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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 19992000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________________________ TO ___________________________
COMMISSION FILE NUMBER: 1-13759
REDWOOD TRUST, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 68-0329422
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
591 REDWOOD HIGHWAY, SUITE 3100
MILL VALLEY, CALIFORNIA 94941
(Address of principal executive offices) (Zip Code)
(415) 389-7373
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Name of Exchange on Which Registered:
CLASS B 9.74%9.74 % CUMULATIVE CONVERTIBLE PREFERRED STOCK, NEW YORK STOCK EXCHANGE
PAR VALUE $0.01 PER SHARE
(Title of Class)
COMMON STOCK, PAR VALUE $0.01 PER SHARE NEW YORK STOCK EXCHANGE
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At March 15, 200027, 2001 the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $114,259,261.$180,480,853.
The number of shares of the Registrant's Common Stock outstanding on March 15,
200027,
2001 was 8,789,376.8,868,838.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement issued in connection
with the 20002001 Annual Meeting of Stockholders are incorporated by reference into
Part III.
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REDWOOD TRUST, INC.
19992000 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
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PART I
Item 1. BUSINESS.........................................................BUSINESS ..................................................... 3
Item 2. PROPERTIES....................................................... 26PROPERTIES ................................................... 25
Item 3. LEGAL PROCEEDINGS................................................ 26PROCEEDINGS ............................................ 25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 26HOLDERS .......... 25
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.................................. 27MATTERS .............................. 26
Item 6. SELECTED FINANCIAL DATA.......................................... 28DATA ...................................... 27
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................... 29OPERATIONS ................ 28
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......... 47DATA ..... 55
Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE........................... 47DISCLOSURE ....................... 55
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............... 47REGISTRANT ........... 55
Item 11. EXECUTIVE COMPENSATION........................................... 47COMPENSATION ....................................... 55
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT............................................ 47MANAGEMENT ........................................ 55
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 47TRANSACTIONS ............... 55
PART IV
Item 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS SCHEDULES AND
REPORTS ON FORM 8-K.............................................. 478-K .......................................... 55
CONSOLIDATED FINANCIAL STATEMENTS..........................................STATEMENTS ...................................... F-1
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PART I
ITEM 1. BUSINESS
REDWOOD TRUST
Redwood Trust is a finance company specializing in the mortgage portfolio
lending business. Our primary activity is the acquisition, financing, and
management of high-quality jumbo residential mortgage loans. We fund our loan
portfolio primarily through the issuance of long-term debt. We also own and
manage a portfolio of residential mortgage securities and originate commercial
mortgages for sale to other financial institutions. Our core business of
mortgage portfolio lending is conducted through Redwood Trust, which is a
qualified real estate investment trust ("REIT"). As a result, Redwood Trust does
not pay tax on net mortgage portfolio income or on dividends received from
taxable affiliates so long as Redwood Trust distributes its taxable income as
dividends and meets certain other REIT tests. See "Certain Federal Income Tax
Considerations" commencing on page 20 of this Form 10-K.
We also own a 99% economic interest in a taxable affiliate company, RWT
Holdings, Inc. ("Holdings"). Our investment in Holdings is accounted for"Safe Harbor" Statement under
the equity method. Holdings originates and sells commercial mortgage loans
through its subsidiary, Redwood Commercial Funding, Inc. ("RCF"). RCF typically
originates shorter-term floating-rate commercial mortgage loans to high-quality
borrowers who require more flexible borrowing arrangements than are usually
offered by life insurance companies or commercial mortgage conduit lending
programs.
Holdings had two other businesses, Redwood Financial Services, Inc. ("RFS") and
Redwood Residential Funding, Inc. ("RRF"). Due to a variety of start-up
difficulties with these operations, RFS was closed in the third quarter of 1999
and RRF was closed in the fourth quarter of 1999.
In accordance with the Private Securities Litigation Reform
Act of 1995, we can
obtain a "Safe Harbor" for1995: Certain matters discussed in this 2000 annual report on
Form 10-K may constitute forward-looking statements within the meaning
of the federal securities laws that inherently include certain risks and
uncertainties. Actual results and the timing of certain events could
differ materially from those projected in or contemplated by identifying thosethe
forward-looking statements due to a number of factors, including, among
other things, credit results for our mortgage assets, our cash flows and
by accompanying those statements with cautionary statements which
identifyliquidity, changes in interest rates and market values on our mortgage
assets and borrowings, changes in prepayment rates on our mortgage
assets, general economic conditions, particularly as they affect the
price of mortgage assets and the credit status of borrowers, and the
level of liquidity in the capital markets, as it affects our ability to
finance our mortgage asset portfolio, and other risk factors that couldoutlined in
this Form 10-K (see Risk Factors below). Other factors not presently
identified may also cause actual results to differ from thosediffer. We continuously
update and revise our estimates based on actual conditions experienced.
It is not practicable to publish all such revisions and, as a result, no
one should assume that results projected in or contemplated by the
forward-looking statements included herein will continue to be accurate
in the forward-looking statements. Accordingly, the following information contains or
may contain forward-looking statements: (1) information included infuture.
Throughout this Annual
Report on Form 10-K regarding investmentsand other company documents, the words
"believe", "expect", "anticipate", "intend", "aim", "will", and similar
words identify "forward-looking" statements.
REDWOOD TRUST
Redwood Trust, Inc. is a real estate finance company specializing in
owning, financing, and credit-enhancing high-quality jumbo residential
mortgage loans nationwide.
High-quality jumbo residential mortgage loans of the type that we own
and credit-enhance have a long and stable history of strong credit
results relative to other types of consumer and commercial lending.
Jumbo residential loans have loan balances that exceed the financing
limit imposed on Fannie Mae and Freddie Mac--the government-sponsored
real estate finance companies. Most of the loans that we finance have
loan balances between $275,000 and $1 million.
There are approximately $800 billion of high-quality jumbo loans in
America. At December 31, 2000, we assisted in the financing of over $24
billion of these. We are involved in the financing of one out of every
32 of the more valuable houses in the country that have a jumbo-sized
mortgage loan.
We finance high-quality jumbo residential loans in two ways.
In our residential credit-enhancement portfolio, we enable the
securitization and funding of loans in the capital markets by
committing our capital to partially credit-enhance the loans. We
do this by structuring and acquiring subordinated
credit-enhancement interests that are created at the time the
loans are securitized. After we have credit-enhanced these
loans, AAA rated mortgage backed securities interest rate agreements, leverage, interest rates,can be created and
statements in Item 7,
Management's Discussion and Analysissold into global capital markets to fund the mortgages. In
essence, we perform a type of Financial Condition and Results of
Operations, and Item 7A, Quantitative and Qualitative Disclosures about Market
Risk and (2) information included in our future filings with the Securities and
Exchange Commission including, without limitation, statementsguarantee or insurance function
with respect to growth, projected revenues, earnings, returnsthese loans.
In our residential retained loan portfolio, we acquire loans and
yieldshold them on our balance sheet to earn interest income. We
typically fund the purchase of these loans through the issuance
of long-term amortizing debt.
To create jumbo loan financing opportunities for our credit-enhancement
portfolio and our residential retained loan portfolio, we work actively
with mortgage origination companies that are selling newly originated
loans and with banks that are selling seasoned loan portfolios.
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We also finance U.S. real estate in a number of other ways, including
through our investment portfolio (mortgage-backed securities) and our
commercial loan portfolio.
In 2000, pricing levels were attractive in the jumbo loan market. We
currently expect attractive pricing to continue into 2001, as the supply
of loans and credit-enhancement opportunities is expected to increase
(as new mortgage assets,origination increases and banks increasingly seek to
sell seasoned loan portfolios). In addition, we believe that competition
to acquire or credit-enhance these loans will remain subdued.
Our credit results have been excellent. We believe that our mortgage
delinquency rates and mortgage credit losses are lower than those of the
impactresidential mortgage portfolios of interest rates, costs,Fannie Mae and business strategiesFreddie Mac and plans.of the
large jumbo residential finance companies such as Bank of America and
Washington Mutual.
We have elected, and intend to continue to elect, to be taxed as a REIT.
As a REIT, we distribute the bulk of our net earnings to stockholders as
dividends. Assuming that we retain REIT status, we will not pay most
types of corporate income taxes.
Redwood Trust, Inc. was incorporated in the State of Maryland on April
11, 1994 and commenced operations on August 19, 1994. Our principal
executive offices are located at 591 Redwood Highway, Suite 3100, Mill
Valley, CA 94941, telephone 415-389-7373.
At March 30, 2001, Redwood had outstanding 8,868,838 shares of common
stock (New York Stock Exchange, Symbol "RWT") and 902,068 shares of
Class B Cumulative Convertible Preferred Stock (New York Stock Exchange,
Symbol "RWT-PB").
For more information about Redwood, please visit www.redwoodtrust.com.
For a description of important risk factors, among others, that could
affect our actual results and could cause our actual consolidated
results to differ materially from those expressed in any forward-looking
statements made by us, see "Risk Factors" commencing on page 13Page 11 of this
Form 10-K.
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COMPANY BUSINESS AND STRATEGY
TheRedwood's objective of Redwood Trust's mortgage portfolio lending operations is to generateproduce attractive growth in earnings per
share and dividends per share for stockholders through the efficient
financing and management of high-quality jumbo residential loans.
An increasing proportion of the high-quality jumbo residential loan
market is financed through securitization in the capital markets rather
than by the deposit bases maintained by banks and thrifts. As a
non-depository finance company funded in the capital markets, Redwood is
positioned to benefit from and to promote this trend. We have been
gaining market share in this segment of the finance business at the
expense of banks and thrifts, and we expect to continue to do so.
While banks and thrifts are our competitors in one sense, for the most
part they are our customers and partners. Most banks are interested in
earning fees from mortgage origination, and also are interested in
maintaining relationships with households so that they can cross-sell
multiple financial products. As a pure mortgage finance company, we
compliment their efforts. We buy residential mortgage loans from them,
thus helping them to divest of assets that they find unattractive to
hold on their balance sheet. When they sell us loans, they continue to
originate new loans (and keep the fees) and continue to service the
loans that they have sold to us (and thus keep the household
relationships). By working together in this fashion, both Redwood and
our bank and thrift partners meet their goals.
An integral part of our objective is growth. We believe that our
earnings per share and dividends per share are likely to benefit from
growth in our equity capital base and in the amount of jumbo loans that
we finance. As we become a larger company, we believe we will benefit
from operating expense leverage (revenues will grow more quickly than
operating expenses). We also believe we will benefit from a lower
effective cost of borrowed funds, and from an improved ability to make
commitments to and form deeper relationships with mortgage originators
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and bank portfolio sellers. In addition, earnings and dividends per
share will likely benefit to the extent that equity offerings at prices
in excess of book value increase average book value per share.
We can grow through internal cash generation and asset appreciation.
Typically our cash flows exceed our dividend, working capital, and
capital expenditure requirements; by retaining this free cash flow, we
can grow. Additionally, absent a poor credit cycle, the market value of
our credit-sensitive assets may increase over time as our loans season
and our risks are reduced. Increased market values for these assets add
to our equity base and allow us to increase our jumbo loan asset
commitments.
We will also seek to increase the size of our capital base through
issuing new equity securities. We will do so when we believe we have
attractive business opportunities and when we believe such issuance is
likely to benefit our per share earnings, dividends, and increasesstock price.
Since we currently assist in the financing of approximately 3% of the
high-quality jumbo residential loans in the U.S., we have the potential
ability to grow for many years by increasing our market share. In
addition, the dollar amount of jumbo loans outstanding in America
typically grows at 6% to 10% per year.
From the founding of Redwood in 1994 through December 31, 2000,
stockholder wealth (consisting of book value per share, (in general,
to create Shareholder Wealth) by acting asdividends
received, and reinvestment of dividends) has increased at a financial intermediary managingcompound
annual rate of 18%. Much of this increase in stockholder wealth was
achieved through the beneficial effects of growth, both
internally-funded growth and externally-funded growth.
PRODUCT LINES
At December 31, 2000, Redwood had four mortgage loans in portfolio funded with AAA-rated callable long-term debt, by
acquiring or creating subordinated mortgage securities or other types of
mortgage equity interests, by managing a portfolio of mortgage securities, and
by otherwise being an efficient investor in mortgage assets. Since Redwood Trust
qualifies as a REIT for tax purposes, we are looking to find those areas of the
mortgage portfolio lending business that are most advantaged by Redwood Trust's
tax status and corporate structure. To achieve our business objective, our
strategyportfolios representing
its four product lines. Our current intention is to focus on the
following elementsmanagement and growth of mortgage portfolio lending
operations.
- Asset Acquisition
- Risk Management
- Capitalthese four existing product lines.
We operate our four product lines as a single business segment of real
estate finance, with common staff and Leverage Utilization
The businessmanagement, commingled financing
arrangements, and strategy of Redwood Trust with respectflexible capital commitments.
RESIDENTIAL CREDIT-ENHANCEMENT PORTFOLIO
In a manner analogous to the commercial loan
origination operationsguarantee programs of our affiliate is discussed below under "RWT Holdings
BusinessFannie Mae and
Strategy" commencing on page 12.
ASSET ACQUISITION
TYPES OF ASSETSFreddie Mac, Redwood Trust acquires and manages single-family, multi-family, and commercial
mortgage loans and residential mortgage securities (collectively, "mortgage
assets"). At the end of 1999, 81% of the mortgage assets that we owned bore
adjustable interest rates. Hybrid mortgages assets, with an initial fixed rate
period to the first rate adjustment greater than one year, made up 17% of our
mortgage assets. The remaining 2% of mortgage assets were fixed-rate mortgages.
We may also acquire common stock, preferred stock, and/or debt in other REITs.
Redwood Trust may also acquire its own common or preferred stock, when permitted
by applicable securities and state corporation laws, or other types of assets
under the direction of our Board of Directors.
The majority of our mortgage assets at December 31, 1999 consistedcredit enhances pools of mortgage loans and pass-through mortgage securities. We may acquire, without limitations,
other types of mortgage assets, including potentially, structured mortgage
securities that are relatively illiquid and have leveraged risk with respect to mortgage credit, prepayment and other risks. We generally intend to increase our
credit risk profile by providing credit-enhancement to, and thus retainingenable
their securitization.
By assuming some of the credit risk of credit loss of these loans, we enable
these loans to be funded in the capital markets. Sellers of mortgage
loans, by taking advantage of our credit-enhancement services, can fund
their originations by creating and selling mortgage-backed securities
with a credit rating of AAA. These AAA securities are sold to a wide
variety of buyers that are willing to fund mortgage assets, but are not
willing to build the operations necessary to manage mortgage credit
risk.
We credit enhance high-quality jumbo residential loans through
structuring and commercial loans produced by Holdings and
others.
We do not plan to acquire or retain any Real Estate Mortgage Investment Conduit
("REMIC") or Collateralized Mortgage Obligation ("CMO") residualacquiring subordinated credit-enhancement interests that
would causeare created at the distribution of excess inclusion income or unrelated business
taxable income to investors. As a result,time the loans are securitized. Sometimes we qualify as an eligible investment
for tax exempt investors, such as pension plans, profit sharing plans, 401(k)
plans, Keogh plans, and Individual Retirement Accounts. See "Certain Federal
Income Tax Considerations - Taxation of Tax-Exempt Entities."
Our Asset Acquisition/Capital Allocation Policies utilize a return on equity
calculation that includes adjustments for credit risk, borrowing costs, hedging
and the Risk-Adjusted Capital Policy requirements. The relative attractiveness
of various asset types will vary over time. We may acquire our mortgage assetsbuy
these credit-enhancement interests in the secondary market for mortgage
market or uponassets; sometimes we work with seller/securitizers directly to choose
loans that will be included in a pool and to structure the terms of the
credit-enhancement interest for that pool.
Generally, we credit-enhance loans from the top 15 high-quality national
mortgage origination pursuant to arrangementsfirms plus a few other smaller firms that
specialize in very high-quality jumbo residential loan originations. We
also work with loan originators, other secondary mortgage market participants, or from
Holdings. We may issue purchase commitments to originators and otherlarge banks that are sellers of seasoned portfolios of
high-quality jumbo loans. We either work directly with these customers,
or we work in conjunction with an investment bank on these transactions.
The pricing that we receive for providing credit-enhancement is a
function of supply and demand (as well as perception of risk). Supply is
largely a function of the number of jumbo mortgage loans originated, the
number of seasoned bank portfolios for sale, and the percentage of such
loans that are securitized. Generally, supply is
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increasing over time as the outstanding balance of jumbo mortgages grows
and as the share of jumbo mortgages that are securitized increases.
Demand also affects the attractiveness of pricing in our market. Demand
is a function of competition. In the two periods in which we increased
our credit-enhancement business at a rapid pace (1994 to 1996 and 1999
to 2000), competition was subdued. Because of the relative lack of
demand, pricing was attractive.
In 1997 and 1998, many financial institutions (including banks, thrifts,
insurance companies, Wall Street firms, and hedge funds) entered this
business. Many of these new entrants had relatively inefficient balance
sheets for this particular business, lacked mortgage securities. Thesecredit management
infrastructure, lacked prudence in their asset/liability management
practices, or lacked focus. Most have now exited this business,
improving pricing for specialist firms such as ourselves.
During the 1997 to 1998 period, the entrance of many new firms into our
business increased demand and generally made pricing unattractive. Our
response was to halt growth of our credit-enhancement portfolio and sell
a portion of our credit-enhancement interests. Because of aggressive
pricing in mortgage credit-enhancement, our new asset commitments will obligate usduring
this period were generally in our investment portfolio.
When pricing improved in 1999, we resumed growth in the jumbo market,
although our largest capital commitment during that year was to purchaseour
common stock repurchase program. During 2000, we increased the size of
our credit-enhancement portfolio and commitments from $8 billion to $25
billion.
We credit-enhance fixed rate, adjustable rate, and hybrid mortgage
assets forloans. For our credit-enhancement portfolio, a specific period"fixed rate" market
(where the percentage of time,newly originated mortgages that are fixed rate
is relatively high) is generally favorable. Since most fixed rate loans
are securitized, we are likely to have an increased supply of
credit-enhancement opportunities in a specific aggregate
principal amountfixed rate market.
Substantially all of the $23 billion of loans that we added to our
credit-enhancement portfolio in 1999 and at a specified price2000 were "A" or margin. In addition, we may issue
commitments to sell mortgage assets to another entity, including Holdings.
PORTFOLIO MANAGEMENT"prime"
quality loans. We only acquire those mortgage assets for which we believe we have the necessary
expertise to evaluate and manage such assets and which are consistent with our
balance sheet guidelines and risk management objectives. Since our intention is
generally to hold our mortgage assets until maturity, we generally do not seek to credit-enhance "B", "C", or "D" quality
loans (sub-prime loans).
Our goal is to post credit results for our mortgage portfolio that equal
or exceed the credit results of Fannie Mae, Freddie Mac, and the large
"A" quality jumbo portfolio lenders such as Bank of America and
Washington Mutual.
The amount of capital that we hold to credit enhance our credit
enhancement portfolio loans (the principal value of the
credit-enhancement interests that we acquire) is determined by the
credit rating agencies (Moody's Investors Service, Standard & Poor's
Ratings Services, and Fitch IBCA). These credit agencies examine each
pool of mortgage loans in detail. Based on their review of individual
loan characteristics, they determine the credit-enhancement capital
levels necessary to award AAA ratings to the bulk of the securities
formed from these mortgages. Once we provide this credit-enhancement
capital, the credit-enhanced AAA securities can be sold to a wide
variety of capital market participants.
Typically the principal value of the credit-enhancement interests that
we acquire 4is equal to 0.5% to 2.0% of the initial principal value of
the mortgages. Our capital requirements are greater than the 0.45% of
loans that Fannie Mae and Freddie Mac are required by regulation to hold
as capital for similar quality smaller-than-jumbo mortgages. However,
our capital requirements are less than the 4.0% of loan balances that
banks and thrifts are required by their regulators to hold as capital
for high-quality residential loans (of any size) if held unsecuritized
on their balance sheets. Thus, by financing in the capital markets, our
capital structure can be more capital efficient than that of the banks
and thrifts that are our competitors in the jumbo market.
Although the principal value of our credit-enhancement interests is
equal to 0.5% to 2.0% of the loans that we credit enhance, our actual
investment (and our risk) is less than this amount since we acquire
these interests at a price which is at a discount to principal value. A
portion of this discount we designate as our credit reserve for future
losses; the remainder we amortize into income over time.
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The loans that we credit-enhance in this portfolio do not appear as
assets whose prospective investment returnson our balance sheet. Rather, our net basis in credit-enhancement
interests is shown as a balance sheet asset. At December 31, 2000, the
principal value of our credit-enhancement interests was $125 million and
our basis in these assets was $81 million.
Our first defense against credit loss is the quality of our loans.
Compared to most corporate and consumer loans, the mortgage loans that
we credit-enhance have a much lower loss frequency (they tend not to
default) and a much lower loss severity (the amount of the loan that we
lose when they do default is low).
Our borrowers typically have stable sources of income. Debt service
payments of all types usually consume less than one-third of their
income (or else there are only attractiveother favorable underwriting characteristics
in the loan that serve as compensating factors to higher debt ratios).
Our borrowers generally have liquid assets. They have proven their
credit-worthiness in a number of ways, including generally having an
unblemished credit record and a credit (FICO) score at origination of
greater than 680.
Our loans are secured by the borrowers' homes. On average, we estimate
that our loan balances are less than 63% of the current market value of
the homes (and other collateral and credit-enhancements) securing these
loans. In the rare instances when a homeowner defaults, we work with our
mortgage servicing partners to mitigate losses, which may include
foreclosing on and selling the house. While we cannot always avoid a
credit loss through our loss mitigation efforts, when we do incur a loss
it is usually a small one relative to our loan balance.
Our exposure to the credit risks of the mortgages that we credit-enhance
is further limited rangein a number of scenarios.respects:
(1) Representations and warranties: As the credit-enhancer
of a mortgage securitization, we benefit from
representations and warranties received from the sellers
of the loans. In limited circumstances, the sellers are
obligated to re-purchase delinquent loans from our
credit-enhanced pools, thus reducing our potential
exposure.
(2) Mortgage insurance: A portion of our credit-enhanced
portfolio consists of loans with initial loan-to-value
(LTV) ratios in excess of 80%. For the vast majority of
these higher LTV loans, we benefit from primary mortgage
insurance provided on our behalf by the mortgage
insurance companies or from pledged asset accounts.
Thus, for what would otherwise be our most risky loans,
we have passed much of the risk on to third parties and
our effective loan-to-value ratios are much lower than
80%.
(3) Risk tranching: A typical mortgage securitization has
three credit-enhancement interests -- a "first loss"
security and securities that are second and third in
line to absorb credit losses. Of Redwood's net
investment in credit-enhancement assets, $12 million, or
15%, was directly exposed to the risk of mortgage
default at December 31, 2000. The remainder of our net
investment, $69 million, was in the second or third loss
position and benefited from credit-enhancements provided
by others (through ownership of credit-enhancement
interests junior to our positions) totaling $87 million.
Credit enhancement varies by specific asset.
(4) Limited maximum loss: Our potential credit exposure to
the mortgages that we credit-enhance is limited to our
investment in the credit-enhancement securities that we
acquire.
(5) Credit reserve established at acquisition: We acquire
credit-enhancement interests at a discount to their
principal value. We set aside some of this discount as a
credit reserve to provide for future credit losses. In
most economic environments, we believe that this reserve
should be large enough to absorb future losses. Thus,
typically, most of our credit reserves are established
at acquisition and are, in effect, paid for by the
seller of the credit-enhancement interest.
(6) Acquisition discount: For many of our credit-enhancement
interests, the discount that we receive at purchase
exceeds anticipated future losses and thus exceeds our
designated credit reserve. Since we own these assets at
a discount to our credit reserve adjusted value, the
income statement effect of any credit losses in excess
of our reserve would be mitigated.
We believe that futurethe outlook for our jumbo mortgage credit enhancement
portfolio line in 2001 is excellent, as the supply of credit-enhancement
opportunities is expected to increase as mortgage originations and
mortgage securitizations increase. We expect pricing to remain
favorable, as we expect demand from competitors will remain subdued. We
expect to achieve continued growth with attractive pricing in this
product line.
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RESIDENTIAL RETAINED PORTFOLIO
We anticipate that the bulk of our growth, in terms of loans financed in
the jumbo residential loan market, is most likely to be in our
credit-enhancement portfolio. Nevertheless, we continuously seek to
create the more specialized situations that allow us to add value by
undertaking securitizations on our balance sheet and thus add to our
residential retained loan portfolio.
Our net retained interests from our securitizations are the assets of
our residential retained portfolio less the long-term debt that we
issue. These retained interests that we create are functionally and
structurally similar to the credit-enhancement interests that we
acquire. In each case, we are using our capital to credit-enhance
high-quality jumbo residential loans so that AAA securities backed by
these loans can be created and sold in the capital markets. For our
retained portfolio, we acquire whole loans and undertake the
securitization of the loans ourselves (structured as an issuance of long
term debt). For our credit-enhancement portfolio, the seller of the
mortgages undertakes the securitization of the loans and we acquire the
credit-enhancement interest from them. Although we have greater control
over mortgage underwriting and servicing in our retained portfolio than
we do sometimes with our acquisitions of credit enhancement interests,
creating retained loan portfolio interests entails certain risks. We
undertake securitizations ourselves only when we believe that we have a
distinct advantage in doing so relative to the alternative of allowing
the seller to undertake the securitization.
At December 31, 2000, our basis in our net retained interests from our
securitizations totaled $37 million and our basis in our portfolio of
acquired credit-enhancement interests totaled $81 million. These assets
are shown in a different manner on our balance sheet. For our
residential retained portfolio securitizations, we show both the
underlying residential whole loans (residential whole loans of $1.13
billion at December 31, 2000) and the securities that we issue (long
term debt of $1.09 billion) on our balance sheet. For acquired
credit-enhancement interests, we show only the net amount ($81 million)
as an asset.
The process of adding to our retained loan portfolio commences when we
underwrite and acquire mortgage loans from sellers. For our retained
portfolio, we generally acquire loans in bulk purchases so that we can
quickly build a portfolio large enough (usually $200 million or more) to
support an efficient issuance of long-term debt. Although there is a
limited supply of large portfolios for sale, competition to acquire
portfolios of this size is also limited. We source our portfolio
acquisitions primarily from large, well-established mortgage originators
and the larger banks and thrifts.
We believe that competition in the jumbo whole loan market is
substantially reduced from its peak in 1997 to 1998. There were several
thrifts and banks that were active buyers of high-quality jumbo
residential loan portfolios. Most of these thrifts and banks are now out
of the market, as they have been acquired by other depository
institutions with different asset gathering strategies or they have
changed strategies to focus on building portfolios of other asset types.
Several other mortgage REITs were also active buyers of large
portfolios, but appear to be less interested now due to severe financial
difficulties, a change in strategy, or a change in ownership.
We generally seek to acquire "A" quality adjustable-rate and hybrid
loans for our retained loan portfolio. The securitization process for
fixed-rate loans is highly efficient; we usually believe that there is
little that we can add by securitizing these loans ourselves.
Securitization of adjustable-rate and hybrid loans is less common, and
is less well understood by many market participants. As the ultimate
buyer of the credit-enhancement interests, and one of the leaders in
developing the technology of securitizing adjustable rate and hybrid
loans, we can sometimes add value by acquiring and securitizing these
loans ourselves.
Bulk sales of residential whole loan portfolios that meet our
acquisition criteria and that are priced attractively relative to our
long-term debt issuance levels have been rare in recent years. Many
banks have portfolios of adjustable-rate and hybrid loans that they
intend to sell. If interest rates drop, a greater supply of such
portfolios may become available. When banks and mortgage originators are
ready to sell, they may sell their portfolios as whole loans, in which
case we would likely have the opportunity to acquire loans for our
retained portfolio. Alternatively, they may hire a Wall Street firm to
assist them with a securitization, in which case we would likely have
the opportunity to acquire credit-enhancement interests for our
credit-enhancement portfolio.
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We fund our loan acquisitions initially with short-term debt. When we
are ready to issue long-term debt, we contribute these loans to our
100%-owned, special purpose-financing subsidiary ("Sequoia"). Sequoia,
through a trust, then issues mostly AAA rated long term debt that
generally matches the interest rate and prepayment characteristics of
the loans and remits the proceeds of this offering back to us. Our net
investment equals our basis in the loans less the proceeds that we
received from the sale of long-term debt. The amount of equity that we
invest in these trusts to support our long-term debt issuance is
determined by the credit rating agencies, based on their review of the
loans and the structure of the transaction.
The net interest income that we generate per dollar of loan financed in
our retained portfolio is higher than it is for our credit-enhancement
portfolio. In our retained portfolio, we are generally both
credit-enhancing the loans and earning the spread between the yield on
the mortgages and the cost of funds of our long-term debt. The amount of
capital that we employ as a percentage of the underlying loans in our
retained portfolio is also generally higher than in our
credit-enhancement portfolio. The returns on equity that we generate
from our retained portfolio can be higher than we earn from our
credit-enhancement portfolio, but also can be more variable with respect
to market factors such as changes in interest rates and mortgage
prepayment ratesrates.
We plan to accumulate more high-quality jumbo residential loans when
loans are very difficultavailable on attractive terms relative to predict. Therefore,our anticipated
costs of issuing long-term debt.
INVESTMENT PORTFOLIO
In our investment portfolio, we seekfinance real estate through acquiring
and funding mortgage securities. Generally these securities have high
credit ratings. The substantial majority of this portfolio is rated AAA
or AA, or effectively has a AAA rating through a corporate guarantee
from Fannie Mae or Freddie Mac.
Since we can fund these securities with a low cost of funds in the
collateralized short-term debt (repo) markets, and since we have an
efficient tax-advantaged corporate structure, we believe that we have
some advantages in the mortgage-backed securities market relative to
acquiremany other capital market investors.
The maintenance of an investment portfolio serves several functions for
us:
(1) Given our balance sheet characteristics, tax status, and
the capabilities of our staff, mortgage securities
investments can earn an attractive return on equity,
(2) Using a portion of our capital to fund mortgage assets
with low levels of credit risk acts as a diversification
for our balance sheet,
(3) The high level of current cash flow from these
securities (including principal receipts from mortgage
prepayments) and the general ability to sell these
assets into active trading markets has attractive
liquidity characteristics for asset/liability management
purposes, and
(4) Our investment portfolio can be an attractive place to
employ capital (and earn rates of return that are higher
than cash) when our capital is not immediately needed to
support our credit-related product lines or when we need
flexibility to adjust our capital allocations.
The bulk of our investment portfolio consists of adjustable-rate and
floating rate mortgage securities funded with floating rate short-term
debt. We do own some fixed rate assets in this portfolio that are either
hedged or that we believe will provide acceptable returns over a broad
rangehold unhedged to counter-balance certain other
characteristics of interest rateour balance sheet.
The substantial majority of our investment portfolio securities are
backed by high-quality residential mortgage loans. We do have smaller
positions in residential securities backed by less than high-quality
loans (when the securities are substantially credit-enhanced relative to
the risks of the loans and prepayment scenarios.
Amongthus qualify for investment grade debt
ratings), in commercial mortgage securities, and in non-real estate
related securities (such as U.S. Treasuries and non-real estate
asset-backed securities).
Although we have the asset choices available to us, we acquire those mortgage assets which
we believe will generate the highest returns on capital invested, after
considering (i) the amount and nature of anticipated cash flows from the asset,
(ii) our ability to pledge the assethold these securities to secure short-term or long-term
collateralized borrowings, (iii) the increase inmaturity, and
our risk-adjusted capital
requirement determined by our Risk-Adjusted Capital Policy resulting from the
purchase and financing of the asset, and (iv) the costs of financing, hedging,
managing, securitizing, and reserving for the asset. Prior to acquisition,
potential returns on capital employed are assessed over the life of the asset
and in a variety of interest rates, yield spread, financing cost, credit loss
and prepayment scenarios.
We also give consideration to balance sheet management and risk diversification
issues. A specific asset whichaverage holding period is being evaluated for potential acquisition is
deemed more (or less) valuable to us to the extent it serves to decrease (or
increase) certain interest rate or prepayment risks which may exist in the
balance sheet, to diversify (or concentrate) credit risk, and to meet (or not
meet) the cash flow and liquidity objectivesquite long, we may establish for the balance
sheetdo sell securities from
time to time. Accordingly, an important part of the evaluation
process is a simulation, using our risk management models, of the addition of a
potential asset and its associated borrowings and hedges to the balance sheet
and an assessment of the impactWe do this potential asset acquisition would have on
the risks in and returns generated by our balance sheet as a whole over a
variety of scenarios.
We acquire floating-rate, adjustable-rate, hybrid and fixed-rate mortgage
assets. We generally intend to acquire fixed-rate loans when such loans can meet
our return and other standards when funded on a long-term basis, financed with
equity only, funded on a short-term basis with a comprehensive hedging program,
or funded short-term and unhedgedeither as part of an overall asset-liabilityour management strategy. Generally itof this
portfolio or in order to
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free capital for other uses. Because of this flexible approach, we
manage this portfolio on a total-rate-of-return basis, taking into
account both prospective income and prospective market value trends in
our investment analysis. To preserve management flexibility, we
generally use mark-to-market accounting for this portfolio. As a result
of market value fluctuations, quarterly reported earnings from our
investment portfolio can be variable.
We compete in the high-grade mortgage securities market with a great
number of capital markets participants. In 1997 and 1998, competition
increased significantly and asset prices rose. We responded by halting
the growth of this portfolio and selling certain assets. Pricing in this
market again became attractive in late 1998 as a result of capital
market turmoil. Pricing has generally remained attractive through the
end of 2000. In 1999 and 2000, our investment portfolio has ranged in
size from $0.8 billion to $1.3 billion, depending on the capital needs
of the rest of our balance sheet.
Our current plan is anticipated that any such long-term
financing or comprehensive hedging program will serve to reduce the risk that
could arise from the fundingrelative importance of fixed-rateour investment
portfolio in our asset mix over time as we acquire residential credit
assets. We may also purchasecurrently plan to add to this portfolio when prospective
returns are attractive relative to our own common or preferred stock or the debt or the common
or preferred stock of other mortgage REITs or other companiesopportunities and, on a
temporary basis, when we believe
that such purchases will yield attractive returnsraise new equity capital.
COMMERCIAL RETAINED PORTFOLIO
Redwood's primary business focus is on capital employed. REIT or
other debt securities may be undervalued at pointsresidential real estate finance.
On a limited basis, we also pursue opportunities in the economic cycle. When
the stock market valuations of companiescommercial real
estate loan market. For several years, we have been originating
commercial real estate loans. Currently, our goal is to originate loans
for portfolio, although we also seek to sell our commercial loans from
time to time. We finance our commercial portfolio with committed bank
lines, and we are lowseeking to diversify our funding sources through
selling senior participations in relation to the market value
of their assets, stock purchases can be a way for us toour loans. We may acquire an interest in a
pool of mortgage assets or other types
of assets at an attractive price. Also,
REITs and other companies may have attractivecommercial mortgage finance or other
businesses in which we may want to become a partial owner. We do not, however,
presently intend to investassets in the securities of other issuers for the purpose of
exercising control orfuture. Total commercial loans,
including those owned by our affiliate, RWT Holdings, Inc. ("Holdings"),
were $76 million at December 31, 2000.
OPERATIONS
Our portfolio management staff forms flexible interdisciplinary product
management teams that work to underwrite securities of other issuers.
We may seekdevelop our four product lines and to acquire and manage other types of assets or to acquire or create
mortgage finance or other businesses when we deem such activities to be in the
best interest of our shareholders.
We intend to acquire new mortgage assets, and will also seek to expand our
capital base in order to further
increase our ability to acquire new assets,
when the potential returns from new investments appear attractive relative to
the return expectations of stockholders.profitability over time. Our finance staff participates on
these teams, and manages our overall balance sheet, borrowings, cash
position, accounting, finance, tax, equity issuance, and investor
relations.
We may in the future acquirebuild and maintain relationships with mortgage assets by offering our debt or equity securities in exchange for such mortgage
assets.
The REIT provisions of the Internal Revenue Code of 1986, (the "Code") limit, in
certain respects, our abilityoriginators, banks
that are likely to sell mortgage assets. See "Certain Federal
Income Tax Considerations - General - Gross Income Tests"loan portfolios, Wall Street firms that
broker mortgage product, mortgage servicing companies that process
payments for us and " - Taxationassist with loss mitigation, technology and
information providers that can help us conduct our business more
effectively with the banks and Wall Street firms that provide us credit
and assist with the issuance of Redwood Trust." However,our long-term debt, and with commercial
property owners.
We evaluate, underwrite, and execute asset acquisitions and commercial
mortgage originations. We also evaluate potential asset sales. Some of
the factors that we may decidetake into consideration are: asset yield
characteristics; liquidity; anticipated credit losses; expected
prepayment rates; the cost of funding; the amount of capital necessary
to carry that investment in a prudent manner and to meet our internal
risk-adjusted capital guidelines; the cost of any hedging that might be
employed; potential market value fluctuations; contribution to our
overall asset/liability goals; potential earnings volatility in adverse
scenarios; and cash flow characteristics.
We monitor and actively manage our credit risks. We work closely with
our residential and commercial mortgage servicers, especially with
respect to all delinquent loans. While procedures for working out
troubled credit situations for residential loans are relatively
standardized, we still find that an intense focus on assisting and
monitoring our servicers in this process yields good results. We work to
enforce the representations and warranties of our sellers, forcing them
to repurchase loans if there is a breach of the conditions established
at purchase. If a mortgage pool starts to under-perform our
expectations, or if a servicer is not fully cooperative with our
monitoring efforts, we will often seek to sell assets from timea credit-enhancement
investment at the earliest opportunity before its market value is
diminished.
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Prior to time for a
number of reasons including, without limitation, to dispose of an asset as to
which credit risk concerns have risen beyond levels that we wish to manage, to
reduce interest rate risk, to substitute one type of mortgage asset for another,
to improve yield, to maintain compliance with the 55% requirement under the
Investment Company Act, to effect a change in strategy, or generally to
re-structure the balance sheet when we deem such action advisable. Management
will select any mortgage asset to be sold according to the particular purpose
such sale will serve. The Board of Directors has not adopted a policy that would
restrict management's authority to determine the timing of sales or the
selection of mortgage assets to be sold.
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As a requirement for maintaining REIT status, we will distribute to stockholders
aggregate dividends equaling at least 95% of our taxable income. See "Certain
Federal Income Tax Considerations - General - Distribution Requirement."
RISK MANAGEMENT
CREDIT RISK MANAGEMENT
We review the credit risk associated with each investment and determine the
appropriate allocation of capital to apply to such investment under our
Risk-Adjusted Capital Policy. In addition, we attempt to diversify our
investment portfolio to avoid undue geographic and other types of
concentrations. Management monitors the overall portfolio risk and determines
appropriate levels of provision for credit loss and provides such information to
the Board of Directors.
With respect to our mortgage securities, we are exposed to various levels of
credit and special hazard risk, depending on the nature of the underlying
mortgages and the nature and level of credit enhancements supporting such
securities. Most of the mortgage securities that we owned at December 31, 1999
had some degree of protection from normal credit losses. At December 31, 1999,
25% of our mortgage assets were mortgage securities covered by credit protection
in the formacquisition of a 100% guarantee fromcredit-enhancement interest, we typically
review origination processes, servicing standards, and individual loan
data. In many cases, we underwrite individual loan files and influence
which loans are included in a government-sponsored entity ("agency
securities").
An additional 17%securitization. Prior to acquisition of
whole loans for our mortgage assets at December 31, 1999 were
privately-issued securities and represented interests in pools of residential mortgage loans with the majority of these having some credit enhancement
("private-label securities"). Of this amount, 93% were rated AAA or AA. Credit
loss protection for private-label securities is achieved through the
subordination of other interests in the pool to our interest, through pool
insurance or other means. The degree of credit protection varies substantially
among the private-label securities thatretained loan portfolio, we own. While 98% of our private-label
securities had some degree of credit enhancement at December 31, 1999, some of
these credit-enhanced mortgage securities are, in turn, subordinated to other
interests. Therefore, should such a private-label security experience credit
losses, such losses could be greater than our pro rata share of the remaining
mortgage pool, but in no event could exceed our investment in the private-label
security.
We also acquire unsecuritized mortgage loans. At December 31, 1999, 58% of our
mortgage assets were mortgage loans. We have developed a quality control program
to monitor the quality of loan underwriting at the time of acquisition and on an
ongoing basis. We may conduct or cause to be conducted, a
legal document review of each mortgagethe loans, review individual loan
acquired to verify the accuracycharacteristics, and completeness of the
information contained in the mortgage notes, security instruments and other
pertinent documents in the file. As a condition of purchase, we generally select
a sample of mortgageunderwrite loans that are targetedappear to be acquired, focusing on those
mortgage loans withhave higher risk
characteristics, and submit them to a third
party, nationally recognized underwriting review firm for a compliance check of
underwriting and review of income, asset and appraisal information. Our own
employees or Holdings' employees may also perform these functions. In addition,
we, or our agents, will generally underwrite all multifamily and commercial
mortgagecharacteristics. We only acquire the loans that we acquire. Duringfeel comfortable
with.
We actively monitor and adjust the time we hold mortgage loans, we will
be subject to risks of borrower defaults and bankruptcies and special hazard
losses (such as those occurring from earthquakes or floods) that are not covered
by standard hazard insurance. We will generally not obtain credit enhancements
such as mortgage pool or special hazard insurance for our mortgage loans,
although individual loans may be covered by FHA insurance, VA guarantees or
private mortgage insurance and, to the extent securitized into agency
securities, by such government-sponsored entity obligations or guarantees.
ASSET/LIABILITY MANAGEMENT
To the extent consistent with our election to qualify as a REIT, we follow an
interest rate risk management program intended to protect principally against
the effects of substantial increases or decreases in interest rates.
Specifically, our interest rate risk management program is formulated with the
intent to offset the potential adverse effects, including changes in market
value, resulting from interest rate fluctuations, changes in prepayment rates,
differences between earning asset yield and cost of fundsasset/liability characteristics of
our mortgagebalance sheet. We follow our internal risk-adjusted capital
guidelines, seeking to make sure that we are sufficiently capitalized to
hold our assets and relatedto maturity through periods of market fluctuation. We
intensely monitor our cash levels, the liquidity of our assets, the
stability of our borrowings, and otherour projected cash flows and market
factors. Our interest rate risk
management program encompasses a number of procedures.values to make sure that we remain well funded and liquid. We attemptgenerally
seek to structure
our borrowings to have interest rate adjustment indices and interest rate
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adjustment periods that, on an aggregate basis, generally correspond tomatch the interest rate adjustment indices and interest rate adjustment periodscharacteristics of our
adjustable-rate, hybrid and fixed-rate mortgage assets. By doing so, we
generally intend to reduce the differences between interest rate indices and
interest rate adjustment periods of mortgage assets and related borrowings that
may occur.
While our interest rate risk management program intends to address most of the
risks associated with interest rate indices, it does not attempt to address
certain types of basis risk present in our portfolio. For example, to the extent
our six-month LIBOR-based assets are funded with one-month LIBOR-based
liabilities, we incur basis risk. Such risk arises because changes in one-month
LIBOR rates may differ significantly from changes in six-month LIBOR rates.
We purchase and sell, from time to time, interest rate agreements in the form of
interest rate caps, interest rate floors, interest rate swaps, interest rate
futures, options on interest rate futures, mortgage, agency, and Treasury
securities and other cash instruments to attempt to mitigate interest rate and
related risks. We also may use such instruments to modify the characteristics of
any loan issuance or sale or to hedge the anticipated issuance of future
liabilities or the market value of certain assets. In this way, we intend
generally to hedge as much of the interest rate risk as management determines is
in the best interest of our stockholders, given the cost of such hedging
transactions and the need to maintain our status as a REIT. See "Certain Federal
Income Tax Considerations - General - Gross Income Tests." As a result, we may
elect to bear a level of interest rate risk that could otherwise be hedged when
we believe, based on all relevant facts, that bearing such risk is prudent in
light of competing tax and market risks. We utilize financial futures contracts,
options, and forward contracts to the extent consistent with our compliance with
the REIT Gross Income Tests and Maryland law. We obtained no-action relief from
the Commodities Futures Trading Commission permitting us to invest a small
percentage of our total assets in certain financial futures contracts and
options thereon without registering as a commodity pool operator under the
Commodity Exchange Act, provided that we use such instruments solely for bona
fide hedging purposes.
We seek to build a balance sheet and undertake an interest rate risk management
program that is likely, in our view, to enable us to generate positive earnings
and maintain an equity liquidation value sufficient to maintain operations given
a variety of potentially adverse circumstances. Accordingly, the hedging program
addresses both income preservation and capital preservation concerns. To monitor
risks of fluctuations in earnings and in liquidation value of our equity due to
market value changes of balance sheet items, we model the impact of various
economic scenarios on the market value of our mortgage assets, liabilities and
interest rate agreements. We believe that the existing hedging programs will
allow us to maintain operations throughout a wide variety of potentially adverse
circumstances without further action. Nevertheless, in order to further preserve
our capital base during periods when we believe an adverse trend has been
established, we may decide to increase hedging activities and/or sell assets.
Each of these types of actions may lower our earnings in the short term in order
to further the objective of maintaining attractive levels of earnings and
dividends over the long term.
In all of our interest rate risk management transactions, we follow certain
procedures designed to limit credit exposure to counterparties, including
dealing only with counterparties whose financial strength meets our
requirements.
We may participate in the lending business and hedging operations conducted by
Holdings or any similarly structured affiliate. Such affiliates may be subject
to Federal and state income taxes to the extent that they have taxable income
after application of any net operating loss carryforwards ("NOLs") from previous
years. A taxable affiliate may not elect REIT status and may or may not
distribute any net profit after taxes to Redwood Trust and its other
stockholders. Any dividend income that we receive from any such taxable
affiliates (combined with all other income generated from our assets, other than
Qualified REIT Real Estate Assets) must not exceed 25% of our gross income. See
"Certain Federal Income Tax Considerations - General - Gross Income Tests."
At December 31, 1999, our weighted-average assets and
liabilities were matched
within a twelve-month period in terms of adjustment frequency and speed of
adjustment to market conditions. Looking at these two factors only (and thus
ignoring periodic and life caps for adjustable-rate mortgage assets and other
risks such as basis, liquidity, market value, and prepayment risk), for any
given change in short-term interest ratesrange. If we cannot achieve our net interest
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spread should tend to stabilize over time periods greater than twelve months
following that change. The majority of our mortgage assets at December 31, 1999
had coupon rates that adjust to market levels at least every twelve months. The
weighted-average term to reset for the adjustable-rate mortgage assets is
approximately four months. The majority of our borrowings at December 31, 1999
will either mature or adjust to a market interest rate levels within one month
of such date. The short-term borrowings had a weighted-average term to rate
reset of 18 days at December 31, 1999. Our hybrid mortgage loans, which, on
average, have a fixed coupon rate through December 2002, are funded with
borrowings which are also fixed-rate until December 2002. The 2% of our
residential mortgage asset portfolio with fixed-rate coupons is funded with
variable-rate short-term borrowings. Wematching objectives
on-balance sheet, we use interest rate hedge agreements to manage
the interest rate risks associated with this portion ofadjust our
portfolio. Bothoverall asset/liability mix. We monitor potential earnings fluctuations
and cash flow changes in coupon rates earned on adjustable-ratefrom prepayments. We project credit losses and
cash flows from our credit sensitive assets, and in rates paidreassess our credit
provisions and reserves, based on borrowings are expected to be highly correlated over time with changes in LIBOR
and/or Treasury rates (subject to effects of periodicinformation from our loss mitigation
efforts, borrower credit trends, and lifetime caps).
In the third quarter of 1998, we adopted mark-to-market accounting for most of
our mortgage securities portfolio and a portion of our mortgage loans.housing price trends. We also
mark-to-market all of our interest rate agreements as a result of designating
them as trading instruments under SFAS 133, Accounting for Derivative
Instruments and Hedging Activities. Relatively small changes in the market value
of mark-to-market assets could have a large effect on our earnings. Our interest
rate hedging activities may partially offset changes in asset market values in
some circumstances. However, market values can change for a wide variety of
reasons, many of which are not linked to interest rate changes or which are
otherwise not hedgeable.
Although we believe we have developed a cost-effective asset/liability
management program to provide a level of protection against interest rate, basis
and prepayment risks, no strategy can completely insulate us from the effect of
interest rate changes, prepayment risks, mortgage credit losses, defaults by
counterparties, or liquidity risk. Further, certain of the Federal income tax
requirements that we must satisfy to qualify as a REIT limit our ability to
fully hedge our interest rate and prepayment risks. Weregularly
monitor carefully, and
may have to limit, our asset/liability management program to assure that we do
not realize excessive hedging income, or hold hedging assets having excess value
in relation to total assets, which would result in our disqualification as a
REIT or, in case of excess hedging income, the payment of a penalty tax for
failure to satisfy certain REIT income tests under the Code, provided such
failure was for reasonable cause. See "Certain Federal Income Tax Considerations
- - General." In addition, asset/liability management involves transaction costs
that increase dramatically as the period covered by the hedging protection
increases. Therefore, we may be prevented from effectively hedging our interest
rate and prepayment risks over the long-term.
PREPAYMENT RISK MANAGEMENT
We seek to minimize the effects of faster or slower than anticipated prepayment
rates through structuring a diversified portfolio with a variety of prepayment
characteristics, investing in mortgage assets with prepayment prohibitions and
penalties, investing in certain mortgage securities structures which have
prepayment protections, passing on prepayment risk to the buyers of our
mortgage-backed debt and, when possible, balancing mortgage assets purchased at
a premium with mortgage assets purchased at a discount when such types of assets
are available in the marketplace and are otherwise attractive for acquisition.
In certain operating environments, however, it was not possible for us to
acquire attractive assets with a relatively small net balance of discount and
premium. In addition, changes in market values subsequent to acquisition can
effect our premium and discount balances to the extent such market value changes
are reflected in earnings and assets' basis. In these types of circumstances,
net mortgage premium or discount balances may rise and the risk of earnings
variability resulting from changes in prepayment rates may increase. We may
purchase interest-only strips, principal-only strips and/or other financial
assets such as floors, calls, swaptions and futures, as a hedge against
prepayment risks. We may also seek to create and sell interest-only and
principal-only strips from existing assets to help manage prepayment risk.
Management and the Board of Directors monitor prepayment risk through periodic
review of the impact of a variety of prepayment scenarios on our revenues, net
earnings, dividends, cash flow and net balance sheet market value.
We own a variety of non-Agency mortgage securities which are structured so that
for several years they receive either less than or more than a pro rata share of
principal repayments experienced in the underlying mortgage pool as a whole. In
such mortgage securities, one or more classes of senior securities are
ordinarily entitled to
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receive all principal prepayments on the underlying pool of loans until such
senior securities have been paid down to a specified amount determined by
formula. To illustrate, a mortgage security totaling $100 million of aggregate
principal balance may be structured so that there is (i) $92 million face value
of senior securities, (ii) mezzanine securities with a face value of $2 million
providing credit support for the senior securities, (iii) subordinated
securities, or mortgage equity interests, with a face value of $6 million
providing credit support for the mezzanine securities and the senior securities,
and (iv) the $100 million face value of senior securities, mezzanine securities
and subordinated securities had been issued in this format, the mezzanine
securities or the subordinated securities would receive no principal prepayments
on the underlying loans until the $92 million face value of senior securities
had been paid down to a formula-determined amount, which would normally be
expected to occur within a range of three to ten years depending on the rate of
prepayments and other factors. We own interests that are similar to the senior
securities, mezzanine securities and subordinated securities in this example. We
intend to increase our investment in subordinated securities and other forms of
mortgage equity interests.
During 1999, we received $839 million in principal payments on our mortgage
assets. One commonly used measure of the average annual rate of prepayment of
mortgage principal is the conditional prepayment rate ("CPR"). The CPR for our
mortgage assets averaged 27% for 1999 compared to an average CPR of 30% for
1998. In addition to prepayments, we also receive scheduled mortgage principal
payments (payments representing the normal principal amortization of a 30-year
mortgage loan) and other principal repayments from calls of mortgage securities
and accelerated principal payment structures of securities. Thus, the total
amount of repayments of mortgage principal received each month may exceed a pro
rata level of prepayments. The reported basis of our mortgage assets at December
31, 1999 was equal to 100.31% of the face value of the assets; the net premium
was 0.31% on average. In general, the smaller the level of net discount or
premium, the less risk there is that fluctuations in prepayment rates will
affect net interest income or net asset appreciation income, although the timing
of the amortization of the premium as compared to the timing of the accretion of
the discount could still cause differences, even if the net premium or discount
was relatively small. Our discount and premium mortgage assets may have
different prepayment incentives for their borrowers, or the borrowers may
respond differently to such incentives, or such assets may have different
effective prepayment lock-out features. Thus, the level of our net premium or
discount may not fully reflect the underlying prepayment risk. We may use
interest rate agreements and other means to seek to mitigate the risk that
premium and discount amortization expenses and income and net asset appreciation
income may rise or fall as mortgage prepayments increase or decrease in falling
or rising interest rate environments.
In the third quarter of 1998, we moved to mark-to-market accounting for a
majority of our mortgage securities. For these assets, increases and decreases
in market values will be recorded in income and the basis of the asset will be
adjusted accordingly. As a result, the net mortgage premium or discount balances
on our records will vary with market values, thus affecting future amortization
income and expense. In addition, changes in prepayment rates will cause changes
in the market values of our assets which, in turn, will cause fluctuations in
reported earnings. Relatively small changes in prepayment rates could cause
material changesand liabilities by reviewing
pricing from external and internal sources.
We initiate new short-term borrowings on a regular basis with a variety
of counter-parties. We structure long-term debt issuance. We model
potential securitizations as market conditions fluctuate, allowing us to
price potential loan acquisitions intended to be funded via long-term
debt in our reported earnings.
CAPITAL AND LEVERAGE UTILIZATION
Our goalretained loan portfolio. We work with respectthe credit rating
agencies to capital usage isdetermine credit-enhancement levels required to utilize our capital in a manner
that yields the highest return to our shareholders over time.issue new
long-term debt. In order to
achieve this objective, we examine all potential investments for their overall
return on equity characteristics. Generally,cases where we intend to invest this capitalacquire a credit-enhancement
interest in earning assets - primarily mortgage assets. At times, however,a securitization performed by others, we may determine
that our capital will yield a higher return throughsometimes assist
them with maximizing the repurchase of a portion
of our outstanding common stock. Stock repurchases have the effect of reducing
the number of shares outstanding and, to the extent that shares are repurchased
at a level below book value, increasing book value per share. During 1999, we
repurchased 2,483,500 shares of our common stock for an average price of $14.96.
Our book value per share at December 31, 1999 was $20.88 per share. At December
31, 1999, there were 1,000,000 shares authorized for repurchase.
Our goal with respect to leverage is to strike a balance between the
under-utilization of leverage, which reduces potential returns to stockholders,
and the over-utilization of leverage, which could reduce our ability to meet our
obligations or execute our business plan during adverse market conditions. We
have established a Risk-Adjusted
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Capital Policy which limits our ability to acquire additional assets during
times when our actual capital base is less than a required amount defined in the
policy (subject to certain permitted exceptions when the proceeds of additional
equity issuances must be invested). In this way, the use of balance sheet
leverage is controlled. The actual capital base as defined for the purposeefficiency of the Risk Adjusted Capital Policy is equal to the market valuestructuring of total assets
funded short-term less the book value of total collateralized short-term
borrowings plus the actual investment on a historical amortized cost basis in
subsidiary trusts ("mortgage equity interests") wherein mortgage assets are
funded with non-recourse, long-term debt less the book value of any parent-level
debt associated with these mortgage equity interests, less any unsecured debt.
At December 31, 1999, 41% of our assets were funded with equity or with
long-term non-recourse debt. Our capital requirement for these assets is
generally equal to 100% of the net equity invested (after taking into account
the issuance of debt), thus equaling the total amount we could potentially lose
in adverse credit circumstances.
Mortgage interests that have some external protection from credit losses but
which are not rated as high as AAA or AA may be leveraged. These interests,
together with mortgage loans not yet securitized and AAA and AA rated mortgage
securities, are typically funded with short-term debt. There are two components
to the capital requirements we establish for short-term funded assets.
The first component of our capital requirements with respect to short-term
funded assets is the current aggregate over-collateralization amount or
"haircut" that lenders require us to hold as capital. The haircut for each such
mortgage asset is determined by the lender and is subject to change when
short-term debt matures and rolls-over. Haircut levels on individual borrowings
range from 2% to 30% on our residential and commercial mortgage assets, and
currently average 4% for our short-funded portfolio as a whole. Should the
market value of the pledged assets decline or haircut requirements increase, we
will be required to deliver additional collateral to the lenders in order to
maintain a constant over-collateralization level on our short-term borrowings.
The second component of our capital requirement with respect to short-term
funded assets is the "liquidity capital cushion." The liquidity capital cushion
is an additional amount of capital, in excess of the haircut, which we maintain
in order to meet the demands for additional collateral by the short-term lenders
should the market value of our short-term funded mortgage assets decline or
haircut levels increase. The aggregate liquidity capital cushion equals the sum
of liquidity cushion amounts assigned under the Risk-Adjusted Capital Policy to
each of our short-term funded mortgage assets. Liquidity capital cushions are
assigned to each short-term funded mortgage asset based on our assessment of
that mortgage asset's market price volatility, credit risk, liquidity and
attractiveness for use as collateral by short-term lenders. The process of
assigning liquidity capital cushions relies on our ability to identify and weigh
the relative importance of these and other factors. Consideration is also given
to hedges associated with the short-term funded mortgage asset and any effect
such hedges may have on reducing net market price volatility, concentration or
diversification of credit and other risks in the balance sheet as a whole and
the net cash flows that can be expected to arise from the interaction of the
various components of our balance sheet. The Board of Directors reviews on a
periodic basis various analyses prepared by management of the risks inherent in
our balance sheet, including an analysis of the effects of various scenarios on
our net cash flow, earnings, dividends, liquidity and net market value. Should
the Board of Directors determine that the minimum required capital base set by
our Risk-Adjusted Capital Policy is either too low or too high, the Board of
Directors may raise or lower the capital requirement accordingly.
We expect that our aggregate minimum capital requirement under the Risk-Adjusted
Capital Policy will approximate 3% to 15% of the market value of our short-term
funded mortgage assets plus the net equity value of our long-term funded
mortgage assets funded with long term debt or equity. This percentage will
fluctuate over time, and may fluctuate out of the expected range, as the
composition of the balance sheet changes, haircut levels required by lenders
change, the market value of short-term funded mortgage assets changes, as
liquidity capital cushions set by the Board of Directors are adjusted over time,
and as the balance of funding between short-term and long-term changes. As of
December 31, 1999, the aggregate Risk-Adjusted Capital Requirement was 8.65% of
total assets. Our actual capital base was 8.68% of total assets at December 31,
1999; thus we were utilizing nearly all of the leverage potential available to
us at that time under our Risk-Adjusted Capital policies.
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At December 31, 1999, 57% of our borrowings were short-term. Our short-term
borrowings have consisted of collateralized borrowing arrangements of various
types (repurchase agreements, notes payable, committed warehouse facilities and
revolving lines of credit). At December 31, 1999, $1.2 billion of the short-term
borrowings were in repurchase agreements and $0.1 billion was in committed
warehouse facilities. Our long-term borrowings at December 31, 1999 consisted of
non-recourse, floating and fixed rate, collateralized mortgage-backed bonds. In
the future, however, borrowings may also be obtained through loan agreements,
Dollar-Roll Agreements (an agreement to sell a security for delivery on a
specified future date and a simultaneous agreement to repurchase the same or a
substantially similar security on a specified future date) and other credit
facilities with institutional lenders, the issuance of long-term collateralized
debt or similar instruments in the form of collateralized mortgage bonds,
collateralized bond obligations, REMICs, FASITs or other forms, and the issuance
of secured and unsecured debt securities such as commercial paper, medium-term
notes and senior or subordinated notes. We may also seek to fund our current
balance sheet or future growth through the issuance of preferred stock, common
stock or other forms of equity.
In early 1999, we extended the maturity of some of our short-term borrowings out
to the year 2000, and may continue to extend the maturities of some of our
short-term borrowings. We may also seek committed short-term borrowing
facilities. We enter into repurchase agreements primarily with national
broker/dealers, commercial banks and other lenders that typically offer such
financing. We enter into short-term collateralized borrowings only with
financial institutions meeting certain credit standards and we monitor the
financial condition of such institutions on a regular basis.
MORTGAGE LOAN SECURITIZATION TECHNIQUES
We contract with conduits, financial institutions, mortgage bankers, investment
banks, Holdings and others to purchase mortgage loans that they are originating
or holding in their
portfolio. We intend to enhance the value and liquidity of
most of the mortgage loans we acquire by securitizing the loans into mortgage
securities or pledging the loans to secure the issuance of long-term,
mortgage-backed debt in the manner which will best meet our needs.
In addition to creating mortgage securities and issuing long-term debt with
mortgage loans in our portfolio, we also may "re-securitize" portions of our
mortgage securities portfolio. In a re-securitization transaction, mortgage
securities rather than mortgage loans are used as collateral to create new
mortgage securities. This would typically be done as the mortgage loans
underlying the mortgage securities improve in credit quality through seasoning,
as values rise on the underlying properties, when the credit quality of junior
classes of mortgage securities improve due to prepayment of more senior classes
or when we desire to replace short-term debt with long-term debt. Such
transactions can result in improved credit ratings, higher market values,
lowered borrowing costs and/or reduced liquidity risk. In December 1997, we
completed our first re-securitization in our "SMFC 97-A Trust".
We may conduct our securitization activities through one or more taxable or
REIT-qualifying subsidiaries formed for such purpose. In 1997, we formed Sequoia
Mortgage Funding Corporation ("Sequoia"), a REIT-qualifying subsidiary, to carry
out securitizations. Since then, Sequoia has completed three securitizations,
issuing non-recourse, mortgage-backed debt with outstanding balances as of
December 31, 1999 of $0.9 billion.
COMPANY POLICIES
The Board of Directors has established the investment policies and strategies
summarized in this report. The Board of Directors has the power to modify or
waive such policies and strategies without the consent of the stockholders to
the extent that the Board of Directors determines that such modification or
waiver is in the best interests of stockholders. Among other factors,
developments in the market which affect the policies and strategies mentioned
herein or which change our assessment of the market may cause the Board of
Directors to revise our policies and strategies.
At all times, we intend to conduct our business so as not to become regulated as
an investment company under the Investment Company Act. Accordingly, we do not
expect to be subject to the restrictive provisions of the Investment Company
Act. The Investment Company Act exempts entities that are "primarily engaged in
the
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business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualifying Interests"). Under the current
interpretation of the staff of the Securities and Exchange Commission, in order
to qualify for this exemption, we must maintain at least 55% of our assets
directly in mortgage loans, qualifying pass-though certificates and certain
other qualifying interests in real estate. In addition, unless certain mortgage
securities represent all the certificates issued with respect to an underlying
pool of mortgages, such mortgage securities may be treated as securities
separate from the underlying mortgage loans and, thus, may not qualify as
Qualifying Interests for purposes of the 55% requirement. Therefore, the
provisions of the Investment Company Act may limit our ownership of certain
mortgage assets.
RWT HOLDINGS, INC. BUSINESS AND STRATEGY
REDWOOD COMMERCIAL FUNDING, INC.
GENERAL
RCF was formed as a subsidiary of Holdings in 1998 to meet the needs of banks
and other investors seeking to acquire commercial mortgage assets. RCF
originates and services high-quality commercial mortgage loans providing funding
to owners of apartment buildings, office buildings, light industrial, mobile
home parks, and retail properties nationwide. RCF originates through commercial
loan brokers or through direct borrower contact. RCF may also acquire portfolios
of commercial mortgage loans. RCF generates revenues from the sale of loans to
its customers and through spread income earned while loans are held in
inventory.
RCF lends to credit-worthy borrowers who nearly always provide personal
guarantees. RCF generally requires that a property be held in a bankruptcy
remote entity and typically requires a loan-to-value ratio of 70% or less and a
debt service coverage ratio of at least 1.20 to 1.00.
COMMERCIAL MORTGAGE LOANS ORIGINATED
Most of the commercial mortgage loans originated by RCF have a principal balance
of $10 million or less, with an average size of approximately $4 million. RCF
may acquire or originate larger loans from time to time. Loans can have fixed
and floating interest rates, or a combination of the two. Floating rate loans
typically adjust quarterly or semi-annually off the corresponding LIBOR index.
Floor rates will typically be the start rate. Fixed rate loans typically have
interest rates 350 to 500 basis points over the 5-year U.S. Treasury rate at
origination.
RCF competes in the commercial loan origination market by offering
responsiveness, reliability, and flexibility. RCF typically structures loan
prepayment penalties to meet the needs of its borrowers and its investors. These
penalties are typically not of the yield maintenance or lock-out variety but
rather may involve a declining percentage of the outstanding balance; for
example, a 5%, 4%, 3%, 2%, 1% penalty structure for years one through five,
respectively of the loan. RCF structures loans to meet special borrower and
investor needs.
SALES PROCESS
RCF sells the loans it originates through whole loan sales to a variety of
institutions, which may include depository institutions, mortgage REITs,
underwriters of commercial mortgage backed securities, and others, through
private placements of loans, participations with investors, or through
securitizations. RCF has not retained interests in these loans to date. RCF may
sell loans or interests in loans to the Redwood Trust portfolio from time to
time.
The length of time between when RCF originates a commercial mortgage loan and it
sells or securitizes such mortgage loan generally ranges from 30 to 180 days.
This period of time may lengthen and has been longer during the start-up phase
of the business. RCF may seek to market individual loans during or after the
origination process. RCF may also seek to make bulk sales, in which case it will
typically build portfolios in the $10 to $25 million range before going to
market. If securitizations or forward sales are contemplated, then larger
portfolios may be assembled.
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13securitization.
RISK FACTORS
The following is a summary of the risk factors that we currently believe
are important and that could cause our actual results to differ from
expectations. This is not an exhaustive list; other factors not listed
here could be material to our expectations. These factors
should not be construed as exhaustive. Readers should understand that many
factors govern whether anyresults.
We can provide no assurances with respect to projections or
forward-looking statement will bestatements made by us or can be achieved.by others with respect to our
future results. Any one of these riskthe factors listed here, or other factors not
so listed, could cause actual results to differ materially from
those projected. We cannot provide any assurance that any important risk
factorexpectations. It is not possible to accurately project future trends
with respect to these factors, or to project which factors will be realizedmost
important in a manner so asdetermining our results, or to allow us to achieveproject what our desired or
projected results.future
results will be.
Throughout this Form 10-K and other company documents, the words
"believe", "except""expect", "anticipate", "intend", "aim", "expect", "will", and similar
words identify forward-looking"forward-looking" statements.
COMPANY OPERATIONS RISKS
AlthoughMortgage loan delinquencies, defaults, and credit losses could reduce
our earnings. We have other types of credit risk that could also cause
losses. Credit losses could reduce our cash flow and access to
liquidity.
As a core part of our business, we assume the credit risk of mortgage
loans. We do this in each of our portfolios. We may add other product
lines over time that may have different types of credit risk than are
described here. We are generally hedgenot limited in the types of assets that
we can own or in the types of credit risk or other types of risk that we
can undertake.
Credit losses on residential mortgage loans can occur for many reasons,
including: poor origination practices (leading to losses from fraud,
faulty appraisals, documentation errors, poor underwriting, legal
errors, etc.); poor servicing practices; weak economic conditions;
declines in the values of homes; special hazards; earthquakes and other
natural events; over-leveraging of the borrower; changes in legal
protections for lenders; reduction in personal incomes; job loss; and
personal events such as divorce or health problems.
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Of our total net investment in our credit-enhancement portfolio, 15%
($12 million) was in a first loss position with respect to the
underlying loans. We generally expect that the entire amount of these
first loss investments will be subject to credit loss, potentially even
in healthy economic environments. Our ability to make an attractive
return on these investments depends on how quickly these expected losses
occur. If the losses occur more quickly than we anticipate, we may not
recover our investment and/or our rates of return may suffer.
Second loss investments, which are subject to credit loss when the
entire first loss investment (whether owned by us or by others) has been
eliminated by credit losses, make up 26% ($21 million) of our net
investment in credit enhancement interests. Third loss investments, or
other investments that themselves enjoy various forms of material
credit-enhancement, make up 59% ($48 million) of our net investment in
credit enhancement interests. Given our normal expectations for credit
losses, we would anticipate some future losses on many of our second
loss interests but no losses on investments in the third loss or similar
position. If credit losses are greater than, or occur sooner than,
expected, our expected future cash flows will be reduced and our
earnings will be negatively affected. Credit losses and delinquencies
could also affect the cash flow dynamics of these securitizations and
thus extend the period over which we will receive a return of principal
from these investments. In most cases, this would reduce our economic
and accounting returns. From time to time, we may pledge these interests
as collateral for borrowings: a deterioration of credit results in this
portfolio may adversely affect the terms or availability of these
borrowings, and thus our liquidity.
In our credit-enhancement portfolio, we may benefit from credit rating
upgrades or restructuring opportunities through re-securitizations or
other means in the future. If credit results deteriorate, these
opportunities may not be available to us, or may be delayed.
In anticipation of future credit losses, we designate a portion of our interest rate risk, the
resultspurchase discount associated with many of our credit enhancement
interests as a form of credit reserve. The remaining discount is
amortized into income over time via the effective yield method. If the
credit reserve we set aside at acquisition proves to be insufficient, we
may need to reduce our effective yield income recognition in the future
or we may adjust our basis in these interests, thus reducing earnings.
We are considering adopting EITF 99-20 during the first quarter of 2001.
Generally, under EITF 99-20, if prospective cash flows from certain
investments deteriorate even slightly from original expectations (due to
changes in anticipated credit losses, prepayment rates, and so forth),
then the asset will be marked-to-market (if the market value is lower
than our basis). Mark-to-market adjustments under EITF 99-20 will reduce
earnings.
In our residential retained loan portfolio, we assume the direct credit
risk of residential mortgages. Realized credit losses will reduce our
earnings and future cash flow. We have a credit reserve for these loans
and we may continue to add to this reserve in the future. There can be
no assurance that our credit reserve will be sufficient to cover future
losses. We may need to reduce earnings by increasing our
credit-provisioning expenses in the future. Prospective changes in
accounting rules may alter, limit, or eliminate our ability to create
such credit reserves.
Despite our efforts to manage our credit risk (as described in "Company
Business and Strategy: Operations"), there are many aspects of credit
that we cannot control, and there can be no assurance that our quality
control and loss mitigation operations will be successful in limiting
future delinquencies, defaults, and losses. Our underwriting reviews may
not be effective. The representations and warranties that we receive
from sellers may not be enforceable. We may not receive funds that we
believe we are affecteddue to us from mortgage insurance companies. We rely on
our servicers; they may not cooperate with our loss mitigation efforts,
or such efforts may otherwise be ineffective. Various service providers
to securitizations (such as trustees, bond insurance providers,
custodians, etc.) may not perform in a manner that promotes our
interests. The value of the homes collateralizing our loans may decline.
The frequency of default, and the loss severity on our loans upon
default, may be greater than we anticipated. Interest-only loans,
negative amortization loans, loans with balances over $1 million, and
loans that are partially collateralized by variousnon-real estate assets may
have special risks. Our geographical diversification may be ineffective
in reducing losses. If loans become REO (real estate owned), we, or our
agents, will have to manage these properties and may not be able to sell
them. Changes in consumer behavior, bankruptcy laws, and the like may
exacerbate our losses. In some states and circumstances, we have
recourse against the borrower's other factors,assets and income; but,
nevertheless, we may only be able to look to the value of the underlying
property for any
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recoveries. Expanded loss mitigation efforts in the event that defaults
increase could be costly. It is likely, in many of which are beyond
our control. The resultsinstances, that we will
not be able to anticipate increased credit losses in a pool soon enough
to allow us to sell such credit-enhancement interests at a reasonable
price.
Most of our operations depend on, amonginvestment portfolio assets (99% at December 31, 2000) were
effectively rated AAA or AA. These assets benefit from various forms of
corporate guarantees from Fannie Mae, Freddie Mac, and other things,companies
and/or from credit enhancement provided by third parties (usually
through their ownership of subordinated credit enhancement interests).
Thus, our investment portfolio assets are protected from currently
expected levels of credit losses. However, in the levelevent of net interest income generated bygreater than
expected future delinquencies, defaults, or credit losses, or a
substantial deterioration in the financial strength of Fannie Mae,
Freddie Mac, or other corporate guarantors, our mortgageresults would likely be
adversely affected. We may experience credit losses. Deterioration of
the credit results or guarantees of these assets may reduce the market
value of suchthese assets, thus limiting our borrowing capabilities and
access to liquidity. Generally, we do not control or influence the
supplyunderwriting, servicing, management, or loss mitigation efforts with
respect to these assets. Results could be affected through credit rating
downgrades, market value losses, reduced liquidity, adverse financing
terms, reduced cash flow, experienced credit losses, or in other ways.
To the extent that we invest in non-investment grade assets in our
investment portfolio (1% of our investment portfolio at December 31,
2000), our protection against credit loss is smaller and demand for suchour credit
risks and liquidity risks are increased. If we acquire equity
securities, results may be volatile.
The loans in our commercial retained loan portfolio may have higher
degrees of credit and other risks than do our residential mortgage
assetsloans, including various environmental and conditions in the debt markets. Ourlegal risks. The net
operating income and market values canof income-producing properties may
vary with economic cycles and as a result of changesother factors, so that debt
service coverage is unstable. The value of the property may not protect
the value of the loan if there is a default. Our commercial loans are
not geographically diverse, so we are at risk for regional factors: at
December 31, 2000, $56 million (73%) of our loan balances that we held
at Redwood and Holdings were on commercial properties located in
California. Many of our commercial loans are not fully amortizing, so
the timely recovery of our principal is dependent on the borrower's
ability to refinance at maturity. We lend against income-properties that
are in transition. Such lending entails higher risks than traditional
commercial property lending against stabilized properties. Initial debt
service coverage ratios, loan-to-value ratios, and other indicators of
credit quality may not meet standard commercial mortgage market
criteria. The underlying properties may not transition or stabilize as
expected. Personal guarantees and forms of cross-collateralization may
not be effective. We generally do not service our loans; we rely on our
servicers to a great extent to manage our commercial assets and work out
loans and properties if there are delinquencies or defaults. This may
not work to our advantage. Our loans are illiquid; if we choose to sell
them, we may not be able to do so in a timely manner or for a reasonable
price. Financing these loans may be difficult, and may become more
difficult if credit quality deteriorates. We may sell senior
participations in our loans, or similarly divide our loan assets so that
the asset we retain is junior and has concentrated credit and other
risks. We have directly originated our commercial loans. This may expose
us to certain credit, legal, and other risks that may be greater than is
usually present with acquired loans. We have sold commercial mortgage
loans. The representations and warranties we made on these sales are
limited, but could cause losses in some circumstances. We may invest in
other types of commercial loan assets, such as mezzanine loans, second
liens, credit-enhancement interests of commercial loan securitizations,
junior participations, collateralized bond obligations (CBO's), and so
forth, that may entail other types of risks.
Aside from mortgage credit risk, we have other credit risks that are
generally related to the counter-parties with which we do business. In
the event a counter-party to our short-term borrowings becomes
insolvent, we may fail in recovering the full value of our collateral,
thus reducing our earnings and long-termliquidity. In the event a counter-party
to our interest rates, supplyrate agreements becomes insolvent, our ability to
realize benefits from hedging may be diminished, and demand
trends, market liquidity, credit results, borrowing costs and prepayment rates,any cash or
collateral that we pledged to these counter-parties may be
unrecoverable. We may be forced to unwind these agreements at a loss. In
the behaviorevent that one of which involve various risks and uncertainties as set forth
below. Such risks may result in net interest lossesour servicers becomes insolvent or net market value losses
for certain periods. Prepayment rates, interest rates, borrowing costsfails to
perform, loan delinquencies and credit losses may increase. We may not
receive funds to which we are entitled. In various other aspects of our
business, we depend on the natureperformance of third parties that we do not
control. We attempt to diversify our counter-party exposure and termsto limit
our counter-party exposure to strong companies with investment-grade
credit ratings, but we are not always able to do so. Our counter-party
risk management strategy may prove ineffective.
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Tax and GAAP accounting for credit losses differ. We have not reduced
our past and current taxable income to provide for a reserve for future
credit losses. Thus, if credit losses occur in the future, taxable
income may be reduced relative to GAAP income. When taxable income is
reduced, our minimum dividend distribution requirements under the REIT
tax rules are reduced. We could reduce our dividend rate in such a
circumstance. Alternatively, credit losses in our assets may be capital
losses for tax. Unless we had offsetting capital gains, our minimum
dividend distribution requirement would not be reduced by these credit
losses, but eventually our cash flow would be. This could reduce our
free cash flow and liquidity.
If we incur increased levels of the mortgage assets, the
geographic locationcredit losses, our earnings might be
reduced, but also our cash flows, asset market values, and access to
borrowings might be reduced. The amount of the properties securing the mortgage loans included in or
underlying the mortgage assets, conditions in financial markets, the fiscalcapital and monetary policies of the United States government and the Board of Governors of
the Federal Reserve System, international economic and financial conditions,
competitioncash reserves
that we hold to help us manage credit and other factors, none of which canrisks may prove to be
predicted with any
certainty. Because changesinsufficient to protect us from earnings volatility, liquidity, and
solvency issues.
Fluctuations in interestour results may be exacerbated by the leverage that we
employ and prepayment rates may significantly
affect our activities, our operating results depend, in large part, upon our
ability to effectively manage our interest rate and prepayment risks while
maintaining our status as a REIT.by liquidity risks.
We employ substantial financial leverage and face potential net interest and operating
losses in connection with borrowings.
We intendon our balance sheet relative
to continue tomany non-financial companies (although we employ our financing strategy of borrowing a
substantial portion of the market value or, in the case of certain forms of
long-term debt, face value of our mortgage assets. The portion borrowed may vary
depending upon the mix of the mortgage assets in our portfolio and the
application of the risk-adjusted capital policy requirements to such mix of
mortgage assets. We expect generally to maintain a ratio of our total capital
base to book value of total mortgage assets of between 3% and 15%, although the
percentage may vary from time to time depending upon the market conditionsless leverage than
most banks, thrifts, and other factors deemed relevant by management. The capital base is the book value
of capital accounts, retained earnings, and subordinated debt deemed by
management to qualify as capital for this purpose, taking into account market
value adjustments. However, we are not limited under our bylaws in respect offinancial institutions). We believe the
amount of leverage that we employ is appropriate, given the risks in our
borrowings, whether secured or unsecured. Also,balance sheet, the aggregate
percentage of total equityfinancing structures that we employ, and our
management policies. In order to operate our business successfully, we
require continued access to debt on favorable terms with respect to
financing costs, capital could at times be outside the range of our
borrowings.efficiency, covenants, and other factors. We may experience net income losses if the returns on the mortgage
assets purchased with borrowed funds fail to cover the cost of the borrowings.
In addition, we
may not be able to achieve the degree of leverage we believe to
be optimal. Increases in haircuts, decreases in the market value of our mortgage
assets, increases in interest rate volatility, availability of financing in the
market, and rating agency and bond insurer requirements for long-term financing
and circumstances then applicable in the lending market are some of the factors
that would prevent us from achieving the optimal degreeamount of leverage.
If we are
not able to achieveGiven the degree of leverage that we believeemploy, earnings fluctuations, and
liquidity and financial soundness issues could arise in the future. Due
to be optimal,our leverage, relatively small changes in asset quality, asset yield,
cost of borrowed funds, and other factors could have relatively large
effects on our company and our stockholders. Our use of leverage may not
enhance our returns.
Although we do not have a corporate debt rating, the
resultsnationally-recognized credit rating agencies have a strong influence on
the amount of capital that we hold relative to the amount of credit risk
we take. The rating agencies determine the amount of net investment we
must make to credit-enhance the long-term debt (mostly rated AAA) that
we issue to fund our residential retained loan portfolio. They also
determine the amount of principal value required for the
credit-enhancement interests we acquire. The credit-rating agencies,
however, do not have influence over how we fund our net credit
investments nor do they determine or influence many of our operationsother capital
and leverage policies. With respect to our short-term debt, our lenders
(typically large commercial banks and Wall Street firms) limit the
amount of funds that they will advance versus our collateral. We
typically employ far less leverage than would be permitted by our
lenders. However, lenders can reduce the amount of leverage that they
will permit us to undertake, or the value of our collateral may decline,
thus reducing our liquidity.
Unlike banks, thrifts, and the government-sponsored real estate finance
companies, we are not regulated by national regulatory bodies. Thus, the
amount of financial leverage that we employ is largely controlled by
management, and by the risk-adjusted capital policies approved by our
Board of Directors.
In the period in which we are accumulating residential whole loans in
order to build a portfolio of efficient size to issue long-term debt,
variations in the market for long-term debt issuance could affect our
results. Ultimately we may not be able to issue long term debt, the cost
of such debt could be greater than we anticipated, the net investment in
our financing trust required by the rating agencies could be greater
than anticipated, certain of our loans could not be accepted into the
financing trust, or other negative effects could occur.
We borrow on a short-term basis to fund our investment portfolio, to
fund residential loans prior to the issuance of long-term debt, to
employ a certain amount of leverage with respect to our net investments
in credit-enhancement interests, to fund our commercial loan portfolio,
to fund working capital and general corporate needs, and for other
reasons. We borrow short-term by pledging our mortgage assets as
collateral. We usually borrow via uncommitted borrowing facilities for
the substantial majority of our short-term debt funded assets that are
generally liquid, have active trading markets, and have readily
discernible market prices. The term of these borrowings can range from
one day to one year. To fund less profitable than they might be otherwise.
Failureliquid or more specialized assets, we
typically utilize committed
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credit lines from commercial banks and finance companies with a one to
refinance outstanding borrowings may adversely affecttwo year term. Whether committed or not, we need to roll over short-term
debt on a frequent basis; our ability to achieve our investment objectives.
Our ability to achieve our investment objectives depends not onlyborrow is dependent on our
ability to borrow money indeliver sufficient amounts and on favorable terms but also on our
ability to renew or replace on a continuous basis our maturing short-term
borrowings. At December 31, 1999, we relied on short-term borrowings and equity
to fund 59% of our mortgage assets. We have utilized short-term borrowings to
fund adjustable-rate, hybrid and fixed-rate
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mortgage assets. In the event we are not able to renew or replace maturing
borrowings, we could be required to sell mortgage assets and related interest
rate agreements under adverse market conditions and could incur losses as a
result. An event or a development such as a sharp increase or decrease in
interest rates or increasing market concern about the value or liquidity of a
type or types of mortgage loans or mortgage securities which are short-term
funded will reduce the market value of the mortgage assets. This would likely
cause lenders to require additional collateral. At the same time, the market
value of the unpledged collateral kept on hand to meet calls for additional
collateral pledgeslender
requirements. Our payment of commitment fees and other expenses to
secure committed borrowing lines may have decreased. A number of such factorsnot protect us from liquidity
issues or losses. Variations in combination
may cause us difficulties, including a possible liquidation of a major portion
of our mortgage assets at disadvantageous prices with consequent losses. This
could have a materially adverse effect on us and our solvency.
Decline in market value of mortgage assets may limit ourlenders' ability to borrow,
resultaccess funds, lender
confidence in lenders initiating margin calls,Redwood, lender collateral requirements, available
borrowing rates, the acceptability and require us to sell mortgage
assets in adverse market conditions.
Some of our mortgage assets may be cross-collateralized to secure our multiple
borrowing obligations from a single lender. A decline in the market value of our
portfolio of mortgage assets may limit our ability to borrow or result in
lenders initiating margin calls. A lender's margin call requires a pledge of
cash or additional mortgage assets to re-establish the ratio of the amount of
the borrowing to the value of the collateral. We may acquire fixed-rate or
hybrid mortgage assets pursuant to our asset acquisition/capital allocation
policies. Such fixed-rate mortgage assets, if funded with short-term debt, may
be more susceptible to margin calls because increases in interest rates tend to
more negatively affect the market value of fixed-rate or hybrid mortgage assets
than adjustable-rate mortgage assets. This remains true despite effective
hedging against such fluctuations because the hedging instruments may not be
part of the collateral securing the collateralized borrowings.
Additionally, it may be difficult to realize the full value of the hedging
instrument when desired for liquidity purposes due to the applicable REIT
provisions of the Code. We could be required to sell mortgage assets under
adverse market conditions in order to maintain liquidity. Management may effect
such sales when deemed by it to be necessary in order to preserve our capital
base. If these sales were made at prices lower than the basis of the mortgage
assets, we would experience losses.
A default by us under our short-term or long-term collateralized borrowings
could also result in a liquidation of the collateral, including any
cross-collateralized assets, and a resulting loss of the difference between the
value of the collateral and the amount borrowed.
Additionally, in the event of our bankruptcy, most reverse repurchase agreements
will qualify for special treatment under the bankruptcy laws. This will allow
the creditors under such agreements to avoid the automatic stay provisions of
the bankruptcy laws and to liquidate the collateral under such agreements
without delay. Conversely, in the event of the bankruptcy of a party with whom
we had a reverse repurchase agreement, we might experience difficulty recovering
the collateral subject to such agreement. In addition, our claims against
creditors could be subject to significant delay. Recoveries, if and when
received, may be substantially less than the damages we actually suffered.
To the extent that we are compelled to liquidate mortgage assets that are
qualified REIT real estate assets to repay borrowings, we may be unable to
comply with the REIT provisions of the Code regarding assets and sources of
income requirements. This would ultimately jeopardize our status as a REIT.
Failure to maintain REIT status would eliminate our competitive advantage over
non-REIT competitors and subject us to federal taxation.
Interest rate fluctuations may result in a decrease in net interest income
and/or may result in a decline in the market value of mortgage assets.
We cannot perfectly match the maturities and interest rate adjustment
frequencies of our assets and liabilities. We cannot hedge away all such
mis-matches. We may not choose to match or hedge assets and liabilities to the
full extent possible. Thus, the spread between interest income and interest
expense will vary, and may go negative, as interest rates fluctuate. In
addition, since earnings also consist of appreciation and depreciation of
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15 market values of assets as well as interest income, overall earnings may be
volatile as comparedour collateral,
and other factors could force us to utilize our cost of funds.
Changes in prepayment characteristics of mortgage assets may result in a
decrease in net interest income and/liquidity reserves or may result in a decline in the market
value of mortgage assets.
Mortgage asset prepayment rates vary from time to
time and may cause changes in
the amount of our net interest income and asset appreciation income. Prepayments
of adjustable-rate, fixed rate, and hybrid mortgage loans and mortgage
securities backed by adjustable-rate, fixed-rate, and hybrid mortgage loans
usually can be expected to increase when mortgage interest rates fall below the
then-current interest rates on suchsell assets, and decrease when mortgage interest
rates exceedthus affect our liquidity, financial soundness, and
earnings. In recent years, we believe that the then-current interest rate on the assets, although such effects
are not fully predictable. Prepayment experience may also be affected by changes
in consumer behavior, the geographic locationmarketplace for our type
of the property securing the
mortgage loans, the assumability of the mortgage loans, advances in technology
and reduction of costs with respect to refinancing mortgages, conditions in the
housing and financial markets, general economic conditions, and other factors.
Mortgage securities backed by single family mortgage loans are often structured
so that certain classes are provided protection from prepayments for a period of
time. However, in a period of extremely rapid prepayments, during which
earlier-paying classes may be retired faster than expected, the protected
classes may receive unscheduled payments of principal earlier than expected and
would have average lives that, while longersecured short-term borrowing has been more stable than the average livescommercial
paper market (corporate unsecured short-term borrowing) utilized by much
of the
earlier-paying classes, would be shorter than originally expected. Commercial
mortgages and some residential mortgages are structured with prepayment
penalties. However, these loans can still prepay, and the cost to us of such
prepayment may exceed the penalties received. We seek to minimize prepayment
risk through a variety of means, which may include, to the extent capable of
being implemented at reasonable cost at various points in time, structuring a
diversified portfolio with a variety of prepayment characteristics, investing in
mortgage assets with prepayment prohibitions and penalties, investing in certain
mortgage securities structures which have prepayment protection, balancing
assets purchased at a premium with mortgage assets purchased at a discount, and
prepayment hedging. In many operating environments, however, it is not be
possible for us to acquire assets with a relatively small net balance of
discount and premium. Our discount and premium mortgage assets may have
different prepayment incentives for their borrowers, or the borrowers may
respond differently to such incentives, or such assets may have different
effective prepayment lock-out features. Thus, the level of our net premium or
discount may not fully reflect the underlying prepayment risk. Even if we do
have low levels of net mortgage premium or discount, changes in prepayment rates
can affect earnings by affecting the market values of assets. We may choose not
to hedge prepayment risk, and any such hedges we do make may not be effective.
In such circumstances, the risk of earning variability resulting from changes in
prepayment rates may rise. In addition, we have purchased and/or created
interest-only and principal-only strips. These securities are leveraged with
respect to prepayment risk although they may also serve as prepayment hedges. No
strategy can completely insulate us from prepayment risks arising from the
effects of interest rate changes while simultaneously meeting returns acceptable
to shareholders.
Changes in anticipated prepayment rates of mortgage assets could affect us in
several adverse ways. The faster than anticipated prepayment of any adjustable-,
hybrid, or fixed-rate mortgage asset that we purchased at a premium would
generally result in higher premium amortization expense. In addition, increased
prepayments may be a disadvantage to us in environments where we can only
acquire assets with lower returns than our existing assets. Slower than
anticipated prepayment rates will decrease discount amortization income for
discount mortgage assets and will reduce our ability to invest in new mortgage
assets with higher yields when such assets are available. In addition, depending
on asset type or characteristics, slowing or increasing mortgage prepayment
rates may reduce market values and thus reduce or eliminate any asset
appreciation income or cause reported losses.
Failing to hedge against interest rate changes effectively may adversely affect
results of operations.
Our operating strategy subjects us to interest rate risks. We follow an
asset/liability management program intended to partially protect against
interest rate changes and prepayments. Nevertheless, developing an effective
asset/liability management strategy is complex and no strategy can completely
insulate us from risks associated with interest rate changes and prepayments.
Also, we do not attempt to hedge all such risks. In addition,corporate America, but there is no assurance that such stability will
continue.
Various of our hedging activities willborrowing arrangements subject us to debt covenants.
While these covenants have not been restrictive through December 31,
2000, they could be restrictive or harmful to stockholder interests in
the desired beneficial impact on
our operating resultsfuture. Should we violate debt covenants, we may incur expenses,
losses, or financial condition. Hedging typically involves costs,
including transaction costs, which increase dramatically as the period covered
by the hedge increases and which also increase during periods of rising and
volatile interest rates. We may
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increase our hedging activity, and thus increase our hedging costs, during such
periods when interest rates are volatile or rising and/or when hedging costs
have increased. Moreover, federal tax laws applicable to REITs may substantially
limit ourreduced ability to engage in asset/liability management transactions. Such
federal tax laws may prevent us from effectively implementing hedging strategies
that we determine, absent such restrictions, would best insulate us from the
risks associated with changing interest rates and prepayments.
We use mark-to-market accounting for all of our interest rate agreements,
whereas, not all of our hedged assets and liabilities are marked-to-market inaccess debt.
Preferred stock makes up a
similar manner. As a result of the use of different accounting treatments
between assets, liabilities, and their hedges, earnings volatility may result.
We purchase and sell from time to time interest rate caps, interest rate swaps,
interest rate futures, and similar instruments to attempt to mitigate the risk
of the spread between the yield on earning assets and the cost of funds
narrowing as interest rates change. We also attempt to hedge, to some degree,
the market values of balance sheet items. Also, we purchase and sell interest
rate caps, interest rate swaps, interest rate futures, and similar instruments
to attempt to modify the characteristics of any fixed-rate loan issuance, or to
hedge the anticipated issuance of future liabilities or the market value of
certain assets. We may also buy or sell US Treasury securities, mortgage
securities, agency securities, or other cash instruments as part of our hedging
strategy. In this way, we intend generally to hedge as much of the interest rate
risk and prepayment risk as management determines is in our best interests given
the cost of such hedging transactions and the need to maintain our status as a
REIT. The amount of income we may earn from our interest rate caps and other
hedging instruments is subject to substantial limitations under the REIT
provisions of the Code. In particular, when we earn income under such
instruments, we will seek advice from tax counsel as to whether such income
constitutes qualifying income for purposes of the 95% gross income test and as
to the proper characterization of such arrangements for purposes of the REIT
asset tests. This determination may result in our electing to bear a level of
interest rate risk that could otherwise be hedged when management believes,
based on all relevant facts, that bearing such risk is advisable.
Hedging poses a credit risk.
In the event that we purchase interest rate caps or floors or enter into other
contractual interest rate agreements to hedge against lifetime and periodic rate
or payment caps, and the provider of interest rate agreements becomes
financially unsound or insolvent, we may be forced to unwind our interest rate
agreements with such provider and may take a loss on such interest rate
agreements. There is no assurance that we can avoid such third party risks.
Difference in performance between the hedging instrument and hedged items may
adversely affect results of operations.
We also accept basis risk in entering into interest rate swap and cap agreements
and other hedges. Basis risk occurs as the performance of hedged items and/or
hedging instruments vary from expectations and differ in performance from each
other. For instance, we hedge our liabilities to mitigate interest rate risk of
mortgage assets that are fixed or reprice at different times or are based on
different indices. Although the hedging item may reduce interest rate risk,
mortgage borrowers may prepay at speeds that vary from initial expectation. We
could have a hedging instrument in place without an underlying hedged liability.
We also, to a partial degree, may seek to hedge changes in asset market values.
Basis risk arises because asset market values can change for many other reasons
than are hedgeable. Any differences from original expectations in basis,
prepayment rates, market values or other factors may have a material adverse
effect on results of our operations.
We face credit loss exposure on mortgage assets.
A substantial portion of our portfolioequity capital base (12% at
December 31, 1999 consisted2000). Our Class B Preferred Stock has a dividend rate of
single-family mortgage loans or mortgage assets evidencing interestsat least $0.755 per share per quarter, and has certain rights to
dividend distributions (and preferences in single-family mortgage loans. At December 31, 1999, 58% of the mortgage assets
we owned were single-family mortgage loans and 41% were single-family mortgage
securities. Commercial mortgage loans totaled $8 million, or 0.4% of assets. We
bear the risk of credit loss on any residential or commercial mortgage assets we
purchase in the secondary mortgage market or through our mortgage lending
business. To the extent third parties have been contracted to provide the credit
enhancement, we are dependent in part upon the credit worthiness and
claims-paying ability of the insurer and the timeliness of reimbursement in the
event of a default on the underlying obligations. Furthermore, the insurance
coverage for various types of losses is limited in amount and losses in excess
of the limitation would be borne us.
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Prior to securitization, we generally do not intend to obtain credit
enhancements such as mortgage pool or special hazard insurance for our
residential and commercial mortgage loans, other than FHA insurance, VA
guarantees, and private mortgage insurance, in each case relating only to
individual residential mortgage loans. Accordingly, during the time we hold such
mortgage loans for which third party insurance or other credit enhancements are
not obtained, we will be subject to risks of borrower defaults and bankruptcies
and special hazard lossesliquidation) that are senior
to common stockholders. Having preferred stock in our capital structure
is a form of leverage, and such leverage may or may not covered by standard hazard insurance,
such as those occurring from earthquakes or floods. In the event of a default on
any mortgage loan held by us, including, without limitation, resulting from
higher default levels as a result of declining property values and worsening
economic conditions, among other factors, we would bear the risk of loss of
principalwork to the
extentadvantage of any deficiency between the value of the related real
property, plus any payments from an insurer or guarantor, and the amount owing
on the mortgage loan. Defaulted mortgage loans would also cease to be eligible
collateral for short-term borrowings and, to the extent not funded with
long-term non-recourse debt, would have to be financed by us out of other funds
or funded with equity until ultimately liquidated, resultingcommon stockholders.
Changes in increased
financing costs and reduced net income or a net loss.
We expect to pool mortgage loans funded short-term and securitize them to obtain
long-term financing. In doing so we may continue to bear the risk of loss on the
underlying mortgage loans because we may not obtain third party credit
enhancements and we may retain the subordinated securities of the resulting
structure. In addition, we intend to continue to purchase subordinated mortgage
securities issued by others wherein the risk of credit loss in our interest is
based on the underlying mortgage loans in the entire pool. In these cases, our
credit loss exposure is based on a larger pool of assets than may appear on our
balance sheet, although our potential losses are limited to our investment in
such subordinated pieces.
A dramatic increase in short-term interest rates may adversely affect our
results of operations.
Our liabilities generally reset monthly while our assets reset monthly,
semi-annually or annually. Thus, a dramatic increase in short-term rates would
result in an increase in our cost of funds sooner than the coupon rates would
reset on our assets. Furthermore, most of our assets have periodic caps and life
caps that may limit the amount by which the coupon rates reset whereas there
generally are no limitations as to how fast or how far our cost of funds might
rise. As a result of these factors, should short-term interest rates rise very
quickly and dramatically, our interest expense for our borrowings may exceed the
interest income earned on our assets for a period of time. In such a
circumstance, not only would our net interest income be reduced or eliminated,
but also the market values of our assets would likely decline. Such declines
could materially effect our reported earnings and our liquidity. We attempt to
mitigate such risk through our hedging programs, but thereliabilities can be no assurance
that such hedge strategies will fully cover this risk.
Inability to acquire attractively priced and underwritten mortgage assets may adversely
affect our ability to achieve our investment objectives.
Sinceearnings, stockholders' equity, and liquidity.
The market values of our assets, pay downliabilities, and hedges are affected by
interest rates, the shape of yield curves, volatility, credit quality
trends, mortgage prepayment rates, supply and demand, capital markets
trends and liquidity, general economic trends, expectations about the
future, and other factors. For the assets that we mark-to-market through
scheduledour income statement and/or balance sheet, such market value
fluctuations will affect our earnings and book value. To the extent that
our basis in our assets is thus changed, future income will be affected
as well. If we sell an asset that has not been marked-to-market through
our income statement at a reduced market price relative to our basis,
our earnings will be reduced. Market value reductions of the assets that
we pledge for short-term borrowings may reduce our access to liquidity.
Generally, reduced asset market values for the assets that we own may
have negative effects, but might improve our opportunities to acquire
new assets at attractive pricing levels. Increases in the market values
of our existing assets may have positive effects, but may mean that
acquiring new assets at attractive prices becomes more difficult.
Changes in mortgage prepayment rates may affect our earnings, liquidity,
and the market values of our assets.
Mortgage prepayment rates are affected by interest rates, consumer
behavior and confidence, seasoning of loans, the amount of equity in the
underlying properties, prepayment terms of the mortgages, the ease and
cost of refinancing, the housing turnover rate, media awareness of
refinancing opportunities, and many other factors.
Changes in prepayment rates may have multiple effects on our operations.
Faster mortgage prepayment rates may lead to increased premium
amortization expenses for premium assets, increased working capital
requirements, reduced market values for certain types of assets, adverse
reductions in the average life of certain assets, and an increase in the
need to reinvest cash to maintain operations. Premium assets may
experience faster rates of prepayments than discount assets. Slower
prepayment rates may lead to reduced discount amortization income for
discount assets, reduced market values for discount and other types of
assets, extension of the average life of certain investments at a time
when this would be contrary to our interests, a reduction in cash flow
available to support operations and make new investments, and a
reduction in new investment opportunities (since the volume of new
origination and securitizations would likely decline). Slower prepayment
rates may lead to increased credit losses.
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The amount of premium and discount we have on our books, and thus our
net amortization expenses, can change over time as we mark-to-market
assets or as our asset composition changes through principal repayments
and through
prepayments, we must reinvest our capital in new assets to keep our capital
fully employedasset purchases and meet our objectives. Theresales.
Interest rate fluctuations can be no assurance that we will
be able to acquire sufficient mortgage assets at spreads above our cost of
funds. Our net income depends, in large part,have various effects on our abilitycompany, and
could lead to acquire mortgage
assets at favorable spreadsreduced earnings and / or increased earnings volatility.
Our balance sheet and asset/liability operations are complex and diverse
with respect to our borrowing costs. In acquiring mortgage
assets, we compete with other REITs, investment banking firms, savings and loan
associations, banks, mortgage bankers, insurance companies, mutual funds, other
lenders, and other entities purchasing mortgage assets, many of which have
greater financial resources than we have.
In addition, in fluctuating interest rate environments, costmovements, so it is not possible to
describe all the borrower on
new adjustable-rate and hybrid mortgage loans may increase relativepossible effects of changing interest rates. We do not
seek to the cost
to the borrower on new fixed-rated mortgage loans. Under such conditions,
borrowers tend to favor fixed-rate mortgage loans, thereby decreasing the supply
of adjustable-eliminate all interest rate and hybrid loans available for us to purchase. In addition,
an increaserisk. Changes in refinancings from adjustable-rate and hybrid loans to fixed-rate
loans may occur, thus increasing the prepayment rates experienced by our
portfolio and increasing our asset purchase requirements. In addition, the
relative availability of adjustable-rate and hybrid mortgage loans may also be
diminished by a number of other market and regulatory considerations. In these
circumstances, we may be required to change our investment strategies to
emphasize different asset
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types, may pay higher prices for relatively scarce adjustable-rate and hybrid
loans, and/or may operate with a reduced asset size. Each of these strategies
may reduce our earnings.
A flattening or inversion of the yield curve between short and long-term interest rates, may adversely affect our results of operations.
The shape ofand
in the yield curve will affect the results of our operations.
Generally, a flat yield curveinterrelationships between one month and one yearvarious interest rates, will
tend to reduce our spread between our yield on assets and our cost of funds,
thereby reducing net interest income. Lower short-term rates reduce the yields
on both our assets and our cost of funds but maycould have
the overall effect of
lowering net interest income over time as the yieldnegative effects on our assets funded with
equity would tend to decline.
The shape of the yield curve between short-term and long-term interest rates
generally affects the prepayment behavior of our mortgage assets. Lower
long-term rates generally result in faster prepayments that increase our
amortization expense, lowerearnings, the market value of our assets and
liabilities, mortgage prepayment rates, and our access to liquidity.
Changes in interest rates can also affect our credit results.
Generally, rising interest rates could lead to reduced asset market
values and slower prepayment rates. Initially, our net interest income
may be reduced if short-term interest rates increase, as our cost of
funds would likely respond to this increase more quickly than would our
asset yields. Within 3 to 12 months of a rate change, however, asset
yields for our adjustable rate mortgages may increase commensurately
with the rate increase. Higher short-term interest rates may reduce
net
income.
We lack voting controlearnings in the short-term, but could lead to higher long-term earnings,
as we earn more on the equity-funded portion of our taxable affiliates.
We formed Holdings to serve as a holding company for our taxable affiliates to
legally separate lines of business from the REIT entity. This was done for
regulatory, tax, risk management, and other reasons. George E. Bull III and
Douglas B. Hansen, executive officers of Redwood Trust, Inc., own 100% of the
voting common stock of Holdings while we own 100% of Holdings' nonvoting
preferred stock. The common stock is entitled to one percent of dividend
distributions of Holdings and the preferred stock is entitled to 99% of such
distributions. Holdings wholly owns RCF and other subsidiaries. Without voting
control of Holdings and its subsidiaries, we cannot be assured that their
business activities and policies may not differ from those that would be
followed if we did have voting control. In addition, while Holdings and Messrs.
Bull and Hansen have entered into an agreement of shareholders which contains
certain management and control provisions and restrictions on transfer of the
common stock of Holdings, we cannot be assured that the agreement will be
enforced in a timely manner against the individuals, their heirs or
representatives. We are obligated to pay preferred dividends before common
dividends, and certain restriction are imposed on us by the preferred
stockholders.
HOLDINGS OPERATIONS RISKS
Holdings operations will have an impact on our overall performance. There are
many risks associated with the business conducted at Holdings, and its operating
results are difficult to ascertain.balance sheet. To
the extent Holdingsthat we own fixed rate assets that are funded with floating
rate debt, our net interest income from this portion of our balance
sheet would be unlikely to recover until interest rates dropped again or
its subsidiaries
engagethe assets matured. Many of our adjustable-rate mortgages have periodic
caps that limit the extent to which the coupon we earn can rise or fall
(usually a 2% annual cap) and life caps that set a maximum coupon
(averaging 11.43% for our portfolio). If short-term interest rates rise
rapidly or rise so that our mortgage coupons reach their life caps, the
ability of our asset yields to rise along with market rates would be
limited, but there would be no such limits on the increase in portfolio lending, they faceour
liability costs.
Falling interest rates can also lead to reduced asset market values in
some circumstances, particularly for prepayment sensitive assets and for
many types of interest rate agreement hedges. Decreases in short-term
interest rates can be positive for earnings in the near-term, as our
cost of funds may decline more quickly than our asset yields would. For
longer time horizons, falling short-term interest rates can reduce our
earnings, as we may earn lower yields from the assets that are
equity-funded on our balance sheet.
Changes in the interrelationships between various interest rates can
reduce our net interest income even in the absence of a clearly defined
interest rate trend. If the short-term interest rate indices that drive
our asset yields were to decline relative to the short-term interest
rate indices that determine our cost of funds, our net interest income
would be reduced.
Hedging activities may reduce long-term earnings and may fail to reduce
earnings volatility or to protect the capital of the risks discussed above. In
addition, RCFcompany in
difficult economic environments.
Hedging against interest rate movements using interest rate agreements
and other instruments usually has the effect over long periods of time
of lowering long-term earnings. To the extent that we hedge, it is
subjectusually to operations risks includingprotect the following:
RCF facescompany from some of the riskseffects of a recently formed enterprise.
RCF israpid or
prolonged increase in short-term interest rates or to lower short-term
earnings volatility. Such hedging may not be in the long-term interest
of stockholders, and may not achieve its desired goals. For instance,
hedging costs may rise as interest rates increase, without an offsetting
increase in hedging income. In a recently formed enterprise. We cannot assure you that RCF will achieverapidly rising interest rate
environment, the market values of hedges may not increase as predicted.
Using interest rate agreements to hedge may increase short-term earnings
volatility, particularly since we employ mark-to-market accounting for
all our hedges. Reductions in market values of interest rate agreements
may not be offset by increases in market values of the assets or
liabilities being hedged. Changes in market values of interest rate
agreement hedges may require us to pledge collateral or cash.
Maintaining REIT status may reduce our flexibility.
To maintain profitability. RCF plansREIT status, we must follow rules and meet certain tests. In
doing so, our flexibility to expand and develop its business. There
can be no assurance that such activities will be effective.
RCFmanage our operations may be adversely impacted byreduced.
Frequent asset sales (acting as a "dealer") may be inconsistent with
REIT regulations.
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Certain types of hedging may produce income that is limited under the
REIT rules. Our ability to own non-real estate related assets and earn
non-real estate related income is limited. Meeting minimum REIT dividend
distribution requirements may reduce our liquidity. Because we
distribute much of our earnings as dividends, we may need to raise new
equity capital in order to grow operations at a rapid pace. Stock
ownership tests may limit our ability to raise significant amounts of
equity capital from one source. Failure to meet REIT requirements may
subject us to taxation, penalties, and / or loss of REIT status. REIT
laws and taxation could change in a manner adverse to our operations. To
pursue our business plan as a REIT, we generally need to avoid becoming
a Registered Investment Company (RIC). To avoid RIC restrictions, we
generally need to maintain at least 55% of our assets in whole loan form
or in other related forms of assets that qualify for this test. Meeting
this test may restrict our flexibility. Failure to meet this test would
limit our ability to leverage and would impose other restrictions on our
operations. Our ability to operate a taxable subsidiary is limited under
the REIT rules. Our REIT status affords us certain protections against
take-over attempts; these take-over restrictions may not always work to
the advantage of stockholders.
Our cash balances and cash flows may become limited relative to our cash
needs.
We need cash to meet our working capital needs, preferred stock
dividend, and minimum REIT dividend distribution requirements. Cash
could be required to pay down our borrowings in the event that the
market values of our assets that collateralize our debt decline, the
terms of short-term debt become less attractive, or for other reasons.
Cash flows from principal repayments could be reduced should prepayments
slow or credit losses.
RCF faces riskquality trends deteriorate (for certain of loss on its commercial mortgage loans dueour assets,
credit tests must be met for us to defaultreceive cash flows). For some of our
assets, cash flows are "locked-out" and we receive less than our
pro-rata share of principal payment cash flows in the early years of the
borrowersinvestment. Operating cash flow generation could be reduced if earnings
are reduced, if discount amortization income significantly exceeds
premium amortization expense, or for credit or other reasons. Commercial mortgage loans of the type
originated by RCFOur minimum dividend
distribution requirements could become large relative to our cash flow
if our income as calculated for tax purposes significantly exceeds our
cash flow from operations. Generally, our cash flow has materially
exceeded our cash requirements. We generally maintain what we believe
are generally subjectample cash balances and access to higher levels of credit and other
risks comparedborrowings to residential mortgage loans in our portfolio.meet projected cash
needs. In the event, of
default, the collateral securing such loanshowever, that our liquidity needs exceed our access
to liquidity, we may not be adequate to fully
discharge the amounts due. RCF bears directly the risk of loss on loans being
held by it for sale to investors. RCF relies on being able to originate and
acquire commercial loans at prices lower than its investors will buy these
loans. Credit concerns from delinquent or defaulted loans, as well as other
factors such as interest rate variations, failure to hedge effectively, supply
and demand considerations in the market place, and the like, can reduce or
eliminate RCF's ability to realize a gain on sale. Although RCF generally does
not make representations and warranties to its investors upon sale of its loans,
if the loans sold by RCF perform poorly, RCF's ability to continueneed to sell loans
to investorsassets at an inopportune time, thus
reducing our earnings. In a serious situation, our REIT status or our
solvency could be significantly diminished and cause RCF to curtailthreatened.
Increased competition could reduce our acquisition opportunities or
suspend its lending activities.
RCF may be adversely impacted by market risk.
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RCF maintains inventory positions in commercial mortgage loans. In addition, RCF
may enter into commitments to sell mortgage loans and may hold loans on a
temporary basis pending resale. As such, RCF is exposed to market risk. Market
risk includes the risk of decrease in market value of the inventoried assets due
to interest rate changes, a downturn in the commercial real estate market, or
other factors and the risk of reduced net interest income or losses from
prepayment levels higher than anticipated or increased funding costs. In
addition, counterparties to loan sale commitments may not be able or willing to
complete transactions, thus potentially exposing RCF to loss.
RCF is dependent on the availability of borrowings.
In order to facilitate its loan originations, RCF will rely on short-term
collateralized borrowing arrangements. The cost and availability of such funding
may affect RCF's profitability and ability to maximize returns on the
opportunities it creates. There is no assurance that RCF will be able to obtain
or retain such borrowing arrangements.
OTHER RISKS
We depend on key personnel for successful operations.
Both our operations and those of Holdings and its affiliates depend
significantly upon the contributions of their respective executive officers.
Many of such executive officers would be difficult to replace. The loss of any
key person could materially adversely affect business and operating results.
Capital stock price volatility may negatively impact liquidity of our common
stock and may cause investors in our common stock to experience losses.
Capital stock price volatility may adversely affect the market price of our
common stock. With respect to the public market for our common stock, it is
likely that the market price of the common stock will be influenced by earnings
volatility and by the market's perception of our ability to achieve earnings
growth. Our earnings resulting from activities at Redwood Trust and Holdings are
dependent on revenues, which consist primarily of net asset appreciation, net
gain on sale and interest income, exceeding expenses, consisting primarily of
interest expense, hedging expenses, credit expenses, operating expenses and, in
the case of Holdings, taxes. All of these elements can be volatile with respect
to a variety of internal and external factors. Liquidity and capital issues can
have large effects. Our dividend, and practices with respect to paying a
dividend, may also effect the stock price. In addition, if the market price of
other REIT or financial stocks decline for any reason, or if there is a
broad-based decline in real estate values or in the value of our mortgage assets
and the market price of our common stock has been adversely affected due to any
of the foregoing reasons, the liquidity of our common stock may be negatively
affected and investors who may desire or be required to sell shares of common
stock may experience losses.
COMPETITION
REDWOOD TRUSTnegative manner.
We believe that our principal competitioncompetitors in theour business of acquiring,
managing, credit-enhancing and financing mortgage assets and issuing
mortgage-backed debt to investorsreal estate
finance are financial institutionsdepositories such as banks savings and loans,thrifts, mortgage and bond
insurance companies, other mortgage REITs, hedge funds and private
investment partnerships, life insurance companies, bond insurance companies, mortgage
insurance companies,government entities
such as Fannie Mae, Freddie Mac, Ginnie Mae, and the Federal Home Loan
Banks, institutional investors such as mutual funds, pension funds, mortgage originators, and hedge funds, and certain
other
mortgage REITs. While most of these entities have significantly greater
resources than us, wefinancial institutions. We anticipate that we will be able to compete
effectively and
generate relatively attractive rates of return for our stockholders due to our relatively low level of operating costs, relative
freedom to securitize our assets, our ability to utilize prudent amounts of leverage, through accessing the
wholesale market for collateralized borrowings,
freedom from certain forms of regulation, focus on our core business,
and the tax advantages of itsour REIT status. The existence of these
competitive entities, as well as the possibility of additional entities forming
in the future, may increase the competition for the acquisition of mortgage
assets resulting in higher prices and lower yields on such mortgage assets. We
believe we are and plan to continue to be a "low cost producer" compared toNevertheless, most of our
competitors in the business of holding, credit-enhancinghave greater operating and financing
mortgage assets.
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RWT HOLDINGS, INC.
Holdings' business unit, RCF, competes in the business of originating,
purchasing, and selling commercial mortgage loans with established mortgage
correspondent programs, investment banking firms, securities broker-dealers,
savings and loan associations, banks, finance companies, mortgage bankers,
mortgage brokers, insurance companies, other lenders, and other entities
originating and selling commercial mortgage assets. Many of the institutions
with which RCF competes in these operations have significantly greater financial resources than RCFwe do.
Competition from these entities, or new entrants, could raise mortgage
prices, reduce our acquisition opportunities, or otherwise materially
effect our operations in a negative manner.
Mortgage assets may not be available at attractive prices, thus limiting
our growth and Holdings. Fluctuations/ or earnings.
In order to reinvest proceeds from mortgage principal repayments, or to
deploy new equity capital that we may raise in the volume and cost of
acquiringfuture, we need to
acquire new mortgage assets resulting from competition from other prospective
originatorsassets. If pricing of mortgage assets is
unattractive, or if the availability of mortgage assets is much reduced,
we may not be able to acquire new assets at attractive prices. Our new
assets may generate lower returns than the assets that we have on our
balance sheet. Generally, unattractive pricing and availability of
mortgage assets is a function of reduced supply and / or increased
demand. Supply can be reduced if originations of a particular product
are reduced, or if there are few sales in the secondary market of
seasoned product from existing portfolios. The supply of securitized
mortgages appropriate for our balance sheet could adverselybe reduced if the
economics of securitization become unattractive or if a form of
securitization that is not favorable for our balance sheet predominates.
Also, assets with a favorable risk/reward ratio may not be available
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if the risks of owning mortgages increase substantially relative to
market pricing levels. Increased competition could raise prices to
unattractive levels.
Accounting conventions can change, thus affecting our reported results
and operations.
Accounting rules for the various aspects of our business change from
year to year. While we believe we use conservative accounting methods,
changes in accounting rules can nevertheless affect our reported income
and stockholders' equity.
Our policies, procedures, practices, product lines, risks, and internal
risk-adjusted capital guidelines are subject to change.
Our company is operated by its management and Board of Directors. In
general, we are free to alter our policies, procedures, practices,
product lines, leverage, risks, internal risk-adjusted capital
guidelines, and other aspects of our business. We can enter new
businesses, or pursue acquisitions of other companies. In most cases, we
do not need to seek stockholder approval to make such changes. We will
not necessarily notify stockholders of such changes.
We depend on key personnel for successful operations.
We depend significantly on the profitabilitycontributions of RCFour executive officers
and staff. Many of our officers and employees would be difficult to
replace. The loss of any key personnel could materially affect our
results.
Investors in our common stock may experience losses, volatility, and
poor liquidity.
Our earnings, cash flow, book value, and dividends can be volatile and
difficult to predict. Investors should not rely on predictions.
Fluctuations in our current and prospective earnings, cash flow, and
dividends, as well as many other factors such as perceptions, economic
conditions, stock market conditions, and the like, can affect our stock
price. Investors may experience volatile returns and material losses. In
addition, liquidity in the trading of our stock may be insufficient to
allow investors to sell their stock in a timely manner or at a
reasonable price.
RWT HOLDINGS, INC BUSINESS AND STRATEGY
RWT Holdings, operations.Inc. ("Holdings") was formed in 1998 to originate and sell
commercial mortgages. Holdings also engaged in other mortgage finance
businesses that were closed in 1999. On January 1, 2001, the common
stockholders of Holdings sold their stock to Redwood, thus giving
Redwood the 1% economic interest in Holdings that it did not already
own. Starting in 2001, Redwood will operate Holdings as a 100%-owned
subsidiary and will consolidate Holdings' financial statements with its
own financial statements. See Redwood's Business and Strategy:
Commercial Retained Portfolio, Risk Factors, and Management's Discussion
and Analysis: Results of Operations: Commercial Retained Portfolio as
well as Holdings' Management's Discussion and Analysis for more
information.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes certain Federal income tax
considerations to Redwood Trust and its stockholders. This discussion is
based on existing Federal income tax law, which is subject to change,
possibly retroactively. This discussion does not address all aspects of
Federal income taxation that may be relevant to a particular stockholder
in light of its personal investment circumstances or to certain types of
investors subject to special treatment under the Federal income tax laws
(including financial institutions, insurance companies, broker-dealers
and, except to the extent discussed below, tax-exempt entities and
foreign taxpayers) and it does not discuss any aspects of state, local
or foreign tax law. This discussion assumes that stockholders will hold
their Common Stock as a "capital asset" (generally, property held for
investment) under the Code. Stockholders are advised to
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consult their tax advisors as to the specific tax consequences to them
of purchasing, holding and disposing of the Common Stock, including the
application and effect of Federal, state, local and foreign income and
other tax laws.
GENERAL
Redwood Trust has elected to become subject to tax as a REIT, for
Federal income tax purposes, commencing with the taxable year ending
December 31, 1994. Management currently expects that Redwood Trust will
continue to operate in a manner that will permit Redwood Trust to
maintain its qualifications as a REIT. This treatment will permit
Redwood Trust to deduct dividend distributions to its stockholders for
Federal income tax purposes, thus effectively eliminating the "double
taxation" that generally results when a corporation earns income and
distributes that income to its stockholders.
There can be no assurance that Redwood Trust will continue to qualify as
a REIT in any particular taxable year, given the highly complex nature
of the rules governing REITs, the ongoing importance of factual
determinations and the possibility of future changes in the
circumstances of Redwood Trust. If Redwood Trust failed to qualify as a
REIT in any particular year, it would be subject to Federal income tax
as a regular, domestic corporation, and its stockholders would be
subject to tax in the same manner as stockholders of such corporation.
In this event, Redwood Trust could be subject to potentially substantial
income tax liability in respect of each taxable year that it fails to
qualify as a REIT and the amount of earnings and cash available for
distribution to its stockholders could be significantly reduced or
eliminated.
The following is a brief summary of certain technical requirements that
Redwood Trust must meet on an ongoing basis in order to qualify, and
remain qualified, as a REIT under the Code.
STOCK OWNERSHIP TESTS
The capital stock of Redwood Trust must be held by at least 100 persons
and no more than 50% of the value of such capital stock may be owned,
directly or indirectly, by five or fewer individuals at all times during
the last half of the taxable year. Under the Code, most tax-exempt
entities including employee benefit trusts and charitable trusts (but
excluding trusts described in 401(a) and exempt under 501(a)) are
generally treated as individuals for these purposes. Redwood Trust must
satisfy these stock ownership requirements each taxable year. Redwood
Trust must solicit information from certain of its shareholdersstockholders to
verify ownership levels and its Articles of Incorporation provide
restrictions regarding the transfer of Redwood Trust's shares in order
to aid in meeting the stock ownership requirements. If Redwood Trust
were to fail either of the stock ownership tests, it would generally be
disqualified from REIT status, unless, in the case of the "five or
fewer" requirement, the "good faith" exemption is available.
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ASSET TESTS
For tax years beginning before December 31, 2000, Redwood Trust must
generally meet the following asset tests (the "REIT Asset Tests") at the
close of each quarter of each taxable year:
(a) at least 75% of the value of Redwood Trust's total assets
must consist of Qualified REIT Real Estate Assets, government
securities, cash, and cash items (the "75% Asset Test"); and
(b) the value of securities held by Redwood Trust but not taken
into account for purposes of the 75% Asset Test must not exceed
either (i) 5% of the value of Redwood Trust's total assets in
the case of securities of any one non-government issuer, or (ii)
10% of the outstanding voting securities of any such issuer.
For tax years beginning after December 31, 2000, Redwood Trust must
generally meet the following REIT Asset Tests at the close of each
quarter of each taxable year:
(a) the 75% Asset Test;
(b) not more than 25% of the value of Redwood Trust's total
assets is represented by securities (other than those includible
under the 75% Asset Test);
(c) not more than 20% of the value of Redwood Trust's total
assets is represented by securities of one or more taxable REIT
subsidiary; and
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(d) the value of securities held by Redwood Trust, other than
those of a taxable REIT subsidiary or taken into account for
purposes of the 75% Asset Test, must not exceed either (i) 5% of
the value of Redwood Trust's total assets in the case of
securities of any one non-government issuer, or (ii) 10% of the
outstanding vote or value of any such issuer's securities.
Redwood Trust expects that substantially all of its assets will be
Qualified REIT Real Estate Assets. In addition, Redwood Trust does not
expect that the value of any non-qualifying security of any one entity,
including interests in taxable affiliates, would ever exceed 5% of
Redwood Trust's total assets, and Redwood Trust does not expect to own
more than 10% of the vote or value of any one issuer's voting securities.
Redwood Trust intends to monitor closely the purchase, holding and
disposition of its assets in order to comply with the REIT Asset Tests.
In particular, Redwood Trust intends to limit and diversify its
ownership of any assets not qualifying as Qualified REIT Real Estate
Assets to less than 25% of the value of Redwood Trust's assets, and to less
than 5%, by value, of any single issuer.issuer and to less than 20%, by value,
of any taxable REIT subsidiaries. If it is anticipated that these limits
would be exceeded, Redwood Trust intends to take appropriate measures,
including the disposition of non-qualifying assets, to avoid exceeding
such limits.
GROSS INCOME TESTS
Redwood Trust must generally meet the following gross income tests (the
"REIT Gross Income Tests") for each taxable year:
(a) at least 75% of Redwood Trust's gross income must be derived
from certain specified real estate sources including interest
income and gain from the disposition of Qualified REIT Real
Estate Assets or "qualified temporary investment income" (i.e.,
income derived from "new capital" within one year of the receipt
of such capital) (the "75% Gross Income Test"); and,
(b) at least 95% of Redwood Trust's gross income for each
taxable year must be derived from sources of income qualifying
for the 75% Gross Income Test, or from dividends, interest, and
gains from the sale of stock or other securities (including
certain interest rate swap and cap agreements, options, futures
and forward contracts entered into to hedge variable rate debt
incurred to acquire Qualified REIT Real Estate Assets) not held
for sale in the ordinary course of business (the "95% Gross
Income Test"); and.
Redwood Trust intends to maintain its REIT status by carefully
monitoring its income, including income from hedging transactions and
sales of mortgage assets, to comply with the REIT Gross Income Tests. In
accordance with the code, Redwood Trust will treat income generated by
its interest rate caps and other hedging instruments as qualifying
income for purposes of the 95% Gross Income Tests to the extent the
interest rate cap or other hedging instrument was acquired to reduce the
interest rate risks with respect to any indebtedness incurred or to be
incurred by Redwood Trust to acquire or carry real estate assets. In
addition, Redwood Trust will treat income generated by other hedging
instruments as qualifying or non-qualifying income for purposes of the
95% Gross Income Test depending on whether the income constitutes gains
from the sale of securities as defined by the Investment Company Act of
1940. Under certain circumstances, for example, (i) the sale of a
substantial amount of mortgage assets to repay borrowings in the event
that other credit is unavailable or (ii) unanticipated decrease in the
qualifying income of Redwood Trust which may result in the
non-qualifying income exceeding 5% of gross income, Redwood Trust may be
unable to comply with certain of the REIT Gross Income Tests. See " -
Taxation of Redwood Trust" below for a discussion of the tax
consequences of failure to comply with the REIT Provisions of the Code.
DISTRIBUTION REQUIREMENT
For tax years before 2001, Redwood Trust must generally distribute to
its stockholders an amount equal to at least 95% of Redwood Trust's REIT
taxable income before deductions of dividends paid and excluding net
capital gain. (See recently enactedBeginning with the 2001 tax legislation section below describing changesyear, this REIT distribution
requirement is reduced to the current distribution
requirement.)
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The IRS has ruled that if a REIT's dividend reinvestment plan allows
stockholders of the REIT to elect to have cash distributions reinvested
in shares of the REIT at a purchase price equal to at least 95% of the
fair market value of such shares on the distribution date, then such
distributions qualify under the 95% distribution requirement.
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Redwood Trust maintains a Dividend Reinvestment and Stock Purchase Plan
("DRP") and intends that the terms of its DRP will comply with this
ruling.
QUALIFIED REIT SUBSIDIARIES
Redwood Trust currently holds some of its assets through Sequoia
Mortgage Funding Corporation, a wholly-owned subsidiary, which is
treated as a "Qualified REIT Subsidiary". As such its assets,
liabilities and income are generally treated as assets, liabilities and
income of Redwood Trust for purposes of each of the above REIT
qualification tests.
TAXABLE REIT SUBSIDIARIES
Effective January 1, 2001, RWT Holdings, Inc. ("Holdings") and Redwood
Trust elected to treat Holdings as a "taxable REIT subsidiary" of
Redwood Trust. As a "taxable REIT subsidiary", Holdings is not subject
to the asset, income and distribution requirements of Redwood Trust nor
are its assets, liabilities or income treated as assets, liabilities or
income of Redwood Trust for purposes of each of the above REIT
qualification tests. "Taxable REIT subsidiaries" are prohibited from,
directly or indirectly, operating or managing a lodging or healthcare
facility or providing to any person, under franchise, license or
otherwise, rights to any lodging or healthcare facility brand name. In
addition, Redwood Trust will be subject to a 100% penalty tax on any
rent or other charges that it imposes on any taxable REIT subsidiary in
excess or an arm's length price for comparable services. Redwood Trust
expects that any rents and charges imposed on Holdings or any taxable
REIT subsidiary will be at arm's length prices.
TAXATION OF REDWOOD TRUST
In any year in which Redwood Trust qualifies as a REIT, Redwood Trust
will generally not be subject to Federal income tax on that portion of
its REIT taxable income or capital gain that is distributed to its
stockholders. Redwood Trust will, however, be subject to Federal income
tax at normal corporate income tax rates upon any undistributed taxable
income or capital gain.
Notwithstanding its qualification as a REIT, Redwood Trust may also be
subject to tax in certain other circumstances. If Redwood Trust fails to
satisfy either the 75% or the 95% Gross Income Test, but nonetheless
maintains its qualification as a REIT because certain other requirements
are met, it will generally be subject to a 100% tax on the greater of
the amount by which Redwood Trust fails either the 75% or the 95% Gross
Income Test. Redwood Trust will also be subject to a tax of 100% on net
income derived from any "prohibited transaction" (which includes
dispositions of property classified as "dealer" property) and if Redwood
Trust has (i) net income from the sale or other disposition of
"foreclosure property" which is held primarily for sale to customers in
the ordinary course of business or (ii) other non-qualifying income from
foreclosure property, it will be subject to Federal income tax on such
income at the highest corporate income tax rate. In addition, if Redwood
Trust fails to distribute during each calendar year at least the sum of
(i) 85% of its REIT ordinary income for such year and (ii) 95% of its
REIT capital gain net income for such year, Redwood Trust would be
subject to a 4% Federal excise tax on the excess of such required
distribution over the amounts actually distributed during the taxable
year, plus any undistributed amount of ordinary and capital gain net
income from the preceding taxable year. Redwood Trust may also be
subject to the corporate alternative minimum tax, as well as other taxes
in certain situations not presently contemplated.
If Redwood Trust fails to qualify as a REIT in any taxable year and
certain relief provisions of the Code do not apply, Redwood Trust would
be subject to Federal income tax (including any applicable alternative
minimum tax) on its taxable income at the regular corporate income tax
rates. Distributions to stockholders in any year in which Redwood Trust
fails to qualify as a REIT would not be deductible by Redwood Trust, nor
would they generally be required to be made under the Code. Further,
unless entitled to relief under certain other provisions of the Code,
Redwood Trust would also be disqualified from re-electing REIT status
for the four taxable years following the year in which it became
disqualified.
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Redwood Trust intends to monitor on an ongoing basis its compliance with
the REIT requirements described above. In order to maintain its REIT
status, Redwood Trust will be required to limit the types of assets that
Redwood Trust might otherwise acquire, or hold certain assets at times
when Redwood Trust might otherwise have determined that the sale or
other disposition of such assets would have been more prudent.
TAXABLE SUBSIDIARIESAFFILIATES
Redwood Trust intends to undertake certain hedging activities, and the
creation of mortgage securities through securitization, and may
originate, sell and manage residential and commercial mortgage loans and
other assets through its taxable affiliates. Redwood Trust has not
elected to treat these taxable affiliates as "taxable REIT
subsidiaries." In order to ensure that Redwood Trust does not violate
the more than 10% voting stock of a single issuer limitation described above,
Redwood Trust owns (or will own) only nonvoting preferred, nonvoting common stock or 10% or less of the voting commonvote or value
of such taxable affiliate's stock and the other persons own (or will
own) all of the remaining
voting common stock of such taxable affiliates. The value of
Redwood Trust's investment in such taxable affiliates must also be
limited to less than 5% of the value of Redwood Trust's total assets at
the end of each calendar quarter so that Redwood Trust can also comply
with the 5% of value, single issuer asset limitation described above
under " - General - Asset Tests." The taxable affiliates do
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REIT status and distribute only net after-tax profits to their
stockholders, including Redwood Trust. Before Redwood Trust engages in
any hedging or securitization activities or uses any such taxable
affiliates, Redwood Trust will obtain an opinion of counsel to the
effect that such activities or the formation and contemplated method of
operation of such corporation will not cause Redwood Trust to fail to
satisfy the REIT Asset and REIT Gross Income Tests.
TAXATION OF STOCKHOLDERS
Distributions (including constructive distributions) made to holders of
Common Stock other than tax-exempt entities (and not designated as
capital gain dividends) will generally be subject to tax as ordinary
income to the extent of Redwood Trust's current and accumulated earnings
and profits as determined for Federal income tax purposes. If the amount
distributed exceeds a stockholder's allocable share of such earnings and
profits, the excess will be treated as a return of capital to the extent
of the stockholder's adjusted basis in the Common Stock, which will not
be subject to tax, and thereafter as a taxable gain from the sale or
exchange of a capital asset.
Distributions designated by Redwood Trust as capital gain dividends will
generally be subject to tax as long-term capital gain to stockholders,
to the extent that the distribution does not exceed Redwood Trust's
actual net capital gain for the taxable year. Distributions by Redwood
Trust, whether characterized as ordinary income or as capital gain, are
not eligible for the corporate dividends received deduction. In the
event that Redwood Trust realizes a loss for the taxable year,
stockholders will not be permitted to deduct any share of that loss.
Further, if Redwood Trust (or a portion of its assets) were to be
treated as a taxable mortgage pool, any "excess inclusion income" that
is allocated to a stockholder would not be allowed to be offset by a net
operating loss of such stockholder.
Future Treasury Department regulations may require
that the stockholders take into account, for purposes of computing their
individual alternative minimum tax liability, certain tax preference items of
Redwood Trust.
Dividends declared during the last quarter of a taxable year and
actually paid during January of the following taxable year are generally
treated as if received by the stockholder on the record date of the
dividend payment and not on the date actually received. In addition,
Redwood Trust may elect to treat certain other dividends distributed
after the close of the taxable year as having been paid during such
taxable year, but stockholders will be treated as having received such
dividend in the taxable year in which the distribution is made.
Generally, a dividend distribution of earnings from a REIT is considered
for estimated tax purposes only when the dividend is made. However,
recently enacted legislation, effective December 15, 1999, requires any
person owning at least 10% of the vote or value of a closely-held REIT
to accelerate recognition of year-end dividends received from the REIT
in computing estimated tax payments.
Upon a sale or other disposition of the Common Stock, a stockholder will
generally recognize a capital gain or loss in an amount equal to the
difference between the amount realized and the stockholder's adjusted
basis in such stock, which gain or loss generally will be long-term if
the stock was held for more than twelve months. Any loss on the sale or
exchange of Common Stock held by a stockholder for six months or less
will generally be treated as a long-term capital loss to the extent of
designated capital gain dividends received by such stockholder.
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DRP participants will generally be treated as having received a dividend
distribution, subject to tax as ordinary income, in an amount equal to
the fair value of the Common Stock purchased with the reinvested
dividends generally on the date Redwood Trust credits such Common Stock
to the DRP participant's account.
Redwood Trust is required under Treasury Department regulations to
demand annual written statements from the record holders of designated
percentages of its Capital Stock disclosing the actual and constructive
ownership of such stock and to maintain permanent records showing the
information it has received as to the actual and constructive ownership
of such stock and a list of those persons failing or refusing to comply
with such demand.
In any year in which Redwood Trust does not qualify as a REIT,
distributions made to its stockholders would be taxable in the same
manner discussed above, except that no distributions could be designated
as capital gain dividends, distributions would be eligible for the
corporate dividends received deduction, the excess inclusion income
rules would not apply, and stockholders would not receive any share of
Redwood Trust's tax preference items. In such event, however, Redwood
Trust would be subject to potentially substantial Federal income tax
liability, and the amount of earnings and cash available for
distribution to its stockholders could be significantly reduced or
eliminated.
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TAXATION OF TAX-EXEMPT ENTITIES
Subject to the discussion below regarding a "pension-held REIT," a
tax-exempt stockholder is generally not subject to tax on distributions
from Redwood Trust or gain realized on the sale of the Securities,
provided that such stockholder has not incurred indebtedness to purchase
or hold its Securities, that its shares are not otherwise used in an
unrelated trade or business of such stockholder, and that Redwood Trust,
consistent with its present intent, does not hold a residual interest in
a REMIC that gives rise to "excess inclusion" income as defined under
section 860E of the Code. However, if Redwood Trust was to hold residual
interests in a REMIC, or if a pool of its assets were to be treated as a
"taxable mortgage pool," a portion of the dividends paid to a tax-exempt
stockholder may be subject to tax as unrelated business taxable income
("UBTI"). Although Redwood Trust does not believe that Redwood Trust, or
any portion of its assets, will be treated as a taxable mortgage pool,
no assurance can be given that the IRS might not successfully maintain
that such a taxable mortgage pool exists.
If a qualified pension trust (i.e., any pension or other retirement
trust that qualifies under Section 401 (a) of the Code) holds more than
10% by value of the interests in a "pension-held REIT" at any time
during a taxable year, a substantial portion of the dividends paid to
the qualified pension trust by such REIT may constitute UBTI. For these
purposes, a "pension-held REIT" is a REIT (i) that would not have
qualified as a REIT but for the provisions of the Code which look
through qualified pension trust stockholders in determining ownership of
stock of the REIT and (ii) in which at least one qualified pension trust
holds more than 25% by value of the interest of such REIT or one or more
qualified pension trusts (each owning more than a 10% interest by value
in the REIT) hold in the aggregate more than 50% by value of the
interests in such REIT. Assuming compliance with the Ownership Limit
provisions in Redwood Trust's Articles of Incorporation it is unlikely
that pension plans will accumulate sufficient stock to cause Redwood
Trust to be treated as a pension-held REIT.
Distributions to certain types of tax-exempt stockholders exempt from
Federal income taxation under Sections 501 (c)(7), (c)(9), (c)(17), and
(c)(20) of the Code may also constitute UBTI, and such prospective
investors should consult their tax advisors concerning the applicable
"set aside" and reserve requirements.
STATE AND LOCAL TAXES
Redwood Trust and its stockholders may be subject to state or local
taxation in various jurisdictions, including those in which it or they
transact business or reside. The state and local tax treatment of
Redwood Trust and its stockholders may not conform to the Federal income
tax consequences discussed above. Consequently, prospective stockholders
should consult their own tax advisors regarding the effect of state and
local tax laws on an investment in the Common Stock.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO
FOREIGN HOLDERS
The following discussion summarizes certain United States Federal tax
consequences of the acquisition, ownership and disposition of Common
Stock or Preferred Stock by an initial purchaser that, for United States
Federal income tax purposes, is a "Non-United States Holder". Non-United
States Holder means: not a citizen or resident of the United States; not
a corporation, partnership, or other entity created or organized in the
United States or under the laws of the United States or of any political
subdivision thereof; or not an estate or trust whose income is
includible in gross income for United States Federal income tax purposes
regardless of its source. This discussion does not consider any specific
facts or circumstances that may apply to particular non-United States
Federal tax consequences of acquiring, holding and disposing of Common
Stock or Preferred Stock, as well as any tax consequences that may arise
under the laws of any foreign, state, local or other taxing
jurisdiction.
DIVIDENDS
Dividends paid by Redwood Trust out of earnings and profits, as
determined for United States Federal income tax purposes, to a
Non-United States Holder will generally be subject to withholding of
United States Federal income tax at the rate of 30%, unless reduced or
eliminated by an applicable tax treaty or unless such dividends are
treated as effectively connected with a United States trade or business.
Distributions paid by Redwood Trust in excess of its earnings and
profits will be treated as a tax-free return of capital to the extent of
the holder's adjusted basis in his shares, and thereafter as gain from
the sale or exchange of a capital asset as described below. If it cannot
be determined at the time a distribution is made whether such
distribution will exceed the earnings and profits of Redwood Trust, the
distribution will be subject to withholding at the same rate as
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dividends. Amounts so withheld, however, will be refundable or
creditable against the Non-United States Holder's United States Federal
tax liability if it is subsequently determined that such distribution
was, in fact, in excess of the earnings and profits of Redwood Trust. If
the receipt of the dividend is treated as being effectively connected
with the conduct of a trade or business within the United States by a
Non-United States Holder, the dividend received by such holder will be
subject to the United States Federal income tax on net income that
applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits
tax).
For any year in which Redwood Trust qualifies as a REIT, distributions
to a Non-United States Holder that are attributable to gain from the
sales or exchanges by Redwood Trust of "United States real property
interests" will be treated as if such gain were effectively connected
with a United States business and will thus be subject to tax at the
normal capital gain rates applicable to United States stockholders
(subject to applicable alternative minimum tax) under the provisions of
the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA").
Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled
to a treaty exemption. Redwood Trust is required to withhold 35% of any
distribution that could be designated by Redwood Trust as a capital
gains dividend. This amount may be credited against the Non-United
States Holder's FIRPTA tax liability. It should be noted that mortgage
loans without substantial equity or shared appreciation features
generally would not be classified as "United States real property
interests."
GAIN ON DISPOSITION
A Non-United States Holder will generally not be subject to United
States Federal income tax on gain recognized on a sale or other
disposition of its shares of either Common or Preferred Stock unless (i)
the gain is effectively connected with the conduct of a trade or
business within the United States by the Non-United States Holder, (ii)
in the case of a Non-United StatedStates Holder who is a nonresident alien
individual and holds such shares as a capital asset, such holder is
present in the United States for 183 or more days in the taxable year
and certain other requirements are met, or (iii) the Non-United States
Holder is subject to tax under the FIRPTA rules discussed below. Gain
that is effectively connected with the conduct of a United States Holder
will be subject to the United States Federal income tax on net income
that applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits
tax) but will not be subject to withholding. Non-United States Holders
should consult applicable treaties, which may provide for different
rules.
Gain recognized by a Non-United States Holder upon a sale of either
Common Stock or Preferred Stock will generally not be subject to tax
under FIRPTA if Redwood Trust is a "domestically-controlled REIT," which
is defined generally as a REIT in which at all times during a specified
testing period less than 50% in value of its shares were held directly
or indirectly by non-United States persons. Because only a minority of
Redwood Trust's
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stockholders isare expected to be Non-United States Holders, Redwood Trust
anticipates that it will qualify as a "domestically-controlled REIT."
Accordingly, a Non-United States Holder should not be subject to United
States Federal income tax from gains recognized upon disposition of its
shares.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Redwood Trust will report to its U.S. shareholdersstockholders and the Internal
Revenue Service the amount of distributions paid during each calendar
year, and the amount of tax withheld, if any. Under the backup
withholding rules, a shareholderstockholder may be subject to backup withholding at
the rate of 31% with respect to distributions paid unless such holder
(a) is a corporation or comes within certain other exempt categories
and, when required, demonstrates that fact; or (b) provides a taxpayer
identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with applicable requirements of the
backup withholding rules. A shareholdersstockholder that does not provide Redwood
Trust with its correct taxpayer identification number may also be
subject to penalties imposed by the Internal Revenue Service. Any amount
paid as backup withholding will be creditable against the shareholder'sstockholder's
income tax liability. In addition, Redwood Trust may be required to
withhold a portion of dividends and capital gain distributions to any
shareholdersstockholders that do not certify under penalties of perjury their
non-foreign status to Redwood Trust.
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RECENTLY ENACTED TAX LEGISLATION
Recently enacted tax legislation (HR 1180) changes the requirement for years
beginning after December 31, 2000 that a REIT not own more than 10% of the
voting power of a corporation (other than a "REIT Subsidiary") to a requirement
based on a 10% of vote or value limit, except in the case of certain taxable
REIT subsidiaries ("TRS") engaged in specific types of activities. The combined
value of all TRS's, however, would be limited to no more than 20% of the total
value of a REIT's assets. In addition, significant other limitations would apply
with respect to transactions between the REIT and the TRS.
In addition, the current REIT 95% distribution requirement (see above) will
decrease to 90% for tax years beginning after December 31, 2000. Several other
REIT provision changes not discussed here were made as part of the recently
enacted tax legislation and are generally effective for years beginning after
December 31, 2000.
Generally, a dividend distribution of earnings from a REIT is considered for
estimated tax purposes only when the dividend is made. However, recently enacted
legislation, effective December 15, 1999, requires any person owning at least
10% of the vote or value of a closely-held REIT to accelerate recognition of
year-end dividends received from the REIT in computing estimated tax payments.
EMPLOYEES
As of March 15, 2000,27, 2001, we employed twenty-fivetwenty-four people RCF employed fourteen
people,at Redwood and RRF employed nine people.its
subsidiaries.
ITEM 2. PROPERTIES
Redwood Trust and Holdings lease space for their executive and
administrative offices at 591 Redwood Highway, Suites 3100, 3120 and 3140,3280,
Mill Valley, California 94941, telephone (415) 389-7373.
RCF leases space for its commercial origination operations at 6548 South
McCarran Blvd., Suite A, Reno, Nevada 89509, telephone (775) 448-9200.
Additionally, RCF leases three offices, all located in California, for use by
its loan production officers.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 1999,2000, there were no pending legal proceedings to which
Redwood Trust was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of Redwood Trust's shareholdersstockholders
during the fourth quarter of 1999.2000.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Effective January 28, 1998, Redwood Trust's Common Stock was listed and
traded on the New York Stock Exchange under the symbol RWT. Prior to
that date, Redwood Trust's Common Stock was traded on the
over-the-counter market and was quoted on the NasdaqNASDAQ National Market
under the symbol RWTI. Redwood Trust's Common Stock was held by
approximately 350330 holders of record on March 15, 200027, 2001 and the total
number of beneficial shareholdersstockholders holding stock through depository
companies was approximately 3,000.2,800. The high and low closing sales prices
of shares of the Common Stock as reported on the New York Stock Exchange
or the NasdaqNASDAQ National Market composite tape and the cash dividends
declared on the Common Stock for the periods indicated below were as
follows:
Common Dividends Declared
-------------------------------------------------------------------------
Stock Prices Record Payable Per
High Low Date Date Share
----------------------------------------------------------------- --- ---- ---- -----
Year Ended
December 31, 20002001
First Quarter (through
March 15, 2000) $1327, 2001) $20.44 $16.81 3/30/01 4/23/01 $0.50
Year Ended
December 31, 2000
Fourth Quarter $17.94 $15.06 12/29/00 1/22/01 $0.44
Third Quarter $15.94 $13.63 9/16 $11 15/1629/00 10/23/00 $0.42
Second Quarter $14.94 $13.50 6/30/00 7/21/00 $0.40
First Quarter $14.81 $11.94 3/31/00 4/21/00 $0.35
Year Ended
December 31, 1999
FirstFourth Quarter $17 3/8 $13 1/2 -- -- --
Second Quarter $17 9/4 $11 5/16 $1412/31/99 1/2 -- -- --21/00 $0.25
Third Quarter $17 1/2 $12 3/4 11/8/99 11/22/99 $0.15
FourthSecond Quarter $17 9/16 $14 1/2 -- -- --
First Quarter $17 3/8 $13 1/4 $11 5/16 12/31/99 1/21/00 $0.252 -- -- --
Year Ended
December 31, 1998
Fourth Quarter $16 1/16 $11 1/16 -- -- --
Third Quarter $17 5/8 $12 3/4 -- -- --
Second Quarter $25 5/8 $17 9/16 8/6/98 8/21/98 $0.01
First Quarter $23 1/2 $18 5/8 5/7/98 5/21/98 $0.27
Second Quarter $25 5/8 $17 9/16 8/6/98 8/21/98 $0.01
Third Quarter $17 5/8 $12 3/4 -- -- --
Fourth Quarter $16 1/16 $11 1/16 -- -- --
Redwood Trust intends to pay quarterly dividends so long as the minimum
REIT distribution rules require it. Redwood Trust intends to make
distributions to its stockholders of all or substantially all of its
taxable income each year (subject to certain adjustments) so as to
qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by Redwood Trust at the discretion of the
Board of Directors and will depend on the taxable earnings of Redwood
Trust, financial condition of Redwood Trust, maintenance of REIT status
and such other factors as the Board of Directors may deem relevant from
time to time. No dividends may be paid on the Common Stock unless full
cumulative dividends have been paid on the Preferred Stock. As of
December 31, 1999,2000, the full cumulative dividends have been paid on the
Preferred Stock.
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2827
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is for the years ended December
31, 2000, 1999, 1998, 1997 1996 and 1995.1996. It is qualified in its entirety by,
and should be read in conjunction with the more detailed information
contained in the Consolidated Financial Statements and Notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" included elsewhere in this Form 10-K.
- --------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
1995
----------- ------------ ------------ ------------ ----------------------- ------------
STATEMENT OF OPERATIONS DATA:
Interest income after provisions for
credit losses $ 147,310169,261 $ 222,804145,964 $ 198,604221,684 $ 67,284195,674 $ 15,72665,588
Interest expense (117,162) (196,124) (160,277) (49,191) (10,608)
Interestand interest rate
agreement expense (2,065) (3,514) (3,741) (1,158) (339)(138,603) (119,227) (199,638) (164,018) (50,349)
Net interest income 28,083 23,166 34,586 16,935 4,779
Provisionafter provision
for credit losses (1,346) (1,120) (2,930) (1,696) (493)30,658 26,737 22,046 31,656 15,239
Equity in earnings (losses) of
RWT Holdings, Inc. (1,676) (21,633) (4,676) -- --
--
Operating expenses(a)expenses (7,850) (3,835) (4,656)(5,876) (4,658) (2,554)
(1,131)Other income 98 175 139 -- --
Net unrealized/realized market
value gains (losses) (2,296) 284 (38,943) 563 --
Dividends on Class B preferred stock (2,724) (2,741) (2,747) (2,815) (1,148)
Change in accounting principle -- Net income (loss) before change in acctg principle (1,013) (30,057) $ 24,746 $ 11,537 $ 3,155-- (10,061) -- --
Net income (loss) available to
common stockholders $ 16,210 $ (1,013) $ (40,118) $ 24,746 $ 11,537
Core earnings: ongoing operations
before mark-to market and
non recurring expenses $ 3,15518,585 $ 16,622 $ 12,666 $ 24,746 $ 11,537
Average common shares - "diluted" 8,902,069 9,768,345 13,199,819 13,680,410 8,744,184 3,703,803
Diluted net income (loss) per share before change in accounting principle $ (0.10) $ (2.28) $ 1.81 $ 1.32 $ 0.85
Diluted net income (loss) per share1.82 $ (0.10) $ (3.04) $ 1.81 $ 1.32
Core earnings per share $ 0.85
Net taxable income2.08 $ 7,8121.71 $ 2,8590.96 $ 29,9641.81 $ 15,168 $ 3,832
Net taxable income available to common stockholders $ 5,071 $ 112 $ 27,149 $ 14,020 $ 3,832
Cash Dividends declared per Class A preferred share -- -- -- -- $ 0.500
Cash1.32
Dividends declared per Class B
preferred share $ 3.0203.02 $ 3.0203.02 $ 3.0203.02 $ 1.141 N/A
Cash3.02 $ 1.14
Dividends declared per common share $ 0.4001.61 $ 0.2800.40 $ 2.1500.28 $ 1.6702.15 $ 0.4601.67
BALANCE SHEET DATA: END OF PERIOD
Mortgage assets $ 2,367,4052,033,705 $ 2,670,8632,362,806 $ 3,366,6222,658,428 $ 2,153,4283,354,510 $ 432,2442,138,364
Total assets $ 2,082,115 $ 2,419,928 $ 2,832,448 $ 3,444,197 $ 2,184,197
$ 441,557
Short-term debt $ 756,222 $ 1,253,565 $ 1,257,570 $ 1,914,525 $ 1,953,103
$ 370,316
Long-term debt $ 1,095,835 $ 945,270 $ 1,305,560 $ 1,172,801 --
--
Total liabilities $ 1,866,451 $ 2,209,993 $ 2,577,658 $ 3,109,660 $ 1,973,192
$ 373,267
Total stockholders' equity $ 215,664 $ 209,935 $ 254,790 $ 334,537 $ 211,005
$ 68,290
Number of Class B preferred
shares outstanding 902,068 902,068 909,518 909,518 1,006,250 --
Number of common shares outstanding (EOP)8,809,500 8,783,341 11,251,556 14,284,657 10,996,572
5,517,299
Reported bookBook value per common share $ 21.47 $ 20.88 $ 20.27 $ 21.55 $ 16.50
$ 12.38
OTHER DATA:
Average assets $ 2,296,641 $ 2,293,238 $ 3,571,889 $ 3,036,725 $ 999,762
$ 220,616
Average borrowings $ 2,070,943 $ 2,046,132 $ 3,250,914 $ 2,709,208 $ 861,316
$ 174,926
Average equity $ 213,938 $ 237,858 $ 307,076 $ 307,029 $ 131,315
$ 43,349
Interest rate spread 0.82% 0.34% 0.68% 1.09% 1.11%after provision
for credit losses 0.86% 0.79% 0.28% 0.59% 0.90%
Net interest margin 1.22% 0.65% 1.14% 1.69% 2.17%
Operating expenses as a % of net interest income(a) 13.66% 20.09% 13.47% 15.08% 23.66%
Operating expenses as a % of average assets(a) 0.17% 0.13% 0.15% 0.26% 0.51%
Operating expenses as a % of average equity(a) 1.61% 1.52% 1.52% 1.94% 2.61%
Return on average assets 0.08% (1.05)% 0.91% 1.27% 1.43%
Average assets/average equity 9.64x 11.63x 9.89x 7.61x 5.09x
Return on average equity 0.73% (12.17)% 8.98% 9.66% 7.28%
Credit reserves $ 5,954 $ 4,973 $ 4,931 $ 2,180 $ 490
Actualafter provision
for credit losses $ (317) $ (1,079) $ (179) $ (6) $ (4)1.33% 1.17% 0.62% 1.04% 1.52%
(a) Excludes one-time termination expense of $1.2 million for 1998.27
28 29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes.
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform
Act of 1995: StatementsCertain matters discussed in this discussion regarding Redwood Trust, Inc., or "Redwood
Trust", and our business which are not historical facts are "forward-looking
statements"2000 annual report Form
10-K may constitute forward-looking statements within the meaning of the
federal securities laws that involveinherently include certain risks and
uncertainties. ForActual results and the timing of certain events could
differ materially from those projected in or contemplated by the
forward-looking statements due to a discussionnumber of such risksfactors, including, among
other things, credit results for our mortgage assets, our cash flows and
uncertainties, which couldliquidity, changes in interest rates and market values on our mortgage
assets and borrowings, changes in prepayment rates on our mortgage
assets, general economic conditions, particularly as they affect the
price of mortgage assets and the credit status of borrowers, and the
level of liquidity in the capital markets, as it affects our ability to
finance our mortgage asset portfolio, and other risk factors outlined in
this Form 10-K (see Risk Factors above.) Other factors not presently
identified may also cause actual results to differ from those
containeddiffer. We continuously
update and revise our estimates based on actual conditions experienced.
It is not practicable to publish all such revisions and, as a result, no
one should assume that results projected in or contemplated by the
forward-looking statements we refer youincluded above will continue to "Company Business
and Strategy" beginning on Page 4 and "Risk Factors" commencing on Page 13 of
this 1999 Form 10-K.
OVERVIEW
Redwood Trust is a finance company specializingbe accurate
in the mortgage portfolio
lending business. Our primary activity isfuture.
Throughout this Form 10-K and other company documents, the acquisition, financing,words
"believe", "expect", "anticipate", "intend", "aim", "will", and management of high-quality jumbo residential mortgage loans. We fund our loans
chiefly through the issuance of long-term debt. We also manage a portfolio of
jumbo residential mortgage securities and originate commercial mortgage loanssimilar
words identify "forward-looking" statements.
RESULTS OF OPERATIONS
EARNINGS SUMMARY
Core earnings were $0.62 per share for sale to other financial institutions.
Our core business of mortgage finance is conducted through Redwood Trust, Inc.,
which is a qualified real estate investment trust ("REIT"). In general, our REIT
status allows us to avoid corporate income taxes by distributing to our
shareholders an amount equal to at least 95% of taxable income.
We also own a 99% economic interest in a taxable affiliate company, RWT
Holdings, Inc. ("Holdings"). Our investment in Holdings is accounted for under
the equity method. Holdings originates commercial mortgage loans for sale to
institutional investors through its Redwood Commercial Funding, Inc. ("RCF")
subsidiary. RCF typically originates shorter-term floating-rate commercial
mortgage loans to high-quality borrowers who require more flexible borrowing
arrangements than are usually offered by life insurance companies or commercial
mortgage conduit lending programs.
Holdings had two other operating businesses, Redwood Financial Services, Inc.
("RFS") and Redwood Residential Funding ("RRF"). Due to a variety of start-up
difficulties with these operations, RFS was closed in the third quarter of 1999
and RRF was closed in the fourth quarter of 2000 and
$2.08 per share for fiscal year 2000, in each case a new record for
Redwood. Increases in core earnings per share were 29% for the fourth
quarter and 22% for the full year of 2000 as compared to the same
periods in 1999. These closures resulted in
restructuring charges of $8.4 million duringCore earnings are earnings from ongoing operations
before mark-to-market adjustments and non-recurring items.
Reported earnings per share were $0.55 for the fourth quarter 2000 and
$1.82 for the year ended December 31,2000. We paid $1.61 per common share in dividends in
year 2000. Book value rose from $20.88 to $21.47 per share during 2000.
REVENUES SUMMARY
Most of our revenue comes from the monthly mortgage payments that
homeowners make on their mortgage loans. To a lesser degree, we also
earn revenues from commercial mortgage loans.
Total revenues increased from $146 million in 1999 to $169 million in
2000. Our average balance of earning assets remained constant at $2.2
billion, while our average asset yield increased from 6.62% to 7.55%.
Asset yields increased because we shifted our asset mix towards higher
yielding products, coupon rates on our adjustable rate mortgages rose in
conjunction with increases in short-term interest rates, premium
amortization expenses declined as mortgage prepayment rates slowed, and
credit provision expenses declined due to strong portfolio credit
performance.
From 1998 to 1999, revenues declined from $222 million to $146 million.
Asset yields increased from 6.42% to 6.62%, but average earning assets
declined from $3.5 billion to $2.2 billion as we utilized a significant
reduction in the headcount and ongoing operating expenses at
Holdings.
For more information, please visit our Web site at: http://www.redwoodtrust.com.
FINANCIAL CONDITION
Our balance sheet presents our mortgage finance assets and liabilities. It also
includes, as one line item, our net investment in Holdings. Holdings' balance
sheet and financial condition are presented separately with discussion and
analysis beginning on Page 39.
At December 31, 1999, we owned $1.4 billion mortgage loans and $1.0 billion
mortgage securities. We financed these mortgage assets with $1.3 billion of
short-term debt, $0.9 billion of long-term debt, and $210 million of equity.
Our exposure to credit loss from our mortgage loans is limited, to some degree,
by the method we use to finance a portion of these loans. The long-term debt we
issue is non-recourse to us; as a result, our credit exposure to our
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30
long-term debt financed loans is limited to our net investment remaining after
the issuance of such debt. A total of $0.9 billion of non-recourse assets and
liabilities are owned by trusts created by our special-purpose finance
subsidiary, Sequoia Mortgage Funding Corporation ("Sequoia"). The trusts are
"bankruptcy-remote" with respect to Redwood Trust. Although the net earnings of
the trusts accrue to Redwood Trust, Redwood Trust is not responsible for the
repayment of Sequoia debt and Sequoia has no call on the liquidity of Redwood
Trust. Our recourse exposure to Sequoia's mortgage assets is limited to our
equity investments in these trusts. At December 31, 1999, these equity
investments had a reported net value of $32 million.
At December 31, 1998, the portion of our balance sheet that was subject to
recourse was $1.5 billion of assets, $1.3 billion of borrowings, and $0.2
billion of equity. The ratio of equity-to-recourse-assets was 14.8%. The ratio
of recourse-debt-to-equity was 6.0 to 1.0.
At December 31, 1998, we reported $2.8 billion in assets, of which $1.5 billion
were recourse, and $2.6 billion of liabilities, of which $1.3 billion were
recourse. Equity capital was $0.3 billion. The ratio of
equity-to-recourse-assets was 16.7% and the ratio of recourse-debt-to-equity was
4.9 to 1.0.
EARNING ASSETS
At December 31, 1999, we owned $2.4 billion of earning assets. At December 31,
1998, we owned $2.7 billion of earning assets. During the year ended December
31, 1999, we reduced the amount of our earning assets, in part, as a result of
using $37 million of our equity capital to repurchase our common stock. Asset yields
rose, despite a decrease in mortgage coupon rates, due to a significant
decline in premium amortization expenses. Premium amortization expenses
declined as a result of significantly reduced premium balances and
slower mortgage prepayment rates.
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In 2001, we expect that revenues may decline from the $169 million that
we earned in 2000, although we currently expect that interest expenses
may decline faster than revenues and that our net interest income may
benefit in the short-term. We expect revenues to decline as asset yields
decline along with falling short-term interest rates and as premium
amortization expenses increase along with faster mortgage prepayment
rates.
Our average earning assets could decline, leading to reduced revenues,
should we acquire additional credit-enhancement interests or other
assets that require a greater amount of capital per dollar of revenue
generated. Declining revenues from such a change in asset mix would not
necessarily imply a decline in net interest income, for liabilities
would decline under such a strategy as well.
If we raise additional equity capital in 2001, we plan to acquire
additional assets, and revenues would likely increase.
TABLE 1
TOTAL INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
NET TOTAL
AVERAGE PREMIUM CREDIT INTEREST EARNING
EARNING COUPON AMORTIZATION PROVISION INCOME ASSET
ASSETS INCOME EXPENSE EXPENSE REVENUES YIELD
---------- ------ ------------ --------- -------- -------
Q1: 1999 $2,551,046 $44,006 $(2,274) $(345) $41,387 6.49%
Q2: 1999 2,208,554 37,722 (1,632) (371) 35,719 6.47%
Q3: 1999 2,054,558 35,337 (782) (416) 34,139 6.65%
Q4: 1999 2,011,107 35,407 (474) (214) 34,719 6.91%
Q1: 2000 2,368,090 43,461 (522) (119) 42,820 7.23%
Q2: 2000 2,287,179 43,091 45 (128) 43,008 7.52%
Q3: 2000 2,192,390 42,959 (1,040) (240) 41,679 7.60%
Q4: 2000 2,123,648 42,816 (818) (244) 41,754 7.86%
1998 $3,451,611 $250,597 $(27,793) $(1,120) $221,684 6.42%
1999 2,204,421 152,472 (5,162) (1,346) 145,964 6.62%
2000 2,242,363 172,327 (2,335) (731) 169,261 7.55%
We operate in the single business segment of real estate finance, with
common staff and management, commingled financing arrangements, and
flexible capital commitments. We allocate our staff and capital
resources in a fluid manner to our real estate finance product lines as
we seek the highest risk-adjusted returns.
To provide a greater level of detail on our revenue trends, we discuss
revenue and portfolio characteristics by product line below. The
following discussion of our assets contains statistics that in some
cases have been obtained from or compiled from information made
available by servicing entities and information service providers.
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RESIDENTIAL CREDIT-ENHANCEMENT PORTFOLIO
We actively added to our residential credit-enhancement portfolio during
2000, increasing our commitments by over 200%. Pricing in this market
was attractive due to reduced competition. We were able to structure a
number of attractive transactions involving seasoned loans (which
generally have less credit risk than newly originated loans). In many of
our transactions, with both new and seasoned loans, we were able to work
with sellers to underwrite loans prior to securitization and to remove
the more risky loans from the loan pools that we agreed to finance.
Substantially all of the $23 billion of loans that we added to our
credit-enhancement portfolio in 1999 and 2000 were "A" quality loans.
Credit-enhancement revenues were $3.0 million in 1998, $4.2 million in
1999, and $8.5 million in 2000. Much of this revenue goes directly to
net interest income, as we utilize a relatively high percentage of
equity to fund this portfolio. Increases in revenues were largely a
result of increases in our credit-enhancement portfolio. Our
credit-enhancement portfolio increased from under $1 billion at the end
of 1998 to $6 billion at the end of 1999 and $23 billion at the end of
2000. The principal value of our credit-enhancement interests increased
from $17 million to $49 million to $125 million, and our net basis in
these assets increased from $8 million to $28 million to $81 million at
the end of 1998, 1999, and 2000, respectively.
The yield on our net credit-enhancement assets decreased from 26% in
1998 to 23% in 1999 to 14% in 2000. Given favorable credit results,
yields on credit-enhancement assets should increase over time. Our
yields on the credit-enhancement interests that we acquired from 1994 to
1997 have been growing. Our returns on these assets were further
increased when we resecuritized these assets in December 1997. Our
average yield for all of our credit-enhancement assets has decreased
over time as we have acquired new credit-enhancement interests and
booked them at relatively low initial yields. In addition, we have
increased the percentage of second and third loss positions in our mix
of credit-enhancement assets; these assets have less risk but also lower
yields. Given favorable credit results, we would expect to be able to
increase the yields of our newer assets over time. After a few years, we
may be able to resecuritize these interests, thus further increasing
their yields.
TABLE 2
CREDIT ENHANCEMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE NET
AVERAGE AVERAGE NET DISCOUNT TOTAL
PRINCIPAL CREDIT DISCOUNT AVERAGE COUPON AMORTIZATION INTEREST
VALUE RESERVE BALANCE BASIS INCOME INCOME INCOME YIELD
--------- ------- -------- ------- ------ ------------ -------- -----
Q1: 1999 $21,096 $(6,096) $(1,887) $13,113 $334 $469 $803 24.51%
Q2: 1999 21,624 (6,107) (2,023) 13,494 341 518 859 25.46%
Q3: 1999 27,020 (5,774) (1,931) 19,315 478 583 1,061 21.97%
Q4: 1999 41,946 (9,263) (5,693) 26,989 747 732 1,479 21.92%
Q1: 2000 56,439 (11,567) (6,758) 38,114 1,048 567 1,615 16.95%
Q2: 2000 77,173 (16,361) (7,654) 53,158 1,412 723 2,135 16.07%
Q3: 2000 100,857 (21,484) (11,956) 67,417 1,928 356 2,284 13.55%
Q4: 2000 113,370 (24,596) (12,514) 76,260 2,144 346 2,490 13.06%
1998 $22,077 $(7,275) $(3,265) $11,537 $1,627 $1,336 $2,963 25.68%
1999 27,976 (7,068) (2,639) 18,269 1,900 2,302 4,202 23.00%
2000 87,070 (18,527) (9,734) 58,809 6,532 1,992 8,524 14.49%
Credit losses in this portfolio (reductions in principal value of our
interests) were $3.3 million in 1998, $1.1 million in 1999, and $0.8
million in 2000. To date, credit losses on our credit-enhancement
interests acquired from 1994 to 1997 have been slightly higher than we
originally anticipated; credit losses on credit-enhancement interests
acquired from 1998 through the present have been lower than we
originally anticipated.
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We charged these losses against our credit reserve for these assets. We
designate a portion of the purchase discount that we book upon
acquisition as credit reserve to provide for estimated future credit
losses. This effectively reduces our discount balances, and thus reduces
discount amortization income and the yields that we recognize on these
assets. Our designated credit reserve for our credit-enhancement
portfolio was $6 million at the end of 1998, $11 million at the end of
1999, and $27 million at the end of 2000.
Some of our credit-enhancement assets are themselves credit-enhanced by
securitized interests held by others (often the originator) that are
junior to us, i.e., we do not always hold a first loss position. The
first loss positions held by others are a form of credit reserve for us
with respect to loan losses within our credit-enhancement portfolio. The
principal value of interests junior to our positions at December 31,
2000 was $87 million. Together with our credit reserve of $27 million,
our effective protection against credit losses in our credit-enhancement
portfolio at December 31, 2000 was $114 million, or 50 basis points
(0.50%) of the current balance of the loans at that time, on average.
Reserves, credit-protection, and risks vary by asset, so we are still
subject to loss on certain assets even with this high level of average
overall credit protection.
If future credit losses exceed our expectations, we will increase our
credit reserve on a specific asset basis. We can do this by lowering the
yield that we recognize on the asset (by designating more of the
purchase discount as reserve) or, under new EITF 99-20 accounting rules
to be adopted in 2001, by reducing our basis in an asset by marking it
to market through the income statement.
Serious delinquencies in our credit enhancement portfolio were $26
million at the end of 1998, $48 million at the end of 1999, and 1998 included$52
million at the following:end of 2000. Serious delinquencies were 0.23% of the
current balance of credit-enhanced loans at December 31, 2000.
TABLE 3
CREDIT ENHANCEMENT PORTFOLIO -- CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
ADDITIONS
UNDERLYING SERIOUS SERIOUS TOTAL REDWOOD'S TO ENDING
MORTGAGE DELINQUENCIES DELINQUENCIES CREDIT CREDIT CREDIT CREDIT
LOANS % $ LOSSES LOSSES RESERVE RESERVE
---------- ------------- ------------- -------- --------- --------- -------
Q1: 1999 $467,114 4.74% $22,141 $(1,762) $(518) $(289) $5,952
Q2: 1999 1,427,355 1.36% 19,475 (656) (166) 310 6,262
Q3: 1999 3,794,055 0.42% 15,785 (377) (365) 1,024 7,286
Q4: 1999 6,376,571 0.71% 45,451 (346) (97) 3,955 11,241
Q1: 2000 8,539,491 0.58% 49,731 (813) (270) 652 11,893
Q2: 2000 20,925,931 0.22% 45,999 (1,537) (187) 8,936 20,829
Q3: 2000 21,609,785 0.27% 58,102 (590) (245) 1,310 22,139
Q4: 2000 22,633,860 0.23% 51,709 (1,568) (56) 4,913 27,052
1998 $542,558 4.86% $26,350 $(10,773) $(3,318) $(1,869) $6,241
1999 6,376,571 0.71% 45,451 (3,141) (1,146) 5,000 11,241
2000 22,633,860 0.23% 51,709 (4,508) (758) 15,811 27,052
At December 31, 1999, $993 million carrying value, or 42% of our total mortgage
asset portfolio, were high-quality residential mortgage2000, we credit-enhanced 63,675 loans with adjustable-rate coupons with a face value of $981 million. Our carrying value of
these loans, after $2.8 million of credit reserves, was 101.21% of the face ortotal
principal value of $23 billion. Of these, 58% were fixed-rate loans, 7%
were hybrid loans (loans that become adjustable after a 3 to 10 year
fixed rate period), and 35% were adjustable-rate loans. The average size
of the loans.loans that we credit-enhanced was $355,500. We credit-enhanced
983 loans with principal balances in excess of $1 million; these loans
had an average size of $1.4 million and a total loan balance of $1.4
billion. Loans over $1 million were 2% of the total number of loans and
6% of the total balance of loans that we credit-enhanced at year-end.
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The geographic dispersion of our credit-enhancement portfolio closely
mirrors that of the jumbo residential market as a whole. At December 31,
1998,2000, our loans were most concentrated in the following states:
California 50%, New York 6%, New Jersey 4%, Texas 3%, and Massachusetts
3%. No other state had more than 3%.
Most of the loans that we owned $822 million
carrying valuecredit-enhance are seasoned. Generally, the
credit risk for these loans is reduced as property values have
appreciated and the loan balances have amortized. In effect, the current
loan-to-value ratio for seasoned loans is often much reduced from the
loan-to-value ratio at origination. Only 16% of the loans we financed at
December 31, 2000 were originated in year 2000. Of our California-based
loans, 12% were originated in 2000.
Loans with loan-to-value ratios ("LTV") at origination in excess of 80%
made up 10% of loan balances; we benefit from primary mortgage insurance
("PMI") on 99% of these loans. With this insurance, our effective LTV on
these loans or 31%is substantially reduced. Our average effective LTV at
origination (including the effect of PMI, pledged collateral, and other
credit-enhancements) was 70%. Given housing appreciation and loan
amortization, we estimate the average current effective LTV for the
loans that we credit-enhance is less than 61%.
TABLE 4
CREDIT ENHANCEMENT PORTFOLIO -- UNDERLYING COLLATERAL CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
1998 1999 2000
-------- ---------- -----------
CREDIT-ENHANCEMENT PORTFOLIO $542,558 $6,376,571 $22,633,860
CREDIT-ENHANCED LOANS 2,576 19,318 63,675
ADJUSTABLE % 100% 11% 35%
HYBRID % 0% 14% 7%
FIXED % 0% 75% 58%
FIRST LOSS POSITION, FACE VALUE $17,281 $20,546 $34,959
SECOND LOSS POSITION, FACE VALUE 0 5,840 30,703
THIRD LOSS POSITION, FACE VALUE 0 22,241 59,216
NET FACE VALUE: CREDIT-ENHANCEMENT INTERESTS 17,281 48,627 124,878
FIRST LOSS POSITION, REPORTED VALUE $7,707 $8,279 $12,080
SECOND LOSS POSITION, REPORTED VALUE 0 3,418 21,109
THIRD LOSS POSITION, REPORTED VALUE 0 16,436 47,576
NET INVESTMENT: CREDIT-ENHANCEMENT INTERESTS 7,707 28,133 80,764
CALIFORNIA % 61% 43% 50%
NEW YORK 3% 1% 6%
NEW JERSEY 3% 2% 4%
MASSACHUSETTS 3% 2% 3%
TEXAS 2% 6% 3%
OTHER STATES 28% 47% 34%
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RESIDENTIAL RETAINED LOAN PORTFOLIO
We have not added to our residential retained loan portfolio atsince we
acquired a carrying value$390 million portfolio in December 1999. Several transactions
that we worked on in 2000 that started as whole loan acquisition
opportunities for our retained portfolio ended up becoming opportunities
for our credit-enhancement portfolio. Instead of 101.52%buying the whole loans,
we credit-enhanced the loans by acquiring credit-enhancement interests
from the seller after the seller securitized the loans.
TABLE 5
RESIDENTIAL RETAINED PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
ANNUAL
MORTGAGE NET
AVERAGE NET PREPAYMENT PREMIUM CREDIT TOTAL
PRINCIPAL PREMIUM RATE COUPON AMORTIZATION PROVISION INTEREST
BALANCE BALANCE (CPR) INCOME EXPENSE EXPENSE INCOME YIELD
---------- ------- ---------- ------ ------------ --------- -------- -----
Q1: 1999 $1,268,383 $15,604 32% $22,049 $(1,477) $(345) $20,227 6.30%
Q2: 1999 1,145,096 14,903 29% 19,091 (1,119) (371) 17,601 6.07%
Q3: 1999 1,067,716 12,121 21% 18,431 (614) (416) 17,401 6.45%
Q4: 1999 985,932 13,000 16% 17,494 (705) (214) 16,575 6.64%
Q1: 2000 1,337,428 16,061 14% 24,378 (640) (119) 23,619 6.98%
Q2: 2000 1,276,340 15,372 16% 23,648 (515) (128) 23,005 7.12%
Q3: 2000 1,202,056 14,760 22% 23,118 (829) (240) 22,049 7.25%
Q4: 2000 1,141,624 14,141 16% 22,316 (611) (244) 21,461 7.43%
1998 $1,806,167 $28,596 26% $131,519 $(10,272) $(1,120) $120,127 6.55%
1999 1,115,874 13,895 25% 77,065 (3,915) (1,346) 71,804 6.36%
2000 1,238,993 15,080 17% 93,460 (2,595) (731) 90,134 7.19%
Revenues from our residential retained portfolio increased from $72
million in 1999 to $90 million in 2000 on a higher average balance ($1.3
billion versus $1.1 billion) and an increased yield (7.19% versus
6.36%). Yields increased due to increases in short-term interest rates,
reduced premium amortization expenses as prepayment rates slowed, and
reduced credit provision expenses.
From 1998 to 1999, revenue decreased from $120 million to $72 million.
Average balances declined from $1.8 billion to $1.1 billion due to loan
sales and principal repayments. Yields dropped from 6.55% to 6.36% due
to declining interest rates and changes in portfolio characteristics
resulting from purchase and sale activity.
Annual realized credit losses in this portfolio have been less than one
basis point (.007%) of the $810current balance of the portfolio per year on
average during 1998, 1999, and 2000. Realized credit losses in 2000 were
$42,000. Cumulative losses during the time we have owned these loan
pools equal $0.3 million, face value (netor 1.3 basis points (.013%) of a $2.0 million credit reserve).
Seriouslythe original
balance of the loans.
During the three years of 1998 to 2000, seriously delinquent loans in
this portionportfolio ranged from $4 million to $7 million, yet total realized
losses for the three years were $0.2 million. Many of our seriously
delinquent loans cure without going into foreclosure. When these loans
do default, we do not necessarily incur a credit loss, as we often have
realized substantial value from the sale of the underlying property or
from the result of other loss mitigation efforts. For defaults where we
did incur a credit loss, our average loss severity (credit loss as a
percentage of loan balance) during these three years was 9%.
We took credit provisions of $0.7 million during 2000 for our
residential retained loan portfolio, equaling 6 basis points (0.06%) of
our average loan balance during the year. We ended the year with a
credit reserve for this portfolio of $4.8 million. The year-end reserve
equals 43 basis points (.43%) of our year-end loan balances. The
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reserve is based upon our assessment of various factors affecting our
mortgage loans, including current and projected economic conditions,
delinquency status, and credit protection. We are cautious about credit
in the current economic environment, but we are comforted by the quality
and seasoning of our portfolio were $3.4 million at
December 31, 1999 and $3.2 million at December 31, 1998.the size of our reserves. We
currently expect realized credit losses to increase somewhat in the
future, based on current delinquency levels, the natural seasoning of
the portfolios (losses are more likely to occur in years two through
five), and the weakening economic environment. Losses on our assets have
historically been substantially lower than our original expectations. If
losses increase substantially, we would, if necessary, increase our
credit-provisioning rate.
TABLE 6
RESIDENTIAL RETAINED PORTFOLIO - CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
SERIOUSLY REALIZED CREDIT ENDING
DELINQUENT GROSS LOSS CREDIT PROVISION CREDIT
LOANS DEFAULTS SEVERITY LOSSES EXPENSE RESERVE
---------- -------- -------- -------- --------- -------
Q1: 1999 $5,961 $0 0.0% $0 $(345) $3,129
Q2: 1999 6,728 0 0.0% 0 (371) 3,500
Q3: 1999 3,832 145 3.8% (5) (416) 3,911
Q4: 1999 4,635 0 0.0% 0 (214) 4,125
Q1: 2000 5,338 0 0.0% 0 (119) 4,244
Q2: 2000 4,968 450 9.3% (42) (128) 4,330
Q3: 2000 4,330 0 0.0% 0 (240) 4,570
Q4: 2000 5,667 0 0.0% 0 (244) 4,814
1998 $3,926 $1,913 10.0% $(191) $(1,120) $2,784
1999 4,635 145 3.8% (5) (1,346) 4,125
2000 5,667 450 9.3% (42) (731) 4,814
At December 31, 1999, $391 million carrying value, or 17% of our total mortgage
asset portfolio, were high-quality2000, we owned 3,633 residential mortgage loans with a total
value of $1.1 billion. These were all "A" quality or "prime" quality
loans at origination. Of these, 71% were adjustable rate loans and 29%
were hybrid loans. Our hybrid loans have fixed rate coupons until
December 2002, on average, and then will become adjustable rate loans.
The average loan size was $311,000. We owned 81 loans with a face value of $392 million. Our hybrid mortgage loans have an
initial fixed coupon rate for three to ten years followed by annual adjustments.
Our carrying value of these loans, after $2.3 million of credit reserves, was
99.84% of face value. At December 31, 1998, we owned $575 million carrying value
of these loans, or 22% of our portfolio, at a carrying value of 100.03% ofloan
balance over $1 million; the $575 million face value (net of a $1.7 million credit reserve). Seriously
delinquent loans in this portion of our portfolio were $1.3 million at December
31, 1999 and $0.7 million at December 31, 1998.
At December 31, 1999, $8.4 million carrying value, or 0.4% of our total mortgage
asset portfolio, were commercial mortgage loans originated by RCF. Our carrying
valueaverage size of these loans was 99.85%$1.5
million. Loans with balances over $1 million made up 2% of the loans and
11% of the balances of our total faceretained loan portfolio. California
loans were 25% of the total. All of the loans were originated in 1999 or
earlier. Loans where the original loan balance exceeded 80% of the value
of $8.4the house and other pledged collateral (loan to value, or "LTV", over
80%) made up 7% of loan balances; we benefit from primary mortgage
insurance ("PMI") on 99% of these loans (serving to substantially lower
our effective LTVs). Average effective LTV at origination for our
residential retained portfolio (including the effect of PMI, pledged
collateral, and other credit-enhancements) was 71%. Given housing
appreciation and loan amortization, we estimate the current effective
LTV of our retained loan portfolio is less than 63%.
Serious delinquencies remained at low levels at $5.7 million, or 0.50%
of the current balance of the loans and 0.24% of the original balance of
the loans. Included in this amount are five real estate owned ("REO")
properties with an estimated value of $0.5 million.
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TABLE 7
RETAINED RESIDENTIAL PORTFOLIO - LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
1998 1999 2000
---------- ---------- ----------
BOOK VALUE $1,397,213 $1,385,589 $1,130,997
NUMBER OF LOANS 4,760 4,348 3,633
AVERAGE LOAN SIZE $ 294 $ 319 $ 311
ADJUSTABLE % 58.1% 70.1% 71.3%
HYBRID % 41.9% 29.3% 28.7%
FIXED % 0.0% 0.6% 0.0%
FUNDED WITH SHORT-TERM DEBT 19% 30% 1%
FUNDED WITH LONG-TERM DEBT 81% 70% 99%
LONG-TERM DEBT $1,035,560 $ 945,270 $1,095,835
NET INVESTMENT IN SEQUOIA $ 40,253 $ 36,618 $ 37,166
CALIFORNIA % 32% 26% 25%
FLORIDA 8% 9% 9%
NEW YORK 6% 8% 8%
NEW JERSEY 5% 5% 5%
TEXAS 4% 5% 5%
GEORGIA 4% 5% 5%
OTHER STATES 41% 42% 43%
YEAR 2000 ORIGINATION n/a n/a 0%
YEAR 1999 ORIGINATION n/a 19% 19%
YEAR 1998 ORIGINATION 33% 32% 32%
YEAR 1997 ORIGINATION 48% 37% 37%
YEAR 1996 OR EARLIER ORIGINATION 19% 12% 12%
For 2001, we are actively seeking high-quality jumbo residential loan
acquisition opportunities that are priced attractively relative to our
long-term debt issuance costs. We are seeking to acquire loans both on a
bulk basis and a flow basis. As we evaluate and structure a portfolio
acquisition transaction, we may prefer to acquire the loans as whole
loans and issue long-term debt to fund the acquisition (thus adding to
our residential retained loan portfolio). Or, we may prefer to have the
seller securitize the loans and sell us the credit-enhancement interest
(thus adding to our credit-enhancement portfolio).
INVESTMENT PORTFOLIO
Our investment portfolio revenues increased from $66 million in 1999 to
$67 million in 2000. Our asset yields increased from 6.56% to 7.53%.
Yields increased as coupon rates rose with short-term interest rates and
as premium amortization expenses were reduced with slower mortgage
prepayments. Average investment portfolio assets declined from $1.0
billion during 1999 to $0.9 billion during 2000. Although opportunities
for growth in our investment portfolio were attractive in 2000, we
allocated an increased amount of our capital to our residential
credit-enhancement business.
Investment portfolio revenues declined from $96 million in 1998 to $66
million in 1999. Our average investment portfolio balance dropped from
$1.5 billion to $1.0 billion as we allocated capital to other portfolios
and reduced our capital base through our common stock repurchase
program. Our investment portfolio yields increased from
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6.15% in 1998 to 6.56% in 1999, in spite of falling interest rates, due
to reductions in premium amortization expenses as a result of
significantly reduced premium balances and slower mortgage prepayment
rates.
TABLE 8
INVESTMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE MORTGAGE NET
AVERAGE NET PREPAYMENT PREMIUM TOTAL
EARNING PREMIUM RATES COUPON AMORTIZATION INTEREST
ASSETS BALANCE (CPR) INCOME EXPENSE INCOME YIELD
---------- ---------- ---------- ---------- ------------ ---------- ----------
Q1: 1999 $1,179,689 $ 9,961 33% $ 20,773 $ (1,266) $ 19,507 6.56%
Q2: 1999 979,909 10,431 28% 17,500 (1,031) 16,469 6.65%
Q3: 1999 900,339 7,878 28% 15,265 (751) 14,514 6.39%
Q4: 1999 943,641 8,467 21% 16,231 (502) 15,729 6.61%
Q1: 2000 944,301 8,118 19% 17,510 (450) 17,060 7.16%
Q2: 2000 902,265 7,225 20% 17,362 (163) 17,199 7.56%
Q3: 2000 868,159 8,946 20% 17,278 (572) 16,706 7.62%
Q4: 2000 822,452 9,595 19% 16,832 (591) 16,241 7.81%
1998 $1,534,270 $ 32,437 34% $ 115,270 $ (18,858) $ 96,412 6.15%
1999 999,972 9,177 27% 69,769 (3,550) 66,219 6.56%
2000 884,081 8,475 20% 68,982 (1,776) 67,206 7.53%
At December 31, 1998,2000, we owned $8.3$765 million carrying value of these loans,mortgage securities,
almost all of which were rated AAA or 0.3% of our
portfolio, at a carrying value of 99.56% of face value of $8.3 million. All of
these loans were current at December 31, 1999 and December 31, 1998.
We own mortgage loans on real estate properties located throughout the United
States. At December 31, 1999, the geographic distribution of our mortgage loan
portfolio was as follows: California 26%; Florida 9%; New York 8%; New Jersey
5%; Texas 5%; Georgia 5%.AA. The remaining 42%majority of our
investments were residential adjustable-rate or floating rate
securities.
TABLE 9
INVESTMENT PORTFOLIO CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
RATING 1998 1999 2000
---------- ---------- ---------- ----------
AGENCY ADJUSTABLE "AAA" $ 600,803 $ 574,711 $ 532,578
AGENCY CMO FLOATERS "AAA" 16,621 6,248 0
JUMBO ADJUSTABLE AAA or AA 550,990 290,658 191,047
JUMBO SHORT FIXED CMOS AAA or AA 19,254 15,554 0
HOME EQUITY FLOATERS AAA or AA 53,972 47,111 23,015
HOME EQUITY FIXED AAA to BBB 15,668 11,889 17,044
INTEREST-ONLY (IO) AAA or AA 347 126 113
US TREASURIES FIXED AAA 48,009 0 0
CBO EQUITY B or NR 0 0 978
TOTAL INVESTMENT PORTFOLIO $1,305,664 $ 946,247 $ 764,775
REALIZED CREDIT LOSES 0 0 0
We added assets to our investment portfolio in states
located throughout the country,first quarter of
2001. Although opportunities for this portfolio currently appear
attractive, it is possible that we might reduce the size of this
portfolio later in the year to fund investments in our residential
credit-enhancement and residential retained loan portfolios. If we raise
additional equity capital during 2001, we would likely add assets and
capital to this portfolio, at least initially.
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COMMERCIAL RETAINED LOAN PORTFOLIO
In conjunction with no one state greater than 5%. At December
31,our affiliate, Holdings, we originated or acquired
commercial mortgage loans totaling $8 million in 1998, 32%$42 million in
1999, and $73 million in 2000. After loan sales and pay offs, we owned a
total of our loan portfolio was secured by properties located in
California, 8% were located in Florida, 6% were in New York, 5% were in New
Jersey, and the remaining 49%$76 million of our portfolio was secured by properties
throughout the United States, with no one state greater than 5%.
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For presentation purposes, the $1.0 billioncommercial loans at December 31, 2000. Of these,
$57 million were owned by Redwood and $19 million were owned by
Holdings.
Commercial revenues at Redwood increased from $0.1 million in 1998 to
$1.0 million in 1999 to $2.0 million in 2000 as the number of loans held
at Redwood increased and the $1.1
billion at December 31,average yield of our commercial loans
increased from 8.83% in 1998 to 9.70% in 1999 to 10.61% in 2000. The
increases in yields were primarily the result of an improved mix of
commercial mortgage loans that are financed with long-term
debt in Sequoia trusts are classified as "Mortgage Loans: held-for investment"
onthe portfolio.
TABLE 10
COMMERCIAL PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE
AVERAGE NET DISCOUNT CREDIT TOTAL
PRINCIPAL DISCOUNT COUPON AMORTIZATION PROVISION INTEREST
VALUE BALANCE INCOME INCOME EXPENSE INCOME YIELD
--------- -------- ------- ------------ --------- -------- -------
Q1: 1999 $ 3,154 $ (13) $ 76 $ 0 $ 0 $ 76 9.67%
Q2: 1999 13,100 0 293 0 0 293 8.94%
Q3: 1999 17,953 0 453 0 0 453 10.09%
Q4: 1999 10,245 (1) 259 0 0 259 10.11%
Q1: 2000 8,710 (13) 211 0 0 211 9.70%
Q2: 2000 15,418 (30) 393 0 0 393 10.21%
Q3: 2000 13,982 (265) 367 5 0 372 10.85%
Q4: 2000 38,020 (477) 987 39 0 1,026 10.93%
1998 $ 1,161 $ (6) $ 102 $ 0 $ 0 $ 102 8.83%
1999 11,151 (3) 1,081 0 0 1,081 9.70%
2000 19,071 (197) 1,958 44 0 2,002 10.61%
To date, we have not experienced any delinquencies or credit losses in
our balance sheetscommercial loan portfolio, nor do we anticipate any credit problems
at this time. We have not established a general credit reserve for
commercial loans. The slowing economy, and are carried at amortized cost. The remaining mortgage
loans that are funded with short-term debt and equity are classified as
"Mortgage Loans: held-for-sale" on our balance sheets and are carried at the
lower-of-cost-or-market, with any related market value adjustments recorded
through the income statement.
MORTGAGE SECURITIES
At December 31, 1999, 24% of our total mortgage asset portfolio, or $575 million
carrying value with a face value of $565 million, consisted of residential
mortgage securities issued and credit-enhanced by Fannie Mae or Freddie Mac and
effectively rated "AAA". The majority of these securities, $565 million or 98%,
were adjustable-rate securities with the remaining 2% fixed-rate securities. The
carrying value of these securities was 101.73% of face value. At December 31,
1998, we owned $601 million carrying value of these securities, or 22% of our
portfolio, at a carrying value of 101.28% of the $593 million face value.
At December 31, 1999, 12% of our total mortgage asset portfolio, or $291 million
carrying and face value, consisted of adjustable-rate residential mortgage
securities issued by private-label security issuers. These securities were
credit-enhanced through subordination or other means and were rated "AAA" or
"AA". The carrying value of these securities was 99.86% of face value. At
December 31, 1998, we owned $551 million carrying value of these securities, or
21% of our portfolio, at a carrying value of 100.16% of the $551 million face
value.
At December 31, 1999, 2% of our total mortgage asset portfolio, or $47 million
carrying value with a face value of $48 million, consisted of residential
floating-rate mortgage securities rated "AAA" or "AA" which were backed by home
equity loans, or "HEL". The carrying value of these securities was 98.79% of
face value. At December 31, 1998, we owned $57 million carrying value of these
securities, or 2% of our portfolio, at a carrying value of 97.62% of the $59
million face value.
At December 31, 1999, 1% of our mortgage asset portfolio, or $28 million
carrying value with a face value of $49 million, consisted of lower-rated,
residential mortgage securities issued by private-label security issuers. These
securities bore some degree offactors particular to each
loan, could cause credit risk and were rated "A" or below. The
carrying value of these securities, after $0.8 million of credit reserves, was
57.85% of face value. At December 31, 1998, we owned $8 million carrying value
of these securities, or 0.3% of our portfolio, at a carrying value, after credit
reserves, of 44.60% of the $17 million face value. We intend to increase our
investment in lower-rated, residential mortgage securitiesissues in the future. At December 31, 1999, 1%If so, we would provide
for future losses and create a specific credit reserve on an asset by
asset basis.
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TABLE 11
COMMERCIAL PORTFOLIO LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
1998 1999 2000
-------- -------- --------
HELD AT REDWOOD $ 8,287 $ 8,437 $57,153
HELD AT HOLDINGS 0 29,309 18,936
TOTAL COMMERCIAL $ 8,287 37,746 76,089
NUMBER OF LOANS 8 13 19
AVERAGE LOAN SIZE $ 1,036 $ 2,904 $ 4,005
SERIOUS DELINQUENCY $ 0 0 0
SERIOUS DELINQUENCY % 0% 0% 0%
SERIOUS DELINQUENCY % 0% 0% 0%
REALIZED CREDIT LOSSES 0 0 0
CALIFORNIA % 84% 74% 73%
Our primary focus in 2001 is improving our financing of these loans
through extending the maturities of our mortgage asset portfolio, or $16 million
carryingcommitted bank lines and face value, consisted of fixed-rate, private-label mortgage
securities. These are commonly called "CMOs". They were rated "AAA" or "AA" and
had average lives of 1 to 2 years. The carrying value of these securities was
97.28% of face value. At December 31, 1998, we owned $19 million carrying value
of these securities, or 1% of our portfolio, at a carrying value of 100.59% of
the $19 million face value.
At December 31, 1999, 0.5% of our mortgage asset portfolio, or $12 million
carrying value with a face value of $13 million, consisted of fixed-rate,
credit-enhanced private-label mortgage securities rated "AA" and backed by
residential mortgage loans with loan-to-value ratios in excess of 100%. The
carrying value of these securities was 91.00% of face value. At December 31,
1998, we owned $12 million carrying value of these securities, or 0.5% of our
portfolio, at a carrying value of 95.09% of the $13 million face value.
At December 31, 1999, 0.3% of our total mortgage asset portfolio, or $6 million
carrying and face value, consisted of floating-rate CMO mortgage securities
issued by Fannie Mae or Freddie Mac and effectively rated "AAA". The carrying
value of these securities was 99.88% of face value. At December 31, 1998, we
owned $17 million carrying value of these securities, or 0.6% of our portfolio,
at a carrying value of 100.18% of the $17 million face value.
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At December 31, 1999, 0.01% of our mortgage asset portfolio, or $0.1 million
carrying value with no face value, consisted of interest-only mortgage
securities rated "AAA" or "AA". At December 31, 1998, we owned $0.4 million
carrying value of these securities, or 0.01% of our portfolio.
For presentation purposes, all of the mortgage securities except for the
lower-rated securities are classified as "Mortgage Securities - trading" on our
balance sheets and are carried at their estimated fair market value, with any
related market value adjustments recorded through
the income statement. The $28
million at December 31, 1999 and $8 million at December 31, 1998, of lower-rated
mortgage securities are classified as "Mortgage Securities - available-for-sale"
on our balance sheets and are also carried at their estimated fair market value.
Market value adjustments on these securities, however,selling senior participations. We are not recorded through
the income statement but are included in "accumulated other comprehensive
income"actively originating new
loans, although we may do so later in the equity portionyear. We believe our
commercial operations have a good chance of the balance sheet.
U.S. TREASURY SECURITIES
At December 31, 1998, we owned $48 millionbeing highly profitable in
2001. Our current intention is to seek profitable ways to expand our
ownership of ten-year U.S. Treasury securities
as part of our asset/liability managementcommercial mortgage assets (loans and securities) over
time.
INTEREST EXPENSE
Interest and hedging program. We sold our
ten-year U.S. Treasury securities in the first half of 1999.
CASH
We had $20 million of unrestricted cash at December 31, 1999 and $56 million at
year-end 1998.
Sequoia owned cash totaling $5 million at December 31, 1999 and $13 million at
year-end 1998. In consolidating Sequoia assets on our balance sheet, we reflect
this cash as "Restricted Cash" since it will be used for the specific purpose of
making payments to Sequoia bondholders and is not available for general
corporate purposes.
INTEREST RATE AGREEMENTS
Our interest rate agreements are carried on our balance sheet at estimated
market value, which was $2.0 million at December 31, 1999 and $2.5 million at
December 31, 1998. Please see "Note 2. Summary of Significant Accounting
Policies", "Note 7. Interest Rate Agreements" and "Note 10. Fair Value of
Financial Instruments" in the Notes to Consolidated Financial Statements for
more information.
INVESTMENT IN RWT HOLDINGS, INC.
We do not consolidate the assets and liabilities of Holdings on our balance
sheet. We reflect the net book value of our investment in one line item on our
balance sheet labeled "Investment in RWT Holdings, Inc." We refer you to
Holdings' "Consolidated Financial Statements and Notes" and Holdings'
"Management's Discussion and Analysis" below for more information on Holdings.
Through December 31, 1999, we had invested $29.7expenses increased from $119 million in the preferred stock1999 to
$139 million in 2000. Average borrowings increased slightly, from $2.0
billion to $2.1 billion, and our cost of Holdings. Our share of the operating losses at Holdings has reduced the
carrying value of this investment. The carrying value was $3.4funds increased from 5.83% to
6.69% as interest rates rose. Net hedging costs decreased as interest
rates increased and we earned hedge income to offset expenses.
Interest and hedging expenses decreased from $200 million at
December 31,in 1998 to
$119 million in 1999 and $15.1 million at December 31, 1998.
At December 31, 1999, our assets also included loans to Holdings of $6.5 million
and a receivable from Holdings of $0.5 million. We expect to collect the full
amount of these receivables during the year 2000. We expect that we will
continue to provide liquidity to Holdings, when necessary, during the year 2000.
At December 31, 1998, loans to Holdings totaled $6.5 million and receivables
from Holdings were $0.4 million.
OTHER ASSETS
Our other assets include accrued interest receivables, other receivables, fixed
assets, leasehold improvements and prepaid expenses. These totaled $14.9 million
at December 31, 1999 and $20.5 million at December 31, 1998.
SHORT-TERM DEBT
Short-term borrowings totaled $1.3 billion at December 31, 1999, or 57% of our
total debt. At December 31, 1998, short-term borrowings were $1.3 billion, or
49% of our total debt. We pledge a portion of our mortgage securities portfolio,
mortgage loan portfolio, and other investments to secure this debt. Maturities
on this debt typically range from one month to one year. The interest rate on
most of this debt adjusts monthly to a spread
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over or under the one-month LIBOR interest rate, with some of it adjusting daily
based on the Fed Funds interest rate.
LONG-TERM DEBT
At December 31, 1999, we owned $1.0 billion of residential mortgage loans that
were financed with long-term debt through trusts owned by our financing
subsidiary, Sequoia Mortgage Funding Corporation ("Sequoia"). The amount of
outstanding Sequoia long-term debt amortizes as the underlying mortgages pay
down. As the equity owner of these trusts, we are entitled to distributions of
the net earnings of the trusts, which principally consist of the interest income
earned from mortgages in each trust less the interest expense of the debt of
each trust. Sequoia debt is non-recourse to Redwood Trust. The debt is
consolidated on our balance sheet and is reflected as long-term debt, which is
carried at historical amortized cost. The original scheduled maturity of this
debt was approximately thirty years. Since these debt balances are retired over
time as principal payments are received on the underlying mortgages, the
expected average life of this debt is two to six years.
At December 31, 1999, 43% of our total debt, or $945 million, was long-term
mortgage-backed debt. Of this long-term debt, $563 million had a floating-rate
and $382 million was fixed-rate until December 2002, and floating-rate
thereafter.
At December 31, 1998, 51% of our total debt, or $1.3 billion, was long-term
mortgage-backed debt. Of this long-term debt, $776 million had a floating-rate
and $530 million had a fixed-rate until December 2002, at which time it becomes
floating-rate debt.
OTHER LIABILITIES
Our other liabilities include accrued interest payable, accrued expenses, and
dividends payable. The net balance of these accounts totaled $11.2 million at
December 31, 1999 and $14.5 million at December 31, 1998.
STOCKHOLDERS' EQUITY
At December 31, 1999, total equity capital was $210 million, preferred stock
equity was $27 million, and reported common equity totaled $183 million, or
$20.88 per common share outstanding.
In reporting equity, we mark-to-market all earning assets and interest rate
agreements except mortgage loans that were financed to maturity (Sequoia). In
accordance with Generally Accepted Accounting Principles ("GAAP"), no
liabilities were marked-to-market.
If we had marked-to-market all of our assets and liabilities, total equity
capital would have been reported as $213 million at December 31, 1999. After
subtracting out the preference value of the preferred stock, common equity on a
full mark-to-market basis was $185 million and the net mark-to-market value per
common share was $21.07.
At December 31, 1998, reported equity capital was $255 million, preferred stock
equity was $27 million, and reported common equity was $228 million, or $20.27
per common share outstanding. Mark-to-market common equity was $220 million, or
$19.53 per common share.
During 1999, total equity fell from $255 million to $210 million primarily as a result of $37 million of stock repurchases. The book value per share increased
from $20.27a decline in average borrowings
($3.3 billion to $20.88,$2.0 billion) and a 3% increase; the mark-to-market common equity per share
increased from $19.53 to $21.07 per share, an increase of 8% or $1.54 per share,
during 1999. This increase was due to net asset appreciation and the effects ofdecline in our stock repurchase program. We acquired 2,483,500 shares, or 22%, of our
common stock during the year ended December 31, 1999 at an average price of
$14.96 per share.
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RESULTS OF OPERATIONS
Our operating results include all of the reported income of our mortgage finance
operations plus, as one line item on our income statement, our share of the
after-tax results of operations at Holdings. Detailed results at Holdings are
discussed separately below. Please see "RWT Holdings, Inc. - Management
Discussion and Analysis of Financial Condition and Results of Operations"
commencing on page 38 of this 1999 Form 10-K for further discussion of Holdings'
financial position and performance.
INTEREST INCOME
For the year ended December 31, 1999, interest income, or total revenues,
generated by our mortgage finance operations was $147 million. Our portfolio had
average earning assets of $2.2 billion and earned an average yield of 6.65%.
During this year, the average coupon rate, or the cash-earning rate on mortgage
principal, was 6.93%. The average value of assets included a net unamortized
premium of 0.62% of mortgage principal totaling $13 million. We write off this
net premium balance as an expense over the life of our assets. Net premium
amortization expense for the year for assets was $5 million, which reduced the
earning asset yield by 0.22%. The prepayment rate on our mortgage assets, which
drives the rate at which we write off net premium balances, was 27% Conditional
Prepayment Rate ("CPR") during the year. Other factors reduced the earning asset
yield by 0.06%.
For the year ended December 31, 1998, interest income was $223 million. Our
portfolio had average earning assets of $3.5 billion and earned an average yield
of 6.48%. The average coupon rate was 7.42%. The average reported value of
assets included a 1.47% net premium, or $49 million. Net premium amortization
expense was $28 million, which reduced earning asset yield by 0.82%. Prepayments
during the year were 30% CPR. Other factors reduced the earning asset yield by
0.12%.
For the year ended December 31, 1997, interest income was $199 million. Our
portfolio had average earning assets of $3.0 billion and earned an average yield
of 6.74%. The average coupon rate was 7.72%. The reported value of assets
included a 2.13% net premium, or $61 million. Net premium amortization expense
was $23 million, which reduced earning asset yield by 0.81%. Prepayments during
the year were 25% CPR. Other factors reduced the earning asset yield by 0.17%.
During 1999, we reduced our earning asset balances in order to free capital to
fund the start-up operations at Holdings and fund our stock repurchases. In the
third quarter of 1998, we began reporting many of our assets at market value for
income statement purposes. This served to decrease our outstanding premium
balance, thereby reducing the effect that prepayments had on our earning asset
yields. As a result, our earning asset yield increased slightly in 1999 from
1998, despite a lower average coupon rate. The increase in yield is due to
reduced premium amortization expenses caused by a combination of lower net
premium balances and slower prepayment speeds during the later half of 1999.
In the fourth quarter of 1999, interest income was $35 million. Our portfolio
had average earning assets of $2.0 billion and earned an average yield of 6.88%.
The average coupon rate was 7.01%. The reported value of assets included a 0.33%
net premium, or $7 million. Net premium amortization expense was $0.5 million,
which reduced earning asset yield by 0.10%. Prepayments during the quarter were
19% CPR. Other factors reduced the earning asset yield by 0.03%.
For the quarter ended December 31, 1998, interest income was $54 million. Our
portfolio had average earning assets of $3.1 billion and earned an average yield
of 6.87%. The coupon rate was 7.17%. The reported value of assets included a
0.63% net premium, or $19 million. Net premium amortization expense was $1.8
million, which reduced earning asset yield by 0.23%. Prepayments during the
quarter were 32% CPR. Other factors reduced the earning asset yield by 0.07%.
INTEREST EXPENSE
Interest expense for the year ended December 31, 1999 was $117 million. We
funded our mortgage portfolio and other assets with an average of $238 million
of equity and $2.0 billion of borrowings. We paid an average cost of
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funds of 5.73% for these borrowings. Short-term debt averaged 47% of total debt
and cost us 5.35%. Long-term debt averaged 53% of total debt and cost us 6.03%.
Interest expense for the year ended December 31, 1998 was $196 million. We
funded our mortgage portfolio and other assets with an average of $307 million
of equity and $3.3 billion of borrowings. We paid an average cost of funds (6.14%
to 5.83%).
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TABLE 12
INTEREST EXPENSE
(ALL DOLLARS IN THOUSANDS)
LONG LONG SHORT SHORT TOTAL TOTAL
AVERAGE TERM TERM AVERAGE TERM TERM INTEREST COST OF
LONG DEBT DEBT SHORT DEBT DEBT EXPENSE FUNDS
TERM INTEREST COST OF TERM INTEREST COST OF COST OF AND AND
DEBT EXPENSE FUNDS DEBT EXPENSE FUNDS HEDGING HEDGING HEDGING
---------- -------- ------- ---------- -------- ------- ------- -------- -------
Q1: 1999 $1,243,474 $18,740 6.03% $1,152,635 $14,751 5.12% 0.06% $33,824 5.65%
Q2: 1999 1,117,790 16,657 5.96% 937,942 11,880 5.07% 0.14% 29,273 5.70%
Q3: 1999 1,031,629 15,503 6.01% 859,429 11,887 5.53% 0.10% 27,848 5.89%
Q4: 1999 971,707 14,885 6.13% 877,634 12,859 5.86% 0.12% 28,282 6.12%
Q1: 2000 972,338 15,359 6.32% 1,225,562 19,163 6.25% 0.07% 34,931 6.36%
Q2: 2000 1,258,859 20,928 6.65% 865,068 13,987 6.47% 0.04% 35,133 6.62%
Q3: 2000 1,191,730 20,448 6.86% 827,114 14,053 6.80% 0.04% 34,694 6.87%
Q4: 2000 1,125,898 19,559 6.95% 819,160 14,152 6.91% 0.03% 33,845 6.96%
1998 $1,275,048 $81,361 6.38% $1,975,866 $114,763 5.81% 0.11% $199,638 6.14%
1999 1,090,242 65,785 6.03% 955,890 51,377 5.37% 0.10% 119,227 5.83%
2000 1,137,324 76,294 6.71% 933,619 61,355 6.57% 0.05% 138,603 6.69%
Our mix of 6.03% for these borrowings. Short-termfunding remained steady, with long-term debt averaged 61%representing 53%
to 55% of totalour borrowings from 1999 to 2000. While long-term debt is more
expensive than short-term debt, it provides us a higher level of
stability and cost
us 5.81%. Long-termattractive liquidity characteristics. Through using
long-term debt, averaged 39%we can utilize a greater degree of total debt and cost us 6.38%.
Interest expense forleverage in a prudent
manner.
TABLE 13
LONG-TERM DEBT CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
LONG INTEREST
TERM ORIGINAL ESTIMATED OUTSTANDING RATE AT
DEBT DEBT ISSUE ISSUE STATED CALLABLE AT YEAR-END DECEMBER
ISSUE RATING DATE AMOUNT INDEX MATURITY DATE 2000 31, 2000
- ----- ------ ------- -------- ----------- -------- -------- ----------- --------
SEQUOIA 1 A1 AAA 7/29/97 $334,347 1m LIBOR 2/15/28 Called $0 n/a
SEQUOIA 1 A2 AAA 7/29/97 200,000 Fed Funds 2/15/28 Called 0 n/a
SEQUOIA 2 A1 AAA 11/6/97 592,560 1y Treasury 3/30/29 2004 289,996 7.21%
SEQUOIA 2 A2 AAA 11/6/97 156,600 1m LIBOR 3/30/29 2004 76,639 6.99%
SEQUOIA 3 A1 AAA 6/26/98 225,459 Fixed 5/31/28 Retired $0 n/a
SEQUOIA 3 A2 AAA 6/26/98 95,000 Fixed 5/31/28 Retired $0 n/a
SEQUOIA 3 A3 AAA 6/26/98 164,200 Fixed 5/31/28 2002 161,268 6.35%
SEQUOIA 3 A4 AAA 6/26/98 121,923 Fixed 5/31/28 2002 121,923 6.25%
SEQUOIA 3 M1 AA 6/26/98 16,127 Fixed 5/31/28 2002 16,127 6.80%
SEQUOIA 3 M2 A 6/26/98 7,741 Fixed 5/31/28 2002 7,741 6.80%
SEQUOIA 3 M3 BBB 6/26/98 4,838 Fixed 5/31/28 2002 4,838 6.80%
SEQUOIA 1A A1 AAA 5/4/99 157,266 1m LIBOR 2/15/28 2003 92,085 7.20%
SEQUOIA 4 A AAA 3/21/00 377,119 1m LIBOR 8/31/24 2008 325,292 7.02%
Should the year ended December 31, 1997 was $160 million. We
fundedtrend towards lower short-term interest rates continue, we
currently expect that our mortgage portfolio and other assets with an average of $307 million
of equity and $2.7 billion of borrowings. We paid an averageoverall cost of funds of
5.92% for these borrowings. Short-term debt averaged 88% of total debt and cost
us 5.86%. Long-term debt averaged 12% of total debt and cost us 6.31%.
Totalwill decline in 2001.
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NET INTEREST INCOME AFTER CREDIT EXPENSES
Net interest expense was lowerincome after credit expenses increased from $22 million in
1998 to $27 million in 1999 due to a reduction$31 million in 2000. For these same
years, our net interest spread after credit expenses increased from
0.28% to 0.79% to 0.86%. This measure shows the sizeprofitability of the
portfolio. Theleveraged portion of our balance sheet; it equals the yield on our
assets less our cost of funds decreasedand hedging. Our net interest margin after
credit expenses increased from 0.62% to 1.17% to 1.33% in 1998, 1999 and
2000, respectively. This measure is net interest income divided by
assets; it is higher than our spread as short-term interest rates fell, on
average,it includes income generated
from their 1998 levels.equity-funded assets.
Our borrowing costs did not fall by the full
amount of the decreasespreads and margins increased in 2000, despite a rapid increase in
short-term interest rates, during this period, asdue to our interest rate management
activities and beneficial changes in asset mix. Total net interest
income also benefited from an increased net investment in our
portfolios, made possible by the retention and reinvestment of the free
cash flow that we utilized an increasing percentagegenerated in excess of more expensive long-term debtour dividend.
TABLE 14
NET INTEREST INCOME
(ALL DOLLARS IN THOUSANDS)
NET INTEREST INTEREST RETURN
INTEREST RATE RATE ON
TOTAL COST OF INCOME COST OF SPREAD MARGIN TOTAL
INTEREST FUNDS AFTER EARNING FUNDS AFTER AFTER CAPITAL
INCOME PLUS CREDIT ASSET PLUS CREDIT CREDIT BEFORE
REVENUES HEDGING PROVISIONS YIELD HEDGING PROVISIONS PROVISIONS OVERHEAD
-------- ------- ---------- ----- ------- ---------- ---------- --------
Q1: 1999 $41,387 $(33,824) $7,563 6.49% 5.65% 0.84% 1.14% 12.09%
Q2: 1999 35,719 (29,273) 6,446 6.47% 5.70% 0.77% 1.12% 10.54%
Q3: 1999 34,139 (27,848) 6,291 6.65% 5.89% 0.76% 1.18% 10.73%
Q4: 1999 34,719 (28,282) 6,437 6.91% 6.12% 0.79% 1.24% 11.58%
Q1: 2000 42,820 (34,931) 7,889 7.23% 6.36% 0.87% 1.30% 14.76%
Q2: 2000 43,008 (35,133) 7,875 7.52% 6.62% 0.90% 1.34% 14.78%
Q3: 2000 41,679 (34,694) 6,985 7.60% 6.87% 0.73% 1.25% 13.10%
Q4: 2000 41,754 (33,845) 7,909 7.86% 6.96% 0.90% 1.46% 14.68%
1998 $221,684 $(199,638) $22,046 6.42% 6.14% 0.28% 0.62% 7.16%
1999 145,964 (119,227) 26,737 6.62% 5.83% 0.79% 1.17% 11.24%
2000 169,261 (138,603) 30,658 7.55% 6.69% 0.86% 1.33% 14.33%
We expect that the decreases in short-term interest rates that occurred
in early 2001, and we
incurred costsany additional decreases in ordershort-term interest
rates, will tend to secure committedboost our net interest income, interest rate spread,
and interest rate margin on a near term basis. As short-term financing.
In the fourth quarter of 1999, interest
expense was $28 million. We fundedrates drop, our
mortgage portfolio with an average of $222 million of equity and $1.8 billion of
borrowings. We paid an average cost of funds should generally decline more quickly than
our asset yield.
While decreases in short-term interest rates should be beneficial for
earnings in 2001, our primary focus is on increasing our normalized rate
of 5.89% for these borrowings.
Short-term debt averaged 47%income generation through growth in our high-quality jumbo
residential credit-enhancement and retained loan portfolios and through
retention of total debt and cost us 5.78%. Long-term debt
averaged 53% of total debt and cost us 6.13%.
For the quarter ended December 31, 1998, interest expense was $44 million. We
funded our mortgage portfolio with an average of $253 million of equity and $3.0
billion of borrowings. We paid an average cost of funds of 5.89% for these
borrowings. Short-term debt averaged 53% of total debt and cost us 5.59%.
Long-term debt averaged 47% of total debt and cost us 6.23%.
INTEREST RATE AGREEMENTS EXPENSE
We use interest rate agreementsfree cash flow in order to strengthen our balance sheet,
increase liquidity, and dampen potential earnings volatility. In the third
quarter of 1998, as a result of early adopting SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, we elected to classify allexcess of our interest rate agreements as trading instruments. As a result ofdividend requirements.
Our average return on capital employed before overhead expenses was
14.33% in 2000; this designation, we marked-to-market our interest rate agreements which resulted in
a write-down of the basis of these agreements. This market value adjustment had
the effect of reducing interest rate agreements amortization expense on an
on-going basis. Total interest rate agreement expense may change over time as
the mix of our assets and liabilities changes. We refer you to "Note 7. Interest
Rate Agreements" in the Notes to Consolidated Financial Statements for
additional details.
Net interest rate agreements expense, [before any market value adjustments which
are reflected in the Statement of Operations line item "Realized and Unrealized
Market Value Gains (Losses)"], was $2.1 million for the year ended December 31,
1999, $3.5 million for the year ended December 31, 1998, and $3.7 million for
the year ended December 31, 1997. As a percent of average borrowings, net
interest rate agreements expense was 0.10% during 1999, 0.11% during 1998, and
0.14% during 1997.
Net interest rate agreements expense was $0.5 million for the fourth quarter of
1999 and $0.3 million for fourth quarter of 1998. As a percent of average
borrowings, net interest rate agreements expense was 0.11% during the fourth
quarter of 1999 and 0.04% during the fourth quarter of 1998.
NET INTEREST INCOME
Net interest income, which equals interest income less interest expense less
interest rate agreements expense, was $28 million for the year ended December
31, 1999. Our interest rate spread, which equals the yield on earning assets
less the cost of funds and hedging, was 0.82%. Our net interest margin, whichmeasure equals net interest income divided by total
capital. Returns have improved as we reduced our capital at Holdings,
improved our capital utilization rate, reduced our premium amortization
expenses, and increased our residential credit-enhancement and retained
portfolios relative to our investment portfolio. The competitive
environment also has improved markedly since 1997 and 1998 as other
financial institutions pulled back from the residential real estate
finance market. This allowed us to expand our activities through
acquisition and credit-enhancement of loans at attractive pricing
levels. We believe that our current marginal return on new capital
employed may equal or exceed the average assets, was 1.22% during this
year. Our net interest income as a percentreturn on capital employed of
average equity
3514.68% that we earned in the fourth quarter of 2000.
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was 11.8% during this year.41
EQUITY IN EARNINGS OF RWT HOLDINGS
For the year ended December 31, 1998, net interest
income2000, a portion of our commercial loan origination and
portfolio finance activities were conducted at Holdings, our 99%-owned,
unconsolidated affiliate. Most of our commercial loan revenues were
earned by Redwood. Redwood's share of Holdings' loss for the year was
$23 million, the interest rate spread was 0.34%,$1.7 million. See Management's Discussion and the net interest
margin was 0.65%. Our net interest incomeAnalysis for Holdings
below.
For year 2001 and beyond, Holdings will be consolidated into Redwood for
accounting purposes as a percentresult of average equity was
7.5% during this year. ForRedwood's acquisition of the
year ended December 31, 1997, net interest income
was $35 million, the interest rate spread was 0.68%,remainder of Holdings it did not already own. This consolidation will
reduce expenses.
OPERATING EXPENSES
We incur operating expenses at Redwood and the net interest margin
was 1.14%. Our net interest income as a percentat our unconsolidated
affiliate, Holdings. A significant portion of average equity was 11.3%
during this year.
Net interest income increasedthese operating expenses
in prior years were associated with business units that have since been
closed. Combined operating expenses rose from 1998 to 1999 despiteas we started
new residential mortgage, finance and commercial mortgage loan
origination operations at Holdings. Some of these operations were
restructured in 1999, and the operating expenses incurred in 1999
include costs associated with the closing of these operations. Total
combined operating expenses declined from $26 million in 1999 to $10
million in 2000. Expenses associated with ongoing operations rose from
$8.5 million in 1999 to $10 million in 2000 as we expanded our
loan-based activities and paid higher performance-based compensation as
earnings and dividends increased.
TABLE 15
OPERATING EXPENSES
(ALL DOLLARS IN THOUSANDS)
CLOSED
BUSINESS
REDWOOD HOLDINGS COMBINED ONGOING UNITS
------- -------- -------- ------- --------
Q1: 1999 $714 $3,264 $3,978 $1,600 $2,378
Q2: 1999 939 4,204 5,143 2,242 2,901
Q3: 1999 964 6,256 7,220 2,727 4,493
Q4: 1999 1,218 8,543 9,761 1,917 7,844
Q1: 2000 2,146 865 3,011 2,814 197
Q2: 2000 2,238 590 2,828 2,828 0
Q3: 2000 2,066 536 2,602 2,602 0
Q4: 2000 1,400 400 1,800 1,800 0
1998 $5,876 $5,235 $11,111 $7,215 $3,896
1999 3,835 22,267 26,102 8,486 17,616
2000 7,850 2,391 10,241 10,044 197
We focused during 2000 on reducing fixed costs, and we expect to benefit
from these cost reductions going forward. A large portion of our
expenses are variable compensation expenses (that depend on earnings per
share and dividends per share) and stock option expenses (that depend on
our stock price). Despite a reduction in fixed costs, our total ongoing
combined operating expenses will likely increase in 2001 if our
performance is strong.
We believe that we currently have the staff and systems that we will
need to manage a much larger company. Thus, we believe that we are
likely to benefit from substantial operating leverage in the event that
we can raise additional equity capital in 2001. With growth in our
portfolios and capital employed following an equity offering, we believe
revenue growth will exceed growth in operating expenses. This could
would result in an increase in earnings per share and dividends per
share.
41
42
CORE EARNINGS
Core earnings are earnings from ongoing operations before mark-to-market
adjustments and non-recurring items.
From 1998 to 2000, annual core earnings increased from $13 million to
$17 million to $19 million. Core earnings increased from $0.96 per share
in 1998 to $1.71 per share in 1999 to $2.08 per share in 2000.
The table below reconciles core earnings to reported GAAP earnings,
showing Holdings and Redwood using the 2001 format for presentation
(i.e., as if Holdings had been consolidated with Redwood for the periods
shown).
TABLE 16
CORE EARNINGS AND GAAP EARNINGS
(ALL DOLLARS IN THOUSANDS)
COMBINED COMBINED COMBINED
INCOME OVERHEAD MARKET CLOSED REPORTED
BEFORE ONGOING PREFERRED CORE VALUE BUSINESS GAAP
OVERHEAD OPERATIONS DIVIDENDS EARNINGS CHANGES UNITS EARNINGS
-------- ---------- --------- -------- -------- ----- --------
Q1: 1999 $7,780 $(1,600) $(687) $5,493 $2,170 $(1,808) $5,855
Q2: 1999 6,622 (2,242) (687) 3,693 1,412 (2,597) 2,508
Q3: 1999 6,595 (2,727) (686) 3,182 (2,075) (4,845) (3,738)
Q4: 1999 6,852 (1,917) (681) 4,254 (1,469) (8,423) (5,638)
Q1: 2000 8,028 (2,814) (681) 4,533 (1,164) (89) 3,280
Q2: 2000 8,014 (2,828) (681) 4,505 (1,452) 43 3,096
Q3: 2000 7,229 (2,602) (681) 3,946 927 0 4,873
Q4: 2000 8,082 (1,800) (681) 5,601 (640) 0 4,961
1998 $22,628 $(7,215) $(2,747) $12,666 $(49,004) $(3,781) $(40,118)
1999 27,849 (8,486) (2,741) 16,622 38 (17,673) (1,013)
2000 31,353 (10,044) (2,724) 18,585 (2,329) (46) 16,210
The table below reconciles core earnings per share to reported GAAP
earnings per share.
TABLE 17
CORE EARNINGS AND GAAP EARNINGS
(DOLLARS PER SHARE)
AVERAGE MARKET CLOSED REPORTED
DILUTED CORE VALUE BUSINESS GAAP
SHARES EARNINGS CHANGES UNITS EARNINGS
----------- ----------- ----------- ----------- -----------
Q1: 1999 10,861,774 $ 0.51 $ 0.20 $ (0.17) $ 0.54
Q2: 1999 10,172,960 0.36 0.14 (0.26) 0.25
Q3: 1999 9,570,933 0.33 (0.22) (0.51) (0.39)
Q4: 1999 8,810,348 0.48 (0.17) (0.96) (0.64)
Q1: 2000 8,848,966 0.51 (0.13) (0.01) 0.37
Q2: 2000 8,883,652 0.51 (0.16) 0.00 0.35
Q3: 2000 8,908,399 0.44 0.10 0.00 0.55
Q4: 2000 8,962,950 0.62 (0.07) 0.00 0.55
1998 $13,199,819 $ 0.96 $ (3.71) $ (0.29) $ (3.04)
1999 9,768,345 1.71 $ 0.00 (1.81) (0.10)
2000 8,902,069 2.08 (0.26) (0.00) 1.82
42
43
MARKET VALUE CHANGES
In 2000, net mark-to-market adjustments recorded in our financial
statements were a positive $1.0 million. Assets and liabilities that
were marked-to-market through the balance sheet accounts (including
stockholders' equity) in 2000 appreciated by $3.3 million. Assets and
liabilities that were marked-to-market through our income statement
declined in value by $2.3 million. The net result of mark-to-market
adjustments for 2000 was a decrease in our average portfolio size. Our interest rate spread (the difference betweenreported earnings of $0.26
per share but an increase in our asset yield and our costbook value of funds) increased from 0.34% to 0.82% during this
period. The yield on our assets increased due to a reduction in premium
amortization expenses while our cost of funds declined due to falling interest
rates.
For the fourth quarter of 1999, net interest income was $7 million, the interest
rate spread was 0.88%, and the net interest margin was 1.28%. Net interest
income as a percent of average equity was 12.0% for this quarter. For the
quarter ended December 31, 1998, net interest income was $10 million, the
interest rate spread was 0.94%, and the net interest margin was 1.19%. Net
interest income as a percent of average equity was 15.2% for this quarter.
NET UNREALIZED AND REALIZED MARKET VALUE GAINS AND LOSSES$0.11 per share.
During the year ended December 31, 1999, our portfolio of assets that
were marked-to-market for income statement purposes increased in
estimated market value by $0.3 million. This net gain consistedAssets and liabilities that were
marked-to-market through the balance sheet declined in value by $3.0
million. Net mark-to-market adjustments to our financial statements of
$1.6negative $2.7 million marketresulted in an increase in reported earnings per
share of $0.03 and a decrease in book value gains on mortgage assets, $3.3 million realized losses on U.S. Treasury
securities,per share of $0.28.
We adopted SFAS No. 133 and $2.0 million market value gains on interest rate agreements.
Market values for our mortgage assets rose as anticipated prepayment speeds
fell. The losses on the U.S. Treasury securities and the gains on our interest
rate agreements were a function of rising interest rates and rising volatility.
In 1998, the net market value loss on our portfolio of assets that was
marked-to-market was $49 million. This net loss consisted of $33 million market
value losses on mortgage assets and $16 million market value losses on interest
rate agreements. Inother mark-to-market accounting principles
in the third quarter of 1998, we adopted1998. Shifting to mark-to-market accounting
and SFAS No. 133. Dueresulted in earnings charges relating to faster prepayment speeds and other factors,
the value of our mortgage assets had been declining since the second half of
1997. Thecumulative market value losseschanges
to that we recognizedpoint of $50 million ($3.81 per share) in income inthe third quarter of
1998. For the year 1998 as a whole, income statement mark-to-market
adjustments were negative $49 million and balance sheet mark-to-market
adjustments were positive $10 million. The result was to lower reported
earnings by $3.71 per share and to increase book value (exclusive of the
adoptioneffect of new accounting methodologies represented the cumulative
marketreported earnings) by $0.73 per share. The net result was a
decrease in book value losses on mortgage assets and interest rate agreements incurred
over a period of several years. Please see "Note 2. Summary of Significant
Accounting Policies", "Note 3. Mortgage Assets", and "Note 7. Interest Rate
Agreements" in the Notes to Consolidated Financial Statements for more
information regarding$2.98 per share from these changes in
accounting methodologies.
Total netprinciples.
TABLE 18
MARKET VALUE CHANGES
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET NET
INCOME BALANCE
STATEMENT SHEET TOTAL
MARKET MARKET MARKET
ADJUST PER SHARE ADJUST PER SHARE ADJUSTMENTS PER SHARE
--------- --------- -------- --------- ----------- ---------
Q1: 1999 $ 2,153 $ 0.20 $ (412) $ (0.04) $ 1,741 $ 0.16
Q2: 1999 1,412 0.14 (1,136) (0.11) 276 0.03
Q3: 1999 (2,069) (0.22) 66 0.01 (2,003) (0.21)
Q4: 1999 (1,212) (0.14) (1,496) (0.17) (2,708) (0.31)
Q1: 2000 (1,225) (0.14) (487) (0.06) (1,712) (0.19)
Q2: 2000 (1,359) (0.15) (886) (0.10) (2,245) (0.25)
Q3: 2000 927 0.10 720 0.08 1,647 0.18
Q4: 2000 (639) (0.07) 3,912 0.44 3,273 0.37
1998 $(49,004) $ (3.71) $ 9,701 $ 0.73 $(39,303) $ (2.98)
1999 284 0.03 (2,978) (0.30) (2,694) (0.28)
2000 (2,296) (0.26) 3,259 0.37 963 0.11
We currently intend to adopt EITF 99-20 in the first quarter of 2001.
Under these new accounting rules, in certain circumstances we will make
mark-to-market adjustments through our income statement on our
credit-enhancement and certain other assets that formerly were only
marked-to-market through our balance sheet. We will mark these through
the income statement if the discounted present value of current cash
flows deteriorates relative to our original assumptions. Only negative
income statement mark-to-market adjustments are allowed under EITF
99-20. Any initial mark-to-market adjustments that we take upon adoption
of EITF 99-20 will be recorded as a cumulative effect of a change in
accounting principle; any subsequent EITF 99-20 adjustments will be
included in our income statement under "Net realized and unrealized
gains onand losses" with our other mark-to-market adjustments. For each of
our credit-enhancement interests and other assets duringsubject to EITF 99-20
(with the
year ended December 31, 1997 were
$0.6 million. This net gain consisted43
44
exception of $0.7 million realized gains on mortgageone set of assets described below), we currently believe
that projected cash flows have improved relative to our original
assumptions, and, in most cases, market values have increased.
We have been marking to market, through our balance sheet, the assets
that we retained from our resecuritization of the credit-enhancement
interests that we acquired from 1994 to 1997. The market values for
these assets that we have been using for our balance sheet estimates are
lower than our basis. They reflect what we believe is an estimate of
realizable sale value that is conservative and takes into consideration
the unique and complex nature of the assets and $0.2 million realized losses on interest rate agreements.
The net loss on our portfolio of assetstheir illiquidity. We
currently project that were marked-to-market in the fourth
quarter of 1999 was $1.2 million. This net loss consisted of $1.1 million market
value loss on mortgage assets and $0.1 million market value loss on interest
rate agreements. During the fourth quarter of 1998, our portfolio experienced a
net gain of $2.0 million. This net gain consisted of $1.5 million market value
gain on mortgage assets and $0.5 million market value gain on interest rate
agreements.
PROVISION FOR CREDIT LOSSES
We take credit provision expenses on our mortgage loans held for investment,
which are those loans financed with long-term debt and accounted for on an
amortized cost basis. During the year ended December 31, 1999, credit provisions
were $1.3 million. In 1998, credit provisions totaled $1.1 million. Credit
provision expenses increased from 1998 to 1999 due to an increase in the average
size of the mortgage loan portfolio. For the year ended December 31, 1997,
credit provisions totaled $2.9 million. Prior to 1998, we also expensed credit
provisions on a portfolio of subordinated mortgage securities. We stopped taking
credit provisions on this pool of securities in December 1997 when we
restructured our credit risk on these securities through a resecuritization
transaction ("SMFC re-Remic securities"). We believe the existing reserve for
the SMFC re-Remic securities of
36
37
$0.8 million at December 31, 1999 will be sufficient to cover likely future
credit losses. Actual realized taxable credit losses for these assets will be somewhat
higher than we had originally projected. Accordingly, upon adoption of
EITF 99-20, we will mark these assets, through our income statement, to
the whole company were
$0.3estimated market values that we use for our balance sheet. We
currently estimate that this mark-to-market adjustment would be
approximately $2.4 million if we make the adjustment in 1999, $1.1 millionthe first
quarter of 2001. This adjustment will lower earnings in 1998, and $0.2 million in 1997.
In the quarter ended December 31, 1999, credit provisions were $0.2 millionthat
we adopt EITF 99-20 and there were no actual credit losses. Forwill increase the fourth quarter of 1998, credit
provisions were $0.4 millionasset yield and there were no actual credit losses.
We have recently purchased, and intend to continue to purchase, mortgage-backed
securitiescumulative
future earnings that have risk of credit loss. In acquiring such assets, we project
cash flows and resulting yields under a variety of potential loss scenarios as
well as other factors (e.g., interest rates, prepayment speeds.) These
securities are purchased at a discount, in part because of the credit risk
inherent in these assets. We anticipate a yield on such assets after factoring
in anticipated losses. Thus, we do not plan to build a credit reserve for such
assets, as such losses are already imbedded in the price paid and resulting
yields on such assets. The amount of discount amortized into income is based on
the projected future cash flows, after credit losses, on such asset. Once
acquired, we continue to review the projected losses on each asset. Should
projected credit losses change (which can occur for a variety of reasons), the
effective yield earnedwill recognize over the remaining life of these
assets (relative to what they would have been without the adjustment).
Since we have already been marking these assets to market on our balance
sheet, book value per share will be unaffected by this change in
accounting principle.
With falling interest rates in the first half of 2001, we would
generally expect that the net market values of our asset and liabilities
could increase as spread earnings opportunities increase. Net market
values may decline later in the year should interest rates stabilize and
spreads return to normalized levels.
SHAREHOLDER WEALTH
In the 6.25 years since the founding of Redwood, cumulative shareholder
wealth, as described below, has grown at a compound rate of 18% per
year. We define shareholder wealth as growth in tangible book value per
share, plus dividends received, plus reinvestment earnings on dividends.
In calculating shareholder wealth, we assume that dividends are
reinvested through the purchase of additional shares of Redwood at book
value. With this assumption, shareholder wealth creation at Redwood can
be compared to book value per share growth at a non-REIT company that
retains its earnings and compounds book value within the company. This
is a measure of management value-added, not a measure of shareholder
returns.
Book value per share was $11.67 in September 1994 when Redwood commenced
operations. We increased book value to $21.47 per share by December 31,
2000 through the retention of cash by keeping dividends lower than cash
flow, changes in market values of assets, issuance of stock at prices
above book value, and repurchases of stock below book value. Since we
mark-to-market most of our assets through our balance sheet, reported
book value is a good approximation of real intrinsic value in the
company. Cumulative dividends paid during this period were $7.32 per
share, and reinvestment earnings on those dividends were $4.11 per
share. Thus, cumulatively, shareholder wealth has increased from $11.67
per share to $32.90 per share during this 6.25-year period. A company
that earned an 18% after-tax return on equity and retained all its
earnings would have shown a similar amount of shareholder wealth growth
during this period.
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45
TABLE 19
SHAREHOLDER WEALTH
(DOLLARS PER SHARE)
BOOK CUMULATIVE
VALUE REINVESTMENT CUMULATIVE
PER ANNUAL CUMULATIVE EARNINGS ON SHAREHOLDER
SHARE DIVIDENDS DIVIDENDS DIVIDENDS WEALTH
------ --------- ---------- ------------ -----------
SEP-94 $11.67 $ 0.00 $ 0.00 $ 0.00 $11.67
DEC-94 10.82 0.25 0.25 0.00 11.07
DEC-95 12.38 0.96 1.21 0.09 13.68
DEC-96 16.50 1.67 2.88 1.07 20.45
DEC-97 21.55 2.15 5.03 3.07 29.65
DEC-98 20.27 0.28 5.31 2.67 28.25
DEC-99 20.88 0.40 5.71 3.07 29.66
DEC-00 21.47 1.61 7.32 4.11 32.90
DIVIDENDS
The dividends that we paid out cumulatively through the end of 2000 were
close to the minimum amount that we needed to pay under the REIT
distribution rules. If taxable income increases in 2001, we will change
accordingly.
OPERATING EXPENSES
Total operating expenses forneed to
raise our mortgage finance operations were $3.8 milliondividend rate. We paid $1.61 per share in common stock
dividends in 2000, all of which was ordinary income. We declared a $0.50
per share common dividend for the first quarter of 2001.
We do not plan to acquire, create, or retain any Real Estate Mortgage
Investment Conduit ("REMIC") or Collateralized Mortgage Obligation
("CMO") residual interests that would cause the distribution of excess
inclusion income or unrelated business taxable income to investors. As a
result, we qualify as an eligible investment for tax exempt investors,
such as pension plans, profit sharing plans, 401(k) plans, Keogh plans,
and Individual Retirement Accounts. See "Certain Federal Income Tax
Considerations - Taxation of Tax-Exempt Entities."
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Our cash flow from operations generally exceeds our earnings. Cash flow
from operations was $25 million in 2000, consisting of earnings of $16
million plus non-cash depreciation and amortization of $5 million plus
non-cash mark-to-market adjustments of $4 million. Our free cash flow,
after investment in working capital, property, plant, equipment, and
other non-earning assets, was $21 million. In addition, we received $7
million from our investment in Holdings and we issued $0.4 million in
new common stock. We used the available cash from these sources to fund
our common stock dividend of $12 million and to increase our investment
in our portfolio activities by $16 million.
Cash flow from operations was $28 million in 1999. Free cash flow was
$44 million as we reduced our working capital requirements. We decreased
our investment in our portfolio operations by $5 million, paid $1
million in common stock dividends, invested $10 million in Holdings, and
repurchased $37 million of common stock.
Cash flow from operations was $47 million in 1998. Free cash flow was
$61 million. We decreased our investment in our portfolio operations by
$20 million, paid $10 million in common stock dividends, invested $27
million in Holdings, and repurchased $45 million of common stock.
45
46
TABLE 20
CASH FLOW
(ALL DOLLARS IN THOUSANDS)
(INVESTMENT)
IN
CASH WORKING FUNDS
FLOW CAPITAL FREE (INVESTMENT) (PURCHASE)/ AVAILABLE FOR
FROM AND OTHER CASH IN COMMON SALE PORTFOLIO
OPERATIONS ASSETS FLOW HOLDINGS DIVIDENDS OF STOCK INVESTING
---------- ------------ -------- ---------- -------- ---------- -------------
Q1: 1999 $ 9,036 $ (3,087) $ 5,949 $ (6,897) $ 0 $(16,034) $(16,982)
Q2: 1999 7,092 9,321 16,413 1,733 0 (3,997) 14,149
Q3: 1999 6,308 3,785 10,093 (17,496) 0 (15,004) (22,407)
Q4: 1999 6,019 5,162 11,181 12,733 (1,323) (2,299) 20,292
Q1: 2000 6,325 71 6,396 4,999 (2,196) 45 9,244
Q2: 2000 5,562 1,435 6,997 1,973 (3,076) 0 5,894
Q3: 2000 5,957 (2,315) 3,642 0 (3,516) 381 507
Q4: 2000 7,239 (3,113) 4,126 0 (3,700) 2 428
0
1998 $ 46,728 $ 13,903 $ 60,631 $(26,745) $ (8,946) $(45,384) $(20,444)
1999 28,455 15,181 43,636 (9,927) (1,323) (37,334) (4,948)
2000 25,083 (3,922) 21,161 6,972 (12,488) 428 16,073
For 2001, we generally expect that the cash flows that we generate from
operations are likely to exceed our minimum dividend requirement under
the REIT tax rules and our other cash needs. As a result, we currently
expect to be able to make an additional net investment in our portfolio
operations and/or to be able to pay a dividend in excess of our minimum
dividend requirements in the next year.
At December 31, 2000, we had over a dozen uncommitted facilities for
short-term collateralized debt, with credit approval for over $4 billion
of borrowings. We had no difficulty securing short term borrowings on
favorable terms during 2000. Outstanding borrowings under these
agreements were $0.7 billion at year-end 2000 and $1.2 billion at year
endedend 1999.
We had three committed borrowing facilities for residential assets
totaling $80 million and two borrowing facilities for commercial assets
totaling $100 million. There are certain restrictions regarding the
collateral for which these committed facilities can be used, but they
generally allow us to fund either our commercial mortgage loans or our
residential credit-enhancement interests. We had no difficulty during
2000 in meeting the debt covenant tests required by our committed bank
credit facility agreements, or in extending these facilities or
negotiating new lines. Outstanding borrowings under these committed
agreements, including borrowings by Holdings, were $88 million at year
end 2000 and $19 million at year end 1999.
Under our internal risk-adjusted capital system, we maintain liquidity
reserves in the form of cash and unpledged liquid assets. These
liquidity reserves may be needed in the event of a decline in the market
value or in the acceptability to lenders of the collateral we pledge to
secure short-term borrowings, or for other liquidity needs. We
maintained liquidity reserves at or in excess of our policy levels
during 2000. At December 31, 2000, we had $54 million of unrestricted
cash and highly liquid (unpledged) assets available to meet potential
liquidity needs. Total available liquidity equaled 7% of our short-term
debt balances. At December 31, 1999, $5.9we had $71 million forof liquid
assets, equaling 6% of our short-term debt balances.
At this time, we see no material negative trends that would affect our
access to short-term borrowings or bank credit lines, that would suggest
that our liquidity reserves would be called upon, or that would be
likely to cause us to be in danger of a covenant default. However many
factors, including ones external to us, may affect our liquidity in the
year endedfuture.
46
47
The $1.1 billion of long-term debt on our December 31, 1998, and $4.7 million for the year ended December 31, 1996. Total operating
expenses for 1998 include $1.2 million of one-time termination expenses incurred
in the fourth quarter. On-going operating expenses in 1998 were $4.7 million.
On-going operating expenses as a percentage of average assets were 0.17% in
1999, 0.13% in 1998, and 0.15% in 1997. Operating expenses as a percentage of
average equity were 1.61% in 1999, 1.52% in 1998, and 1.52% in 1997. These
ratios have increased over time as we have decreased the size2000 balance
sheet is non-recourse debt. The holders of our portfoliolong-term debt can look
only to the cash flow from the mortgages specifically collateralizing
this debt for repayment. By using this source of financing, our
liquidity risks are limited. Our special purpose financing subsidiaries
that issue this debt have no call on our general liquidity reserves, and
reduced ourthere is no debt rollover risk as the loans are financed to maturity.
The market for AAA rated long-term debt of the type that we issue is a
large, global market that has been relatively stable for many years. At
this time, we know of no reason why we would not be able to issue more
of this debt on reasonable terms in 2001 if we should choose to do so.
Excluding short and long term collateralized debt, we are capitalized
entirely by common and preferred equity through the repurchase of stock.
Total on-going operating expenses for the mortgage finance operations were $1.2capital. Our equity base
increased from $210 million for the fourth quarter of 1999 and $1.1 million for the fourth quarter
of 1998 (excluding the $1.2 million one-time termination charge). On-going
operating expenses as a percentage of average assets were 0.23% for the fourth
quarter of 1999 and 0.14% for the fourth quarter of 1998. Operating expenses as
a percentage of average equity were 2.19% for the quarter ended December 31,
1999 and 1.75% for the quarter ended December 31, 1998.
We share many operating expenses of Holdings, including personnel and related
expenses. Holdings' share is subject to full reimbursement by Holdings. We
incurred reimbursable operating expenses for Holdings of $3.0$216 million during 1999 and $2.3 million in 1998. For the quarter ended December 31, 1999,
reimbursable operating expenses were $0.3 million. For the quarter ended
December 31, 1998, reimbursable operating expenses were $0.6 million. As
Holdings reduces the scope of its operations, a greater percentage of the
combined operating expenses of the two companies will be recognized and reported
at Redwood Trust. We also expect to report significantly higher operating
expenses at Redwood Trust in 2000 due to an expected increase in Dividend
Equivalent Right expenses and bonus expenses assuming Redwood's dividends and
profitability rates increase.
NET EARNINGS FROM MORTGAGE FINANCE OPERATIONS
Net earnings from mortgage finance operations include all revenue and expense
items except for the losses from Holdings and preferred dividends. For the year
ended December 31, 1999, net earnings from mortgage finance operations were
$23.4 million, or $2.39 per share. Net losses from mortgage finance operations
were $32.7 million for the year ended December 31, 1998, or negative $2.48 per
share. For the year ended December 31, 1997, net earnings were $27.6 million, or
$2.01 per share.
In the fourth quarter of 1999, net earnings from mortgage finance operations
totaled $4.1 million, or $0.46 per share. In the fourth quarter of 1998, net
earnings from mortgage finance operations were $9.0 million, $0.79 per share.
37
38
EQUITY IN EARNINGS (LOSSES) OF RWT HOLDINGS, INC.
Our share of the losses generated by start-up operations at Holdings was $21.6
million for the year ended December 31, 1999. This included $8.4 million of
restructuring charges at RFS and RRF as a result of
ceasing their operations.
During 1998, we recognized losses from Holdingsinternal operations and stock issuance of $4.7 million.
In the fourth quarter of 1999, we recognized losses from Holdings of $9 million,
which included $6 million of restructuring charges at RRF. In the fourth quarter
of 1998, we recognized losses from Holdings of $3$0.4 million. We refer youdo plan to
Holdings' "Consolidated Financial Statementsraise new equity capital in the future when opportunities to expand our
business are attractive and Notes"when such issuance is likely to benefit
earnings and Holdings' "Management's Discussion and Analysis" below for more information on
Holdings.
NET INCOME
For the year ended December 31, 1999, net income for all of our operations was
$1.7 million. After preferred dividends of $2.7 million, net income available to
common stockholders was negative $1.0 million. For the year ended December 31,
1998, net losses for all of our operations were $37.3 million. After preferred
dividends of $2.7 million, net income available to common stockholders was
negative $40.0 million. For the year ended December 31, 1997, net income for all
of our operations was $27.6 million. After preferred dividends of $2.8 million,
net income available to common stockholders was $24.7 million.
In the fourth quarter of 1999, net losses for all of our operations were $4.9
million. After preferred dividends of $0.7 million, net income available to
common stockholders was negative $5.6 million. For the quarter ended December
31, 1998, net income for all of our operations was $6.5 million. After preferred
dividends of $0.7 million, net income available to common stockholders was $5.8
million.
EARNINGS PER SHARE
Average diluted common shares outstanding were 9.8 million for the year ended
December 31, 1999, 13.2 million for 1998, and 13.7 million for 1997. Diluted
earnings per share were negative $0.10 for the year ended December 31, 1999,
negative $3.04 for 1998, and positive $1.81 for 1997. Diluted earnings per share
include losses from Holdings of $2.21 per share in 1999 and $0.35 per share in
1998.
Average diluted common shares outstanding were 8.8 million for the quarter ended
December 31, 1999 and 11.4 million for the fourth quarter of 1998. Diluted
earnings per share were negative $0.64 for the quarter ended December 31, 1999
and positive $0.51 for the fourth quarter of 1998. Diluted earnings per share
include losses from Holdings of $1.03 per share for the quarter ended December
31, 1999 and $0.22 per share for the quarter ended December 31, 1998.
Shares outstanding declined as a result of our common stock repurchase program.
We repurchased 2.5 million shares during 1999 and 3.1 million shares during
1998.
DIVIDENDS
We declared common stock dividends of $0.40 per share for the year ended
December 31, 1999, $0.28 per share for 1998, and $2.15 per share for 1997.
For the quarter ended December 31, 1999, we declared common stock dividends of
$0.25 per share.
We didhave not, declareto date, issued unsecured corporate debt. In the future, we
may consider issuing longer-term unsecured corporate debt to supplement
our capital base and improve the efficiency of our capital structure.
The amount of portfolio assets that can be supported with a common stock dividendgiven
capital base is limited by our internal risk-adjusted capital policies.
Our risk-adjusted capital policy guideline amounts are expressed in
terms of an equity-to-assets ratio and vary with market conditions and
asset characteristics. At December 31, 2000, our minimum capital amounts
were: 62% of residential credit-enhancement portfolio interests; 100% of
net retained interests in residential retained loan portfolio after
long-term debt issuance; 15% of short-term debt funded residential whole
loans; 9% of investment portfolio securities; and 36% of commercial
retained loan portfolio. Our total risk-adjusted capital guideline
amount for the fourth
quarterassets on our balance sheet was $186 million (9% of 1998.
For the first quarterasset
balances) at December 31, 2000. Capital required for commitments for
asset purchases settling in 2001 was $13 million. Total capital was $216
million; our capital exceeded our internal risk-adjusted capital policy
guideline minimum amount by $17 million at December 31, 2000.
At December 31, 2000, our capital base of 2000, we declared a $0.35 per share common stock
dividend.
RISK MANAGEMENT
Our market risks include changes in market valuations, changes in net interest
income, liquidity risk, prepayment risk, credit risk,$216 million supported at-risk
assets (excluding long-term funded residential loans owned by financing
trusts) of $983 million funded with short-term debt of $756 million.
Excluding non-recourse debt and others. Management's
discussionrelated assets, our equity-to-assets
ratio was 22% and selected information on these risks is included in "Item 7(a)
Quantitativeour debt to equity ratio was 3.5 times at year end
2000. At year end 1999, our equity-to-assets ratio was 14% and Qualitative Disclosures About Market Risk" in this Form 10-K,
beginning on page 41.
38our debt
to equity ratio was 6.0 times.
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3948
TABLE 21
RECOURSE ASSETS
(ALL DOLLARS IN THOUSANDS)
EQUITY
AT TO RECOURSE
RISK RECOURSE AT-RISK DEBT TO
ASSETS DEBT EQUITY ASSETS EQUITY
---------- ---------- ---------- ---------- ----------
Q1: 1999 $1,288,485 $1,033,643 $ 244,198 18.95% 4.2
Q2: 1999 1,169,880 922,745 241,574 20.65% 3.8
Q3: 1999 1,100,480 854,465 222,898 20.25% 3.8
Q4: 1999 1,471,570 1,253,565 209,935 14.27% 6.0
Q1: 2000 1,141,241 922,405 209,700 18.37% 4.4
Q2: 2000 1,026,281 806,643 208,384 20.30% 3.9
Q3: 2000 1,055,032 822,389 210,664 19.97% 3.9
Q4: 2000 983,097 756,222 215,663 21.94% 3.5
1998 $1,523,280 $1,257,570 $ 254,789 16.73% 4.9
1999 1,471,570 1,253,565 209,935 14.27% 6.0
2000 983,097 756,222 215,663 21.94% 3.5
RWT HOLDINGS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware in February
1998 and commenced operations on April 1, 1998. Holdings' start-up
operations have been funded primarily by Redwood Trust, which has a
significant investment in Holdings
through the ownership ofHoldings. Prior to January 1, 2001, Redwood
owned all of Holdings' non-voting preferred stock, and bystock. Redwood Trust's
senior management who own Holding'sowned all of Holdings' voting common stock. We refer
you to "Note 1. The Company" in the Notes to the Consolidated Financial
Statements of RWT Holdings, Inc. and Subsidiariestaxable subsidiaries for additional
information on Holdings' initial capitalization. On January 1, 2001,
Redwood acquired the common stock of Holdings originatesand intends to operate
Holdings in the future as a wholly-owned taxable subsidiary with
consolidated financial statements.
Holdings originated commercial mortgage loans for sale to institutional
investors through its Redwood Commercial Funding, Inc. ("RCF")
subsidiary. RCF originated $42$73 million of commercial mortgage loans in
1999. At December 31,2000, $42 million in 1999, and $8 million in 1998. After loan sales and
payoffs, remaining commercial mortgage loans originated or acquired by RCF totaled
$38$76 million at December 31, 2000, of which $57 million were owned by
Redwood and $19 million were owned by Holdings.
In 2000, Holdings sold $44 million of commercial loans, some of them to
Redwood. In addition, Holdings sold the remaining residential loans that
its wholly-owned residential mortgage finance subsidiaries had
previously acquired. Net gains on sales recognized by Holdings in 2000
totaled $0.4 million which $8 million were heldoffset by Redwood Trust and $30 million were
held at Holdings. These loans are all held for future sale.
RCF recorded net revenue for 1999unrealized losses on assets of
$0.2 million. Loan sales were minimal, and
net interest income at RCF was low as most of the commercial loans originated by
RCF were held by Redwood Trust for most of the year. For the year ended December
31, 1999, direct RCF operating expenses were $1.5 million. RCF expects to
recognize sale revenues upon the sale of the commercial loan portfolio.
Holdings had two other operating businesses, Redwood Financial Services,
Inc. ("RFS") and Redwood Residential Funding ("RRF"). Due to a variety
of start-up difficulties with these units, operations were closed at RFS
in the third quarter of 1999 and at RRF in the fourth quarter of 1999.
These closures resulted in restructuring charges of $8.4$8 million during
the year ended December 31, 1999, and a significant reduction in the
headcount and ongoing operating expenses at Holdings. This contributed
to Holdings recording a net loss of $22 million in 1999. In 1998, the
initial start up expenses associated with these operations resulted in a
net loss of $5 million.
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49
Holdings recorded a net loss of $1.5 million in 2000. This was based on
net interest income of $0.7 million, net gains on sales of $0.2 million
and its subsidiaries share operating expenses with Redwood Trust.
Operating expenses paidof $2.4 million. Most of the commercial loans
originated by RCF were owned by Redwood Trust and reimbursable by Holdings were $3.0
million during 1999.
In 2000, we will continue to develop RCF's operations and seek to increase its
profitability and value as a business.
FINANCIAL CONDITION
On a consolidated basis, at December 31, 1999, Holdings owned $4 million of
residential mortgage loans and $30 million of commercial mortgage loans.
Holdings also had $2 million in cash, $2 million of accrued interest receivable,
and $1 million in other assets, for total assets of $39 million. Holdings had
commitments to acquire $8 million of commercial mortgage loans and $16 million
of residential mortgage loans from Redwood Trust for settlement during the first
half of 2000. The residential loans were purchased by RRF and RFS prior to their
closures. Holdings intends to sell these loans in 2000.
The loans owned by Holdings were funded with short-term borrowings and equity.
Short-term debt was $22 million, loans from Redwood Trust were $7 million,
accrued restructuring charges were $4 million, and other liabilities totaled $3
million, for total liabilities of $36 million. The majoritymost of the accrued
restructuring charges are expected to be paid inyear, so
Holdings did not benefit from the first quarter of 2000.
Redwood Trust expects to continue to provide liquidity to Holdings, when
necessary, during the year 2000. Total equity at December 31, 1999 was $3
million.
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40
At December 31, 1998, Holdings owned $12 million of residential mortgage loans,
$10 million in cash, and $1 million in other assets, for total assets of $23
million. Loans from Redwood Trust totaled $7 million and other liabilities were
$1 million. Equity at this time totaled $15 million.
RESULTS OF OPERATIONS
For the year ended December 31, 1999, net interest income on a consolidated
basis was $1.1 million, including interest income of $4.8 million and interest
expense of $3.7 million. Holdings also had net losses as a result of mortgage
asset sales and market value adjustments of $0.7 million during 1999, resulting
in net revenues of $0.4 million. Operating expenses at Holdings totaled $13.8
million for 1999, including Holdings' share of operating expenses from Redwood
Trust. Restructuring charges related to the closures of RFS and RRF totaled $8.4
million. Holdings' net loss for the year ended December 31, 1999 was $21.9
million.
For the period from April 1, 1998 (commencement of operations) through December
31, 1998, net interest income on a consolidated basis was $0.5 million,
including interest income of $3.2 million and interest expense of $2.7 million.
Holdings also had small net gains as a result of mortgage asset sales and market
value adjustments during 1998, resulting in net revenues of $0.5 million.
Operating expenses at Holdings totaled $5.2 million for 1998. Holdings' net loss
for the period ended December 31, 1999 was $4.7 million.
Holdings' continued to experience losses during 1999, primarily due to the
increase in operating expenses as a result of the ramping up of operations
though the first nine months of the year. The closures of RFS and RRF also
contributed significantly to the overall losses at Holdings. The restructuring
charges recognized as a result of these closures reflect the majority of costs
necessary to exit the businesses of RFS and RRF. The restructuring resulted in a
significant reduction in the headcount and ongoing operating expenses at
Holdings. The restructuring accrual includes costs associated with existing
contractual and lease arrangements at both subsidiaries which have no future
value. In addition, as a result of the closure of the two subsidiaries, certain
assets utilized in these businesses were determined to have little or no
realizable value, resulting in impairment losses. These assets included software
developed for use at RRF and certain fixed assets at both subsidiaries.
Restructuring charges were determined in accordance with the provisions of Staff
Accounting Bulletin No. 100 "Restructuring and Impairment Charges", Emerging
Issues Task Force No. 94-3 "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity", and other relevant
accounting guidance. Holdings expects to incur some additional costs during
2000, approximately $1.0 million, in connection with the closure of RRF.
For the quarter ended December 31, 1999, net interest income on a consolidated
basis was $0.3 million, including interest income of $2.1 million and interest
expenses of $1.8 million. Holdings also had net losses as a result of mortgage
asset sales and market value adjustments of $0.9 million during the fourth
quarter of 1999, resulting in net revenues of negative $0.6 million. Operating
expenses at Holdings totaled $2.3 million for this quarter. Restructuring
charges related to the closure of RRF totaled $6.2 million. Holdings' net loss
for the quarter ended December 31, 1999 was $9.1 million.
For the quarter ended December 31, 1998, net interest income on a consolidated
basis was $0.2 million, including interest income of $.2 million and minimal
interest expenses. Holdings also had minor net losses as a result of market
value adjustments during the fourth quarter of 1998, resulting in net revenues
of $0.2 million. Operating expenses at Holdings totaled $2.7 million for this
quarter. Holdings' net loss for the quarter ended December 31, 1998 was $2.5
million.loans.
At December 31, 1999,2000, Holdings had net operating loss carryforwards of
approximately $21$25 million for federal tax purposes and $11 million for
state income tax purposes. The federal loss carryforwards and a portion
of the state loss carryforwards expire throughbetween 2018 and 2020, while the
largest portion of the state carryforwards expire through 2004. Due to the start-up nature of its operations,
Holdings has not been able to record a tax benefit relating to its net operating
losses for GAAP at this time.
40
41between 2003 and 2005.
ITEM 7(a).7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We seek to manage the risks inherent in all financial institutions --
interest rate, market value, liquidity, prepayment, and credit risks inherent in all financial institutions--
in a prudent manner designed to insure our longevity. At the same time,
we endeavor to provide our shareholders an opportunity to realize an
attractive total rate of return through Redwood Trust stock ownership.ownership in our company.
We do not seek to avoid all risks. We do seek, to the best of our ability, to only assume riskrisks that can be
quantified from historical experience, to actively manage such risk,risks, to
earn sufficient compensation to justify the taking of such risks, and to
maintain capital levels consistent with the risks we do undertake.
Our strategy for managing some of these risks includes the use of derivative
interest rate agreements. Please see "Note 2. Summary of Significant Accounting
Policies" for additional discussions on our use of interest rate agreements and
their designation as "trading" instruments.
QUALITATIVE INFORMATION ABOUT MARKET RISK
MARKET VALUE RISK
The market value of our assets can fluctuate due to changes in interest rates,
prepayment rates, liquidity, financing, supply and demand, credit, and other
factors. These fluctuations affect our earnings.
At December 31, 1999,2000, we owned mortgage securities and loans totaling
$946$0.8 billion that we account for on a mark-to-market basis or, in(in the case
of mortgage loans, on a lower-of-cost-or-market basis,basis) for purposes of
determining reported earnings. Of these assets, 96%98% had adjustable-rate
coupons and 4%2% had fixed-rate coupons. Our interest rate agreements hedging program may offset some asset market value
fluctuations due to interest rate changes. All of our $3.8$2.0 billion in
notional amounts of interest rate agreements are marked-to-market for
income statement purposes. Market value fluctuations of these assets and
interest rate agreements not only affect our earnings, but also can
affect our liquidity, especially to the extent assetsthey are funded with
short-term borrowings,borrowings.
At December 31, 2000, we owned $86 million of assets that are
marked-to-market on our balance sheet. Market value fluctuations of
these assets can also affect the reported value of our access to liquidity.stockholders' equity
base
INTEREST RATE RISK
At December 31, 1999,2000, we including Sequoia, owned $2.4$2.1 billion of assets and had $2.2$1.9
billion of liabilities. The majority of the assets were adjustable-rate,
as were a majority of the liabilities.
Fixed-rate mortgage assets and hybrid mortgage assets (with fixed-rate coupons
for 3 to 7 years and adjustable-rate coupons thereafter) totaled $0.4 billion,
or 19% of total assets. We had debt with interest rate reset characteristics
matched to the hybrid mortgages totaling $0.4 billion.
On average, our cost of funds has the ability to rise or fall more
quickly as a result of changes in short-term interest rates than does
the earning rate on our assets. In addition, in the case of a large
increase in short-term interest rates, periodic and lifetime caps for a
portion of our assets could limit increases in interest income. The risk
of reduced earnings in a rising interest rate environment ismay be
mitigated to some extent by our interest rate agreementagreements hedging program
and by any concurrent slowing of mortgage prepayment rates that may
occur.
OurAt December 31, 2000, we owned hybrid mortgage assets (with fixed-rate
coupons for 3 to 7 years and adjustable-rate coupons thereafter)
totaling $0.3 billion. We had debt with interest rate reset
characteristics matched to the hybrid mortgages totaling $0.3 billion.
At December 31, 2000, we owned $0.5 billion of adjustable-rate mortgage
assets with coupons that adjust monthly as a function of one-month LIBOR
interest rates, funded with equity and with debt that also adjusts
monthly as a function of one-month LIBOR interest rates. The spread
between the coupon rates on these assets and the cost of funds of our
liabilities has been stable.
For other parts of our balance sheet, our net income may vary somewhatfluctuate as
the yield curve between one-month interest rates and six- and
twelve-month interest rates varies, and as the differences between U.S.
Treasury rates, the 11th District cost of funds rate (COFI), and LIBOR
rates vary. At December 31, 1999,2000, we effectively owned $0.7$0.5 billion of
adjustable-rate mortgage assets with interest rates that adjust every
six or twelve months as a function of six-month LIBOR
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50
interest rates of
the same maturity funded with $0.7 billion ofequity and with debt that had an interest
rate that adjusts monthly as a function of one-month LIBOR interest
rates. At December 31, 1999, we owned $0.6 billion of adjustable-rate mortgage assets
that adjust monthly as a function of one-month interest rates, funded with $0.6
million of debt that also adjusts monthly as a function of one-month LIBOR
interest rates.
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42
Adjustable-rate assets with earnings rates dependent on one-year
U.S. Treasury rates with annual adjustments totaled $0.6 billion at
December 31, 1999. Liabilities2000. These Treasury-based assets were effectively funded
with equity and with $0.3 billion of liabilities with a cost of funds
dependent on one-year U.S. Treasury rates totaled $0.3 billion at that time. As partwith annual adjustments. The
remainder of our hedging program, we alsothe liabilities associated with these assets had $0.3 billion notional amounta cost of
basis swaps
that, in effect, increased our U.S. Treasury-based liabilities to $0.6 billion.
Thus, atfunds dependent on one-month LIBOR rates or the daily Fed Funds rate.
At December 31, 1999, our U.S. Treasury-based2000, we owned a total of $81 million of fixed rate
assets equaled our U.S.
Treasury-based liabilities. These basis swaps all maturedfunded, in early 2000. Topart, with short-term variable rate debt which is only
partially hedged. Holding these positions should mitigate earnings
declines caused by lower yields on equity-funded assets as interest
rates fall. As interest rates rise, net earnings on these assets should
fall, but this would likely be offset, in part, by the extent our Treasury-based assets are not funded with Treasury-based liabilities
(or effectively funded with Treasury-based liabilities through the usebeneficial effect
of interest rate agreements), we incur basis risk. Such risk arises because changes
in Treasury rates may differ significantly from changes in the Fed Funds, LIBOR,
or Euro-dollar interest rates.higher yields on equity-funded assets.
Interest rates and related factors can affect our spread income and our
mark to market results. Changes in interest rates also affect prepayment
rates (see below) and influence other factors that may affect our
results.
LIQUIDITY RISK
Our primary liquidity risk arises from financing long-maturity mortgage
assets with short-term debt. Even if the interest rate adjustments of
these assets and liabilities are well matched, maturities may not be
matched. In addition, trends in the liquidity of the U.S. capital
markets in general may affect our ability to rollover short-term debt.
The assets that we pledge to secure short-term borrowings are generally
high-quality, liquid assets. As a result, we have not had difficulty refinancing
our short-term debt as it matures, even during the financial market liquidity
crisis in late 1998. Still, changes in the market values of our assets, in our
perceived credit worthiness, in lender over-collateralization requirements, and
in the capital markets, can impact our access to liquidity.
At December 31, 1999,2000, we had $71 million of highly liquid assets which were
unpledged and available to meet margin calls on short-term debt that could be
caused by asset value declines or changes in lender over-collateralization
requirements. These assets consisted of unrestricted cash and unpledged "AAA"
rated mortgage securities. Total available liquidity, including unrestricted
cash, equaled 6% of our short-term debt balances.
We paid commitment fees in 1999 to secure two committed lines$0.8 billion of short-term financing. There are certain restrictions regarding the collateral for which
these lines can be used, but they generally allow us to fund whole loan
acquisitions for the term of the commitments. There is no assurance that we will
be able to renew or wish to renew such lines upon expiration.debt.
PREPAYMENT RISK
As we receive repayments of mortgage principal, we amortize into income our
mortgage premium balances as an expense and our mortgage discount balances as
income. Mortgage premium balances arise when we acquire mortgage assets at a
price in excess of the principal value of the mortgages. Premium balances are
also created when an asset appreciates and is marked-to-market at a price above
par. Mortgage discount balances arise when we acquire mortgage assets at a price
below the principal value of the mortgages, or when an asset depreciates in
market value and is marked-to-market at a price below par.
At December 31, 1999,2000, mortgage premium balances were $27.6$22 million. Most
of this premium, $14 million, was associated with our residential
retained loan portfolio, and the rest, $8 million, with our investment
portfolio. Total mortgage discount balances were $20.3 million. Net$44 million, primarily
all of which was associated with our credit-enhancement portfolio. Of
this total discount amount, we are currently amortizing $17 million into
income over time in a manner dependent on mortgage premium was $7.3 million. Since the prepayment characteristicsrates. The
remainder, $27 million, we have designated as a credit reserve to
provide for future losses. We will realize this portion of our premium and discount mortgage assets may vary, gross
premium levels, net premium levels, and other factors may influence our
earnings.
Sequoia's long-term debt has associated deferred bond issuance costs. These
capitalized costs are amortized as an expense as the bonds are paid off with
mortgage principal receipts. These deferred costs totaled $2.8 million at
December 31, 1999. In addition, premium received from the issuance of bonds at
prices over principal value is amortized
as income as the bond issues pay down.
These balances totaled $3.8 million at December 31, 1999. The combined effect of
these two items was to reduce our effective mortgage-related premium by $1.0
million.only if future credit losses are less than projected. Our net
premium at December 31, 1999balance for assets and liabilities affected byour whole balance sheet, after removing the
rate of mortgage principal receiptsdesignated credit reserve, was $6.3$5 million. This net premium equaled
3.4% of common equity. Amortization expense and income will vary as prepayment
rates on mortgage assets vary. In addition, changes in prepayment rates will
effect the
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43
market value of our assets and our earnings. Changes in the value of our assets,
to the extent they are incorporated into the basis of our assets, will also
affect future amortization expense.
CREDIT RISK
Our principal credit risk comes from residential mortgage loans owned by Sequoia, mortgage
loans held in our
retained portfolio and credit-enhancement portfolio and from our
lower-ratedcommercial mortgage securities.loan portfolio. A small amount of our investment
portfolio is currently exposed to credit risk; the bulk of this
portfolio has very high credit ratings and would not normally be
expected to incur credit losses. We also have credit risk with
counter-parties with whom we do business.
Not including mortgage loans owned by Sequoia,It should be noted that the establishment of a credit reserve for GAAP
purposes for our residential retained portfolio or a designated credit
reserve under the effective yield method for our credit-enhancement
portfolio does not reduce our taxable income or our dividend payment
obligations as a REIT. For taxable income, many of our credit expenses
will be recognized only as incurred. Thus, the timing of recognition of
credit losses for GAAP and tax, and for our earnings and our dividends,
may differ.
The method that we owned $416 million inuse to account for future credit losses depends upon
the type of asset that we own. For our credit enhancement portfolio, we
effectively are provided with a credit reserve upon the acquisition of
such assets. We designate a portion of our discount as a credit reserve.
In addition, first loss and other credit-enhancement interests that are
junior to our positions that we do not own act as a form of credit
reserve for us on a specific asset basis. For our retained residential
mortgage loans at December 31, 1999. Of these, $0.5 million were
seriously delinquent (delinquent over 90 days, in foreclosure, in bankruptcy, or
real estate owned). We also owned $8 million in commercial mortgage loans. These
commercial mortgage loans were all current at December 31, 1999.
The three Sequoia trusts owned $1.0 billion in residential mortgage loans at
December 31, 1999. Our totalloan portfolio, we establish a credit reserve based on
anticipation of losses. For our investment portfolio, most of the assets
do not have material credit risk, from these trusts is limited to our
equity investment in these trusts. These equity investments had a reported value
of $32 million, net of relatedand no credit reserves at December 31, 1999. Atare generally
established. When we acquire any assets for this portfolio where credit
risk exists, we will establish the appropriate reserve as necessary. For
our commercial retained portfolio, we take credit reserves on a specific
asset basis when specific circumstances may warrant such a charge for a
particular loan. Management constantly monitors the performance of all
of its assets and takes appropriate actions to mitigate potential losses
to the extent
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51
possible. Regardless of how we account for future credit loss
expectations, there can be no assurance that time, $4.1 million ofour estimates will be prove
to be correct, and thus we may need to adjust the underlying loans, or 0.42%, were seriously delinquent.
At December 31, 1999, we had $5.1 millionamounts of credit
reserves to provide for
potential future credit losses from our mortgage loans. The reserve is based
upon our assessment of various factors affecting our mortgage loans, including
current and projected economic conditions, delinquency status, and credit
protection. Total seriously delinquent loans had a loan balance of $4.6 million.
To date, our realized credit losses from defaulted residential mortgage loanswe have averaged 9% of the loan balance of the defaulted loans. Loss severity may
increase in the future, however, particularly if real estate values decline. We
believe our current level of reserve and credit provision policy is reasonable.
At December 31, 1999, we also had $0.8 million credit reserves for our SMFC
re-REMIC securities. Our total potential credit exposure from these securities
(after this credit reserve) is our net cost basis of $6.7 million. At this time,
we believe the credit reserve is sufficient to cover currently foreseen credit
losses from these assets.established.
CAPITAL RISK
Our capital levels, and thus our access to borrowings and liquidity, may
be tested, particularly if the market value of our assets securing
short-term borrowings declines.
Through our risk-adjusted capital policy, we assign a guideline capital
adequacy amount, expressed as a guideline equity-to-assets ratio, to
each of our mortgage assets. For short-term funded assets, this ratio
will fluctuate over time, based on changes in that asset's credit
quality, liquidity characteristics, potential for market value
fluctuation, interest rate risk, prepayment risk, and the
over-collateralization requirements for that asset set by our
collateralized short-term lenders. Capital requirements for equityresidential
mortgage securities rated below AA, residential credit-enhancement
interests, retained interests from our Sequoia securitizations of our
residential retained portfolio assets, and commercial mortgage whole
loans are generally higher than for higher-rated residential securities
and residential whole loans. Capital requirements for these less-liquid
assets depend chiefly on our access to secure funding for these assets,
the number of sources of such funding, the funding terms, and on the
amount of extra capital we decide to hold on hand to protect against
possible liquidity events with these assets. Capital requirements for
most of our retained interests in Sequoia trusts
and for lower-rated mortgage securities generally equal our net
investment. The sum of the capital adequacy amounts for all of our
mortgage assets is our aggregate guideline capital adequacy guideline amount.
TheGenerally, our total guideline equity-to-assets ratio capital amount has
declined over the last few years as we have eliminated some of the risks
of short-term debt funding through issuing long-term debt. In the most
recent quarters, however, the total guideline ratio has increased as we have
acquired new types of assets requiring more capital, such as commercial
mortgage loans and lower-rated mortgage securities.residential credit-enhancement interests.
We do not expect that our actual capital levels will always exceed the
guideline amount. If interest rates were to rise in a significant
manner, our capital guideline amount may rise, as the potential interest
rate risk of our mortgages would increase, at least on a temporary
basis, due to periodic and life caps and slowing prepayment rates. We
measure all of our mortgage assets funded with short-term debt at
estimated market value for the purpose of making risk-adjusted capital
calculations. Our actual capital levels, as determined for the
risk-adjusted capital policy, would likely fall as rates increase as the
market values of our mortgages, net of mark-to-market gains on hedges,
decreased. (Such market value declines may be temporary as well, as
future coupon adjustments on adjustable-rate mortgage loans may help to
restore some of the lost market value.)
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44
In this circumstance, or any other circumstance in which our actual
capital levels decreased below our capital adequacy guideline amount, we
would generally cease the acquisition of new mortgage assets until
capital balance was restored through prepayments, interest rate changes,
or other means. In certain cases prior to a planned equity offering or
other circumstances, the Board of Directors has authorized management to
acquire mortgage assets in a limited amount beyond the usual constraints
of our risk-adjusted capital policy.
Growth in assets and earnings may be limited when our access to new equity
capital is limited. Holdings can benefit over time from the re-investment of
retained earnings at Holdings. Our mortgage finance operation, however, is
generally required to distribute at least 95% of taxable income as dividends.
INFLATION RISK
Virtually all of our assets and liabilities are financial in nature. As
a result, interest rates, changes in interest rates and other factors
drive our performance far more than does inflation. Changes in interest
rates do not necessarily correlate with inflation rates or changes in
inflation rates.
Our financial statements are prepared in accordance with Generally Accepted
Accounting PrinciplesGAAP and our
dividends must equal at least 95% (90% for years 2001 and after) of our
net income as calculated for tax purposes. In each case, our activities
and balance sheet are measured with reference to historical cost or fair
market value without considering inflation.
QUANTITATIVE INFORMATION ABOUT MARKET RISK
The information presented in the table belowon the following pages includes
all of our interest rate sensitive assets and liabilities. We acquire
interest-rate sensitive assets, fund them with interest-rate sensitive
liabilities and also utilize
51
52
interest-rate sensitive derivative financial instruments. We designate
some of these assets as "trading" and others as "non-trading."trading." The designation of an asset as
"trading" does not necessarily imply that we have a short-term intended
holding period for that asset.
The table below includes information about the possible future
repayments and interest rates of our assets and liabilities and
constitutes a "forward-looking statement." There are many assumptions
used to generate this information and there can be no assurance that
assumed events will occur as assumed. Other events will occur and will
affect the outcomes. Furthermore, future sales, acquisitions, calls, and
restructurings could materially change our interest rate risk profile.
For interest-rate sensitive assets, the table presents principal cash
flows and related average interest rates by year of maturity. The
forward curve (future interest rates as implied by the yield structure
of debt markets) as of December 31, 19992000 was used to project the average
interest rates for each year, based on the existing characteristics of
the portfolio. The maturity of cash flows includes assumptions on the
prepayment speeds of these assets based on their recent prepayment
performance; actual prepayment speeds will vary.
As of December 31, 1999, all short-term interest-rate sensitive liabilities were
scheduled to mature in 2000. The balance of long-term interest-rate sensitive
liabilities is amortized with the receipt of principal payments from the
mortgages securing such debt. Thus, long-term liability maturities are presented
based on the principal maturities of the underlying mortgages at assumed
prepayment rates. Weighted average interest rates for the year are based on the
forward curve and the characteristics of such debt.
Information presented on derivative financial instruments includes the notional
amounts of such instruments by maturity date and the effective strike, pay or
receive rates by the year in which instruments mature. The information includes
all of our derivative instruments owned as of December 31, 1999, regardless of
whether they were effective at December 31, 1999 or were scheduled to become
effective at a later date.
4452
4553
QUANTITATIVE INFORMATION ABOUTON MARKET RISK
(All Dollars in Thousands)(ALL DOLLARS IN THOUSANDS)
INTEREST RATE SENSITIVE ASSETS
PRINCIPAL EST. MARKET
PRINCIPAL AMOUNTS MATURING AND EFFECTIVE RATES DURING PERIOD
VALUE AT VALUE AT
DEC. 31, DEC. 31,
2000----------------------------------------------------------------
2001 2002 2003 2004 2005 THEREAFTER
1999 1999
------------------------------------------------------------ ----------------------------- ------- ------- ------- ------- ----------
"NON-TRADING" ASSETS, LIABILITIES AND DERIVATIVE FINANCIAL INSTRUMENTS
INTEREST-RATE SENSITIVE ASSETS
Adjustable-Rate Residential Mortgage Loans
Sequoia 1 LoansRESIDENTIAL CREDIT ENHANCEMENT INTERESTS Principal 441 502 528 589 1,984 36,152
ADJUSTABLE RATE Interest Rate 8.48% 8.20% 8.41% 8.53% 8.53% 9.00%
Principal 226 243 262 957 2,063 10,045
HYBRID Interest Rate 7.25% 7.25% 7.25% 7.20% 7.14% 7.61%
Principal 854 916 983 1,054 1,130 65,948
FIXED RATE Interest Rate 7.02% 7.02% 7.02% 7.02% 7.02% 7.02%
RETAINED RESIDENTIAL LOAN PORTFOLIO Principal Value 37,300 25,728 17,806 12,326 8,522 18,735 120,417 120,298247,598 172,757 120,197 82,381 56,510 122,741
ADJUSTABLE RATE RESIDENTIAL MORTGAGE LOANS Interest Rate 8.09% 8.93% 9.14% 9.16% 9.18% 9.98% 99.90%
Sequoia 2 Loans7.51% 7.23% 7.46% 7.59% 7.59% 7.80%
Principal Value 67,271 57,180 51,165 45,596 38,417 188,841 448,470 451,951157,183 93,581 31,690 17,216 9,337 10,979
HYBRID RESIDENTIAL MORTGAGE LOANS Interest Rate 8.09% 8.71% 8.80% 8.80% 8.81% 9.16% 100.78%
Redwood Trust Loans6.79% 6.82% 7.49% 7.37% 7.29% 7.72%
INVESTMENT PORTFOLIO Principal Value 126,742 87,771 60,929 42,283 29,318 65,413 412,456 415,880252,420 162,532 105,159 68,649 45,152 89,383
ADJUSTABLE RATE MORTGAGE SECURITIES Interest Rate 7.92% 8.52% 8.61% 8.62% 8.62% 8.92% 100.83%
Adjustable-rate Commercial
Mortgage Loans
Commercial Loans7.67% 7.07% 7.18% 7.20% 7.12% 7.45%
Principal Value 43 45 50 53 52 8,208 8,450 8,4372,062 5,656 6,668 7,305 4,794 7,168
FIXED RATE MORTGAGE SECURITIES Interest Rate 9.85% 10.68% 10.75% 10.87% 11.29% 11.82% 99.85%
Hybrid Residential
Mortgage Loans
Sequoia 3 Loans7.38% 7.42% 7.43% 7.43% 7.41% 7.37%
COMMERCIAL RETAINED LOAN PORTFOLIO Principal Value 62,902 53,095 44,793 36,874 31,116 163,260 392,040 383,40413,226 16,243 22,675 0 0 0
ADJUSTABLE RATE MORTGAGE LOANS Interest Rate 6.76% 6.76% 6.76% 8.93% 9.15% 10.17% 97.80%
Adjustable-rate Residential
Mortgage Securities
SMFC 97-A10.63% 9.49% 9.50% n/a n/a n/a
Principal 163 163 177 195 215 14,822 15,736 6,623Value 74 82 883 84 92 4,340
HYBRID MORTGAGE LOANS Interest Rate 7.95% 8.61% 8.81% 8.82% 8.84% 9.63% 42.09%9.50% 9.50% 9.50% 9.51% 9.56% 9.92%
INTEREST-RATE SENSITIVE LIABILITIES
SHORT-TERM DEBT Reverse Repurchase
Agreements and Bank Principal 1,253,565756,222 0 0 0 0 0
1,253,565 1,253,565
Warehouse FacilitiesREVERSE REPURCHASE AGREEMENTS Interest Rate 6.31% N/6.85% n/a N/n/a N/n/a N/n/a N/n/a
100.00%AND BANK WAREHOUSE FACILITIES
LONG-TERM DEBT Sequoia 1 Debt Principal 37,300 25,728 17,806 12,326 8,522 18,775 120,458 120,458244,165 171,058 119,359 81,968 56,306 111,156
VARIABLE RATE Interest Rate 7.04% 7.59% 7.68% 7.69% 7.69% 7.99% 100.00%
Sequoia 2 Debt6.39% 5.97% 6.15% 6.24% 6.21% 6.45%
Principal 67,271 57,180 51,165 45,596 38,417 181,273 440,902 437,231157,183 93,581 31,690 17,216 9,337 2,890
HYBRID (FIXED TO DECEMBER 2002) Interest Rate 6.81% 7.53% 7.73% 7.74% 7.76% 8.62% 99.17%
Sequoia 3 Debt6.35% 6.40% 6.60% 7.16% 7.36% 7.51%
AT DECEMBER 31, 2000
--------------------------------
PRINCIPAL REPORTED EST. MARKET
VALUE VALUE VALUE
--------- -------- -----------
RESIDENTIAL CREDIT ENHANCEMENT INTERESTS Principal 62,902 53,095 44,793 36,874 31,116 154,085 382,865 370,75940,196 28,206 28,206
ADJUSTABLE RATE Interest Rate 6.40% 6.35% 6.35% 7.56% 7.59% 8.12% 96.84%
------------------------------------------------------------ ----------------------
"TRADING" ASSETS, LIABILITIES AND DERIVATIVE FINANCIAL INSTRUMENTS70.17% 70.17%
Principal 13,797 7,419 7,419
HYBRID Interest Rate 53.77% 53.77%
Principal 70,885 45,140 45,140
FIXED RATE Interest Rate 63.68% 63.68%
RETAINED RESIDENTIAL LOAN PORTFOLIO Principal Value 802,183 811,927 801,605
ADJUSTABLE RATE RESIDENTIAL MORTGAGE LOANS Interest Rate 101.21% 99.93%
Principal Value 319,986 319,069 318,442
HYBRID RESIDENTIAL MORTGAGE LOANS Interest Rate 99.71% 99.52%
INVESTMENT PORTFOLIO Principal Value 723,295 731,529 731,529
ADJUSTABLE RATE MORTGAGE SECURITIES Interest Rate 101.14% 101.14%
Principal Value 33,654 33,246 33,246
FIXED RATE MORTGAGE SECURITIES Interest Rate 98.79% 98.79%
COMMERCIAL RETAINED LOAN PORTFOLIO Principal Value 52,144 51,992 51,992
ADJUSTABLE RATE MORTGAGE LOANS Interest Rate 99.71% 99.71%
Principal Value 5,556 5,177 5,177
HYBRID MORTGAGE LOANS Interest Rate 93.19% 93.19%
INTEREST-RATE SENSITIVE ASSETS
Adjustable-Rate Residential
Mortgage Securities
Agency SecuritiesLIABILITIES
SHORT-TERM DEBT Principal Value 149,077 109,855 81,202 60,045 44,330 120,430 564,941 574,847756,222 756,222 756,222
REVERSE REPURCHASE AGREEMENTS Interest Rate 7.95% 8.61% 8.81% 8.82% 8.84% 9.63% 101.75%
Privately-issued Securities100.00% 100.00%
AND BANK WAREHOUSE FACILITIES
LONG-TERM DEBT Principal 120,672 78,820 51,604 33,771 22,072 41,005 347,944 345,651784,012 784,462 777,624
VARIABLE RATE Interest Rate 7.96% 8.64% 8.77% 8.78% 8.79% 9.19% 99.34%
Fixed-rate Residential
Mortgage Securities
Agency and Privately-
issued Securities100.06% 99.19%
Principal 3,887 3,487 3,126 2,802 2,511 19,427 35,240 33,666
Rated AAA and AA311,897 311,373 307,843
HYBRID (FIXED TO DECEMBER 2002) Interest Rate 7.15% 7.15% 7.15% 7.15% 7.15% 7.15% 95.53%
Privately-issued
Securities Rated Principal 2,617 2,346 2,102 1,883 1,686 13,075 23,710 13,593
A and Below Interest Rate 6.60% 6.60% 6.60% 6.60% 6.60% 6.60% 57.33%
------------------------------------------------------------ ----------------------99.83% 98.70%
45
4654
QUANTITATIVE INFORMATION ABOUTON MARKET RISK
(All Dollars in Thousands)
(Continued)(ALL DOLLARS IN THOUSANDS)
(CONTINUED)
INTEREST RATE AGREEMENTS
(INTEREST RATE AGREEMENTS WHICH REPRESENT MIRRORING
TRANSACTIONS ARE NOT INCLUDED IN THIS TABLE.)
Notional Est. Market
Notional Amounts Maturing and Effective Rates During Period Value At Value At
DEC. 31, DEC. 31,
2000NOTIONAL AMOUNTS MATURING AND EFFECTIVE RATES DURING PERIOD
---------------------------------------------------------------------------
2001 2002 2003 2004 2005 THEREAFTER
1999 1999
----------------------------------------------------------- -------------------------------- --------- --------- --------- --------- ----------
INTEREST-RATE SENSITIVE DERIVATIVE FINANCIAL INSTRUMENTS
(Interest Rate Agreements Which Represent Mirroring Transactions are Not Included in This Table.)
Interest Rate CapsINTEREST RATE CAPS -
(See Below for Details)(SEE BELOW FOR DETAILS) Notional 381,000 520,000 310,000 0 64,000 82,400 2,357,400 2,161851,000 309,900 5,800 59,600 84,000 12,000
(PURCHASED) Strike Rate 7.31% 9.71% 10.30% n/a 6.58% 8.33% 0.09%
Floors8.81% 10.31% 7.14% 6.49% 8.23% 7.35%
FLOORS Notional 0 0 5,000 2,000 1,000 3,000 11,000 315,000 5,000
(PURCHASED) Strike Rate n/a n/a 5.33% 5.33% 5.33% 5.33% 0.28%
Basis Swaps: Libor vs.
Treasury5.62% 6.00%
EURODOLLAR FUTURES Notional 250,000101,000 61,000 56,000 56,000 22,000 10,000
(SOLD) Sale Price 93.20% 93.36% 93.20% 92.86% 92.95% 92.35%
5 YEAR TREASURY NOTE FUTURES Notional 600 0 0 0 0 0
250,000 122
(PURCHASED) Pay Rate 6.03%(SOLD) Sale Price 101.88% n/a n/a n/a n/a n/a
0.05%
Receive Rate 6.08%PUT OPTIONS ON EURODOLLAR FUTURES Notional 125,000 0 0 0 0 0
(PURCHASED) Strike Price 93.06% n/a n/a n/a n/a n/a
Put SwaptionsCALL OPTIONS ON EURODOLLAR FUTURES Notional 67,00025,000 0 0 0 0 0
67,000 14
(PURCHASED) Strike Rate 6.36%Price 93.00% n/a n/a n/a n/a n/a
0.02%
Treasury Call OptionsFORWARD RATE AGREEMENT Notional 11,000200,000 0 0 0 0 0
11,000 0
(PURCHASED)(SOLD) Strike Rate 5.10%7.00% n/a n/a n/a n/a n/a
0.00%
Treasury Call Option SpreadsINTEREST RATE SWAPS Notional 32,000 0 0 0 0 0 32,000 (644)5,000
(PURCHASED) Strike Rate 5.46% n/a n/a n/a n/a n/a -2.01%
Stopout Rate 4.96% n/a n/a n/a n/a n/a
Treasury Put Option Spreads Notional 21,000 0 0 0 0 0 21,000 0
(SOLD) Strike Rate 5.46% n/a n/a n/a n/a n/a 0.00%
Stopout Rate 5.91% n/a n/a n/a n/a n/a
Eurodollar Futures Notional 180,000 60,000 45,000 60,000 120,000 150,000 615,000 211
(SOLD) Sale Price 93.61% 93.39% 93.27% 93.06% 92.88% 92.65% 0.03%
Put Options on Eurodollar
Futures Notional 475,000 0 0 0 0 0 475,000 22
(PURCHASED) Strike Price 93.44% n/a n/a n/a n/a n/a 0.00%
FNMA MBS Forward Sales Notional 15,000 0 0 0 0 0 15,000 115
(SOLD) Sale Price 99.55% n/a n/a n/a n/a n/a 0.77%
Call Options on FNMA MBS
Forwards Notional 7,500 0 0 0 0 0 7,500 6
(PURCHASED) Strike Price 100.55% n/a n/a n/a n/a n/a 0.08%
----------------------------------------------------------- -----------------------6.29%
DETAIL OF INTEREST RATE CAPS
(totaled above)(TOTALED ABOVE)
with Strike Rates <6% Notional 555,000 0 0 0 0 0 555,000 404
Strike Rate 5.70% n/a n/a n/a n/a n/a 0.07%
with Strike Rates of
6% to 7% Notional 200,000 0 5,000 0 54,000 2,000 261,000 765
Strike Rate 6.42% n/a 6.25% n/a 6.32% 6.63% 0.29%
with Strike Rates of
7% to 8% Notional 25,000 20,000 0 0 0 10,000 55,000 415
Strike Rate 7.00% 7.13% n/a n/a n/a 7.50% 0.75%
with Strike Rates of
8% to 9% Notional 406,000 0 5,000 0 10,000 54,000 475,000 348
Strike Rate 8.60% n/a 8.60% n/a 8.00% 8.34% 0.07%
with Strike Rates of
9% to 10% Notional 125,000 200,000 0 0 0 16,400 341,400 103
Strike Rate 9.40% 9.53% n/a n/a n/a 9.00% 0.03%
with Strike Rates of
10% to 11% Notional 20,000 300,000 200,000 0 0 0 520,000 121
Strike Rate 10.00% 10.00% 10.10% n/a n/a n/a 0.02%
with Strike Rates >< 6% Notional 0 0 0 0 0 0
Strike Rate n/a n/a n/a n/a n/a n/a
with Strike Rates of 6% to 7% Notional 80,000 4,000 0 54,000 0 2,000
Strike Rate 6.69% 6.25% n/a 6.32% n/a 6.63%
with Strike Rates of 7% to 8% Notional 270,000 0 5,000 0 18,000 10,000
Strike Rate 7.59% n/a 7.00% n/a 7.40% 7.50%
with Strike Rates of 8% to 9% Notional 0 5,000 0 5,000 54,000 0
Strike Rate n/a 8.60% n/a 8.00% 8.34% n/a
with Strike Rates of 9% to 10% Notional 201,000 900 800 600 12,000 0
Strike Rate 9.53% 9.00% 9.00% 9.00% 9.00% n/a
with Strike Rates of 10% to 11% Notional 300,000 200,000 0 0 0 0
Strike Rate 10.00% 10.10% n/a n/a n/a n/a
with Strike Rates >11% Notional 50,000 0 100,000 0 0 0 150,000 50
Strike Rate 12.00% n/a 11.00% n/a n/a n/a n/a
AT DECEMBER 31, 2000
-------------------------------------
NOTIONAL REPORTED EST. MARKET
VALUE VALUE VALUE
--------- --------- -----------
INTEREST RATE CAPS -
(SEE BELOW FOR DETAILS) Notional 1,322,300 591 591
(PURCHASED) Strike Rate 0.04% 0.04%
FLOORS Notional 18,000 272 272
(PURCHASED) Strike Rate 1.51% 1.51%
EURODOLLAR FUTURES Notional 306,000 (775) (775)
(SOLD) Sale Price -0.25% -0.25%
5 YEAR TREASURY NOTE FUTURES Notional 600 (10) (10)
(SOLD) Sale Price -1.69% -1.69%
PUT OPTIONS ON EURODOLLAR FUTURES Notional 125,000 2 2
(PURCHASED) Strike Price 0.00% ----------------------------------------------------------- -----------------------0.00%
CALL OPTIONS ON EURODOLLAR FUTURES Notional 25,000 69 69
(PURCHASED) Strike Price 0.28% 0.28%
FORWARD RATE AGREEMENT Notional 200,000 0 0
(SOLD) Strike Rate 0.00% 0.00%
INTEREST RATE SWAPS Notional 5,000 (83) (83)
(PURCHASED) Strike Rate -1.65% -1.65%
DETAIL OF INTEREST RATE CAPS
(TOTALED ABOVE)
with Strike Rates < 6% Notional 0 0 0
Strike Rate n/a n/a
with Strike Rates of 6% to 7% Notional 140,000 282 282
Strike Rate 0.20% 0.20%
with Strike Rates of 7% to 8% Notional 303,000 185 185
Strike Rate 0.06% 0.06%
with Strike Rates of 8% to 9% Notional 64,000 108 108
Strike Rate 0.17% 0.17%
with Strike Rates of 9% to 10% Notional 215,300 17 17
Strike Rate 0.01% 0.01%
with Strike Rates of 10% to 11% Notional 500,000 0 0
Strike Rate 0.00% 0.00%
with Strike Rates > 11% Notional 100,000 0 0
Strike Rate 0.00% 0.00%
46
4755
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company and Holdings and
the related Notes, together with the Reports of Independent Accountants
thereon, are set forth on pages F-1 through F-36F-42 of this Form 10-K and
incorporated herein by reference.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors and executive
officers of the Company is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A under
the headings "Election of Directors" and "Management of the Company."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A
under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A
under the heading "Security Ownership of Certain Beneficial Owners and
Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A
under the heading "Executive Compensation --- Certain Relationships and
Related Transactions."
PART IV
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON
FORM 8-K
(a) Documents filed as part of this report:
(1) Consolidated Financial Statements
(2) Schedules to Consolidated Financial Statements: All
Consolidated Financial Statements schedules not included
have been omitted because they are either inapplicable
or the information required is provided in the Company's
Consolidated Financial Statements and Notes thereto,
included in Part II, Item 8, of this Annual Report on
Form 10-K.
4755
4856
(3) Exhibits:
Exhibit
Number Exhibit
- ------- -------
3.1 Articles of Amendment and Restatement of the Registrant(a)Registrant (a)
3.1.1 Certified Certificate of Amendment of the Charter of Registrant(l)Registrant (l)
3.2 Articles Supplementary of the Registrant(a)Registrant (a)
3.3 Amended and Restated Bylaws of the Registrant(b)Registrant (b)
3.3.1 Amended and Restated Bylaws, amended December 13, 1996(g)1996 (g)
3.3.2 Amended and Restated Bylaws, amended March 15, 2001
3.4 Articles Supplementary of the Registrant, dated August 14, 1995(d)1995 (d)
3.4.1 Articles Supplementary of the Registrant relating to the Class B
9.74% Cumulative Convertible Preferred Stock, filed August 9, 1996(f)1996
(f)
4.2 Specimen Common Stock Certificate(a)Certificate (a)
4.3 Specimen Class B 9.74% Cumulative Convertible Preferred Stock
Certificate(f)Certificate (f)
4.4 In May 1999, the Bonds issued pursuant to the Indenture, dated as of
June 1, 1997, between Sequoia Mortgage Trust 1 and First Union
National Bank, as Trustee, were redeemed, restructured, and
contributed to Sequoia Mortgage Trust 1A, interests in which were
then privately placed with investors(i)investors (i)
4.4.1 Indenture dated as of October 1, 1997 between Sequoia Mortgage Trust
2 (a wholly-owned, consolidated subsidiary of the Registrant) and
Norwest Bank Minnesota, N.A., as Trustee(j)Trustee (j)
4.4.2 Sequoia Mortgage Trust 1A Trust Agreement, dated as of May 4, 1999
between Sequoia Mortgage Trust 1 and First Union National Bank(m)Bank (m)
9.1 Voting Agreement, dated March 10, 2000
10.1 Purchase Terms Agreement, dated August 18, 1994, between the
Registrant and Montgomery Securities(a)Securities (a)
10.2 Registration Rights Agreement, dated August 19, 1994, between the
Registrant and Montgomery Securities(a)Securities (a)
10.3 [Reserved]
10.4 Founders Rights Agreement, dated August 19, 1994, between the
Registrant and the original holders of Common Stock of the
Registrant(a)Registrant (a)
10.5 Form of Reverse Repurchase Agreement for use with Agency
Certificates, Privately-Issued Certificates and Privately-Issued
CMOs(a)CMOs (a)
10.5.1 Form of Reverse Repurchase Agreement for use with Mortgage Loans(d)Loans (d)
10.6.1 [Reserved]
10.7 [Reserved]
10.8 Forms of Interest Rate Cap Agreements(a)Agreements (a)
10.9 [Reserved]
10.9.2 Clearance[Reserved]
10.9.3 Custodian Agreement (U.S. Custody), dated December 1, 1996,2000, between
the Registrant and Bankers Trust Company(d)Company
10.10 Employment Agreement, dated August 19, 1994, between the Registrant
and George E. Bull(a)Bull (a)
10.11 Employment Agreement, dated August 19, 1994, between the Registrant
and Douglas B. Hansen(a)Hansen (a)
10.12 [Reserved]
10.13 [Reserved]
10.13.1 Employment Agreement, dated March 13, 2000, between the Registrant
and Harold F. Zagunis (o)
10.13.2 Employment Agreement, dated March 23, 2001, between the Registrant
and Andrew I. Sirkis
10.13.3 Employment Agreement, dated April 20, 2000, between the Registrant
and Brett D. Nicholas
10.14 1994 Amended and Restated Executive and Non-Employee Director Stock
Option Plan(c)Plan (c)
10.14.1 1994 Amended and Restated Executive and Non-Employee Director Stock
Option Plan, amended March 6, 1996(d)1996 (d)
56
57
10.14.2 Amended and Restated 1994 Executive and Non-Employee Director Stock
Option Plan, amended December 13, 1996(h)1996 (h)
10.14.3 Amended and Restated Executive and Non-Employee Director Stock
Option Plan, amended March 4, 1999 (p)
10.14.4 Amended and Restated Executive and Non-Employee Director Stock
Option Plan, amended January 18, 2001
10.27 [Reserved]
10.29 Form of Dividend Reinvestment Plan(b)[Reserved]
10.29.1 Form of Dividend Reinvestment and Stock Purchase Plan(g)
48
49
Plan (g)
10.30 Office Building Lease(d)Lease (d)
10.30.1 Amendment to Office Building Lease(k)Lease (k)
10.31 RWT Holdings, Inc. Series A Preferred Stock Purchase Agreement,
dated March 1, 1998 (n)
10.32 Administrative Personnel and Facilities Agreement dated as of April
1, 1998, between Redwood Trust, Inc. and RWT Holdings, Inc.(n)
10.32.1 First Amendment to Administrative Personnel and Facilities Agreement
dated as of April 1, 1998, between Redwood Trust, Inc. and RWT
Holdings, Inc.(n)
10.33 Lending and Credit Support Agreement dated as of April 1, 1998,
between RWT Holdings, Inc., Redwood Residential Funding, Inc.,
Redwood Commercial Funding, Inc., and Redwood Financial Services,
Inc., and Redwood Trust, Inc.(n)
10.34 Form of Master Forward Commitment Agreements for RWT Holdings, Inc.,
Residential Redwood Funding, Inc., Redwood Commercial Funding, Inc.
and Redwood Financial Services, Inc.(n)
11.1 Statement re: Computation of Per Share Earnings
21 List of Subsidiaries(k)Subsidiaries
23 Consent of Accountants
27 Financial Data Schedule
- ---------------------------------------------------
(a) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-92272)
filed by the Registrant with the Securities and Exchange
Commission on May 19, 1995.
(b) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-97946)
filed by the Registrant with the Securities and Exchange
Commission on October 10, 1995.
(c) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-94160)
filed by the Registrant with the Securities and Exchange
Commission on June 30, 1995.
(d) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (333-02962)
filed by the Registrant with the Securities and Exchange
Commission on March 26, 1996.
(e) [Reserved]
(f) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (333-08363)
filed by the Registrant with the Securities and Exchange
Commission on July 18, 1996.
(g) Incorporated by reference to the Registration Statement on Form
S-3 (333-18061) filed by the Registrant with the Securities and
Exchange Commission on January 2, 1997.
(h) Incorporated by reference to the correspondingly numbered
exhibit to Form 8-K (000-26436) filed by the Registrant with the
Securities and Exchange Commission on January 7, 1997.
57
58
(i) Incorporated by reference to the Form 8-K filed by Sequoia
Mortgage Funding Corporation with the Securities and Exchange
Commission on August 12, 1997.
(j) Incorporated by reference to the Form 8-K filed by Sequoia
Mortgage Funding Corporation with the Securities and Exchange
Commission on November 18, 1997.
49
50
(k) Incorporated by reference to the Form 10-K (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal year ended December 31, 1997.
(l) Incorporated by reference to the Form 8-K (1-13759) filed by the
Registrant with the Securities and Exchange Commission on July
20, 1998.
(m) Incorporated by reference to the Form 10-Q (0-26436) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal quarter ended June 30, 1999.
(n) Incorporated by reference to the Form 10-K (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal year ended December 31, 1998.
(o) Incorporated by reference to the Form 10-Q (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal quarter ended March 31, 2000.
(p) Incorporated by reference to the Form 10-K (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal year ended December 31, 1999
(b) Reports on Form 8-K:
None.
5058
5159
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
REDWOOD TRUST, INC.
Dated: March 15, 200027, 2001 By: /s/ George E. Bull
----------------------------------------------------------------------
George E. Bull
Chairman and Chief
Executive Officer
Pursuant to the requirements the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ George E. Bull George E. Bull March 27, 2001
- --------------------------- Chairman of the Board and
March 15, 2000
- ---------------------------- Chief Executive Officer
George E. Bull
(Principal Executive Officer)
/s/ Douglas B. Hansen Director, President March 15, 2000
- ----------------------------
Douglas B. Hansen March 27, 2001
- --------------------------- Director, President
/s/ Harold F. Zagunis Harold F. Zagunis March 27, 2001
- --------------------------- Chief Financial Officer, Secretary,
March 15, 2000
- ---------------------------- Treasurer and Controller
Harold F. Zagunis
(Principal Financial and Accounting Officer)
/s/ Richard D. Baum Richard D. Baum March 27, 2001
- --------------------------- Director
/s/ Thomas C. Brown Director March 15, 2000
- ----------------------------
Thomas C. Brown March 27, 2001
- --------------------------- Director
/s/ Mariann Byerwalter DirectorMariann Byerwalter March 15, 200027, 2001
- ----------------------------
Mariann Byerwalter--------------------------- Director
/s/ Thomas F. Farb Director March 15, 2000
- ----------------------------
Thomas F. Farb /s/ Nello GonfiantiniMarch 27, 2001
- --------------------------- Director March 15, 2000
- ----------------------------
Nello Gonfiantini
/s/ Terrance G. Hodel Director March 15, 2000
- ----------------------------
Terrance G. Hodel
/s/ Charles J. Toeniskoetter Charles J. Toeniskoetter March 27, 2001
- --------------------------- Director
/s/ David L. Tyler David L. Tyler March 15, 200027, 2001
- ----------------------------
Charles J. Toeniskoetter--------------------------- Director
5159
5260
REDWOOD TRUST, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
For Inclusion in FormFOR INCLUSION IN FORM 10-K
Annual Report Filed with
Securities and Exchange Commission
DecemberANNUAL REPORT FILED WITH
SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 19992000
F-1
5361
REDWOOD TRUST, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Consolidated Financial Statements - Redwood Trust, Inc.:
Consolidated Balance Sheets at December 31, 19992000 and 1998..................1999...................... F-3
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 1998 and 1997......................................1998.......................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2000, 1999 1998 and 1997......................................1998.......................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 1998 and 1997......................................1998.......................................... F-6
Notes to Consolidated Financial Statements.................................Statements..................................... F-7
Report of Independent Accountants............................................... F-23Accountants................................................... F-28
F-2
5462
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
2000 1999 1998
----------- -----------
ASSETS
Net Investment In Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 48,495 $ 23,237
Mortgage securities available-for-sale, pledged 32,269 3,762
----------- -----------
80,764 26,999
Residential Retained Loan Portfolio:
Mortgage loans Residential:held-for-investment 1,124,339 969,709
Mortgage loans held-for-sale $ 415,880 $ 265,914
Residential: held-for-investment, net 968,709 1,131,300
Commercial:531 7,639
Mortgage loans held-for-sale, 8,437 8,287pledged 6,127 408,241
----------- -----------
1,393,026 1,405,5011,130,997 1,385,589
Investment Portfolio:
Mortgage securities Residential: trading 946,373 1,257,655
Residential:57,450 60,878
Mortgage securities trading, pledged 702,162 880,903
Mortgage securities available-for-sale net 28,006 7,7075,163 --
----------- -----------
974,379 1,265,362
U.S. Treasury securities: trading764,775 941,781
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment 5,177 --
48,009Mortgage loans held-for-investment, pledged 17,717 --
Mortgage loans held-for-sale 14,325 8,437
Mortgage loans held-for-sale, pledged 19,950 --
----------- -----------
57,169 8,437
Cash and cash equivalents 15,483 19,881 55,627
Restricted cash 5,240 5,384 12,857
Interest rate agreements 66 2,037 2,517
Accrued interest receivable 15,797 13,244
18,482Principal receivable 7,986 4,599
Investment in RWT Holdings, Inc. 1,899 3,391 15,124
Loans to RWT Holdings, Inc. 6,500-- 6,500
Receivable from RWT Holdings, Inc. -- 472 445
Other assets 1,939 1,614 2,024
----------- -----------
Total Assets $ 2,419,9282,082,115 $ 2,832,4482,419,928
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 1,253,565756,222 $ 1,257,5701,253,565
Long-term debt, net 1,095,835 945,270 1,305,560
Accrued interest payable 5,657 5,462 10,820
Accrued expenses and other liabilities 4,180 2,819 3,022
Dividends payable 4,557 2,877 686
----------- -----------
Total Liabilities 1,866,451 2,209,993 2,577,658
----------- -----------
Commitments and contingencies (See Note 13)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74% Cumulative
Convertible 902,068 and 909,518 shares authorized, issued and outstanding
($28,645 and $28,882 aggregate liquidation preference) 26,517 26,73626,517
Common stock, par value $0.01 per share; 49,097,932 and 49,090,482 shares authorized;
8,783,3418,809,500 and 11,251,5568,783,341 issued and outstanding 88 11388
Additional paid-in capital 242,522 242,094 279,201
Accumulated other comprehensive income (89) (3,348) (370)
Cumulative earnings 27,074 8,140 6,412
Cumulative distributions to stockholders (80,448) (63,556) (57,302)
----------- -----------
Total Stockholders' Equity 215,664 209,935 254,790
----------- -----------
Total Liabilities and Stockholders' Equity $ 2,419,9282,082,115 $ 2,832,4482,419,928
=========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
5563
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
Years Ended December 31,
2000 1999 1998 1997
------------ ------------ ------------
INTEREST INCOME
Net Investment In Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 8,524 $ 4,202 $ 2,963
Residential Retained Loan Portfolio:
Mortgage loans Residential: held-for-sale $ 7,220 $ 9,005 $ --
Residential: held-for-investment 83,815 65,930 112,242
65,328
Commercial:Mortgage loans held-for-sale 1,081 102 --7,050 7,220 9,005
------------ ------------ ------------
74,231 121,349 65,32890,865 73,150 121,247
Investment Portfolio:
Mortgage securities Residential: trading 67,055 65,300 46,162
Mortgage securities available-for-sale 151 -- Residential: available-for-sale 4,202 52,638 131,95049,675
U.S. Treasury securities trading -- 919 575
------------ ------------ ------------
69,502 98,800 131,950
U.S. Treasury securities: trading 919 57567,206 66,219 96,412
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment 520 -- --
Mortgage loans held-for-sale 1,482 1,081 102
------------ ------------ ------------
2,002 1,081 102
Cash and cash equivalents 1,395 2,658 2,080 1,326
------------ ------------ ------------
Total interest income 169,992 147,310 222,804 198,604
INTEREST EXPENSE
Short-term debt (61,355) (51,377) (114,763)
(140,140)
Long-term debt (76,294) (65,785) (81,361) (20,137)
------------ ------------ ------------
Total interest expense (137,649) (117,162) (196,124) (160,277)
Net interest rate agreements expense (954) (2,065) (3,514)
(3,741)Provision for credit losses on residential mortgage
loans held-for-investment (731) (1,346) (1,120)
------------ ------------ ------------
NET INTEREST INCOME 28,083 23,166 34,586AFTER PROVISION FOR CREDIT LOSSES 30,658 26,737 22,046
Net unrealized and realized market value gains (losses)
Loans and securities 1,060 (1,700) (33,034) 718
Interest rate agreements (3,356) 1,984 (5,909) (155)
------------ ------------ ------------
Total net unrealized and realized market value gains (losses) (2,296) 284 (38,943)
563
Provision for credit losses (1,346) (1,120) (2,930)
------------ ------------ ------------
NET REVENUES 27,021 (16,897) 32,219
Operating expenses (7,850) (3,835) (5,876)
(4,658)
Other income 98 175 139
--
Equity in earnings (losses)losses of RWT Holdings, Inc. (1,676) (21,633) (4,676) --
------------ ------------ ------------
Net income (loss) before preferred dividend and change
in accounting principle 18,934 1,728 (27,310)
27,561
Less cash dividends on Class B preferred stock (2,724) (2,741) (2,747) (2,815)
------------ ------------ ------------
Net income (loss) before change in accounting principle 16,210 (1,013) (30,057) 24,746
Cumulative transition effect of adopting SFAS No. 133 (See Note 2) -- -- (10,061) --
------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ 16,210 $ (1,013) $ (40,118) $ 24,746
============ ============ ============
Earnings (Loss) per Share:
Basic Earnings (Loss) Per Share:
Net income (loss) before change in accounting principle $ 1.84 $ (0.10) $ (2.28) $ 1.86
Cumulative transition effect of adopting SFAS No. 133 $ -- $ (0.76)-- $ --(0.76)
Net income (loss) $ 1.84 $ (0.10) $ (3.04) $ 1.86
Diluted Earnings (Loss) Per Share:
Net income (loss) before change in accounting principle $ 1.82 $ (0.10) $ (2.28) $ 1.81
Cumulative transition effect of adopting SFAS No. 133 $ -- $ (0.76)-- $ --(0.76)
Net income (loss) $ 1.82 $ (0.10) $ (3.04) $ 1.81
Weighted average shares of common stock and common stock equivalents:
Basic 8,793,487 9,768,345 13,199,819
13,334,163
Diluted 8,902,069 9,768,345 13,199,819 13,680,410
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
5664
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Class B Accumulated Cumulative
Preferred stock Common stock Additional other distributions
-------------------------------------- paid-in comprehensive Cumulative to
Shares Amount Shares Amount capital income earnings stockholders Total
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 1,006,250 $29,579 10,996,572 $110 $187,507 $ (3,460) $ 16,222 $(18,953) $211,005
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income before
preferred dividend -- -- -- -- -- -- 27,561 -- 27,561
Net unrealized loss on
assets available-
for-sale -- -- -- -- -- (6,611) -- -- (6,611)
--------
Total comprehensive
income -- -- -- -- -- -- -- -- 20,950
Conversion of preferred
stock (96,732) (2,843) 96,732 1 2,842 -- -- -- --
Issuance of common stock -- -- 4,031,353 41 157,321 -- -- -- 157,362
Repurchase of common
stock -- -- (840,000) (9) (23,115) -- -- -- (23,124)
Dividends declared:
Preferred -- -- -- -- -- -- -- (2,815) (2,815)
Common -- -- -- -- -- -- -- (28,841) (28,841)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 909,518 26,736 14,284,657 143 324,555 (10,071) 43,783 (50,609) 334,537
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net loss before preferred
dividend and change in
accounting principle -- -- -- -- -- --- - - - - - (27,310) --- (27,310)
Reclassification adjustment
due to adoption of
SFAS No. 133 -- -- -- -- --- - - - - 19,457 -- --- - 19,457
Net unrealized loss
on assets available-
for-sale -- -- -- -- --- - - - - (9,756) -- --- - (9,756)
--------
Total comprehensive income -- -- -- -- -- -- -- --- - - - - - - - (17,609)
Cumulative transition effect
of adopting SFAS No. 133 -- -- -- -- -- --- - - - - - (10,061) --- (10,061)
Issuance of common stock -- --- - 98,399 1 1,563 -- -- --- - - 1,564
Repurchase of common stock -- --- - (3,131,500) (31) (46,917) -- -- --- - - (46,948)
Dividends declared:
Preferred -- -- -- -- -- -- --- - - - - - - (2,747) (2,747)
Common -- -- -- -- -- -- --- - - - - - - (3,946) (3,946)
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 909,518 26,736 11,251,556 113 279,201 (370) 6,412 (57,302) 254,790
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income before
preferred dividend -- -- -- -- -- --- - - - - - 1,728 --- 1,728
Net unrealized incomeloss
on assets available-
for-sale -- -- -- -- --- - - - - (2,978) -- --- - (2,978)
--------
Total comprehensive loss -- -- -- -- -- -- -- --- - - - - - - - (1,250)
Repurchase of preferred stock (7,450) (219) -- -- -- -- -- --- - - - - - (219)
Issuance of common stock -- --- - 15,285 --- 22 -- -- --- - - 22
Repurchase of common stock -- --- - (2,483,500) (25) (37,129) -- -- --- - - (37,154)
Dividends declared:
Preferred -- -- -- -- -- -- --- - - - - - - (2,741) (2,741)
Common -- -- -- -- -- -- --- - - - - - - (3,513) (3,513)
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 902,068 $26,517$ 26,517 8,783,341 $ 88 $242,094 $ (3,348) $ 8,140 $(63,556)$ (63,556) $209,935
====================================================================================================================================- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income before
preferred dividend - - - - - - 18,934 - 18,934
Net unrealized income
on assets available-
for-sale - - - - - 3,259 - - 3,259
--------
Total comprehensive income - - - - - - - - 22,193
Issuance of common stock - - 26,159 - 428 - - - 428
Dividends declared:
Preferred - - - - - - - (2,724) (2,724)
Common - - - - - - - (14,168) (14,168)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 902,068 $ 26,517 8,809,500 $ 88 $242,522 $ (89) $ 27,074 $ (80,448) $ 215,664
- -----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
5765
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
2000 1999 1998
1997
-------------------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before preferred dividend and
change in accounting principle $ 18,934 $ 1,728 $ (27,310) $ 27,561
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 4,170 6,773 32,046 27,066
Provision for credit losses 731 1,346 1,120
2,930
Equity in (earnings) losses of RWT Holdings, Inc. 1,676 21,633 4,676 --
Net unrealized and realized market value losses (gains) losses2,296 (284) 38,943 (563)
Purchases of mortgage loans:loans held-for-sale (92,532) (516,408) (8,296) --
Proceeds from sales of mortgage loans:loans held-for-sale 455,389 153,303 688,941
Principal payments on mortgage loans held-for-sale 20,598 59,782 202,965
Purchases of mortgage securities trading (302,585) (170,723) (149,934)
Proceeds from sales of mortgage securities trading 205,472 7,668 --
Principal payments on mortgage loans: held-for-sale 59,782 202,965 --
Purchases of mortgage securities:securities trading (170,723) (149,934) --
Proceeds from sales of mortgage securities: trading 7,668 -- --
Principal payments on mortgage securities: trading 468,344 433,314 --277,489 460,508 433,637
Purchases of U.S. Treasury securities:securities trading -- (45,844) (49,704) --
Proceeds from sales of U.S. Treasury securities:securities trading -- 90,519 --
--
Purchases of interest rate agreements (1,133) (14,373) (7,892)
Proceeds fromNet (purchases) sales of interest rate agreements 1,409 2,769 --(2,810) 276 (11,604)
(Increase) decrease in accrued interest receivable (2,553) 5,238 4,637
(8,985)
Decrease(Increase) decrease in principal receivable (3,387) 7,836 (323)
(Increase) decrease in other assets (365) 195 595 11
Increase (decrease) in accrued interest payable 195 (5,358) (3,656) 416
Increase (decrease) in accrued expenses and other liabilities 1,361 (203) 850
1,411
-------------------- ----------- -----------
Net cash provided by operating activities 584,079 77,985 1,157,583
41,955
-------------------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans:loans held-for-investment (407,204) -- (1,596,673) (1,322,732)
Proceeds from sales of mortgage loans:loans held-for-investment -- -- 369,119 --
Principal payments on mortgage loans:loans held-for-investment 226,179 310,892 475,905 288,982
Purchases of mortgage securities:securities available-for-sale (58,306) (17,691) (231,167) (978,979)
Proceeds from sales of mortgage securities:securities available-for-sale 2,897 -- 9,296 88,284
Principal payments on mortgage securities:securities available-for-sale 1,875 442 443,057
684,150
Net (increase) decrease in restricted cash 144 7,473 11,800 (24,657)
Investment in RWT Holdings, Inc., net of dividends received -- (9,900) (19,800) --
Loans to RWT Holdings, Inc., net of repayments 6,500 -- (6,500)
--
IncreaseDecrease (increase) in receivable from RWT Holdings, Inc. 472 (27) (445)
--
-------------------- ----------- -----------
Net cash (used in) provided by (used in) investing activities (227,442) 291,189 (545,408)
(1,264,952)
-------------------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on short-term debt (497,343) (4,005) (656,955) (38,578)
Proceeds (costs) from issuance of long-term debt 375,844 (337) 635,193 1,285,197
Repayments on long-term debt (225,434) (359,180) (502,601) (112,798)
Net proceeds from issuance of common stock 428 22 1,564 157,362
Repurchases of preferred stock -- (202) -- --
Repurchases of common stock -- (37,154) (46,948)
(23,124)
Dividends paid (14,531) (4,064) (11,693)
(31,238)
-------------------- ----------- -----------
Net cash provided by (used in)used in financing activities (361,036) (404,920) (581,440)
1,236,821
-------------------- ----------- -----------
Net (decrease) increase (decrease) in cash and cash equivalents (4,398) (35,746) 30,735 13,824
Cash and cash equivalents at beginning of period 19,881 55,627 24,892
11,068
-------------------- ----------- -----------
Cash and cash equivalents at end of period $ 15,483 $ 19,881 $ 55,627
$ 24,892
==================== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 137,454 $ 122,520 $ 199,762
$ 160,690
========= =========== ===========
Conversion of preferred stock $ -- $ -- $ 2,843
========= =========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
5866
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 19992000
NOTE 1. THE COMPANY
Redwood Trust, Inc. ("Redwood Trust") was incorporated in Maryland on April 11,
1994 and commenced operations on August 19, 1994. During 1997, Redwood Trust
formed Sequoia Mortgage Funding Corporation ("Sequoia"), a special-purpose
finance subsidiary. Redwood Trust acquired an equity interest in RWT Holdings,
Inc. ("Holdings"), a taxable affiliate of Redwood Trust, during the first
quarter of 1998. For financial reporting purposes, references to the "Company"
mean Redwood Trust, Sequoia, and Redwood Trust's equity interest in Holdings.
Redwood Trust, together with its affiliates, is a real estate finance company
specializing in the mortgage portfolio spread lending business. The Company's primary
activity is the acquisition,owning, financing, and management ofcredit enhancing high-quality jumbo
residential mortgage loans with funds raisednationwide. Redwood Trust also finances real estate
through long-term debt issuance.
The Company also acquires, finances,its investment portfolio (mortgage securities) and managesits commercial mortgage loansloan
portfolio. Redwood Trust's primary source of revenue is monthly payments made by
homeowners on their mortgages, and residential mortgage securities (collectively "Mortgage Assets"its primary expense is the cost of borrowed
funds. As Redwood Trust is structured as a Real Estate Investment Trust
("REIT")., the majority of net earnings are distributed to shareholders as
dividends.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Redwood Trust and
Sequoia. Substantially all of the assets of Sequoia, consisting primarily of
residential whole loans shown as part of the Residential Retained Loan
Portfolio, are pledged or subordinated to support long-term debt in the form of
collateralized mortgage bonds ("Long-Term Debt") and are not available for the
satisfaction of general claims of the Company. The Company's exposure to loss on
the assets pledged as collateral for Long-Term Debt is limited to its net equity
investment in Sequoia, as the Long-Term Debt is non-recourse to the Company. All
significant inter-companyintercompany balances and transactions with Sequoia have been
eliminated in the consolidation of the Company. Certain amounts for prior
periods have been reclassified to conform to the 19992000 presentation.
During March 1998, the Company acquired an equity interest in Holdings, which
originates and sells commercial mortgage loans. The Company owns all of the
preferred stock and has a non-voting, 99% economic interest in Holdings. As theThe
Company does not own the voting common stock of Holdings or control Holdings,accounts for its investment in Holdings is accounted for under the equity method. Under
this method, original equity investments in Holdings arewere recorded at cost and
adjusted by the Company's share of earnings or losses and decreased by dividends
received. On January 1, 2001, the Company purchased the common stock of
Holdings, and Holdings became a wholly-owned consolidated subsidiary of the
Company (See Note 14).
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of certain revenues and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair valueS presented in Notes 3, 7 and 10.
F-7
67
Reserve for Credit Losses. A reserve for credit losses is maintained at a level
deemed appropriate by management to provide for known losses, as well as
potential losses inherent in its Mortgage Assetresidential mortgage loan portfolio. The
reserve is
F-7
59 based upon management's assessment of various factors affecting its
Mortgage
Assets,residential mortgage loans, including current and projected economic conditions,
delinquency status, and credit protection. In determining the reserve for credit losses, the
Company's credit exposure is considered based on its credit risk position in the
mortgage pool. These estimates are reviewed
periodically and, as adjustments become necessary, they are reported in earnings
in the periods in which they become known. The reserve is increased by
provisions, which are charged to income from operations. When a loan or portions
of a loan are determined to be uncollectible, the portion deemed uncollectible
is charged against the reserve and subsequent recoveries, if any, are credited
to the reserve. The Company's actual credit losses may differ from those
estimates used to establish the reserve. Summary information regarding the
Reserve for Credit Losses is presented in Note 4.
Individual mortgage loans are considered impaired when, based on current
information and events, it is probable that a creditor will be unable to collect
all amounts due according to the contractual terms of the loan agreement. When a
loan is impaired, impairment is measured based upon the present value of the
expected future cash flows discounted at the loan's effective interest rate, the
loan's observable market price, or the fair value of the underlying collateral.
At December 31, 2000 and 1999, there were no impaired mortgage loans.
ADOPTION OF SFAS NO. 133
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, effective July 1, 1998. In accordance with the transition
provisions of SFAS No. 133, the Company recorded a net-of-tax
cumulative-effect-
typecumulative-effect-type transition adjustment of $10.1 million (loss) in earnings
to recognize at fair value the ineffective portion of all interest rate
agreements that were previously designated as part of a hedging relationship.
The Company, upon its adoption of SFAS No. 133, also reclassified $1.53$1.5 billion
of mortgage securities from available-for-sale to trading. This reclassification
resulted in an $11.9 million reclassification loss adjustment, which was
transferred from other comprehensive income to current earnings effective July
1, 1998. Under the provisions of SFAS No. 133, such a reclassification does not
call into question the Company's intent to hold current or future debt
securities to their maturity. Immediately afterUpon the adoption of SFAS No. 133 and the
reclassification, the Company elected to not seek hedge accounting for any of
the Company's interest rate agreements.
MORTGAGE ASSETS
The Company's Mortgage Assetsmortgage assets consist of mortgage loans and mortgage securities.securities
("Mortgage Assets"). Mortgage loans and securities pledged as collateral under
borrowing arrangements in which the secured party has the right by contract or
custom to sell or repledge the collateral have been classified as "pledged" in
the accompanying Consolidated Balance Sheets. Interest is recognized as revenue
when earned according to the terms of the loans and securities and when, in the
opinion of management, it is collectible. Discounts and premiums relating to
Mortgage Assets are amortized into interest income over the lives of the
Mortgage Assets using methods that approximate the effective yield method. Gains or losses on the sale of
Mortgage Assets are based on the specific identification method.
Mortgage Loans: Held-for-Sale
Effective September 30, 1998,Held-for-Investment
Mortgage loans classified as held-for-investment are carried at their unpaid
principal balance, adjusted for net unamortized premiums or discounts, and net
of the related allowance for credit losses. All of the Sequoia assets that are
pledged or subordinated to support the Long-Term Debt are classified as
held-for-investment. Commercial loans that the Company electedhas secured financing
through the term of the loan or otherwise has the intent and the ability to reclassify certain
short-funded mortgagehold
to maturity, are classified as held-for-investment.
Mortgage Loans: Held-for-Sale
Mortgage loans from held-for-investment to held-for-sale. These
mortgage loansheld-for-sale are carried at the lower of original cost or
aggregate market value ("LOCOM"). Realized and unrealized gains and losses on
these loans are recognized in "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations. Real estate owned
("REO") assets of the Company are also presented as "Mortgage loans
held-for-sale."
F-8
68
Some of the commercial mortgage loans purchasedheld by the Company for which securitization or
sale is contemplated are committed for sale
by the Company to Holdings, or a subsidiary of Holdings, under a Master Forward
Commitment Agreement.Agreements at December 31, 2000 and 1999. As the forward commitment
isagreements were entered into on the same date that the Company commitscommitted to
purchase the loans, the price under the forward commitment is the same as the
price that the Company paid for the mortgage loans, as established by the
external market. Fair value is therefore equal to the commitment price, which is
the carrying value of the mortgage loans. Accordingly, no gain or loss is
recognized on the subsequent sales of these mortgage loans to Holdings or
subsidiaries of Holdings.
Mortgage Loans: Held-for-Investment
Mortgage loans held-for-investment are carried at their unpaid principal balance
adjusted for net unamortized premiums or discounts, and net of the related
allowance for credit losses.
Mortgage Securities: Trading
Effective July 1, 1998, concurrent with the adoption of SFAS No. 133, the
Company elected to reclassify all of its mortgage securities with a rating of AA
or higher from available-for-sale to trading.
Mortgage securities classified as trading are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, such securities are recorded at their estimated fair market value.
F-8
60
Unrealized and realized gains and losses on these securities are recognized as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
Mortgage Securities: Available-for-Sale
Effective July 1, 1998, the Company reclassified all of its mortgage securities
rated AA or higher as trading investments, while all mortgage securities rated A
or lower remained in the available-for-sale classification. All mortgageMortgage securities classified as available-for-sale are carried at their
estimated fair value. Current period unrealized gains and losses are excluded
from net income and reported as a component of Other Comprehensive Income in
Stockholders' Equity with cumulative unrealized gains and losses classified as
Accumulated Other Comprehensive Income in Stockholders' Equity.
Unrealized losses on mortgage securities classified as available-for-sale that
are considered other-than-temporary, are recognized in income and the carrying
value of the mortgage security is adjusted. Other-than-temporary unrealized
losses are based on management's assessment of various factors affecting the
expected cash flow from the mortgage securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool
and a significant change in the prepayment characteristics of the underlying
collateral.
Interest income on mortgage securities available-for-sale is calculated using
the effective yield method based on projected cash flows over the life of the
security. Yields on each security vary as a function of credit results,
prepayment rates, and interest rates, and may also vary depending on the mix of
first, second and third loss positions the Company holds. As the Company
purchases these securities, a portion of the discount for each security is
designated as a credit reserve, with the remaining portion of the discount
designated to be amortized into income over the life of the security using the
effective yield method. If future credit losses exceed the Company's original
expectations, the Company may take a charge to write down the basis in the
security, and may adjust the yield over the remaining life of the security.
U.S. TREASURY SECURITIES
U.S. Treasury securities include notes issued by the U.S. Government. Interest
is recognized as revenue when earned according to the terms of the Treasury
securities. Discounts and premiums are amortized into interest income over the
life of the security using the effective yield method. U.S. Treasury securities
are classified as trading and, accordingly, are recorded at their estimated fair
market value with unrealized gains and losses recognized as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less.
At December 31, 1998, cash
equivalents included $25 million in reverse repurchase agreements.F-9
69
RESTRICTED CASH
Restricted cash of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, and cash pledged
as collateral on certain interest rate agreements.agreements, and cash held back from
borrowers until certain loan agreement requirements have been met. The
corresponding liability for cash held back from borrowers is reflected as a
component of "Accrued expenses and other liabilities" on the Consolidated
Balance Sheets.
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy that incorporatesmay
incorporate the use of derivative interest rate agreements to minimizefor a variety of
reasons, including minimizing significant unplanned fluctuations in earnings that aremay be
caused by interest-rate volatility. Interest rate agreements that are usedthe Company may use
as part of the Company'sits interest-rate risk management strategy include interest rate
options, swaps, options on swaps, futures contracts, options on futures
contracts, forward sales of fixed-rate Agency mortgage securities ("MBS"), and
options on forward purchases or sales of MBS'MBS (collectively "Interest Rate
Agreements"). On the date an Interest Rate Agreement is entered into, the
Company designates the interest rate agreement as (1) a hedge of the fair value
of a recognized asset or liability or of an unrecognized firm commitment ("fair
value" hedge), (2) a hedge of a forecasted transaction or of the variability of
cash flows to be received or paid related to a recognized asset or liability
("cash flow" hedge), or (3) held for trading ("trading" instruments). Since the
adoption of SFAS No. 133, the Company has elected to designate all of its
Interest Rate Agreements as trading instruments. Accordingly, such instruments
are recorded at their estimated fair market value with changes in their fair
value reported in current-period earnings in "Net unrealized and realized market
value gains (losses)" on the Consolidated Statements of Operations.
Net premiums on interest rate options are amortized as a component of net
interest income over the effective period of the interest rate option using the
effective interest method. The income and/or expense related to interest rate
options and swaps are recognized on an accrual basis.
F-9
61
Prior to the adoption of SFAS No. 133, Interest Rate Agreements that were
hedging mortgage securities available-for-sale were carried at fair value with
unrealized gains and losses reported as a component of Accumulated Other
Comprehensive Income in Stockholders' Equity, consistent with the reporting of
unrealized gains and losses on the related securities. Similarly, Interest Rate
Agreements that were used to hedge mortgage loans,DEBT
Short-Term Debt or Long-Term
Debt was carried at amortized cost. Realized gains and losses from the
settlement or early termination of Interest Rate Agreements were deferred and
amortized into net interest income over the remaining term of the original
Interest Rate Agreement, or, if shorter, over the remaining term of the
associated hedged asset or liability, as adjusted for estimated future principal
repayments.
DEBT
Short-Term and Long-Term Debt are carried at their unpaid principal
balances, net of any unamortized discount or premium and any unamortized
deferred bond issuance costs. The amortization of any discount or premium is
recognized as an adjustment to interest expense using the effective interest
method based on the maturity schedule of the related borrowings. Bond issuance
costs incurred in connection with the issuance of Long-Term Debt are deferred
and amortized over the estimated lives of the Long-Term Debt using the interest
method adjusted for the effects of prepayments.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code (the "Code") and the corresponding provisions of
State law. In order to qualify as a REIT, the Company must annually distribute
at least 95% of its taxable income to stockholders and meet certain other
requirements. If these requirements are met, the Company generally will not be
subject to Federal or stateState income taxation at the corporate level with respect
to the taxable income it distributes to its stockholders. Because the Company
believes it meets the REIT requirements and also intends to distribute all of
its taxable income, no provision has been made for income taxes in the
accompanying consolidated financial statements.
Under the Code, a dividend declared by a REIT in October, November or December
of a calendar year and payable to shareholders of record as of a specified date
in such month, will be deemed to have been paid by the Company and received by
the shareholders on the last day of that calendar year, provided the dividend is
actually paid before February 1st of the following calendar year, and provided
that the REIT has any remaining undistributed taxable income on the record date.
Therefore, the dividends declared in December 19992000 which were paid in January
20002001 are considered taxable income to shareholdersstockholders in 1999,2000, the year declared.
All 2000 dividends were ordinary income to the Company's preferred and common
stockholders.
F-10
70
NET INCOME (LOSS) PER SHARE
Net income (loss) per share for the years ended December 31, 1999, 1998, and
1997 is shown in accordance with SFAS No. 128, Earnings Per Share.
Basic net income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted net income (loss) per share is computed
by dividing the net income (loss) available to common stockholders by the
weighted average number of common shares and common equivalent shares
outstanding during the period. The common equivalent shares are calculated using
the treasury stock method, which assumes that all dilutive common stock
equivalents are exercised and the funds generated by the exercise are used to
buy back outstanding common stock at the average market price during the
reporting period. Due to the net loss available to common stockholders for both
the years ended December 31, 1999 and 1998, the addition of potential dilutive
shares is anti-dilutive and therefore, the basic and diluted net loss per share
are the same.
F-10
62
The following tables provide reconciliations of the numerators and denominators
of the basic and diluted net income (loss) per share computations.
(IN THOUSANDS, EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31,
2000 1999 1998
1997
----------------------- ------------ ------------
NUMERATOR:
Numerator for basic and diluted earnings per share--
Net income (loss) before preferred dividend and
change in accounting principle $ 18,934 $ 1,728 $ (27,310) $ 27,561
Cash dividends on Class B preferred stock (2,724) (2,741) (2,747)
(2,815)
----------------------- ------------ ------------
Net income (loss) before change in accounting principle 16,210 (1,013) (30,057) 24,746
Cumulative transition effect of adopting SFAS No. 133 -- -- (10,061)
--
----------------------- ------------ ------------
Basic and Diluted EPS - Net income (loss)
available to common stockholders $ 16,210 $ (1,013) $ (40,118)
$ 24,746
======================= ============ ============
DENOMINATOR:
Denominator for basic earnings (loss) per share--
Weighted average number of common shares
outstanding during the period 8,793,487 9,768,345 13,199,819 13,334,163
Net effect of dilutive stock options 108,582 -- --
346,247
----------------------- ------------ ------------
Denominator for diluted earnings (loss) per share-- 8,902,069 9,768,345 13,199,819
13,680,410
======================= ============ ============
BASIC EARNINGS (LOSS) PER SHARE:
Net income (loss) before change in accounting principle $ 1.84 $ (0.10) $ (2.28) $ 1.86
Cumulative transition effect of adopting SFAS No. 133 -- -- (0.76)
--
----------------------- ------------ ------------
Net income (loss) per share $ 1.84 $ (0.10) $ (3.04)
$ 1.86
======================= ============ ============
DILUTED EARNINGS (LOSS) PER SHARE:
Net income (loss) before change in accounting principle $ 1.82 $ (0.10) $ (2.28) $ 1.81
Cumulative transition effect of adopting SFAS No. 133 -- -- (0.76)
--
----------------------- ------------ ------------
Net income (loss) per share $ 1.82 $ (0.10) $ (3.04)
$ 1.81
======================= ============ ============
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires the Company to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. In accordance with SFAS No. 130, currentCurrent period unrealized gains and losses on assets available-for-sale are
reported as a component of Comprehensive Income on the Consolidated Statements
of Stockholders' Equity with cumulative unrealized gains and losses classified
as Accumulated Other Comprehensive Income in Stockholders' Equity. At December
31, 19992000 and 1998,1999, the only component of Accumulated Other Comprehensive Income
was net unrealized gains and losses on assets available-for-sale.
F-11
6371
RECENT ACCOUNTING PRONOUNCEMENTS
During March 2000, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation -- an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 by expanding upon a number of
issues not specifically addressed in APB Opinion No. 25, such as the definition
of an employee and the accounting for modifications to a previously fixed stock
option award. FIN 44 was effective July 1, 2000. There was no material impact on
the operating results of the Company upon the adoption of FIN 44.
In September 2000, FASB issued Statement of Financial Accounting Standards
("FAS") No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguisments of Liabilities. FAS No. 140 replaces FAS No. 125, revises the
standards for accounting for securitizations and other transfers of financial
assets, and requires certain new disclosures, while carrying over most of FAS
No. 125's provisions. FAS No. 140 is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March 31,
2001. The Company adopted the disclosure requirements of FAS No. 140 effective
December 31, 2000.
During 1999, the Emerging Issues Task Force ("EITF") issued EITF 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets. EITF 99-20 establishes new
income and impairment recognition standards for interests in certain securitized
assets. Under the provisions of EITF 99-20, if the discounted value of probable
future cash flows deteriorates from original assumptions, the securitized
interest should be marked-to-market through the income statement. Only negative
mark-to-market adjustments are allowed under EITF 99-20. As the Company's
accounting for credit-enhancement interests and certain other assets will be
affected by EITF 99-20, the Company is conducting an ongoing review of these
assets with respect to the provisions of EITF 99-20. Upon adoption of EITF
99-20, the Company estimates that approximately $2.4 million of its market
valuation adjustments on its credit-enhancement interests that have been
recognized as a component of Accumulated Other Comprehensive Income in
stockholders' equity, may need to be taken as a charge in the Statement of
Operations. Since this is a reclassification of declines in market values that
have already been recognized in the Company's balance sheet and stockholders'
equity accounts, there will be no change in book value upon adoption. The
Company is considering adopting EITF 99-20 effective January 1, 2001; if it does
so, first quarter 2001 results would be affected. Initial mark-to-market
adjustments made at the time of adoption will be recognized as a cumulative
effect of a change in accounting principle. Any subsequent income statement
adjustments under the provisions of EITF 99-20 will be recognized as
mark-to-market adjustments under "Realized and unrealized gain or loss on
assets."
NOTE 3. MORTGAGE ASSETS
At December 31, 19992000 and 1998,1999, investments in Mortgage Assets consisted of
interests in adjustable-rate, hybrid or fixed-rate mortgage loans on residential
and commercial properties. The hybrid mortgages have an initial fixed coupon
rate for three to ten years followed by annual adjustments. Agency mortgage
securities ("Agency Securities") represent securitized interests in pools of
adjustable-rate mortgages from the Federal Home Loan Mortgage Corporation and
the Federal National Mortgage Association. The Agency Securities are guaranteed
as to principal and interest by these United States government-sponsored
entities. The original
maturity of the majority of the Mortgage Assets is thirty years; the actual
maturity is subject to change based on the prepayments of the underlying
mortgage loans.
At December 31, 19992000 and 1998,1999, the annualized effective yield after taking into
account the amortization expense due to prepayments on the Mortgage Assets was
7.00%8.01% and 6.95%7.00%, respectively, based on the reported cost of the assets. At
December 31, 2000, 79% of the Mortgage Assets owned by the Company were
adjustable-rate mortgages, 17% were hybrid mortgages, and 4% were fixed-rate
mortgages. At December 31, 1999, 81% of the Mortgage Assets owned by the Company
were adjustable-rate mortgages, 17% were hybrid mortgages, and 2% were
fixed-rate mortgages. At December 31, 1998, 76% of the Mortgage Assets owned by the Company
were adjustable-rate mortgages, 23% were hybrid mortgages,2000 and 1% were
fixed-rate mortgages. At December 31, 1999, and 1998, the coupons on 61%59% and 64%61%
of the adjustable-rate Mortgage Assets were limited by periodic caps (generally
interest rate adjustments are limited to no more than 1% every six months or 2%
every year), respectively. The majority of the coupons on the adjustable-rate
and hybrid Mortgage Assets owned by the Company are limited by lifetime caps. At
December 31, 19992000 and 1998,1999, the weighted average lifetime cap on the
adjustable-rate Mortgage Assets was 11.64%11.43% and 11.48%11.64%, respectively.
F-12
72
At December 31, 19992000 and 1998,1999, Mortgage Assets consisted of the following:
MORTGAGE LOANS:NET INVESTMENT IN RESIDENTIAL CREDIT ENHANCEMENT INTERESTS
DECEMBER 31, DECEMBER 31,
2000 1999
(IN THOUSANDS) MORTGAGE MORTGAGE
SECURITIES SECURITIES
AVAILABLE-FOR-SALE AVAILABLE-FOR-SALE
------------------ ------------------
Current Face $ 124,878 $ 48,620
Unamortized Discount (43,935) (18,273)
Unamortized Premium -- --
--------- ---------
Amortized Cost 80,943 30,347
Gross Unrealized Gains 2,646 166
Gross Unrealized Losses (2,825) (3,514)
--------- ---------
Carrying Value $ 80,764 $ 26,999
========= =========
During the year ended December 31, 2000 and 1998, the Company sold mortgage
securities classified as available-for-sale for proceeds of $2.9 million and
$9.3 million, respectively, resulting in a net gain of $0.2 million in 2000, and
no gain recognized in 1998. No such sales were made during 1999. No write-downs
of available-for-sale mortgage securities occurred during the years ended
December 31, 2000 and 1999. During the year ended December 31, 1998, the Company
recognized a $0.7 million loss on the write-down of certain mortgage securities
available-for-sale. The gains and losses on the sales and write-downs of
mortgage securities available-for-sale are reflected as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
RESIDENTIAL RETAINED LOAN PORTFOLIO
DECEMBER 31, 2000 DECEMBER 31, 1999
(IN THOUSANDS) HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
(IN THOUSANDS)
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
--------- ------------ ----------- --------- ----------------------- ----------- ----------- ----------- -----------
Current Face $ 6,784 $ 1,115,386 $ 1,122,170 $ 412,456 $ 960,928 $ 1,373,384
$ 266,306 $ 1,118,375 $ 1,384,681
Unamortized Discount (126) -- (126) (305) -- (305)
(1,062)Unamortized Premium -- (1,062)
Unamortized Premium13,767 13,767 3,729 12,906 16,635
670 16,709 17,379
--------- --------- ----------- -------------------- ----------- ----------- ----------- -----------
Amortized Cost 6,658 1,129,153 1,135,811 415,880 973,834 1,389,714 265,914 1,135,084 1,400,998
Reserve for Credit Losses -- (5,125) (5,125)(4,814) (4,814) -- (3,784) (3,784)
--------- ---------(4,125) (4,125)
----------- -------------------- ----------- ----------- ----------- -----------
Carrying Value $ 6,658 $ 1,124,339 $ 1,130,997 $ 415,880 $ 968,709969,709 $ 1,384,589 $ 265,914 $ 1,131,300 $ 1,397,214
========= =========1,385,589
=========== ==================== =========== =========== =========== ===========
The Company recognized losses of $0.1 million during the year ended December 31,
2000, gains of $0.3 million during the year ended December 31, 1999, and losses
of $6.5 million during the year ended December 31, 1998 as a result of LOCOM
adjustments on residential mortgage loans held-for-sale. Also during the years
ended December 31, 2000, 1999, and 1998, the Company sold residential mortgage
loans held-for-sale for proceeds of $397.6 million, $103.0 million, and $688.9
million, resultingrespectively. These sales resulted in no net gain or loss recognized in
2000, and net gains of $0.1 million, and $4.6 million in 1999 and 1998,
respectively. There
were no mortgage loans classified as held-for-sale during the year ended
December 31, 1997. The LOCOM adjustments and net gains on sales are reflected as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
There were no sales of residential mortgage loans held-for-investment for the
years ended December 31, 19992000 and 1997.1999. During the year ended December 31, 1998,
the Company sold held-for-investment residential mortgage loans with an
amortized cost of $370.1 million for proceeds of $369.1 million. The net
realized loss of $1 million is reflected as a component of "Net unrealized and
realized market value gains (losses)" on the Consolidated Statements of
Operations.
During the second quarter of 1999, as a result of the call and subsequent
restructuring of a portion of the Long-Term Debt, the Company reclassified $154
million of residential mortgage loans held-for-sale to residential mortgage
loans held-for-investment (see Note 9).
F-12F-13
64
MORTGAGE LOANS: COMMERCIAL73
INVESTMENT PORTFOLIO
DECEMBER 31, 1999 DECEMBER 31, 1998
(IN THOUSANDS) HELD-FOR-SALE HELD-FOR-SALE
----------------- -----------------
Current Face $8,450 $8,324
Unamortized Discount (13) (37)
------ ------
Carrying Value $8,437 $8,287
====== ======
During the year ended December 31, 1999, the Company sold commercial mortgage
loans to Redwood Commercial Funding ("RCF"), a subsidiary of Holdings, for
proceeds of $50.3 million. To date, pursuant to the Master Forward Commitment
Agreement, all commercial mortgage loans purchased by the Company are sold to
RCF at the same price for which the Company acquires the commercial mortgage
loans (see Note 12). Accordingly, there were no LOCOM adjustments or gains on
sales related to commercial mortgage loans during the years ended December 31,
1999 and 1998.
MORTGAGE SECURITIES: RESIDENTIAL
DECEMBER 31,2000 DECEMBER 31, 1999
1998MORTGAGE MORTGAGE
(IN THOUSANDS) MORTGAGE SECURITIES MORTGAGE SECURITIES
SECURITIES AVAILABLE- SECURITIES AVAILABLE-
(IN THOUSANDS)
TRADING FOR-SALE TOTAL TRADING FOR-SALE TOTAL
--------- --------- --------- ----------- ------------ -------------------- --------- ---------
Current Face $ 938,943751,449 $ 48,6275,500 $ 987,570756,949 $ 1,250,749934,351 -- $ 17,281 $ 1,268,030934,351
Unamortized Discount (388) (427) (815) (3,548) (16,444) (19,992) (3,089) (8,015) (11,104)-- (3,548)
Unamortized Premium 8,551 -- 8,551 10,978 -- 10,978
9,995--------- --------- --------- --------- --------- ---------
Unamortized Cost 759,612 5,073 764,685 941,781 -- 9,995
--------- -------- --------- ----------- -------- -----------
Amortized Cost 946,373 32,183 978,556 1,257,655 9,266 1,266,921
Reserve for Credit Losses -- (829) (829) -- (1,189) (1,189)941,781
Gross Unrealized Gains -- 166 166105 105 -- 313 313-- --
Gross Unrealized Losses -- (3,514) (3,514)(15) (15) -- (683) (683)-- --
--------- -------- --------- ----------- -------- -------------------- --------- --------- ---------
Carrying Value $ 946,373759,612 $ 28,0065,163 $ 974,379764,775 $ 1,257,655941,781 -- $ 7,707 $ 1,265,362941,781
========= ======== ========= =========== ======== ==================== ========= ========= =========
Agency $ 580,958521,204 -- $ 580,958521,204 $ 617,423576,980 -- $ 617,423576,980
Non-Agency 365,415 $ 28,006 393,421 640,232 $ 7,707 647,939238,408 5,163 243,571 364,801 -- 364,801
--------- -------- --------- ----------- -------- -------------------- --------- --------- ---------
Carrying Value $ 946,373759,612 $ 28,0065,163 $ 974,379764,775 $ 1,257,655941,781 -- $ 7,707 $ 1,265,362941,781
========= ======== ========= =========== ======== ==================== ========= ========= =========
For both of the yearyears ended December 31, 2000 and 1999, the Company recognized
a market value gaingains of $1.2 million on mortgage securities classified as tradingtrading.
During the years ended December 31, 2000 and 1999, the Company sold mortgage
securities classified as trading for proceeds of $205.5 million and $7.7
million.million, respectively. During the year ended December 31, 1998, the Company
elected to reclassify alla majority of its short-funded mortgage securities from
available-for-sale to trading (see Note 2). As a result of this
reclassification, the Company recognized a reclassification loss of $11.9
million, which was transferred from other comprehensive income to current
earnings, and a market value loss of $17.5 million on mortgage securities
classified as trading. The market value adjustments are reflected as a component
of "Net unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
No sales or write-downs of available-for-sale mortgage securities occurred
during the year ended December 31, 1999.COMMERCIAL RETAINED LOAN PORTFOLIO
DECEMBER 31, 2000 DECEMBER 31, 1999
(IN THOUSANDS) HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
-------- -------- -------- -------- -------- --------
Current Face $ 34,275 $ 23,425 $ 57,700 $ 8,450 $ -- $ 8,450
Unamortized Discount -- (531) (531) (13) -- (13)
======== ======== ======== ======== ======== ========
Carrying Value $ 34,275 $ 22,894 $ 57,169 $ 8,437 $ -- $ 8,437
======== ======== ======== ======== ======== ========
During the years ended December 31, 19982000 and 1997,1999, the Company sold commercial
mortgage securities available-for-saleloans to Redwood Commercial Funding ("RCF"), a subsidiary of Holdings,
for proceeds of $9.3$57.8 million and $88.3 million, resulting in net gains of $0 and
$0.5$50.3 million, respectively. ThePursuant to
Master Forward Commitment Agreements, all commercial mortgage loans purchased by
the Company also recognized a $0.7 million lossare sold to RCF at the same price for which the Company acquires the
commercial mortgage loans (see Note 12). Accordingly, there were no LOCOM
adjustments or gains on the write-down of certainsales related to commercial mortgage securities available-for-saleloans during the
yearyears ended December 31, 1998. The gains2000 and losses on the sales and write-downs of
mortgage securities available-for-sale are reflected as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
F-131999.
F-14
6574
NOTE 4. RESERVE FOR CREDIT LOSSES
The Reserve for Credit Losses on Residential Mortgage Loans Held-For-Investment
is reflected as a component of Mortgage Assets on the Consolidated Balance
Sheets. The following table summarizes the Reserve for Credit Losses on
Residential Mortgage Loans Held-For-Investment activity:
YEARS ENDED DECEMBER 31,
(IN THOUSANDS) 2000 1999 1998
1997
------ ------- ------------- -------
Balance at beginning of year $4,973 $ 4,931 $2,1804,125 $ 2,784 $ 1,855
Provision for credit losses 731 1,346 1,120
2,930
Charge-offs (365) (1,078) (179)
------(42) (5) (191)
------- ------------- -------
Balance at end of year $5,954 $4,973 $4,931
======$ 4,814 $ 4,125 $ 2,784
======= ============= =======
NOTE 5. U.S. TREASURY SECURITIES
The Company did not hold any U.S. Treasury securities at December 31, 2000 or
1999. At December 31, 1998, the Company owned $45 million face value of U.S.
Treasury securities at a carrying value of $48 million. The Company did not hold
any U.S. Treasury securities during 2000. For the years ended December 31, 1999
and 1998, the Company recognized market value losses of $3.3 million and market
value gains of $0.1 million on U.S. Treasury securities, respectively. During
the year ended December 31, 1999, the Company sold U.S. Treasury securities for
proceeds of $90.5 million. The market value adjustments are reflected as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
NOTE 6. COLLATERAL FOR LONG-TERM DEBT
The Company has pledged collateral in order to secure theas security for Long-Term Debt issued in the form of
collateralized mortgage bonds ("Bond Collateral"). This Bond Collateral consists
primarily of adjustable-rate and hybrid, conventional, 30-year mortgage loans
secured by first liens on one- to four-family residential properties. All Bond
Collateral is pledged to secure repayment of the related Long-Term Debt
obligation. All principal and interest (less servicing and related fees) on the
Bond Collateral is remitted to a trustee and is available for payment on the
Long-Term Debt obligation. The Company's exposure to loss on the Bond Collateral
is limited to its net investment, as the Long-Term Debt is non-recourse to the
Company.
During 1999, as a result of the call and subsequent restructuring of a portion
of the Long-Term Debt, the Company reclassified $154 million of mortgage loans
held-for-sale to mortgage loans held-for-investment (see Note 9).
The components of the Bond Collateral are summarized as follows:
(IN THOUSANDS) DECEMBER 31, DECEMBER 31,
(IN THOUSANDS)2000 1999
1998
------------ ----------------------- -----------
Mortgage loans
Residential: held-for-sale $ --315 $ 197,646174
Residential: held-for-investment, net 1,124,339 968,709 1,131,300
Restricted cash 4,791 12,8573,729 4,783
Accrued interest receivable 7,010 5,633
7,707
-------- ----------
$979,133 $1,349,510
========----------- -----------
$1,135,393 $ 979,299
========== ==========
For presentation purposes, the various components of the Bond Collateral
summarized above are reflected in their corresponding line items on the
Consolidated Balance Sheets.
F-14F-15
6675
NOTE 7. INTEREST RATE AGREEMENTS
At December 31, 19992000 and 1998,1999, all of the Company's Interest Rate Agreements
were classified as trading, and therefore, reported at fair value.
ForDuring the yearyears ended December 31, 2000 and 1999, the Company recognized anet
market value gainlosses of $3.4 million and net market value gains of $2.0 million
on Interest Rate Agreements classified as trading and sold
Interest Rate Agreements classified as trading for proceeds of $1.4 million.trading. The market value gains are
reflected as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
During the year ended December 31, 1998, as a result of adopting SFAS No. 133,
the Company recorded a net-of-tax cumulative-effect-type transition adjustment
of $10.1 million loss in earnings to recognize at fair value the ineffective
portion of Interest Rate Agreements that were previously designated as part of a
hedging relationship (see Note 2). This loss is reflected on the Consolidated
Statements of Operations as "Cumulative Transition Effect of Adopting SFAS No.
133." Approximately $7.6 million of this transition adjustment was transferred
from other comprehensive income to current earnings. Additionally, during the
year ended December 31, 1998, the Company recognized a net market value loss of
$5.9 million on Interest Rate Agreements classified as trading. This loss is
reflected as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
The following table summarizes the aggregate notional amounts of all of the
Company's Interest Rate Agreements as well as the credit exposure related to
these instruments.
NOTIONAL AMOUNTS CREDIT EXPOSURE(a)
(IN THOUSANDS) DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1998 1999 1998
------------ ------------ ----------- ------------
Interest Rate Options Purchased $2,960,900 $3,569,200 -- --
Interest Rate Swaps 250,000 440,000 $2,632 $8,673
Interest Rate Futures and Forwards 630,000 -- 593 --
---------- ---------- ------ ------
Total $3,840,900 $4,009,200 $3,225 $8,673
========== ========== ====== ======
(a) ReflectsThe credit exposure reflects the fair market value of all
cash and collateral of the Company held by counterparties.
NOTIONAL AMOUNTS CREDIT EXPOSURE
(IN THOUSANDS) DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2000 1999 2000 1999
----------- ----------- ----------- -----------
Interest Rate Options
Purchased $1,490,300 $2,960,900 -- --
Interest Rate Swaps 5,000 250,000 $ 2,814 $ 2,632
Interest Rate Futures and 506,600 630,000 948 593
Forwards
---------- ---------- ----------- -----------
Total $2,001,900 $3,840,900 $ 3,762 $ 3,225
========== ========== ========== ==========
Interest Rate Options purchased (sold), which may include caps, floors, call and
put corridors, options on futures, options on MBS forwards, and swaption collars
(collectively, "Options"), are agreements which transfer, modify or reduce
interest rate risk in exchange for the payment (receipt) of a premium when the
contract is initiated. Purchased interest rate cap agreements provide cash flows
to the Company to the extent that a specific interest rate index exceeds a fixed
rate. Conversely, purchased interest rate floor agreements produce cash flows to
the Company to the extent that the referenced interest rate index falls below
the agreed upon fixed rate. Purchased call (put) corridors will cause the
Company to incur a gain to the extent that the yield of the specified index is
below (above) the strike rate at the time of the option expiration. The maximum
gain or loss on a purchased call (put) corridor is equal to the up-front
premium. Call (put) corridors that are sold will cause the Company to incur a
loss to the extent that the yield of the specified index is below (above) the
strike rate at the time of the option expiration. Such loss, if any, will, in
part, belosses are partially
offset by upfrontthe up front premium received. The maximum gain or loss on a call
(put) corridor sold is determined at the time of the transaction by establishing
a minimum (maximum) index rate. The Company will receive cash on the purchased
options on futures/forwards if the futures/forward price exceeds (is below) the
call (put) option strike price at the expiration of the option. For the written
options on futures/forwards, the Company receives an up-front premium for
selling the option, however, the Company will incur a loss on the written option
if the futures/forward price exceeds (is below) the call (put) option strike
price at the expiration of the option. Purchased receiver (payor) swaption
collars will cause the Company to incur a gain (loss) should the index rate be
below (above) the strike rate as of the expiration date. The maximum gain or
loss on a receiver (payor) swaption is established at the time of the
transaction by establishing a minimum F-15
67
(maximum) index rate. The Company's credit
risk on the purchased Options is limited to the carrying value of the Options
agreements. The credit risk on options on futures is limited due to the fact
that the exchange and its members are required to satisfy the obligations of any
member that fails to perform.
F-16
76
Interest Rate Swaps ("Swaps") are agreements in which a series of interest rate
flows are exchanged over a prescribed period. The notional amount on which the
interest payments are based is not exchanged. Most of the Company's Swaps
involve the exchange of one floating interest payment for another floating
interest payment based on a different index. Most of the Swaps require that the
Company provide collateral, such as mortgage securities, to the counterparty.
Should the counterparty fail to return the collateral, the Company would be at
risk for the fair market value of that asset.
Interest Rate Futures and Forwards ("Futures and Forwards") are contracts for
the purchase or sale of securities or cash in which the seller (buyer) agrees to
deliver (purchase) on a specified future date, a specified instrument (or the
cash equivalent), at a specified price or yield. Under these agreements, if the
Company has sold (bought) the futures/forwards, the Company will generally
receive additional cash flows if interest rates rise (fall). Conversely, the
Company will generally pay additional cash flows if interest rates fall (rise).
The credit risk inherent in futures and forwards arises from the potential
inability of counterparties to meet the terms of their contracts, however, the
credit risk on futures is limited by the requirement that the exchange and its
members make good on obligations of any member that fails to perform.
In general, the Company has incurredincurs credit risk to the extent that the counterparties
to the Interest Rate Agreements do not perform their obligations under the
Interest Rate Agreements. If one of the counterparties does not perform, the
Company would not receive the cash to which it would otherwise be entitled under
the Interest Rate Agreement. In order to mitigate this risk, the Company has
only entered into Interest Rate Agreements that are either a) transacted on a
national exchange or b) transacted with counterparties that are either i)
designated by the U.S. Department of the Treasury as a "primary government
dealer", ii) affiliates of "primary government dealers", or iii) rated BBB or
higher. Furthermore, the Company has entered into Interest Rate Agreements with
several different counterparties in order to diversify the credit risk exposure.
NOTE 8. SHORT-TERM DEBT
The Company has entered into repurchase agreements, bank borrowings, and other
forms of collateralized short-term borrowings (collectively, "Short-Term Debt")
to finance acquisitions of a portion of its Mortgage Assets. This Short-Term
Debt is collateralized by a portion of the Company's Mortgage Assets.
At December 31, 2000, the Company had $756 million of Short-Term Debt
outstanding with a weighted-average borrowing rate of 6.85% and a
weighted-average remaining maturity of 122 days. This debt was collateralized
with $778 million of Mortgage Assets. At December 31, 1999, the Company had $1.3
billion of Short-Term Debt outstanding with a weighted-average borrowing rate of
6.22% and a weighted-average remaining maturity of 96 days. This debt was
collateralized with $1.3 billion of Mortgage Assets.
At December 31, 1998, the Company had $1.3
billion of Short-Term Debt outstanding with a weighted-average borrowing rate of
5.62%2000 and a weighted-average remaining maturity of 48 days. This debt was
collateralized with $1.3 billion of Mortgage Assets and U.S. Treasury
securities.
At December 31, 1999, and 1998, the Short-Term Debt had the following remaining
maturities:
(IN THOUSANDS) DECEMBER 31, DECEMBER 31,
2000 1999
1998
------------ ----------------------- -----------
Within 30 days $ 100,885 $ 163,394
$ 428,292
3031 to 90 days 268,867 385,729 714,114
Over 90 days 386,470 704,442
115,164
---------- ----------========== ==========
Total Short-Term Debt $ 756,222 $1,253,565 $1,257,570
========== ==========
For the years ended December 31, 2000, 1999 1998 and 1997,1998, the average balance of
Short-Term Debt was $0.9 billion, $1.0 billion $2.0 billion and $2.4$2.0 billion with a
weighted-average interest cost of 5.35%6.57%, 5.81%5.35%, and 5.86%5.81%,
F-16
68 respectively. The
maximum balance outstanding during both of the years ended December 31, 1999, 1998,2000 and
19971999, was $1.3 billion. The maximum balance outstanding during the year ended
December 31, 1998 was $2.5 billion. The Company met all of it debt covenants for
its short-term borrowing arrangements and credit facilities during the years
ended December 31, 2000 and 1999.
F-17
77
In addition to the committed facilities listed below, the Company has
uncommitted facilities with credit lines in excess of $4 billion $2.5 billion,at December 31,
2000. It is the intention of the Company's management to renew committed and
$3.1 billion,
respectively.uncommitted facilities, if and as needed.
In July 1999,March 2000, the Company entered into a one-year, $90$50 million committed revolving
mortgage warehousing credit facility with two banks. At the Company's request,
this line was reduced to $20 million in December 1999.facility. The facility is primarily intended to finance newly
originated residentialcommercial mortgage loans. At December 31,
1999, the Company had outstanding borrowings of $6.4 million under this
facility, which are reflected as a component of Short-Term Debt. Holdings may borrow under this facility as
a co-borrower. In September 2000, this facility was extended through August 2001
and was increased to $70 million. At December 31, 1999,2000, the Company and Holdings
had no outstanding borrowings under this facility of $16.5 million and $18.2 million,
respectively. In addition, a portion of this facility allows for loans to be
financed to the maturity of the loan, which may extend beyond the expiration
date of the facility. Borrowings under this facility bear interest based on a
specified margin over the London Interbank Offered Rate ("LIBOR"). At December
31, 1999,2000, the weighted-averageweighted average borrowing rate under this facility was 6.87%8.57%.
The Company and Holdings wereThis committed facility expires in compliance with all
material representations, warranties, and covenants under this credit facility
at December 31, 1999, or had obtained the appropriate waivers.August 2001.
In July 1999,2000, the Company entered intorenewed for one year, a one-year, $350$30 million committed master
loan and security agreement with a Wall Street firm.Firm. The facility is primarily intended to
finance newly originated commercial and residential mortgage loans. At
December 31, 1999, the Company had outstanding borrowings of $119.9 million
underIn September 2000, this
facility which are reflected as a component of Short-Term Debt.was increased to $50 million. Holdings may borrow under this facility
as a co-borrower. At December 31, 1999,
Holdings2000, the Company had outstanding borrowings of $19.8 million under this
facility.facility of $26.7 million. Holdings did not have borrowings under this facility
at December 31, 2000. Borrowings under this facility bear interest based on a
specified margin over LIBOR. At December 31, 2000, the weighted average
borrowing rate under this facility was 8.23%. This committed facility expires in
July 2001.
In September 2000, the Company entered into two separate $30 million committed
master repurchase agreements with a bank and a Wall Street Firm. These
facilities are intended to finance residential mortgage-backed securities with
lower than investment grade ratings. At December 31, 2000, the Company had
borrowings under these facilities of $22.7 million. Borrowings under these
facilities bear interest based on a specified margin over LIBOR. At December 31,
2000, the weighted average borrowing rate under these facilities was 7.43%.
These committed facilities expire in September 2001.
In October 2000, the Company entered into a $20 million committed master
repurchase agreement with a Wall Street Firm. This facility is intended to
finance residential mortgage-backed securities with lower than investment grade
ratings. At December 31, 2000, the Company had borrowings under this facility of
$3.6 million. Borrowings under this facility bear interest based on a specified
margin over LIBOR. At December 31, 2000, the weighted average borrowing rate
under this facility was 7.56%. This committed facility expires in October 2001.
In July 1999, the Company entered into a one-year, $90 million committed
revolving mortgage warehousing credit facility with two banks. At the Company's
request, this line was reduced to $20 million in December 1999. This facility
expired in February 2000. The facility was primarily intended to finance newly
originated residential mortgage loans. Holdings was a co-borrower under this
facility. At December 31, 1999, the Company had borrowings under this facility
of $6.4 million. Holdings did not have borrowings under this facility at
December 31, 1999. Borrowings under this facility bore interest based on a
specified margin over LIBOR. At December 31, 1999, the weighted-average
borrowing rate under this facility was 6.87%.
F-18
78
In July 1999, the Company entered into a one-year, $350 million committed master
loan and security agreement with a Wall Street firm. This facility expired in
June 2000, but was renewed as a one-year, $30 million committed commercial loan
facility in July 2000 as previously discussed above. The Company renewed a
residential portion of this facility for one year in June 2000 on an uncommitted
basis. The $350 million committed facility entered into in July 1999, was
primarily intended to finance newly originated commercial and residential
mortgage loans. Holdings was a co-borrower under this facility. At December 31,
1999, the Company and Holdings had borrowings under this facility of $119.9
million and $19.8 million, respectively. Borrowings under this facility bore
interest based on a specified margin over LIBOR. At December 31, 1999, the
weighted-average borrowing rate under this facility was 5.72%.
The Company and Holdings were in compliance with all
material representations, warranties, and covenants under this credit facility
at December 31, 1999.
NOTE 9. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured by a
pledge of Bond
Collateral. As required by the indentures relating to the Long-Term Debt, the
Bond Collateral is held in the custody of trustees. The trustees collect
principal and interest payments on the Bond Collateral and make corresponding
principal and interest payments on the Long-Term Debt. The obligations under the
Long-Term Debt are payable solely from the Bond Collateral and are otherwise
non-recourse to the Company.
Each series of Long-Term Debt consists of various classes of bonds at variable
rates of interest. The maturity of each class is directly affected by the rate
of principal prepayments on the related Bond Collateral. Each series is also
subject to redemption according to the specific terms of the respective
indentures. As a result, the actual maturity of any class of a Long-Term Debt
series is likely to occur earlier than its stated maturity.
During the second quarter of 1999, the Company exercised its right to call the
Long-Term Debt of Sequoia Mortgage Trust 1 ("Sequoia 1"), a series of debt
issued by Sequoia. This Long-Term Debt was called on May 4, 1999. In conjunction
with this call, the Company restructured and contributed the Sequoia 1 debt to
Sequoia Mortgage Trust 1A ("Sequoia 1A"), a newly formed trust, and Sequoia 1A
issued Long-Term Debt collateralized by Sequoia 1 debt. As a result, the $154
million of Bond Collateral in the form of mortgage loans held-for-sale was
reclassified to mortgage loans held-for-investment.
For the years ended December 31, 2000, 1999, 1998, and 1997,1998, the average effective
interest cost for Long-Term Debt, as adjusted for the amortization of bond
premium, deferred bond issuance costs, and other related expenses, was 6.03%6.71%,
6.38%6.03%, and 6.31%6.38%, respectively. At December 31, 19992000 and December 31, 1998,1999, accrued interest
payable on Long-Term Debt was $3.0$3.1 million and $4.2$3.0 million, respectively, and
is reflected as a component of Accrued Interest Payable on the Consolidated
Balance Sheets. F-17
69For the years ended December 31, 2000, 1999, and 1998, the
average balance of Long-Term Debt was $1.1 billion for both 2000 and 1999, and
$1.3 billion for 1998.
The components of the Long-Term Debt at December 31, 19992000 and 19981999 along with
selected other information are summarized below:
(IN THOUSANDS) DECEMBER 31, DECEMBER 31,
2000 1999
1998
------------ ----------------------- -----------
Long-Term Debt $944,225 $1,303,405$ 1,095,909 $ 944,225
Unamortized premium on Long-Term Debt 3,045 3,881 5,783
Deferred bond issuance costs (3,119) (2,836)
(3,628)
-------- --------------------- -----------
Total Long-Term Debt $945,270 $1,305,560
======== ==========$ 1,095,835 $ 945,270
=========== ===========
Range of weighted-average interest rates, by series6.35% to 7.20% 6.21% to 6.88%
5.75% to 6.55%series
Stated maturities 2017 - 2029 2017 - 2029
Number of series 34 3
F-19
79
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at December 31, 19992000 and 1998.1999.
(IN THOUSANDS) DECEMBER 31, 19992000 DECEMBER 31, 19981999
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- -------------------------------------- -----------------------------
Assets
Mortgage Loans
Residential: held-for-sale $ 6,658 $ 6,658 $ 415,880 $ 415,880
$ 265,914 $ 266,015
Residential: held-for-investment $1,124,339 1,113,389 968,709 $ 955,653 $1,131,300 $1,120,376
Commercial: held-for-sale $34,275 34,275 8,437 $ 8,437
$ 8,287 $ 8,287Commercial: held-for-investment 22,894 22,894 -- --
Mortgage Securities
Residential: trading $759,612 759,612 941,781 946,373 $ 946,373 $1,257,655 $1,257,655
Residential: available-for-sale $85,927 85,927 26,999 28,006 $ 28,006 $ 7,707 $ 7,707
U.S. Treasury Securities -- -- $ 48,009 $ 48,009
Interest Rate Agreements $66 66 2,037 $ 2,037 $ 2,517 $ 2,517
Investment in RWT Holdings, Inc. $1,899 1,989 3,391 $ 3,675 $ 15,124 $ 15,132
Liabilities
Short-Term Debt $1,253,565 $1,253,565 $1,257,570 $1,257,570756,222 756,222 1,253,565 1,253,565
Long-Term Debt $1,095,835 1,085,368 945,270 $ 928,449 $1,305,560 $1,302,330
The carrying values of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 11. STOCKHOLDERS' EQUITY
CLASS B 9.74% CUMULATIVE CONVERTIBLE PREFERRED STOCK
On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred
Stock ("Preferred Stock"). Each share of the Preferred Stock is convertible at
the option of the holder at any time into one share of Common Stock. Effective
October 1, 1999, the Company can either redeem or, under certain circumstances,
cause a conversion of the Preferred Stock. The Preferred Stock pays a dividend
equal to the greater of (i) $0.755 per share, per quarter or (ii) an amount
equal to the quarterly dividend declared on the number of shares of the Common
Stock into which the Preferred Stock is convertible. The Preferred Stock ranks
senior to the Company's Common Stock as to the payment of dividends and
liquidation rights. The liquidation preference entitles the holders of the
Preferred Stock to receive $31.00 per share plus any accrued dividends before
any distribution is F-18
70
made on the Common Stock. As of December 31, 19992000 and 1998,1999,
96,732 shares of the Preferred Stock have been converted into 96,732 shares of
the Company's Common Stock.
In March 1999, the Company's Board of Directors approved the repurchase of up to
150,000 shares of the Company's Preferred Stock. PursuantThe Company did not repurchase
any shares of Preferred Stock during 2000, and, pursuant to thisthe repurchase
program, the Company repurchased 7,450 shares of its Preferred Stock for $0.2 million during
the year ended December 31, 1999. At December 31, 1999,2000, there wereremained 142,550 shares available under the
authorization for repurchase.
STOCK OPTION PLAN
The Company has adopted a Stock Option Plan for executive officers, employees,
and non-employee directors (the "Plan"). The Plan authorizes the Board of
Directors (or a committee appointed by the Board of Directors) to grant
"incentive stock options" as defined under Section 422 of the Code ("ISOs"),
options not so qualified ("NQSOs"), deferred stock, restricted stock,
performance shares, stock appreciation rights, limited stock appreciation rights
("Awards"), and dividend equivalent rights ("DERs") to such eligible recipients
other than non-employee directors. Non-employee directors are automatically
provided annual grants of NQSOs with DERs pursuant to a formula under the Plan.
F-20
80
The number of shares of Common Stock available under the Plan for options and
Awards, subject to certain anti-dilution provisions, is 15% of the Company's
total outstanding shares of Common Stock. The total outstanding shares are
determined as the highest number of shares outstanding prior to any stock
repurchases. At December 31, 1999 and 1998, 283,975 and 273,312 shares of Common
Stock, respectively, were available for grant. Of thethese shares of Common Stock available for grant, no more than
500,000 shares of Common Stock shall be cumulatively available for grant as
ISOs. At December 31, 2000 and 1999, 476,854 and 1998,283,975 shares of Common Stock,
respectively, were available for grant. At December 31, 2000 and 1999, 328,152
and 389,942
and 381,298 ISOs had been granted, respectively. The exercise price for ISOs
granted under the Plan may not be less than the fair market value of shares of
Common Stock at the time the ISO is granted. All stock options granted under the
Plan vest no earlier than ratably over a four-year period from the date of grant
and expire within ten years after the date of grant.
The Company's Plan permits certainCompany has granted stock options granted underthat accrue and pay stock and cash DERs.
This feature results in current operating expenses being incurred that relate to
long-term incentive grants made in the plan to
accruepast. To the extent the Company increases
its common dividends, such operating expenses may increase. For the years ended
December 31, 2000, 1999, and 1998, the Company accrued cash and stock DERs.DER
expenses of $2.1 million, $0.5 million, and $0.2 million, respectively. Stock
DERs represent shares of stock which are issuable to holders of stock options
when the holders exercise the underlying stock options. The number of stock DER
shares accrued is based on the level of the Company's common stock dividends and
on the price of the common stock on the related dividend payment date. For the years endedAt
December 31, 1999, 1998, and 1997, the2000, there were 166,451 unexercised options with stock DERs under
the Plan. Cash DERs are accrued and paid based on NQSOsthe level of the Company's
common stock dividend. At December 31, 2000, there were 1,180,797 unexercised
options with cash DERs under the Plan. At December 31, 2000, there were 147,550
outstanding stock options that had adid not have cash or stock DER feature resulted in charges to operating expenses of
$68,319, $55,222, and $437,393, respectively.DERs.
A summary of the status of the Company's Plan as of December 31at year end and changes during the
periodsyears ending on that date is presented below.
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
1997
-------------------- -------------------- ---------------------------------------- ---------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
(IN THOUSANDS, EXCEPT SHARE DATA) SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- ------- -------- ------- ----------------- ------ --------- ------
Outstanding options at January 1 1,713,836 $21.97 1,739,787 $23.68 840,644 $29.79
421,583 $19.05
Options granted 163,050 $16.90 371,950 $13.37 929,125 $16.73
460,328 $37.08
Options exercised (26,158) $12.26 (15,285) $ 0.68 (29,723) $ 0.11
(54,485) $ 0.89
Options canceled (372,070) $18.11 (387,990) $21.50 (2,699) $29.81
-- --
Dividend equivalent rights earned 16,140 -- 5,374 -- 2,440 --
13,218 --
--------- --------- ----------------- ---------- ----------
Outstanding options at December 31 1,494,798 $22.32 1,713,836 $21.97 1,739,787 $23.68
840,644 $29.79
========= ========= ================= ========== ==========
Options exercisable at year-end 644,098 $25.47 401,697 $26.89 336,121 $25.95 81,774 $22.10
Weighted average fair value of options
granted during the year $ 1.33 $ 1.63 $ 3.17$1.64 $1.33 $1.63
F-19F-21
7181
The following table summarizes information about stock options outstanding at
December 31, 1999.2000.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------------------------------------- -----------------------------
WEIGHTED-AVERAGE
RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFEEXERCISE EXERCISABLE EXERCISE PRICE
EXERCISABLE EXERCISELIFE PRICE
- --------------- ----------- ---------------- ---------------- ----------- ---------------------------- ---------------
$0 to 10 41,360 6.9$10 48,109 4.7 $ 1.10 35,3120.57 48,109 $ 1.29
100.57
$10 to 20 851,668 8.8 $13.94 97,626 $18.16
20$20 712,903 8.2 $14.43 181,967 $16.39
$20 to 30 398,756 8.0 $22.46 93,348 $22.61
30$30 349,614 7.0 $22.37 171,311 $22.44
$30 to 40 302,200 7.0 $37.45 141,218$40 283,200 6.0 $37.49 40189,724 $37.57
$40 to 50 111,102 7.5 $45.09 29,193 $45.09
50$50 93,472 6.6 $45.03 47,363 $45.04
$50 to 53 8,750 7.5$53 7,500 6.5 $52.25 5,0005,625 $52.25
--------- -------------
$0 to 53 1,713,836 8.2 $21.97 401,697 $26.89$53 1,494,798 7.3 $22.32 644,099 $25.47
========= =============
At December 31, 1999,2000, the Company had one Stock Option Plan, which is described
above. The Company applies Accounting Principles Board ("APB") Opinion 25 and
related interpretations in accounting for this plan. Accordingly, no
compensation cost has been recognized for its Plan. Had compensation cost for
the Company's Plan been determined consistent with SFAS No. 123, Accounting for
Stock-Based Compensation, the Company's net income (loss) and earnings (loss)
per share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31,
2000 1999 1998
1997
------- -------- ----------------
Net income (loss) As reported $16,210 $(1,013) $(40,118)
$24,746
(IN THOUSANDS)(in thousands) Pro Forma $15,611 $(1,687) $(40,674) $24,504
Basic net income (loss) As reported $ (0.10) $ (3.04) $ 1.86$1.84 $(0.10) $(3.04)
per share Pro Forma $ (0.17) $ (3.08) $ 1.84$1.78 $(0.17) $(3.08)
Diluted net income (loss) As reported $ (0.10) $ (3.04) $ 1.81$1.82 $(0.10) $(3.04)
per share Pro Forma $ (0.17) $ (3.08) $ 1.79$1.75 $(0.17) $(3.08)
For purposes of determining option values for use in the above tables, the
values are based on American valuation using the Black/ScholesBlack-Scholes option pricing
model as of the various grant dates, using the following principal assumptions:
expected stock price volatility 33%, risk free rates of return based on the 5
year treasury rate at the date of grant, and a dividend growth rate of 10%. The
actual value, if any, that the option recipient will realize from these options
will depend solely on the increase in the stock price over the option price when
the options are exercised.
COMMON STOCK REPURCHASES
Since September 1997, the Company's Board of Directors has approved the
repurchase of 7,455,000 shares of the Company's Common Stock. Pursuant to this
repurchase program, the Company did not repurchase any shares of Common Stock
during the year ended December 31, 2000, repurchased 2,483,500 shares for $37
million at an average price of $14.96 per share during the year ended December
31, 1999.
During the year ended December 31, 1998, the Company1999, and repurchased 3,131,500 shares of its Common Stock for $47 million
at an average price of $14.99 per share. Duringshare during the year ended December 31, 1997, the Company repurchased 840,000
shares of its Common Stock for $23 million at an average price of $27.53 per
share.1998.
At December 31, 1999,2000, there wereremained 1,000,000 shares available under the
authorization for repurchase. The repurchased shares have been returned to the
Company's authorized but unissued shares of Common Stock.
NOTE 12. RELATED PARTY TRANSACTIONS
PURCHASES AND SALES OF MORTGAGE LOANS
During the years ended December 31, 2000 and 1999, the Company sold $58 million
and $50 million of commercial mortgage loans to Redwood Commercial Funding
("RCF"), respectively, pursuant to Master Forward Commitment Agreements. There
were no such sales during the year ended December 31, 1998. The Company sold the
mortgage loans to RCF at the same price for which the Company acquired the
mortgage loans. At December 31, 2000 and 1999, under the terms of Master Forward
Commitment Agreements, the Company had committed to sell $34 million and $8
million of commercial mortgage loans to RCF for settlement during the first
quarter of 2001 and 2000, respectively.
F-22
82
During the year ended December 31, 2000, the Company purchased commercial
mortgage loans from RCF aggregating $18 million, which were not subject to the
terms of Master Forward Commitment Agreements. The Company made no such
purchases from RCF during the years ended December 31, 1999 or 1998. The Company
intends to hold these commercial loans through maturity. All such commercial
mortgage loans purchased by the Company from RCF are purchased at the market
price at the time of the sale. Accordingly, any inter-company gains or losses
recorded on the sale of the commercial mortgage loans from RCF to the Company
are eliminated against the basis of the commercial mortgage loan purchased by
the Company. During the year ended December 31, 2000, Redwood's 99% interest of
such gains recognized by Holdings was $0.2 million.
During the years ended December 31, 2000 and 1999, the Company sold $17 million
and $61 million of residential mortgage loans to Redwood Residential Funding
("RRF"), a subsidiary of Holdings. There were no such sales during the year
ended December 31, 1998. Pursuant to Master Forward Commitment Agreements, the
Company sold the mortgage loans to RRF at the same price for which the Company
acquired the mortgage loans. As RRF ceased operations in 1999, there were no
remaining outstanding commitments at December 31, 2000. At December 31, 1999,
RRF had committed to purchase $16 million or residential mortgage loans from the
Company during the first and second quarters of 2000, pursuant to the terms of
Master Forward Commitment Agreements.
During December 1999, Holdings purchased $390 million of residential mortgage
loans and subsequently sold a participation agreement on the mortgage loans to
the Company. Pursuant to the terms of the Mortgage Loan F-20
72
Participation Purchase
Agreement, the Company purchased a 99% interest in the mortgage loans, and
assumesassumed all related risks of ownership. Holdings did not recognize any gain or
loss on this transaction. During the year ended December 31, 1999, the Company sold $50 million of
commercial mortgage loans to RCF. Pursuant to the Master Forward Commitment
Agreement,March 2000, the Company sold the mortgage loansparticipation
agreement back to RCF at the same priceHoldings for which the Company acquired the mortgage loans. There were no such sales during
the year ended December 31, 1998. At both December 31, 1999 and 1998, under the
termsproceeds of the Master Forward Commitment Agreement, the Company had committed to
sell $8 million of commercial mortgage loans to RCF for settlement during the
first quarter of 2000 and 1999, respectively.
During the year ended December 31, 1999, the Company$380.5 million. Holdings
simultaneously sold $61$384 million of residential mortgage loans to Redwood Residential Funding ("RRF"),Sequoia for
proceeds of $384 million. Sequoia pledged these loans as collateral for a subsidiarynew
issue of Holdings. Pursuant to the Master Forward Commitment Agreement, the Company
sold the mortgage loans to RRF at the same price for which the Company acquired
the mortgage loans. There were no such sales during the year ended December 31,
1998. At December 31, 1999, under the terms of the Master Forward Commitment
Agreement, the Company had committed to sell $16 million of residential mortgage
loans to RRF during the first and second quarters of 2000. There were no such
commitments at December 31, 1998.Long-Term Debt.
OTHER
Under a revolving credit facility arrangement, the Company may loan funds to
Holdings to finance certain mortgage loans owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.50% over the LIBOR interest rate. At bothDecember 31, 2000, the
Company had no such loans to Holdings. At December 31, 1999, and
1998, the Company had
loaned $6.5 million to Holdings in accordance with the provisions of this
arrangement. During the years ended December 31, 2000, 1999 and 1998, the
Company earned $0.3 million, $1.1 million and $18,539,$18,000, respectively, in interest
on loans to Holdings.
The Company shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the years ended December 31, 2000, 1999 and 1998, $0.2 million, $3.0
million and $2.3 million, respectively, of Holdings' operating expenses were
paid by the Company, and were subject to reimbursement by Holdings.
The Company may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of the Company's Short-Term Debt agreements subject to
the Company continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays the Company credit support fees on borrowings subject
to this arrangement. At December 31, 2000 and 1999, the Company was providing
credit support on $18.2 million and $22.4 million of Holdings' Short-Term Debt.
No such borrowings were
outstanding atDuring each year ended December 31, 1998. During the years ended December 31,2000, 1999 and 1998, the Company recognized $0.1 million and
$0.1 million in credit support fee income. Credit support fees are reflected as
a component of "Other Income" on the Consolidated Statements of Operations.
Holdings may borrow under several of Redwood Trust's Short-Term Debt agreements
as a co-borrower (see Note 4). At December 31, 2000 and 1999, Holdings had
borrowings of $18.2 million and $22.4 million subject to these arrangements.
F-23
83
NOTE 13. COMMITMENTS AND CONTINGENCIES
At December 31, 1999,2000, the Company had entered into commitments to purchase
$18.0$100.4 million of residential mortgage securities and $7.7 million of residential
mortgage loans for settlement during January
and February 2000.2001. At December 31, 1999,2000, the Company had also entered into
commitmentsMaster Forward Agreements to sell $8.4$34.3 million of commercial mortgage loans to
RCF and $16.0 million of residential mortgage loans
to RRF for settlement during the first and second quartersquarter of 2000.2001.
At December 31, 1999,2000, the Company is obligated under non-cancelable operating
leases with expiration dates through 2003.2006. The total future minimum lease
payments under these non-cancelable leases is $632,574$3.0 million and is expected to be
recognized as follows: 2000 - $363,571; 2001 - $171,856;$0.5 million; 2002 - $53,546;$0.6 million; 2003 - $43,601.
F-21
73$0.6
million; 2004 - $0.6 million; 2005 -- $0.5 million; 2006 - $0.2 million.
NOTE 14. SUBSEQUENT EVENTS
Effective December 15, 1999, the United States Congress enacted the Real Estate
Investment Trust ("REIT") Modernization Act (RMA) which, among other things,
permits REITs to own 100% of the outstanding voting securities of a taxable REIT
subsidiary beginning after December 31, 2000. Accordingly, on January 1, 2001,
Redwood Trust acquired 100% of the voting common stock of Holdings for $300,000
in cash consideration from two officers of Holdings. Redwood Trust's Audit
Committee determined the purchase price based on an independent appraisal
obtained by the Audit Committee and through negotiations with the two officers,
taking into account projected cost savings to Redwood Trust from being able to
consolidate Holdings into Redwood Trust's future financial statements and other
potential benefits to Redwood Trust and its stockholders.
Following Redwood Trust's acquisition of the voting common stock of Holdings,
Redwood Trust transferred its preferred stock interest in exchange for
additional voting common stock in Holdings as part of the Holdings equity
recapitalization. As a result of these transactions, Redwood Trust owns 100% of
the voting common stock of Holdings and Holdings became a wholly-owned
subsidiary of Redwood Trust on January 1, 2001. Subsequently, Holdings elected
to become a taxable REIT subsidiary of Redwood Trust.
Prior to the Company's acquisition of 100% of the voting common stock of
Holdings, Holdings was operated and managed independently of the Company, as the
Company is subject to tax as a REIT and Holdings is not. Holdings' activities
resulted in it being characterized as a taxable, non-qualified REIT subsidiary.
To qualify as a REIT, the Company, among other things, was unable to own greater
than 10% of the outstanding voting securities of any non-qualified REIT
subsidiary.
The transaction has been accounted for using the purchase method of accounting.
The assets and liabilities of Holdings have been recorded by the Company at
their fair market value. The transaction did not have a material impact on the
financial statements of the Company. Goodwill of $0.3 million was recorded by
the Company as a result of this transaction and will be amortized on a
straight-line basis over four years beginning in January 2001.
F-24
84
The following are the pro forma consolidated balance sheet and a statement of
operations at December 31, 2000 and for the year ended December 31, 2000,
respectively, as if the Company had owned 100% of Holdings.
REDWOOD TRUST, INC.
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(PRO FORMA) DECEMBER 31, 2000
(IN THOUSANDS) ----------------------------- REDWOOD TRUST
REDWOOD TRUST RWT HOLDINGS CONSOLIDATION CONSOLIDATED
------------- ------------ ------------- -------------
ASSETS
Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 80,764 $ -- $ -- $ 80,764
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment 1,124,339 -- -- 1,124,339
Mortgage loans available-for-sale 6,658 -- -- 6,658
----------- ----------- ----------- -----------
1,130,997 -- -- 1,130,997
Investment Portfolio:
Mortgage securities trading 57,450 -- -- 57,450
Mortgage securities available-for-sale 707,325 -- -- 707,325
----------- ----------- ----------- -----------
764,775 -- -- 764,775
Commercial retained loan portfolio:
Mortgage loans held-for-investment 22,894 -- -- 22,894
Mortgage loans held-for-sale 34,275 18,913 -- 53,188
----------- ----------- ----------- -----------
57,169 18,913 -- 76,082
Cash and cash equivalents 15,483 1,892 (300) 17,075
Restricted cash 5,240 1,119 -- 6,359
Accrued interest receivable 15,797 169 -- 15,966
Investment in RWT Holdings, Inc. 1,899 -- (1,899) --
Goodwill -- -- 281 281
Other assets 9,991 38 -- 10,029
----------- ----------- ----------- -----------
Total Assets $ 2,082,115 $ 22,131 $ (1,918) $ 2,102,328
=========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 756,222 $ 18,200 $ -- $ 774,422
Long-term debt 1,095,835 -- -- 1,095,835
Accrued interest payable 5,657 134 -- 5,791
Accrued expenses and other liabilities 8,737 1,879 -- 10,616
----------- ----------- ----------- -----------
1,866,451 20,213 -- 1,886,664
----------- ----------- ----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock 26,517 -- -- 26,517
Series A preferred stock -- 29,700 (29,700) --
Common stock 88 -- -- 88
Additional paid-in-capital 242,522 300 (300) 242,522
Accumulated other comprehensive income (89) -- -- (89)
Cumulative earnings (deficit) 27,074 (28,082) 28,082 27,074
Cumulative distributions to stockholders (80,448) -- -- (80,448)
----------- ----------- ----------- -----------
Total Stockholder's Equity 215,664 1,918 (1,918) 215,664
----------- ----------- ----------- -----------
Total Liabilities and Stockholders' Equity $ 2,082,115 $ 22,131 $ (1,918) $ 2,102,328
=========== =========== =========== ===========
F-25
85
REDWOOD TRUST, INC.
CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
(PRO FORMA) YEAR ENDED DECEMBER 31, 2000
(IN THOUSANDS) ---------------------------- REDWOOD TRUST
REDWOOD TRUST RWT HOLDINGS CONSOLIDATION CONSOLIDATED
------------- ------------ ------------- -------------
INTEREST INCOME
Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 8,524 $ -- $ -- $ 8,524
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment 83,815 -- -- 83,815
Mortgage loans held-for-sale 7,050 69 -- 7,119
--------- --------- --------- ---------
90,865 69 -- 90,934
Investment Portfolio:
Mortgage securities trading 67,055 -- -- 67,055
Mortgage securities available-for-sale 151 -- -- 151
--------- --------- --------- ---------
67,206 -- -- 67,206
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment 520 -- -- 520
Mortgage loans held-for-sale 1,482 3,301 -- 4,783
--------- --------- --------- ---------
2,002 3,301 -- 5,303
Cash and cash equivalents 1,395 122 (343) 1,174
--------- --------- --------- ---------
Total interest income 169,992 3,492 (343) 173,141
INTEREST EXPENSE
Short-term debt (61,355) (2,316) -- (63,671)
Long-term debt (76,294) -- -- (76,294)
Credit support fees -- (98) 98 --
Loans from Redwood Trust, Inc. -- (343) 343 --
--------- --------- --------- ---------
Total interest expense (137,649) (2,757) 441 (139,965)
Net interest rate agreements expense (954) -- -- (954)
Provision for credit losses (731) -- -- (731)
--------- --------- --------- ---------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 30,658 735 98 31,491
Net unrealized and realized market value gains
(losses)
Loans and securities 1,060 149 (186) 1,023
Interest rate agreements (3,356) -- -- (3,356)
--------- --------- --------- ---------
Total net unrealized and realized market value (2,296) 149 (186) (2,333)
gains (losses)
Operating expenses (7,850) (2,391) -- (10,241)
Other income 98 -- (98) --
Equity in losses of RWT Holdings, Inc. (1,676) -- 1,676 --
--------- --------- --------- ---------
Net income before preferred dividend 18,934 (2,391) 1,490 18,917
Less dividends on Class B preferred stock (2,724) -- -- (2,724)
--------- --------- --------- ---------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 16,210 $ (1,507) $ 1,490 $ 16,193
========= ========= ========= =========
Basic Earnings Per Share $ 1.84 $ 1.84
Diluted Earnings Per Share $ 1.82 $ 1.82
F-26
86
On March 9, 2000,15, 2001, the Company declared a $0.35$0.50 per share common stock dividend
and a $0.755 preferred stock dividend for the first quarter of 2000.2001. The common
and preferred stock dividend isdividends are payable on April 21,
200023, 2001 to common and
preferred shareholders of record on March 31, 2000.
On March 8, 2000, the Company committed to the issuance of $377 million in face
value of Long-Term Debt, for settlement on March 21, 2000. This Long-Term Debt
will be issued by Sequoia Mortgage Trust 4, a business trust that will be
established by Sequoia. The debt will be collateralized by a pool of
adjustable-rate, 30-year mortgage loans. The proceeds received from this
issuance are expected to be used to pay down a portion of the Company's
Short-Term Debt.30, 2001.
NOTE 15. QUARTERLY FINANCIAL DATA - UNAUDITED
Selected quarterly financial data follows:
(IN THOUSANDS, EXCEPT SHARE DATA) THREE MONTHS ENDED
-----------------------------------------------------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------------- -------- ------------ -----------
2000
Operating results:
Interest income $ 42,939 $ 43,136 $ 41,919 $ 41,998
Interest expense (34,522) (34,915) (34,501) (33,711)
Provision for credit losses (119) (128) (240) (244)
Interest rate agreement expense (409) (218) (193) (134)
Net interest income after provision for credit losses 7,889 7,875 6,985 7,909
Net income (loss) available to common stockholders 3,280 3,096 4,873 4,961
Per share data:
Net income (loss) - diluted $ 0.37 $ 0.35 $ 0.55 $ 0.55
Dividends declared per common share (a) $ 0.35 $ 0.40 $ 0.42 $ 0.44
Dividends declared per preferred share $ 0.755 $ 0.755 $ 0.755 $ 0.755
1999
Operating results:
Interest income $ 41,73141,732 $ 36,09136,090 $ 34,555 $ 34,933
Interest expense (33,491) (28,537) (27,390) (27,744)
Provision for credit losses (345) (371) (416) (214)
Interest rate agreement expense (333) (737) (457)(736) (458) (538)
Net interest income 7,907 6,817 6,708 6,651after provision for credit losses 7,563 6,446 6,291 6,437
Net income (loss) available to common stockholders 5,854 2,5095,855 2,508 (3,738) (5,638)
Per share data:
Net income (loss) - diluted $ 0.54 $ 0.25 $ (0.39) $ (0.64)
Dividends declared per common share(a)share (a) -- -- $ 0.1500.15 $ 0.2500.25
Dividends declared per preferred share $ 0.755 $ 0.755 $ 0.755 $ 0.755
1998
Operating results:
Interest income $ 53,861 $ 53,783 $ 61,558 $ 53,602
Interest expense 46,097 50,169 56,170 43,688
Interest rate agreement expense 1,378 1,624 247 265
Net interest income 6,386 1,990 5,141 9,649
Income (loss) before change in accounting principle 2,450 (491) (37,805) 5,789
Cumulative transition effect of adopting SFAS No. 133 -- -- (10,061) --
Net income (loss) available to common stockholders 2,450 (491) (47,866) 5,789
Per share data:
Income (loss) before change in accounting principle - diluted 0.17 (0.03) (2.85) 0.51
Cumulative transition effect of adopting SFAS No. 133 -- -- (0.76) --
Net income (loss) - diluted 0.17 (0.03) (3.61) 0.51
Dividends declared per common share(a) 0.270 0.010 -- --
Dividends declared per preferred share 0.755 0.755 0.755 0.755
(a) Reflects period for which the common dividend was declared. Reported
dividends may have been declared during the following quarter.
F-22F-27
7487
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Redwood Trust, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of Redwood
Trust, Inc. and subsidiary (the Company), at December 31, 19992000 and 1998,1999 and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999,2000, in conformity with accounting principles generally accepted
in the United States.States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits.audit. We conducted our auditsaudit
of these statements in accordance with auditing standards generally accepted in
the United States of America which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provideaudit provides a reasonable basis for the opinion expressed above.our opinion.
In July 1998, the Company adopted Financial Accounting Standards Board Statement
No. 133,133. Accounting forof Derivative Instruments and Hedging Activities. This
change is discussed in Note 2 to the consolidated financial statements.
/s/ PricewaterhouseCoopers L.L.P.LLP
San Francisco, California
February 21, 2000
F-2315, 2001
F-28
7588
RWT HOLDINGS, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
For Inclusion in Form 10-K
Annual Report Filed with
Securities and Exchange Commission
December 31, 1999
F-242000
F-29
7689
RWT HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Consolidated Financial Statements - RWT Holdings, Inc.
Consolidated Balance Sheets at December 31, 19992000 and 1998 .................................. F-261999.......................................... F-31
Consolidated Statements of Operations for the yearyears ended December 31, 2000 and 1999,
and for the period from April 1, 1998 (commencement of operations) to December 31, 1998 ............ F-271998..... F-32
Consolidated Statements of Stockholders' Equity for the yearyears
ended December 31, 2000 and 1999, and for the period from
April 1, 1998 (commencement of operations) to December 31, 1998 .... F-281998............................. F-33
Consolidated Statements of Cash Flows for the yearyears ended December 31, 2000 and 1999,
and for the period from April 1, 1998 (commencement of operations) to December 31, 1998 ............ F-291998..... F-34
Notes to Consolidated Financial Statements ................................................. F-30Statements......................................................... F-35
Report of Independent Accountants ................................................................ F-36Accountants........................................................................ F-42
F-25F-30
7790
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
2000 1999 1998
-------- --------
ASSETS
Mortgage loans: held-for sale
Residential $ -- $ 4,399
$ 12,247
Commercial, pledged 18,913 29,605 --
-------- --------
18,913 34,004 12,247
Cash and cash equivalents 1,892 1,999 9,711
Restricted cash 1,119 50 --
Accrued interest receivable 169 1,520 78
Property, equipment and leasehold improvements, net -- 299 622
Other assets 38 1,081 120
-------- --------
Total Assets $ 38,95322,131 $ 22,77838,953
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 22,42718,200 $ --22,427
Loans from Redwood Trust, Inc. 6,500-- 6,500
Payable to Redwood Trust, Inc. -- 472 445
Accrued interest payable 134 831 3
Accrued restructuring charges 430 4,039 --
Accrued expenses and other liabilities 1,449 1,259 554
-------- --------
Total Liabilities 20,213 35,528 7,502
-------- --------
Commitments and contingencies (See Note 10)
STOCKHOLDERS' EQUITY
Series A preferred stock, par value $0.01 per share; 10,000 shares
authorized; 5,940 issued and outstanding
($5,940 aggregate liquidation preference) 29,700 19,80029,700
Common stock, par value $0.01 per share;
10,000 shares authorized; 3,000 issued and outstanding -- --
Additional paid-in capital 300 200300
Accumulated deficit (28,082) (26,575) (4,724)
-------- --------
Total Stockholders' Equity 1,918 3,425 15,276
-------- --------
Total Liabilities and Stockholders' Equity $ 38,95322,131 $ 22,77838,953
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-26F-31
7891
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
For the period
from April 1, 1998
(commencement of
Year Ended Year Ended operations) to
December 31, 2000 December 31, 1999 December 31, 1998
----------------- ----------------- ------------------
REVENUES
Interest income
Mortgage loans: held-for-sale
Residential $ 69 $ 1,955 $ 2,803
Commercial 3,301 1,555 --
-------- --------------- --------
3,370 3,510 2,803
-------- -------- --------
Mortgage securities: trading -- 1,021 --
Cash and cash equivalents 122 330 350
-------- --------------- --------
Total interest income 3,492 4,861 3,153
-------- -------- --------
Interest expense
Short-term debt (2,316) (2,457) (2,503)
Credit support fees (98) (149) (139)
Loans from Redwood Trust, Inc. (343) (1,118) (18)
-------- --------------- --------
Total interest expense (2,757) (3,724) (2,660)
-------- -------- --------
Net interest income 735 1,137 493
-------- -------- --------
Net unrealized and realized market value gains (losses) 149 (747) 18
Other income -- 26 --
-------- -------
Net revenues 416 511
EXPENSES
Compensation and benefits (1,485) (8,414) (3,395)
General and administrative (906) (5,430) (1,840)
Restructuring charge -- (8,423) --
-------- --------------- --------
Total expenses (2,391) (22,267) (5,235)
-------- -------- --------
NET LOSS $ (1,507) $(21,851) $(4,724)$ (4,724)
======== =============== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-27F-32
7992
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Series A
Preferred stock Common stock Additional
---------------------------------------------------------------------------------- paid-in Accumulated
Shares Amount Shares Amount capital deficit Total
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Balance, April 1, 1998 -- $ -- -- $--$ -- $ -- $ -- $ --
- -----------------------------------------------------------------------------------------------------------
Comprehensive income:-----------------------------------------------------------------------------------------------------------------------------
Net loss -- -- -- -- -- (4,724) (4,724)
Issuance of preferred stock 3,960 19,800 -- -- -- -- 19,800
Issuance of common stock -- -- 2,000 -- 200 -- 200
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 3,960 19,800 2,000 -- 200 (4,724) 15,276
- -----------------------------------------------------------------------------------------------------------
Comprehensive income:-----------------------------------------------------------------------------------------------------------------------------
Net loss -- -- -- -- -- (21,851) (21,851)
Issuance of preferred stock 1,980 9,900 -- -- -- -- 9,900
Issuance of common stock -- -- 1,000 -- 100 -- 100
- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 5,940 $29,700$ 29,700 3,000 $-- $300$ -- $ 300 $(26,575) $ 3,425
===========================================================================================================- -----------------------------------------------------------------------------------------------------------------------------
Net loss -- -- -- -- -- (1,507) (1,507)
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 5,940 $ 29,700 3,000 $ -- $ 300 $(28,082) $ 1,918
- -----------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
F-28F-33
8093
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the period
from April 1, 1998
(commencement of
Year Ended Year Ended operations) to
December 31, 2000 December 31, 1999 December 31, 1998
----------------- ----------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,507) $ (21,851) $ (4,724)
Adjustments to reconcile net loss to net cash
used inprovided by (used in) operating activities:
Depreciation and amortization 31 829 27
Net unrealized and realized market value
(gains) losses (149) 747 (18)
Write-off of property, equipment and leasehold
improvements, net 82 3,131 --
Purchases of mortgage loans: held for sale (508,642) (657,295) (543,296)
Proceeds from sales of mortgage loans: held for sale 509,784 533,743 525,418
Principal payments on mortgage loans: held for sale 14,099 1,614 5,622
Purchases of mortgage securities: trading -- (4,619) --
Proceeds from sales of mortgage securities: trading -- 99,488 --
Principal payments on mortgage securities: trading -- 3,549 --
IncreaseDecrease (increase) in accrued interest receivable 1,351 (1,442) (78)
(Increase) decreaseDecrease (increase) in other assets 1,043 54 (55)
Increase(Decrease) increase in amounts due to Redwood Trust (472) 27 445
Increase(Decrease) increase in accrued interest payable (697) 828 3
Increase(Decrease) increase in accrued restructuring charges (3,609) 4,039 --
Increase in accrued expenses and other liabilities 190 705 554
--------- --------- ---------
Net cash used inprovided by (used in) operating activities 11,504 (36,453) (16,102)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
PurchasesSales (purchases) of property, equipment and leasehold
improvements, net 185 (3,636) (687)
Net increase in restricted cash (1,069) (50) --
--------- --------- ---------
Net cash used in investing activities (884) (3,686) (687)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) proceeds from issuance of short-term debt (4,227) 22,427 --
Loans from Redwood Trust, Inc. (net of repayments) (6,500) -- 6,500
Net proceeds from issuance of preferred stock -- 9,900 19,800
Net proceeds from issuance of common stock -- 100 200
--------- --------- ---------
Net cash (used in) provided by financing activities (10,727) 32,427 26,500
--------- --------- ---------
Net (decrease) increase (decrease) in cash and cash equivalents (107) (7,712) 9,711
Cash and cash equivalents at beginning of period 1,999 9,711 --
--------- --------- ---------
Cash and cash equivalents at end of period $ 1,892 $ 1,999 $ 9,711
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest expense $ 3,454 $ 2,810 $ 2,518
Non-cash transaction:
Securitization of mortgage loans into mortgage securities $ -- $ 98,315 $ --
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-29F-34
8194
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 19992000
NOTE 1. THE COMPANY
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware on February 13,
1998 and commenced operations on April 1, 1998. Holdings originates and sells
commercial mortgage loans. Redwood Trust, Inc. ("Redwood Trust") owns all of the
preferred stock and has a non-voting, 99% economic interest in Holdings. The
consolidated financial statements include the three subsidiaries of Holdings.
Redwood Commercial Funding, Inc. ("RCF") originates commercial mortgage loans
for sale to Redwood Trust and other institutional investors. Redwood Residential
Funding, Inc. ("RRF") and Redwood Financial Services, Inc. ("RFS") were start-up
ventures that ceased operations in 1999. Holdings and its subsidiaries currently
utilize both debt and equity to finance acquisitions. References to Holdings in
the following footnotes refer to Holdings and its subsidiaries. On January 1,
2001, Redwood Trust acquired 100% of the voting common stock of Holdings, as
further discussed in Note 11.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Holdings and its
subsidiaries. All significant intercompany balances and transactions with
Holdings' consolidated subsidiaries have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Note 6.7.
ADOPTION OF SFAS NO. 133
Holdings adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, effective July 1, 1998. Upon the adoption of SFAS No. 133, Holdings
did not record a transition adjustment, as there were no outstanding derivative
instruments. Immediately after the adoption of SFAS No. 133, Holdings elected to not seek hedge accounting for any of its
derivative financial instruments employed for hedging activities.
MORTGAGE ASSETS
Holdings' mortgage assets consist of mortgage loans and mortgage securities
("Mortgage Assets"). Interest is recognized as revenue when earned according to
the terms of the loans and when, in the opinion of management, it is
collectible.
Mortgage Loans: Held-for-Sale
Mortgage loans are recorded at the lower of cost or aggregate market value
("LOCOM"). Cost generally consists of the loan principal balance net of any
unamortized premium or discount and net loan origination fees. Interest income
is accrued based on the outstanding principal amount of the mortgage loans and
their contractual terms. Realized and unrealized gains or losses on the loans
are based on the specific identification method and are F-30
82
recognized in "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
F-35
95
Some of the mortgage loans purchased by Redwood Trust for which securitization
or sale is contemplated are committed for sale by
Redwood Trust to Holdings, or a subsidiary of Holdings, under a Master Forward
Commitment Agreement.Agreements. As thea forward commitment is entered into on the same date
that Redwood Trust commits to purchase the loans, the price under thea forward
commitment is the same as the price Redwood Trust paid for the mortgage loans,
as established by the external market.
Mortgage Securities: Trading
Mortgage securities classified as trading are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, such securities are recorded at their estimated fair market value.
Unrealized and realized gains and losses on these securities are recognized as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
LOAN ORIGINATION FEES
Loan fees, discount points and certain direct origination costs are recorded as
an adjustment to the cost of the loan and are recorded in earnings when the loan
is sold.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less.
RESTRICTED CASH
Restricted cash includes cash held back from borrowers until certain loan
agreement requirements have been met. The corresponding liability for this cash
is reflected as a component of "Accrued expenses and other liabilities" on the
Consolidated Balance Sheets.
DERIVATIVE FINANCIAL INSTRUMENTS
Holdings utilizes derivative financial instruments to mitigate the risks that a
change in interest rates will result in a change in the value of the Mortgage
Assets. At December 31, 2000, Holdings had no derivative financial instruments.
At December 31, 1999, Holdings had entered into forward contracts for the sale
of mortgage loans.loans which had an aggregate notional value of $1 million. Holdings currently
designates all derivative financial instruments as trading instruments.
Accordingly, such instruments are recorded at their estimated fair market value
with unrealized and realized gains and losses on these instruments recognized as
a component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations. During the year ended December 31, 2000,
Holdings recognized market value losses on derivative financial instruments of
$5,000. During the year ended December 31, 1999, Holdings recognized market
value gains on derivative financial instruments of $1.0 million. There were no
derivative financial instruments outstanding during the period ended December
31, 1998. At December 31, 1999, Holdings had $1 million notional value of
outstanding derivative financial instruments.
INCOME TAXES
Taxable earnings of Holdings are subject to state and federal income taxes at
the applicable statutory rates. Holdings provides for deferred income taxes if
any, to reflect the estimated future tax effects under the provisions of SFAS
No. 109, Accounting for Income Taxes. Under this pronouncement, deferred income
taxes, if any, reflect the estimated future tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations.
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires Holdings to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. As of December 31, 1999 there was no other comprehensive
income.
F-31F-36
8396
NOTE 3. MORTGAGE ASSETS
At December 31, 19992000 and 19981999 Mortgage Assets consisted of the following:
MORTGAGE LOANS: HELD-FOR-SALE
(IN THOUSANDS) DECEMBER 31, 19992000 DECEMBER 31, 19981999
RESIDENTIAL COMMERCIAL TOTAL RESIDENTIAL COMMERCIAL TOTAL
-------------------------------- ------------------------------------------- ---------- -------- ----------- ---------- --------
Current Face $4,995 $30,324 $35,319 $12,072$ -- $12,072$ 19,883 $ 19,883 $ 4,995 $ 30,324 $ 35,319
Unamortized Premium (Discount) -- (970) (970) (596) (719) (1,315)
175 -- 175
-------------------------------- ---------------------------------------- -------- -------- -------- -------- --------
Carrying Value $4,399 $29,605 $34,004 $12,247$ -- $12,247
================================ ================================$ 18,913 $ 18,913 $ 4,399 $ 29,605 $ 34,004
======== ======== ======== ======== ======== ========
For the years ended December 31, 2000, 1999 and 1998, Holdings recognized losses
of $0.2 million, $1.8 million and $11,118,$11,000 respectively, as a result of LOCOM
adjustments on mortgage loans held-for-sale. During the years ended December 31,
2000, 1999 and 1998, Holdings recognized gains on sales of mortgage loans of
$0.4 million, $1.0 million, and $29,000, respectively. These losses are
reflected as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
MORTGAGE SECURITIES: TRADING
Holdings did not own any mortgage securities during 2000 or 1998. For the year
ended December 31, 1999, Holdings recognized a market value gain of $0.1 million
on mortgage securities classified as trading. This gain is reflected as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations. During the year ended December 31, 1999,
Holdings sold mortgage securities classified as trading for proceeds of $99.5
million.
Holdings did not own any mortgage securities prior to
1999.
NOTE 4. SHORT-TERM DEBT
Holdings has entered into reverse repurchase agreements and other forms of
collateralized short-term borrowings (collectively, "Short-Term Debt") to
finance acquisitions of a portion of its Mortgage Assets. This Short-Term debt
is collateralized by a portion of Holdings' mortgage loans.
At December 31, 2000, and December 31, 1999, Holdings had $18.2 million and
$22.4 million of Short-Term Debt outstanding with a weighted-average borrowing
rate of 8.51% and 7.02%, respectively. The average balance of Short-Term Debt
outstanding during the years ended December 31, 2000 and 1999 and 1998
was $42$28 million
and $55$42 million, with a weighted-average borrowing rateinterest cost of 6.22%8.40% and 6.30%6.22%,
respectively. The maximum balance outstanding during the years ended December
31, 2000 and 1999 was $44 million and 1998 was $397 million, and $367 million, respectively.
In July 1999, Redwood Trust entered into a one-year, $90 million revolving
mortgage warehousing credit facility with two banks. At Redwood Trust's request,
this line was reduced to $20 million in December 1999. The facility is primarily
intended to finance newly originated residential mortgage loans. Holdings may
borrow under this facility as a co-borrower. At December 31, 1999, Holdings had
no outstanding borrowings under this facility.
Redwood Trust and Holdings were in compliance with all material representations,
warranties and covenants under all its credit facilities. It is the intention of
management to renew committed and uncommitted facilities, if and as needed.
In March 2000, Redwood Trust entered into a $50 million committed revolving
mortgage warehousing credit facility. The facility is intended to finance newly
originated commercial mortgage loans. Holdings may borrow under this facility as
a co-borrower. In September 2000, this facility was extended through August 2001
and was increased to $70 million. In addition, a portion of this facility allows
for loans to be financed to the maturity of the loan, which may extend beyond
the expiration date of the facility. At December 31, 2000, Redwood Trust and
Holdings had outstanding borrowings of $16.5 million and $18.2 million,
respectively, under this facility. Borrowings under this facility bear interest
based on a specified margin over the London Interbank Offered Rate ("LIBOR"). At
December 31, 2000, the weighted average borrowing rate under this facility was
8.57%. This committed facility expires in August 2001.
In July 2000, Redwood Trust renewed for one year, a $30 million committed master
loan and security agreement with a Wall Street Firm. The facility is intended to
finance newly originated commercial mortgage loans. In September 2000, this
facility was increased to $50 million. Holdings may borrow under this facility
as a co-borrower. At December 31, 2000, Holdings had no outstanding borrowings
under this facility. Borrowings under
F-37
97
this facility bear interest based on a specified margin over LIBOR. At December
31, 2000, the weighted average borrowing rate under this facility was 8.06%.
This committed facility expires in July 2001.
In July 1999, Redwood Trust entered into a one-year, $90 million committed
revolving mortgage warehousing credit facility atwith two banks. This facility
expired in February 2000. The facility was primarily intended to finance newly
originated residential mortgage loans. Holdings was a co-borrower under this
facility. At Redwood Trust's request, this line was reduced to $20 million in
December 1999. At December 31, 1999, orHoldings had obtained the appropriate
waivers.no outstanding borrowings
under this facility.
In July 1999, Redwood Trust entered into a one-year, $350 million committed
master loan and security agreement with a Wall Street firm. This facility
expired in June 2000. The facility iswas primarily intended to finance newly
originated commercial and residential mortgage loans. Holdings may borrowwas a co-borrower
under this facility as a co-borrower.facility. At December 31, 1999, Holdings had outstanding borrowings
of $19.8 million under this facility. Borrowings under this facility bearbore
interest based on a specified margin over the London Interbank Offered Rate
("LIBOR"). At December 31, 1999, the weighted-average borrowing rate under this
facility was 7.23%. Redwood Trust and
Holdings were in compliance with all material representations, warranties, and
covenants under this credit facility at December 31, 1999.
Redwood Trust may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of Redwood Trust's Short-Term Debt agreements subject to
Redwood Trust continuing to F-32
84
remain jointly and severally liable for repayment.
Accordingly, Holdings pays Redwood Trust credit support fees on borrowings
subject to this arrangement. During the years ended December 31, 2000, 1999 and
1998, Holdings paid Redwood Trust credit support fees of $98,000, $149,000 and
$139,000, respectively. At December 31, 2000 and 1999, Redwood Trust was
providing credit support on $18.2 million and $22.4 million, respectively, of
Holdings' Short-Term Debt. No such borrowings were outstanding at December
31, 1998. These expenses are reflected as "Credit support fees"
on the Consolidated Statements of Operations.
NOTE 5. RESTRUCTURING CHARGE
During the year ended December 31, 1999, Holdings recognized $8.4 million in
restructuring charges as a result of the closure of two of its subsidiaries, RRF
and RFS. Restructuring charges were determined in accordance with the provisions
of Staff Accounting Bulletin No. 100 "Restructuring and Impairment Charges",
Emerging Issues Task Force No. 94-3 "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity", and other relevant
accounting guidance. The restructuring accrual includes costs associated with
existing contractual and lease arrangements at both subsidiaries which have no
future value. In addition, as a result of the closure of the two subsidiaries,
certain assets utilized in these businesses were determined to have little or no
realizable value, resulting in impairment losses. These assets included software
developed for use at RRF and certain fixed assets at both subsidiaries. The
following table provides a summary of the primary components of the
restructuring charge and the associated liability.
F-38
98
(IN THOUSANDS) 1999 ACTUAL 2000 ACTUAL DECEMBER 31, 2000
TOTAL ESTIMATED TOTAL ACTUAL
(IN THOUSANDS)PAYMENTS/ PAYMENTS/ ACCRUED
LIABILITY/IMPAIRMENTS PAYMENTS/CHARGE-OFFS CHARGE-OFFS RESTRUCTURING
--------------------- ------------------------------- ------------ -----------------
Payroll, severance, and termination benefits $3,511 $1,080 benefits$2,431 $ --
Asset impairmentsImpairments 2,858 2,858 -- --
Lease and other commitments 1,314 246 643 425
Other 740 200 535 5
------ ------ ------ ------
Total $8,423 $4,384
====== ======4,384 3,609 $ 430
The Company expects to pay the majority of the remaining restructuring costs during the year
2000.2001. The remaining liability for restructuring costs at December 31, 2000 and
1999 of $0.4 million and $4.0 million, respectively, is reflected as "Accrued
restructuring charges" on the Consolidated Statements of Operations.Balance Sheets.
NOTE 6. INCOME TAXES
The current provision for income taxes for the period from January 1, 1999 throughyears ended December 31, 2000,
1999 amounted toand 1998 was $3,200 for both 2000 and represents1999, and $2,400 for 1998. These
amounts represent the minimum California franchise taxes. The effectiveNo additional tax
rate differs fromprovision has been recorded for the statutory federal income tax rate
primarilyyears ended December 31, 2000, 1999 and
1998, as Holdings reported a loss in each of these years, and due to state limitations on recognizing the
benefituncertainty of realization of net operating losses, (NOL).no deferred tax benefit has
been recorded. A valuation allowance has been provided to offset the deferred
tax assets related to net operating loss carryforwards and other future
temporary deductions at December 31, 2000 and 1999. At December 31, 2000 and
1999, the deferred tax assets and associated valuation allowances were
approximately $9.5 million and $8.9 million, respectively. At December 31, 2000
and 1999, Holdings had NOLnet operating loss carryforwards of approximately $21$24.6
million and $19.5 million for federal tax purposes, and $11 million and $9
million for state income tax purposes. The federal loss carryforwards and a portion of
the state loss carryforwards expire throughbetween 2018 and 2004 respectively.
Due to2020, while the uncertainty of realizationlargest
portion of the $8 million tax benefit of the NOL,
a valuation allowance of $8 million has been provided to eliminate the deferred
tax assets at December 31, 1999. The increase in the valuation allowance
amounted to $6.1 million for the period ended December 31, 1999.
F-33
85state loss carryforwards expire between 2003 and 2005.
NOTE 7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
Holdings' financial instruments at December 31, 19992000 and 1998.1999.
(IN THOUSANDS) DECEMBER 31, 19992000 DECEMBER 31, 19981999
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
Assets
Mortgage loans: held-for-sale
Residential $ -- $ -- $ 4,399 $ 4,415
$12,247 $12,255
Commercial $18,913 $19,004 $29,605 $29,876 -- --
Liabilities
Short-term debt $18,200 $18,200 $22,427 $22,427 -- --
Loans from Redwood Trust, Inc. $ 6,500-- $ 6,500-- $ 6,500 $ 6,500
The carrying amounts of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 8. STOCKHOLDERS' EQUITY
The authorized capital stock of Holdings consists of Series A Preferred Stock
("Preferred Stock") and Common Stock. Until January 1, 2001, Holdings iswas
authorized to issue 10,000 shares of Common Stock, each having a par value of
$0.01, and 10,000 shares of Preferred Stock, each having a par value of $0.01.
All voting power iswas vested in the common stock.
Holdings has issued a total of 5,940 shares of Preferred Stock to Redwood Trust. The
Preferred Stock entitlesentitled Redwood Trust to receive 99% of the aggregate amount of
any such dividends or distributions made by Holdings. The holders
F-39
99
of the Common Stock arewere entitled to receive the remaining 1% of the aggregate
amount of such dividends or distributions. The Preferred Stock ranksranked senior to
the Common Stock as to the payment of dividends and liquidation rights. The
liquidation preference entitlesentitled the holders of the Preferred Stock to receive
$1,000 per share liquidation preference before any distribution iswas made on the
Common Stock. After the liquidation preference, the holders of Preferred Stock
arewere entitled to 99% of any remaining assets. At January 1, 2001, Redwood Trust
acquired the Common Stock of Holdings. For more information on this subsequent
event, see Note 11.
NOTE 9. RELATED PARTY TRANSACTIONS
PURCHASES AND SALES OF MORTGAGE LOANS
During December 1999, Holdings purchased $390 million of residential mortgage
loans and subsequently sold a participation agreement to Redwood Trust on the mortgage loans. Pursuant to the terms of the Mortgage Loan Participation
Purchase Agreement, Redwood purchased a 99% interest in the mortgage loans, and
assumes all related risks of ownership. Holdings did not recognize any gain or
loss on this transaction.
During the yearyears ended December 31, 2000, and 1999, RCF purchased $58 million
and $50 million of commercial mortgage loans from Redwood Trust.Trust, respectively.
There were no such purchases during the year ended December 31, 1998. Pursuant
to the Master Forward Commitment Agreement,Agreements, RCF purchased the mortgage loans from
Redwood Trust at the same price for which Redwood Trust acquired the mortgage
loans. At December 31, 2000 and 1999, under the terms of Master Forward
Commitment Agreements, RCF had committed to purchase $34 million and $8 million
of commercial mortgage loans from Redwood Trust for settlement during the first
quarter of 2001 and 2000, respectively.
During the year ended December 31, 2000, RCF sold commercial mortgage loans
aggregating $18 million to Redwood Trust which were not subject to terms of the
Master Forward Commitment Agreements. All such commercial mortgage loans sold by
RCF to Redwood Trust are sold at the market price at the time of the sale.
During the year ended December 31, 2000, the gains recognized by Holdings on
such sales of RCF assets were $0.2 million and are recorded on the Holdings'
Statements of Operations under "net unrealized and realized market value gains
(losses)." No such sales were made by RCF to Redwood Trust during the years
ended December 31, 1999 and 1998.
During the years ended December 31, 2000 and 1999, RRF purchased $17 million and
$61 million of residential mortgage loans from Redwood Trust, respectively.
There were no such purchases during the year ended December 31, 1998. At both December 31, 1999 and
1998, under the terms of thePursuant
to Master Forward Commitment Agreement, Redwood Trust
had committed to sell $8 million of commercial mortgage loans to RCF during the
first quarter of 2000 and 1999, respectively.
During the year ended December 31, 1999, RRF purchased $61 million of
residential mortgage loans from Redwood Trust. Pursuant to the Master Forward
Commitment Agreement,Agreements, RRF purchased the mortgage loans from
Redwood Trust at the same price for which Redwood Trust acquired the mortgage
loans. ThereAs RRF ceased operations in 1999, there were no F-34
86
such sales during the year endedremaining outstanding
commitments at December 31, 1998.2000. At December 31, 1999, under
the terms of the Master Forward Commitment Agreement, Redwood TrustRRF had committed to
sellpurchase $16 million of residential mortgage loans to RRFfrom Redwood Trust during the
first and second quarters of 2000. There were no such commitments at2000, pursuant to the terms of Master Forward
Commitment Agreements.
During December 31, 1998.1999, Holdings purchased $390 million of residential mortgage
loans and subsequently sold a participation agreement on the mortgage loans to
Redwood Trust. Pursuant to the terms of the Mortgage Loan Participation Purchase
Agreement, Redwood Trust purchased a 99% interest in the mortgage loans, and
assumed all related risks of ownership. Holdings did not recognize any gain or
loss on this transaction. During March 2000, Redwood Trust sold the
participation agreement back to Holdings for proceeds of $381 million. Holdings
simultaneously sold $384 million of residential mortgage loans to Sequoia for
proceeds of $384 million.
OTHER
Under a revolving credit facility arrangement, Redwood Trust may loan funds to
Holdings to finance certain Mortgage Assets owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.5%3.50% over LIBOR. At bothDecember 31, 2000, Holdings had no such
borrowings from Redwood Trust. At December 31, 1999, and 1998, Holdings had borrowed $6.5
million from Redwood Trust in accordance with the provisions of this
arrangement. During the years ended December 31, 2000, 1999 and 1998, Holdings
incurred $0.3 million, $1.1 million and $18,539,$18,000, respectively, in interest on
loans from Redwood Trust.
Redwood Trust shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the years ended December 31, 2000, 1999 and 1998, Redwood Trust paid $0.2
million, $3.0 million and $2.3 million, respectively, of Holdings' operating
expenses were paid by Redwood
Trust andwhich were subject to reimbursement by Holdings.
F-40
100
Holdings may borrow under several of Redwood Trust's Short-Term Debt agreements
as a co-borrower (see Note 4). At December 31, 2000 and 1999, Holdings had
borrowings of $18.2 million and $22.4 million subject to this arrangement. No such borrowings were outstanding
at December 31, 1998.these arrangements.
NOTE 10. COMMITMENTS AND CONTINGENCIES
At December 31, 1999,2000, RCF is obligated under non-cancelable operating leases
with expiration dates through 2006.2004. The total future minimum lease payments
under these non-cancelable leases is $419,821$580,185 and is expected to be recognizedpaid as
follows: 2000- $73,949; 2001 -- $345,715; 2002 -- $78,214; 2003 -- $80,499; 2004 - $85,240; 2002 - $87,472; 2003 - $89,772; 2004
through 2006 - $83,388.$75,757.
At December 31, 1999,2000, RCF had entered into commitments to purchase $8.4$34 million
of commercial mortgage loans from Redwood Trust for settlement during the first
quarter of 2000.2001.
At December 31, 1999, RRF2000, RCF had entered into commitments to purchase $16.0 million
of residential mortgage loans fromprovide for additional
loan fundings, subject to the borrowers meeting certain conditions, aggregating
$2.9 million.
NOTE 11. SUBSEQUENT EVENTS
On January 1, 2001, Redwood Trust acquired 100% of the voting common stock of
Holdings for settlement during$300,000 in cash consideration from two officers of Holdings.
Redwood Trust's Audit Committee determined the firstpurchase price based on an
independent appraisal obtained by the Audit Committee and second quartersthrough negotiations
with the two officers, taking into account projected cost savings to Redwood
Trust from being able to consolidate Holdings into Redwood Trust's future
financial statements and other potential benefits to Redwood Trust and its
stockholders.
Following Redwood Trust's acquisition of 2000.
F-35the voting common stock of Holdings,
Redwood Trust transferred its preferred stock interest in exchange for
additional voting common stock in Holdings as part of the Holdings equity
recapitalization. As a result of these transactions, Redwood Trust owns 100% of
the voting common stock of Holdings and Holdings became a wholly-owned
subsidiary of Redwood Trust. Subsequently, Holdings has elected to become a
taxable REIT subsidiary of Redwood Trust.
F-41
87101
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and StockholdersStockholder of
RWT Holdings, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of RWT
Holdings, Inc. and subsidiaries (the(the Company), at December 31, 19992000 and 1998,1999 and the results of its
operations and its cash flows for the yearyears ended December 31, 2000 and 1999 and
for the period from April 1, 1998 (commencement of
operations)(inception) to December 31, 1998, in conformity
with accounting principles generally accepted in the United States.States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits.audit. We conducted our auditsaudit of these statements in accordance with
auditing standards generally accepted in the United States of America which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provideaudit provides a
reasonable basis for the opinion expressed above.our opinion.
/s/ PricewaterhouseCoopers L.L.P.LLP
San Francisco, California
February 21, 2000
F-3615, 2001
F-42
88102
REDWOOD TRUST, INC.
INDEX TO EXHIBIT
Sequentially
Exhibit
Numbered
Number Page
- -------
------------
10.14.33.3.2 Amended and Restated Bylaws, amended March 15, 2001
9.1 Voting Agreement, dated March 10, 2000
10.9.3 Custodian Agreement (U.S. Custody), dated December 1, 2000, between
the Registrant and Bankers Trust Company
10.13.2 Employment Agreement, dated March 23, 2001, between the Registrant
and Andrew I. Sirkis
10.13.3 Employment Agreement, dated April 20, 2000, between the Registrant
and Brett D. Nicholas
10.14.4 Amended and Restated Executive and Non-Employee Directordirector Stock
Option Plan, amended March 4, 1999January 18, 2001
11.1 Computation of Earnings per Share
23 Consent21 List of Subsidiaries
23 Consent of Accountants
27 Financial Data Schedule