S-1 1 y30182sv1.htm FORM S-1 S-1
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As filed with the Securities and Exchange Commission on May 9, 2007
Registration No. 333-          
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
 
 
 
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
 
 
 
 
Everquest Financial Ltd.
(Exact Name of Registrant as Specified in Its Charter)
 
         
Cayman Islands
  6199   Not Applicable
(State or Other Jurisdiction
of Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification No.)
 
 
 
 
152 West 57th Street
New York, New York 10019
United States
(212) 457-0220
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)
 
Everquest Financial LLC
152 West 57th Street
New York, New York 10019
United States
(212) 457-0220
(Name, Address, Including Zip Code and Telephone Number, Including Area Code, of Agent for Service)
 
 
 
 
Copies to:
 
     
Corey R. Chivers, Esq.
Weil, Gotshal & Manges LLP
767 Fifth Avenue
New York, New York 10153
Tel. (212) 310-8000
  Daniel M. LeBey, Esq.
Hunton & Williams LLP
Riverfront Plaza, East Tower
951 East Byrd Street
Richmond, Virginia 23219
Tel. (804) 788-8200
 
 
 
 
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 of 1933 check the following box.  o
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
CALCULATION OF REGISTRATION FEE
 
             
      Proposed Maximum
     
Title of Each Class of
    Aggregate Public
    Amount of
Securities to be Registered     Offering Price(1)(2)     Registration Fee
Ordinary Shares, par value $0.001 per share
    $100,000,000     $3,070.00
             
 
(1) Includes ordinary shares that the underwriters have the option to purchase to cover over-allotments, if any. Also includes shares initially offered and sold outside of the United States that may be resold from time to time in the United States. These ordinary shares are not being registered for the purpose of sales outside the United States.
 
(2) Estimated solely for the purpose of computing the amount of the registration fee. The estimate is made pursuant to Rule 457(o) of the Securities Act of 1933, as amended (the “Securities Act”).
 
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, 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 prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.
 
SUBJECT TO COMPLETION, DATED MAY 9, 2007
 
Preliminary Prospectus
 
           shares
 
 
Everquest Financial Ltd.
 
Ordinary Shares
 
 
We are a specialty finance holding company that provides our shareholders with returns derived primarily from our structured finance subsidiaries, commonly known as collateralized debt obligations issuers.
 
We are jointly managed and advised by our managers, Bear Stearns Asset Management Inc., an affiliate of The Bear Stearns Companies Inc., a holding company that, through its broker-dealer and international bank subsidiaries, principally Bear, Stearns & Co. Inc., Bear, Stearns Securities Corp., Bear, Stearns International Limited and Bear Stearns Bank plc, is a leading investment banking, securities and derivatives trading, clearance and brokerage firm, and Stone Tower Debt Advisors LLC, an affiliate of Stone Tower Capital LLC, an alternative investment firm focused on credit and credit-related assets.
 
This is our initial public offering. No public market currently exists for our ordinary shares. We are offering           ordinary shares.
 
We currently expect the initial public offering price to be between $           and $           per share.
 
Investing in our ordinary shares involves risks.  See “Risk Factors” beginning on page 19.
 
                 
    Per Share   Total
 
Public offering price
  $                     $                    
Underwriting discounts and commissions
  $                $                    
Proceeds to us (before expenses)
  $                     $             
                 
 
 
 
 
We have granted the underwriters an option to purchase up to an additional     ordinary shares from us at the public offering price, less underwriting discounts and commissions, within 30 days from the date of this prospectus, solely to cover over-allotments, if any.
 
The underwriters expect to deliver the ordinary shares to purchasers on or about      2007.
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
 
Bear, Stearns & Co. Inc.
 
The date of this prospectus is          , 2007


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PRESENTATION OF CERTAIN INFORMATION
 
We have prepared this prospectus using a number of conventions, which you should consider when reading the information contained herein. Unless the context suggests otherwise:
 
  •  “Everquest,” or the “company,” refers to Everquest Financial Ltd., a Cayman Islands exempted company incorporated with limited liability;
 
  •  “Everquest LLC” refers to Everquest Financial LLC, a Delaware limited liability company that is a subsidiary of Everquest and in which the capital interests are owned 99% by Everquest and 1% by Everquest Cayman Ltd., a wholly owned subsidiary of Everquest and in which certain profits interests are owned by the managers.;
 
  •  “Parapet CDO” refers to Parapet 2006, Ltd., a Cayman Islands exempted company incorporated with limited liability;
 
  •  “we,” “us” and “our” refer to the company and/or its subsidiaries;
 
  •  “managers” or “manager” refers to Bear Stearns Asset Management Inc. (“BSAM”) and Stone Tower Debt Advisors LLC (“Stone Tower”), individually or collectively, as the context may suggest;
 
  •  “CEOs” refers to the two chief executive officers of the company;
 
  •  “Bear Stearns” refers to The Bear Stearns Companies Inc., a holding company that, through its broker-dealer and international bank subsidiaries, principally Bear, Stearns & Co. Inc., Bear, Stearns Securities Corp. (“BSSC”), Bear, Stearns International Limited and Bear Stearns Bank plc, is a leading investment banking, securities and derivatives trading, clearance and brokerage firm;
 
  •  “BSHG Funds,” collectively, refers to Bear Stearns High Grade Structured Credit Strategies Master Fund Ltd. and Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd.;
 
  •  “I/ST” refers collectively to a group of related private funds managed by or under the direction of I/ST Equity Partners LLC, a management company controlled by affiliates of Michael J. Levitt;
 
  •  “ordinary shares” and “shares” refer to the ordinary voting shares of the company;
 
  •  the “offering” refers to the initial public offering of our ordinary shares; and
 
  •  ‘$” or “dollars” are the lawful currency of the United States.
 
Stone Tower® and Stone Tower Capital® are trade names registered with the U.S. Patent and Trademark Office.
 
Unless otherwise indicated, information in this prospectus assumes that the option granted by us to the underwriters to purchase additional ordinary shares solely to cover over-allotments has not been exercised.


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CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING STATEMENTS
 
This prospectus contains certain forward-looking statements that are subject to various risks and uncertainties, including, without limitation, statements relating to the operating performance of our assets and financing needs. Forward-looking statements are generally identifiable by the use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition, or state other forward-looking information. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to:
 
  •  our lack of operating history;
 
  •  our inability to find suitable opportunities to form or acquire new CDO subsidiaries or to source assets for these CDO subsidiaries;
 
  •  changes in the markets in which our CDO subsidiaries expect to invest, interest rates or economic conditions generally;
 
  •  the inability of our financial models to forecast adequately the actual performance results of our CDO subsidiaries due to the variance of the default, loss severity, prepayment, reinvestment spread and other assumptions used in our models from actual performance of the assets held by our CDO subsidiaries;
 
  •  our dependence on the CEOs and the managers and our inability to find suitable replacements if the CEOs were to terminate their position with us, or if the managers were to terminate their management agreements with us;
 
  •  the existence of conflicts of interests in our relationship with BSAM and/or its affiliates and with Stone Tower and/or its affiliates, which could result in decisions that are not in the best interests of our shareholders;
 
  •  limitations imposed on our business by our exemptions from the Investment Company Act of 1940, as amended, or the 1940 Act;
 
  •  changes in our business strategy;
 
  •  general volatility of the securities markets and the market price of the ordinary shares;
 
  •  availability of qualified personnel;
 
  •  the inability of our due diligence or surveillance to reveal all relevant information regarding assets or corporate credits held by our CDO subsidiaries;
 
  •  the degree and nature of our competition; and
 
  •  changes in governmental regulations, tax laws and tax rates and other similar matters that may affect us and holders of our ordinary shares.
 
When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this prospectus. Readers are cautioned about relying on any of these forward-looking statements, which reflect our management’s views as of the date of this prospectus. The “Risk Factors” and other factors noted throughout this prospectus could cause our actual results to differ significantly from those contained in any forward-looking statement.
 
We cannot guarantee future results, levels of activity, performance or achievements. We undertake no duty to update any of the forward-looking statements after the date of this prospectus to conform these statements to actual results, except as may be required by law.


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PROSPECTUS SUMMARY
 
The following summary highlights information contained elsewhere in this prospectus. You should read the entire prospectus, including “Risk Factors” and our consolidated financial statements and related notes, before making a decision to invest in our ordinary shares. Any decision to invest in our ordinary shares should be based on a consideration of this prospectus as a whole. Unless indicated otherwise, the information included in this prospectus assumes (i) the common stock to be sold in this offering will be sold at $   per share, which is the midpoint of the price range set forth on the front cover of this prospectus, and (ii) no exercise by the underwriters of their option to purchase additional ordinary shares to cover over-allotments, if any.
 
Overview
 
We are a specialty finance holding company that provides our shareholders with returns derived primarily from our structured finance subsidiaries, commonly known as collateralized debt obligations issuers, or CDOs. We are jointly managed and advised by our managers, Bear Stearns Asset Management Inc., or BSAM, and Stone Tower Debt Advisors LLC, or Stone Tower. Relying on the structured finance expertise of our managers, our objective is to create, structure and own CDOs and other structured finance assets that will provide attractive risk-adjusted returns to us and our shareholders.
 
We generate earnings primarily through a diversified portfolio of CDOs in which we beneficially own all or a majority of the equity. Our CDOs are special purpose vehicles that hold a range of cash-generating financial assets, such as corporate leveraged loans, asset-backed securities and securities issued by other CDOs. To finance the acquisition of these assets, our CDOs typically issue multiple tranches of securities, ranging from highly rated senior debt securities, which are secured or collateralized by these assets, to unrated equity tranches. As the sole or principal equity owner in our CDO subsidiaries, we are entitled to all or a portion of any cash flow, which is typically paid quarterly, generated by the underlying financial assets, after deducting the interest and required principal payments made to holders of CDO debt securities and other expenses.
 
We expect to continue to increase our holdings of CDOs, primarily through the formation and acquisition of additional CDO subsidiaries in which we plan to hold all or a majority of the equity. To a lesser extent, we also acquire and hold minority equity positions in CDOs. We expect to form and hold CDOs structured by our managers as well as to help structure and opportunistically acquire CDOs sponsored by third parties where we believe we can do so on attractive terms. We may also form or hold, from time to time, other structured finance assets.
 
We expect to allocate capital primarily to creating and owning two types of CDOs: (i) corporate credit CDOs, or CLOs, that primarily hold corporate leveraged loans and high-yield bonds, and (ii) asset-backed securities CDOs, or ABS CDOs, which hold asset-backed securities, including residential mortgage-backed securities and commercial mortgage-backed securities. These two types of CDOs include cash CDOs, which hold an underlying portfolio of cash-generating assets, and synthetic CDOs, which enter into total return swaps, credit default swaps or other derivative instruments designed to replicate the economic consequences of holding a referenced portfolio of assets. A synthetic CDO may generally be structured more rapidly to capitalize on favorable market conditions.
 
As of December 31, 2006, our paid-in capital had been fully employed, and we owned a seasoned portfolio of CDOs and related assets with an aggregate fair value of $719.7 million. We believe that our holdings are diversified by asset type and structure.
 
Our managers have substantial expertise in evaluating, structuring and managing CDOs and other structured finance assets.
 
  •  BSAM, which was founded in 1985, managed over $29.0 billion in structured credit assets as of December 31, 2006, including approximately $14.0 billion of CDOs managed since 2003. As of December 31, 2006, the team of investment professionals at BSAM responsible for managing our business, which we refer to as the BSAM Team, had managed seven CDOs, excluding Parapet CDO, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — BSAM’s Track Record,” and had purchased for vehicles it manages equity tranches in


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  18 CDOs managed by third parties, which are described in ‘‘Our Management and Corporate Governance — Managers’ Personnel and Track Record — BSAM’s Track Record.” As of December 31, 2006, the weighted average annualized cash return of the seven CDOs managed by the BSAM Team was 12.3%, net of management fees, or 19.9%, on an adjusted gross basis before deducting management fees, and the weighted average annualized cash return of the 17 CDO equity tranches it purchased that have made at least one quarterly distribution was 24.5%.
 
  •  Stone Tower, which was founded in 2001, managed over $7.7 billion in structured credit assets as of December 31, 2006, including approximately $6.2 billion in CLOs and over $1.5 billion in assets in credit hedge funds. Stone Tower focuses on managing non-investment-grade credit and credit-related assets. Stone Tower’s structured funds have the objective of generating consistent, low volatility returns, and Stone Tower has developed a reputation among market participants as one of the leading cash flow CLO managers in North America. As of December 31, 2006, the weighted average annualized cash return of the nine CDOs sponsored by Stone Tower that have made at least one quarterly distribution, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — Stone Tower’s Track Record,” was 14.0%, net of management fees, or 18.3%, before deducting management fees.
 
As demonstrated by their track records, we believe that BSAM’s and Stone Tower’s market positions, expertise and long-standing and productive relationships with a broad range of CDO market participants, including leading commercial and investment banks and third-party collateral managers, will help us to identify, evaluate and source attractive opportunities with the best relative value.
 
Our CDOs
 
As of December 31, 2006, our CDO holdings consisted of 19 CDOs, including 11 CDOs in which we own all or a majority of the equity, one in which we own 50% of the equity and seven in which we own a minority interest. In addition, at that date, our largest CDO subsidiary, Parapet CDO, a CDO of CDO securities, held a portfolio consisting of preference share or income note tranches of 15 CDOs and mezzanine debt securities of 22 CDOs. The aggregate fair value of our CDO and related holdings as of that date was $719.7 million.
 
The following charts illustrate the diversification of our portfolio by CDO type and manager as of December 31, 2006:
 
     
Everquest Assets by Type(1)
  Everquest Assets by Manager(1)
(PIE CHART)
  (PIE CHART)
 
 
(1) The percentages of assets presented, both by type and by manager, have been apportioned by fair value. For purposes of this presentation, the aggregate percentage attributable to Parapet CDO of 53% has been further apportioned among the specified asset classes on a pro rata basis based on the fair value of each asset class as a percentage of Parapet CDO’s total assets.
 
Subsequent to December 31, 2006, and through March 31, 2007, we have acquired equity tranches in three additional CDOs for a total purchase price of $32.9 million. See “Our Company — CDO Holdings Acquired after December 31, 2006.” In addition, we continue to actively evaluate multiple opportunities, some of which may be material in relation to our size. We believe the growth in CDO issuance will continue to provide attractive opportunities to expand our asset base.


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We currently own equity, which may consist of subordinated securities, income notes, preference or ordinary shares, common stock and/or other equity securities, in the following primary types of CDOs:
 
  •  Corporate Credit CDOs (or CLOs).  CDOs that invest primarily in corporate credits, such as loans or bonds, are referred to as collateralized loan obligations, or CLOs, or corporate credit CDOs. As of December 31, 2006, CLOs, not including those held through Parapet CDO, accounted for approximately 27.6% of our total CDO and related assets, which includes holdings in CDOs, warehouse agreements and swaps, and, for the period then ended, approximately 24.1% of our revenue. Our CLOs invest directly or synthetically in the following primary asset classes:
 
  •  corporate leveraged loans, which currently constitute a substantial majority of the assets held by our corporate credit CDOs; and
 
  •  high-yield bonds.
 
  •  Asset-Backed Securities CDOs (or ABS CDOs).  CDOs that invest primarily in asset-backed securities are referred to as asset-backed securities CDOs, or ABS CDOs. As of December 31, 2006, ABS CDOs, not including those held through Parapet CDO, accounted for approximately 16.2% of our total CDO and related assets and, for the period then ended, approximately 18.3% of our revenue. Our ABS CDOs directly or synthetically invest primarily in:
 
  •  residential mortgage-backed securities, or RMBS, rated in the range of “A2” to “Ba2,”which currently constitute a substantial majority of the assets held by our ABS CDOs;
 
  •  commercial mortgage-backed securities, or CMBS;
 
  •  other asset-backed securities, or ABS; and
 
  •  securities issued by other CDOs.
 
  •  Parapet CDO.  Our CDO subsidiary, Parapet CDO, which is a CDO of CDO securities, accounted for approximately 53.0% of our total CDO and related assets as of December 31, 2006 and, for the period then ended, approximately 57.6% of our revenue.
 
As of December 31, 2006, Parapet CDO had $136.9 million in AA/Aa3 rated debt outstanding that was held by the BSHG Funds and which was collateralized by and has a prior claim upon the assets held in Parapet CDO.
 
Parapet CDO holds the following types of CDO securities:
 
  •  mezzanine debt tranches of CDOs, which constituted approximately 38.6% of the total CDO assets of Parapet CDO as of December 31, 2006; and
 
  •  preference share and income note tranches of CDOs, which constituted approximately 61.4% of the total CDO assets of Parapet CDO as of December 31, 2006, of which the preference share and income note tranches of CLOs and ABS CDOs constituted approximately 18.6% and 42.8%, respectively, of the total CDO assets of Parapet CDO as of December 31, 2006.
 
As of December 31, 2006, we held approximately $22.0 million in deposits in warehouse agreements, which provide short-term CDO financing prior to a permanent CDO securitization, and approximately $0.7 million of hedging contracts. These deposits and hedging contracts accounted for approximately 3.2% of our total CDO and related assets.
 
Our Market Opportunity
 
We believe that the size and dynamics of the CDO market create an attractive environment for Everquest.
 
We believe the CDO market is characterized by the following trends:
 
Significant Growth in the CDO Market.  The volume of CDO issuance has grown significantly in recent years. According to Moody’s Quarterly Review, the annual volume of CDO issuances rated by Moody’s has


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increased from approximately $14 billion in 1996 to approximately $158 billion in 2006, representing a compound annual growth rate, or CAGR, of approximately 31%. We believe the growth in the sector has been driven by strong collateral performance, attractive asset and liability spreads when compared to alternatives and the value of structural considerations such as diversification, subordination, increasingly experienced collateral managers and the benefits of a maturing and more sophisticated market.
 
We also believe that the rapid growth in the CDO market has been driven in part by a strong demand for fixed-income assets, particularly rated debt securities. The demand by large investors, such as pension funds and insurance companies, for rated income-producing investments has significantly outstripped the supply of new corporate debt and ABS in recent years. This imbalance has accelerated a trend by commercial banks, investment banks and other financial intermediaries to securitize or re-securitize existing financial assets in order to create additional supply. For example, loans have been repackaged into CLOs, and ABS, RMBS and CMBS have been repackaged into ABS CDOs. In connection with these repackagings, senior tranches of debt securities issued by the CDO can be sold to satisfy the ongoing demand for rated debt securities. Initially, such repackagings took the form of CDOs that aggregated actual cash-generating loans or securities. Therefore, cash loans or securities had to be acquired in the market before they could be securitized into a CDO. The development of market-standard documentation for credit default swaps and total return swaps, however, has made it practicable to create CLOs and ABS CDOs synthetically, eliminating the requirement to source cash assets, which in turn reduces the time required to create these structures and enables them to be sized more flexibly. We believe the demand for rated CDO debt securities will provide us with attractive opportunities to create and structure new CDO subsidiaries.
 
Market Developments Favoring CDO Equity and Other Subordinated Tranches.  We believe that the dynamics of the CDO market have led to increased cash flows to certain CDO equity and other subordinated tranches, which in turn produce higher current yields relative to other fixed income opportunities. Specifically, we believe the increase in demand for rated debt securities issued by CDOs described above has had the effect of increasing the positive interest rate spreads between assets and liabilities of CDOs, creating an attractive arbitrage opportunity for the equity owner of CDOs. We expect this trend, to the extent it continues, to provide us with opportunities to form or acquire new CDO subsidiaries with favorable risk-adjusted return profiles, and to leverage our market position to gain access to opportunities not available to the wider market.
 
Robust Leveraged Buyout Activity.  A strong and steady flow of leveraged buyout, or LBO, transactions in the market over the past year, combined with a move towards larger LBO transaction sizes, has contributed to the continued sizeable supply of leveraged loans, high-yield bonds and other fixed-income assets targeted by our business strategy. According to Thomson Venture Expert, as of 2006 there were over 1,800 private equity funds in existence globally. Private equity funds, which are a key driver for the recent growth in LBO transactions, have experienced significant inflows of capital recently, with over $220.0 billion of capital raised in the United States in 2006, according to Thomson Venture Expert. According to Standard & Poors’ Leveraged Buyout Review, total LBO volume in the United States increased from $19.5 billion in 2001 to $223.0 billion in 2006, representing a CAGR of 64%, and the average size of LBO transactions, as measured by total sources of funding, increased from $388.6 million in 2001 to $1,308.8 million in 2006. We expect this trend, to the extent it continues, to enhance the managers’ ability to source assets for future corporate credit CDOs.
 
We believe we are well positioned to benefit from these market opportunities and create attractive current income and long-term capital appreciation for our ordinary shareholders.
 
Competitive Advantages
 
We believe that we enjoy the following competitive advantages:
 
Fully Employed Paid-in Capital and Diversified Portfolio of CDOs.  We have fully employed our paid-in capital to date in a seasoned portfolio of CDOs diversified by manager, collateral type, vintage and duration. As of December 31, 2006, our CDO holdings consisted of 19 CDOs, including 11 in which we own all or a majority of the equity, one in which we own 50% of the equity and seven in which we own a minority interest. In addition, at that date, our largest CDO subsidiary, Parapet CDO, held a portfolio consisting of preference


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share and income note tranches of 15 CDOs and mezzanine debt securities of 22 CDOs. As of December 31, 2006, five of the CDOs in which we hold equity securities were managed by our managers. We believe that this diversification reduces our exposure to individual market sectors or credit events.
 
Management Expertise.  Our co-chief executive officers, Ralph R. Cioffi and Michael J. Levitt, have a combined total of more than 54 years of experience in structured finance, non-investment-grade debt investing, leveraged finance and private equity. Mr. Cioffi joined Bear Stearns in 1985, and founded the BSHG Funds in March 2003. He was instrumental in the creation of the structured credit effort at Bear Stearns, which is a leading underwriter and secondary trader in structured credit securities. Mr. Levitt founded Stone Tower Capital LLC, or STC, in 2001. Before that, he was instrumental in building the leveraged finance business at Morgan Stanley and subsequently at Smith Barney (a Citigroup predecessor). Mr. Levitt was also a managing partner of the New York office of the private equity firm of Hicks, Muse Tate & Furst Incorporated. Messrs. Cioffi and Levitt will have principal management responsibility for Everquest. We believe that their experience, together with the experience of the other investment professionals at BSAM and Stone Tower in investing in debt and equity securities and managing investments in structured credit securities, will afford us a competitive advantage in identifying and creating new CDO opportunities with the potential to generate attractive returns.
 
Strengths of Our Managers.  We believe that we will be able to leverage the strengths of our managers, which include the following:
 
  •  Strong Track Record.  We believe BSAM has a strong track record of developing transaction structures, managing structured vehicles and selecting vehicles managed by third parties. In particular, BSAM has developed innovative transaction structures that increase the efficiency with which pools of structured securities can be funded. For example, BSAM designed and marketed the Klio series of CDOs, which use commercial paper as a funding mechanism for highly rated structured finance assets and which BSAM believes were the first transactions of their kind. BSAM often takes an active role in structuring the securities it buys on issue from third parties, and from time to time restructures them to increase their funding efficiency.
 
As of December 31, 2006, the BSAM Team had managed seven CDOs, excluding Parapet CDO, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — BSAM’s Track Record,” and had purchased for vehicles it manages equity tranches in 18 CDOs managed by third parties, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — BSAM’s Track Record.” As of December 31, 2006, the weighted average annualized cash return of the seven CDOs managed by the BSAM Team was 12.3%, net of management fees, or 19.9%, on an adjusted gross basis before deducting management fees, and the weighted average annualized cash return of the 17 CDO equity tranches it purchased that have made at least one quarterly distribution was 24.5%.
 
Stone Tower has developed a reputation among market participants as one of the leading cash flow CLO managers in North America. As of December 31, 2006, the weighted average annualized cash return of the nine CDOs sponsored by Stone Tower that have made at least one quarterly distribution, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — Stone Tower’s Track Record,” was 14.0%, net of management fees, or 18.3%, before deducting management fees.
 
  •  Complementary Expertise.  We believe that one of our competitive strengths is the extensive and complementary expertise of each of our managers. BSAM generally invests in a range of structured finance assets, with particular expertise in ABS CDOs, and Stone Tower focuses on non-investment-grade corporate credit assets. We believe that the complementary expertise of our managers will help us form new CDOs and allocate our capital among either ABS CDOs or CLOs and related asset classes where we believe we can achieve the best relative value, in light of prevailing market conditions.
 
  •  History of Cooperation.  BSAM and Stone Tower have worked together for more than four years in a variety of capacities. They have jointly identified and evaluated potential opportunities, including


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  collateral portfolios, based on each entity’s particular expertise. They also have acted as subadvisor for funds managed by each other and jointly structured and managed CDOs. Currently, BSAM and Stone Tower jointly manage two CDOs, portions of the equity of which are held by us and by Parapet CDO. They have also jointly established three CDOs that were structured by them with assets selected by them and in which funds they manage have invested. We believe their history of cooperation will enable them to work together effectively on our behalf.
 
Access to Proprietary and High-Quality Deal Flow.  We believe BSAM and Stone Tower’s market position, expertise and long-standing relationships with a broad range of market participants have provided and will continue to provide us with the opportunity to evaluate a pipeline of attractive opportunities before they become available to the wider market. These opportunities include the ability to source high-quality collateral for CDOs that may be structured by our managers, including potentially CDOs of CDOs, as well as the ability to structure and acquire equity in CDOs managed by third parties on attractive terms.
 
High-Quality Risk Management Systems.  We believe the strong track record to date of our managers is due, among other things, to the surveillance and risk management systems they utilize. We believe that access to those systems is a significant competitive advantage. The proprietary and third-party surveillance systems used by BSAM were designed to ensure that all assets are reviewed real time and those showing signs of potential credit deterioration or poor performance are designated for further review. BSAM’s surveillance systems track over 80,000 securities on a daily basis and monitor the performance of all of our CDO holdings as well as perform in-depth analysis on all the underlying collateral backing such holdings. We believe our managers’ systems enhance our ability to quickly identify, and where possible, sell or otherwise hedge potentially credit-impaired assets before significant credit deterioration begins or rating downgrades occur. We benefit from these systems not only in the case of CDOs managed by our managers but also with respect to those managed by third parties. With respect to CDOs managed by third parties, we integrate the underlying credits into our surveillance systems so that they can be monitored in the same way as CDOs managed by our managers. When we identify a potential credit-impaired asset in a third party managed CDO, we notify the manager and work with the manager to sell or hedge the asset. If the asset is not sold, we attempt to hedge our exposure to the asset. Additionally, Stone Tower performs daily surveillance on all loans underlying each of our CLO investments. Both BSAM and Stone Tower monitor assets in real time with systems that are designed to be early warning in nature, as opposed to systems that provide alerts only after an asset begins to deteriorate.
 
Access to BSAM and Stone Tower Investment Professionals and Infrastructure.  We also believe we have a significant competitive advantage through our access to BSAM’s and Stone Tower’s structured finance professionals, who are supported by an established operational infrastructure. As of December 31, 2006, the combined BSAM Team and Stone Tower team responsible for Everquest included a total of approximately 52 professionals, consisting of portfolio managers, research analysts and other professionals. In addition, Everquest has access to the broader operational infrastructure of BSAM and Stone Tower, including information technology, legal, administrative and other back office operational infrastructure. As of December 31, 2006, BSAM and Stone Tower had more than 440 employees in the aggregate.
 
Strong Alignment of Interest among Everquest, BSAM and Stone Tower.  The interests of BSAM and Stone Tower are strongly aligned with ours. The BSHG Funds, which are managed by BSAM, owned approximately 67.0% of our ordinary shares as of December 31, 2006, and are expected to own approximately  % of our ordinary shares after this offering. I/ST, a fund managed by an affiliate of Stone Tower, owned approximately 8.4% of our ordinary shares as of December 31, 2006, and is expected to own approximately     % of our ordinary shares after this offering. In addition, as a result of this offering each of BSAM and Stone Tower, or their designees, will be entitled to receive share grants representing 2.5% (or together an aggregate of 5.0%) of our ordinary shares outstanding upon completion of this offering.


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Our Business Strategy
 
We intend to continue to grow our holdings in CDOs and other structured finance assets. We seek to generate attractive returns by leveraging the strengths of our managers to:
 
  •  evaluate and source attractive opportunities with the best relative value in varying market environments, through both CDOs we structure ourselves and opportunities presented to us by third parties;
 
  •  select high quality assets to be held by the CDOs that are managed by our managers and in which we hold interests, and actively participate in the structuring of, and asset selection for, CDOs that are managed by third parties and in which we hold interests;
 
  •  maximize the yield on the underlying assets relative to our cost of financing their acquisition;
 
  •  achieve a level of diversification in our overall portfolio in terms of asset type and manager to minimize the effect of negative credit events;
 
  •  employ and develop innovative strategies, including synthetic techniques, to improve the quality, execution and performance of our CDO assets;
 
  •  actively monitor through proprietary and third-party surveillance systems the performance and management of assets held by the CDOs in which we hold interests, including those managed by third parties; and
 
  •  utilize credit default swaps to manage risks of credit events relating to our assets and other hedging techniques to manage interest rate risks.
 
Our Managers
 
Founded in 1923, The Bear Stearns Companies Inc. (NYSE: BSC), a holding company that, through its broker-dealer and international bank subsidiaries, principally Bear, Stearns & Co. Inc., Bear, Stearns Securities Corp. Bear, Stearns International Limited and Bear Stearns Bank plc, is a leading investment banking, securities and derivatives trading, clearance and brokerage firm serving corporations, governments and institutional and individual investors worldwide. Headquartered in New York City, Bear Stearns has approximately 13,500 employees worldwide.
 
BSAM is an asset management subsidiary of The Bear Stearns Companies Inc. BSAM, established in 1985, is an SEC-registered investment advisor and provides investment management services to corporations, trusts, employee benefit plans, public authorities, foundations, endowments, religious organizations, high net worth individuals, mutual funds, Taft-Hartley plans, private investment funds, venture capital funds and issuers of collateralized bond and loan obligations and other structured securities products. BSAM offers investment expertise across a wide spectrum of investment strategies, including: hedge funds; private equity; large, small and mid-cap domestic equities; corporate, government, municipal and high-yield bonds; balanced portfolio management; mortgage-backed and mortgage derivative securities and systematic equity and collateralized loan accounts. BearMeasurisk, an affiliate of BSAM, provides performance and risk analytics for institutional clients.
 
BSAM employed approximately 409 individuals as of December 31, 2006, of which approximately 150 are classified as investment professionals and 259 are administrative personnel. The investment professionals total is comprised of approximately 42 portfolio managers, 53 research analysts and 55 other professionals, a category that includes traders, hedge fund administrators and private equity professionals. The majority of BSAM’s business, including portfolio management, research, administration and operations, is conducted at Bear Stearns’ world headquarters in New York City, although BSAM also has an investment management presence in San Francisco. The Marketing and Client Service Group is headquartered in the New York City office, but is represented through branch offices in Chicago and San Francisco. Internationally, the firm is represented through offices in London and Tokyo.
 
Stone Tower is an affiliate of STC, which was founded in 2001 as an alternative investment firm focused on credit and credit-related assets. Through its affiliates, Stone Tower managed, as of December 31, 2006,


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approximately $7.7 billion in leveraged finance-related assets across several structured finance and hedge fund vehicles as described in “Our Management and Corporate Governance — Manager’s Personnel and Track Record — Stone Towers’ Track Record.” As of December 31, 2006, Stone Tower had 37 employees, which included 19 investment professionals. Stone Tower’s objective is to generate stable and consistent returns for its investors, which include domestic and international banking institutions, insurance companies, pension funds, institutional money management firms, family offices and high net worth individuals.
 
Our CEOs
 
Our co-chief executive officers are Ralph R. Cioffi, a senior managing director at Bear Stearns, and Michael J. Levitt, chairman of Stone Tower.
 
Mr. Cioffi is a senior managing director of Bear Stearns, where he has worked since 1985, and is a member of BSAM’s board of directors. From 1985 through 1991, Mr. Cioffi worked in institutional fixed income sales, where he specialized in structured finance products. He served as the New York head of fixed income sales from 1989 through 1991. From 1991 through 1994, Mr. Cioffi served as global product and sales manager for high-grade credit products. He was involved in the creation of the structured credit effort at Bear Stearns and was a principal force behind Bear Stearns’ position as a leading underwriter and secondary trader of structured finance securities, specifically CDOs and esoteric asset-backed securities. Mr. Cioffi founded and has been managing the BSHG Funds since March 2003.
 
Mr. Levitt founded Stone Tower Capital LLC in 2001. He is also the chairman and chief investment officer of Stone Tower. Mr. Levitt has spent his entire 25-year career managing or advising non-investment-grade companies and investing in non-investment-grade assets. Previously, Mr. Levitt served as a partner in the New York office of the private equity firm of Hicks, Muse, Tate & Furst Incorporated, where he was responsible for originating, structuring, executing and monitoring many of the firm’s investments in the consumer products, media and broadcasting industries. Additionally, he managed and maintained many of the firm’s relationships with investment and commercial banking firms. Previously, Mr. Levitt served as the co-head of the investment banking division of Smith Barney Inc. with management responsibility for the advisory and leveraged finance activities of the firm. Mr. Levitt began his investment banking career at, and ultimately served as a managing director of, Morgan Stanley & Co., Inc. While there, he oversaw the firm’s businesses related to private equity firms and non-investment-grade companies.
 
Our Formation
 
Everquest Financial Ltd. is a recently formed holding company, incorporated as a Cayman Islands exempted company with limited liability. On September 28, 2006:
 
  •  the BSHG Funds, which are managed by BSAM, agreed to transfer to us equity in 10 CDOs, including Parapet CDO, for a purchase price of approximately $548.8 million. In consideration, we agreed to issue 16,000,000 of our shares, at $25 per share, and pay approximately $148.8 million in cash.
 
  •  HY II Investments, L.L.C. and EGI-Fund (05-07) Investors, L.L.C., or collectively, HY, affiliates of a Stone Tower investor, agreed to transfer to us equity in two CDOs with an NAV of approximately $6.4 million and cash in the amount of approximately $18.6 million in exchange for 1,000,000 of our shares, at $25 per share.
 
  •  Other investors paid cash of approximately $137.5 million, or $25 per share, in exchange for 5,500,100 of our shares.
 
As a result of these transactions, which closed on October 5, 2006, we received CDO equity of approximately $555.2 million and cash of approximately $7.3 million, net of the cash consideration paid to the BSHG Funds. We valued the equity interests in the CDOs we acquired in connection with our formation at their fair value as of the date we agreed to acquire these interests, taking into account a number of factors, including the projected cash flows we expected to be generated by these interests and valuation information provided by third-party market participants.


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As part of the assets we purchased from the BSHG Funds, the BSHG Funds transferred to us 100% of the equity of Parapet CDO, which equity was then valued at approximately $369.8 million.
 
Subsequent to October 5, 2006, institutions and sophisticated investors paid approximately $97.3 million in aggregate to purchase additional shares in further private-round financings. The proceeds of these financings have been used to purchase additional CDO equity or pay down outstanding amounts under an existing secured credit facility. The shares received by the BSHG Funds, HY and other initial and private-round investors consisted of nonvoting participating shares, which we expect will become ordinary shares in connection with the offering.
 
Risk Factors
 
An investment in the ordinary shares being offered hereby involves various material risks. You should consider carefully the risks discussed under “Risk Factors” before purchasing the ordinary shares.
 
1940 Act Exclusion
 
We conduct our operations so that we are not required to register as an investment company under the 1940 Act. Pursuant to Section 3(a)(1)(C) of the 1940 Act, 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 will be deemed to be an investment company. Excluded from the term “investment securities,” among other things, are 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 provided by Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. We believe that more than 60% of our assets consist of CDO subsidiaries that are themselves not investment companies as a result of the exception for structured finance companies, Rule 3a-7, rather than in reliance on Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. Accordingly, we do not own or propose to acquire investment securities having a value in excess of 40% of the value of our total assets on an unconsolidated basis, and are therefore not required to register as an investment company.
 
If it were determined that one or more of our CDO subsidiaries could not rely on the exclusion from investment company status under the 1940 Act for structured finance companies, these CDO subsidiaries would have to restructure their operations in order to rely on that exclusion. If they could not restructure their operations to comply with the exclusion, then we could have to register as investment companies under the 1940 Act, either of which could materially and adversely affect our earnings.
 
Tax Matters
 
U.S. persons may be subject to certain adverse U.S. federal income tax consequences relating to the ownership and disposition of our shares. See “Certain Tax Considerations — U.S. Federal Income Tax Considerations.”


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Our Organizational Structure
 
The following chart illustrates our expected corporate structure and ownership upon the closing of this offering. All percentages reflect anticipated actual ownership.
 
(GRAPH)
 
 
(1) We hold 100% of the voting securities of Parapet CDO.
 
(2) At December 31, 2006, we held all or a majority of the voting securities in five CDO subsidiaries, including Parapet CDO, which accounted for 71.0% of our total assets.
 
(3) Also includes, but is not limited to, CDOs in which we hold all or a majority of the equity securities, but not the voting securities.
 
(4) Calculated on a basis similar to management and incentive fees, subject to the availability of profits for distribution; management and incentive fees do not duplicate amounts distributable in respect of the profits interests.


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Our Management Structure and Corporate Governance
 
Everquest is a holding company incorporated as a Cayman Islands exempted company with limited liability. Our board of directors consists of seven directors, a majority of whom meet the independence standards of the New York Stock Exchange, or NYSE. Our CEOs and managers manage the business and affairs of our company under the supervision of our board of directors. The memorandum and articles of association of the company require that our board of directors will consist of not fewer than seven or more than 12 directors. The current directors include each of our CEOs, an additional director designated by BSAM, and four members who meet the independence standards of the NYSE.
 
Shareholders elect our directors, except the BSAM and Stone Tower designated directors. Special voting share classes granted to BSAM and Stone Tower entitle each to elect one director so long as the relevant management agreement remains in effect, or the relevant manager or its affiliates has over $50 million invested in Everquest, and in the case of BSAM entitle BSAM to elect one additional director so long as the BSAM-affiliated investment in Everquest is over $100 million. Independent directors may be removed for cause at any time by the vote of two-thirds of the ordinary shares. BSAM and Stone Tower may remove any director they are entitled to designate, and a director who is a BSAM or Stone Tower designee may also be removed for cause by a two-thirds vote of the independent directors. Any vacancy of a BSAM or Stone Tower designated director will be filled by BSAM or Stone Tower, and any other vacancy will be filled by majority vote of the remaining directors. Our board of directors has formed a nominating and corporate governance committee, an audit committee and a compensation committee. The nominating and corporate governance committee is required to recommend a slate of nominees for election as independent directors.
 
Management Agreements
 
We and each of BSAM and Stone Tower are parties to management agreements, pursuant to which the managers, subject to applicable law and our organizational documents and in accordance with the policies and control of our operating committee and, in certain circumstances, subject to our board of directors’ approval: (i) perform diligence, structure on our behalf our CDO subsidiaries and oversee the purchase and sale of assets (which purchases or sales may be from affiliates of either or both of the managers); (ii) monitor and manage our assets and financial activities (including through the use of leverage and our hedging policies); (iii) provide us with certain advisory services, (iv) are responsible for the day-to-day activities relating to our assets, with such allocation of responsibilities as between the managers as determined by our board of directors; and (v) such other matters as our board of directors and the managers may agree upon from time to time. See “The Management Agreements.”
 
In general, the managers receive the following compensation and incentive allocation in connection with the management services provided to us. The compensation comes in two forms: a profits interest in Everquest LLC, and fees paid by Everquest to the extent that the managers are managing Everquest assets not held directly or indirectly by Everquest LLC. Amounts distributable to the managers in respect of the profits interests in Everquest LLC are calculated on a basis similar to the management and incentive fees described below, subject to the availability of profits for distribution. The management and incentive fees do not duplicate the amounts distributable in respect of the profits interests.
 
Fee Summary Description and Method of Computation
 
Base Management Fee As compensation for their services, the managers are entitled to a management fee, or Base Fee, payable quarterly in arrears, equal to (i) 1.75% on an annualized basis of the company’s net assets up to $2 billion, plus (ii) 1.50% on an annualized basis of the company’s net assets over $2 billion and up to $3 billion, plus (iii) 1.25% on an annualized basis of the company’s net assets over $3 billion and up to $4 billion, plus (iv) 1% on an annualized basis of the company’s net assets over $4 billion. For purposes of calculating the Base Fee, the company’s net assets will be adjusted to exclude special one-time costs pursuant to changes in GAAP, and non-cash charges.


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Such adjustments will be made only after discussion between the company and the independent directors on our board of directors and approval by a majority of the independent directors.
 
Incentive Fee In addition, the managers are entitled to an incentive fee, or Incentive Fee, payable quarterly in arrears, equal to (i) 25% of the dollar amount by which (a) the quarterly net increase in net assets resulting from operations of the company, as determined in accordance with GAAP, before accounting for the Incentive Fee, per weighted average ordinary share, exceeds (b) an amount equal to the weighted average of the price per ordinary share for all issuances of ordinary shares, after deducting any underwriting discounts and commissions and other costs and expenses related to such issuances, multiplied by the greater of 2.00% per quarter or 0.50% plus one-fourth of the U.S. Ten Year Treasury Rate for such quarter, multiplied by (ii) the weighted average number of shares outstanding during the quarter.
 
The Incentive Fee will be adjusted to exclude special one-time events pursuant to changes in GAAP and non-cash charges. Such adjustments will be made only after discussion between the company and the independent directors on our board of directors and approval by a majority of the independent directors.
 
Certain Reduction in Fees To the extent we have purchased after September 28, 2006, or in the future purchase, a stake in a CDO or other structured finance issuer sponsored by BSAM or Stone Tower, the fees payable by us under the management agreements will be reduced by the portion of any management or incentive fees received by BSAM or Stone Tower as manager of the CDO or other issuer that is allocable to our stake in such CDO or other issuer, to the extent such fees are not otherwise waived by BSAM or Stone Tower. The foregoing fee reduction provision does not apply to our initial portfolio of CDOs that we acquired in our formation transactions. In addition, no management or incentive fees are paid by Parapet CDO to BSAM or Stone Tower, although BSAM and Stone Tower may be entitled to investment management fees with regard to certain of Parapet CDO’s underlying CDO assets.
 
Fee Allocation The compensation paid to the managers will be allocated between them as follows: (i) compensation relating to the first $562.0 million of book capital of our ordinary shares outstanding at the time of determination of such compensation will be allocated 80%/20% between BSAM and Stone Tower, respectively, and (ii) compensation relating to book capital of our ordinary shares in excess of $562.0 million will be allocated 60%/40% between BSAM and Stone Tower, respectively.
 
Reimbursement of Expenses The managers are entitled to be reimbursed by the company for certain expenses incurred by the managers or their affiliates on behalf of the company or in connection with the provision of certain services under the management agreement.
 
Term, Termination and Termination Payment Each management agreement has a term of one year and will be automatically renewed at the stated expiration for additional one-year periods, unless either the company or the respective manager gives 30 days’ prior written notice that the related management agreement will not be renewed.


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Neither management agreement will be renewed if, upon the affirmative vote of at least two-thirds of the independent directors, or a vote of at least two-thirds of the ordinary shares held by disinterested shareholders, it is determined there has been (i) unsatisfactory performance that is materially detrimental to us, or (ii) the compensation payable to a manager is unfair. If the company gives a notice of nonrenewal of a management agreement (other than for cause), the applicable manager will be entitled to certain potentially significant termination fees. The applicable manager may waive payment of any such fees to it.
 
Conflicts of Interest
 
Conflicts with BSAM and Stone Tower
 
We are subject to conflicts of interest relating to BSAM and its affiliates, including Bear, Stearns & Co. Inc., which is one of the underwriters of this offering, and Stone Tower and its affiliates, including, among others, the following:
 
  •  Each of our CEOs also serves as an executive officer of BSAM or Stone Tower. As a result of these relationships, these persons have a conflict of interest with respect to our agreements and arrangements with our managers, which were not negotiated at arm’s length, and the terms of which may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
 
  •  Substantially all of our initial CDO holdings were contributed by the BSHG Funds, which are managed by BSAM. Thus, the consideration given by us in exchange for these assets was not negotiated at arm’s length and may exceed the values that could be achieved upon the sale or other disposition of these assets to third parties. In addition, the performance of the CDO holdings retained by the BSHG Funds may differ from the performance of those initially contributed to us.
 
  •  BSAM, Stone Tower and/or their affiliates currently advise, sponsor or act as manager to other business ventures or clients that have investment objectives that overlap with our business plan and strategies and therefore compete with us for asset acquisition, investment and other opportunities and may create additional vehicles in the future that compete for such opportunities. We will therefore face conflicts of interests with the managers and/or their affiliates with respect to the allocation of asset acquisition, investment and other opportunities.
 
  •  We may purchase assets from, finance the assets of or make co-purchases alongside BSAM or Stone Tower, their affiliates and/or business ventures or clients that they manage, including assets of CDOs structured by BSAM or Stone Tower. These transactions will not be the result of arm’s length negotiations and will involve conflicts between our interests and the interests of BSAM or Stone Tower and/or their affiliates in obtaining favorable terms and conditions.
 
  •  In structuring our CDO subsidiaries, our managers may have conflicts between us and other entities managed by them that purchase debt securities in our CDOs with regard to setting subordination levels, determining interest rates, pricing the securities, providing for divesting or deferring distributions that would otherwise be made to CDO equity, or otherwise setting the amounts and priorities of distributions to the holders of debt and equity interests in the CDOs.
 
  •  Not all of the CDO equity assets of the BSHG Funds were contributed to us. The retained assets include CDO equity interests in CDOs in which we acquired an interest, which may result in the BSHG Funds having an interest that conflicts with ours.
 
  •  We may also compete with BSAM’s and Stone Tower’s current and future business ventures or clients for access to management time, resources, services and functions. The managers are only required to devote as much of their time and resources to our business as they deem necessary and appropriate to fulfill their obligations under their respective management agreements, and neither CEO is required to devote a specific amount of time to our affairs.


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  •  Ralph R. Cioffi, one of our CEOs, is a director of BSAM, the founder of the BSHG Funds and beneficially owns equity in the BSHG Funds and in Bear Stearns. Affiliates of Bear Stearns, including the BSHG Funds and other BSAM-managed funds, may compete with us for asset acquisitions and CDO investments either directly or as brokers, dealers or underwriters of CDO securities or the assets underlying such securities.
 
  •  Michael J. Levitt, one of our CEOs, is the founder of and beneficially owns equity interests in Stone Tower. Affiliates of Stone Tower may compete with us for asset acquisition and CDO investments. Therefore, he has interests in our relationship with Stone Tower that are different from the interests of our shareholders.
 
  •  Subject to certain conditions, BSAM and Stone Tower are entitled to elect two and one of our directors, respectively. Although all of our directors will owe fiduciary duties to all shareholders, the directors elected by our managers may have interests different from those of our independent directors and aligned with the interests of our managers.
 
  •  Each of BSAM and Stone Tower manage funds or are affiliated with funds that are significant shareholders of Everquest. Each of our CEOs has beneficial interests in their related funds. BSAM and Stone Tower may enter into transactions at the shareholder level, such as transactions that hedge exposures to Everquest’s assets, which provide benefits to these shareholders that are not provided to Everquest or our other shareholders.
 
  •  Affiliates of HY have significant beneficial interests in Stone Tower. As a contributor (in exchange for shares in the company) of two of our initial CDO holdings and as a holder of an indirect economic interest in Stone Tower, these affiliates may have interests that are not aligned with those of other shareholders.
 
  •  I/ST, an entity controlled by Michael J. Levitt, beneficially owned approximately 8.4% of our shares as of December 31, 2006. In exercising his management discretion on behalf of I/ST, Mr. Levitt may take actions, or refrain from taking actions, which would not benefit us or our other shareholders.
 
  •  BSAM and Stone Tower, through their activities on behalf of other clients or entities, may acquire confidential or material non-public information or be restricted by internal policies from initiating transactions in certain securities. These restrictions may prevent us from managing our assets in a manner that is otherwise in our best interests.
 
  •  We may purchase assets that are senior or junior to, or have rights and interests different from or adverse to, assets held by other accounts or funds managed by BSAM or Stone Tower. Our interests in such assets may conflict with the interests of such other accounts in related investments at the time of origination or in the event of a default or restructuring of a company, property or other asset.
 
  •  We purchase additional assets from third parties in negotiated transactions. Some of the asset sellers may be entities with which BSAM or Stone Tower or their affiliates has engaged in other commercial transactions, are clients of BSAM or Stone Tower or their affiliates or have other business relationships and may include shareholders. Such relationships could influence the purchase price for the additional assets.
 
  •  Although both our company and our managers are expected to benefit from the ability to jointly develop relationships with dealers, sponsors, originators and other participants in the CDO markets, there may be instances in which our managers receive greater benefits in these relationships by reason of their roles with us. We will benefit from reduced fees payable to our managers to the extent they receive fees from third parties in transactions in which we invest; the degree of this benefit will depend in part on the manner in which our managers allocate investments between us and third parties.
 
  •  Bear, Stearns & Co. Inc., one of the underwriters of this offering and an affiliate of BSAM, may in the future execute trades with us or on our behalf, perform valuation services for BSAM on our behalf, extend or arrange debt financing to us or on our behalf, assist with structuring and placing securities of our CDO subsidiaries and perform other services for us.


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Conflicts Relating to the Management Agreements
 
We are subject to conflicts of interests relating to our managers’ roles under the management agreements, including, among others, the following:
 
  •  Although our management agreements are subject to annual renewal, failure by us to renew the management agreements in certain circumstances and at certain times may result in our incurring additional costs. Upon termination of a management agreement other than for cause, we are required to pay the manager a termination fee if the termination occurs before September 2009.
 
  •  Our managers’ liability is limited under the management agreements. Except under certain circumstances, we have agreed to indemnify our managers and their affiliates to the fullest extent permitted by law against all liabilities and expenses arising from acts or omissions of any such indemnified party arising from, or in connection with, the provision of services by BSAM and Stone Tower, or on behalf of BSAM and Stone Tower, under the management agreements.
 
  •  The amounts payable to our managers were not approved by our independent directors and may be higher than the company could achieve on an arm’s length basis with third parties.
 
  •  The Incentive Fee, which is based upon the company’s achievement of targeted levels of net increase in net assets resulting from operations, may lead our managers to place undue emphasis on the maximization of net increase in net assets resulting from operations at the expense of other criteria, such as preservation of capital, maintaining sufficient liquidity and/or management of credit risk or market risk, in order to achieve higher incentive compensation.
 
  •  The Base Fee, which is based on the amount of our net assets (as defined in the management agreements), is generally payable regardless of our operating performance. The Base Fee may reduce our managers’ incentive to devote the time and effort of their professionals to seeking profitable opportunities for our portfolio.
 
  •  The Base Fee and Incentive Fee are based on the value of our net assets. The value of our net assets is based on highly subjective assumptions by our managers, who also receive the Base Fee and Incentive Fee.
 
  •  No members of the BSAM Team or Stone Tower, including the CEOs, have entered into contracts with us requiring them to provide us or the managers with their services. Consequently, members of the BSAM Team and Stone Tower may devote a significant amount of time managing other BSAM or Stone Tower-managed vehicles and may not be available to our managers to provide services pursuant to our management agreements.
 
Resolution of Potential Conflicts of Interest; Equitable Allocation of Investment Opportunities
 
The management services to be provided by our managers under the management agreements are not exclusive to us and our subsidiaries. Our managers and/or their affiliates engage in a broad spectrum of activities, including investment advisory activities, and have extensive investment activities that are independent from, and may conflict or compete with, our business plan and strategies. BSAM, Stone Tower and/or their affiliates currently advise, sponsor or act as manager to other business ventures or clients that have investment objectives that overlap with our business plan and therefore compete with us for asset acquisition, development and structuring opportunities. Each of BSAM, Stone Tower and/or their affiliates sponsor or manage structured products funds, hedge funds, CDOs and separate accounts that invest in CDO equity, asset-backed securities, corporate debt securities and other structured fixed income securities. We will therefore face a number of conflicts of interest with our managers and/or their affiliates with respect to the allocation of asset acquisition opportunities. In addition, our managers may raise new investment funds whose investment objectives overlap with our business plan, which may further compound these conflicts.
 
Our managers are required to act in a manner that they consider fair and equitable in the allocation of business opportunities, and each of the managers internally oversees conflicts in a manner designed to prevent any client from receiving unduly favorable treatment over time. However, because the decision to offer any


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business opportunity to us lies within the discretion of the managers, it is possible that we may not be given the opportunity to participate in certain opportunities that meet our business objectives and that are made available to other clients or affiliates of the managers.
 
Each manager intends to allocate asset acquisition opportunities among us, on the one hand, and the investment management accounts managed or advised by it, on the other, in accordance with its asset allocation policies and procedures. Under these policies and procedures, the respective manager will use its reasonable best judgment and act in a manner which it considers fair and reasonable in allocating asset acquisition opportunities. When it is determined that it would be appropriate for us or one of our subsidiaries and one or more of such other investment management accounts to participate together in an acquisition opportunity, the respective manager will seek to allocate opportunities for all of the participating entities, including us, on an equitable basis, taking into account, among other things, such factors as the relative amounts of capital available for new purchases, the financing available in respect of an asset, legal restrictions, the size, liquidity and anticipated duration of the proposed asset acquisition, and the respective business objectives and policies and asset portfolios of us and the other entities for which participation is appropriate. Accordingly, we may not be given the opportunity to participate at all in certain acquisitions made by such other investment management accounts that meet our business objectives, but we expect over time to receive a fair allocation of such opportunities.
 
To further address potential conflicts arising out of transactions between us, on the one hand, and our managers and/or their affiliates, on the other, a majority of the members of our board of directors are directors who are unaffiliated with either BSAM or Stone Tower and/or their affiliates and satisfy the NYSE independence standard. Our policies state that certain transactions involving our managers and/or their affiliates or directors who are not independent must be approved by a majority of our disinterested directors.
 
We co-purchase assets alongside affiliates of our managers, including purchases of assets from, and interests in loans to, unaffiliated third parties. In addition, we may acquire interests in unaffiliated third parties where an affiliate of one of our managers has acquired, is concurrently acquiring, or intends to acquire a different interest in the same counterparty. In such instances, our interest may be senior or junior to, or have rights different from or adverse to, the interest owned by the manager’s affiliates. These acquisitions will be in compliance with applicable law and the manager’s internal procedures.
 
Our managers may determine, in light of differing business objectives of an affiliate that has an interest in a transaction in which we also have a financial interest and other factors applicable to the specific situation, to dispose of all or a portion of an asset on our behalf at the same time as such asset or portion thereof or a related asset is being retained by such affiliate. Conversely, the managers may determine to retain all or a portion of an asset on our behalf where such asset or a related instrument is being disposed of on behalf of such affiliate. Each of these determinations may present an actual or potential conflict of interest that is subject to either of the managers’ internal procedures.
 
Under the management agreements, there are no limits on the percentage of our total assets that may be comprised of assets of the type described above. Assets of the type described above may not be the result of arm’s length negotiations and may involve actual or potential conflicts between our interests and the interests of other affiliates of our managers. In addition, where we co-purchase assets with another affiliate of our managers, our returns on these assets may differ, in some cases materially, from our managers’ affiliates’ returns as a result of a variety of factors, including differences in the rates at which we are able to finance our assets as compared to the managers’ affiliates and differences in the timing of our disposition of such asset as compared with the managers’ affiliates.


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Summary Financial and Other Data
 
In the table below, we provide you with summary consolidated financial and other data of the company. We have prepared this information for the period from September 28, 2006 (commencement of operations) to December 31, 2006 using our audited consolidated financial statements for the period from September 28, 2006 (commencement of operations) to December 31, 2006. Results for the period from September 28, 2006 (commencement of operations) to December 31, 2006 are not necessarily indicative of results that may be expected for an entire year. The company’s fiscal year will end on December 31 of each calendar year.
 
When you read this summary consolidated financial and other data, it is important that you read along with it the consolidated financial statements and related notes, as well as the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included in this prospectus.
 
         
    For the Period
    September 28, 2006
    (Commencement of operations)
    through
    December 31, 2006
    ($ in thousands,
    except per share data)
 
Statement of Income Data:
       
Total revenue
  $ 25,024  
Total expenses
    10,672  
Net investment income
    14,352  
Net realized and unrealized gain on investment transactions
    7,600  
         
Net increase in net assets resulting from operations
  $ 21,952  
         
Per Share Data:
       
Net asset value
  $ 25.93  
Net increase in net assets resulting from operations
    0.94  
         
         
         
Balance Sheet Data:
       
Total assets
  $ 726,215  
Total liabilities
    106,761  
         
Total net assets
  $ 619,454  
         
Other Data:
       
Net investment income ratio(1)
    12.25 %
Weighted average yield(2)
    17.68 %
Cash distributions received from investments
  $ 11,976,102  
Return on equity(3)
    15.10 %
 
 
(1) Annualized.
 
(2) The weighted average of the bond equivalent yields of securities specified in the consolidated schedule of investments contained in the consolidated financial statements included in this prospectus, weighted by amortized cost.
 
(3) Return on equity, also known as total return, is an annualized rate based on daily compounding and is equal to the net increase in net assets from operations divided by the weighted average of the net asset value since commencement of operations.


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The Offering
 
Shares offered in the offering           ordinary shares.
 
Option to purchase additional ordinary shares The underwriters have the option to purchase up to an additional           ordinary shares from us at the public offering price, less the underwriting discounts and commissions, within 30 days from the date of this prospectus, solely to cover over-allotments, if any.
 
Ordinary shares to be outstanding immediately after the offering            ordinary shares, or           ordinary shares if the underwriters exercise in full their option to purchase additional ordinary shares solely to cover over-allotments.
 
Use of proceeds We estimate that the net proceeds we will receive from the sale of           ordinary shares in this offering will be approximately $     , or approximately $      if the underwriters fully exercise their over-allotment option, in each case assuming an initial offering price of $      per share, which is the midpoint of the price range set forth on the front cover of this prospectus, after deducting underwriting discounts and commissions, and estimated offering expenses of approximately $      payable by us. We expect to use the proceeds from this offering:
 
• to repay our debt under our existing secured credit facility;
 
• to create or acquire additional CDOs and other structured finance assets; and
 
• for general corporate purposes.
 
Initial offering price $      per ordinary share.
 
Our Corporate Information
 
Our principal executive offices are located at 152 West 57th Street, New York, New York 10019. Our telephone number is (212) 457-0220.


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RISK FACTORS
 
An investment in our ordinary shares involves a high degree of risk. You should carefully consider the following information, together with the other information contained in this prospectus, before investing in our ordinary shares. In connection with the forward-looking statements that appear in this prospectus, you should also carefully review the cautionary statement referred to under “Cautionary Statement Regarding Forward-Looking Statements.”
 
Risks Related to Our Business
 
We have a limited operating history and, accordingly, it is difficult to evaluate an investment in our ordinary shares.
 
We were recently formed and have a limited operating history. Consequently, it is difficult to evaluate our future prospects and an investment in our ordinary shares. We will be subject to the risks generally associated with the formation of any new business such as our lack of established operating procedures as well as BSAM’s and Stone Tower’s relative inexperience with the management of a public entity. We cannot assure you that we will be able to operate our business successfully or implement our operating policies and strategies described in this prospectus. We are subject to all of the business risks and uncertainties associated with any new business, including the risk that we will not achieve our investment objectives and that the value of your investment could decline substantially. We may not generate sufficient revenue from operations to pay our expenses and make or sustain distributions to shareholders.
 
Our financial performance is sensitive to changes in overall economic conditions and may affect our ability to pay dividends on our shares.
 
We own primarily ABS CDOs and CLOs. Our ABS CDOs hold primarily RMBS and to a lesser extent CMBS, synthetic asset-backed securities and other asset-backed securities. A downturn in overall economic conditions could lead to an increase in the default rates of residential or commercial mortgages, which would have a negative effect on the quality of the assets collateralizing these securities. For example, the majority of the RMBS held by our CDOs are backed by collateral pools comprised of subprime mortgages. Subprime mortgages have experienced increased default rates in recent periods. A deterioration in the assets collateralizing the asset-backed securities held by our CDOs could negatively affect the cash flows of the CDOs, and consequently our ability to receive dividends or distributions from these CDOs and pay dividends or distributions to our shareholders. See “— Risks Related to Our Assets — Subprime mortgage loans backing RMBS held by our CDOs are subject to additional risks.”
 
Our CLOs invest primarily in corporate leveraged loans and high-yield bonds that are rated below investment-grade. Non-investment-grade assets have greater credit and liquidity risk than investment-grade securities. The lower rating of these assets reflects a greater possibility that adverse changes in the financial condition of the issuer of these non-investment-grade assets or in general economic conditions, or both, may negatively affect the cash flows of the CDOs in which we hold equity interests. In addition, issuers of below-investment-grade debt obligations may be highly leveraged and may not have available to them more traditional methods of financing. During an economic downturn, a sustained period of rising interest rates or a period of fluctuating exchange rates (in respect of those issuers located in non-U.S. countries), such issuers may be more likely to experience financial stress and may be unable to meet their debt obligations due to the issuers’ inability to meet specific projected business forecasts or the unavailability of financing. While the results to date of our CLO holdings reflect that default rates for below-investment-grade debt obligations have been low relative to prior years, default rates may increase, perhaps significantly, in the future.
 
Fluctuations and changes in interest rates may cause losses and negatively affect our financial condition and results of operations, and can have a negative effect on our share price.
 
Changes in interest rates can affect our CDO subsidiaries’ net interest income, which is the difference between the interest received on interest-earning assets and the interest paid on interest-bearing liabilities. Changes in the level of interest rates also can affect, among other things, prepayment rates, yield spreads


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during periods when our CDOs may be required to reinvest principal payments on underlying assets, our ability to acquire new assets and create new CDOs, and the value of the assets we hold. In the event of a rising interest rate environment, corporate loan defaults may increase and result in credit losses that would affect the operating results of our CDOs. Increases in interest rates may also increase our cost of borrowing, which may restrict our ability or the ability of our future CDOs to obtain future debt financings.
 
In addition, if market interest rates increase, prospective investors may desire a higher distribution or dividend rate on our ordinary shares or seek to invest in other securities paying higher distributions or dividends. As a result, interest rate fluctuations and capital market conditions can affect the market value of our ordinary shares. For instance, if interest rates rise, the market price of our ordinary shares may decrease because potential investors may require a higher yield on our ordinary shares.
 
Our CDOs are complex and operate with a high degree of leverage, which may adversely affect the returns we earn on our assets and may reduce our cash available for distribution.
 
Our CDOs are complex and operate on a highly leveraged basis through collateralized financings, including potentially private or public offerings of debt, warehouse facilities, bank credit facilities, repurchase agreements and other borrowings. Although our CDOs’ actual use of leverage may vary depending on their ability to obtain credit facilities and the lenders’ and rating agencies’ estimate of the stability of their cash flows, our policies do not limit the amount of leverage we or any of our CDOs may incur. The cash flows of our CDOs may be reduced to the extent that changes in market conditions cause the cost of these financings to increase relative to the income that can be derived from the assets acquired. Defaults and lower than expected recoveries as well as delays in recoveries on the assets held by our subsidiaries could rapidly erode our equity in our CDOs. Increased debt service payments that are not offset by increased cash flow from underlying CDO assets would reduce cash flow available for distributions by our CDOs to us and, in turn, by us to our shareholders. Increased leverage increases the risk that our CDOs will not be able to meet their debt service obligations. See “— Risks Related to Our Assets — The equity issued by our CDO subsidiaries is subject to substantial risks.”
 
Holdings in our CDO subsidiaries or other CDO equity holdings are carried at estimated fair value, which is a highly subjective determination based predominately on management assumptions, including assumptions based on estimated future cash flow. The value of our shares could be adversely affected if our determinations regarding the fair value of our CDO equity or other holdings are materially higher than the values that we ultimately realize upon their disposal.
 
Holdings in our CDO subsidiaries and other CDO equity holdings are carried at estimated fair value, with unrealized gains and losses reported as a component of a net increase or decrease in net assets from operations in our consolidated statement of operations. However, there is no liquid public trading market for CDO equity upon which the value of our holdings may be readily determinable. The fair value of each holding is initially based on our cost. Upon each balance sheet date thereafter, fair value is estimated using the discounted cash flow technique. Accordingly, fair value is highly sensitive to our estimates of future cash flows attributable to our CDO equity holdings. Our estimates of future cash flows are in turn highly subjective and sensitive to a number of assumptions we must make regarding the collateral underlying each CDO, including assumptions as to forecasted default, recovery, reinvestment and prepay or call rates of the underlying CDO collateral as of the balance sheet date, and may also fluctuate over short periods of time. Our determinations of fair value may differ materially from the values that would have been used if a ready market for these investments existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our holdings are materially higher than the values that we ultimately realize upon these holdings.
 
Declines in the credit quality of our CDOs’ assets may adversely affect periodic reported results, which may reduce earnings and, in turn, cash available for distribution to us and our shareholders.
 
The credit quality of our CDOs’ assets may decline for a number of reasons, such as poor operating results of borrowers, declines in the value of the collateral supporting debt they hold and increases in defaults. A decline in the credit quality of our CDOs’ assets may force our subsidiaries to sell certain assets at a loss,


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or retain certain assets with unrealized losses or write downs, which in either instance, may reduce their earnings and, in turn, cash available for distribution to us and our shareholders.
 
Substantially all of our CDO holdings are illiquid in nature, and, accordingly, there can be no assurances that we will be able to realize the value at which many of our assets are carried if we are required to dispose of them.
 
Substantially all of our assets consisting of equity in CDOs are highly illiquid and are not publicly traded or readily marketable. As a result, we can provide no assurance that any given asset could be sold at a price equal to the amount ascribed to such asset, which may result in unexpected losses if we are required to sell such assets. Furthermore, because of applicable securities law and 1940 Act transfer restrictions, the equity securities we hold in our CDO subsidiaries that are excluded from the registration requirements of the 1940 Act by virtue of Rule 3a-7 thereunder may be less liquid than securities issued by other CDOs.
 
Substantially all of our initial CDO holdings were contributed by hedge funds managed by BSAM. Thus, the consideration given by us in exchange for these assets was not negotiated at arm’s length and may exceed the values that could be achieved upon the sale of such assets.
 
Substantially all of our initial CDO holdings were purchased from the BSHG Funds which are managed by BSAM. These assets are difficult to value. The values of the assets transferred to us were determined based on certain models, assumptions and methods and not by any arm’s length negotiation, and do not necessarily reflect the values that could be achieved by us upon the sale or other disposition of such assets. Performance of these assets is expected to differ, and may differ materially, from that used in the valuation models that were used. Small variations in one or more of the assumptions used to value the initial assets could result in large variations in the value of our initial CDO holdings.
 
Failure to procure adequate capital and funding would adversely affect our ability to pay distributions to our shareholders and, in turn, negatively affect the dividend yield and market price of our ordinary shares.
 
We depend upon the availability of adequate funding and capital for our operations. Our dividend policy is to distribute over time approximately 90% of our net investment income out of assets legally available for distribution. Therefore, we will not retain a substantial portion of our earnings and will have to rely on outside sources of funding for new investments. See “Dividend Policy.”
 
We cannot assure you that any, or sufficient, funding or capital will be available to us in the future on terms that are acceptable to us. In the event that we cannot obtain sufficient funding on acceptable terms, we may lower our distributions to shareholders, which may have a negative impact on the dividend yield and market price of our ordinary shares.
 
Maintenance of our 1940 Act exclusions imposes limits on our operations, and a failure to maintain our 1940 Act exclusions could cause us to restructure our business or register as an investment company, each of which could negatively affect our financial condition and results of operations.
 
We are a holding company that indirectly engages in various businesses through majority-owned CDO subsidiaries, most of which rely on various exclusions or exemptions from the 1940 Act and engage in the businesses described herein. More than 60% of our assets by value consist of interests in majority-owned CDO subsidiaries, including Parapet CDO, that rely on the exemption provided to certain structured financing vehicles by Rule 3a-7 of the 1940 Act.
 
Rule 3a-7 imposes limitations on the ability of a CDO issuer to purchase or sell assets, including prohibiting the issuer from purchasing or selling assets for the primary purpose of recognizing gains or decreasing losses resulting from market value changes. Thus, provisions in the indentures that govern our CDO subsidiaries, including Parapet CDO, restrict them from purchasing and selling assets in circumstances in which it may otherwise be advantageous for them to do so. As a practical result, the issuers may not acquire or dispose of assets primarily to enhance returns to the holder of the CDO equity.


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Depending on the anticipated asset mix and liability structure of a particular CDO subsidiary, compliance with Rule 3a-7 could require us to place additional limitations and prohibitions on the circumstances under which a CDO may sell assets, on the type of assets the subsidiary may 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, on the level of transactions that may occur or on other provisions of the indentures that govern the operation of those subsidiaries. We must monitor the activities of our subsidiaries, including those assets managed by third parties, to ensure that we meet these tests, which will limit the types and nature of business and assets in which we may engage indirectly through our Rule 3a-7 subsidiaries. If we were to determine that one or more of our CDO subsidiaries could not rely on Rule 3a-7, these CDO subsidiaries would have to rely on another 1940 Act exemption, which could require them to restructure their operations and, thus, adversely affect our earnings. In addition, we have a limited operating history and accordingly have only recently begun to implement procedures for maintaining appropriate qualifying assets levels to maintain exemption under the 1940 Act.
 
If we cannot rely on any exemption, exception or other exclusion from registration as an investment company, we could, among other things, be required either to (i) substantially change the manner in which we conduct our operations to avoid being required to register as an investment company or (ii) register as an investment company, either of which could have an adverse effect on us and the market price of our ordinary shares. 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.
 
As opposed to Section 3(c)(7) of the 1940 Act, compliance with Rule 3a-7 imposes limitations on our CDO subsidiaries’ ability to purchase and sell assets. Compliance with the Rule 3a-7 restrictions may result in our CDOs generating less yield than Section 3(c)(7) CDOs, which could result in lower earnings and distributions for holders of our ordinary shares relative to owners of Section 3(c)(7) CDOs.
 
Most CDO issuers are excluded from status as investment companies under the 1940 Act by reason of their compliance with Section 3(c)(7) thereunder. Section 3(c)(7) essentially requires such issuers to engage in private offerings made only to “qualified purchasers” (as defined in the 1940 Act), but places no limitations on the ability of the issuers to purchase or sell assets or otherwise trade the underlying portfolio of securities.
 
Rule 3a-7, on the other hand, imposes limitations on the ability of a CDO issuer to purchase or sell assets, including prohibiting the issuer from purchasing or selling assets for the primary purpose of recognizing gains or decreasing losses resulting from market value changes. Thus, as described above, provisions in the indentures that govern our CDO subsidiaries, including Parapet CDO, restrict them from purchasing and selling assets in circumstances in which it may otherwise be advantageous for them to do so.
 
Rule 3a-7 CDOs provide the manager with less opportunity to manage portfolio assets than Section 3(c)(7) CDOs. This may result in Rule 3a-7 CDOs being less liquid and generating less yield than Section 3(c)(7) CDOs, which would result in lower earnings and distributions for our shareholders.
 
BSAM’s and Stone Tower’s track record information may not be indicative of their or our future performance.
 
BSAM and Stone Tower’s track record information contained in this prospectus may not be representative of the performance of CDOs currently held by us or CDOs we hold in the future and we caution you that our future returns may be substantially lower than those achieved in the past, including for the following reasons:
 
  •  the historical track records include performance of instruments during earlier periods that may have been influenced by different economic, market or interest rate conditions or by various other factors that could cause future results to vary from historical results. For example, we are currently in a low default rate environment conducive to producing the returns demonstrated in BSAM’s and Stone Tower’s track record. There can be no assurance of similar returns in other market environments. For an


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  additional description of these factors, see “Cautionary Statement Regarding Forward-Looking Statements”;
 
  •  the historical track records set out the cash return of holdings in CDO equity. These returns, while reflecting the actual cash received by an equity holder, may differ significantly from the yields that may be accrued in respect of these holdings in our financial statements in accordance with GAAP. Cash flows to CDO equity can be expected to decline over time as the CDO debt is amortized (thereby de-levering the equity) or if the underlying collateral pool experiences defaults. Under GAAP, the yield reflects an accrual of the aggregate projected cash flows to the CDO equity, with any excess cash flows deemed to amortize the underlying asset. Consequently, cash returns to CDO equity in the early accounting periods will generally exceed the yields of such equity as reflected in the financial statements of the holder for such accounting periods;
 
  •  the annualized cash returns in most cases relate to CDOs that are still outstanding or that may have operated for only a limited period of time, and therefore their results to date or during earlier periods in their life cycle may not be reflective of the future or final results that will be achieved by those CDOs; and
 
  •  the CDOs used for calculating the track record were structured in nearly all cases to comply with the 1940 Act exemption provided by Section 3(c)(7) thereunder, whereas most, by fair value, of the CDO subsidiaries we own will be structured to comply with the 1940 Act exemption provided by Rule 3a-7 thereunder. As described above, the regulatory requirements of Rule 3a-7 impose limitations on the CDO manager with respect to trading and other operations. As a result, the returns of the CDOs used for purposes of calculating the track record may not be comparable to most of the CDOs proposed for us.
 
Our holding company structure may limit our ability to make regular distributions to our shareholders because we rely on distributions from our subsidiaries and other companies in which our subsidiaries hold assets, which may face constraints in making such distributions.
 
We are a holding company with no operations. Therefore, we are dependent upon the ability of our subsidiaries and their businesses and assets to generate earnings and cash flows and distribute them to us in the form of dividends or distributions to enable us to meet our expenses and to make distributions to our shareholders. The ability of our subsidiaries and the businesses in which they hold assets to make distributions or pay dividends depend on their respective operating results and may be subject to limitations, including, among other things, laws limiting the amount of funds available for the payment of dividends or distributions, and the terms and covenants of any present or future outstanding indebtedness, contract or agreement. If, as a consequence of these various limitations and restrictions, we are unable to generate sufficient funds for distributions from our subsidiaries and their businesses and assets, we may not be able to make or may have to delay distributions or dividends on our ordinary shares.
 
We are highly dependent on the information systems of BSAM, Stone Tower and third parties, and system failures could significantly disrupt our business, which may, in turn, negatively affect the value of our ordinary shares.
 
Our business is highly dependent on communications and information systems. We also depend on sophisticated software and access to information to derive expected cash flows of our investments. Any failure or interruption of our systems could cause delays or other problems in our activities, which could have a material adverse effect on our operating results and negatively affect the value of our shares and our ability to pay dividends or distributions on our ordinary shares.
 
Hedging transactions may limit our income or result in losses and will not completely insulate us from certain risks.
 
We engage, and will continue to engage in the future, in certain hedging transactions at the company or CDO subsidiary level to seek to limit our exposure to changes in credit default risks, changes in interest rates, changes in currency exchange rates and other financial market changes and therefore may expose ourselves to risks associated with such transactions. For instance, our subsidiaries may utilize instruments such as puts and


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calls on securities or indices of securities, futures contracts and options on such contracts, interest rate swaps and/or swaptions to seek to hedge against mismatches between the cash flows on their assets and the interest payments on their liabilities or fluctuations in the relative values of their portfolio positions, in each case resulting from changes in relevant market rates. In addition, we may enter into credit default swaps to manage the risks of credit-related events. Our hedging may not limit the exposures or manage the risks in the manner intended. Hedging does not eliminate the possibility of fluctuations or prevent losses. For example, we may enter into certain hedging strategies in subprime mortgage loans relating to exposure to tranches of RMBS held by certain of our CDO subsidiaries. Our hedging transactions may not completely insulate us from subprime risk. Although hedging can establish other positions designed to benefit from those same developments, thereby offsetting the declines, hedging transactions may also limit the opportunity for income or gain if rates change favorably. Moreover, it may not be possible to hedge against a rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.
 
The success of our hedging transactions depends on the managers’ ability to correctly predict movements of relevant market rates. Therefore, while we may enter into such transactions to seek to reduce relevant market rate risks, unanticipated changes may result in an overall investment performance below that which we would have obtained 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 the price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to the risk of loss. We are also exposed to the credit risk of the counterparty with respect to payments under derivative instruments.
 
We operate in a highly competitive market for business opportunities.
 
We are subject to significant competition in seeking business opportunities. Some of our competitors may have greater resources than we do and we may not be able to compete successfully for assets. Furthermore, competition for assets of the types and classes which our subsidiaries intend to acquire may lead to the price of such assets increasing, which may further limit our ability to generate our desired returns. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive business opportunities from time to time, and we or our CDO subsidiaries may not be able to identify and acquire assets that are consistent with our business objective. Moreover, other companies and funds may be formed to compete with us in pursuing a strategy similar to ours.
 
We may change our business strategy and operational policies without shareholder consent, which may result in a determination to pursue riskier business activities.
 
We may change our business strategy at any time without the consent of our shareholders, which could result in our acquiring subsidiaries or assets that are different from, and possibly riskier than, the strategy described in this prospectus. Our board of directors will determine our operational policies and may amend or revise our policies, including our policies with respect to our asset acquisitions, operations, indebtedness, capitalization and distributions, or approve transactions that deviate from these policies, without a vote of, or notice to, our shareholders. Operational policy changes could adversely affect the market price of our ordinary shares and our ability to make distributions to our shareholders.
 
Our due diligence may not reveal all of an entity’s liabilities and may not reveal other weaknesses in its business.
 
Before purchasing assets held in CDOs managed by our managers or before acquiring equity in CDOs sponsored by third parties, the managers assess the value of the underlying assets and other factors that they believe will determine the CDO’s success. In making the assessment and otherwise conducting customary due


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diligence, the managers rely on the resources available to them and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly organized entities because there may be little or no information publicly available or little or no historical information at all. Against this background, the managers’ due diligence processes may not uncover all relevant facts and any purchase may not be successful.
 
Non-U.S. assets may involve risks that are not present with U.S. assets, such as currency rate exposure and uncertainty of non-U.S. laws and markets.
 
Our CDO subsidiaries may in the future invest in debt obligations and other assets denominated in non-U.S. currencies. Non-U.S. debt obligations involve risks relating to political, social and economic developments abroad, as well as risks resulting from the differences between the regulations to which U.S. and non-U.S. obligors and markets are subject. These risks may include:
 
  •  seizure by the government of non-U.S. assets held by debt obligors, excessive taxation, withholding taxes on dividends and interest, limitations on the use or transfer of our non-U.S. assets, and political or social instability;
 
  •  enforcing legal rights may be difficult, costly and slow in non-U.S. countries, and there may be special problems enforcing claims against non-U.S. governments;
 
  •  non-U.S. obligors may not be subject to accounting standards or governmental supervision comparable to U.S. companies, and there may be less public information about their operations;
 
  •  non-U.S. markets may be less liquid and more volatile than U.S. markets; and
 
  •  costs of buying, selling and holding non-U.S. debt obligations, including brokerage, tax and custody costs, may be higher than those involved in domestic transactions.
 
In addition, non-U.S. assets denominated in currencies other than the U.S. dollar are subject to additional risks. Changes in currency exchange rates will affect the value of non-U.S. assets, the value of dividends and interest earned, and gains and losses realized on the sale of non-U.S. securities. An increase in the strength of the U.S. dollar relative to these other currencies may cause the value of our non-U.S. assets to decline. Certain non-U.S. currencies may be particularly volatile, and non-U.S. governments may intervene in the currency markets, causing a decline in value or liquidity of our securities holdings. Although we may hedge our non-U.S. currency risk, we may not be able to do so successfully and may incur losses in these assets as a result of exchange rate fluctuations.
 
We may experience fluctuations in our quarterly results.
 
We could experience fluctuations in our quarterly operating results and cash distributions due to a number of factors including the difference in actual cash received and expected cash, the timing of cash flows, changes in assumptions, such as default and prepayment risk, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains and losses and general market conditions. As a result of these factors, results of any period should not be relied upon as being indicative of performance in future periods.
 
Terrorist attacks may negatively affect our financial condition and results of operations.
 
Terrorist attacks across the globe, as well as events occurring in response to or in connection with them, may adversely affect our financial condition and results of operations. A terrorist attack could have a material adverse effect on the assets held by our CDO subsidiaries and therefore on our financial condition and results of operations. Furthermore, terrorist attacks of significant scale could cause volatility in the financial markets and uncertainty in the economies of the areas where they occur, and even possibly the global economy.


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Risks Related to Our Managers
 
Our performance is dependent on BSAM and Stone Tower and certain of their key personnel, and we may not find a suitable replacement if either of the management agreements is terminated or such key personnel are no longer available to us.
 
All of our executive officers and other senior personnel responsible for our day-to-day operations, other than our chief financial officer, are also employees or officers of either BSAM or Stone Tower and will not spend all of their time managing our activities. We depend on the diligence, skill and network of business contacts of the employees of BSAM and Stone Tower and our CEOs, our board of directors and our investment committee. BSAM and Stone Tower evaluate, negotiate, and monitor our holdings. Our future success will depend on the continued services of the management team of BSAM and Stone Tower. The continued services of the management team of BSAM and Stone Tower are not guaranteed because the management agreements do not require that any particular individual’s services be made available to us. However, we can not renew the management agreements with either of our managers during the 90-day period following the death, disability or voluntary resignation of the related CEO. If any such event occurs and we terminate the related management agreement, we have no assurance that a suitable replacement CEO or manager may be identified or, if identified, could be engaged on terms as favorable as those with our current CEOs and managers. We do not carry any key-man life insurance policies covering either of our CEOs.
 
We are also dependent on BSAM and Stone Tower for certain services, including administrative and business advice. The departure of either of our CEOs or any of the other senior members of the management team at BSAM or Stone Tower could have a material adverse effect on our ability to achieve our business objectives. We are subject to the risk that BSAM and/or Stone Tower will terminate their respective management agreement and that no suitable replacement will be found.
 
The base management fee payable to our managers is payable regardless of the performance of our portfolio.
 
We will pay our managers substantial management fees, based in part on our equity capital (as defined in the management agreements), regardless of the performance of our portfolio, with certain exceptions. The management fee is based, among other things, on our net assets. The value of our net assets is based on highly subjective management assumptions, including assumptions to arrive at estimated future cash flows from our CDO and our CDOs’ asset values. Our managers’ entitlement to nonperformance-based compensation as a portion of the total compensation might reduce their incentive to devote the time and effort of their professionals to seeking profitable opportunities for our portfolio, which could result in a lower performance of our portfolio and negatively affect our ability to pay distributions to our shareholders.
 
The incentive fee payable to our managers may induce BSAM and Stone Tower to engage in riskier activities than they otherwise would.
 
The management incentive allocation structure that we have agreed to with BSAM and Stone Tower may cause BSAM and Stone Tower to purchase high-risk assets or take other risks. In addition to the base management fee, BSAM and Stone Tower or their respective affiliates are entitled to receive an incentive fee and corresponding distribution from the company based upon the company’s achievement of targeted levels of net increase in net assets resulting from operations. In evaluating acquisitions and other management strategies, the opportunity to earn an incentive fee based on net increase in net assets resulting from operations may lead BSAM and Stone Tower to place undue emphasis on the maximization of net increase in net assets resulting from operations at the expense of other criteria, such as preservation of capital, maintaining sufficient liquidity, and/or management of credit risk or market risk, in order to achieve a higher incentive fee. Assets with higher yield potential are generally riskier or more speculative. This could result in increased risk to the value of our assets.


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Although our board of directors may approve broad business guidelines for our managers, our board of directors does not approve each business decision made by our managers.
 
Our managers are authorized to follow a very broad business approach on our behalf. We cannot predict with any certainty the percentage of our assets that will be in each asset category. We may change our business strategy and policies without a vote of shareholders. Our board of directors will periodically review our business approach and our assets. However, our board of directors is not required to review every proposed purchase or disposition of assets. Furthermore, even though a majority of our board of directors consists of independent directors, there is no assurance that our board of directors will provide effective oversight over the activities of our managers.
 
Each of our managers has broad operational latitude, and even if either of the managers finds a business opportunity that is appropriate for us, it may allocate, in its discretion, some or all of such opportunity to other accounts managed by it and its affiliates.
 
As registered investment advisors, each of our managers is required to allocate opportunities equitably among its clients. However, each manager has broad operational latitude in allocating opportunities, and we may not be given the opportunity to participate at all in certain acquisitions made by such other clients that meet our business objectives.
 
We may compete with BSAM’s and Stone Tower’s or their affiliates’ current and future investment vehicles for access to capital and assets.
 
The management services to be provided by the managers under the management agreements are not exclusive to us and our subsidiaries. The managers and/or their affiliates engage in a broad spectrum of activities, including investment advisory activities, and have extensive investment activities that are independent from, and may from time to time conflict with, our business activities and strategies. The managers and/or their affiliates may advise, sponsor or act as manager to other investment funds, portfolio companies of private equity investments and other persons or entities (including prospective investors in the ordinary shares) that have investment objectives that overlap with our business plan and that may, therefore, compete with us for asset acquisition opportunities. We will therefore face a number of conflicts of interest with the managers and/or their affiliates with respect to the allocation of asset acquisition opportunities. In addition, the managers may raise new investment funds with investment objectives that overlap with our business plan, which may further compound these conflicts.
 
We may compete with BSAM’s and Stone Tower’s current and future business ventures or clients for access to management time, services and functions.
 
BSAM and Stone Tower will devote as much of their time to our business as they deem necessary or appropriate to fulfill their obligation under their respective management agreement. However, they are currently committed to and expect to be committed in the future to providing investment advisory services and securities research and brokerage services for other clients, including other funds that they manage, and engage in other business ventures in which we have no interest. Furthermore, neither of the Co-CEOs is required to devote a specific amount of time to our affairs. As a result of these separate business activities, the managers will have conflicts of interest in allocating management time, services and functions between us and other business ventures or clients.
 
BSAM and Stone Tower may acquire confidential or material non-public information that may prevent them from initiating certain transactions for us that they otherwise might have initiated.
 
BSAM and Stone Tower, through their activities on behalf of other clients or entities, may acquire confidential or material non-public information or be restricted by internal policies from initiating transactions in certain securities. The managers will not be free to divulge, or to act upon, any such confidential or material non-public information and, due to these restrictions, may not be able to initiate certain types of


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transactions in certain securities or instruments for us that they otherwise might have initiated. We may be frozen in an investment position that we otherwise might have liquidated or closed out.
 
We were established by BSAM and Stone Tower and as such our arrangements may contain terms that are less favorable to us than those which otherwise might have been obtained from unrelated parties.
 
Our management agreements, governance documents and other arrangements with BSAM and Stone Tower, including with respect to our initial holdings, were negotiated in the context of an affiliated relationship. Our independent directors were not then appointed and did not participate in the negotiation of such terms and did not approve the arrangements on our behalf. Because these arrangements were negotiated between related parties, their terms, including terms relating to compensation, contractual or fiduciary duties, conflicts of interest and the ability of BSAM and Stone Tower to engage in outside activities, including activities that compete with us, our activities and limitations on liability and indemnification, may be less favorable than otherwise might have resulted if the negotiations had involved unrelated parties.
 
We may purchase assets from BSAM or Stone Tower or their affiliates, make co-purchases alongside BSAM or Stone Tower or their affiliates or otherwise participate in asset acquisitions in which BSAM or Stone Tower or their respective affiliates have an interest, which could result in conflicts of interest.
 
We may purchase assets from, finance the assets of or make co-purchases alongside BSAM or Stone Tower, their affiliates and/or business ventures or clients that they manage, including assets of CDOs structured by BSAM or Stone Tower. These transactions will not be the result of arm’s length negotiations and will involve conflicts between our interests and the interest of BSAM or Stone Tower and/or their affiliates in obtaining favorable terms and conditions. Accordingly, certain of these transactions may require approval by the disinterested directors. There can be no assurance that any procedural protections, such as obtaining the approval of the disinterested directors, 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 would have been obtained in an arm’s length transaction.
 
We may purchase assets in situations where our interests conflict with those of BSAM or Stone Tower or their respective affiliates.
 
We may purchase assets that are senior or junior to, or have rights and interests different from or adverse to, assets held by other accounts or funds managed by BSAM or Stone Tower. Certain of these transactions may require approval by our disinterested directors. Our interests in such assets may conflict with the interests of such other accounts in related investments at the time of origination or in the event of a default or restructuring of a company, property or other asset.
 
In addition, in structuring our CDO subsidiaries, the managers may have conflicts between us and other entities managed by them that purchase debt securities in our CDOs with regard to setting subordination levels, determining interest rates, providing for divesting or deferring distributions that would otherwise be made to CDO equity or otherwise setting the amounts and priorities of distributions to the holders of debt and equity interests in the CDO.
 
We depend on BSAM and Stone Tower in pricing asset purchases, and BSAM and Stone Tower may have business relationships that affect asset purchases.
 
We purchase additional assets from third parties in negotiated transactions. The prices at which the additional assets are purchased will be influenced by many economic, market and other factors using price modeling by BSAM and Stone Tower that is based on various assumptions and estimates. Accordingly, the purchase price for the additional assets will depend upon the ability of BSAM and Stone Tower to effectively price such additional assets in the then-current lending, interest rate and securitization markets. The expected future cash flow and the discount rates used in determining the purchase price of such additional assets will also be affected by BSAM’s and Stone Tower’s estimates of the performance of the underlying assets.
 
Some of the asset sellers may be entities with which BSAM or Stone Tower has engaged in other commercial transactions, are clients of BSAM or Stone Tower or have other business relationships and may


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include shareholders. Such relationships could influence the purchase price for the additional assets or the proceeds realized from the offering of securities in the securitizations. Accordingly, the purchase prices for such additional assets may not reflect the best prices achievable for us absent such conflicts.
 
BSAM and Stone Tower affiliates are able to exercise substantial influence over important matters coming before our shareholders and board of directors regarding our business and affairs.
 
After the offering, funds managed by or affiliated with BSAM and Stone Tower are expected to hold  % and  %, respectively, of our ordinary shares and accordingly will have significant influence over shareholder voting, including independent director elections. Additionally, the special voting share classes granted to BSAM and Stone Tower entitle each to elect one director. These special voting shares remain valid so long as the relevant management agreement remains in effect, or the relevant manager or its affiliates have over $50 million invested in Everquest. BSAM’s special voting shares entitle it to designate one additional director so long as the BSAM-affiliated investment in Everquest is over $100 million. Due to operation of these special voting share classes, currently three of our seven directors are affiliated with BSAM and Stone Tower. As a result, BSAM and Stone Tower will be able to substantially influence our company’s decisions.
 
BSAM’s and Stone Tower’s liability is limited, and we have agreed to indemnify them under the management agreements.
 
BSAM and Stone Tower will manage our operations pursuant to the management agreements. The management agreements provide that BSAM, Stone Tower and their affiliates and their respective legal and other representatives will not be liable to us, any of our subsidiaries, our directors, our shareholders or any of our subsidiary’s shareholders for any acts or omissions or any errors of judgment by any of the foregoing or losses suffered by us arising from, or in connection with the provision of services by BSAM or Stone Tower, or on behalf of BSAM or Stone Tower, under the management agreements, except those resulting from the willful misconduct, fraud, criminal misconduct or gross negligence of the managers or by reason of the managers’ reckless disregard of their obligations and duties. We have agreed to indemnify BSAM and Stone Tower and their affiliates and their respective legal and other representatives to the fullest extent permitted by law against all liabilities and expenses arising from acts or omissions of any such indemnified party arising from, or in connection with, the provision of services by BSAM and Stone Tower, or on behalf of BSAM and Stone Tower, under the management agreements, except those resulting from the willful misconduct, fraud, criminal misconduct or gross negligence or reckless disregard in performance of their obligations and duties.
 
The management agreements may be difficult and costly to terminate.
 
The management agreements may be difficult and costly to terminate. The term of each management agreement is one year from its commencement, and will be renewed automatically for a one-year term on each anniversary date after the initial one-year term unless we or a manager party to such management agreement terminates such management agreement by providing a termination notice to the other party. If we deliver a termination notice to a manager, other than with respect to a termination for cause, such manager will be entitled to a termination payment in an amount equal to between one and three times the average annual fees paid to the manager in prior years, depending on the timing and circumstances of the termination. These provisions may increase the effective cost to us of terminating the management agreements.
 
Risks Related to Our Assets
 
We may not realize gains or income from our CDO and other assets.
 
We seek to generate both current income and capital appreciation. However, the securities we invest in may not appreciate in value and, in fact, may decline in value. In addition, collateral assets underlying our CDOs may default on interest and/or principal payments. Accordingly, we may not be able to realize gains or income from our CDOs. Any gains that we do realize may not be sufficient to offset any other losses we experience. Any income that we realize may not be sufficient to offset our expenses.


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An increase in the rate of default on the assets purchased and held by the CDOs we hold could decrease the distributions we receive from such CDOs and, therefore, reduce our earnings and decrease our ability to make distributions to our shareholders.
 
To the extent that the rate of default with respect to assets held by any of our CDO holdings increases, the amount available to be paid to us as an equity holder decreases as does the value of our equity in that CDO holding. Additionally, we may have to record an asset-impairment charge in our financial statements relating to our CDO assets experiencing increased defaults. Because our holdings of CDO equity typically represent a leveraged investment, the occurrence of defaults with respect to only a small portion of the assets could result in the substantial or complete loss of our holding in the CDO equity.
 
Subprime mortgage loans backing RMBS held by our CDOs are subject to additional risks.
 
The substantial majority of the asset-backed CDOs in which we hold equity have invested in RMBS, including primarily RMBS backed by collateral pools of subprime residential mortgage loans. “Subprime” mortgage loans refer to mortgage loans that have been originated using underwriting standards that are less restrictive than the underwriting requirements used as standards for other first and junior lien mortgage loan purchase programs, such as the programs of Fannie Mae and Freddie Mac. These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories (including outstanding judgments or prior bankruptcies), mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgaged property, mortgage loans made to borrowers with low credit scores, mortgage loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified.
 
Additionally, some of the mortgage loans backing the RMBS held by some of our CDOs are “non-conforming loans” and are not eligible for purchase by Fannie Mae or Freddie Mac due to either credit characteristics of the related mortgagor or documentation standards in connection with the underwriting of the related mortgage loan that do not meet the Fannie Mae or Freddie Mac underwriting guidelines for “A” credit mortgagors. These credit characteristics include mortgagors whose creditworthiness and repayment ability do not satisfy such Fannie Mae or Freddie Mac underwriting guidelines and mortgagors who may have a record of credit write-offs, outstanding judgments, prior bankruptcies and other credit items that do not satisfy such Fannie Mae or Freddie Mac underwriting guidelines. These documentation standards may include mortgagors who provide limited or no documentation in connection with the underwriting of the related mortgage loan. In addition, certain mortgage loans may fail to conform to the underwriting standards of the related originators.
 
Due to economic conditions, including increased interest rates and lower home prices, as well as aggressive lending practices, subprime mortgage loans have in recent periods experienced increased rates of delinquency, foreclosure, bankruptcy and loss, and they are likely to continue to experience rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus, because of the higher delinquency rates and losses associated with subprime mortgage loans, the performance of RMBS backed by collateral pools with a significant subprime component could be correspondingly adversely affected, which, in turn, would adversely affect the performance of CDOs containing such RMBS in their collateral pools.
 
The CDOs we hold may not be able to reinvest proceeds from matured, prepaid or sold assets in other assets with similar or higher yields, and therefore net income available to be distributed to us from those CDOs may decline.
 
The income that a CDO is capable of earning and distributing to us will decrease to the extent that during its applicable reinvestment period it is unable to reinvest the proceeds it receives from matured, prepaid, sold or called CDO assets into similar or higher yielding instruments. The ability of a collateral manager of a CDO to reinvest proceeds in similar or higher yielding instruments will depend on a variety of factors, including the general interest rate environment and the availability of investments satisfying the investment policies of the collateral manager or the requirements of the applicable indentures. A decline in net income earned by our CDOs resulting from a failure to reinvest proceeds at similar or higher yields will decrease the distributions we receive from those CDOs.


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The equity issued by our CDO subsidiaries is subject to substantial risks.
 
Our largest CDO subsidiary, Parapet CDO, also holds preference shares and income notes in CDOs. These equity securities are subject to substantial risks, including the following:
 
Leveraged Investment.  CDO equity securities represent leveraged investments in the underlying assets held by the CDO. This leverage arises from the debt securities issued by the CDO, which will increase the cash flow available to equity holders as compared with the cash flow that would be available for a comparable investment in a non-leveraged transaction. This increased cash flow will directly affect the yield on the CDO equity securities. However, the use of leverage also creates risk for the holders of CDO equity, like us, because the leverage increases their exposure to losses with respect to the underlying assets. This is particularly true of the equity securities issued by Parapet CDO, because both the equity securities issued by Parapet CDO, as well as the CDO securities constituting the assets held by Parapet CDO, represent leveraged investments. As a result, the occurrence of defaults with respect to only a small portion of the collateral could result in the substantial or complete loss of the investment in the CDO equity we hold in our subsidiaries. Due to the existence of leverage, changes in the market value of the CDO equity we hold or the CDO equity held by Parapet CDO could be greater than the changes in the values of the underlying assets of the relevant issuer, which itself may be subject to, among other things, credit and liquidity risk. You should consider with particular care the risks of leverage because it increases substantially the risk that the holders of the CDO equity securities could lose their entire investment if the pool of assets is adversely affected.
 
Limited Assets to Pay Dividends and Other Distributions on the CDO Equity Securities.  CDO equity securities represent equity interests in the relevant CDO issuer only. Like other securities issued by CDOs, they are payable solely from and to the extent of the available proceeds from the underlying assets held by the issuer. The CDO equity securities are part of the issued share capital of the issuer and are not secured. Except for the issuer, no person is obligated to pay dividends or any other amounts with respect to the CDO equity. Consequently, holders of the CDO equity must rely solely upon distributions on the underlying assets. If distributions on the underlying assets are insufficient to pay required fees and expenses, to make payments on the debt securities of the issuer or to pay dividends or other distributions on the CDO equity, all in accordance with the applicable priority of payments, no other assets of the CDO issuer or any other person will be available for the payment of the deficiency. Once all proceeds of the underlying assets have been applied, no funds will be available for payment of dividends or other distributions on the CDO equity. Therefore, whether holders of the CDO equity receive a return equivalent to or greater than the purchase price paid for the CDO equity by holders of the CDO equity will depend upon the aggregate amount of dividends and other distributions paid on the CDO equity prior to any final redemption date and the amount of available funds on the final redemption date available for distribution to holders of the CDO equity.
 
Subordination of the CDO Equity.  CDO equity receives distributions from the CDO only if the CDO generates enough income to first pay the holders of the CDO debt securities and related CDO expenses. Payments of principal of and interest on debt issued by CDOs, and dividends and other distributions on CDO equity securities, are subject to priority of payments. CDO equity is subordinated to the prior payment of all obligations under debt securities. Furthermore, in the event of default under any debt securities issued by a CDO, holders of the CDO equity generally have no right to determine the remedies to be exercised. To the extent that any elimination, deferral or reduction in payments on debt securities occurs, such elimination will be borne first by the CDO equity and then by the debt securities in reverse order of seniority. Thus, the greatest risk of loss relating to defaults on the collateral held by CDOs is borne by the CDO equity. To the extent that a default occurs with respect to any collateral and the trustee sells or otherwise disposes of such collateral, it is likely that the proceeds of such sale or other disposition will be less than the unpaid principal and interest on such collateral. Excess funds available for distribution to the CDO equity will be reduced by losses occurring on the collateral, and returns on the CDO equity will be adversely affected.
 
Equity Status of the CDO Equity.  The CDO equity securities represent equity in the applicable issuer and are not secured by the underlying assets held by the issuer, which generally secures the classes of debt securities issued by the issuer. As such, the holders of the CDO equity securities will rank behind all of the


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creditors, whether secured or unsecured and known or unknown, of the issuer, including, without limitation, the holders of all the classes of debt securities issued by the CDO.
 
Payments in respect of preference shares and other equity securities are also subject to certain requirements imposed by the relevant jurisdiction of a CDO. Payments to holders of preference shares, other than payments made on the final redemption date, and the other equity securities will generally be paid as dividends in accordance with the corporate law of the issuer. Under Cayman Islands law, for example, any amounts paid as dividends or other distributions on equity securities will be payable only if the issuer has sufficient distributable profits and/or share premium and meets any other application restrictions imposed on the issuer. In addition, such distributions (including any distribution upon redemption of preference shares) will be payable only to the extent that the issuer is and remains solvent after such distributions are paid. Under Cayman Islands law, for example, a company is generally deemed to be solvent if it is able to pay its debts in the ordinary course of its business as they come due.
 
To the extent the requirements under the applicable law are not met, amounts otherwise payable to the holders of equity securities may be delayed or altogether precluded.
 
Yield, Maturity, Distributions and Other Performance Considerations.  The amount of distributions on the CDO equity will be affected by, among other things, the timing of purchases of underlying assets, the rates of repayment of or distributions on the underlying assets, the timing of reinvestment in substitute underlying assets and the interest rates available at the time of reinvestment. The longer the period of time before reinvestment of cash in underlying assets, the greater the adverse impact may be on the aggregate interest collected, thereby lowering yields and otherwise affecting performance of the CDO equity. The amount of distributions on CDO equity may also be affected by rates of delinquencies and defaults on and liquidations of the underlying assets, sales of underlying assets and purchases of underlying assets having different payment characteristics. The yield and other measures of performance may be adversely affected to the extent that the issuer incurs any significant unexpected expenses.
 
The different asset classes held by our CDO subsidiaries will subject us to specific risks as described below that could adversely affect our operating results and the value of our assets.
 
In addition to the risks relating to CDO equity securities issued by CDOs described above, our CDO subsidiaries will invest in a range of asset classes, which will subject us to further risks, including, among others, credit risks, liquidity risks, interest rate and other market risks, operational risks, structural risks and other legal risks. Some, but not all, of these additional asset classes and certain related risks are described below.
 
Corporate Leveraged Loans.  Our CDO subsidiaries may hold interests in corporate leveraged loans originated by banks and other financial institutions (as well as in some cases by affiliates of the managers). These loans will be term loans and revolving loans, may pay interest at a fixed or floating rate, may be senior or subordinated and may be secured or unsecured. These loans may be illiquid. To the extent that they are non-investment-grade, they may also bear risks associated with high-yield bonds described below.
 
Our CDO subsidiaries may acquire interests in corporate leveraged loans either directly (by way of sale or assignment) or indirectly (by way of participation). The purchaser of an assignment typically succeeds to all the rights and obligations of the assigning institution and becomes a lender under the credit agreement with respect to the debt obligation; however, its rights can be more restricted than those of the assigning institution. Participation interests in a portion of a debt obligation typically result in a contractual relationship only with the institution participating out the interest, not with the borrower. In purchasing participations, our CDO subsidiaries generally will have no right to enforce compliance by the borrower with the terms of the credit agreement, or any rights of set-off against the borrower, and our CDO subsidiaries may not directly benefit from the collateral supporting the debt obligation in which it has purchased the participation. As a result, our CDO subsidiaries will assume the credit risk of both the borrower and the institution selling the participation.
 
High-Yield Bonds.  Many of the high-yield bonds our CDO subsidiaries may acquire are rated below-investment-grade by one or more nationally recognized statistical rating organizations or are unrated but of comparably low credit quality, and have greater credit and liquidity risk than more highly rated bonds.


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High-yield bonds may be unsecured, and may be subordinate to other obligations of the obligor. The lower rating of high-yield bonds (or lack of a rating) reflects a greater possibility that adverse changes in the financial condition of the obligor or in general economic conditions (including, for example, a substantial period of rising interest rates or declining earnings or both) may impair the ability of the obligor to make payment of principal and interest. Many issuers of high-yield bonds are highly leveraged, and their relatively high debt-to-equity ratios create increased risks that their operations might not generate sufficient cash flow to service their debt obligations. Overall declines in the below-investment-grade bond and other markets may adversely affect such issuers by inhibiting their ability to refinance their debt at maturity. High-yield bonds are often less liquid than higher rated bonds.
 
High-yield bonds are often issued in connection with leveraged acquisitions or recapitalizations in which the issuers incur a substantially higher amount of indebtedness than the level at which they had previously operated. High-yield bonds have historically experienced greater default rates than investment-grade bonds.
 
Mortgage-backed Securities.  RMBS and CMBS held by our CDOs bear various risks, including credit, market, interest rate, structural and legal risks. Risks affecting the underlying real estate investments of an RMBS or CMBS include general economic conditions, the condition of financial markets, political events, developments or trends in any particular industry and changes in prevailing interest rates. The cyclicality and leverage associated with real estate-related instruments have historically resulted in periods, including significant periods, of adverse performance, including performance that may be materially more adverse than the performance associated with other instruments.
 
Prepayment rates could negatively affect the value of our mortgage-backed securities, including RMBS and CMBS, which could result in reduced earnings or losses and negatively affect the cash available for distribution to our shareholders. Volatility in prepayment rates may affect our ability to maintain targeted amounts of leverage on our mortgage-backed securities portfolio and may result in reduced earnings or losses for us and negatively affect the cash available for distribution to our shareholders.
 
  •  RMBS.  At any time, a portfolio of RMBS held by a CDO may be backed by residential mortgage loans with disproportionately large aggregate principal amounts secured by properties in only a few states or regions. As a result, the residential mortgage loans may be more susceptible to geographic risks relating to such areas, such as adverse economic conditions, adverse events affecting industries located in such areas and natural hazards affecting such areas, than would be the case for a pool of mortgage loans having more diverse property locations. In addition, the residential mortgage loans may include so-called “jumbo” mortgage loans having original principal balances that are higher than is generally the case for residential mortgage loans. As a result, a portfolio of RMBS may experience increased losses. See also “— Subprime mortgage loans backing RMBS held by our CDOs are subject to additional risks” above for a description of additional risks relating to subprime RMBS.
 
  •  CMBS.  In addition, commercial mortgage loans generally lack standardized terms, tend to have shorter maturities than residential mortgage loans and may provide for the payment of all or substantially all of the principal only at maturity. Additional risks may be presented by the type and use of a particular commercial property. Commercial properties tend to be unique and are more difficult to value than single-family residential properties. Commercial lending is generally viewed as exposing a lender to a greater risk of loss than residential one-to-four family lending since it typically involves larger loans to a single borrower than residential one-to-four family lending.
 
CDO Debt Securities.  Our CDOs may hold debt securities issued by other CDOs. These CDO debt securities rely on distributions of the CDO’s underlying assets. Interest payments on the CDO debt securities (other than the most senior tranche or tranches of a given issue) are generally subject to deferral, without causing an event of default or permitting exercise of remedies by the holders thereof. If distributions on the collateral of the CDO or proceeds of such collateral are insufficient to make payments on the CDO debt securities held by our CDO subsidiaries, no other assets will be available for payment of the deficiency. CDO securities are generally privately placed and offer less liquidity than other investment-grade or high-yield corporate debt.


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Total Return Swaps.  Our CDO subsidiaries may enter into total return swaps. Total return swaps are subject to risks related to changes in interest rates, credit spreads, credit quality and expected recovery rates of the underlying credit instrument as well as renewal risks. A total return swap agreement is a two-party contract to exchange returns from predetermined investments or instruments. Total return swaps allow investors to gain exposure to an underlying credit instrument without actually owning the credit instrument. In these swaps, the total return (fixed interest fees and capital gains/losses on an underlying credit instrument) 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 credit instrument that is referenced in the swap as collateral posted with the swap counterparty. The total return swap, therefore, is a leveraged investment in the underlying credit instrument. The gross returns to be exchanged or “swapped” between the parties are calculated based on a “notional amount,” which is valued monthly to determine each party’s obligation under the contract. We are charged a finance cost by counterparties with respect to each agreement. Because swap maturities may not correspond with the maturities of the credit instruments underlying the swap, we may wish to renew many of the swaps as they mature. However, there is a limited number of providers of such swaps, and there is no assurance the initial swap providers will choose to renew the swaps, and, if they do not renew, that we would be able to obtain suitable replacement providers.
 
Credit Default Swaps.  We may own credit default swaps. Credit default swaps are subject to risks related to changes in interest rates, credit spreads, credit quality and expected recovery rates of the underlying credit obligations referenced in the credit default swap. A credit default swap is a contract in which the contract buyer pays a periodic premium until the contract expires or a credit default occurs. In return for this premium, the contract seller makes a payment to the buyer if there is a credit default or other specified credit event with respect to the issuer of the underlying credit instrument referenced in the credit default swap. We may act as a buyer and seller of credit default swaps by entering into contracts that reference CDOs from cash and synthetic structures backed by pools of corporate, consumer or structured finance debt. The change in fair value resulting from movements in interest rates, credit spreads, changes in credit quality and expected recovery rates is unrealized as credit default swaps are not traded to realize this value. The valuation of credit default swaps may require management to make certain assumptions and estimates and actual experience may materially differ from the estimates reflected in our subsequent financial statements.
 
Our investments in synthetic CDOs are subject to a number of risks that could adversely affect our returns.
 
We hold synthetic CDOs and we expect to invest in similar assets in the future. Synthetic CDOs enter into credit default swaps and total return swaps which entail the risks described above. In addition, synthetic CDOs are subject to a number of risks, including the following:
 
  •  The individual reference obligations referenced in the credit default swaps may be static. Therefore, no additions, removals, substitutions or modifications to the credit default swap portfolio will be effected in response to any changes in the market conditions applicable to the reference obligations.
 
  •  Our underlying CDOs that invest in credit default swaps rely on the creditworthiness of the credit default swap counterparty. Consequently, in addition to relying upon the creditworthiness of the reference entities, the issuer is also relying upon the creditworthiness of the credit default swap counterparty to perform its obligations under the credit default swaps and of the issuers of or obligors with respect to the other eligible investments.
 
  •  Under the credit default swaps, the issuer has a contractual relationship only with the credit default swap counterparty. Consequently, the issuer has no legal or beneficial interest in any reference obligation or any other obligation of any reference entity. The issuer has no right directly to enforce compliance by the obligor under any reference obligation with the terms thereof, does not have any rights of set-off against such obligor, does not have any voting rights with respect to such reference obligation, does not directly benefit from any collateral supporting such reference obligation and does not have the benefit of the remedies that would normally be available to a holder of such reference obligation.


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The CDO subsidiaries that we form internally may not be able to acquire eligible collateral securities for a future CDO issuance, or may not be able to issue future CDO debt securities on attractive terms that closely match the duration of the assets and liabilities, which may require our CDO subsidiaries to seek more-costly financing for these assets or cause us to lose the opportunity to create a CDO subsidiary.
 
We operate primarily through ownership of our CDO subsidiaries. To the extent we form new CDO subsidiaries internally, relatively short-term credit facilities may be used to finance the acquisition of securities for new CDO subsidiaries until a sufficient quantity of securities is accumulated, at which time the assets are refinanced through a securitization, such as a CDO issuance, or other long-term financing. As a result, we are subject to the risk that a CDO subsidiary will not be able to acquire, during the period that the short-term facilities are available, a sufficient amount of eligible securities to create a new CDO subsidiary that will increase our earnings potential. We also bear the risk that our future CDO subsidiaries we form will not be able to obtain such short-term credit facilities or may not be able to renew any short-term credit facilities after they expire should it be necessary to obtain extensions for such short-term credit facilities to allow more time to seek and acquire the necessary eligible instruments for a long-term financing. Inability to renew or extend these short-term credit facilities may cause a CDO subsidiary to seek more-costly financing for these assets or to lose the ability to utilize them in connection with the creation of a CDO issuance. In addition, conditions in the capital markets may make the creation of a CDO issuance less attractive to us when a sufficient pool of collateral is available. We, through our subsidiaries, may also participate in the equity of CDO entities established by third parties with respect to which we will assume all or a portion of the risk of losses prior to completion of a securitization by such CDO entity. Although participation in such equity may result in attractive yields during the warehouse period prior to securitization, default on the underlying assets and changes in market conditions can lessen or eliminate our expected yield or could result in the partial or total loss of our investment.
 
We may enter into warehouse agreements in connection with CDOs we create or in connection with CDOs to be formed by or on behalf of third parties, under which we will assume all or a portion of the risk of losses prior to completion of a securitization by the CDO.
 
In the normal course of business, we may enter into an agreement which requires a deposit for the purpose of covering all or a portion of any losses or costs associated with the accumulation of securities under a warehouse agreement. If the CDO transaction is not consummated, the warehouse securities could be liquidated and we could bear losses to the extent the original purchase price of the securities exceeds its sale price, subject to negotiated caps, if any, on our exposure. In addition, regardless of whether the CDO transaction is consummated, if any of the warehoused securities is sold before the consummation, we could be required to bear all or a portion of any resulting loss on the sale. In certain cases, we could be required to acquire the equity of the CDO.
 
The use of CDO financings with over-collateralization requirements may have a negative impact on our cash flow.
 
The indentures governing our CDOs 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.” The CDO terms provide that, if certain delinquencies and/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, as holders of the CDO’s equity interests, to receive cash flow from these investments. While completing the long-term financing of CDOs, we will be engaged in negotiations with the rating agencies or other key transaction parties on future CDO financings regarding the CDO delinquency tests, over-collateralization terms, cash flow release mechanisms or other significant factors regarding the release of cash flow to us by our CDOs. Failure to obtain favorable terms with regard to these matters may materially and adversely affect our cash flows, liquidity and the value of our equity interests. If assets held by our CDO subsidiaries fail to perform as anticipated, their


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over-collateralization or other credit enhancement expense will increase, resulting in a reduction in our income and cash flow from these investments.
 
Risks Related to the Offering
 
Pending our identification and acquisition of assets meeting our investment objectives, we may deploy the portion of the net proceeds of this offering that is not used to repay our existing $200 million secured credit facility in short-term instruments, which are likely to produce an initial return on your investment that may be lower than when we have fully employed the proceeds of the offering in securities meeting our investment objectives.
 
We plan to deploy the portion of net proceeds of this offering that is not used to repay our existing $200 million secured credit facility in accordance with our investment objectives described in this prospectus. We intend initially to invest a substantial portion of the net proceeds in short-term investments which may be lower-yielding than our targeted assets. We expect to deploy this portion of the net proceeds from this offering in our targeted asset classes as soon as practicable depending on the availability of appropriate investment opportunities. However, we cannot assure you that any particular class of investments will be available when we begin to invest the proceeds from this offering.
 
We may issue additional securities that dilute existing holders of shares or that have rights and privileges that are more favorable than the rights and privileges of holders of our shares.
 
Under our memorandum and articles of association, we may issue additional securities, including ordinary shares, and options or other rights to purchase ordinary shares for such consideration and on such terms and conditions as our board of directors may determine with the approval of a majority of our independent directors. Our board of directors is able to determine the class, designations, preferences, rights, powers and duties of any additional corporate securities, including any rights to share in our profits, losses and distributions, any rights to receive corporate assets upon a dissolution or liquidation of the company and any redemption, conversion and exchange rights. We may use such authority to issue additional ordinary shares, which could dilute existing holders of ordinary shares, or to issue securities with rights and privileges that are more favorable than those of our ordinary shares. You will not have any right to consent to or otherwise approve the issuance of any such securities or the terms on which any such securities may be issued.
 
If you purchase ordinary shares in the offering, you may experience immediate dilution in the net tangible book value per share.
 
We expect the initial public offering price of our ordinary shares to be higher than the net asset value per share of our outstanding ordinary shares immediately after the offering. If you purchase our ordinary shares in the offering, you will incur immediate dilution of approximately           in the net asset value per share of our ordinary shares from the price you pay for our ordinary shares in the offering.
 
Our ordinary shares have never been publicly traded, and an active and liquid trading market for our ordinary shares may not develop. If our share price fluctuates after this offering, you could lose all or a significant part of your investment.
 
Prior to the offering, there has not been a market for our ordinary shares. After the offering, we expect that the principal trading market for our ordinary shares will be on a U.S. exchange. We cannot predict the extent to which investor interest will lead to the development of an active and liquid trading market for our ordinary shares or, if such a market develops, whether it will be maintained.
 
The underwriters may sell a substantial amount of our ordinary shares to a limited number of investors, which, together with the effect of certain of our ordinary shares being subject to lock-up agreements and other restrictions on transfer, could impact the development of an active and liquid market for our ordinary shares.
 
We cannot predict the effects on the price of our ordinary shares if a liquid and active trading market for our ordinary shares does not develop. In addition, if such a market does not develop, relatively small sales


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may have a significant negative impact on the price of our ordinary shares. For example, sales of a significant number of ordinary shares may be difficult to execute at a stable price.
 
Even if an active trading market develops, the market price of our ordinary shares may be highly volatile and could be subject to wide fluctuations after this offering. Some of the factors that could negatively affect our share price include:
 
  •  actual or anticipated variations in our quarterly results;
 
  •  negative developments in the asset classes held by our CDO subsidiaries;
 
  •  changes in our earnings estimates or publication of research reports about us or our industry;
 
  •  increases in market interest rates that may lead purchasers of our shares to demand a higher yield;
 
  •  changes in market valuations of similar companies;
 
  •  adverse market reaction to any increased indebtedness we incur in the future;
 
  •  additions or departures of our managers’ key personnel or other changes in management;
 
  •  changes in accounting rules that affect our earnings;
 
  •  speculation in the press or investment community; and
 
  •  general market and economic conditions.
 
As a result of these factors, investors in our ordinary shares may not be able to resell their shares at or above the initial public offering price.
 
The market price of our ordinary shares could be adversely affected by sales or the possibility of sales of substantial amounts of those securities.
 
Upon completion of the offering, we expect to have           ordinary shares outstanding, including the           ordinary shares that we are selling in the offering, assuming that the underwriters do not exercise their option to purchase additional ordinary shares to cover over-allotments. We have agreed to make a shelf registration statement available for the benefit of the holders of the shares issued in connection with our formation and our private-round financing to have the resale of their shares registered under the Securities Act. Upon registration and following the termination of any applicable lock-up period, these ordinary shares will be eligible for sale into the market.
 
We may also issue from time to time additional ordinary shares in connection with the acquisition of investments, and we may grant demand or piggyback registration rights in connection with such issuances.
 
Of the ordinary shares outstanding following the offering and related transactions, approximately           ordinary shares will be held by affiliates of the managers and will be subject to resale restrictions under lock-up agreements with the underwriters of the offering. We cannot assure you that the holders of any of our ordinary shares that are subject to lock-up restrictions will not sell substantial amounts of their ordinary shares upon any waiver, expiration or termination of the restrictions. The occurrence of any such sales, or the perception that such sales might occur, could have a material adverse effect on the price of our ordinary shares and could impair our ability to obtain capital through an offering of equity securities.
 
We will be subject to the requirements of the Sarbanes-Oxley Act.
 
After becoming a public company, 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 of 2002, or the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act requires our auditors 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 December 31 subsequent to the year in which our registration becomes effective. As permitted by SEC release 2006-136, compliance with Section 404 of the Sarbanes-Oxley Act is likely to be deferred until after we have filed one annual report with the SEC. 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. We cannot give any assurances that material weaknesses will not be identified in the future in


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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 registered public accounting firm that we maintained effective internal control over financial reporting.
 
We will incur increased costs as a result of being a public company.
 
Following the offering, as a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We will incur costs associated with our public company reporting requirements. We also anticipate that we will incur costs associated with recently adopted corporate governance requirements, including requirements under the Sarbanes-Oxley Act. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We also expect that these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. We are currently evaluating these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
 
The ordinary shares are equity of the company and hence dividend and other distributions will only be payable from distributable profits and/or share premium of the company.
 
The ordinary shares are equity of the company. Any amounts paid by the company as dividends or other distributions on the ordinary shares will be payable only to the extent of the company’s distributable profits and/or share premium (determined in accordance with Cayman Islands law). In addition, such distributions will be payable only to the extent that the company is solvent on the applicable distribution date and the company will not be insolvent after such distributions are paid. Under Cayman Islands law, a company is generally deemed to be solvent if it is able to pay its debts as they fall due.
 
Tax Risks
 
Our status as a Passive Foreign Investment Company may result in significant additional tax costs for shareholders who are U.S. taxpayers.
 
Each of Everquest and its non-US corporate subsidiaries is and will likely remain a “passive foreign investment company,” or a PFIC, for U.S. federal income tax purposes. There are potentially adverse U.S. federal income tax consequences of investing in a PFIC for a shareholder who is a U.S. taxpayer. These consequences include the following:
 
  •  if a shareholder makes a Qualified Electing Fund, or a QEF, election with respect to the company and its subsidiaries (or a QEF election applies to those subsidiaries), the shareholder will have to include annually in his, her or its taxable income an amount reflecting an allocable share of the earnings, as calculated for U.S. federal income tax purposes, income of the company and such subsidiaries, regardless of whether dividends are paid to the shareholder;
 
  •  if a shareholder is permitted to make and makes a mark-to-market election with respect to the company, the shareholder will have to include annually in his, her or its taxable income an amount reflecting any year-end increases in the price of our ordinary shares, regardless of whether dividends are paid by the company to the shareholder (and it is unclear how such an election would affect the shareholder with respect to our subsidiaries); and
 
  •  if a shareholder does not make a mark-to-market election (and, with respect to clauses (ii) and (iii) below, even if a shareholder does make a mark-to-market election) or a QEF election which is valid with respect to us and our subsidiaries for such shareholder’s entire holding period, such shareholder may incur significant additional U.S. federal income taxes with respect to (i) distributions on, or gain from the sale or other disposition of, our ordinary shares; (ii) distributions from our subsidiaries; or (iii) our gain on any sale or other disposition of interests in our subsidiaries.


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In this regard, prospective purchasers should be aware that it is possible that a significant amount of our earnings, as calculated for U.S. federal income tax purposes, will not be distributed on a current basis, resulting in phantom income subject to tax.
 
The PFIC rules are very complex, there are uncertainties as to the application of the PFIC rules to us, and the tax reporting with respect to multiple PFICs is complicated. In particular, we believe that the better view appears to be that QEF elections made by our shareholders with respect to Everquest Financial Ltd. and Everquest Cayman Ltd., in conjunction with QEF elections made by Everquest LLC with respect to its PFIC subsidiaries, should be sufficient to enable the shareholders to report their share of our earnings and the earnings of our subsidiaries under the QEF regime. We intend to report our earnings, as calculated for U.S. federal income tax purposes, to you on this basis should you choose to make a QEF election with respect to Everquest Financial Ltd. and Everquest Cayman Ltd. However, substantial uncertainty exists concerning this view because of the absence of any judicial decisions or Internal Revenue Service, or IRS, guidance directly on point, and we cannot provide any assurance that the IRS will not treat the QEF elections made by Everquest LLC as invalid with respect to you on the basis that you should have made QEF elections with respect to each of our subsidiaries as well. We will use our reasonable best efforts to obtain and provide separate information for each of our PFIC subsidiaries to enable you to make separate QEF elections for such subsidiaries if you specifically request such information. However, we cannot assure you that such information will be available for all of our PFIC subsidiaries. Potential investors are therefore urged to consult their tax advisors regarding the advisability of making protective or actual QEF elections with respect to our subsidiaries and the consequences to them of not having valid QEF elections in effect for their and our entire holding period with respect to our subsidiaries and being subject to the Excess Distribution Rules (described under “Certain Tax Considerations — U.S. Federal Income Tax considerations — Tax Consequences of Our PFIC Status to U.S. Holders of Ordinary Shares — If no QEF or Mark-to-Market Election is in Effect”) if the IRS were to take a contrary position.
 
In addition, we cannot be sure that we will be able to provide you with all the information necessary for you to file your tax returns on a timely basis (without taking into account any available extensions). Moreover, the amounts reported under separate QEF elections for Everquest and each of its direct and indirect subsidiaries may differ from the amounts we report to you with respect to QEF elections you make for Everquest and Everquest Cayman Ltd. (which take into account QEF elections made by Everquest LLC). Because we may not distribute to you all amounts includible under the QEF elections, the amount of capital gain you derive on a disposition of our shares may be less, and the amount of capital loss greater, than if we distributed all of our earnings currently. Also, with respect to some of our subsidiaries, a QEF election may not avoid the application of the Excess Distribution Rules with respect to those shares. See “Certain Tax Considerations — U.S. Federal Income Tax Considerations — Tax Consequences of Our PFIC Status to U.S. Holders of Ordinary Shares.”
 
Certain subsidiaries of Everquest LLC may also be controlled foreign corporations, or CFCs, for U.S. federal income tax purposes, and, thus will have inclusions of gross income from such subsidiaries under the rules applicable to CFCs, including rules which treat the pledge of stock in such subsidiaries as creating additional income to the extent there are untaxed accumulated earnings in such subsidiaries.
 
You are urged to consult your own tax advisors concerning your particular circumstances and the U.S. federal, state, local and non-U.S. tax consequences to you of owning and disposing of our ordinary shares.
 
If we are found to be engaged in a U.S. trade or business, we may be liable for significant U.S. taxes.
 
We believe that the company, both directly and through its subsidiaries, generally operates its businesses in a manner that should not result in it being treated as engaged in a trade or business within the United States. Consequently, we do not pay U.S. corporate income or branch profits tax on our income. However, we may determine in the future that it would be advantageous to acquire certain assets or engage in certain activities which could give rise to U.S. corporate income tax or branch profits tax. Under such circumstances, we intend to acquire such assets or engage in such activities in a corporate subsidiary and in a manner such that only the income from such assets or activities are subject to U.S. tax (and not all of our income). In


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addition, because the determination of whether a foreign corporation is engaged in a trade or business in the United States is inherently factual and there are no definitive standards for making such a determination, there can be no assurance that the IRS will not contend successfully that we or our subsidiaries are engaged in a trade or business in the United States. See “Certain Tax Considerations — U.S. Federal Income Tax Considerations — Taxation of Everquest and Its Subsidiaries.”
 
We expect that payments received by us from our subsidiaries as well as payments received by our subsidiaries on their investments generally will not be subject to withholding or other taxes imposed by the United States or reduced by withholding or other taxes imposed by other countries from which such payments are sourced. Such payments, however, might become subject to U.S. or other withholding or other tax due to a change in law or other causes. The imposition of unanticipated withholding taxes, tax on our income or other tax could materially impair our ability to make distributions to you.
 
Under current U.S. federal income tax law, the treatment of synthetic securities in the form of credit default swaps is unclear. Certain possible tax characterizations of a credit default swap, if adopted by the IRS and if applied to credit default swaps to which we are a party, could subject payments received by us under such swaps to U.S. withholding or excise tax. While it is not expected, it is also possible that because of such tax characterizations, based on all the facts and circumstances, we could be treated as engaging in a trade or business in the United States and therefore subject to net income tax. We may not be entitled to a full gross-up on such taxes under the terms of the synthetic securities. The imposition of such unanticipated taxes could materially impair our ability to make distributions to you.
 
Legislation recently proposed in the United States Senate would, for tax years beginning at least two years after its enactment, tax a corporation as a domestic corporation for U.S. federal income tax purposes if the equity of that corporation is regularly traded on an established securities market and the management and control of the corporation occurs primarily within the United States. If this legislation caused us to be taxed as a domestic corporation, we would be subject to United States net income tax. However, it is unknown whether this proposal will be enacted in its current form and, if enacted, whether we would be subject to its provisions.


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USE OF PROCEEDS
 
We estimate that the net proceeds we will receive from the sale of        ordinary shares in the offering will be approximately $     , or approximately $      if the underwriters fully exercise their over-allotment option, in each case assuming an initial offering price of $      per share, after deducting underwriting discounts and commissions, and estimated offering expenses of approximately $      payable by us. We expect to use the proceeds from this offering:
 
  •  to repay $      of our debt under our existing $200 million secured credit facility;
 
  •  to create or acquire additional CDOs and other structured finance assets; and
 
  •  for general corporate purposes.
 
Under the terms of our existing secured credit facility, we are required to repay any outstanding amounts under the facility with the proceeds of this offering. This credit facility bears an annual interest rate of the applicable three-month LIBOR plus 2.00% on all amounts drawn. The proceeds of this facility were used to purchase CDO equity.
 
In connection with the offering, we expect to enter into a new credit facility upon which we may draw to make additional acquisitions of CDO subsidiaries. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”


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DIVIDEND POLICY
 
We intend to distribute quarterly dividends to our shareholders. We intend to distribute over time approximately 90% of our net investment income out of assets legally available for distribution. All distributions will be made at the discretion of our board of directors, and will depend on a number of factors such as:
 
  •  our financial condition;
 
  •  general business conditions;
 
  •  actual results of operations;
 
  •  the timing of the deployment of our equity capital;
 
  •  our and our subsidiaries’ debt service requirements;
 
  •  the availability of cash distributions from our subsidiaries;
 
  •  our operating expenses;
 
  •  any contractual, legal and regulatory restrictions on the payment of distributions by us to our shareholders or by our subsidiaries to us; and
 
  •  other factors our board of directors in its discretion deems relevant.
 
At a minimum, to the extent we have available cash resources (including cash of Everquest LLC that may be distributed in accordance with applicable law and subject to the priorities set forth in its limited liability company agreement) in excess of reasonable reserves and our reasonably foreseeable business needs, we intend (although we are not obligated) to distribute annually in the aggregate an amount sufficient to cover the taxes payable by the ordinary shareholders to pay their taxes resulting from a QEF election made by them with respect to Everquest or Everquest Cayman Ltd., assuming they are subject to the highest marginal statutory combined federal, state and local tax rate prescribed for an individual living in New York, New York.
 
We are a holding company with no operations and are dependent upon the ability of our subsidiaries to generate and distribute dividends to us.
 
In January 2007, we declared a dividend of $14,352,016, or $0.61 per ordinary share, for the fourth quarter of 2006, which we paid on March 31, 2007 to shareholders of record on December 31, 2006.


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CAPITALIZATION
 
The following table sets forth (i) our actual cash and net assets as of December 31, 2006, (ii) our pro forma cash, debt and net assets to reflect drawings under our existing secured credit facility and shares issued in the private-round financings we completed in January and February 2007, and (iii) our pro forma cash, debt and net assets as adjusted to reflect the effects of the sale of our ordinary shares in the offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, and the application of the net proceeds as described in “Use of Proceeds.” You should read this table together with “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this prospectus.
 
                         
    As of December 31, 2006  
                Pro Forma
 
    Actual     Pro Forma     As Adjusted  
    ($ in thousands, except per share data)  
 
Cash and cash equivalents
  $ 2,618     $             $          
                         
Debt(1)
                       
Existing secured credit facility
    25,650                
                         
Net Assets
                       
Share capital
    24                  
Additional paid-in capital
    597,479                  
Undistributed net investment income
    14,352                  
Net realized loss on investment
    (1,838 )                
Net unrealized appreciation on investments
    9,437                  
                         
Net assets
  $ 619,454     $       $  
                         
Net asset value per share
  $ 25.93     $       $  
                         
 
 
(1) Under the terms of our existing $200 million secured credit facility, we are required to repay any debt outstanding under the credit facility with the proceeds of the offering. In connection with the offering, we expect to enter into a new credit facility, upon which we may draw to make additional acquisitions of CDO subsidiaries. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”


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DILUTION
 
Purchasers of ordinary shares offered in this prospectus will experience immediate and substantial dilution of the net asset value of their ordinary shares from the offering price. Our net asset value as of December 31, 2006 was approximately $619.5 million, or $25.93 per share. After giving effect to the sale of           ordinary shares in the offering at an assumed offering price of $      per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our as adjusted net asset value on December 31, 2006 would have been approximately $      million, or $      per share. This amount represents an immediate dilution in net asset value of $      per share to new investors who purchase our ordinary shares in the offering at an assumed offering price per share of $          . The following table shows this immediate per share dilution:
 
         
Offering price per share
  $          
Net asset value per share on December 31, 2006, before giving effect to the offering
    25.93  
Dilution in net asset value per share attributable to the offering
       
As adjusted net asset value per share on December 31, 2006, after giving effect to the offering
       
Dilution in as adjusted net asset value per share to new investors
  $  
 
The following table summarizes, as of December 31, 2006, the differences between the average price per share paid by our existing shareholders and by new investors purchasing ordinary shares in the offering at the offering price of $      per share, before deducting underwriting discounts and commissions and estimated offering expenses payable by us in the offering:
 
                                         
                            Average
 
    Shares Purchased     Total Consideration     Price Per
 
    Number     Percent     Amount     Percent     Share  
 
Existing shareholders(1)
                  %   $                   %   $        
New investors in this offering(2)
                                       
Total
                  %   $                   %   $        
 
 
(1) Also includes shares sold in our private placements completed in January and February 2007. Average price per share is a weighted average.
 
(2) Assumes no exercise of the underwriters’ option to cover over allotments.
 
If the underwriters fully exercise their over allotment option, the number of ordinary shares held by existing holders will be decreased to  % of the aggregate number of ordinary shares outstanding after the offering, and the number of ordinary shares held by new investors will be increased to  %, of the aggregate number of ordinary shares outstanding after the offering.


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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
 
In the table below, we provide you with selected consolidated financial and other data of the company. We have prepared this information for the period from September 28, 2006 (commencement of operations) to December 31, 2006 using our audited consolidated financial statements for the period from September 28, 2006 (commencement of operations) to December 31, 2006. Results for the period from September 28, 2006 (commencement of operations) to December 31, 2006 are not necessarily indicative of results that may be expected for an entire year.
 
When you read this selected consolidated financial and other data, it is important that you read along with it the consolidated financial statements and related notes, as well as the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are included in this prospectus.
 
         
    As of December 31,
 
Consolidated Statement of Assets and Liabilities Data
  2006  
    ($ in thousands,
 
    except per share data)  
 
Assets
       
Cash and cash equivalents
  $ 2,618  
Affiliated investments in securities, at fair value (amortized cost $437,357)
    443,247  
Nonaffiliated investments in securities, at fair value (amortized cost $250,862)
    253,709  
Credit default swaps, at fair value
    701  
Deposits in CDO warehouses, at fair value
    22,000  
Due from affiliates
    207  
Due from brokers
    3,512  
Prepaid directors and officers insurance
    220  
         
Total assets
  $ 726,215  
         
Liabilities
       
Due to affiliates
    790  
Due to brokers
    72,393  
Management fees payable — to affiliates
    2,827  
Incentive fees payable — to affiliates
    3,784  
Other liabilities
    26,967  
         
Total liabilities
  $ 106,761  
         
Net Assets
       
Common stock
    24  
Additional paid-in-capital
    597,479  
Undistributed net investment income
    14,352  
Net realized loss on investments
    (1,838 )
Net unrealized appreciation on investments
    9,437  
         
Net assets
  $ 619,454  
         
Net asset value per share
  $ 25.93  
         


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    Period from
 
    September 28, 2006
 
    (commencement of
 
    operations) to
 
Consolidated Statement of Operations Data
  December 31, 2006  
    ($ in thousands,
 
    except share data)  
 
Revenue
       
Interest income — affiliated
  $ 15,383  
Interest income — nonaffiliated
    9,641  
         
Total revenue 
    25,024  
         
Operating expenses
       
Management fees — to affiliates
    2,827  
Incentive fees — to affiliates
    3,784  
Organization fees
    2,231  
Professional fees
    1,142  
Other expenses
    688  
         
Total expenses
    10,672  
         
Net investment income
    14,352  
         
Realized and unrealized gain (loss) on investment transactions
       
Net realized gain (loss) on investment transactions
    (1,838 )
Net unrealized appreciation on investments
    8,736  
Net unrealized appreciation on credit default swaps
    701  
         
Net realized and unrealized gain on investment transactions
    7,600  
         
Net increase in net assets resulting from operations
  $ 21,952  
         
Net increase in net assets resulting from operations per share 
  $ 0.94  
         
Weighted average number of shares outstanding
    23,390,146  
         
Other Data
       
Net investment income ratio(1)
    12.25 %
Weighted average yield(2)
    17.68 %
Cash distributions received from investments
  $ 11,976,102  
Return on equity(3)
    15.10 %
 
 
(1) Annualized.
 
(2) The weighted average of the bond equivalent yields of securities specified in the consolidated schedule of investments contained in the consolidated financial statements included in this prospectus, weighted by amortized cost.
 
(3) Return on equity, also known as total return, is an annualized rate based on daily compounding and is equal to the net increase in net assets from operations divided by the weighted average of the net asset value since commencement of operations.


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus.
 
Formation
 
We are a newly formed company. We commenced operations on September 28, 2006. On that date:
 
  •  the BSHG Funds, which are managed by BSAM, transferred to us equity in 10 CDOs, including Parapet CDO, for a purchase price of approximately $548.8 million. In consideration, we issued 16,000,000 of our shares, at $25 per share, and paid approximately $148.8 million in cash.
 
  •  HY II Investments, L.L.C. and EGI-Fund (05-07) Investors, L.L.C., or collectively, HY, affiliates of an entity that has an economic interest in Stone Tower, transfered to us equity in two CDOs with a purchase price of approximately $6.4 million and approximately $18.6 million in cash in exchange for 1,000,000 of our shares, at $25 per share.
 
  •  Other investors paid cash of approximately $137.5 million, or $25 per share, in exchange for 5,500,100 of our shares.
 
As a result of these transactions, at the initial closing, we received approximately $555.2 million of CDO equity and approximately $7.3 million in cash, net of the cash consideration we paid to the BSHG Funds and HY. We valued the equity interests in the CDOs we acquired in connection with our formation at their fair value as of the initial closing date, taking into account a number of factors, including the projected cash flows we expected to be generated by these interests and valuation information provided by third-party market participants. As of December 31, 2006, our CDO holdings, which includes equity tranches in 19 CDOs, had an aggregate fair value of $719.7 million.
 
Subsequent to December 31, 2006, and through March 31, 2007, we acquired equity tranches of an additional three CDOs for a purchase price of $32.9 million. In addition, we continue to actively evaluate multiple opportunities, some of which may be material in relation to our size. We believe that the growth in CDO issuance will continue to provide attractive opportunities to expand our portfolio.
 
We expect to use the net proceeds from this offering primarily to repay amounts outstanding under our existing $200 million secured credit facility, which were previously used to finance the acquisition of CDO equity. We also intend to use a portion of the remaining proceeds to form or make additional acquisitions of CDO equity. See “Use of Proceeds.” We may also employ leverage under a new secured credit facility to finance the acquisition of additional CDO equity.
 
Key Factors that Affect Our Ability to Generate Cash Flow
 
We generate cash flow primarily through distributions we receive as an equity holder in our CDO subsidiaries. To a lesser extent, we may generate earnings through minority holdings in CDO equity. We may also receive distributions from assets maintained in short-term warehouse facilities in which we share the risk of loss and that are utilized to finance the purchase of assets prior to permanent CDO securitizations.
 
As an equity holder in CDOs, we anticipate that distributions to us will be made, typically quarterly, out of the returns received by our subsidiaries from their underlying cash generating assets, but only after they pay their operating and other expenses and make any required debt service payments to the holders of the debt tranches. In addition, our CDOs are typically subject to a series of collateral tests that are designed to protect the holders of, and to maintain the credit ratings associated with, the senior debt tranches. At times, these tests require that distributions on the equity tranches be deferred or diverted (without triggering an event of default) which would prevent our subsidiaries, even if they are generating profits, from making distributions of these profits to us.


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The following factors also affect the distributions to us from our CDO subsidiaries or other CDOs in which we hold equity:
 
     
Factor
 
How it affects CDO results
 
• Default and recovery rates
  If the rates of defaults and delinquencies on underlying assets increases, the cash generated by those assets through principal and interest payments decreases. If the recovery rate following a default, bankruptcy or liquidation decreases, the cash generated decreases. The average time lag between a default and recovery will also affect the present value of future recoveries.
• Prepayment or redemption rates
and reinvestment rates
  If the underlying assets are prepaid or redeemed for cash prior to maturity, this cash must be reinvested in comparable assets during a permitted reinvestment period in order to maintain the same level of cash generation. The timing of reinvestment in substitute collateral and the interest rates available at the time of reinvestment will affect the amount of distributions. The inability to reinvest, due to restrictions under the CDOs’ governing documents or the unavailability of comparable assets, would also reduce overall returns.
• Interest rate trends
  Our CDO subsidiaries operate on a leveraged basis. Their returns will be affected by changes in interest rates that cause changes in the costs of their financing to increase relative to the income that can be derived from their underlying assets.
• Expenses
  Yield and other measures of performance may be adversely affected to the extent that the CDO issuer incurs any significant unexpected expenses.
 
In addition, a variety of factors relating to our business may also impact our overall financial condition and operating performance. These factors include:
 
  •  our amount of outstanding debt and interest rates thereon;
 
  •  our access to funding and borrowing capacity for new CDOs;
 
  •  our ability to continuously form or acquire additional CDO subsidiaries as existing CDO holdings amortize;
 
  •  our hedging activities;
 
  •  changes in markets affecting the market value of our existing CDO holdings; and
 
  •  the requirements to qualify for an exemption from regulation under the 1940 Act.
 
Trends and Uncertainties
 
As described more fully in “Summary — Our Market Opportunity,” we noted the following market trends:
 
  •  significant growth in the CDO market;
 
  •  market developments favoring CDO equity tranches, such as increased demand for rated debt securities issued by CDOs and reduced interest rate spreads for the higher-rated debt securities issued by CDOs; and
 
  •  robust leveraged buyout activity that generates collateral assets for CLOs.


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While corporate credit default rates are at historically low levels, there is uncertainty as to whether these default rates will remain at current levels. While we continue to monitor and manage credit risk as part of our risk management process, an increase in corporate credit default rates, with all other factors remaining the same, would have a negative effect on our results of operations which, depending on the extent of the increase, could be material. We may seek to hedge our exposure if default rates increase significantly and if hedges are available on attractive terms.
 
Furthermore, a substantial majority of the ABS CDOs in which we hold equity have invested primarily in RMBS backed by collateral pools of subprime residential mortgages. The value and returns of these RMBS may be affected by general economic conditions in some geographic regions, including increased interest rates and lower housing prices, which have negatively affected collateral pools of subprime residential mortgages that underlie certain RMBS. Generally, our ABS CDOs hold RMBS rated in the range of “A2” to “Ba2” which, because of their higher position within the RMBS structure, are less susceptible to loss than the equity or lower-rated tranches of RMBS. Nevertheless, increased losses within the underlying collateral pools of subprime mortgages could also cause the higher-rated RMBS to suffer losses, which could be material. For a description of steps we have taken to manage these risks, see “— Credit Risk.”
 
For a discussion of additional risks relating to our business see “Risk Factors” and “— Quantitative and Qualitative Disclosures about Market Risk.”
 
Critical Accounting Policies and Estimates
 
Our consolidated financial statements were prepared by management in accordance with accounting principles generally accepted in the United States of America, or GAAP.
 
Although we conduct our operations so that we are not required to register as an investment company under the 1940 Act, for financial reporting purposes we follow the AICPA Audit and Accounting Guide for Investment Companies, or the Guide. Our significant accounting policies are fundamental to understanding our financial condition and results of operations because some of those policies require that we make significant estimates and assumptions that may affect the value of our assets or liabilities and our financial results.
 
Principles of Consolidation
 
Our consolidated financial statements contained elsewhere in this prospectus include the accounts of Everquest Financial Ltd. and its subsidiaries, Everquest LLC and Everquest Cayman, Ltd. We have eliminated all intercompany accounts and transactions.
 
On December 24, 2003, the Financial Accounting Standards Board, or FASB, issued FASB Interpretation No. 46 (Revised December 2003), “Consolidation of Variable Interest Entities,” or FIN 46(R), to clarify the application of Accounting Research Bulletin (“ARB”) No. 51, “Consolidated Financial Statements,” as amended by FASB Statement No. 94, “Consolidation of All Majority-Owned Subsidiaries.” The effective date of FIN 46(R) has been deferred for investment companies (including nonregistered investment companies) that are accounting for investments in accordance with the Guide. For accounting purposes, we have evaluated all CDO equity investments, including Parapet 2006, Ltd., under a control based model in accordance with ARB No. 51 and have not consolidated any of our CDO equity investments. As required by the Guide, all investments are reported at fair value.
 
  Valuation
 
We use the discounted cash flow valuation technique to estimate the fair value of our equity in a CDO. Our methodology is a three step process which includes the following:
 
Forecast expected cash flow.  We generally use INTEX, a third party vendor of CDO analytical software, which is a widely used industry tool, to forecast, based on assumptions we provide, the timing and amount of expected cash flows we receive as an equity owner in our CDOs. While INTEX itself renders an objective analysis, management is required to provide assumptions, based on observable market parameters and standard


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industry practice, such as default and recovery scenarios, prepayment, reinvestment spread, future interest rates, and call optionality.
 
Generally, there is a three to six month delay between when a CDO closes and the time it is modeled on INTEX. Until the deal is modeled on INTEX, we use either the CDO underwriter’s cash flow model or the collateral manager’s model. There are also instances when a CDO equity holding may never be modeled on INTEX and in such instances we will continue to use either the CDO underwriter’s cash flow model or its collateral manager’s model.
 
When we form or acquire CDO equity, the assumptions initially used are typically based on those made by the CDO underwriter. These are market conventions that are found in the standard marketing literature, which we review in making our own determination as to the assumptions to use. As part of ongoing surveillance and portfolio management, the assumptions we use are constantly tested in relation to the market parameters and actual performance of the underlying collateral. As a result, our assumptions may change.
 
Calculate the discount rate.  The initial discount rate we use in valuing each CDO is determined by reference to the internal rate of return (IRR), which is calculated based on the estimated future cash flows and our initial investment or cost.
 
In subsequent periods we continue to use a discount rate to revalue the assets using our best estimate of the rate market participants would use to value a similar asset, based on actual performance of the underlying collateral, the surveillance results or other market parameters.
 
Calculate the fair value of our equity in the CDO.  The fair value of our equity in a CDO is the net present value of the expected future cash flows calculated using our current assumptions and the applicable discount rate.
 
We revalue our CDO equity on a monthly basis based on newly generated cash flow estimates using our current assumptions and discount rate. The current and future characteristics of the underlying CDO portfolio, the interest rate environment, market parameters and all other assumptions are continuously monitored.
 
As part of the valuation, we currently carry out the following process:
 
  •  first, each quarter our managers value the investments;
 
  •  second, preliminary valuation conclusions are documented and discussed with our senior management; and
 
  •  third, any changes to the discount rate or cash flow assumptions used to value assets are approved by our senior management and the BSAM pricing committee, which includes an Everquest board member and BSAM’s Head of Risk Management, CFO, Head of Compliance, CIO, the General Counsel and Chief Strategist.
 
Because of the methodology described above, fair value is highly sensitive to both the discount rate we select and our estimates of future cash flows attributable to our CDO equity ownership. Our estimates of future cash flows are, in turn, highly subjective and sensitive to the assumptions we make, which require considerable judgment and knowledge of market factors. The actual items set forth in our assumptions and therefore the actual future cash flows attributable to our CDO equity ownership may vary materially from our current assumptions and estimated cash flows.
 
Due to uncertainty inherent in the valuation process, our estimates of fair value may differ materially from the values that would have been used had a more developed market for the CDO holding existed. Additionally, changes in the market environment and other events that may occur over the life of a CDO may cause the gains and losses ultimately realized on these CDOs to be different from the valuations currently assigned.


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Interest and Unrealized Gains and Losses
 
Amortized Cost.  For accounting purposes, equity in CDOs is treated as a debt-like instrument accounted for under the principles of Emerging Issues Task Force Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” or EITF 99-20. We recognize interest and realized gains and losses in accordance with EITF 99-20.
 
Under EITF 99-20, at any balance sheet date, the amortized cost of the investment is equal to (1) the initial investment plus (2) the yield accreted to date less (3) all cash received to date regardless of whether labeled interest or principal less (4) any write downs for impairment.
 
Accretion of periodic interest.  As of the purchase date, the excess of the estimated future cash flows over the initial investment is the accretable yield, which is recognized as interest income over the life of the CDO using the effective yield method.
 
On a quarterly basis, if estimated cash flows generated from the CDOs differ from the cash flows previously estimated, revised yields are calculated based on the current amortized cost of the CDO and the revised estimated cash flows. The revised yields are then applied prospectively to recognize interest income.
 
The revised yield is determined by solving for the IRR which equates those future cash flows back to the amount of the amortized cost.
 
As is the case with our valuation methodology described above, the amount of accretion of interest is based on our estimates of future cash flows attributable to our CDO equity ownership and is therefore highly subjective and sensitive to the assumptions we make, which require considerable judgment and knowledge of market factors. Our actual yield and cash flows may vary materially from those estimated.
 
Unrealized Gains and Losses and Realized Losses.  Any difference between the fair value and the amortized cost is reflected as unrealized gain or loss. The difference in the amortized cost and the fair value is caused primarily by changes in the future expected cash flows and variations in actual cash flows compared to previously expected cash flows.
 
Determining realized loss.  The rules under EITF 99-20 requires a specific impairment analysis to be done on a security by security basis to determine if there has been an other-than-temporary change to a CDO holding. We evaluate securities for impairment as of each calendar quarter end, or more frequently if we become aware of any material information that would lead us to believe that our equity in a CDO may be impaired.
 
If the fair value of the CDO holdings is less than amortized cost and the fair value based on the current yield and revised cash flows is less than the fair value based on the current yield and original cash flows, then an other-than-temporary impairment must be recognized. The recognized impairment will equal the difference between the current fair value and the amortized cost. The amortized cost of the CDO is written down by the recognized impairment which will impact future accretion of income.
 
Results of Operations for the Period September 28, 2006 (commencement of operations) to December 31, 2006
 
Summary
 
Our net increase in net assets resulting from operations for the period was $22.0 million, or $0.94 per weighted average number of shares outstanding. This result reflects interest income accrued during the period on our fully invested portfolio of CDO equity, after deducting operating expenses, which included in significant part organizational fees which under GAAP are required to be expensed in total.


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Set forth below are certain ratios for the period, which are calculated by dividing the specified items for the period by the average of total monthly net assets. The net investment income ratio and total expense ratio includes accrued incentive fees.
 
         
    Ratio*  
 
Net investment income
    12.25 %
         
Total expenses before incentive, interest and organizational fees
    3.00 %
Incentive fees
    0.64 %
Interest expense
    0.03 %
Organizational fees
    0.38 %
         
Total expenses
    4.05 %
         
 
 
Annualized, except for incentive and organizational fees.
 
Revenue
 
Total revenue for the period was $25.0 million, which consists primarily of interest income earned from our holdings in CDO equity.
 
Operating Expenses and Net Investment Income
 
Operating expenses for the period totaled $10.7 million, which includes one-time organizational fees of $2.2 million, management and incentive fees of $6.6 million and professional fees payable of $1.1 million, and which resulted in net investment income of $14.3 million.
 
Realized and Unrealized Gain/Loss on Investment Transactions
 
During the period from September 28, 2006 through December 31, 2006, we realized a net loss of $1,837,691, of which $2,157,691 related to losses taken as a result of other than temporary impairment on investments and $320,000 pertained to realized gains. Unrealized gains for the period from September 28, 2006 through December 31, 2006 were $9,437,212.
 
Net Increase in Net Assets Resulting from Operations
 
As a result of the foregoing, net increase in net assets resulting from operations was $22.0 million.
 
Financial Condition
 
Assets
 
As of December 31, 2006 our share capital (including additional paid-in capital) was fully invested in our holdings of CDO equity, consisting primarily of CDOs where we held all or a majority of the equity. At that date, our total assets of $726.2 million included affiliated investments in securities, at fair value of $443.2 million, which primarily represented our holdings in our subsidiary Parapet CDO, and nonaffiliated investments in securities, at a fair value of $253.7 million, which represented our holding in CDOs where the collateral manager was an unrelated third party.
 
Liabilities
 
As of December 31, 2006 we had total liabilities of approximately $106.8 million, of which $72.4 million consisted of amounts due to brokers, relating to acquisitions of CDO equity that had not settled as of the balance sheet date, and $25.6 million consisted of loans incurred under our secured credit facility. See “— Liquidity and Capital Resources” below for a description of liabilities entered into subsequent to the balance sheet date.


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Net Assets
 
As of December 31, 2006, we had net assets of approximately $619.5 million, consisting almost entirely of share capital (including additional paid-in-capital), representing a net asset value per share of $25.93.
 
Subsequent to December 31, 2006, we raised additional share capital as described below under “— Liquidity and Capital Resources.” See also “Dilution.”
 
Liquidity and Capital Resources
 
We held cash and cash equivalents of approximately $2.6 million as of December 31, 2006.
 
We used approximately $214.1 million of net cash and cash equivalents in operating activities for the period September 28, 2006 (commencement of operations) to December 31, 2006, primarily reflecting $307.5 million of cost of securities purchased offset by an increase of liabilities due to brokers of $72.4 million. These securities purchased include the equity tranches in CDOs, other than Parapet CDO, acquired in connection with our formation as well as subsequent acquisitions of CDO equity contracted for but not closed between our formation and December 31, 2006. These subsequent acquisitions resulted in the due to brokers liability of $72.4 million and were settled after the balance sheet date with cash generated by private-round financings and amounts drawn under our secured credit line.
 
Cash flows from financing activities were approximately $216.7 million, reflecting the proceeds from issuances of our ordinary shares in connection with our formation.
 
On December 15, 2006 we entered a $200 million credit facility for a term of one year with Citigroup Financial Products Inc., or CFPI, secured by a first-priority perfected security interest on 100% of our assets. This facility has been drawn upon and is available to fund investments, pre-approved by CFPI, prior to an initial public offering, or IPO. At December 31, 2006, there was approximately $174.4 million of availability under this facility. We are required to repay any outstanding amounts under the facility with proceeds of our initial public offering. See “Use of Proceeds.”
 
Subsequent to December 31, 2006, and through March 31, 2007, we received an additional $62.3 million of private-round financing. The proceeds of this financing have been used in part to pay down certain amounts outstanding under the CFPI credit facility and in part to purchase additional CDO equity.
 
The offering will provide additional estimated net proceeds of approximately $      million. See “Use of Proceeds.”
 
In connection with the offering, we expect to enter into a new credit facility of approximately $      million. We expect that the proceeds of a new credit facility would be used to finance the formation or acquisition of additional CDO subsidiaries.
 
We believe cash generated by our CDO holdings, together with cash available from the offering and under the new credit facility, will permit us to satisfy our liquidity needs during the foreseeable future. If, in the future, we need additional capital we would expect to raise funds primarily through additional equity offerings, although we may not be able to obtain additional equity financing on attractive terms or at all.
 
We expect that any new CDO subsidiaries will finance their operations in the ordinary course through the issuance of CDO debt to third parties. Pending permanent CDO financing, to the extent we form new CDO subsidiaries we would expect to use traditional financing techniques such as warehousing facilities (through which third parties, typically large banks, hold the underlying assets funded with warehousing facility borrowings), or repurchase agreements.
 
Contractual Obligations and Commitments
 
As of September 28, 2006, we entered into a management agreement with each of BSAM and Stone Tower whereby we will pay to the managers a base management fee quarterly in arrears in an amount equal to (i) 1.75% on an annualized basis of the company’s net assets up to $2 billion, plus (ii) 1.50% on an annualized basis of the company’s equity over $2 billion and up to $3 billion, plus (iii) 1.25% on an annualized basis of


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the company’s net asset over $3 billion and up to $4 billion, plus (iv) 1% on an annualized basis of the company’s net asset over $4 billion. Each manager uses its management fee in part to pay compensation to its officers and employees who, notwithstanding that certain of them also are our officers, receive no cash compensation directly from us.
 
For purposes of calculating the management fee, the company’s net assets will be adjusted to exclude special one-time events pursuant to changes in GAAP, as well as noncash charges after discussion between the company and the independent directors on our board of directors and approval by a majority of the independent directors.
 
In addition to the management fee, the managers are entitled to receive a quarterly incentive allocation in an amount equal to 25% of the amount by which the company’s net increase in net assets resulting from operations, as calculated prior the incentive allocation and excluding noncash charges and special one-time events pursuant to changes in GAAP, exceeds the greater of 2.0%, or 0.50% plus one-fourth of the U.S. Ten Year Treasury Rate of the company’s capital at the beginning of the quarter. As of December 31, 2006 the incentive allocation accrued was approximately $3.8 million.
 
As described in “Use of Proceeds,” we are required to repay outstanding amounts under our existing secured credit facility.
 
Off-Balance Sheet Arrangements
 
Swaps
 
In the normal course of business, we may enter into swap agreements, or Swaps, for investment, financing or hedging purposes. The Swaps are utilized to structure and hedge CDO holdings and to economically meet our objectives and help us manage risk. We may enter into total return, credit default, interest rate and currency swap agreements.
 
Swaps are contractual agreements between a company and a third party to exchange a series of cash flows. Total return swaps are agreements where one party receives equity returns based on reference pools of assets in exchange for short term floating rate payments based on notional amounts. Credit default swaps, are agreements in which one party pays fixed periodic payments to a counterparty in consideration for a guarantee from the counterparty to make specific payment should a negative credit event take place. Risks arise from the possible inability of counterparties to meet the terms of their contracts. See “ — Credit Risk.”
 
As of December 31, 2006, Everquest had four credit default swaps valued at $701,117 in its portfolio.
 
Deposits in Warehouse Agreements
 
In the normal course of business, we may enter into an agreement which requires a deposit for the purpose of covering a portion of any losses or cost associated with the accumulation of securities under a warehouse agreement. Such a deposit of cash allows for notional participation in the income, or the carry, generated by the assets acquired within the warehouse arrangement, after deducting the notional debt cost. At the termination of the agreement, depending on the performance of the collateral securities accumulated in the warehouse, we have the potential to either lose our deposit or earn a residual carry and LIBOR based interest along with the return of our deposit. We are obligated to acquire 100% of the equity of the CDO should the CDO closing fail to occur and the existing collateral manager is replaced by BSAM.
 
These agreements are treated as derivatives for accounting purposes and are reported at fair value.
 
As of December 31, 2006, Everquest had deposited $22.0 million in two such warehouses which also represents the fair value.
 
Credit Risk
 
Credit risk is the principal form of risk that we face. Substantially all of the assets held by our CDOs are credit-related assets. Credit risk represents the maximum potential loss we face if a counterparty fails to


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perform pursuant to the terms of the applicable agreement or instrument. We face credit risk at multiple levels within our structure. Within our CDOs, we face the risk that the counterparties to the underlying debt instruments held by our CDOs, such as corporate borrowers in the case of loans or the issuer in the case of RMBS or other asset-backed securities, fail to make interest or principal payments on their obligations.
 
As a holder of CDO equity, or the so-called “first-loss” tranche of a CDO, our cash flow will decrease for any failure on the part of an obligor to pay its obligations that we are unable to recover subsequently. As a result, all of our equity holdings in CDOs are sensitive to changes in the credit quality of the borrowers of corporate credits or the issuers of the asset-backed securities, including changes in the forecasted default rates and any declines in the anticipated recovery rates. In periods of increasing default rates or decreasing recovery rates, our cash flows from our CDOs would be reduced. Our financial exposure is limited to its investments in the equity interests in the CDOs.
 
The asset-backed securities held by our asset-backed CDO subsidiaries are themselves also subject to credit risk. For example, RMBS are collaterized by pools of residential mortgages, where the cash flow depends on homeowners making payments of principal and interest on their residential mortgages.
 
Because of the credit risk we face, we are required to monitor continually the overall credit quality of the underlying collateral. See “Our Company — Risk Management — Monitoring and Surveillance.” We also monitor whether the collateral managers of the structures in which we hold equity manage the underlying collateral in accordance with the criteria established in the collateral management agreements. We seek to manage credit risk in various ways. We may seek to sell credit impaired assets or if we are not the collateral manager recommend to the collateral manager that it sell the asset. We also seek to manage our risk by monitoring our exposure to any one issuer or corporate borrower. We may also seek to hedge our exposure to an issuer, borrower or credit (including, for example, tranches of subprime RMBS held by our CDO subsidiaries) by entering into credit default swaps, total return swaps or similar hedging techniques.
 
Prior to and since our formation, our manager BSAM has hedged exposures to certain tranches of ABS held by some of our CDOs, particularly RMBS with a high degree of exposure to sub-prime residential mortgage loans. These hedging transactions were originally entered into between the BSHG Funds and third parties and were not initially transferred to us pending our entry into relevant International Swaps and Derivatives Association, or ISDA, master agreements or other appropriate documentation with the third-party counterparties to the swaps. On May 8, 2007, the BSHG Funds transferred to us their interests in credit default swaps that reference 48 tranches of ABS securities held by our CDOs with a notional amount of approximately $201 million. We have agreed to pay the BSHG Funds approximately $4.4 million, representing accrued premiums on the swaps from the date of our formation or the effective date of the swaps, if later, through May 8, 2007 and, in the case of swaps in existence at the time of our formation, the fair value of such swaps as of that date. As a result of these transfers, we bear the risk of any decrease in value, and benefit from any gain or payments, with respect to these credit default swap contracts from May 8, 2007. We are also required to pay the ongoing premiums relating to the contracts.
 
The consideration we paid for the swaps was less than their fair value as of the date of transfer, which BSAM estimated to be approximately $21.6 million as of that date, and was designed to represent the amount we would have paid if the swaps that were in existence at the time of our formation had been transferred to us at that time and if we had otherwise directly entered into the swaps that were entered into after our formation. As a result, to the extent the fair value continues to exceed the amount we paid, we would expect our second quarter results to include a gain relating to the recognition of the swaps on our balance sheet as of the transfer date. While the BSHG Funds as principal shareholders will continue to benefit from the swaps they transferred to us to the extent of their equity ownership in us, we have been advised that BSAM has agreed to compensate the BSHG Funds for the decrease in their net asset value resulting from the transfer of their interests in the swaps to us.
 
The hedges will not cover all our exposure to RMBS held by our CDOs that are backed primarily by sub-prime residential mortgage loans. Our CDOs may experience negative credit events relating to RMBS tranches that are not hedged. However, the contracts were designed to hedge tranches that our manager BSAM believed were appropriate in light of exposures to sub-prime residential mortgage loans. Prior to their expiration, the fair value of these credit default swaps may increase or decrease in ways that may not ultimately be reflected


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by the amounts actually received under these hedges, if any. Further, decreases in the fair value of our CDOs relating to their sub-prime residential loan exposure may not necessarily be offset in whole by increases in the fair value of these credit default swaps. Similarly, any increases in the fair value of our CDOs relating to favorable developments relating to the RMBS held by our CDOs that are backed by sub-prime residential mortgage loans could be more than offset by decreases in the fair value of these credit default swaps as a result of the same developments.
 
Market Risk
 
Interest Rate Risk.  With respect to our consolidated entities, the borrowings under our $200 million credit facility will be repaid upon the closing of the offering. We expect to have a new facility in place upon closing of the offering, which will similarly be sensitive to interest rate risk. At December 31, 2006, we had $25.6 million outstanding on our current facility, which bears interest at a floating rate. Based on this amount outstanding, an increase in interest rates of 1% held over the course of a year, with all other factors remaining the same, would increase our consolidated interest expense by approximately $0.26 million.
 
Our other assets, which consist almost entirely of our equity ownership in our CDOs, which are not consolidated, are not per se market rate sensitive instruments, but the cash flows we derive by virtue of our ownership of our CDOs primarily result from the difference between earnings of the assets our CDOs hold, which consist generally of a portfolio of assets that typically bear interest at floating rates or other CDO equity securities, and the financing costs associated with the multiple tranches of debt issued by the CDOs, which also typically bear interest at floating rates. Generally, the assets and liabilities of the CDO are matched so that the CDO and our equity interest therein are not per se highly sensitive to changes in interest rates, i.e. an increase in floating rates, with all other things being equal, would typically result in an increase in the interest expense associated with the CDO’s debt tranches, but would be offset depending on the match by increased earnings on the floating rate assets. However, in managing asset and liabilities in a CDO, reinvestment risk and yield spread risk arise, as further described below.
 
Reinvestment Risk.  We intend to continue to fund a substantial portion of our investments with borrowings that, after the effect of hedging, have interest rates based on indices and repricing terms similar to, but of somewhat longer maturities than, the interest rate indices and repricing terms of our assets. Thus, we anticipate that in most cases the interest rate indices and repricing terms of our assets and our funding sources will not be identical, thereby creating a reinvestment risk on a significant portion of our portfolio. During periods of changing interest rates, such reinvestment risk could impact our financial condition, cash flows and results of operations.
 
Yield Spread Risk.  Most of our investments are also subject to yield spread risk. For a majority of these securities, value is based on a market credit spread over the rate payable to LIBOR or U.S. Treasuries of like maturity. An excessive supply of these securities combined with reduced demand will generally cause the market to require a higher spread on these securities, resulting in the use of a higher or “wider” spread over the benchmark rate to value these securities. Under these conditions, the value of our securities portfolio would tend to decrease. Conversely, if the spread used to value these securities were to decrease or “tighten,” the value of our securities would tend to increase. Such changes in the market value of our securities portfolio may affect our net equity or cash flow either directly through their impact on unrealized gains or losses on available-for-sale securities by diminishing our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow, access capital or receive structured product flows.
 
Our analysis of risks is based on management’s experience, estimates, models and assumptions. These analyses rely on models that utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or the implementation of investment decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in this prospectus.
 
In respect of floating rate syndicated bank loans, we enter into a contractual relationship directly with the corporate borrower, and as such we are exposed to certain degrees of risk, including interest rate, market risk and the potential nonpayment of principal and interest, including the default or bankruptcy of the corporate borrower or early payment by the corporate borrower.


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CDO MARKET OVERVIEW
 
In general, CDOs are bankruptcy remote, special purpose investment vehicles formed to acquire, monitor and, to varying degrees, manage a pool of fixed-income or other cash-generating assets. CDOs are financing vehicles that allow owners of financial assets to obtain long-term funding, manage refinancing and maturity risks, and secure a fixed cost of funds over an underlying market interest rate. Issuers have different motivations for creating or sponsoring CDOs. Investment advisory firms create and sponsor CDOs as a means of maximizing for the CDO equity holders the spread between the cost of borrowings and the return profile of the CDOs underlying collateral. This type of CDO is commonly referred to as an “arbitrage CDO.” CDOs are also created by commercial banks and other financial institutions to efficiently finance and transfer the risk of owning fixed-income assets. Commercial banks and other financial institutions usually structure this type of CDO for the purpose of addressing regulatory capital and balance sheet considerations. This type of CDO is commonly referred to as a “balance sheet CDO.”
 
The CDO market can be further divided into two major sectors based on the types of fixed-income assets that comprise their underlying collateral pool: (i) asset-backed CDOs and (ii) corporate credit CDOs, or CLOs. The following chart contains estimates of the approximate percentage of total CDO issuance volume for the year ended December 31, 2006 in each of the two major CDO categories, as well as for other CDOs that do not fall into either of the two major CDO categories.
 
2006 Global CDO Issuance Volume
and Underlying Collateral
 
Pie Chart
 
Total Issuance Volume: $329.3 billion
Source: Moody’s Quarterly Review
 
According to Moody’s Quarterly Review, the annual volume of CDO issuances rated by Moody’s has increased from approximately $14 billion in 1996 to approximately $158 billion in 2006, representing a compound annual growth rate, or CAGR, of approximately 27%. We believe the growth in the sector has been driven by the continued search for returns by CDO equity investors and that investors in general have been attracted to the market by strong collateral performance, attractive asset and liability spreads when compared to alternatives, and the value of structural considerations such as diversification, subordination, increasingly experienced collateral managers and the benefits of a maturing and more sophisticated market. We believe the


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combination of these factors has provided investors with consistent returns, improved liquidity and transparency in a variety of market and economic conditions.
 
Structure Overview
 
A CDO issues different classes of securities, the repayment of which is linked to the performance of the underlying collateral. The securities issued by a CDO are tranched into rated and unrated classes. The rating of each class is determined by a variety of factors, including but not limited to the priority of the claim on the cash flows generated by the underlying collateral. The following is a brief description of each CDO tranche:
 
  •  The senior notes issued by a CDO are typically rated by one or more rating agencies in one of the two highest rating categories (e.g., “Double A” or above), may pay interest at a fixed or a floating rate and have the highest priority claim on cash flows.
 
  •  The mezzanine debt classes issued by a CDO are typically rated by one or more rating agencies in the third or lower rating categories (e.g., “Single A” and below), may pay interest at a fixed or floating rate, may be required to defer and capitalize interest payments and have a claim on the cash flows subordinate to that of the senior notes.
 
  •  CDO equity, the most junior tranche of securities issued by a CDO, commonly structured as preferred shares, income notes or subordinated notes, is generally unrated and represents the first loss position in a CDO. The holders of CDO equity receive a payment from any residual interest proceeds or principal proceeds generated by the underlying collateral, after the payment of debt service and expenses on the securities that rank senior to the CDO equity.
 
In a typical CDO, a substantial portion of the capital is represented by CDO debt, which normally can be raised at a low cost in the debt markets relative to the yield earned on the collateral purchased since most of the CDO debt is highly rated.
 
Ownership of the CDO equity represents a leveraged exposure primarily to the credit performance of the underlying collateral, and is characterized by a combination of expected significant current cash flow as well as the opportunity for positive returns through long-term appreciation of the underlying portfolio due primarily to credit improvement. However, due to the level of payment subordination of CDO equity, these securities usually receive lower ratings or no ratings at all.
 
CDO securities representing the tranches in a CDO capital structure generally are limited recourse obligations of the CDO, payable solely from the underlying assets of the CDO or proceeds thereof. Consequently, holders of CDO securities must rely solely on distributions on the underlying collateral or proceeds thereof for payments. If distributions on the underlying collateral are insufficient to make payments on the CDO securities, no other assets will be available for payment of the deficiency, and following realization or liquidation of the underlying assets, the obligations of the issuer to pay such deficiency will be extinguished. As an additional credit enhancement, many CDOs provide for the deferral of interest on all but the most senior tranches. The subordinate tranches of many CDOs provide that a deferral of interest does not constitute an event of default that would provide holders of such tranches with associated default remedies. During periods of nonpayment, deferred interest will generally be capitalized and added to the outstanding principal balance of the related security. Any such deferral will reduce the amount of current payments made on such securities.
 
Synthetic vs. Asset Purchase Structure
 
CDOs do not always own their underlying collateral outright, but rather achieve collateral exposure synthetically by entering into total return and/or credit default swaps. In a total return swap, the CDO receives the total return (interest, fees and capital gains/losses on underlying securities) in exchange for a fixed rate of interest payment. The CDO may also be required to pay a fraction of the value of the total amount of the securities that are referenced in the swap as collateral posted with the swap counterparty. The total return swap, therefore, is a leveraged investment in the underlying securities portfolio. By contrast, in a credit default swap, the CDO receives periodic payments from a counterparty that seeks protection against the default of a


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referenced fixed-income asset. In return for this payment, the CDO must pay the protection buyer default losses on the referenced assets if the obligor of the referenced assets defaults. A CDO may have a few synthetic exposures or be comprised entirely of synthetic exposures.
 
Typical CDO Terms
 
The terms of a typical CDO may vary depending on the type of underlying collateral, prevailing market and economic conditions, and the quality of the portfolio manager. As discussed in detail below, most of our CDOs rely on a different exclusion from the 1940 Act than the majority of CDOs in the marketplace. The following summarizes certain of the material terms of a typical CDO and some of the areas in which our CDOs will differ.
 
Ramp-up Period
 
At closing, a cash CDO typically will have purchased approximately 50-75% of its targeted assets and is given an additional period, known as the ramp-up period, to complete the purchase of its remaining targeted assets. This ramp-up period typically ranges from 90 to 180 days. A synthetic CDO, which purchases some or all of its assets in swap form, may have a significantly shorter ramp-up period.
 
Maturity
 
The maturity date of a CDO refers to the last date on which any remaining CDO debt must be repaid. In general, CDO debt matures between 12 to 40 years from the closing date.
 
Duration
 
Duration measures the price sensitivity of a CDO and is calculated based on the weighted average of the present values for all anticipated cash flows over its expected life. CDO equity often has a relatively short expected duration (usually less than 10 years), as a typical CDO distributes excess cash flows quarterly or semi-annually concurrent with the payment of interest on its liabilities subject to compliance with overall collateral quality tests and other performance criteria.
 
Trading Baskets
 
Most CDOs allow the portfolio manager to trade fixed-income assets, subject to compliance with selected collateral tests and annual volume limitations, which typically allow trading of up to 15% of the aggregate par amount of non-credit-impaired assets, or free trading basket, and unlimited trading with regard to credit-impaired and credit-improved assets. By contrast, most of our CDOs that are structured to comply with Rule 3a-7 are limited by the terms of their indentures with respect to trading fixed-income assets. The indentures of such CDOs generally do not contain any free trading basket and generally do not permit trading with regard to credit-improved assets. However, the managers may substitute for or sell assets that are credit-impaired or may substitute for or sell other assets in order to cause, maintain or restore compliance with a collateral coverage test, collateral quality test or eligibility criteria set forth in the related indentures that would not be satisfied in the absence of such substitution. In no event will any dispositions or acquisitions be permitted for the primary purpose of recognizing gains or decreasing losses resulting from market value changes.
 
Reinvestment Period
 
Since many of the fixed-income assets held by a CDO represent debt obligations, which may mature or be prepaid during its life, many CDOs are structured to allow the portfolio manager, at its discretion, to reinvest the principal payments, subject to certain restrictions. The reinvestment period for a typical CDO commences on the closing date and extends for a period of three to seven years, subject to earlier termination in the event of a default.


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Reinvestment Criteria
 
Generally, the portfolio manager is required to reinvest principal payments received during the reinvestment period in accordance with specified investment guidelines that are designed to preserve or enhance the credit ratings assigned to the CDO debt. The primary difference between a typical CDO and our CDOs that will be structured to comply with Rule 3a-7 with respect to reinvestment criteria is that the indentures of our CDOs will contain prohibitions against disposing of assets or acquiring new assets for the primary purpose of recognizing gains or decreasing losses due to changes in market value.
 
Collateral Tests
 
CDOs typically are subject to a number of collateral tests that are designed to protect the holders of, and to maintain the credit ratings associated with, CDO debt, including the following:
 
Collateral Coverage Tests
 
Collateral coverage tests exist to ensure that the collateral securing the underlying assets of a CDO is sufficient to pay CDO debt in case of defaults on the underlying assets. The two main collateral coverage tests are the over-collateralization test and the interest coverage test. Additionally, some CDOs utilize a ratings-based test. Collateral coverage tests can divert cash flows from subordinated tranches, prevent reinvestment in new CDO assets and cause senior tranches to be paid down before payments to subordinated tranches.
 
Collateral Quality Tests
 
Collateral quality tests ensure that the type of collateral securing the underlying assets of a CDO are of a sufficient quality such that the collateral may be used to pay CDO debt upon the default of the underlying assets. These tests restrict portfolio trading, and may include objective measures of portfolio diversity, average rating, average life, prospective average recovery and minimum weighted average coupon or spread.
 
Diversity Score
 
A diversity score is a rating agency’s index of a portfolio’s diversification, which generally focuses on the number of credits, the number of industries, geographical diversity and the asset categories of the underlying collateral. The purpose of the diversity score is to measure the potential collateral effects that a default on some of the assets underlying the CDO will have on the other assets underlying the CDO.
 
Concentration Tests
 
Concentration tests address the presence in the portfolio of single issuers, the percentage of the collateral represented by loan participations, non-U.S. obligors, triple-C credits, deferred interest instruments and other factors. Like the diversity score, concentration tests are utilized to prevent the concentration of the underlying assets of a CDO in a particular asset type.
 
Fees
 
The portfolio manager in a typical CDO is entitled to receive senior and subordinate management fees periodically. In addition, portfolio managers may be entitled to receive incentive fees periodically.
 
Redemption
 
CDO debt is typically subject to a right of redemption at the direction of at least a majority of the CDO equity generally after a three- to five-year non-call period and subject, in many cases, to the payment of a make-whole premium. The exercise of this right is typically also conditioned on the availability of sufficient funds to satisfy the redemption obligation, including any make-whole premium. CDO debt is also typically subject to special redemption in the event that during the reinvestment period the portfolio manager is unable to reinvest principal payments in additional qualifying collateral. In addition, CDO debt will be mandatorily redeemed, subject to the availability of sufficient funds, in the event of a collateral coverage test failure.


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1940 Act Exclusion
 
Most CDO issuers are excluded from the registration requirements of investment companies under the 1940 Act by reason of their compliance with Section 3(c)(7). Section 3(c)(7) essentially requires such issuers to engage in private offerings made only to “qualified purchasers” (as defined in the 1940 Act), but places no limitations on the ability of the issuer to purchase or sell assets or otherwise trade the underlying portfolio of securities.
 
However, CDOs may also be structured to be excluded from investment company status under Rule 3a-7. Rule 3a-7 does not have restrictions on the manner of offering. Instead, Rule 3a-7 excludes from treatment as investment companies issuers engaged in the business of purchasing, or otherwise acquiring, and holding “eligible assets” (as defined in Rule 3a-7), including financial assets that by their terms convert into cash within a finite period of time, and in activities related or incidental thereto, and who do not issue redeemable securities. Rule 3a-7 imposes certain restrictions on the activities of such issuers, including the following:
 
(i) the issuer issues securities that entitle holders thereof to receive payments that depend primarily on the cash flow from such eligible assets;
 
(ii) the securities sold are fixed-income securities rated investment-grade by at least one nationally recognized statistical rating agency (fixed-income securities that are unrated or rated below-investment-grade may be sold to 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);
 
(iii) the issuer acquires and disposes of eligible assets only if:
 
  •  done in accordance with the agreements pursuant to which the securities are issued;
 
  •  the acquisition or disposition does not result in a downgrading in the rating of the issuer’s fixed-income securities;
 
  •  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
 
(iv) 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.
 
Compliance by our CDO subsidiaries with Rule 3a-7 may be viewed as requiring that the indenture governing a CDO subsidiary include limitations on the types of assets the CDO 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, on the overall level of transactions that may occur or on other provisions of the indentures that govern the operation of the particular CDO subsidiary. It is intended that the indentures of our CDO subsidiaries will contain these types of provisions.
 
Most of our CDO subsidiaries are excluded from investment company status under Rule 3a-7. Some of our CDO subsidiaries may also be structured to be excluded from investment company status under Section 3(c)(7), which excludes from investment company status issuers that are engaged in private offerings made only to “qualified purchasers” (as defined in the 1940 Act).


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Overview
 
We are a specialty finance holding company that provides our shareholders with returns derived primarily from our structured finance subsidiaries, commonly known as collateralized debt obligations issuers, or CDOs. We are jointly managed and advised by our managers, Bear Stearns Asset Management Inc., or BSAM, and Stone Tower Debt Advisors LLC, or Stone Tower. Relying on the structured finance expertise of our managers, our objective is to create, structure and own CDOs and other structured finance assets that will provide attractive risk-adjusted returns to us and our shareholders.
 
We generate earnings primarily through a diversified portfolio of CDOs in which we beneficially own all or a majority of the equity. Our CDOs are special purpose vehicles that hold a range of cash-generating financial assets, such as corporate leveraged loans, asset-backed securities and securities issued by other CDOs. To finance the acquisition of these assets, our CDOs typically issue multiple tranches of securities, ranging from highly rated senior debt securities, which are secured or collateralized by these assets, to unrated equity tranches. As the sole or principal equity owner in our CDO subsidiaries, we are entitled to all or a portion of any cash flow, which is typically paid quarterly, generated by the underlying financial assets, after deducting the interest and required principal payments made to holders of CDO debt securities and other expenses.
 
We expect to continue to increase our holdings of CDOs, primarily through the formation and acquisition of additional CDO subsidiaries in which we plan to hold all or a majority of the equity. To a lesser extent, we also acquire and hold minority equity positions in CDOs. We expect to form and hold CDOs structured by our managers as well as to help structure and opportunistically acquire CDOs sponsored by third parties where we believe we can do so on attractive terms. We may also form or hold, from time to time, other structured finance assets.
 
We expect to allocate capital primarily to creating and owning two types of CDOs: (i) corporate credit CDOs, or CLOs, that primarily hold corporate leveraged loans and high-yield bonds, and (ii) asset-backed securities CDOs, or ABS CDOs, which hold asset-backed securities, including residential mortgage-backed securities and commercial mortgage-backed securities. These two types of CDOs include cash CDOs, which hold an underlying portfolio of cash-generating assets, and synthetic CDOs, which enter into total return swaps, credit default swaps or other derivative instruments designed to replicate the economic consequences of holding a referenced portfolio of assets. A synthetic CDO may generally be structured more rapidly to capitalize on favorable market conditions.
 
Competitive Advantages
 
We believe that we enjoy the following competitive advantages:
 
Fully Employed Paid-in Capital and Diversified Portfolio of CDOs.  We have fully employed our paid-in capital to date in a seasoned portfolio of CDOs diversified by manager, collateral type, vintage and duration. As of December 31, 2006, our CDO holdings consisted of 19 CDOs, including 11 CDOs in which we own all or a majority of the equity tranches, one of which we own 50% of the equity and seven in which we own a minority interest. In addition, at that date, our largest CDO subsidiary, Parapet CDO, held a portfolio consisting of preference share and income note tranches of 15 CDOs and mezzanine debt securities of 22 CDOs. As of December 31, 2006, five of the CDOs in which we hold equity securities were managed by our managers. We believe that this diversification reduces our exposure to individual market sectors or credit events.
 
Management Expertise.  Our co-chief executive officers, Ralph R. Cioffi and Michael J. Levitt, have a combined total of more than 54 years of experience in structured finance, non-investment-grade debt investing, leveraged finance and private equity. Mr. Cioffi joined Bear Stearns in 1985, and founded the BSHG Funds in March 2003. He was instrumental in the creation of the structured credit effort at Bear Stearns, which is a leading underwriter and secondary trader in structured credit securities. Mr. Levitt founded Stone Tower


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Capital LLC, or STC, in 2001. Before that, he was instrumental in building the leveraged finance business at Morgan Stanley and subsequently at Smith Barney (a Citigroup predecessor). Mr. Levitt was also a managing partner of the New York office of the private equity firm of Hicks, Muse Tate & Furst Incorporated. Messrs. Cioffi and Levitt will have principal management responsibility for Everquest. We believe that their experience, together with the experience of the other investment professionals at BSAM and Stone Tower in investing in debt and equity securities and managing investments in structured credit securities, will afford us a competitive advantage in identifying and creating new CDO opportunities with the potential to generate attractive returns.
 
Strengths of Our Managers.  We believe that we will be able to leverage the strengths of our managers, which include the following:
 
  •  Strong Track Record.  We believe BSAM has a strong track record of developing transaction structures, managing structured vehicles and selecting vehicles managed by third parties. In particular, BSAM has developed innovative transaction structures that increase the efficiency with which pools of structured securities can be funded. For example, BSAM designed and marketed the Klio series of CDOs, which use commercial paper as a funding mechanism for highly rated structured finance assets and which BSAM believes were the first transactions of their kind. BSAM often takes an active role in structuring the securities it buys on issue from third parties, and from time to time restructures them to increase their funding efficiency.
 
As of December 31, 2006, the BSAM Team had managed seven CDOs, excluding Parapet CDO, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — BSAM’s Track Record,” and had purchased for funds it manages equity tranches in 18 CDOs managed by third parties, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — BSAM’s Track Record.” As of December 31, 2006, the weighted average annualized cash return of the seven CDOs managed by the BSAM Team was 12.3%, net of management fees, or 19.9%, on an adjusted gross basis before deducting management fees, and the weighted average annualized cash return of the 17 CDO equity tranches it purchased that have made at least one quarterly distribution was 24.5%.
 
Stone Tower has developed a reputation among market participants as one of the leading cash flow CLO managers in North America. As of December 31, 2006, the weighted average annualized cash return of the nine CDOs sponsored by Stone Tower that have made at least one quarterly distribution, which are described in “Our Management and Corporate Governance — Managers’ Personnel and Track Record — Stone Tower’s Track Record,” was 14.0%, net of management fees, or 18.3%, before deducting management fees.
 
  •  Complementary Expertise.  We believe that one of our competitive strengths is the extensive and complementary expertise of each of our managers. BSAM generally invests in a range of structured finance assets, with particular expertise in ABS CDOs, and Stone Tower focuses on non-investment-grade corporate credit assets. We believe that the complementary expertise of our managers will help us form new CDOs and allocate our capital among either ABS CDOs or CLOs and related asset classes where we believe we can achieve the best relative value, in light of prevailing market conditions.
 
  •  History of Cooperation.  BSAM and Stone Tower have worked together for more than four years in a variety of capacities. They have jointly identified and evaluated potential opportunities, including collateral portfolios, based on each entity’s particular expertise. They also have acted as subadvisor for funds managed by each other and jointly structured and managed CDOs. Currently, BSAM and Stone Tower jointly manage two CDOs, portions of the equity of which are held by us and by Parapet CDO. They have also jointly established three CDOs that were structured by them with assets selected by them and in which funds they manage have invested. We believe their history of cooperation will enable them to work together effectively on our behalf.
 
Access to Proprietary and High-Quality Deal Flow.  We believe BSAM and Stone Tower’s market position, expertise and long-standing relationships with a broad range of market participants have provided and


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will continue to provide us with the opportunity to evaluate a pipeline of attractive opportunities before they become available to the wider market. These opportunities include the ability to source high-quality collateral for CDOs that may be structured by our managers, including potentially CDOs of CDOs, as well as the ability to structure and acquire equity in CDOs managed by third parties on attractive terms.
 
High-Quality Risk Management Systems.  We believe the strong track record to date of our managers is due, among other things, to the surveillance and risk management systems they utilize. We believe that access to those systems is a significant competitive advantage. The proprietary and third-party surveillance systems used by BSAM were designed to ensure that all assets are reviewed real time and those showing signs of potential credit deterioration or poor performance are designated for further review. BSAM’s surveillance systems track over 80,000 securities on a daily basis and monitor the performance of all of our CDO holdings as well as perform in-depth analysis on all the underlying collateral backing such holdings. We believe our managers’ systems enhance our ability to quickly identify, and where possible, sell or otherwise hedge potentially credit-impaired assets before significant credit deterioration begins or rating downgrades occur. We benefit from these systems not only in the case of CDOs managed by our managers but also with respect to those managed by third parties. With respect to CDOs managed by third parties, we integrate the underlying credits into our surveillance systems so that they can be monitored in the same way as CDOs managed by our managers. When we identify a potential credit-impaired asset in a third party managed CDO, we notify the manager and work with the manager to sell or hedge the asset. If the asset is not sold, we attempt to hedge our exposure to the asset. Additionally, Stone Tower performs daily surveillance on all loans underlying each of our CLO investments. Both BSAM and Stone Tower monitor assets in real time with systems that are designed to be early warning in nature, as opposed to systems that provide alerts only after an asset begins to deteriorate.
 
Access to BSAM and Stone Tower Investment Professionals and Infrastructure.  We also believe we have a significant competitive advantage through our access to BSAM’s and Stone Tower’s structured finance professionals, who are supported by an established operational infrastructure. As of December 31, 2006 the combined BSAM Team and Stone Tower team responsible for Everquest included a total of approximately 52 professionals, consisting of portfolio managers, research analysts and other professionals. In addition, Everquest has access to the broader operational infrastructure of BSAM and Stone Tower, including information technology, legal, administrative and other back office operational infrastructure. As of December 31, 2006, BSAM and Stone Tower had more than 440 employees in the aggregate.
 
Strong Alignment of Interest among Everquest, BSAM and Stone Tower.  The interests of BSAM and Stone Tower are strongly aligned with ours. The BSHG Funds, which are managed by BSAM, owned approximately 67.0% of our ordinary shares as of December 31, 2006, and are expected to own approximately  % of our ordinary shares after this offering. I/ST, a fund managed by an affiliate of Stone Tower, owned approximately 8.4% of our ordinary shares as of December 31, 2006, and is expected to own approximately     % of our ordinary shares after this offering. In addition, as a result of this offering each of BSAM and Stone Tower, or their designees, will be entitled to receive share grants representing 2.5% (or together an aggregate of 5.0%) of our ordinary shares outstanding upon completion of this offering.
 
Our Business Strategy
 
We intend to continue to grow our holdings in CDOs and other structured finance assets. We seek to generate attractive returns by leveraging the strengths of our managers to:
 
  •  evaluate and source attractive opportunities with the best relative value in varying market environments, through both CDOs we structure ourselves and opportunities presented to us by third parties;
 
  •  select high quality assets to be held by the CDOs that are managed by our managers and in which we hold interests, and actively participate in the structuring of, and asset selection for, CDOs that are managed by third parties and in which we hold interests managed by third parties;
 
  •  maximize the yield on the underlying assets relative to our cost of financing their acquisition;


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  •  achieve a level of diversification in our overall portfolio in terms of asset type and manager to minimize the effect of negative credit events;
 
  •  employ and develop innovative strategies, including synthetic techniques, to improve the quality, execution and performance of our CDO assets;
 
  •  actively monitor through proprietary and third-party surveillance systems the performance and management of assets held by the CDOs in which we hold interests, including those managed by third parties; and
 
  •  utilize credit default swaps to manage risks of credit events relating to our assets and other hedging techniques to manage interest rate risks.
 
Our Corporate Credit CDO Subsidiaries (CLOs)
 
Our CLO subsidiaries primarily acquire corporate leveraged loans and high-yield bonds. Most of the assets held by our CLO subsidiaries are rated below-investment-grade by one or more of the rating agencies. The composition of each CLO is generally governed by the specific asset limitations provided in each CLO and the rating criteria attributed to a particular CLO.
 
Corporate Leveraged Loans
 
Corporate leveraged loans are debt obligations of highly leveraged corporations, partnerships and other entities in the form of first and second lien loans, participations in corporate leveraged loans, commercial real estate mezzanine loans and bridge facilities. Given the high proportion of debt that is typically found in the capital structure of this type of borrower, these debt obligations are referred to as leveraged loans. Our CLO subsidiaries may acquire leveraged loans that are (i) widely syndicated, (ii) middle-market loans, which are not widely syndicated, (iii) U.S. dollar-denominated, and (iv) euro-denominated. Our CLOs, to the extent allowed by a CLO indenture, may also hold the second lien loans and commercial real estate mezzanine loans of certain issuers. A second lien loan is a loan in which the holder of such loan is subordinated in its right to receive principal and interest payments from the borrower to the rights of the holder of the senior loan. Commercial real estate mezzanine loans are loans that are subordinated to a first mortgage loan on the same property, and are typically secured by pledges of ownership interests in the property and/or property owner.
 
High-Yield Bonds
 
High-yield bonds are below-investment-grade debt obligations of corporations and other non-governmental entities. These bonds could be secured by a borrowers’ assets or unsecured, and could have an interest-only payment schedule, with the principal amount remaining outstanding and at risk until the bond matures.
 
Our Asset-Backed CDO Subsidiaries
 
Our asset-backed CDO subsidiaries primarily acquire RMBS, CMBS, diverse consumer and commercial ABS and debt tranches of other asset-backed CDOs.
 
Residential Mortgage-Backed Securities (RMBS)
 
RMBS represent interests in pools of residential mortgage loans secured by one- to four-family residential mortgage loans in which payments of both principal and interest are generally made monthly, net of any fees paid to the issuer, servicer or guarantor of the securities. The RMBS held by our CDOs are principally collateralized by adjustable rate RMBS, fixed rate RMBS, hybrid adjustable rate RMBS and agency-backed RMBS. A majority of the RMBS held by our CDOs consist of non-agency adjustable rate and three- and five-year hybrid adjustable rate mortgage-backed securities. Most of the RMBS held by our CDOs are rated investment-grade by one or more rating agencies.


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RMBS include:
 
  •  Residential A Mortgage-Backed Securities (Residential A MBS).  Residential A MBS entitle the holders thereof to receive payments that depend on the cash flow from prime residential mortgage loans secured, on a first priority basis, by residential real estate (single or multifamily properties) the proceeds of which are used to purchase real estate and purchase or construct dwellings thereon (or to refinance indebtedness previously so used).
 
  •  Residential B/C Mortgage-Backed Securities (Residential B/C MBS).  Residential B/C MBS entitle the holders thereof to receive payments that depend on the cash flow from subprime residential mortgage loans secured, on a first priority basis, by residential real estate (single or multi-family properties) the proceeds of which are used to purchase real estate and purchase or construct dwellings thereon (or to refinance indebtedness previously so used).
 
The subprime residential mortgage loans backing Residential B/C MBS are originated using underwriting standards that are less restrictive than the underwriting requirements used as standards for other first and junior lien mortgage loan purchase programs, including the programs of Fannie Mae and Freddie Mac. These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories, mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgaged property, mortgage loans made to borrowers with low credit scores, mortgage loans made to borrowers who have other debt that represents a large portion of his or her income and mortgage loans made to borrowers whose income is not required to be disclosed or verified. Additionally, some of the subprime residential mortgage loans backing Residential B/C MBS are “non-conforming loans” and are not eligible for purchase by Fannie Mae or Freddie Mac due to either credit characteristics of the related mortgagor or documentation standards in connection with the underwriting of the related mortgage loan that do not meet the Fannie Mae or Freddie Mac underwriting guidelines for “A” credit mortgagors. These credit characteristics include mortgagors whose creditworthiness and repayment ability do not satisfy such Fannie Mae or Freddie Mac underwriting guidelines and mortgagors who may have a record of credit write-offs, outstanding judgments, prior bankruptcies and other credit items that do not satisfy such Fannie Mae or Freddie Mac underwriting guidelines. These documentation standards may include mortgagors who provide limited or no documentation in connection with the underwriting of the related mortgage loan. In addition, certain mortgage loans may fail to conform to the underwriting standards of the related originators.
 
The substantial majority of the asset-backed CDOs in which we hold equity have invested in RMBS, including primarily RMBS backed by collateral pools of subprime residential mortgages. The value and returns of these RMBS may be affected by general economic conditions in some geographic regions, including increased interest rates and lower housing prices, which have negatively affected collateral pools of subprime residential mortgages that underlie certain RMBS. Generally, our asset-backed CDOs hold RMBS rated in the range of “A2” to “Ba2,” which because of their higher position within the RMBS structure are less susceptible to loss than the equity or lower-rated tranches of RMBS. Nevertheless, increased losses within the underlying collateral pools of subprime mortgages could also cause the higher rated RMBS to suffer losses, which could be material. For a description of steps we have taken to manage these risks, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Credit Risk.”
 
  •  Home Equity Loan Securities (HEL).  HEL entitle the holders thereof to receive payments that depend on the cash flow from balances (including revolving balances) outstanding under lines of credit secured by (but not, upon origination, by a first priority lien on) residential real estate (single or multifamily properties) the proceeds of which lines of credit are not used to purchase such real estate or to purchase or construct dwellings thereon (or to refinance indebtedness previously so used).


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Commercial Mortgage-Backed Securities (CMBS)
 
CMBS are securities backed by obligations (including certificates of participation in obligations) that are principally secured by mortgages on real property or interests therein having a multifamily or commercial use, such as regional malls, other retail space, office buildings, industrial or warehouse properties, hotels, nursing homes and senior living centers. These securities may be senior, subordinate, investment-grade or non-investment-grade securities. The majority of the CMBS assets that our CDOs acquire are rated between A2 – Baa2 and A – BBB by Moody’s and S&P, respectively. The majority of these CMBS assets consist of securities that are part of a capital structure or securitization where the rights of such class to receive principal and interest are subordinate to senior classes but senior to the rights of lower-rated classes of securities. Our CDOs acquire CMBS with high-yield current interest income and where we consider the return of principal to be likely. Our CDOs 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.
 
Other Asset-Backed Securities (ABS)
 
ABS are securities backed by either consumer or commercial receivables in sectors such as auto, credit cards, student loans and equipment. Our CDO subsidiaries acquire investment-grade and non-investment-grade ABS. The structure of an asset-backed security and the terms of the investors’ interest in the collateral can vary widely depending on the type of collateral, the desires of investors and the use of credit enhancements. ABS issuers are special-purpose entities owned or sponsored by banks and finance companies, captive finance subsidiaries of nonfinancial corporations or specialized originators such as credit card lenders. Most of the asset-backed securities that we acquire are rated between A2 – Baa2 and A – BBB by Moody’s and S&P, respectively.
 
CDO Debt Securities
 
CDO debt securities consist of the senior and mezzanine debt securities of CDOs. Our CDO subsidiaries acquire the debt tranches of CDOs sponsored by third parties as well as by the managers. We believe that CDO debt represents a potentially attractive acquisition opportunity for our CDO subsidiaries. Most of the CDO debt tranches that we acquire are rated between A2 – Baa2 and A – BBB by Moody’s and S&P, respectively.
 
Other
 
To a lesser extent, our CDO subsidiaries also invest in commercial real estate subordinated loans, or B – Notes, mezzanine loans and trust preferred securities. B – Notes are loans that are (i) secured by a first mortgage on a single large commercial property or group of related properties, and (i) subordinated to an A – Note secured by the same first mortgage on the same property. Mezzanine loans are loans that are subordinated to a first mortgage loan on a commercial property and are senior to the borrower’s equity in the property. Mezzanine loans are typically secured by pledges of ownership interests in the property and/or property owner. Trust preferred securities are hybrid instruments that have characteristics of debt and equity securities.


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Our CDOs
 
The following summarizes our CDO holdings, as of December 31, 2006, including asset type and value:
 
                                         
Our CDO Holdings
                                Everquest
       
                    Portfolio
  Total
  Total Equity
  Equity
  % of
   
Closing
                  Implied
  Capitalization(3)
  Amount(4)
  Amount
  Class
  Fair Value
Date
  Issuer/Tranche   Manager   CDO Type   Collateral Type(1)   Rating(2)   ($)   ($)   ($)   Held   ($)
 
Parapet CDO
                                       
10/2006
  Parapet 2006, Ltd.   BSAM   Static CDO of CDOs   CDO debt and CDO equity   Baa1/BBB+   507,260,000   369,759,613   369,759,613   100   381,576,484
                                         
 
Corporate Credit CDOs (CLOs)
12/2004
  Stone Tower CDO Ltd.   Stone Tower   Managed Cashflow CDO of CLOs   Corporate leveraged loans and CDO debt   Ba1/BB+   306,000,000   33,000,000   4,095,000   12   3,899,395
03/2006
  Stone Tower CLO IV Ltd.   Stone Tower   Managed Cashflow CLO   Corporate leveraged loans   B1/B+   750,000,000   60,000,000   2,475,000   4   2,460,931
06/2006
  Comstock Funding Ltd. 2006-1A   Silvermine Capital Management LLC   Managed Cashflow CLO   Corporate leveraged loans and CDO debt   B1/B+   466,500,000   37,500,000   36,340,000   97   37,790,971
07/2006
  Aimco 2006-AA   Allstate Investment Management Company   Managed Cashflow CLO   Corporate leveraged loans and
high yield bonds
  B1/B+   410,000,000   32,000,000   3,000,000   9   3,107,471
08/2006   Tiers Beach Street 2006-4 F2   None   Static Synthetic CLO   Synthetic corporate leveraged loans   B1/B+   500,000,000   36,000,000   5,800,000   16   5,684,378
10/2006   Beach Street   None   Static Synthetic CLO   Synthetic corporate leveraged loans   Ba3/BB-   1,028,500,000   52,781,250   52,781,250   100   52,114,421
12/2006
  ACA CLO 2006-2   ACA Management   Managed Cashflow CLO   Corporate leveraged loans   B1/B+   307,800,000   24,600,000   5,000,000   20   4,136,594
11/2006
  Cannington Funding Ltd.   Silvermine Capital Management   Managed Cashflow CLO   Corporate leveraged loans   B1/B+   465,500,000   42,000,000   36,820,000   88   34,978,438
11/2006
  Rampart CLO 2006-I Ltd.   Stone Tower   Managed Cashflow CLO   Corporate leveraged loans   B1/B+   613,000,000   48,000,000   48,000,000   100   48,806,245
11/2006
  Primus CLO I, Ltd.    Primus Asset Management   Managed Cashflow CLO   Corporate leveraged loans   B1/B+   400,000,000   26,000,000   7,000,000   27   5,642,799
                                         
                                        198,621,643
                                         
 
Asset-Backed CDOs
02/2006
  Montauk Point Ltd. 2006 Preferred   Fortis Investment Management USA, Inc.   Managed Synthetic/ Cash CDO   RMBS, CDO debt, CMBS   Baa2/BBB   401,800,000   13,000,000   9,800,000   75   8,653,913
05/2006
  Class V Funding II Ltd.   Credit Suisse Alternative Capital, Inc. (BSAM as sub-advisor)   Managed Cashflow CDO
of CDOs
  CDO debt and CDO equity   Baa2/BBB   300,000,000   18,000,000   12,000,000   67   12,118,108
05/2006
  Vertical Ltd.   Vertical Capital, LLC   Managed Cashflow CDO   CMBS, CDO debt, Mezzanine Loan, B-Note   NA   306,600,000   18,100,000   12,300,000   68   11,845,243
06/2006
  IXCBO 2006-1X   IXIS Securities North America Inc.   Managed Synthetic/Cash CDO   RMBS, CDO debt   Baa2/BBB   506,500,000   20,000,000   11,000,000   55   10,112,393
07/2006
  Cherry Creek Ltd.   Surge Capital Management, LLC   Managed Cashflow CDO   RMBS, CDO debt, CMBS   Baa2/BBB   300,000,000   14,000,000   14,000,000   100   12,100,344


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Our CDO Holdings
                                Everquest
       
                    Portfolio
  Total
  Total Equity
  Equity
  % of
   
Closing
                  Implied
  Capitalization(3)
  Amount(4)
  Amount
  Class
  Fair Value
Date
  Issuer/Tranche   Manager   CDO Type   Collateral Type(1)   Rating(2)   ($)   ($)   ($)   Held   ($)
 
08/2006
  Strata Trust   None   Static Synthetic CLO   Synthetic senior secured assets   NA   30,000,000   30,000,000   30,000,000   100   30,578,814
12/2006   Hudson Mezzanine Funding 2006-1A   None   Static Synthetic CDO   Mid-grade asset-backed securities   Baa2/BBB   837,000,000   60,000,000   30,000,000   50   24,844,995
12/2006
  Tallships Funding Ltd.   BSAM   Managed Cashflow Mezz ABS CDO   RMBS   Baa2/BBB   589,000,000   46,500,000   9,625,000   21   6,503,809
                                         
                                        116,757,619
                                         
Total
                                      696,955,746
                                         

 
 
(1)  Collateral type refers to the primary holdings of each issuer.
 
(2)  ‘Portfolio Implied Rating’ refers to the weighted average rating factor, or WARF, of the issuer. WARF is a measure that considers a portfolio as a single security, and assigns it a single rating. Data is based on (i) the closing documents for the transaction or (ii) the most recent monthly report issued on or prior to December 31, 2006.
 
(3)  Total initial face or notional amount of all debt and equity securities issued.
 
(4)  Total initial face or notional amount of equity shares issued.
 
         
         
NR — not rated               WR — withdrawn rating
       
         
         
 

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Parapet 2006, Ltd.
 
Our subsidiary, Parapet CDO, is a CDO of CDO securities which holds CDO mezzanine securities and preference share and income notes tranches. All of Parapet CDO’s assets, including the preference share and income note tranches, by their terms convert into cash within a finite time period. Parapet CDO has issued an AA/Aa3-rated tranche of Class A floating rate notes that as of December 31, 2006, had an aggregate principal amount of $136.9 million, as well as a tranche of preference shares and ordinary shares. We acquired all the outstanding preference shares and ordinary shares of Parapet CDO from the BSHG Funds in connection with our formation. The Class A floating rate notes were retained by the BSHG Funds.
 
The following summarizes the assets in Parapet CDO, as of December 31, 2006, including asset type and value:
 
                                                 
Parapet CDO Portfolio
                    Par
      Credit Rating
             
Mezzanine Tranches               Amount
      of Mezzanine
  Portfolio
         
Closing
                  Held
      Tranches(2)(3)   Implied
  Fair Value      
Date
  Issuer/Tranche   Manager   CDO Type   Collateral Type(1)   ($)   Coupon(2)   Moody’s   S&P   Rating(2)(4)   $     Maturity
 
03/2004
  Vertical CDO Ltd. 2004-1A   Vertical Capital, LLC   Managed Cashflow CDO
of CDOs
  Senior Tranches of CDO debt   3,000,000   3ML + 4.5   Baa1   NR/WR   Aaa/AAA     3,002,507     09/10/2042
10/2004
  High Grade Structured Credit 2004-1 E   BSAM   Managed Synthetic CDO
of CDOs
  RMBS   4,000,000   1ML + 2.75   A1   NR   A2/A     4,054,315     10/15/2044
10/2004
  High Grade Structured Credit 2004-1 F   BSAM   Managed Synthetic CDO
of CDOs
  RMBS   10,000,000   1ML +3.00   A3   NR/WR   A2/A     10,114,092     10/15/2044
10/2004
  Klio Funding Ltd. 2004 2-A   BSAM   Managed Cashflow CDO   RMBS, CDO debt, CMBS, ABS   18,922,035   3ML + 1.50   A3   A-   Aa2/AA     19,181,562     10/29/2039
10/2004
  Klio Funding Ltd. 2004-2A   BSAM   Managed Cashflow CDO   RMBS, CDO debt, CMBS, ABS   30,000,000   3ML + 2.00   Baa2   BBB   Aa2/AA     28,670,345     10/29/2039
10/2004
  Merrill Lynch Mortgage Investors Trust 2004-WMC5   None   Static CDO   RMBS   6,000,000   1ML + 1.85   Baa1   AA-   NA     6,060,949     7/25/2035
10/2004
  Structured Asset Investment Loan Trust, Series 2004-10   None   Static CDO   CDO debt   2,000,000   1ML + 2.35   NR/WR   A-   NA     2,017,419     11/25/2034
10/2004
  Structured Asset Investment Loan Trust, Series 2004-BNC2   None   Static CDO   CDO debt   8,943,000   1ML + 2.00   NR/WR   A   NA     9,078,977     12/25/2034
12/2004
  Stone Tower CDO Ltd. 2004 1A   Stone Tower   Managed Cashflow CDO
of CLOs
  Corporate leveraged loans, CDO debt   17,000,000   3ML + 1.75   A2   A   Ba1/BB+     17,140,267     01/29/2040
12/2004
  Stone Tower CDO Ltd. 2004 1A   Stone Tower   Managed Cashflow CDO
of CLOs
  Corporate leveraged loans, CDO debt   918,196   3ML + 2.75   Baa2   BBB   Ba1/BB+     925,849     01/29/2040
 
 
(1)  Collateral type refers to the primary holdings of each issuer.
 
(2)  Data based on the most recent monthly report issued on or prior to December 31, 2006. “1ML” and “3ML” refer to the one month LIBOR rate and three month LIBOR rate, respectively.
 
(3)  The ratings in the “Credit Rating” column pertain to the specific tranche identified.
 
(4)  “Portfolio Implied Rating” refers to the WARF of the issuer.
 
         
         
NR — not rated               WR — withdrawn rating
       
         
         
 


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Parapet CDO Portfolio
                    Par
      Credit Rating
             
Mezzanine Tranches               Amount
      of Mezzanine
  Portfolio
         
Closing
                  Held
      Tranches(2)(3)   Implied
  Fair Value      
Date
  Issuer/Tranche   Manager   CDO Type   Collateral Type(1)   ($)   Coupon(2)   Moody’s   S&P   Rating(2)(4)   ($)     Maturity
 
01/2005
  Synthetic Residential Asset Hybrid CDO 2004-10AC   None   Static Synthetic CDO   Synthetic RMBS   7,875,000   1ML + 1.95   NR/WR   A   NA     7,826,321     01/27/2040
01/2005
  Synthetic Residential Asset Hybrid CDO 2004-10AD   None   Static Synthetic CDO   Synthetic RMBS   11,404,800   1ML + 4.00   NR/WR   BBB   NA     11,249,236     01/27/2040
03/2005
  Stack 2005-1A   TCW Asset Management   Managed Synthetic CDO   RMBS   15,000,000   1ML + 3.50   NR/WR   BBB   Baa2/BBB     14,787,073     03/27/2040
03/2005
  North Street Referenced Linked Notes 2005-7A   UBS Principal Finance   Managed Synthetic CDO   Synthetic, CDO debt, CMBS, ABS   10,000,000   3ML + 5.00   NR/WR   B   A2/A     9,776,063     04/14/2039
07/2005
  Klio Structured Investments   BSAM   Managed Cashflow CDO   High-grade asset-backed securities   14,040,000   3ML + 2.75   Baa2   BBB   Aa2/AA     14,045,325     04/23/2039
09/2005
  Endeavor Funding Ltd. 2005-1A   Silvermine Capital Management   Managed Synthetic CLO   Corporate leveraged loans   3,000,000   3ML + 1.80   Baa2   BBB   B1/B+     3,012,800     11/15/2019
11/2005
  Klio Funding, Ltd. 2005-3A   BSAM   Managed Cashflow CDO   RMBS, CDO debt, ABS   4,834,149   3ML + 2.60   Baa2   BBB   Aa2/AA     4,766,200     11/01/2040
12/2005
  Liberty CLO Ltd. 2005-1A   Highland Capital Management   Managed Cashflow CLO   RMBS, CDO debt, ABS, Trust Preferred Securities   3,400,000   3ML + 1.90   Baa2   BBB   B2/B     3,430,809     11/01/2017
12/2005
  Marathon CLO Ltd. 2005-2A   Marathon Asset Management   Managed Cashflow CLO   Corporate leveraged loans, ABS   9,500,000   3ML + 1.80   Baa2   BBB   B1/B+     9,546,274     12/20/2019
12/2005
  North Cove CDO Ltd. 2005-1A   None   Static Synthetic CDO   RMBS   6,858,526   3ML + 3.00   Baa2   BBB   Baa2/BBB     6,785,872     11/11/2042
01/2006
  Tabs 2005-4A   Tricadia CDO Management   Managed Cashflow CDO   RMBS, CMBS, CDO debt, ABS   4,000,000   3ML + 4.25   Baa2   BBB   Baa3/BBB-     4,110,333     08/30/2045
03/2006
  Long Hill, Ltd. 2006-1A   Alliance Capital Management   Managed Synthetic/Cash CDO   RMBS, CDO debt, ABS   6,456,319   3ML + 3.75   Baa2   BBB   Baa2/BBB     6,505,009     10/07/2045
                                                 
Total
                                        196,087,597      
                                                 
 
         
         
         
NR — not rated               WR — withdrawn rating
       
         
         
         


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Parapet CDO Portfolio  
                              Total
    Parapet CDO
             
                              Preference
    Preference
             
Preference Shares and Income Notes           Portfolio
  Total
    Share
    Share
    % of
       
Closing
                  Implied
  Capitalization(3)
    Amount(4)
    Amount
    Class
    Fair Value  
Date   Issuer/Tranche   Manager   CDO Type   Collateral Type(1)   Rating(2)   ($)     ($)     ($)     Held     $  
 
 
Corporate CDOs (CLOs)
07/2005
  North Street Referenced Linked Notes, 2005-9AG   UBS Principal Finance   Managed Synthetic CDO   Corporate leveraged loans   Ba3/BB-     309,600,000       40,000,000       35,000,000       88       40,332,756  
07/2005
  North Street Referenced Linked Notes, 2005-9AH   UBS Principal Finance   Managed Synthetic CDO   Corporate leveraged loans   Ba3/BB-     309,600,000       10,400,000       8,000,000       77       9,187,251  
09/2005
  Endeavor Funding Ltd. 2005-1X    Silvermine Capital Management   Managed Synthetic CLO   Corporate leveraged loans   B1/B+     140,600,000       42,600,000       13,800,000       32       13,538,106  
11/2005
  Symphony CLO Ltd. 2005-1X    Symphony Asset Management   Managed Cashflow CLO   Corporate leveraged loans   B1/B+     412,900,000       31,400,000       8,500,000       27       8,456,910  
05/2006
  Mt. Wilson CLO Ltd. 2006-1X    Western Asset Management Co.   Managed Cashflow CLO   Corporate leveraged loans   B1/B+     307,000,000       24,500,000       23,500,000       96       23,181,772  
                                                             
                                                          94,696,795  
                                                             
Asset-Backed CDOs
03/2002
  North Street Referenced Linked Notes 2002-4A    UBS Principal Finance   Managed Synthetic CDO   RMBS, CMBS, ABS,
corporate leveraged loans
  Baa1/BBB+     574,000,000       49,000,000       11,000,000       22       10,364,101  
10/2004
  Klio II Funding Ltd. 2004-2A    BSAM   Managed Cashflow CDO   High-grade asset-backed securities   Aa2/AA     5,048,750,000       86,250,000       86,250,000       100       99,007,285  
12/2004
  Stone Tower CDO Ltd.    Stone Tower   Managed Cashflow CDO of CLOs   Corporate leveraged loans,
CDO debt
  Ba1/BB+     306,000,000       33,000,000       8,250,000       25       7,748,447  
01/2005
  Neptune CDO 2004-1A    Fund America Management Corp   Managed Synthetic/ Cashflow CDO   RMBS, CDO debt, CMBS   Baa2/BBB     405,075,000       17,600,000       2,500,000       14       2,438,045  
03/2005
  North Street Referenced Linked Notes, 2005-7A    UBS Principal Finance   Managed Synthetic CDO   RMBS   A2/A     228,000,000       10,000,000       9,500,000       95       11,534,845  
07/2005
  Klio Structured Investments 2005-1   BSAM   Managed Cashflow CDO   High-grade asset-backed securities   Aa2/AA     57,440,000       38,400,000       38,400,000       100       41,017,834  
07/2005
  North Cove CDO Ltd.    250 Capital LLC of Merrill Lynch & Co.   Static Synthetic CDO   Synthetic RMBS, CMBS,
CDO debt, ABS
  Baa2/BBB     151,800,000       16,695,000       16,695,000       100       12,486,513  
10/2005
  Stone Tower CDO II Ltd.    Stone Tower and BSAM   Managed Cashflow CDO of CDOs   Corporate leveraged loans,
CDO debt
  Ba2/BB     307,500,000       22,500,000       14,850,000       66       14,563,658  
11/2005
  Duke Funding, Ltd. 2005-9A    Duke Funding Management   Managed Synthetic/ Cashflow CDO   RMBS, CMBS   Baa3/BBB     2,500,000,000       118,750,000       9,100,000       8       8,962,167  
01/2006
  Static Residential Trust 2005-CX    None   Static Synthetic CDO   RMBS   Baa2/BBB     500,000,000       21,000,000       10,000,000       48       9,286,434  
                                                             
                                                          217,409,329  
                                                             
Total
                                                        508,193,721  
                                                             
 
 
(1)  Collateral type refers to the primary holdings of each issuer.
 
(2)  ‘Portfolio Implied Rating’ refers to the WARF of the issuer. Data are based on the most recent monthly report issued on or prior to December 31, 2006.
 
(3)  Total initial face as notional amount of all debt and equity securities issued.
 
(4)  Total initial face as notional amount of preference share and income notes issued.
 
         
         
NR — not rated          WR — withdrawn rating
       
         
         
 


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CDO Holdings Acquired after December 31, 2006
 
The following summarizes our CDO holdings acquired subsequent to December 31, 2006 and through March 31, 2007(1):
 
                                                     
                              Total
             
                    Portfolio
  Total
    Equity
          Purchase
 
Closing
              Collateral
  Implied
  Capitalization(4)
    Amount(5)
    % of
    Price
 
Date
  Issuer/Tranche   Manager   CDO Type   Type(2)   Rating(3)   ($)     ($)     Class Held     ($)  
 
3/2007
  Octonion CDO, Ltd. Income Notes   Harding Advisory LLC   Mezzanine ABS CDO   RMBS, CMBS, ABS   Baa2/BBB   $ 1,040,250,000     $ 24,000,000       48     $ 13,200,000  
3/2007
  Premier Funding CLO SE Note   Citigroup Global Markets Realty Corp.   Managed Synthetic CLO   Middle market corporate loans   N/A   $ 288,266,475     $ 12,106,106       75     $ 12,106,106  
3/2007
  Stone Tower CLO VI Ltd.   Stone Tower   Managed Cashflow CLO   Corporate leveraged loans   B1/B+   $ 1,000,000,000     $ 8,000,000       10     $ 7,600,000  
                                                     
Total
                                              $ 32,906,106  
                                                     
 
 
(1) Does not include investment in short-term warehousing facilities.
 
(2) Collateral type refers to the primary holdings of each issuer.
 
(3) “Portfolio Implied Rating” refers to the WARF of the issuer. Data is based on the closing documents for the transactions.
 
(4) Total initial face as notional amount of all debt and equity securities issued.
 
(5) Total initial face as notional amount of equity securities issued.
 
         
         
NR — not rated               WR — withdrawn rating
       
         
         
 


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Business Operations
 
Our significant business operations include the following principal activities:
 
  •  CDO formation and acquisition;
 
  •  asset sourcing; and
 
  •  risk management, including asset monitoring, surveillance and hedging.
 
Currently, our managers act as collateral manager for the majority of our CDO subsidiaries. Whether our CDO subsidiaries are managed by the managers or by third parties, we actively participate in and oversee each key aspect of our CDO subsidiaries’ operations.
 
Operating Committee
 
Our day-to-day operations are supervised by our operating committee, which is composed of our CEOs, Ralph R. Cioffi and Michael J. Levitt, our CFO and certain other BSAM and Stone Tower investment professionals. Our operating committee meets regularly to discuss business opportunities, review the performance of our CDO holdings and oversees our business operations. The operating committee considers, among other things:
 
  •  investments in our existing portfolio;
 
  •  our deal flow pipeline (including investments and rejections);
 
  •  the performance of our CDO subsidiaries;
 
  •  securities on our surveillance list;
 
  •  our cash status (including amounts currently available, projections and financing);
 
  •  compliance with regulations;
 
  •  the valuation of our assets; and
 
  •  the returns on our previous and current investments.
 
All of our investments must be approved by our operating committee, which requires the unanimous approval of both CEOs. The operating committee operates pursuant to general policies, procedures and guidelines established by our board of directors. Under these guidelines, the operating committee is required to seek board approval for investments that meet certain amount thresholds and in cases where certain conflicts of interest have been identified.
 
CDO Formation and Acquisition
 
To meet our business objectives, we are continually seeking opportunities to form or acquire additional CDO subsidiaries. Through our managers we have the opportunity to form new CDO subsidiaries. We also believe that the ability of the managers to identify and work with high-quality third-party CDO collateral managers is important to our success, and gives us a competitive advantage over our competitors. In either case, in forming and acquiring new CDO subsidiaries we take an active role in structuring the overall CDO, determining the rights and conditions attaching to our equity interests, negotiating the management fee if a third party is retained, negotiating the underwriting fees charged by the underwriter in connection with the financing of the CDO, and negotiating and determining the overall return profile and other economic characteristics of our equity interests.
 
Portfolio Construction and Asset Sourcing
 
The portfolio of each CDO subsidiary is constructed utilizing strict sector and asset diversification parameters within the managers’ rigorous credit processes, focusing on principal preservation. Each portfolio is constructed based on the specific business parameters of the CDO’s indenture and working within rating


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agency constraints. The CDO indentures contain numerous criteria for their portfolios relating to credit quality, type of instrument, maturity, industry, issuer, and other diversification and credit quality parameters. The managers’ overall goals in portfolio construction, executed within the portfolio guidelines and the constraints of the indenture, are (i) to maximize relative value based on its credit views and (ii) to maximize diversification in order to minimize the effect of isolated credit events on the overall portfolio.
 
The managers currently source many of the assets they manage through close relationships with a large and diverse group of financial intermediaries, including investment banks, financial sponsors, specialty dealers and brokerage firms. The managers also capitalize on their relationships in the financial community through their management of multiple CDOs and their involvement in a vast number of credit positions. We also rely on the relationships that the managers’ asset management professionals have developed in their many years of involvement in the financial services industry. A primary function of the managers’ asset management professionals is to maintain relationships with these institutions and maximize the managers’ asset sourcing capabilities.
 
We also rely, where applicable, on the asset sourcing capability of third-party collateral managers. In such cases, we also advise and oversee the asset selection process carried out by the collateral manager.
 
Asset Allocation/Diversification
 
One of the major steps in constructing the portfolio for a CDO is to achieve the levels of diversification among credit quality, type of instrument, industries, issuers and other parameters that are necessary in order to obtain the desired ratings of the CDO debt. The CDO is then required to maintain compliance with various tests in order to protect these ratings and the cash flow expected to be available to the holders of the CDO equity. This process requires identifying and acquiring a wide variety of fixed-income instruments, each of which plays a role in achieving on a portfolio-wide basis the levels of diversification required under the indenture. In the managers’ experience, a typical ABS CDO will own approximately 100 different credit assets. We view our access to a large number and variety of assets through the managers and/or their affiliates and through the high-quality collateral managers with whom we have relationships as a critical component of our ability to achieve these asset allocation and diversification requirements.
 
Asset Sourcing
 
The following summarizes some features of the credit process employed by the managers with respect to our CDO assets and the ABS and corporate credit assets underlying the CDOs.
 
CDOs
 
Deal Structure.  The managers’ CDO credit process begins with understanding the CDO’s structure. The CDO type and size are studied and reviewed to determine if the deal is static or has a reinvestment period. They also analyze the CDO’s amortization schedules and payment structure as well as interest rate hedges. Pricing of the CDO tranches is also analyzed.
 
Manager Review.  The managers conduct an in-depth review of the CDO manager, focusing on the manager’s CDO experience, organization staffing and stability and past CDO performance. Finally, the managers examine the manager’s ownership of CDO equity and liabilities, assets under management and CDOs under management.
 
Documentation Review.  The documentation of a CDO deal, including the CDO indenture, is reviewed by the managers, with particular attention to hedge agreements on high-grade ABS transactions, manager removal provisions, amendment procedures and trading restrictions.
 
Transaction Parties.  In addition to a manager review, the managers analyze the other parties to a CDO deal, including the underwriter, trustee and rating agencies participating in the transaction.
 
Collateral/Trigger Analysis.  The managers also analyze the collateral coverage tests, collateral quality tests and eligibility criteria that are incorporated into each CDO deal. In particular the managers’ analysis


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focuses on the senior securities’ over-collateralization requirements, the subordinate securities’ over-collateralization requirements, the WARF of the collateral portfolio, the portfolio diversity score and asset correlation, obligor and sector concentrations and minimum coupon and spread requirements.
 
Structure Default Analysis.  The managers apply a structure default analysis to each CDO it reviews. The equity return profile of the CDO is an especially important component of this analysis, as are any special features of the cash flow waterfall. The managers also examine the possibility of early redemption of the CDO as a result of the exercise of any optional redemption right or clean-up or auction call mechanism.
 
Break-even Analysis.  The managers’ also perform a customized break-even analysis on each CDO. This analysis examines the CDO’s constant default rate, recovery rate and cumulative default loss, as well as payment speed and reinvestment rates.
 
In addition, we may also perform customized default analysis where return profiles are measured by varying the timing and severity of loss for the default of specific assets within the portfolio.
 
ABS
 
Knowing the Originator and Servicer.  Knowing the originator and servicer of ABS, particularly RMBS servicers, is paramount to the managers’ ABS credit process. The managers regularly meet with originators and servicers. The managers review the origination channels and analyze the originators’ underwriting philosophies and processes. The managers also review the originators’ and services track records.
 
Understanding Collateral and Enhancement.  The managers’ also focus on understanding the underlying collateral and the credit enhancement provisions of ABS assets. The managers utilize proprietary and third-party surveillance and risk management systems in assessing ABS assets. The managers develop tailored loan stratifications, review geographic exposures and apply their adjusted FICO score analysis to ABS assets. With respect to geographic exposures, BSAM has developed and maintains a proprietary system that provides analysis of the demographics of metropolitan structural areas such as employment, population, industry and the distribution of income. We believe this is a valuable tool in assessing the credit quality of the underlying collateral pool of RMBS, which are the principal assets in which our ABS CDOs invest. Through this examination, the managers are able to understand and minimize layered risks within ABS assets.
 
Generating Stress Runs and Cash Flow Analysis.  The managers apply stress runs and cash flow analysis to each ABS asset. The managers’ generate customized default vectors and analyze standard default scenarios, which includes reviewing the available funds cap risk of ABS assets. Finally, the managers subject ABS assets to a loss coverage multiple test to determine the suitability of each asset.
 
Corporate Credit
 
Asset Review Process.  The managers review individual credits in the CDO issuers’ portfolios and assess the cash flow generation capability and enterprise value of the underlying corporate credit assets, a process which seeks to minimize risk of default and maximize recoveries in the event of a default. When evaluating corporate credit assets, the managers generally endeavor to, among other things: (i) conduct credit-based research and analysis; (ii) assess the fair market value of the enterprise of the borrower’s business and avoid making investments where the face value of all of the debt of the business exceeds the managers’ view of the enterprise value; and (iii) avoid making investments in companies that do not generate free cash flow from business operations or, based on our proprietary financial models, will not be able to meet debt service on a timely basis. The managers’ credit-based research and analysis considers, among other things: (i) an assessment of the default probability of the borrower; (ii) an analysis of the relative value of the investment compared to other comparable investment opportunities; (iii) the nature, adequacy and value of the collateral, if applicable; and (iv) the creditworthiness of a borrower’s business, including, but not limited to, its cash flows, capital structure and future prospects.


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Risk Management
 
The risk management and operational oversight functions for our CDOs are supervised by the managers’ asset management and compliance professionals, particularly their specialized credit and structuring professionals.
 
Monitoring and Surveillance
 
In order to achieve appropriate diversification in our portfolio and to manage credit risks, we use our proprietary and third-party surveillance and risk management systems. Our systems utilize a specialized database designed specifically for structured credit products and their underlying portfolios. The surveillance system aggregates data from vendors (including INTEX, Bloomberg and Loan Performance), trustees, servicers and rating agencies in order to generate frequent alerts and collateral management reports. Our managers’ portfolio managers and credit analysts evaluate these alerts and reports, using analytic tools including INTEX, Bear Stearns BondStudio, Salomon Yield Book, Bloomberg and proprietary models. The monitoring and surveillance process enables effective portfolio construction, monitoring and management by helping the managers identify suspect assets before the occurrence of credit deterioration or ratings downgrades.
 
Individual portfolio holdings of each CDO managed by each manager are continually monitored by specific portfolio managers. The extent of monitoring or intervention is generally determined by the degree of credit stress that a given underlying asset is experiencing. The managers conduct monthly portfolio monitoring meetings. At these meetings, the portfolio managers provide updated credit reviews, discuss outlooks for their respective sectors, and defend and justify portfolio holdings.
 
The following summarizes some features of the monitoring and surveillance process employed by the managers with respect to their CDO assets and the ABS and corporate credit assets underlying CDOs:
 
CDOs
 
Our proprietary and third-party surveillance system assist our managers in:
 
  •  summarizing each CDO’s current and historical collateral test compliance as well as portfolio characteristics.
 
  •  comparing collateral performance against historical and projected performance.
 
  •  reviewing trading activity within a CDO, which provides insight into a CDO manager’s view of the market and can help predict future performance.
 
  •  reviewing a CDO’s cashflow structure to determine early signs of structural problems in a deal.
 
Our managers also:
 
  •  perform a manual review of troubled credit assets in a deal, particularly in the more-troubled asset classes; and
 
  •  conduct periodic conference calls and/or visits with managers to review operations, including staffing, specific credits and future CDO plans.
 
ABS
 
Using a proprietary surveillance system, all assets are reviewed monthly and those showing signs of future credit deterioration or poor performance are “flagged” for further review. Certain parameters that would cause an asset to be “flagged” include:
 
  •  For RMBS, changes in delinquencies, cumulative loss, initial and current credit enhancement and CPR rates over time.
 
  •  For CDOs, changes in all coverage ratios and the weighted average portfolio rating over time, CCC buckets, loss and defaulted securities.


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Our CDO, RMBS, ABS and corporate portfolio managers and credit analysts evaluate the reported statistics on flagged positions and perform additional analysis when necessary. All comments are passed on to the senior portfolio managers and logged in the surveillance system.
 
Hedging
 
Once our managers detect that our assets are subject to potential credit deterioration, they may from time to time utilize derivative financial instruments to hedge all or a portion of the credit risks of such assets. Our managers may use credit default swaps to hedge this risk. In a credit default swap, the investor receives periodic payments from a counterparty that seeks protection against the default of a referenced fixed-income asset. In return for this payment, the investor must pay the protection buyer default losses on the referenced assets if the obligor of the referenced assets defaults.
 
Asset Replacement
 
We substitute assets that are credit impaired or in order to cause, maintain or restore compliance with a collateral coverage test, collateral quality test or eligibility criteria set forth in the related indentures that would not be satisfied in the absence of such substitution. However, pursuant to Rule 3a-7 of the 1940 Act, an asset may not be sold if the primary purpose of sale is to realize gain or minimize loss resulting from market value changes. We generally expect to hold most of the assets in our CDO subsidiaries to maturity and, accordingly, do not expect to engage in a significant volume of asset replacements. The proceeds of payoffs at maturity and principal prepayments may also be redeployed to purchase replacement assets during the reinvestment period provided by the indenture. Replacement assets are selected strictly in accordance with the terms of the indenture through the same process as the construction of the initial portfolio. The manager’s goal is to minimize defaults and to the extent defaults do occur, maximize recoveries.
 
1940 Act Exclusion
 
We conduct our operations so that we are not required to register as an investment company under the 1940 Act. Pursuant to Section 3(a)(1)(C) of the 1940 Act, 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 will be deemed to be an investment company. Excluded from the term “investment securities,” among other things, are 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 provided by Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. We believe that more than 60% of our assets consist of CDO subsidiaries that are themselves not investment companies as a result of the exception for structured finance companies, Rule 3a-7, rather than in reliance on Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. Accordingly, we do not own or propose to acquire investment securities having a value in excess of 40% of the value of our total assets on an unconsolidated basis, and are therefore not required to register as an investment company.
 
If it were determined that one or more of our CDO subsidiaries could not rely on the exclusion from investment company status under the 1940 Act for structured finance companies, these CDO subsidiaries would have to restructure their operations in order to rely on that exclusion. If they could not restructure their operations to comply with the exclusion, then we could have to register as investment companies under the 1940 Act, either of which could adversely affect our earnings.
 
Competition
 
We are subject to significant competition in seeking business opportunities. A number of entities compete with us to make the types of assets that we or our CDOs seek to acquire, including REITs, financial and insurance companies, commercial and investment banks, commercial finance companies, public and private investment funds and other investors. A number of our competitors have greater resources than we do and we may not be able to compete successfully for assets.


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Staffing
 
The management, operation and policy of the company is vested exclusively in our board of directors. Our board of directors, however, has the power to delegate to either of the CEOs or the managers any of its responsibility for the management and operation of the company. Our CEOs are employees of the managers or one or more of their affiliates.
 
Legal Proceedings
 
We and the managers are not currently subject to any material legal proceedings.
 
Our Corporate Information
 
Our principal executive offices are located at 152 West 57th Street, New York, New York 10019. Our telephone number is (212) 457-0220.


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THE MANAGEMENT AGREEMENTS
 
The Management Agreements
 
Services
 
We are party to a management agreement with each manager, pursuant to which the managers monitor and manage our assets and financial activities. Pursuant to each management agreement and subject to the policies and control of our operating committee and, in certain instances, our board of directors, the managers, among other things, (i) perform diligence, structure on our behalf our CDO subsidiaries and oversee the purchase and sale of assets (which purchases may be from affiliates of either or both of the managers) on behalf of our CDO subsidiaries, (ii) monitor and manage our assets and financial activities (including through the use of leverage and our hedging policies), (iii) provide us with certain advisory services, (iv) are responsible for the day-to-day activities relating to its assets, with such allocation of responsibilities as between the managers as determined by our board of directors, and (v) such other matters as our board of directors and the managers may agree upon from time to time. We believe our managers have well respected and established management resources for each of our subsidiaries’ targeted asset classes and a mature infrastructure supporting those resources. We benefit from the managers’ finance and administrative capabilities for certain legal, compliance and other operational matters, including the allocation and execution of purchases and sales of assets, securities valuation, risk management and information technology services.
 
Each management agreement provides that the respective manager will not be liable to us, our affiliates or representatives for any acts or omissions or any errors of judgment or any loss suffered by us. However, each manager will be liable for losses resulting from its willful misconduct, fraud, criminal misconduct or gross negligence or by reason of its reckless disregard of its obligations and duties under its management agreement.
 
Each management agreement requires the respective manager to manage our business affairs in conformity with the policies and controls of our operating committee, and in certain instances subject to the approval of our board of directors. The managers, in conjunction with the CEOs, are responsible for the day-to-day management of our assets and financial activities and perform (or cause to be performed) such services and activities relating to our assets and financial activities as may be appropriate, which may include the following:
 
  •  serving as our consultant with respect to the structuring of CDO subsidiaries, making acquisitions and dispositions of assets for our CDO subsidiaries prior to putting in place long-term financing, determining the capitalization and borrowings of our CDO subsidiaries, and developing such policies, procedures and guidelines as our board of directors determines are useful to the management of our business;
 
  •  assisting us in developing criteria for asset purchase commitments and programs that are specifically tailored to our business objectives and making available to us their knowledge and experience;
 
  •  investigating, analyzing, selecting and executing acquisition, disposition and hedging opportunities (including accumulating assets for us, participating in the warehouse equity in CDO entities sponsored by third parties and making short-term investments of excess cash);
 
  •  conducting negotiations with sellers and purchasers and their respective agents, representatives and investment bankers with respect to prospective acquisitions and dispositions of assets by us;
 
  •  engaging and supervising, on our behalf and at our expense, independent contractors (which may include affiliates of a manager) that provide investment banking, securities brokerage, back office and other financial services, and such other services as may be required relating to our assets;
 
  •  coordinating and managing operations of any joint venture, asset acquisition programs, warehousing equity participations or co-purchased interests held by us;
 
  •  providing executive and administrative personnel, office space and office services required in rendering services to us, to the extent that we have not developed internally administrative capability to handle our day-to-day business and operations;


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  •  administering and servicing our day-to-day operations, assisting and supporting the CEOs and our chief financial officer with respect to financial, bookkeeping, accounting and disclosure matters and such other administrative service functions necessary to manage us and which are mutually agreed, including in connection with the collection of revenues, the payment of our obligations, the maintenance of appropriate computer services and the production on a timely basis of information, reports and accounts and other assistance to us relating to financial bookkeeping, accounting and disclosure matters to assist us in timely satisfying any filing obligations under the Securities Exchange Act of 1934, or Exchange Act, as amended;
 
  •  communicating on our behalf with the holders of any of our equity or debt securities and helping us to maintain effective relations with such holders;
 
  •  counseling us in complying with all regulatory requirements applicable to us in respect of our business activities, including, where applicable, the maintenance of our exclusions or exemptions from the 1940 Act and monitoring compliance with the requirements for maintaining same;
 
  •  monitoring the operating performance of our assets, providing periodic reports with respect thereto to our operating committee and board of directors (including comparative information with respect to such operating performance and budgeted or projected operating results), and furnishing reports and statistical and economic research regarding the services performed for us by the managers;
 
  •  advising us as to our capital structure and capital raising;
 
  •  assisting us in retaining qualified accountants and legal counsel, as applicable, to assist in the conduct of our business;
 
  •  assisting and counseling us regarding the development of an annual budget and periodically monitoring our performance against such budget;
 
  •  advising us with respect to obtaining appropriate warehouse or other financings;
 
  •  assisting us and our service providers in making required tax filings and reports;
 
  •  advising us with respect to structuring long-term financing vehicles for our assets, and with respect to offering and selling securities publicly or privately in connection with any structured financings; and
 
  •  performing such other services as may be required from time to time for management and other activities relating to our assets and our business and operations as our board of directors shall reasonably request or the managers deem appropriate under the particular circumstances.
 
The managers will not be required to provide services that would require them to make any certification pursuant to the Sarbanes-Oxley Act, although they will provide support and assistance, to the extent necessary, to enable our CEOs and chief financial officer to provide such certifications.
 
In addition, the managers will not knowingly take any actions or conduct themselves in a manner that would cause us to be engaged in a U.S. trade or business within the meaning of Section 864 of the U.S. Internal Revenue Code of 1986, as amended. In fulfilling these obligations, the managers may rely on opinions of tax counsel and on our operating guidelines.
 
Indemnification
 
We have agreed to indemnify each manager, its affiliates and their respective legal or other representatives to the fullest extent permitted by law against all losses, liabilities, damages, expenses or costs suffered, incurred or sustained by reason of the fact that they were in such roles with respect to the company. However, we will not indemnify them for matters resulting from their willful misconduct, fraud, criminal misconduct or gross negligence or their reckless disregard in the performance of their obligations and duties.
 
Furthermore, the managers may consult with legal counsel and accountants in respect of our and our subsidiaries’ affairs and will be fully protected and justified in any action or inaction taken in accordance with the advice or opinion of such counsel or accountants, provided that such legal counsel or accountants were selected with reasonable care.


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Term
 
Each management agreement is effective until September 28, 2007 and will be automatically extended for one-year terms unless either party gives 30 days’ prior written notice that it elects to not renew the management agreement at the end of the one-year term.
 
In the event we elect to not renew a management agreement without cause (that is, unless the non-renewal is because the manager or the related CEO is finally adjudicated to have engaged in fraud, willful misconduct or gross negligence with respect to the company’s assets or business), the manager will be entitled to the payment of a termination fee. In such case, the termination fee will be equal to the base fees and incentive fees that would have been payable to the manager by us and our subsidiary, Everquest LLC, for either two full years (based on the average annual fees paid to such manager in prior years) if such non-renewal occurs on or prior to September 28, 2009 or one full year of such fees if the non-renewal occurs after September 28, 2009. An additional termination fee is payable if the manager is so not renewed prior to September 28, 2007 so that three full years of fees are received by the manager.
 
In the event that we do not renew a management agreement for cause or a manager does not renew its management agreement, the manager will receive from us an amount equal to the base management fees and incentive fees through the end of the then-current annual term.
 
If either CEO voluntarily ceases to be a CEO of our company, dies or becomes disabled, we may not renew the related management agreement during the 90-day period following such event and pay the related manager one full year’s base and incentive fees, calculated as described above.
 
The managers will also provide management services to Everquest LLC on substantially the same terms and conditions as they provide to the company pursuant to the management agreements.
 
Either manager may waive or defer the right to payment of fees to it, and such fees may be paid by the company, Everquest LLC, or both (without duplication).
 
Each management agreement will be governed by the laws of the State of New York.
 
Management Fees, Expenses and Incentive Allocation
 
Base Fee
 
We pay the managers a base management fee, quarterly in arrears, in an amount equal to (i) 1.75% on an annualized basis of the company’s net assets up to $2 billion, plus (ii) 1.50% on an annualized basis of the company’s net assets over $2 billion and up to $3 billion, plus (iii) 1.25% on an annualized basis of the company’s net assets over $3 billion and up to $4 billion, plus (iv) 1% on an annualized basis of the company’s net assets over $4 billion.
 
For purposes of calculating the base fee, the company’s net assets will be adjusted to exclude special one-time events pursuant to changes in GAAP and non-cash charges. Such adjustments will be made only after discussion between the company and the independent directors on our board of directors and approval by a majority of the independent directors.
 
To the extent we have purchased after September 28, 2006, or in the future purchase, an equity stake in a CDO or other structured finance interest sponsored by BSAM or Stone Tower or our managers are able to obtain any fee rebates for deals in which we and other vehicles they manage invest (but, excluding secondary purchases or other purchases after completion of an offering), the fees payable by us under the management agreements will be reduced by the portion of any management or incentive fees received by BSAM or Stone Tower as manager of the CDO or other issuer that is allocable to our stake in such CDO or other issuer, to the extent such fees are not otherwise waived by BSAM or Stone Tower. The foregoing fee reduction provision does not apply to our initial portfolio of CDOs that we acquired in our formation transactions. No management or incentive fees are paid by Parapet CDO to BSAM or Stone Tower, although BSAM and Stone Tower may be entitled to investment management fees with regard to certain of Parapet CDO’s underlying CDO assets. The managers use their management fee in part to pay compensation to their officers and employees.


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Incentive Allocation
 
In addition to the base fee, the managers receive a quarterly incentive allocation from Everquest LLC and cash distribution from us in an aggregate amount equal to:
 
(i) 25% of the dollar amount by which:
 
(a) the company’s quarterly net increase in net assets resulting from operations (as determined in accordance with GAAP before non-cash equity compensation expense), before accounting for the incentive allocation and distribution, per weighted average company ordinary shares for such quarter, exceeds
 
(b) an amount equal to (A) the weighted average of the price per ordinary share for all issuances of company ordinary shares, after deducting any underwriting discounts and commissions and other costs and expenses relating to such issuances, multiplied by (B) the greater of 2.00% per quarter (or 8% annually) and 0.50% plus one-fourth of the U.S. Ten-Year Treasury Rate for such quarter,
 
multiplied by
 
(ii) the weighted average number of ordinary shares outstanding during such quarter.
 
The foregoing calculation and cash distribution of the incentive allocation is adjusted to exclude special one-time events pursuant to changes in GAAP and non-cash charges. Such adjustments are made only after discussion between the managers and the independent directors on our board of directors and approval by a majority of the independent directors on our board of directors. The incentive allocation calculation and associated incentive distribution is made quarterly in arrears. Furthermore, to the extent that Everquest LLC does not have any net increase in net assets resulting from operations, as calculated for federal tax purposes during any particular taxable year, no amounts will be allocated to the manager in respect of their profits interests.
 
The compensation paid to the managers is allocated between them as follows: (i) compensation relating to the first $562.0 million of book capital of the ordinary shares of the company outstanding at the time of the determination of such compensation will be allocated 80%/20% between BSAM and Stone Tower, respectively, and (ii) compensation relating to the book capital of the ordinary shares in excess of $562.0 million will be allocated 60%/40% between BSAM and Stone Tower, respectively.
 
Reimbursement of Expenses
 
We will reimburse the managers for any expenses incurred on our behalf as set forth in the management agreements, including asset purchase and sale expenses (i.e., expenses that the managers reasonably determine to be related to the purchase of our assets), such as brokerage commissions, custodial fees, bank service fees, interest expenses and expenses related to any proposed acquisition of assets that was not consummated the costs associated with the establishment of any credit facilities and other indebtedness of ours (including commitment fees, legal fees, closing costs and other costs); the costs of preparing, printing, delivering and filing any notices, proxy materials, reports and filings to any person, and other expenses connected with communications to such persons; reasonable travel and other out-of-pocket expenses incurred by officers, employees and agents of the managers and their affiliates in connection with the purchase, financing, hedging, refinancing, sale or disposition of assets and proposed assets; hedging expenses; legal expenses; professional fees (including, without limitation, expenses of consultants and experts); internal and external accounting expenses (including costs associated with any computer software or hardware used by us); accounting, auditing and tax preparation expenses; the costs and expenses of rendering financial assistance to or arranging for financing for any assets; entity-level taxes; our tax-related litigation expenses, including our attorney’s fees; expenses of any registrar, custodian and transfer agent; our organizational expenses; administrative fees and expenses related to third-party asset valuation services; other expense categories approved by our board of directors; our winding-up costs, and all other expenses actually incurred by the managers and their affiliates that are reasonably necessary for the performance by the managers of their functions, duties and obligations under the management agreements.


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OUR MANAGEMENT AND CORPORATE GOVERNANCE
 
The management, operation and policy making functions of the company are vested exclusively in our board of directors. Our board of directors, however, has the power to delegate to either of the CEOs or the managers any of its responsibility for the management and operation of the company. Our board of directors consists of the CEOs, an additional director designated by BSAM and four independent directors as determined by our board using the standards for independence established by the NYSE.
 
Directors and Executive Officers
 
The following table presents certain information concerning our board of directors and the individuals who serve as our CEOs and other executive officers.
 
             
Name
 
Age
 
Position
 
James S. Gilmore, III
  57   Chairman of the Board of Directors and Independent Director
Ralph R. Cioffi
  51   Co-Chief Executive Officer and Director
Michael J. Levitt
  48   Co-Chief Executive Officer and Director
Gary Cohen
  64   Independent Director
John W. Geissinger
  47   Director
Jay M. Green
  60   Independent Director
Gregory J. Parseghian
  46   Independent Director
Smita Conjeevaram
  46   Chief Financial Officer
 
Set forth below is biographical information for our CEOs, chief financial officer and directors.
 
James S. Gilmore, III.  Mr. Gilmore is the chairman of the board of directors. Mr. Gilmore has been a partner at the law firm of Kelley Drye & Warren LLP since 2002, where he practices corporate and technology law and provides advice to clients on homeland security issues in the areas of public relations, information technology and international relations. He also currently serves as chairman of the National Council on Readiness and Preparedness, a nonprofit community-based organization. From 1998 to 2002, he was Governor of the Commonwealth of Virginia and was Attorney General of the Commonwealth of Virginia in 1993. Previously, he served in various public and private legal positions, as well as in the U.S. Army. Mr. Gilmore serves as a director of Atlas Air, Inc., Barr Pharmaceuticals, Inc. and Cypress Telecommunications Corp. Mr. Gilmore received a B.A. in Foreign Affairs from the University of Virginia, and a J.D. from the University of Virginia Law School.
 
Ralph R. Cioffi.  Mr. Cioffi is a co-chief executive officer and a director of the company. Mr. Cioffi is a senior managing director at BSAM, has been with Bear Stearns since 1985 and is a member of BSAM’s board of directors. From 1985 through 1991 Mr. Cioffi worked in institutional fixed-income sales where he specialized in structured finance products. He served as the N.Y. head of fixed-income sales from 1989 through 1991. From 1991 through 1994 Mr. Cioffi served as global product and sales manager for high-grade credit products. He was involved in the creation of the structured credit effort at Bear Stearns and was a principal force behind Bear Stearns’ position as a leading underwriter and secondary trader of structured finance securities, specifically CDOs and esoteric ABS. Mr. Cioffi founded and has been managing the High Grade Structured Credit Strategies Fund since March 2003. He holds a B.S. degree in Business Administration with distinction from Saint Michael’s College, Vermont, and is a member of the international business management and administration honor society, Sigma Beta Delta.
 
Michael J. Levitt.  Mr. Levitt is a co-chief executive officer and a director of the company. Mr. Levitt founded Stone Tower Capital LLC, or STC, in 2001. He is responsible for the overall strategic direction of STC and the development of the firm’s investment philosophies. He also serves as Chairman and Chief Executive Officer of I/ST and Chairman of Hanover-STC. He has spent his entire twenty-five year career managing or advising non-investment-grade companies and investing in non-investment-grade assets. Previously, Mr. Levitt worked as a partner in the New York office of Hicks, Muse, Tate & Furst Incorporated, where he was involved in many of the firm’s investments. Additionally, he managed the firm’s relationships with


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banking firms. Prior thereto, Mr. Levitt served as the Co-Head of the Investment Banking Division of Smith Barney Inc. with responsibility for the advisory, private equity sponsor and leveraged finance activities of the firm. Mr. Levitt began his investment banking career at, and ultimately served as a Managing Director of, Morgan Stanley & Co., Inc. Mr. Levitt oversaw the firm’s corporate finance and advisory businesses related to private equity firms and non-investment-grade companies. Mr. Levitt has a B.B.A. from the University of Michigan and a J.D. from the University of Michigan Law School. Mr. Levitt serves on the University’s Investment Advisory Board.
 
Gary Cohen.  Mr. Cohen is a director of the company. He currently teaches classes at various graduate business schools and serves as a consultant to start-up hedge funds. From 2001 to 2003, he was chief investment officer and chief operating officer for the Americas at Deutsche Bank’s Deutsche Asset Management. From 1973 to 2000, Mr. Cohen served in various positions at Citibank and Citigroup, eventually becoming a senior managing director at Citi Alternative Investment Strategies and global chief investment officer at Citigroup Alternative Investments. Previously, he served as a U.S. Army officer. Mr. Cohen holds a B.S. in Social Science Education from Indiana University of Pennsylvania, and an M.B.A. in Finance and Operations Research from Syracuse University.
 
John W. Geissinger.  Mr. Geissinger is a director of the company. He joined BSAM in 1998, and is currently the chief investment officer of BSAM. Prior to joining BSAM, he served as managing director and head of investment-grade fixed income at Chancellor LGT Asset Management. From 1986 to 1993, Mr. Geissinger was senior vice president and senior portfolio manager at Putnam Investments. Prior to that, he was director of quantitative fixed income research at Aetna Life and Casualty from 1983 to 1986. Mr. Geissinger received a B.S. in Mathematics and Economics from Wake Forest University and an M.B.A. in Statistics from New York University. Mr. Geissinger is a member of the Fixed Income Analyst Society and is a CFA charterholder.
 
Jay M. Green.  Mr. Green is a director of the company. Mr. Green has been a private investor since 1998. Mr. Green was executive vice president and chief financial officer of General Cigar Holdings, Inc. and its predecessor parent, Culbro Corporation, from 1988 to 1998, which at the time were NYSE-listed companies. From 1981 to 1988, he served in various leadership positions at Columbia Pictures and its then parent, The Coca-Cola Company. From 1969 through 1981, Mr. Green was with Price Waterhouse where he supervised audit examinations of large domestic and international companies. Mr. Green has previously served as a director of the following entities: The Smith & Wollensky Restaurant Group; The Walter Reade Organization; The Burbank Studios; Fedcap Rehabilitation Services, Inc.; and Griffin Gaming and Entertainment. Mr. Green graduated with a B.S. from Boston University in 1969 and is a Certified Public Accountant.
 
Gregory J. Parseghian.  Mr. Parseghian is a director of the company. He is the founder and chief executive officer of Parseghian Investment Advisors, LLC, an independent consultant to investment managers. From 1996 to 2003, Mr. Parseghian was employed by the Freddie Mac Corporation, serving first as Chief Investment Officer and subsequently from June to December 2003 as President and Chief Executive Officer. Previously, Mr. Parseghian was a managing director of Salomon Brothers and Credit Suisse First Boston and a partner in BlackRock Financial Management. Mr. Parseghian graduated from the Wharton School of the University of Pennsylvania with a B.S. in Economics and an M.B.A. in Finance.
 
Smita Conjeevaram.  Ms. Conjeevaram is the chief financial officer of the company. Ms. Conjeevaram has been actively involved in the hedge fund industry for over 15 years and has held senior positions at several large hedge funds. From September 2005 to August 2006; Ms. Conjeevaram was the COO/CFO of a newly launched private equity fund, SC Capital. Prior to SC Capital, Ms. Conjeevaram was a Partner and CFO of Strategic Value Partners, a distressed debt fund, from July 2004 to September 2005. From March 2003 to May 2004 Ms. Conjeevaram was the CFO of ESL Investments, a hedge fund. From 1999 to 2002 Ms. Conjeevaram was a Principal of Sentinel Advisors, LLC. Prior to joining Sentinel Advisors, Ms. Conjeevaram was a Tax Manager at Long Term Capital Management, L.P. beginning in 1994. Ms. Conjeevaram served as Tax Manager at Price Waterhouse from l987 to l994. Her education includes a B.S. in Accounting from Butler University, Indiana and a B.A. in Economics from Ethiraj College, Madras, India. Ms. Conjeevaram is a Certified Public Accountant.


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Corporate Governance
 
The structure, practices and committees of our board of directors, including matters relating to the size, independence and composition of our board of directors, the election and removal of directors, requirements relating to board of directors’ action, the powers delegated to board of directors committees and the appointment of executive officers, are governed by our memorandum and articles of association. The following is a summary of certain provisions of our memorandum and articles of association that affect our corporate governance. This summary is qualified in its entirety by reference to all of the provisions of the memorandum and articles of association. Because this description is only a summary of our memorandum and articles of association, it does not necessarily contain all of the information that you may find useful. We therefore urge you to review our memorandum and articles of association in their entirety.
 
During the preceding five years, none of our directors, the CEOs or our chief financial officer has been convicted of any fraudulent offenses, served as an officer or director of any company subject to a bankruptcy proceeding, receivership or liquidation, been the subject of sanctions by a regulatory authority or been disqualified by any court of competent jurisdiction from acting as a member of the administrative, management or supervisory body of any issuer or from participating in the management or conduct of the affairs of any issuer.
 
Size, Independence and Composition of Our Board of Directors
 
Our board of directors, which currently has seven members, may consist of between seven and 12 directors. At least a majority of the directors holding office must be independent, as determined by the full board of directors using the standards for independence established by the NYSE. If the death, resignation or removal of an independent director results in our board of directors consisting of less than a majority of independent directors, the vacancy must be filled promptly with another independent director appointed by majority vote of the remaining directors. Pending the filling of such vacancy, our board of directors may temporarily consist of less than a majority of independent directors.
 
Election and Removal of Directors
 
Shareholders elect all our directors, except the BSAM and Stone Tower designated directors. The special voting share classes granted to BSAM and Stone Tower entitle each to elect one director. These special voting shares remain valid so long as the relevant management agreement remains in effect, or the relevant manager or its affiliates have over $50 million invested in our company. BSAM’s special voting shares entitle it to designate one additional director so long as the BSAM-affiliated investment in our company is over $100 million. Independent directors may be removed for cause at any time by the vote of holders of two-thirds of our outstanding shares. BSAM and Stone Tower may remove any director they are entitled to designate. A director who is a BSAM or Stone Tower designee may also be removed for cause by the two-thirds vote of the independent directors. Any vacancy of a BSAM or Stone Tower designated director will be filled by BSAM or Stone Tower, and any other vacancy will be filled by majority vote of the remaining directors.
 
Action by Our Board of Directors
 
Members of our board of directors may take action in a meeting in which a quorum is present or by a written resolution signed by all directors then holding office. A quorum of our board of directors consists of a majority of our board of directors, which includes a majority of the independent directors. Our board of directors generally acts by majority vote. Under our management agreements, our board of directors has delegated to the managers substantial authority for carrying out the day-to-day management and operations of our business, including making specific investment decisions.
 
Transactions in Which a Director Has an Interest
 
A director who directly or indirectly has an interest in a contract, transaction or arrangement with us or certain of our affiliates is required to disclose the nature of his or her interest to the full board of directors. Such disclosure may generally take the form of a general notice given to our board of directors to the effect


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that the director has an interest in a specified company or firm and is to be regarded as interested in any contract, transaction or arrangement entered into by the company. A director may participate in any meeting called to discuss or any vote called to approve the transaction in which the director has an interest, and any transaction approved by our board of directors will not be void or voidable solely because the director was present at or participates in the meeting in which the approval was given, provided that our board of directors or a committee of the board of directors authorizes the transaction in good faith after the director’s interest has been disclosed or the transaction is fair to us.
 
Audit Committee
 
The audit committee consists solely of independent directors, and all members are financially literate. In addition, at least one member of the audit committee has accounting or related financial management expertise. The audit committee presently consists of each independent director. We consider Messrs. Green, Parseghian, Gilmore and Cohen to be financially literate, and Messrs. Green, Parseghian and Cohen to have accounting or related financial management expertise.
 
The audit committee is responsible for assisting and advising our board of directors with matters relating to:
 
  •  our accounting and financial reporting processes;
 
  •  the integrity and audits of our financial statements;
 
  •  our compliance with legal and regulatory requirements;
 
  •  the compliance of the investments selected by the managers with our investment policies and procedures;
 
  •  the review of the managers’ performance under the management agreements;
 
  •  the qualifications, performance and independence of our independent registered public accounting firm; and
 
  •  the qualifications, performance and independence of any third party that provides valuations for our investments.
 
The audit committee will also be responsible for engaging our independent registered public accounting firm, reviewing the plans and results of each audit engagement with our independent registered public accounting firm, approving professional services provided by our independent registered public accounting firm, considering the range of audit and nonaudit fees charged by our independent registered public accounting firm and reviewing the adequacy of our internal accounting controls.
 
Nominating and Corporate Governance Committee
 
Our board of directors is required to establish and maintain a nominating and corporate governance committee at all times. The nominating and corporate governance committee is required to consist only of directors who are independent directors. Currently, the nominating and corporate governance committee shall be required to recommend a slate of nominees for election as directors. It also reviews and makes recommendations on matters involving the general operation of the board of directors and our corporate governance, and annually recommends to the board of directors nominees for each committee of the board of directors. In addition, the nominating and corporate governance committee annually facilitates the assessment of the board of directors’ performance as a whole and of the individual directors and reports thereon to the full board of directors.
 
Compensation Committee
 
Our board of directors is required to establish and maintain a compensation committee at all times. The compensation committee is required to consist of only directors who are independent directors. Currently, the compensation committee shall be required to set the salary of our chief financial officer.


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Code of Business Conduct and Ethics
 
We have adopted a corporate code of business conduct and ethics relating to the conduct of our business by our employees, officers and directors. We intend to maintain the highest standards of ethical business practices and compliance with all laws and regulations applicable to our business.
 
Director Compensation
 
Each independent director will receive an annual fee of $50,000. The chairman of the board of directors and the co-chairmen of the audit committee will receive an additional $25,000 annually. Each independent director will also receive $1,000 for each board of directors or committee meeting attended, whether in person or telephonically, plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each board of directors or committee meeting. Independent directors each additionally receive an annual grant of 4,000 restricted shares.
 
In December 2006, the independent directors each earned $1,000 plus expenses as compensation for attending one board of directors meeting.
 
Executive Compensation
 
We have not paid, and do not intend to pay, any annual cash compensation to the company’s executive officers for their services as executive officers, other than the chief financial officer. Our other executives are employees of the managers and are compensated by the managers or their affiliates. The managers’ fees are set forth in the respective management agreements.
 
During 2006, our chief financial officer Ms. Conjeevaram, who was appointed to her position in September 2006, received salary of $83,333 and bonus of $150,000, totaling $233,333, pursuant to her compensation arrangements set forth in her employment agreement described in “— Employment Agreements.”
 
Compensation Discussion and Analysis
 
We have not paid, and do not intend to pay, any compensation to the company’s executive officers for their services as executive officers, other than the chief financial officer. Our other executives are employees of the managers and are compensated by the managers or their affiliates. The managers’ fees are set forth in the management agreements, which were entered into in connection with our formation. We do not have any influence over the compensation our managers’ pay to our executive officers.
 
Our chief financial officer is paid pursuant to an employment agreement entered into prior to our formation as a private company. Her compensation was set through negotiation that took into account her past experience, the compensation of similarly senior financial company officers and the start-up nature of our business. The policies and principles upon which our chief financial officer’s compensation will be set in future periods not covered by her employment agreement will be established by our compensation committee following its formation.
 
Equity Incentive Plan
 
We do not have in place an equity incentive plan. As a result of the offering, each of BSAM and Stone Tower will be entitled to receive share grants representing 2.5% (or together an aggregate of 5.0%) of our ordinary shares outstanding after giving effect to the issuance of shares in our initial public offering.
 
Employment Agreements
 
The CEOs and directors of the company have not entered into any employment agreements with us and are not entitled to any benefits upon the termination of their respective offices.
 
We have entered into an employment agreement with Ms. Conjeevaram, pursuant to which she will be given the title of Chief Financial Officer of the company and will receive an initial annual salary of $250,000


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(subject to proration in the event her employment is terminated prior to September 2007). She is also eligible to receive an annual bonus based on the success of the company and her contribution thereto as determined by the CEOs. Ms. Conjeevaram’s bonus for the year ended August 31, 2007 will be $350,000 so long as she is an employee in good standing on the date on which the bonus is paid in September 2007 (subject to proration in the event her employment is terminated prior to September 2007 other than for cause). Contingent on the closing of this offering, Ms. Conjeevaram will be granted restricted shares in an amount equal to 0.25% of the fully diluted equity of the company at the closing of the offering. Such restricted shares will be subject to a plan approved by our board of directors that is expected to provide that one-third of such stock will vest on each of the first three anniversaries of the grant thereof, provided that she is employed by the company on the vesting dates. Ms. Conjeevaram will also be eligible to participate in any employee benefit plans, policies or programs established by the company for similarly situated employees. She has agreed to adhere to the terms of the company’s employee policy manual, code of ethics or other policies that may be adopted by the company. Except as provided above, her employment by the company is at will.
 
Indemnification and Limitations on Liability
 
Our Memorandum and Articles of Association
 
Cayman Islands law does not limit the extent to which a company’s articles of association may provide for the indemnification of officers and directors, except to the extent that any such provision may be held by Cayman Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. The company’s memorandum and articles of association permit us to indemnify officers and directors for losses, damages, costs and expenses incurred in their capacities as such, other than in relation to acts or failure to act which are finally adjudicated to have been grossly negligent or fraudulent or which resulted from willful misconduct or criminal misconduct. If the director or officer is found liable by the court, we may indemnify him or her only if the court determines that the director or officer is fairly and reasonably entitled to indemnity.
 
Insofar as indemnification for liabilities arising under the U.S. Securities Act may be permitted to directors, officers or persons controlling the registrant pursuant to the foregoing provisions, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the U.S. Securities Act and is therefore unenforceable as a matter of U.S. law.
 
Insurance
 
We currently maintain an insurance policy under which our directors and officers are 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 the policy in their respective capacities as directors or officers of the company, including certain liabilities under securities laws.
 
Compliance with Cayman Islands Corporate Governance Requirements
 
We comply in all material respects with the corporate governance requirements that are applicable to the company under Cayman Islands law.
 
Our chief financial officer is paid pursuant to an employment agreement entered into prior to our formation as a private company.


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Managers’ Personnel and Track Record
 
BSAM’s Personnel
 
The following table summarizes the organizational structure of the BSAM team as of December 31, 2006.
 
(GRAPH)
 
We will use the resources of BSAM. Certain information regarding some of BSAM’s professionals who will be most directly involved with managing Everquest is set forth below.
 
Ralph R. Cioffi.  Mr. Cioffi is senior managing director at BSAM. See “— Directors and Executive Officers” for more biographical information.
 
Matthew Tannin.  Mr. Tannin is the chief operating officer of the BSHG Funds and a senior managing director at BSAM. Mr. Tannin has been with Bear Stearns since 1994. In 2003 he and Mr. Cioffi started the Bear Stearns High-Grade Structured Credit Strategies Fund. Prior to this, he spent seven years on the


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collateralized debt obligation structuring desk focusing on emerging markets, high-grade and market value transactions. From June 2001 through February 2003 he followed the CDO market as a Bear Stearns CDO research analyst in the asset-backed research group. Mr. Tannin has a J.D. from the University of San Francisco, was a law clerk on the California Court of Appeal and a Preston Warren scholar in philosophy at Bucknell University. He is a registered investment advisor.
 
Raymond McGarrigal.  Mr. McGarrigal is a senior managing director and senior portfolio manager at BSAM. Mr. McGarrigal started his Wall Street career with Bear Stearns in 1991 in the Financial Analytics and Structured Transactions (F. A.S.T.) group as an analyst. He moved to UBS in 1993 and worked as a CMO structurer and CMO floater trader until 1995. Following his time at UBS, Mr. McGarrigal was a member of the New York Mercantile Exchange, where he traded options on energy futures as a local. He returned to Bear Stearns in 1997 and has structured a wide variety of fixed-income structured products in the F. A.S.T. group. His product specialties include all types of CDOs, RMBS and structured credit derivatives. He brings to BSAM an in-depth understanding of structure, risk, the ratings process and relative value analysis across a wide range of fixed-income structured credit products. Mr. McGarrigal holds an M.B.A. in Finance from New York University and a B.S. in Mathematics and Business Economics from the State University College at Oneonta.
 
James Crystal.  Mr. Crystal is a senior managing director and senior portfolio manager at BSAM with 18 years of derivatives, investment banking and portfolio management experience. From 2004 to 2005 Mr. Crystal was a managing director at Silverback Asset Management, a hedge fund specializing in convertible arbitrage and structured credit investments. Prior to joining Silverback, he was a senior managing director at Bear Stearns, in the investment banking department and in the asset-backed investments department. Before joining Bear Stearns in 1997, Mr. Crystal worked for nine years at predecessor companies to UBS Investment Bank (S.G. Warburg Securities, S.G. Warburg & Co. and SBC Warburg), in Tokyo, London and New York. Mr. Crystal holds a B.A., magna cum laude, from Yale University and an A.M. in Regional Studies — East Asia from Harvard University.
 
Stuart Rothenberg.  Mr. Rothenberg is a managing director, portfolio management and surveillance at BSAM. Mr. Rothenberg joined BSAM in November of 2005. He is currently responsible for structuring, analysis and surveillance of CDOs issued by BSAM as well as the CDO investments of the BSHG Funds. Prior to joining BSAM, he spent six years at S&P, where he was a director in the CDO group. Prior to S&P, he was the product manager of structured finance trust services at IBJ Schroder. Mr. Rothenberg holds an M.B.A. in Finance & Investments from Baruch College and B.S. degree in Business Administration from the State University of New York at Oswego.
 
Andrew Lipton.  Mr. Lipton is a managing director, portfolio management and surveillance at BSAM. Prior to joining BSAM, Mr. Lipton was vice president and senior credit officer in the structured finance group at Moody’s Investors Service. Mr. Lipton analyzed and wrote about many asset-backed and mortgage-backed securitizations at Moody’s, involving numerous asset classes. His background in mortgage-related assets includes the prime and subprime sectors, Alt-A mortgages, home equity, HELOCs, high LTV, seasoned mortgages, tax liens and timeshares. Mr. Lipton was as an attorney with the Department of Housing Preservation and Development of the City of New York before going to Moody’s. Mr. Lipton obtained his J.D. from Hofstra Law School and his B.A. from Queens College.
 
Steven Van Solkema.  Mr. Van Solkema is a managing director, portfolio management and surveillance, at BSAM. Mr. Van Solkema has worked for BSAM since 2003. He is currently responsible for structuring, analysis and surveillance of CDOs issued by BSAM as well as the CDO investments of the Bear Stearns High-Grade Structured Credit Strategies Funds. Prior to that, he spent five years at Goldman Sachs as a performance and risk analyst, specializing in attribution analysis of leveraged fixed income accounts. He holds an M.B.A. in Finance from New York University, and a B.B.A. in Finance and Investments from Baruch College, where he was Solon E. Summerfield Scholar. Mr. Van Solkema is a CFA charterholder.
 
Dhruv Mohindra.  Mr. Mohindra is an associate director, portfolio management and surveillance, at BSAM. Mr. Mohindra joined BSAM in 2005 as research analyst responsible for the analysis and trading of residential and commercial mortgage-backed securities. Prior to joining BSAM, Mr. Mohindra worked at


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Moody’s Investors Service as a residential mortgage-backed analyst and prior to that worked in structured product sales at Deutsche Bank in London. Prior to attending business school Mr. Mohindra worked at Goldman, Sachs & Co., initially in a risk management capacity and subsequently in equity sales. Mr. Mohindra holds an M.B.A. in Finance from New York University and undergraduate degrees in Economics as well as Business Administration from Boston University, which he attended on a full academic scholarship. In addition, he is a CFA charterholder and a Licensed Real Estate Broker.
 
Jamie Karper.  Mr Karper is an associate director, portfolio management and surveillance, at BSAM. Mr. Karper has been with Bear Stearns since 2001. He is presently an analyst focusing on sub-prime and residential mortgage-backed securities. Prior to joining BSAM, he was a trader on the Institutional Futures Agency Desk covering financial and energy products for Asia/Pacific hours. Mr. Karper received his B.A. in History from Hobart and William Smith College in 1998.
 
BSAM’s Track Record
 
Founded in 1923, The Bear Stearns Companies Inc. (NYSE: BSC) is a holding company that, through its broker-dealer and international bank subsidiaries, principally Bear, Stearns & Co. Inc., Bear, Stearns Securities Corp., or BSSC, Bear, Stearns International Limited and Bear Stearns Bank plc, is a leading investment banking, securities and derivatives trading, clearance and brokerage firm serving corporations, governments, institutional and individual investors worldwide. Through BSSC, it offers financing, securities lending, clearing and technology solutions. Headquartered in New York City, the company has approximately 13,000 employees worldwide.
 
BSAM is the asset management subsidiary of The Bear Stearns Companies Inc. BSAM was incorporated in the State of New York on March 15, 1985. BSAM is a registered investment advisor with the SEC, and provides investment management services to corporations, trusts, employee benefit plans, public authorities, foundations, endowments, religious organizations, high net worth individuals, mutual funds, private investment funds, venture capital funds and issuers of collateralized bond and loan obligations and other structured securities products. BSAM offers investment expertise across a wide spectrum of investment strategies, including: hedge funds; private equity; large, small and mid-cap domestic equities; corporate, government, municipal and high-yield bonds; balanced portfolio management; mortgage-backed and mortgage derivative securities; and systematic equity and collateralized loan accounts. BearMeasurisk, an affiliate of BSAM, provides performance and risk analysis for institutional clients.
 
BSAM employed approximately 409 individuals at December 31, 2006, of which approximately 150 were classified as investment professionals and 259 as administrative personnel. The investment professionals total is comprised of approximately 42 portfolio managers, 53 research analysts and 55 other professionals — a category that includes traders, hedge fund administrators and private equity professionals. The majority of BSAM’s business, including portfolio management, research, administration and operations, is conducted at Bear Stearns’ world headquarters in New York City, although BSAM also has an investment management presence in San Francisco. The Marketing and Client Service Group is headquartered in the New York City office, but is represented through branch offices in Chicago and San Francisco. Internationally, the firm is represented through offices in London and Tokyo.


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When considering the track record information contained below, you should take note of the fact that the historical track record information may not be representative of the performance of CDOs currently held by us or CDOs we hold in the future, including for the reasons described in “Risk Factors — Risks Relating to Our Business — BSAM’s and Stone Tower’s track record information may not be indicative of their or our future performance.”
 
The following table sets forth certain information as of December 31, 2006, for the seven CDOs, excluding Parapet CDO, managed by the BSAM Team and all or a portion of the equity of which BSAM retained for funds it manages.
 
Managed Deals (Excluding Parapet CDO)
 
                                                                       
                                  Annualized
 
                      Original
    Cumulative
    Cash Return(5) (%)  
Closing
        Total
    Total
    Investment
    Distributions
    Adjusted
             
Date
  Entity Name     Capitalization(1)     Equity(2)     in Equity(3)     Made(4)     Gross     Gross     Net  
          ($ in millions)     ($ in millions)     ($ in millions)     ($ in millions)                    
 
04/2004
    Klio Funding, Ltd.       2,423.24       38.40 (6)     38.40       13.3677       20 .8       15 .7       12 .2  
10/2004
    Klio II Funding, Ltd.**       5,048.75       86.25 (7)     86.25       23.0215       22 .5       17 .5       13 .9  
12/2004
    Kirkwood CDO, Ltd. 2004-1       550.80       9.25       9.25       4.8913       30 .4       30 .4       30 .4  
12/2004
    Stone Tower CDO Ltd.*       306.00       33.00       8.25       2.0233       20 .1       16 .9       13 .9  
04/2005
    High Grade Structured Credit CDO, Ltd. 2005-1       811.90       19.25       14.25       1.6610       13 .5       13 .5       7 .3  
10/2005
    Stone Tower CDO II Ltd.**       307.50       22.50       14.85       1.7796       22 .4       19 .2       12 .1  
11/2005
    Klio III Funding, Ltd.**       4,030.00       60.00       60.00       4.3832       14 .9       12 .4       8 .1  
                                                                       
    Weighted Average     19 .9 %     16 .2 %     12 .3 %
                                   
 
 
(1) Total initial face or notional amount of all debt and equity securities issued.
 
(2) Total initial face or notional amount of equity securities issued.
 
(3) Total notional investment in equity securities acquired by BSAM managed funds.
 
(4) Cumulative actual cash distributed to the BSAM managed funds in respect of equity securities held by them.
 
(5) Annualized cash return is calculated as the cumulative cash distributions paid through the last distribution date as a percentage of the total purchase price of the equity investment amount divided by the number of years from the closing date, assuming a 365-day year. Adjusted gross returns reflect annualized cash returns, including (i) any collateral management fees paid to BSAM which may include a proportionate share of fees on equity held by third parties; and (ii) certain cash flows which would, in transactions of this kind, typically be paid to the equityholders, but where the priority of payments of each transaction indicated above diverts either to (a) amortize the highest-cost debt in the transaction; or (b) purchase additional collateral. It has been the practice of the BSAM Team to structure the priority of payments in this way in each transaction managed by it. Gross returns reflect annualized cash returns including (i) and excluding (ii) above. Net returns reflect annualized cash returns excluding (i) and (ii) above. Due to the timing of cash payments received by CDO equity holders and other factors, the annualized cash returns on outstanding CDOs to date may not be reflective of the final annualized cash returns ultimately received. See “Risk Factors — Risks Related to Our Business — BSAM’s and Stone Tower’s track record information may not be indicative of their or our future performance.” The annualized cash return is as of the latest payment date in 2006.
 
(6) Total notional amount of equity of Klio Funding, Ltd. was restructured from $57,440,000 to $38,440,000 as of July 21, 2005.
 
(7) Total notional amount of equity of Klio II Funding, Ltd. was restructured from $34,500,000 to $86,250,000 as of April 1, 2005.
 
* In both Everquest and Parapet CDO portfolios.
 
** In Parapet CDO portfolio.


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The following table sets forth certain information as of December 31, 2006, for the 18 CDO equity tranches managed by third parties that were purchased by the BSAM Team for funds it manages.
 
Non-Managed Deals
 
                                           
                Original
    Cumulative
    Annualized
 
Closing
              Investment
    Distributions
    Cash Return(3)
 
Date
    Entity Name   Manager     in Equity(1)     Made(2)     (%)  
                ($ in millions)     ($ in millions)        
 
  03/2002     North Street Referenced Linked Notes 2002-4     UBS Principal Investment Group       11.00       1.1000       34 .7  
  01/2005     Neptune CDO 2004-1 Ltd. **     Fund America Management Corporation       2.50       0.6588       15 .6  
  03/2005     North Street Referenced Linked Notes 2005-7**     UBS Principal Investment Group       9.50       3.4273       23 .9  
  05/2005     Athos Funding, Ltd 2005-1     Terwin Money Management LLC       10.35       2.4051       17 .4  
  06/2005     Independence VI CDO, Ltd.     Declaration Management & Research LLC       13.00       2.8317       20 .4  
  07/2005     North Cove CDO, Ltd. 2005-1**     250 Capital LLC       16.70       5.099       25 .4  
  07/2005     North Street Referenced Linked Notes 2005-9 G**     UBS Principal Investment Group       35.00       10.3424       25 .7  
  07/2005     North Street Referenced Linked Notes 2005-9 H**     UBS Principal Investment Group       8.00       3.0286       43 .2  
  09/2005     Endeavor Funding, Ltd. 2005-1 S1**     Silvermine Capital Management       21.30       4.0357       18 .5  
  11/2005     Duke Funding IX CDO, Ltd.**     Duke Funding Management LLC       9.10       1.8126       22 .2  
  11/2005     Symphony CLO, Ltd. 2005-1**     Symphony Asset Management LLC       9.00       1.8353       24 .4  
  01/2006     Static Residential CDO 2005-C Ltd.**     None       10.00       2.2527       35 .6  
  02/2006     Montauk Point CDO, Ltd 2006-1*     Fortis Investment Management USA, Inc.        9.80       0.6704       15 .7  
  05/2006     Class V Funding II, Ltd. 2006-1*     Credit Suisse Alternative Capital, Inc.        12.00       1.1895       22 .4  
  05/2006     Mt. Wilson CLO, Ltd. 2006-1A**     Western Asset Management Company       23.50       ***       ***        
  05/2006     Vertical CRE CDO 2006-1, Ltd*     Vertical Capital LLC       12.30       0.7565       16 .5  
  07/2006     Aimco CLO 2006-AA     Allstate Investment Management Company       3.00       0.0974       11 .1  
  07/2006     Cherry Creek CDO, Ltd. 2006-1*     Surge Capital Management       14.00       1.1740       33 .5  
                                           
        Weighted Average(4)     24 .5 %
                   
 
 
(1) Total investment in equity securities by BSAM managed funds.
 
(2) Cumulative actual cash distributed to the BSAM managed funds in respect of equity securities held by them.
 
(3) Annualized cash return is calculated as the cumulative cash distributions (including any fee rebates) paid through the last distribution date as a percentage of the total equity amount divided by the number of years from the closing date of the acquisition of the securities, assuming a 365-day year. For outstanding CDOs, the annualized cash returns to date may not be reflective of the final annualized cash returns ultimately received. The annualized cash return is as of the last payment date in 2006.
 
(4) Includes only those CDOs that have made at least one quarterly distribution prior to December 31, 2006.
 
* In Everquest portfolio.
 
** In Parapet CDO portfolio.
 
*** As of December 31, 2006, no cash had been distributed to the CDO equity holders.


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Stone Tower’s Personnel
 
The following table summarizes the organizational structure of the Stone Tower team as of March 31, 2007.
 
(FLOWCHART)
 
We will use the resources of Stone Tower. Certain information regarding some of Stone Tower’s key professionals who will be most directly involved with managing Everquest is set forth below:
 
Michael J. Levitt.  Mr. Levitt is the chairman and chief investment officer of Stone Tower. See ‘‘— Directors and Executive Officers” for more biographical information.
 
W. Anthony Edson.  Mr. Edson is a senior managing director and chief strategy officer of Stone Tower. Mr. Edson was one of the original founders of STC in 2001. He is primarily responsible for the implementation of the firm’s strategic initiatives. In addition, he co-chairs and oversees daily credit and investment committee reviews. Previously, Mr. Edson was an executive with Hicks, Muse, Tate & Furst Incorporated in the firm’s New York and London offices. Prior thereto, Mr. Edson worked in the Merger, Acquisition and Restructuring Department of Morgan Stanley & Co. Mr. Edson holds a B.A. in Business Administration with a concentration in Finance from Morehouse College.
 
William J. Sheoris.  Mr. Sheoris is a senior managing director and chief financial officer of Stone Tower. Mr. Sheoris was one of the original founders of STC in 2001. He is responsible for all administrative, compliance and reporting activities of STC, as well as advising on the investment activities of the firm. Previously, Mr. Sheoris was a general partner of a venture capital fund and a venture capital fund-of-funds. Prior thereto, Mr. Sheoris was the Manager of Finance for Barnes & Noble, Inc., where he participated in all aspects of financial and treasury management. Prior to joining Barnes & Noble, Mr. Sheoris worked for Smith Barney Inc. in the Equity Capital Markets Group. Mr. Sheoris holds a B.S. in Business Administration with majors in Finance and Management Information Systems from the University of Arizona.
 
Gregory M. Stover.  Mr. Stover is a senior portfolio manager at Stone Tower. Mr. Stover is responsible for analyzing, monitoring and overseeing STC’s investment activities and portfolios in corporate credit. In addition, he co-chairs and oversees daily credit and investment committee reviews. Mr. Stover has twenty-two


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years of experience in various aspects of corporate finance and credit analysis. Previously, he was with Tyco Capital and its predecessor companies including The CIT Group, Inc. Mr. Stover was a founding member of Tyco Capital’s Merchant Banking and CIT’s Private Equity Sponsor Groups. Prior thereto, Mr. Stover spent over ten years with Chase Manhattan Bank’s corporate finance group. Mr. Stover holds a B.A. in Psychology and a B.B.A. in Finance from Southern Methodist University and an M.B.A. in Finance from the Wharton School of the University of Pennsylvania.
 
James E. Galowski.  Mr. Galowski is a senior portfolio manager at Stone Tower. Mr. Galowski is responsible for overseeing STC’s investment activities in asset-backed securities. He has over twenty-five years experience in the financial services industry. Previously, Mr. Galowski was with WestLB in New York, London and Singapore. In Singapore, he was responsible for the bank’s Financial Markets activities in the APAC region with trading rooms in Hong Kong, Singapore, Tokyo, Sydney and Shanghai. He was a Managing Director and served on the Board and Executive Committee of WestLB Asset Management (U.S.) LLC, which ultimately became Brightwater Capital Management. While in London, Mr. Galowski focused on the reorganization of the bank’s European treasury operations and served as the acting Group Treasurer of the Thomas Cook Group. While with WestLB in New York, Mr. Galowski was responsible for the ABS portfolio management business. Prior to WestLB, Mr. Galowski was with the Canadian Imperial Bank of Commerce. Mr. Galowski holds a B.S. in Finance from St. John’s University and an M.B.A. from Fordham University’s School of Business.
 
Alexander T.D. Clarke.  Mr. Clarke is a portfolio manager at Stone Tower. Mr. Clarke is responsible for analyzing, monitoring and overseeing STC’s investment positions in the healthcare, printing and publishing sectors. Mr. Clarke has over twenty years of experience in various aspects of asset management, credit analysis and distressed debt management. Previously, he was a founding member and Portfolio Manager of Citadel Hill Advisors LLC, a credit-based asset management firm formed by Scotiabank. Prior thereto, Mr. Clarke spent eight years in Scotiabank’s Global Risk Management division where he was a Managing Director in the Loan Workout Group. Prior to joining Global Risk Management, Mr. Clarke worked in Scotiabank’s Corporate Banking division. Mr. Clarke holds a B.A. in Economics and an M.B.A. with concentrations in Finance and Marketing from Queen’s University of Kingston, Ontario.
 
Andy Y. Wong.  Mr. Wong is an analyst at Stone Tower. He is responsible for analyzing, monitoring and overseeing STC’s investment positions in the chemical, industrial and packaging sectors. Previously, Mr. Wong was with GE Capital Corporation, where he was responsible for the identification, evaluation and execution of distressed debt investments. Prior thereto, he worked in private equity investing at Schroder Ventures. Mr. Wong holds a B.S. with a concentration in Finance from the Wharton School of the University of Pennsylvania and an M.B.A. with concentrations in Finance and Management & Strategy from the Kellogg School of Management at Northwestern University.
 
David Saitowitz.  Mr. Saitowitz is an analyst at Stone Tower. He is responsible for analyzing and monitoring STC’s investment positions in the cable, communications and business services sectors. Previously, Mr. Saitowitz was with JPMorgan Chase & Co., where he was responsible for analyzing and evaluating the bank’s corporate loan portfolio. Prior thereto, he was in the Syndicated and Leveraged Finance group where he structured various financing transactions. Mr. Saitowitz holds a B.S. in Finance from the University of Colorado at Boulder.


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Stone Tower’s Track Record
 
Stone Tower is an affiliate of Stone Tower Capital LLC, which was founded in 2001 as an alternative investment firm focused on credit and credit-related assets. Through its affiliates, Stone Tower managed approximately $7.7 billion in leveraged finance-related assets across several structured fund vehicles and a limited partnership, as of December 31, 2006. Stone Tower was established to provide a variety of asset management and investment advisory services. Stone Tower’s general investment approach stresses investments in credit-intensive leveraged finance investments with objectives of achieving a superior return on invested capital while preserving principal. Under this investment approach, Stone Tower focuses on investments in companies with stable or improving credit profiles and selects investments according to their assessed ability to withstand and adapt to then current business cycles. As of December 31, 2006 the Stone Tower team had 37 employees, which included 19 investment professionals. Stone Tower’s objective is to generate stable and consistent returns for its investors, which include domestic and international banking institutions, insurance companies, institutional money management firms, family offices and high net worth individuals.
 
When considering the track record information provided below, you should take note of the fact that the historical track record information may not be representative of the performance of CDOs currently held by us or CDOs we will hold in the future, including for the reasons described in “Risk Factors — Risks Relating to Our Business — BSAM’s and Stone Tower’s track record information may not be indicative of their or our future performance.”
 
The following table identifies the performance of the nine CDOs sponsored by Stone Tower that closed and that have made at least one distribution as of December 31, 2006.
 
Stone Tower’s Track Record
                                                 
                      Cumulative
             
          Total
          Distributions
    Annualized Cash Return(4)
 
          Capitalization(1)
    Total Equity(2)
    Made(3)
    (%)  
Closing Date
    Entity Name   ($ in millions)     ($ in millions)     ($ in millions)     Gross     Net  
 
  7/2003     Stone Tower CLO Ltd.(5)     325.50       15.13       23.6912       37.2 (6)     27.1 (6)
  8/2004     Stone Tower CLO II Ltd.      300.00       22.00       10.0919       24.6       21.2  
  12/2004     Stone Tower CDO Ltd. (CDO of CLOs)(7)*     306.00       33.00       8.0930       15.9       13.2  
  4/2005     Granite Ventures I Ltd.      360.40       28.90       9.4986       23.6       20.6  
  5/2005     Stone Tower CLO III Ltd.      700.00       56.25       10.9944       17.6       12.9  
  10/2005     Stone Tower CDO II Ltd. (CDO of CLOs)(7)**     307.50       22.50       2.6964       17.0       10.9  
  12/2005     Granite Ventures II Ltd.      361.00       32.00       4.8626       20.8       18.1  
  3/2006     Stone Tower CLO IV Ltd.***     750.00       60.00       2.0300       11.0       5.8  
  5/2006     Granite Ventures III Ltd.     412.00       37.00       2.1503       16.2       13.5  
                                                 
        Weighted Average     18.3 %     14.0 %
                         
 
 
(1) Total initial face or notional amount of all debt and equity securities issued.
(2) Total initial face or notional amount on all equity securities issued.
(3) Cumulative actual cash distributed to holders of equity securities since issuance.
(4) Annualized cash return is calculated as the cumulative cash distributions paid through the last distribution date as a percentage of the total notional equity amount divided by the number of years from the closing date, assuming a 365-day year. Gross returns reflect annualized cash returns before deducting fees paid to the manager. Net returns reflect annualized cash returns net of fees paid to the manager. Due to the timing of cash payments received by CDO equity holders and other factors, the annualized cash returns on outstanding CDOs to date may not be reflective of the final annualized cash returns ultimately received. See “Risk Factors — Risks Relating to Our Business — BSAM’s and Stone Tower’s track record information may not be indicative of their or our future performance.”
(5) Due to the optional redemption exercised by preferred shareholders in August 2005, the annualized cash returns reflect the final annualized cash returns received.
(6) Accrued and unpaid interest as of redemption date assumed received on the August 2005 redemption date. Cash return excludes repayment of initial equity.
(7) The gross annualized cash returns to Stone Tower CDO Ltd. and Stone Tower CDO II Ltd., including certain cash flows which would, in transactions of this kind, typically be paid to equityholders, but which the priority of payments of each transaction indicated above diverts to amortize the highest-cost debt in the transaction, were 18.7% and 19.6%, respectively.
* Portion of equity securities in each of Everquest’s and Parapet CDO’s portfolio.
** Portion of equity securities in Parapet CDO portfolio.
*** Portion of equity securities in Everquest portfolio.


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CONFLICTS OF INTEREST
 
Conflicts with BSAM and Stone Tower
 
We are subject to conflicts of interest relating to BSAM and its affiliates, including Bear, Stearns & Co. Inc., which is one of the underwriters of this offering, and Stone Tower and its affiliates, including, among others, the following:
 
  •  Each of our CEOs also serves as an executive officer of BSAM or Stone Tower. As a result of these relationships, these persons have a conflict of interest with respect to our agreements and arrangements with our managers, which were not negotiated at arm’s length, and the terms of which may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
 
  •  Substantially all of our initial CDO holdings were contributed by the BSHG Funds, which are managed by BSAM. Thus, the consideration given by us in exchange for these assets was not negotiated at arm’s length and may exceed the values that could be achieved upon the sale or other disposition of these assets to third parties. In addition, the performance of the CDO holdings retained by the BSHG Funds may differ from the performance of those initially contributed to us.
 
  •  BSAM, Stone Tower and/or their affiliates currently advise, sponsor or act as manager to other business ventures or clients that have investment objectives that overlap with our business plan and strategies and therefore compete with us for asset acquisition, investment and other opportunities and may create additional vehicles in the future that compete for such opportunities. We will therefore face conflicts of interest with the managers and/or their affiliates with respect to the allocation of asset acquisition, investment and other opportunities.
 
  •  We may purchase assets from, finance the assets of or make co-purchases alongside BSAM or Stone Tower, their affiliates and/or business ventures or clients that they manage, including assets of CDOs structured by BSAM or Stone Tower. These transactions will not be the result of arm’s length negotiations and will involve conflicts between our interests and the interests of BSAM or Stone