to joining UBS, Ms. McCormack worked at Credit Suisse and as a real estate and finance attorney at Stroock, Stroock & Lavan LLP and Brown Raysman Millstein Felder & Steiner. Ms. McCormack graduated cum laude with a B.A. in English from the State University of New York at Stony Brook and earned a J.D. from St. John’s University School of Law.

Robert Perelman.    Robert Perelman is our Managing Director and Head of Asset Management. Mr. Perelman has served as Managing Director and Head of Asset Management of Ladder Capital Finance Holdings LLC since October 2008 and Ladder Capital Realty Finance Manager LLC since June 2009. Mr. Perelman worked as a Director and Head of Asset Management. Prior to joining UBS in 2006, Mr. Perelman was a Managing Director/Partner at Hudson Realty Capital LLC, a private equity fund, where he worked from 2003 to 2006 and was responsible for loan origination, real estate investments and asset management. Mr. Perelman worked as a Vice President and later as a Director at Credit Suisse from 1998 to 2003. While at Credit Suisse, Mr. Perelman had significant responsibility for the structuring and closing of a wide variety of real estate investments within the U.S. and Asia. Before joining Credit Suisse in 1998, Mr. Perelman practiced law in New York for eight years at Kaye Scholer LLP, Hahn & Hessen LLP and Brown Raysman Millstein Felder & Steiner, specializing in all aspects of real estate and real estate finance, including acquisition, development and workout. Mr. Perelman earned a J.D. from Fordham University School of Law and a B.S. in Telecommunications Management from Syracuse University.

Corporate governance—Board of directors and committees

Our business is managed by our Manager, subject to the supervision and oversight of our board of directors, which has established target asset guidelines described under “Business—Target asset guidelines” for our Manager to follow in its day-to-day management of our business. A majority of our board of directors is anticipated to be “independent,” as determined by the requirements of the NYSE and the regulations of

 

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the SEC. Our directors will keep informed about our business by attending meetings of our board of directors and its committees and through supplemental reports and communications. Our independent directors are expected to meet regularly in executive sessions without the presence of our corporate officers or non-independent directors.

Prior to the completion of this offering and the concurrent private placement, our board of directors will form an audit committee, a compensation committee and a nominating and corporate governance committee and adopt charters for each of these committees. Each of these committees will have three directors and will be composed exclusively of independent directors, as defined by the listing standards of the NYSE. Moreover, the compensation committee will be composed exclusively of individuals intended to be, to the extent provided by Rule 16b-3 of the Exchange Act, non-employee directors and will, at such times as we are subject to Section 162(m) of the Internal Revenue Code, qualify as outside directors for purposes of Section 162(m) of the Internal Revenue Code.

Audit committee

The audit committee will comprise of                 ,                  and                  each of whom will be an independent director and “financially literate” under the rules of the NYSE.                      will chair our audit committee and serve as our audit committee financial expert, as that term is defined by the SEC.

The committee assists the board of directors in overseeing:

 

 

our financial reporting, auditing and internal control activities, including the integrity of our financial statements;

 

 

our compliance with legal and regulatory requirements and ethical behavior;

 

 

the independent auditor’s qualifications and independence;

• the performance of our internal audit function and independent auditor; and

 

 

prepare committee audit reports.

The audit committee is also responsible for engaging our independent registered public accounting firm, reviewing with the independent registered public accounting firm the plans and results of the audit engagement, approving professional services provided by the independent registered public accounting firm, reviewing the independence of the independent registered public accounting firm, considering the range of audit and non-audit fees and reviewing the adequacy of our internal accounting controls.

Compensation committee

The compensation committee will comprise of                     ,                      and                     , each of whom will be an independent director.                      will chair our compensation committee.

The principal functions of the compensation committee will be to:

 

 

review and approve on an annual basis the corporate goals and objectives relevant to our Chief Executive Officer’s compensation, if any, evaluate our Chief Executive Officer’s performance in light of such goals and objectives and, either as a committee or together with our independent directors (as directed by the board of directors), determine and approve the remuneration of our Chief Executive Officer based on such evaluation;

 

 

review and oversee management’s annual process, if any, and evaluate the performance of our senior officers and review and approve on an annual basis the remuneration of our senior officers;

 

 

oversee any equity-based remuneration plans and programs;

 

 

assist the board of directors and the chairman in overseeing the development of executive succession plans;

 

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determine from time to time the remuneration for our non-executive directors (including the chairman);

 

 

evaluate the performance of our Manager;

 

 

review the compensation and fees payable to our Manager under the Management Agreement; and

 

 

prepare compensation committee reports.

Nominating and corporate governance committee

The nominating and corporate governance committee will comprise of             ,              and             , each of whom will be an independent director.                      will chair our nominating and corporate governance committee.

The nominating and corporate governance committee will be responsible for

 

 

providing counsel to the board of directors with respect to the organization, function and composition of the board of directors and its committees;

 

 

overseeing the self-evaluation of the board of directors as a whole and of the individual directors and the board of director’s evaluation of management and report thereon to the board;

 

 

periodically reviewing and, if appropriate, recommending to the board of directors changes to, our corporate governance policies and procedures;

• identifying and recommending to the board of directors potential director candidates for nomination;

 

 

monitoring compliance by our Manager with the conflicts of interest policies relating to interactions with our company and our Manager and its affiliates; and

 

 

approve and recommend to the full board of directors the appointment of each of our executive officers.

Risk and underwriting committee

We have a risk and underwriting committee of our board or directors, which will consist of Brian Harris, Jonathan Bilzin, Howard Park and              and             , two of our independent directors. The approval of the risk and underwriting committee by an 80% supermajority vote will be required for any investment in excess of 10% of our equity. Any investment in excess of 20% of our equity requires the approval of our board of directors. In addition, from time to time, as it deems appropriate or necessary, our risk and underwriting committee will review and evaluate our risk management and processes and procedures relating to the underwriting of risks undertaken by us as well as review on an ongoing basis the target asset guidelines and policies that govern the process by which our exposure to risk is assessed and managed by management. It will also periodically review our portfolio and its compliance with our target asset guidelines and the appropriateness of our target asset guidelines and strategies and make reports and recommendations to our board of directors.

Executive and director compensation

Compensation of directors

A member of our board of directors who is also an employee or affiliate of the Ladder Capital Group is referred to as an executive director. Executive directors will not receive compensation for serving on our board of directors. Each non-executive director will receive an annual base fee for his or her services of $             and an annual deferred director fee of $             in restricted shares of our common stock under our 2009 equity incentive plan. Such restricted shares will vest pro rata on an annual basis over a period of three

 

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years. Each non-executive director will receive $             for each meeting of a committee of our board of directors that he or she attends in person, and $             for each meeting of our board of directors or a committee of our board of directors that he or she attends telephonically. The chairman of our audit committee, the chairman of our compensation committee, the chairman our nominating and corporate governance committee and the chairman of our risk and underwriting committee will receive additional annual fees of $            , $            , $             and $            , respectively. The base annual fee and the meeting fees will be paid in cash and the annual deferred fee will be paid in restricted shares of our common stock which may not be sold or transferred during the non-executive director’s service on our board of directors. The base annual fee, the meeting fees and the annual deferred fee will be paid on a quarterly basis. We will also reimburse each of our directors for their travel expenses incurred in connection with their attendance at full board of directors and committee meetings.

Executive compensation

Because our management agreement provides that our Manager will assume principal responsibility for managing our affairs, our officers, in their capacities as such, will not receive cash compensation from us. Instead we will pay our Manager the fees described in “Our Manager and the management agreement—Management agreement—Management services.” In their capacities as officers or personnel of affiliates of the Ladder Capital Group, persons other than our Chief Financial Officer (who will be exclusively dedicated to our company) will devote such portion of their time to our affairs as is necessary to enable us to operate our business.

Except for certain equity grants, our Manager will compensate each of our executive officers. We will pay our Manager a base management fee and our Manager will use the proceeds from its base management fee in part to pay compensation to its officers and personnel (other than our Chief Financial Officer). Prior to the completion of this offering and the concurrent private placement, we will adopt an equity incentive plan for our officers, our non-employee directors, our Manager’s personnel and other service providers to encourage their efforts toward our continued success, long-term growth and profitability and to attract, reward and retain key personnel. See “—2009 equity incentive plan” for detailed description of our 2009 equity incentive plan.

Section 162(m) of the Internal Revenue Code limits publicly held companies to an annual deduction for federal income tax purposes of $1,000,000 for compensation paid to each of their chief executive officer and their three highest compensated executive officers (other than the Chief Executive Officer or the Chief Financial Officer) determined at the end of each year, referred to as covered employees. However, performance-based compensation is excluded from this limitation. Our 2009 equity incentive plan is designed to permit our compensation committee to grant awards that qualify as performance-based for purposes of satisfying the conditions of Section 162(m), but it is not required under the equity incentive plan that awards qualify for this exception. Our 2009 equity incentive plan provides that no participant in the plan will be permitted to acquire, or will have any right to acquire, shares thereunder if such acquisition would be prohibited by the ownership limits contained in our charter or would impair our status as a REIT.

2009 equity incentive plan

Prior to the completion of this offering and the concurrent private placement, we will adopt an equity incentive plan to provide incentive distribution to attract and retain qualified directors, officers, advisors, consultants and other personnel, including our Manager and affiliates and personnel of our Manager and its affiliates, and any joint venture affiliates of ours. Unless terminated earlier, our 2009 equity incentive plan will terminate in 2019, but will continue to govern unexpired awards. Our 2009 equity incentive plan provides for grants of share options, restricted shares of common stock, phantom shares, dividend equivalent rights and other equity-based awards up to an aggregate of             % of the number of shares of our common stock that we issue in this offering and the concurrent private placement (without giving effect to any exercise by the underwriters of their overallotment option, but including shares issuable upon exchange of OP units issued in the concurrent private placement). In making awards under the plan, our

 

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board of directors or the compensation committee, as applicable, may consider the recommendations of our Manager as to the personnel who should receive awards and the amounts of the awards. We will grant shares of restricted common stock to our Manager under our 2009 equity incentive plan, equal to             % of the number of shares that we issue in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement, which will vest ratably on an annual basis over a three-year period commencing on the first anniversary of the completion of this offering and the concurrent private placement.

Our 2009 equity incentive plan is administered by the compensation committee appointed for such purposes. The compensation committee, as appointed by our board of directors, has the full authority (1) to administer and interpret our 2009 equity incentive plan, (2) to make recommendations to our board of directors with respect to equity awards that are subject to board approval (other than with respect to our chief executive officer), (3) to determine the eligibility of directors, officers, advisors, consultants and other personnel, including our Manager and affiliates and personnel of our Manager and its affiliates, and any joint venture affiliates of ours, to receive an equity award, (4) to determine the number of shares of common stock to be covered by each award (subject to the individual participant limitations provided in our 2009 equity incentive plan), (5) to determine the terms, provisions and conditions of each award (which may not be inconsistent with the terms of our 2009 equity incentive plan), (6) to prescribe the form of instruments evidencing such awards and (7) to take any other actions and make all other determinations that it deems necessary or appropriate in connection with our 2009 equity incentive plan or the administration or interpretation thereof. In connection with this authority, the compensation committee may, among other things, establish performance goals that must be met in order for awards to be granted or to vest, or for the restrictions on any such awards to lapse. From and after the consummation of this offering and the concurrent private placement, the compensation committee will consist solely of non-employee directors, each of whom is intended to be, to the extent required by Rule 16b-3 under the Exchange Act, a non-employee director and will, at such times as we are subject to Section 162(m) of the Internal Revenue Code, qualify as an outside director for purposes of Section 162(m) of the Internal Revenue Code, or, if no committee exists, the board of directors.

Available shares

Our 2009 equity incentive plan provides for grants of share options, restricted common stock, phantom shares, dividend equivalent rights and other equity based awards up to an aggregate of 10% of the number of shares of our common stock that we issue in this offering and the concurrent private placement (without giving effect to any exercise by the underwriters of their overallotment option, but including shares issuable upon exchange of OP units issued in the concurrent private placement). Subject to adjustment upon certain corporate transactions or events, options for more than              shares of common stock over the life of our 2009 equity incentive plan may not be granted. In addition, the maximum number of shares that may underlie awards in any one year to any eligible person may not exceed             . If an award granted under our 2009 equity incentive plan expires or terminates, the shares subject to any portion of the award that expires or terminates without having been exercised or paid, as the case may be, will again become available for the issuance of additional awards. Unless previously terminated by our board of directors, no new award may be granted under our 2009 equity incentive plan after the tenth anniversary of the date that such plan was initially approved by our board of directors. No award may be granted under our 2009 equity incentive plan to any person who, assuming payment of all awards held by such person, would own or be deemed to own more than 9.8% of the outstanding shares of our common stock.

Awards under the plan

Share options.    The terms of specific options, including whether options shall constitute “incentive stock options” for purposes of Section 422(b) of the Internal Revenue Code, shall be determined by the compensation committee. The exercise price of an option shall be determined by the committee and

 

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reflected in the applicable award agreement. The exercise price of an option shall be determined by the compensation committee and reflected in the applicable award agreement. The exercise price with respect to incentive stock options may not be lower than 100% (110% in the case of an incentive stock option granted to a 10% stockholder, if permitted under the 2009 equity incentive plan) of the fair market value of our common stock on the date of grant. Each option will be exercisable after the period or periods specified in the award agreement, which will generally not exceed ten years from the date of grant (or five years in the case of an incentive stock option granted to a 10% stockholder, if permitted under the 2009 equity incentive plan. Options will be exercisable at such times and subject to such terms as determined by the compensation committee.

Restricted shares of common stock.    A restricted share award is an award of shares of common stock that is subject to restrictions on transferability and such other restrictions, if any, the compensation committee may impose at the date of grant. Grants of restricted shares of common stock will be subject to vesting schedules as determined by the compensation committee. The restrictions may lapse separately or in combination at such times, under such circumstances, including, without limitation, a specified period of employment or the satisfaction of pre established criteria, in such installments or otherwise, as the compensation committee may determine. Except to the extent restricted under the award agreement relating to the restricted shares of common stock, a participant granted restricted shares of common stock has all of the rights of a stockholder, including, without limitation, the right to vote and the right to receive dividends on the restricted shares of common stock. Although dividends may be paid on restricted shares of common stock, whether or not vested, at the same rate and on the same date as on shares of our common stock, holders of restricted shares of common stock are prohibited from selling such shares until they vest.

Phantom shares.    A phantom share represents a right to receive the fair value of a share of common stock, or, if provided by the compensation committee, the right to receive the fair value of a share of common stock in excess of a base value established by the compensation committee at the time of grant. Phantom shares may generally be settled in cash or by transfer of shares of common stock (as may be elected by the participant or the compensation committee, as may be provided by the compensation committee at grant). The compensation committee may, in its discretion and under certain circumstances, permit a participant to receive as settlement of the phantom shares installments over a period not to exceed ten years. Unless otherwise determined by the compensation committee, the holders of awards of phantom shares will be entitled to receive dividend equivalents, which shall be payable at such time that dividends are paid on outstanding shares.

Dividend equivalents.    A dividend equivalent is a right to receive (or have credited) the equivalent value (in cash or shares of common stock) of dividends paid on shares of common stock otherwise subject to an award. The compensation committee may provide that amounts payable with respect to dividend equivalents shall be converted into cash or additional shares of common stock. The compensation committee will establish all other limitations and conditions of awards of dividend equivalents as it deems appropriate.

Other share based awards.    Our 2009 equity incentive plan authorizes the granting of other awards based upon shares of our common stock (including the grant of securities convertible into shares of common stock and share appreciation rights), subject to terms and conditions established at the time of grant.

Change in control

Under our 2009 equity incentive plan, a change in control is defined as the occurrence of any of the following events: (i) the acquisition of more than 50% of our voting shares by any person; (ii) the sale or disposition of all or substantially all of our assets; (iii) a merger, consolidation or statutory share exchange where our stockholders immediately prior to such event hold less than 50% of the voting power of the surviving or resulting entity; (iv) during any two year period, our directors, including subsequent directors recommended or approved by our directors, at the beginning of such period cease for any reason other

 

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than due to death to constitute a majority of our board of directors; or (v) stockholder approval of our liquidation or dissolution. Notwithstanding the foregoing, no event or condition described in clauses (i) through (v) above shall constitute a change in control if it results from a transaction between us and our Manager or an affiliate of our Manager.

Upon a change in control, the compensation committee may make such adjustments as it, in its discretion, determines are necessary or appropriate in light of the change in control, but only if the compensation committee determines that the adjustments do not have an adverse economic impact on the participants (as determined at the time of the adjustments).

Amendments and termination

Our board of directors may amend, alter or discontinue our 2009 equity incentive plan but cannot take any action that would impair the rights of a participant without such participant’s consent. To the extent necessary and desirable, the board of directors must obtain approval of our stockholders for any amendment that would:

 

 

other than through adjustment as provided in our 2009 equity incentive plan, increase the total number of shares of common stock reserved for issuance under our 2009 equity incentive plan;

 

 

change the class of officers, directors, employees, consultants and advisors eligible to participate in our 2009 equity incentive plan;

 

 

reprice any awards under our 2009 equity incentive plan; or

 

 

otherwise require such approval.

The compensation committee may amend the terms of any award granted under our 2009 equity incentive plan, prospectively or retroactively, but generally may not impair the rights of any participant without his or her consent.

Code of business conduct and ethics

Our board of directors has established a code of business conduct and ethics that applies to our officers and directors and to our Manager’s officers and any personnel of the Ladder Capital Group when such individuals are acting for or on our behalf. Among other matters, our code of business conduct and ethics is designed to deter wrongdoing and to promote:

 

 

honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

 

 

full, fair, accurate, timely and understandable disclosure in our SEC reports and other public communications;

 

 

compliance with applicable governmental laws, rules and regulations;

 

 

prompt internal reporting of violations of the code to appropriate persons identified in the code; and

 

 

accountability for adherence to the code.

Any waiver of the code of business conduct and ethics for our executive officers or directors may be made only by our board of directors or one of our board committees and will be promptly disclosed as required by law or stock exchange regulations.

 

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Limitation of liability and indemnification

Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision and limits the liability of our directors and officers to the maximum extent permitted by Maryland law.

Our charter authorizes us, to the maximum extent permitted by Maryland law, to indemnify and pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (1) any present or former director or officer of our company or (2) any individual who, while serving as our director or officer and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise as a director, officer, partner or trustee of such corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise, from and against any claim or liability to which such person may become subject or which such person may incur by reason of his or her service in such capacity or capacities. Our bylaws obligate us, to the maximum extent permitted by Maryland law, to indemnify and pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (1) any present or former director or officer of our company who is made or threatened to be made a party to the proceeding by reason of his service in that capacity or (2) any individual who, while serving as our director or officer and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise as a director, officer, partner or trustee of such corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise, and who is made or threatened to be made a party to the proceeding by reason of his service in that capacity. Our charter and bylaws also permit us to indemnify and advance expenses to any person who served any predecessor of our company in any of the capacities described above and to any personnel or agent of our company or of any predecessor.

The MGCL requires us (unless our charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made or threatened to be made a party by reason of his or her service in that capacity. The MGCL permits us to indemnify our present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made or threatened to be made a party by reason of their service in those or other capacities unless it is established that:

 

 

the act or omission of the director or officer was material to the matter giving rise to the proceeding and (1) was committed in bad faith or (2) was the result of active and deliberate dishonesty;

 

 

the director or officer actually received an improper personal benefit in money, property or services; or

 

 

in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful.

Under the MGCL, we may not indemnify a director or officer in a suit by or in the right of the corporation in which the director or officer was adjudged liable on the basis that personal benefit was improperly received. A court may order indemnification if it determines that the director or officer is fairly and reasonably entitled to indemnification, even though the director or officer did not meet the prescribed standard of conduct, was adjudged liable on the basis that personal benefit was improperly received. However, indemnification for an adverse judgment in a suit by us or in our right, or for a judgment of liability on the basis that personal benefit was improperly received, is limited to expenses.

 

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In addition, the MGCL permits us to advance reasonable expenses to a director or officer upon our receipt of:

 

 

a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by the corporation; and

 

 

a written undertaking by the director or officer or on the director’s or officer’s behalf to repay the amount paid or reimbursed by the corporation if it is ultimately determined that the director or officer did not meet the standard of conduct.

We have obtained a policy of insurance under which our directors and officers will be insured, subject to the limits of the policy, against certain losses arising from claims made against such directors and officers by reason of any acts or omissions covered under such policy in their respective capacities as directors or officers, including certain liabilities under the Securities Act.

Rule 10b5-1 sales plans

Our directors and executive officers may adopt written plans, known as Rule 10b5-1 plans, in which they will contract with a broker to buy or sell shares of our common stock on a periodic basis. Under a Rule 10b5-1 plan, a broker executes trades pursuant to parameters established by the director or officer when entering into the plan, without further direction from them. The director or officer may amend a Rule 10b5-1 plan in some circumstances and may terminate a plan at any time. Our directors and executive officers also may buy or sell additional shares outside of a Rule 10b5-1 plan when they are not in possession of material nonpublic information subject to compliance with the terms of our insider trading policy. Prior to the 180th-day anniversary of the date of this prospectus (subject to potential extension or early termination), the sale of any shares under such plan will be subject to the lock-up agreement that the director or officer has entered into with the underwriters.

 

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Our Manager and the management agreement

General

We will be externally managed and advised by our Manager. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers is also an executive at one or more affiliates of the Ladder Capital Group. The executive offices of our Manager are located at 600 Lexington Avenue, 23rd Floor, New York, New York 10022, and the telephone number of our Manager’s executive offices is (212) 715-3170.

Officers of our manager

The following sets forth certain information with respect to each of the executive officers of our Manager:

 

Officer    Age    Position held with our Manager
 

Brian Harris

   48    Chief Executive Officer and Director

Greta Guggenheim

   50    President

Marc Fox

   49    Chief Financial Officer

Pamela McCormack

   38    General Counsel, Head of Transaction Management and Secretary

Robert Perelman

   46    Managing Director and Head of Asset Management
 

Set forth below is biographical information for the officers of our Manager.

See “Our management—Our directors, director nominees and executive officers” for biographical information regarding Brian Harris, Greta Guggenheim, Marc Fox, Pamela McCormack and Robert Perelman.

Investment committee

Our Manager will have an investment committee that will initially be chaired by Brian Harris and will also include Greta Guggenheim, Pamela McCormack and our Chief Financial Officer. Our Manager’s investment committee will make investment, financing, asset management and disposition decisions on our behalf. The investment committee will periodically review our portfolio and its compliance with our target asset guidelines, and our asset management team will provide our board of directors a report at the end of each quarter in conjunction with its review of our quarterly results. For a description of our target asset guidelines, please see “Business—Target asset guidelines.” All of our investments will require the approval of our Manager’s investment committee. In addition, any investment in excess of 10% of our equity will require the approval of the risk and underwriting committee of our board of directors, which consists of Brian Harris, Jonathan Bilzin, Howard Park and              and             , two of our independent directors, acting by an 80% supermajority vote. Any investment in excess of 20% of our equity will require the approval of our board of directors. From time to time, as it deems appropriate or necessary, the risk and underwriting committee of our board of directors and our board of directors will also review our portfolio and its compliance with our target asset guidelines and the appropriateness of our target asset guidelines and strategies. For a description of our risk and underwriting committee, please see “Our management—Risk and underwriting committee.”

Management agreement

Upon completion of this offering and the concurrent private offering, we will enter into a management agreement with our Manager pursuant to which it will implement our investment strategy and perform certain services for us. The management agreement will require our Manager to manage our business affairs in conformity with the target asset guidelines and other policies that are approved and monitored by our board of directors. Our Manager’s role as manager will be under the supervision and direction of our board of directors.

 

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Management services

The management agreement requires our Manager to manage our business affairs in conformity with the target asset guidelines and other policies that are approved and monitored by our board of directors. Our manager’s role as manager is under the supervision and oversight of our board of directors. Our Manager will be responsible for, among other duties, (1) performing all of our day-to-day functions, (2) determining our investment strategy and guidelines in conjunction with our board of directors, (3) sourcing, analyzing and executing investments, asset sales and financings, (4) performing asset management duties; and (5) performing financial and accounting management services. In addition, our Manager will have an investment committee that will oversee compliance with our investment strategy and guidelines, investment portfolio holdings and financing strategy.

Along with our day-to-day functions, our Manager will perform (or will cause to be performed) such services and activities relating to our assets and operations as may be appropriate, which may include, without limitation, the following:

 

  (i) serving as our consultant with respect to the periodic review of the target asset guidelines and other parameters for our assets, financing activities and operations, any modification to which will be approved by a majority of our independent directors;

 

  (ii) investigating, analyzing and selecting possible investment opportunities and acquiring, financing, retaining, selling, restructuring or disposing of assets consistent with the target asset guidelines;

 

  (iii) with respect to prospective purchases, sales or exchanges of assets, conducting negotiations on our behalf with sellers, purchasers and brokers and, if applicable, their respective agents and representatives;

 

  (iv) negotiating and entering into, on our behalf, repurchase agreements, credit agreement, securitizations, interest rate swap agreements and other hedging agreements, agreements relating to borrowings under programs established by the U.S. Government and other agreements and instruments required for us to conduct our business;

 

  (v) engaging and supervising, on our behalf and at our expense, independent contractors that provide investment banking, securities brokerage, mortgage brokerage, special servicing, other financial services, due diligence services, underwriting review services, legal and accounting services, and all other services (including transfer agent and registrar services) as may be required relating to our operations or investments (or potential assets);

 

  (vi) advising us on, preparing, negotiating and entering into, on our behalf, applications and agreements relating to programs established by the U.S. Government;

 

  (vii) coordinating and managing operations of any joint venture interests held by us and conducting all matters with the joint venture partners;

 

  (viii) providing executive and administrative personnel, office space and office services required in rendering services to us;

 

  (ix) administering the day-to-day operations and performing and supervising the performance of such other administrative functions necessary to our management as may be agreed upon by our Manager and our board of directors, including, without limitation, the collection of revenues and the payment of our debts and obligations and maintenance of appropriate computer services to perform such administrative functions;

 

  (x) communicating on our behalf with the holders of any of our equity or debt securities as required to satisfy the reporting and other requirements of any governmental bodies or agencies or trading markets and to maintain effective relations with such holders;

 

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  (xi) counseling us in connection with policy decisions to be made by our board of directors;

 

  (xii) evaluating and recommending to our board of directors hedging strategies and engaging in hedging activities on our behalf, consistent with such strategies as so modified from time to time, with our qualification as a REIT and with our target asset guidelines;

 

  (xiii) counseling us regarding the maintenance of our qualification as a REIT and monitoring compliance with the various REIT qualification tests and other rules set out in the Internal Revenue Code and Treasury Regulations thereunder and using commercially reasonable efforts to cause us to qualify for taxation as a REIT;

 

  (xiv) counseling us regarding the maintenance of our exemption from the status of an investment company required to register under the 1940 Act, monitoring compliance with the requirements for maintaining such exemption and using commercially reasonable efforts to cause us to maintain such exemption from such status;

 

  (xv) furnishing reports and statistical and economic research to us regarding our activities and services performed for us by our Manager;

 

  (xvi) monitoring the operating performance of our assets and providing periodic reports with respect thereto to the board of directors, including comparative information with respect to such operating performance and budgeted or projected operating results;

 

  (xvii) deploying and reinvesting any moneys and securities of ours (including investing in short-term investments pending investment in other investments, payment of fees, costs and expenses, or payments of dividends or distributions to our stockholders and partners) and advising us as to our capital structure and capital raising;

 

  (xviii) causing us to retain qualified accountants and legal counsel, as applicable, to assist in developing appropriate accounting procedures and systems, internal controls and other compliance procedures and testing systems with respect to financial reporting obligations and compliance with the provisions of the Internal Revenue Code applicable to REITs and, if applicable, TRSs, and to conduct quarterly compliance reviews with respect thereto;

 

  (xix) assisting us in qualifying to do business in all applicable jurisdictions and to obtain and maintain all appropriate licenses;

 

  (xx) assisting us in complying with all regulatory requirements applicable to us in respect of our business activities, including preparing or causing to be prepared all financial statements required under applicable regulations and contractual undertakings and all reports and documents, if any, required under the Exchange Act, the Securities Act, or by the NYSE;

 

  (xxi) assisting us in taking all necessary action to enable us to make required tax filings and reports, including soliciting stockholders for required information to the extent required by the provisions of the Internal Revenue Code applicable to REITs;

 

  (xxii) placing, or arranging for the placement of, all orders pursuant to our Manager’s investment determinations for us either directly with the issuer or with a broker or dealer (including any affiliated broker or dealer);

 

  (xxiii) handling and resolving all claims, disputes or controversies (including all litigation, arbitration, settlement or other proceedings or negotiations) in which we may be involved or to which we may be subject arising out of our day-to-day operations (other than with our Manager or its affiliates), subject to such limitations or parameters as may be imposed from time to time by the board of directors;

 

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  (xxiv) using commercially reasonable efforts to cause expenses incurred by us or on our behalf to be commercially reasonable or commercially customary and within any budgeted parameters or expense guidelines set by the board of directors from time to time;

 

  (xxv) advising us with respect to and structuring long-term financing vehicles for our portfolio of assets, and offering and selling securities publicly or privately in connection with any such structured financing;

 

  (xxvi) forming our Manager’s investment committee, which will propose target asset guidelines to be approved by a majority of our independent directors;

 

  (xxvii) serving as our consultant with respect to decisions regarding any of our financings, hedging activities or borrowings undertaken by us including (1) assisting us in developing criteria for debt and equity financing that is specifically tailored to our investment objectives, and (2) advising us with respect to obtaining appropriate financing for our investments;

 

  (xxviii) providing us with portfolio management;

 

  (xxix) arranging marketing materials, advertising, industry group activities (such as conference participations and industry organization memberships) and other promotional efforts designed to promote our business;

 

  (xxx) performing such other services as may be required from time to time for management and other activities relating to our assets and business as our board of directors shall reasonably request or our Manager shall deem appropriate under the particular circumstances; and

 

  (xxxi) using commercially reasonable efforts to cause us to comply with all applicable laws.

Liability and indemnification

Pursuant to the management agreement, our Manager will not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Our Manager maintains a contractual as opposed to a fiduciary relationship with us. Under the terms of the management agreement, our Manager, its officers, stockholders, members, managers, directors, personnel, any persons controlling or controlled by our Manager and any person providing sub-advisory services to our Manager will not be liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the management agreement, except because of acts constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the management agreement, as determined by a final non-appealable order of a court of competent jurisdiction. We have agreed to indemnify our Manager, and its affiliates, including the Ladder Capital Group, with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts or omissions of such indemnified parties not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties, performed in good faith in accordance with and pursuant to the management agreement. Our Manager has agreed to indemnify us, our directors and officers, personnel, agents and any persons controlling or controlled by us with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our Manager constituting bad faith, willful misconduct, gross negligence or reckless disregard of its duties under the management agreement or any claims by our Manager’s personnel relating to the terms and conditions of their employment by our Manager. Our Manager will not be liable for trade errors that may result from ordinary negligence, such as errors in the investment decision making process (such as a transaction that was effected in violation of our target asset guidelines) or in the trade process (such as a buy order that was entered instead of a sell order, or the wrong purchase or sale of security, or a transaction in which a security was purchased or sold in an amount or at a price other than the correct amount or price).

 

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If our Manager or any of its officers, directors, stockholders or employees becomes involved in any suit, action, proceeding or investigation in connection with any matter arising out of or in connection with our Manager’s duties under the management agreement, we will periodically reimburse such person for reasonable legal and other expenses (including the cost of any investigation and preparation) incurred in connection therewith. However, prior to any such advancement of expenses, such person must provide us with (i) an undertaking to promptly repay us if it is ultimately determined that such person was not entitled to be indemnified as provided in the management agreement, and (ii) a written affirmation that such person in good faith believes that it has met the standard of conduct necessary for indemnification under the management agreement.

Any person entitled to indemnification under the management agreement must seek recovery under any insurance policies by which such person is covered and must obtain our written consent prior to entering into any compromise or settlement which would result in us having an obligation to indemnify such person. Any amounts actually recovered under any applicable insurance policies will offset any amounts that we owe pursuant to our indemnification obligations under the management agreement. If the amounts for which indemnification is sought arise out of the conduct of our business and affairs and also of any other person for which an indemnified party was then acting in a similar capacity, the amount of the indemnification to be provided by us may be limited to our proportionate share thereof if so determined by us in good faith.

Management team

Pursuant to the terms of the management agreement, our Manager will be responsible for administering our business activities and day-to-day operations and will provide us with our management team and appropriate support personnel. Pursuant to an advisory agreement between our Manager and our Advisor, our Manager will have access to the personnel and resources of the Ladder Capital Group necessary for the implementation and execution of our investment strategy. Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. The Ladder Capital Group will not be obligated to dedicate any of its other executive officers or personnel exclusively to us. In addition, none of the Ladder Capital Group, its executive officers and other personnel, including our executive officers supplied to us by the Ladder Capital Group (other than our Chief Financial Officer), will be obligated to dedicate any specific portion of its or their time to our company. Our Manager will be subject to the supervision and oversight of our board of directors.

Our Manager is required to refrain from any action that, in its sole judgment made in good faith, (1) is not in compliance with the target asset guidelines, (2) would adversely and materially affect our qualification as a REIT under the Internal Revenue Code or our status as an entity intended to be exempted or excluded from investment company status under the 1940 Act or (3) would violate any law, rule or regulation of any governmental body or agency having jurisdiction over us or that would otherwise not be permitted by our charter or bylaws. If our Manager is ordered to take any action by our board of directors, our Manager will promptly notify the board of directors if it is our Manager’s judgment that such action would adversely and materially affect such status or violate any such law, rule or regulation or our charter or bylaws. Our Manager, its directors, members, officers, stockholders, managers, personnel, employees and any person controlling or controlled by our Manager and any person providing sub-advisory services to our Manager will not be liable to us, our board of directors, our stockholders, partners or members, for any act or omission by our Manager, its directors, officers, stockholders or employees except as provided in the management agreement.

Term and termination

The management agreement may be amended or modified by agreement between us and our Manager. The initial term of the management agreement expires on the third anniversary of the closing of this

 

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offering and the concurrent private placement and will be automatically renewed for a one-year term each anniversary date thereafter unless previously terminated as described below. Our independent directors will review annually our Manager’s performance and the fees payable to our Manager and, following the initial term, the management agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, based upon (1) unsatisfactory performance that is materially detrimental to us or (2) our determination that the fees payable to our Manager are not fair, subject to our Manager’s right to prevent such termination due to unfair fees by accepting a reduction of fees agreed to by at least two-thirds of our independent directors. We must provide 180 days prior notice of any such termination. Upon such a termination, we will pay our Manager a termination fee equal to three times the average annual base management fee during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter.

We may also terminate the management agreement at any time, including during the initial term, without the payment of any termination fee, with 30 days prior written notice from our board of directors for cause, which is defined as:

 

 

our Manager’s continued material breach of any provision of the management agreement following a period of 30 days after written notice thereof (or 45 days after written notice of such breach if our Manager, under certain circumstances, has taken steps to cure such breach within 30 days of the written notice);

 

 

our Manager’s fraud, misappropriation of funds, or embezzlement against us;

 

 

our Manager’s gross negligence of duties under the management agreement;

 

 

the occurrence of certain events with respect to the bankruptcy or insolvency of our Manager, including an order for relief in an involuntary bankruptcy case or our Manager authorizing or filing a voluntary bankruptcy petition;

 

 

a change of control (as defined in the management agreement) of our Manager to which at least 75% of the members of our Board of Directors, after receiving notice of such change of control, have objected in writing based on the reasonable belief that such change of control will result in unsatisfactory performance by our Manager that is materially detrimental to us;

 

 

our Manager is convicted (including a plea of nolo contendere) of a felony; and

 

 

the dissolution of our Manager.

The termination fee will be equal to three times the average annual base management fee during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. The termination fee will be payable upon termination of the management agreement by us without cause or by our Manager if we materially breach the management agreement.

In addition, if the management agreement is terminated under circumstances pursuant to which we are obligated to pay a termination fee to our Manager, our operating partnership will redeem, concurrently with such termination, the Class B units for an amount equal to three times the average annual distributions paid in respect of the Class B units during the 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. If the management agreement is terminated under circumstances where we are not obligated to pay a termination fee to our Manager, then our operating partnership will redeem the Class B units for $100.

Our Manager may assign the agreement in its entirety or delegate certain of its duties under the management agreement to any of its affiliates without the approval of our independent directors if such assignment or delegation does not require our approval under the 1940 Act.

 

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Our Manager may terminate the management agreement if we become required to register as an investment company under the 1940 Act, with such termination deemed to occur immediately before such event, in which case we would not be required to pay a termination fee. Our Manager may decline to renew the management agreement by providing us with 180 days written notice, in which case we would not be required to pay a termination fee. In addition, if we default in the performance of any material term of the agreement and the default continues for a period of 30 days after written notice to us, our Manager may terminate the management agreement upon 60 days’ written notice. If the management agreement is terminated by our Manager upon our breach, we would be required to pay our Manager the termination fee described above.

We may not assign our rights or responsibilities under the management agreement without the prior written consent of our Manager, except in the case of assignment to another REIT or other organization which is our successor, in which case such successor organization will be bound under the management agreement and by the terms of such assignment in the same manner as we are bound under the management agreement.

Management fees, incentive fees and expense reimbursements

We do not expect to maintain an office or directly employ personnel. Instead we rely on the facilities and resources of our Manager to manage our day-to-day operations.

Base management fee

We will pay our Manager a base management fee in an amount equal to 1.50% of our stockholders’ equity per annum and calculated and payable quarterly in arrears in cash. For purposes of calculating the base management fee, our stockholders’ equity means: (1) the sum of (a) the net proceeds from all issuances of our equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus (b) our retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less (2) any amount that we pay to repurchase our common stock since inception. Our stockholders’ equity also excludes (1) any unrealized gains and losses and other non-cash items that have impacted stockholders’ equity as reported in our financial statements prepared in accordance with GAAP, and (2) one-time events pursuant to changes in GAAP, and certain non-cash items not otherwise described above, in each case after discussions between our Manager and our independent directors and approval by a majority of our independent directors. As a result, our stockholders’ equity, for purposes of calculating the base management fee, could be greater or less than the amount of stockholders’ equity shown on our financial statements. Our Manager will use the proceeds from its base management fee in part to pay compensation to its officers and personnel (other than our Chief Financial Officer) who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us.

The management fee of our Manager shall be calculated within 30 days after the end of each quarter and such calculation shall be promptly delivered to us. We are obligated to pay the management fee in cash within five business days after delivery to us of the written statement of our Manager setting forth the computation of the management fee for such quarter.

As a component of our Manager’s compensation, we may in the future issue to our Manager or personnel of our Manager stock-based compensation under our 2009 equity incentive plan.

Except for Class B units, we will treat issuances of limited partner interests of our operating partnership other than to us as equity securities for purposes of calculating the base management fee.

 

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Incentive distribution and allocation

Our operating partnership has issued Class B units to our Manager to provide an incentive to our Manager to enhance the value of our common stock. Under the partnership agreement of our operating partnership, the Class B units owned by our Manager entitle it to receive an incentive allocation and distribution (which we refer to as the incentive distribution), until redeemed, in an amount equal to 20% of the dollar amount by which Core Earnings (as defined in the partnership agreement of our operating partnership), on a rolling four-quarter basis and before the incentive distribution for the current quarter, exceeds the product of (1) the weighted average of the issue price per share of all of our offerings multiplied by the weighted average number of shares of common stock outstanding in such quarter and (2) 8%.

For the initial four quarters following this offering, Core Earnings will be calculated on the basis of each of the previously completed quarters on an annualized basis. Core Earnings for the initial quarter will be calculated from the settlement date of this offering on an annualized basis. Core Earnings is a non-GAAP measure and is defined as GAAP net income (loss) excluding non-cash equity compensation expense, unrealized gains, losses or other non-cash items recorded in the period, regardless of whether such items are included in other comprehensive income or loss, or in net income. The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between our Manager and our independent directors and after approval by a majority of our independent directors.

Any net loss incurred by us in a given quarter or quarters will be offset against any net income earned by us in future quarters for purposes of calculating the incentive distribution in such future quarters. For example, if we experience a net loss of $20.0 million in the fourth quarter of a fiscal year and a net loss of $20.0 million in the first quarter of the following fiscal year (for a cumulative net loss of $40.0 million in those two quarters), but then earn net income of $25.0 million in the second quarter and $25.0 million in the third quarter, then our $25.0 million of net income in the second quarter would be reduced to zero, and no incentive distribution would be payable for the second quarter, and our $25.0 million of net income in the third quarter would be reduced by the remaining $15.0 million of net loss to $10.0 million for purposes of calculating the incentive distribution for the third quarter.

Our Manager may elect to receive all or a portion of its incentive distribution in the form of our common stock or OP units, subject to the approval of a majority of our independent directors and all applicable NYSE rules and securities laws; provided, that under our management agreement, our Manager may not receive payment of its incentive distribution in shares of our common stock if such payment would result in our Manager owning directly or indirectly through one or more subsidiaries, shares of our common stock in excess of the ownership limitation applicable to it. To the extent such distribution is paid in shares of our common stock or OP units, the number of shares of our common stock or OP units to be received by our Manager will be based on the average of the closing prices of the shares of our common stock on any national securities exchange over the ten consecutive trading days immediately preceding the issuance of such common stock of OP units.

The number of shares or OP units to be received by our Manager will be based on the fair market value of these shares or units. Shares of our common stock or OP units delivered as payment of the incentive distribution to our Manager will be immediately vested or exercisable, provided that our Manager has agreed not to sell such shares or units prior to one year after the date they are paid. Our Manager has the right in its discretion to allocate these shares or OP units to its officers, employees and other individuals who provide services to it. All shares or OP units allocated by our Manager to such officers, employees and other individuals is not governed by the one-year restriction on sale.

We have agreed to register the resale of these shares of our common stock or shares of common stock that may be issuable upon exchange of OP units. We have also granted our Manager the right to include these shares in any registration statements we might file in connection with any future public offerings, subject only to the right of the underwriters of those offerings to reduce the total number of secondary shares included in those offerings (with such reductions to be proportionately allocated among selling stockholders participating in those offerings).

 

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Reimbursement of expenses

We will be required to reimburse our Manager for the expenses described below. Expense reimbursements to our Manager are made in cash on a monthly basis following the end of each month. Our reimbursement obligation is not subject to any dollar limitation. Because our Manager’s personnel perform certain legal, accounting, due diligence tasks and other services that outside professionals or outside consultants otherwise would perform, our Manager is paid or reimbursed for the documented cost of performing such tasks, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm’s-length basis. We will also reimburse expenses associated with a dedicated Chief Financial Officer and, if provided by our Manager, a dedicated Compliance Officer. Except as referred to in the previous two sentences, we will not reimburse our Manager for the salaries and compensation of its other personnel.

We also pay all operating expenses, except those specifically required to be borne by our Manager under the management agreement. The expenses required to be paid by us include, but are not limited to:

 

 

expenses in connection with the issuance and transaction costs incident to the acquisition, disposition and financing of our investments;

 

 

costs of legal, tax, accounting, consulting, auditing, administrative and other similar services rendered for us by providers retained by our Manager or, if provided by our Manager’s personnel, in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm’s-length basis;

 

 

the compensation and expenses of our directors and the cost of liability insurance to indemnify our directors and officers;

 

 

costs associated with the establishment and maintenance of any of our credit facilities, other financing arrangements, or other indebtedness of ours (including commitment fees, accounting fees, legal fees, closing and other similar costs) or any of our securities offerings;

 

 

expenses in connection with the application for, and participation in, programs established by the U.S. Government;

 

 

expenses connected with communications to holders of our securities or of our subsidiaries and other bookkeeping and clerical work necessary in maintaining relations with holders of such securities and in complying with the continuous reporting and other requirements of governmental bodies or agencies, including, without limitation, all costs of preparing and filing required reports with the SEC, the costs payable by us to any transfer agent and registrar in connection with the listing and/or trading of our stock on any exchange, the fees payable by us to any such exchange in connection with its listing, costs of preparing, printing and mailing our annual report to our stockholders and proxy materials with respect to any meeting of our stockholders;

 

 

costs associated with any computer software or hardware, electronic equipment or purchased information technology services from third-party vendors that is used for us;

 

 

expenses incurred by managers, officers, personnel and agents of our Manager for travel on our behalf and other out-of-pocket expenses incurred by managers, officers, personnel and agents of our Manager in connection with the purchase, financing, refinancing, sale or other disposition of an investment or establishment and maintenance of any of our securitizations or any of our securities offerings;

 

 

costs and expenses incurred with respect to market information systems and publications, research publications and materials, and settlement, clearing and custodial fees and expenses;

 

 

compensation and expenses of our custodian and transfer agent, if any;

 

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the costs of maintaining compliance with all federal, state and local rules and regulations or any other regulatory agency;

 

 

all taxes and license fees;

 

 

all insurance costs incurred in connection with the operation of our business except for the costs attributable to the insurance that our Manager elects to carry for itself and its personnel;

 

 

costs and expenses incurred in contracting with third parties;

 

 

all other costs and expenses relating to our business and investment operations, including, without limitation, the costs and expenses of acquiring, owning, protecting, maintaining, developing and disposing of investments, including appraisal, reporting, audit and legal fees;

 

 

expenses relating to any office(s) or office facilities, including but not limited to disaster backup recovery sites and facilities, maintained for us or our investments separate from the office or offices of our Manager;

 

 

expenses associated with a dedicated Chief Financial Officer and, if provided by our Manager, a dedicated Compliance Officer;

 

 

expenses connected with the payments of interest, dividends or distributions in cash or any other form authorized or caused to be made by the board of directors to or on account of holders of our securities or of our subsidiaries, including, without limitation, in connection with any dividend reinvestment plan;

 

 

any judgment or settlement of pending or threatened proceedings (whether civil, criminal or otherwise) against us or any subsidiary, or against any trustee, director, partner, member or officer of us or of any subsidiary in his capacity as such for which we or any subsidiary is required to indemnify such trustee, director, partner, member or officer by any court or governmental agency; and

 

 

all other expenses actually incurred by our Manager (except as described below) which are reasonably necessary for the performance by our Manager of its duties and functions under the management agreement.

We will not reimburse our Manager for the salaries and other compensation of its personnel, other than our Chief Financial Officer and, if provided by our Manager, a dedicated Compliance Officer. In addition, we may be required to pay our pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of our Manager and its affiliates required for our operations.

Advisory agreement

Our Manager will enter into an advisory agreement with our Advisor effective upon the closing of this offering and the concurrent private placement. Pursuant to this agreement, our Manager will be provided with access to, among other things, the Ladder Capital Group’s portfolio management, asset valuation, risk management and asset management services as well as administration services addressing legal, compliance, investor relations and information technologies necessary for the performance of our Manager’s duties in exchange for a fee representing our Manager’s allocable cost for these services. The fee paid by our Manager pursuant to this agreement shall not constitute a reimbursable expense under the management agreement.

 

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Grants of equity compensation to our Manager, its personnel and its affiliates

Prior to the completion of this offering and the concurrent private placement, we will adopt an equity incentive plan. Our 2009 equity incentive plan will include provisions for grants of restricted common stock and other equity based awards to our directors or officers or any personnel of our Manager and the Ladder Capital Group who provide services to us. We will grant shares of restricted common stock to our Manager under our 2009 equity incentive plan, equal to     % of the number of shares that we issue in this offering (without giving effect to any exercise by the underwriters of their overallotment option) and the concurrent private placement, which will vest ratably on an annual basis over a three-year period commencing on the first anniversary of the completion of this offering and the concurrent private placement. See “Our management—executive and director compensation—2009 equity incentive plan.”

Conflicts of interest

We are subject to the following conflicts of interest relating to the Ladder Capital Group and its affiliates, including our Manager:

Conflicts with the Ladder Capital Group

 

 

Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers will also serve as an officer of the Ladder Capital Group. As a result, these persons will have a conflict of interest with respect to our agreements and arrangements with our Manager and other affiliates of the Ladder Capital Group, which were not negotiated at arm’s length, and their terms may not have been as favorable to us as if they had been negotiated at arm’s length with an unaffiliated third party.

 

 

Other than our Chief Financial Officer who will be exclusively dedicated to our company, our other executive officers will not be required to devote a specific amount of time to our affairs. Accordingly, we will compete with the Ladder Capital Group and any of its current and future programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group, including the Ladder Capital Bank, if acquired, for the time and attention of these officers in connection with our business. In particular, as of June 30, 2009, Holdings, which has an investment strategy substantially similar to ours, has $183.5 million of undrawn committed equity available to be deployed to support future investments, including the purchase of $             million of our common stock (              shares) and $             million of OP units (              OP units) in a private placement to be completed concurrently with this offering.

 

 

Brian Harris, who is our Chief Executive Officer and Chief Executive Officer of our Manager, owns an equity interest in Holdings, the parent entity of the Ladder Capital Group, which is the indirect parent company of our Manager. A portion of the remaining equity interest in Holdings is held by other members of our management team and by entities affiliated with two of our directors. Therefore, Brian Harris and other members of our management team and certain of our directors have interests in our relationships with our Manager and the Ladder Capital Group that are different than the interests of our stockholders. In particular, Brian Harris and the other members of our management team and certain of our directors will have an interest in the financial success of the Ladder Capital Group, which may encourage them to support strategies that impact our company based upon these considerations.

 

 

We have not adopted a policy that expressly prohibits our directors, officers, security holders or affiliates from having a direct or indirect pecuniary interest in any asset to be acquired or disposed of by us or any of our subsidiaries or in any transaction to which we or any of our subsidiaries is a party or has an interest. Nor do we have a policy that expressly prohibits any such persons from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contains a conflict of interest policy that prohibits our directors, officers and employees from engaging in any transaction that involves an actual or apparent conflict of interest with us.

 

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There will be conflicts of interest in allocating investment opportunities to us, the Ladder Capital Group and other programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by the Ladder Capital Group currently or in the future, including the Ladder Capital Bank, if acquired. For example, our management team currently manages Holdings, a specialty finance company that provides a comprehensive set of financing solutions to the commercial real estate industry and which has an investment strategy substantially similar to ours. Further, the profits incentive structure (also known as the “promote structure”) in the Ladder Capital Group or other future entities, including the Ladder Capital Bank, if acquired, could be more advantageous to our management team, which could incentivize them to allocate certain investment opportunities to other entities and/or affiliates of the Ladder Capital Group rather than to our company.

 

 

The Ladder Capital Group may in the future form or sponsor additional programs, funds, vehicles, managed accounts, ventures or other entities, in each case which could have overlapping investment objectives with ours. The Ladder Capital Group will compete with us, and such programs, funds, vehicles, managed accounts, ventures or other entities may compete with us, for investment opportunities. The Ladder Capital Group’s allocation policy may limit our ability to deploy the proceeds from this offering and the concurrent private placement in revenue-generating assets in the near term, which could have a material adverse effect on our results of operations and ability to make distributions to our stockholders.

Conflicts relating to our Manager

 

 

Our Manager may cause us to purchase assets from the Ladder Capital Group or make co-purchases alongside the Ladder Capital Group. Although our management agreement requires that investments in loans originated by and purchased from the Ladder Capital Group and investments in securities structured, issued or managed by the Ladder Capital Group must be approved by a majority of our independent directors, these transactions may not be the result of arm’s length negotiations and may involve conflicts between our interests and the interests of the Ladder Capital Group in obtaining favorable terms and conditions. Any fees paid by us to any affiliate of the Ladder Capital Group in connection with such investments or purchases or in connection with investments managed by it shall be deducted from the base management fee due to our Manager.

 

 

The management agreement provides that, in the absence of cause, it may only be terminated by us after the third anniversary of the closing of this offering and the concurrent private placement, upon the vote of two-thirds of our independent directors or the holders of a majority of our outstanding common stock, based upon unsatisfactory performance by our Manager that is materially detrimental to us or a determination that the compensation payable to our Manager under the management agreement is not fair, unless our Manager agrees to compensation that two-thirds of our independent directors determine is fair. Upon any such termination by us, or upon termination by our Manager due to our material breach, we will be required to make a termination payment to our Manager equal to three times the average annual base management fee during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. In addition, our operating partnership will redeem concurrently with such termination, the Class B units for an amount equal to three times the average annual distributions paid in respect of the Class B units during the 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal quarter. These provisions may substantially restrict our ability to terminate the management agreement without cause, even if we believe our Manager’s performance is not satisfactory, and would cause us to incur substantial costs in connection with such a termination.

 

 

Our Manager does not assume any responsibility beyond the duties specified in the management agreement and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Our Manager’s liability is limited under the management agreement, and we have agreed to indemnify our Manager and its affiliates, including the Ladder Capital Group, with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from

 

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acts or omissions of such indemnified parties not constituting fraud, willful misconduct, gross negligence or reckless disregard of our Manager’s duties under the management agreement which has a material adverse effect on us. As a result, we could experience poor performance or losses for which our Manager would not be liable.

 

 

The manner of determining the base management fee may not sufficiently incentivize our Manager to maximize risk-adjusted returns on our portfolio since it is based on our stockholders’ equity and not on our performance.

 

 

Our Manager, as holder of the Class B units in our operating partnership, will be entitled to an incentive distribution based entirely on our financial performance. This feature of the Class B units may cause our Manager to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, to achieve such eligibility.

Resolution of potential conflicts of interest in allocation of investment opportunities

The Ladder Capital Group has adopted an allocation policy containing both subjective and objective procedures designed to manage potential conflicts of interest between its fiduciary obligations to us and its fiduciary obligations to any current and/or future programs, funds, vehicles, managed accounts, ventures or other entities that the Ladder Capital Group and/ or our Manager own and/or manage with which we have an overlapping strategy. The objective of this policy is to ensure that investment opportunities are allocated in a fair and equitable manner among our company and such other current and/or future programs, funds, vehicles, managed accounts, ventures or other entities that the Ladder Capital Group and/or our Manager own and/or manage with which we have an overlapping strategy.

If the Ladder Capital Group and/or our Manager identify an investment opportunity in our target asset classes that is appropriate for us and any other programs, funds, vehicles, managed accounts, ventures or other entities owned and/or managed by them, but the amount available is less than the amount sought by all of such programs, funds, vehicles, managed accounts, ventures or other entities, the Ladder Capital Group and/or our Manager will allocate the investment opportunity in accordance with the Ladder Capital Group’s allocation policy.

In the event that two such programs have simultaneous needs and/or claims on a given investment opportunity, the Ladder Capital Group and our Manager shall attempt to meet the obligations by allocating such investment opportunity based on need. In the event that is not practicable, the Ladder Capital Group and our Manager shall be required to use their best judgment to resolve the conflict in their sole discretion, usually through a sequential rotation. The Ladder Capital Group and our Manager have agreed that, until at least $300 million of the net proceeds of this offering and the concurrent private placement have been deployed by us into investments in first mortgage loans, they will allocate to our company at least two out of every three first mortgage loan opportunities that are identified as appropriate for our company. Thereafter, with respect to first mortgage loan originations, and at all times with respect to our other target assets, the Ladder Capital Group and our Manager have agreed that they will allocate to our company at least one of every two investment opportunities they source with respect to our other target assets.

Factors that will be considered in prioritizing an investment opportunity among programs, funds, vehicles, managed accounts, ventures or other entities will include the following:

 

 

whether the investment opportunity falls within the program’s investment objectives, policies and strategies;

 

 

availability of capital;

 

 

ability of a program to comply with the investment opportunity’s timing and sensitivities;

 

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whether the transaction is complementary in terms of yield, credit quality and diversification to the program’s existing portfolio;

 

 

duration of the program’s outstanding need;

 

 

ability of the program to best exert control rights;

 

 

availability and terms of financing for such asset; and

 

 

in the event of sequential rotation, the aggregate dollars invested and number of previously closed transactions on behalf of the program.

The foregoing allocation procedures will also apply between us and any current or future programs, funds, vehicles, managed accounts, ventures or other entities that the Ladder Capital Group and/or our Manager own and/or manage with which we have an overlapping strategy, subject to any rights of first offer or similar rights.

The Ladder Capital Group and/or our Manager may make exceptions to these general policies when other circumstances make application of the policies inequitable or inapplicable.

Any transaction between us and the Ladder Capital Group not specifically permitted by our management agreement or the advisory agreement must be approved by a majority of our independent directors. In particular, our management agreement will permit us to purchase loans originated by and purchased from the Ladder Capital Group or in securities structured, issued or managed by the Ladder Capital Group, provided that we obtain prior approval of a majority of our independent directors.

The Ladder Capital Group and/or our Manager may in the future change then-existing, or adopt additional, conflicts of interest resolution policies and procedures designed to support the equitable allocation and to prevent the preferential allocation of investment opportunities among entities with overlapping investment objectives.

Our independent directors will periodically review our Manager’s and the Ladder Capital Group’s compliance with these conflicts of interest and allocation provisions.

The “Ladder Capital Group” license agreement

We have entered into a license agreement with Holdings pursuant to which it has granted us a non-exclusive, royalty-free license to use the name “Holdings.” Under this agreement, we have a right to use this name for so long as Ladder Capital Realty Finance Manager LLC serves as our Manager pursuant to the management agreement. This license will terminate concurrently with any termination of the management agreement.

 

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Principal stockholders

Immediately prior to the completion of this offering and the concurrent private placement, there will be 1,000 shares of common stock outstanding and one stockholder of record. At that time, we will have no other shares of capital stock outstanding. The following table sets forth certain information, prior to and after this offering and the concurrent private placement, regarding the ownership of each class of our capital stock by:

 

 

each of our directors and director nominees;

 

 

each of our executive officers;

 

 

each holder of 5% or more of each class of our capital stock; and

 

 

all of our directors, director nominees and executive officers as a group.

In accordance with SEC rules, each listed person’s beneficial ownership includes:

 

 

all shares the investor actually owns beneficially or of record;

 

 

all shares over which the investor has or shares voting or dispositive control (such as in the capacity as a general partner of an investment fund); and

 

 

all shares the investor has the right to acquire within 60 days (such as shares of restricted common stock that are currently vested or which are scheduled to vest within 60 days).

Unless otherwise indicated, all shares are owned directly, and the indicated person has sole voting and investment power. Except as indicated in the footnotes to the table below, the business address of the stockholders listed below is the address of our principal executive office, 600 Lexington Avenue, 23rd Floor, New York, New York 10022.

 

      Percentage of common stock outstanding
     Immediately prior to
this offering
    Immediately after
this offering(2)
Name and address    Shares owned     Percentage     Shares owned    Percentage
 

Ladder Capital Realty Finance Holdings LLC(1)

   1,000      100%             %

Brian Harris

         

Howard Park

         

Jonathan Bilzin

         

Greta Guggenheim

         

Marc Fox

         

Pamela McCormack

         

Robert Perelman

         

All directors, director nominees and executive officers as a group (     persons)

               
 

 

 *   Represents less than 1% of the number of shares of common stock outstanding upon the closing of this offering and the concurrent private placement.

 

(1)   The Ladder Investor purchased 1,000 shares of our common stock in connection with our initial capitalization on July 13, 2009.

 

(2)   Assumes issuance of              shares of common stock offered hereby,              shares of common stock offered in the concurrent private placement and              restricted shares of common stock granted to our Manager upon completion of this offering and the concurrent private placement. Does not reflect              shares of our common stock reserved for issuance upon exercise of the underwriters’ overallotment option,              shares of our common stock issuable upon an exchange of OP units to be issued in the concurrent private placement and              shares of our common stock reserved for issuance under our 2009 equity incentive plan.

 

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Certain relationships and related transactions

Management agreement, advisory agreement and license agreement

Prior to the completion of this offering and concurrent private placement, we will enter into a management agreement with our Manager, pursuant to which our Manager will provide the day-to-day management of our operations, implement our business strategy and perform certain services for us. The management agreement requires our Manager to manage our business affairs in conformity with the policies and the target asset guidelines that are approved and monitored by our board of directors. The management agreement has an initial three-year term and will be renewed for one-year terms thereafter unless terminated by either us or our Manager. Our Manager is entitled to receive a termination fee from us under certain circumstances. We are also obligated to reimburse certain expenses incurred by our Manager. Our Manager is entitled to receive from us a base management fee and an incentive distribution from us. See “Our Manager and the management agreement—Management agreement.”

Other than our Chief Financial Officer who will be exclusively dedicated to our company, each of our executive officers is also an officer of one or more affiliates of the Ladder Capital Group. As a result, the management agreement between us and our Manager and the partnership agreement of our operating partnership were negotiated between related parties, and the terms, including fees payable to our Manager and the terms of the Class B units held by our Manager, may not be as favorable to us as if it had been negotiated with an unaffiliated third party. See “Our Manager and the management agreement—Conflicts of interest” and “Risk factors—Risks related to our relationship with our Manager—There are various conflicts of interest in our relationship with Holdings and its affiliates, including our Manager, which could result in decisions that are not in the best interests of our stockholders, including that our executive officers (other than our Chief Financial Officer) are also executive officers of Holdings and/or its affiliates, which may result in conflicts between their duties to us and them.”

In addition, our Manager will enter into an advisory agreement with our Advisor, pursuant to which our Advisor will provide our Manager with access to, among other things, the Ladder Capital Group’s portfolio management, asset valuation, risk management and asset management services as well as office space, equipment, personnel, administration services addressing legal, compliance, investor relations and information technologies necessary for the performance of our Manager’s duties in exchange for a fee representing our Manager’s allocable cost for these services. The fee paid by our Manager pursuant to the advisory agreement shall not constitute a reimbursable expense under the management agreement. See “Our Manager and the management agreement—Advisory agreement.”

Our management agreement and the advisory agreement are intended to provide us with access to our Manager’s pipeline of investment opportunities and its personnel and its experience in capital markets, credit analysis, debt structuring and risk and asset management, as well as assistance with corporate operations, legal and compliance functions and governance.

We will also enter into a license agreement with Holdings pursuant to which it will grant us a non-exclusive, royalty-free license to use the name “Holdings.” See “Our Manager and the management agreement—The “Ladder Capital Group” license agreement.” This license will terminate concurrently with any termination of the management agreement.

Related party transaction policies

Our code of business conduct and ethics contains a conflicts of interest policy that prohibits our directors and officers and any other personnel of the Ladder Capital Group who provide services to us from engaging in any transaction that involves an actual conflict of interest with us.

In addition, we expect our board of directors to adopt a policy regarding the approval of any “related person transaction,” which is any transaction or series of transactions in which we or any of our subsidiaries

 

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is or are to be a participant, the amount involved exceeds $120,000, and a “related person” (as defined under SEC rules) has a direct or indirect material interest. Under the policy, a related person would need to promptly disclose to our Secretary any related person transaction and all material facts about the transaction. Our Secretary would then assess and promptly communicate that information to the compensation committee of our board of directors. Based on its consideration of all of the relevant facts and circumstances, the compensation committee will decide whether or not to approve such transaction and will generally approve only those transactions that do not create a conflict of interest. If we become aware of an existing related person transaction that has not been preapproved under this policy, the transaction will be referred to this committee which will evaluate all options available, including ratification, revision or termination of such transaction. Our policy requires any director who may be interested in a related person transaction to recuse himself or herself from any consideration of such related person transaction.

Restricted common stock and other equity-based awards

Our 2009 equity incentive plan will include provisions for grants of restricted common stock and other equity based awards to our directors or officers or any personnel of our Manager and the Ladder Capital Group who provide services to us, up to an aggregate of 10% of the number of shares of our common stock that we issue in this offering and the concurrent private placement (without giving effect to any exercise by the underwriters of their overallotment option, but including shares issuable upon exchange of OP units issued in the concurrent private placement). We will grant shares of restricte