Beth A. Di Santo, Partner at Di Santo LLP and REIT Lawyer, Moderator of "Specialty Finance REITs" at the Global REIT Symposium.

1. Di Santo LLP www.reitlawyer.com Global REIT Symposium Specialty Finance REITs BY: Beth A. Di Santo, Esq. Di Santo LLP

2. Di Santo LLP www.reitlawyer.com Mortgage REITs Characteristics: No Direct Property Portfolio: Unlike equity REITs that own and operate portfolios of real estate, mortgage REITs originate mortgage loans and invest in mortgage-backed securities. Yield Spread: Derives income from the spread between the yield on their mortgage-backed securities (MBS) and their cost of funding. Yield spread: Borrow in the short-term and lend on the long-term Wide spreads = more money Small spreads (or negative spreads) = big problems REIT Structure = No Retained Earnings Given the requirement that mortgage REITs are obligated to pay out 90% percent of their taxable income in dividends means that growing the operations of a mortgage REIT is largely predicated on ongoing access to fresh capital in the equity markets or borrowed money. Although some argue this exacerbated the impact of sub-prime meltdown, it is likely that retained cash would just have meant more borrowing by the REIT. Historic Perspective: Result: High dividends and increases in stock prices 2001 – 2004 2001: Short term rates were low and long term rates were high 2004: 12 residential mortgage REITs raised as much as $2.6 billion through follow-on public equity offerings in 2004. 2005: Federal Reserve began to increase short term rates flattening yield curve 2006: Yield curve inverted (i.e., short term rates were higher than long term rates) 2007: Yield spread remains very thin

3. Di Santo LLP www.reitlawyer.com Mortgage REITS Impact of Market Fundamentals Decline of the Index Fund iShares FTSE NAREIT Mortgage REITs Index Fund (REM): Started trading around $50 on May 4, 2007. 20/20 Hind-Sight Missed Opportunity: Mortgage REITs’ stock were trading at highs over the past few years, which was an opportunity to reduce bank credit by issuing unsecured corporate bonds. Exposure to Housing Market Slump Slowdown in housing market resulted in lower origination volume Sub-Prime Meltdown Correlation Overly aggressive lending practices led to questionable loans, which were pooled and sold as bonds to investors in the capital markets. Margin Calls: Mortgage REITs borrowed money based on the value of their loan portfolio. The value of the loans declined as borrowers defaulted on the loans. As a result, banks called for mortgage REITs to put up more money. Short-Term vs. Long-Term Rates Thin Yield Curve = continuing issue as Federal Reserve continues to lower short term rates

4. Di Santo LLP www.reitlawyer.com Mortgage REITs Prospects Short-Term Wall Street will not support premium pricing for private mortgage securities, which will continue to reduce capital to Mortgage REITs Margin calls: Need to find cash to fund margin calls Case studies Mortgage REITs with aggressive lending and investment strategies will fare the worst New Century * American Home Sell off mortgage portfolios at a loss to increase liquidity Thornburg Mortgage Long Term Role of Private Equity and Hedge Funds Private equity and hedge funds can provide cash for short-term financing needs. Luminent Mortgage Capital, Inc. and Hanover Disadvantages: Significant dilution to existing shareholders Abandon Ship…Does the REIT structure make sense? No interest from equity markets + payout of earnings = limited access to capital Strategic mergers with financial institutions = lower cost of funds and access to fresh capital Aames Investment Corporation merger with Accredited Home Lenders MortgageIT merger with Deutsche Bank

5. Di Santo LLP www.reitlawyer.com Specialty Finance REITs Distinguished from Mortgage REITS Diverse Lending Practices: Specialty Finance REITs (or SFR) do not exclusively lend money out for residential home purchases. Like Business Development Companies (BDCs), SFRs can also invest up to 25% of their capital in direct private lending deals. Private Equity Market: SFRs can participate in the private equity market with higher lending rates and equity kickers for future capital gains. Professional Management of Investment Portfolios: SFRs are able to adjust their portfolios rapidly to react to rising or declining interest rates. SFRs contain the necessary flexibility to position their funds that benefit best from the prevailing trends in interest rates through the use of leverage and derivatives. Actively Traded Portfolios: SFRs generally build actively traded portfolios of structured notes backed by real estate assets (i.e., loan portfolios). SFRs invest in notes that are investment grade as rated by Standard & Poors or Moody's Investment Service.

6. Di Santo LLP www.reitlawyer.com Specialty Finance REITs Impact of Credit Crisis Capital Markets: Valuation of mortgage-backed securities declined with market uncertainty and widening of credit spreads CDO issuances steeply declined thereby reducing funds available to lend Lenders: Cost of the secured borrowings used to operate SFR’s business increased as availability of credit is reduced Margin reductions on borrowings = reduction of liquidity unencumbered assets and cash used as additional collateral less leverage available and at a higher cost = reduced earnings growth

7. Di Santo LLP www.reitlawyer.com Specialty Finance REITs Portfolio Strategies Procure additional funding sources Private Equity, hedge funds, credit facilities, leverage unencumbered assets Commercial Real Estate (CRE): Market outlook in commercial real estate remains high. Focus the investment portfolio on CRE opportunities. Invest in CMBS at wider yield spreads Yield spreads tied to 10-year Treasuries have widened as a result of the sub-prime fallout. Revisit RMBS sector if attractive yield spreads exist Continue judicious use of CDO issuances to secure term financing Pursue opportunistic investments from over-levered competitors